Renewing economic growth


Delivered by: 

Sir Suma Chakrabarti, EBRD President

Venue: 

Vienna, Austria

Event: 

Euromoney Conference

'Integrationists win their battle,' says EBRD President

Good morning. It’s a great pleasure to be here with you today.

The pursuit of renewed economic growth has become the obsession of the modern age. Many governments and forecasters spend hours looking for signs of the green shoots of recovery, only to be disappointed time and again. They are learning, the hard way, that those who live by the crystal ball soon learn to eat broken glass.

At the heart of the debate on how to reignite growth and cure the current troubles in Europe is the `I` word, INTEGRATION. Is the answer more integration in Europe or more national autonomy which would give policymakers greater leeway to take their own decisions? After all, say the sceptics, wasn’t it integration that got us in to the current mess in the first place? The single currency project, the high water mark of EU integration, so far, has turned in to a transmission mechanism – spreading the impact of a debt crisis in one country far and wide across the continent. The highly integrated global financial system made sure that what started in 2007, as a problem with American mortgages, swiftly turned in to an international credit crunch. In the face of all that, it would be easy to turn one’s back on integration and retreat inwards, precisely the response which brought depression between the two world wars.

History of integration

The truth is that integration isn’t the problem – the problem is not that integration happened but rather that it has not gone far enough. In addition, the QUALITY of integration matters. This is particularly the case in the financial sector, where there needs to be a balance between institutional integration – meaning both the spread of good practices and standards - and common institutions – to balance growing cross-border assets and liabilities.

From 1945 onwards, integration gathered speed and delivered economic gains. In Europe, it was a significant motor of growth from the founding of what is now known as the European Union, more than five decades ago, until very recently. Just think of the gains made after the European Single Market came in to being in 1992 – a single market for goods and services which still isn’t complete and could still yield further benefits. After the Berlin Wall came down, in 1989, the very event which led to the setting up of my organisation, the European Bank for Reconstruction and Development, integration in Europe intensified. The first step was the EU single market and then the single currency.

Even outside the EU, in former communist Europe and what we now refer to as emerging Europe, integration was the watchword. There was a rapid transition to a free market, characterised by increasing trade and capital flows. The result was a closing of the gap with the west which the EBRD has been proud to promote. It was not only the free flow of goods, but also of institutions that enabled convergence. Between 1992 and 2007, most countries in emerging Europe joined the Central European Free Trade Agreement. Ten later joined the EU, with Croatia set to join this year. Undoubtedly, these countries strengthened their institutional frameworks to foster their economic linkages with the rest of Europe, with the EU serving as a strong anchor. Integration was the driver of change.

Why was the conventonal wisdom challenged?

So, where did it all start to run out of steam? Why did policy makers in emerging Europe and elsewhere begin questioning the conventional wisdom? Perhaps, we need to cast our minds back fifteen or so years, long before the current global crisis. In 1997, the start of the Asian crisis sparked fears of a global financial meltdown and trouble for emerging markets, including in our region, far away from what were then called the Tiger economies. Many of those Asian economies were over-leveraged and when the bubble burst, they suffered a credit crunch. They had benefited from international investment, strong global financial markets, and then felt the pain as the funds dried up. Global financial integration brought first increasing wealth and then economic contagion as the impact couldn’t be contained within national borders. It sounds familiar doesn’t it? A dry run, in some ways, for what has unfolded over the past five years.

So, when the 2007 credit crunch hit and all the consequences unfolded, it was easy for some to draw the conclusion that integration could be a curse as well as a blessing. Europe has suffered as much as anywhere. The Euro was meant to help build on the success of the single market, another step down the road of integration. However, its architects could only go so far. They agreed on the need for a common monetary policy to run it but not on a common fiscal policy. Even more importantly, they did not agree on a strong institutional framework to deal with the growth of finance, within countries, but particularly across borders. Too little institutional integration, not too much. The result has been some countries racking up huge debts and dragging down the whole Eurozone economy.

Emerging Europe has felt the pain, even though many countries are not members of the Euro. It has imported the financial instability. It has been buffeted by rapid deleveraging. Western European banks, which are active in emerging Europe, have cut back their lending, some have closed down operations. The credit crunch isn’t just a phrase for emerging Europe, it is a destroyer of economic growth.

In these circumstances, it’s hardly surprising that some governments prefer to pursue national solutions to their troubles. These can seem comforting: politicians can believe that they have more control than if they’re part of an integrated world. It is illusory, though.

The fightback

It is time to restate the case for integration. Integrationists need to fight back. Let’s remind ourselves of why it matters. International trade not only benefits consumers; it also encourages firms’ innovation and helps them enlarge. Foreign direct investment in our region is increasingly integrating local firms to global supply chains. Greater market access lowers the costs of innovation and exporting. Crucially, however, trade integration highlights the importance of local economic institutions. Technology adoption is unlikely in environments with weak property rights and unstable business environments.

A similar story applies to finance. This is perhaps one area where the newest practices at the frontier reach the fastest to our region. Prior to 2008, policy makers often viewed cross-border and multinational banking as a natural element of economic integration and a driver of growth. Indeed, existing evidence shows that foreign banks increased access to finance and the efficiency of local financial systems in our region. It is therefore universally accepted that financial development and economic development go hand-in-hand. Given this background, policymakers had little doubt, if any, about the benefits of integration. Just as in the Asian crisis of 1997, this belief has been challenged but it remains true. Emerging Europe needs cross-border finance. While the EBRD strongly promotes the development of local deposit bases, many countries in our region will need access to foreign savings for some time.

It is now time for integrationists to drive their arguments home. Some decisive actions taken by policy makers in the last six months, combined with the talent and good will of people in this room, make me more optimistic in this respect.

Next steps

The whole continent is unmistakably dependent on securing a common financial framework and a stronger political union. In emerging Europe, integration also takes the form of lowering barriers to trade.

Progress is already being made on a “banking union”. The proposals include a single supervisor for the Eurozone. We argue that the interests of emerging Europe need to be taken in to account, too. Narrowing the gap between institutional integration and financial integration is crucial. We at the EBRD believe that a single supervisor for all EU banks could be very positive for all.

Indeed, it is a prerequisite for a resolution of the sovereign debt crisis. The creation of a fiscal backstop at the European level in the form of the European Stability Mechanism is also an integral part of the design. However, the proposals are not without their drawbacks. For instance, current plans would, for the foreseeable future, leave the responsibility for resolving failing banks in national hands. Yet at the same time they would render the ultimate fiscal responsibility Eurozone-wide. This creates a potential moral hazard.

To address this, it is important to accelerate the creation of a single resolution mechanism. In this regard, we feel encouraged by the conclusions of the European council meeting in mid-December, which calls for just that. Moral hazard can also be avoided by requiring those countries who receive ESM fiscal support to share banking-related losses up to a pre-determined level. In addition, coordination gaps can be reduced by cross-border “stability groups.” These groups could include home and host country authorities, the ECB, and the European Banking Authority. In summary, there is a thorny road ahead of Europe for closing the gap between institutional and financial integration. But possible solutions are very much there. Positive steps in this direction will surely support the long-term growth prospects of the whole continent.

The second dimension of integration concerns fostering trade within the region. The latest development in this respect is the creation, within the Eurasian Economic Community, of a Customs Union and Common Economic Space by Belarus, Kazakhstan, and Russia, and of new supranational institutions, including a Eurasian Economic Commission. The latter involves developing new institutions modelled explicitly or implicitly on those of the EU. The benefits of such regional integration are many. The most important one might be the reduction of non-tariff trade barriers through the elimination of border controls and improved cross-border infrastructure. Trade creation within the region increases consumer choice and a larger market size reduces the costs of innovation for producers. Regional integration helps build cross-border value chains and larger and more efficient markets across member countries. It also presents an opportunity to build stronger economic institutions.

The EBRD’s role in integration

What role can the European Bank for reconstruction and development play as policy is developed – how can we underpin integration and the process of recovery in emerging Europe?

First of all, the EBRD continues to invest heavily in the region, matching its money with policy dialogue aimed at economic restructuring, diversification, and enhancing corporate governance. Our response to the crisis has been very closely coordinated with other IFIs, as in earlier episodes. In November, we announced a new Joint Action Plan with the European Investment Bank Group and the World Bank Group as part of the “Vienna Initiative.” The plan will see more than €30 billion channelled to the region in the next two years, at a time when the pains of Eurozone bank deleveraging may be felt at ever greater scale. We expect to invest an additional €4 billion in the region as part of the plan to facilitate regional integration and export-led growth. In addition, we continue to target our lending to SMEs and refinance corporate clients with key roles in their markets. In 2012, we signed more than one project every day in our countries of operations , for a total business volume of almost €9 billion. With the new Joint Action Plan, we will be building on this.

Secondly, the EBRD believes in a further intensification of reforms in the transition region against the backdrop of slow export growth and a credit squeeze. We will continue to push for reforms via our investments, policy advice and technical cooperation. We stand ready to assist transition countries in boosting their exports base and capacity, in developing a knowledge-based economy driven by innovation and skills acquisition, and in building a high quality institutional environment that is attractive to businesses. We will be supporting growth not only through project financing, but also through expert advice and guidance. For example, within the EBRD, we house the Legal Transition Programme which consists of a

group of specialist lawyers dedicated to creating an investor-friendly, transparent and predictable legal environment. The programme conducts assessments of commercial laws in transition countries, prepares legal standards for policy-makers, and engages in technical cooperation with local governments in legal and institutional reforms.

Thirdly, the EBRD will continue cooperating with other IFIs and the private sector to enhance its local currency and local capital markets initiative, which was launched in May 2010. In order to maintain economic recovery in the region, investment growth in the real economy will need to rely on continued growth of the financial sector. This crucially depends on a sound banking system at its core and supportive local capital markets, which should strengthen domestic saving. Hence, we will continue to play an active role in the “Vienna Initiative” and discussions over the banking union as well as contributing to local financial deepening.

Conclusion

No one should doubt our commitment to integration. The EBRD has been part of the change in emerging Europe – building up substantial economic knowledge on the way. We know the importance of our region, the hard-won achievements during the transition to the market economy and, we know the huge potential. You, gathered in this room, also have a role to play. Capitalise on that potential; invest in a region which will one day return to high growth. Join us in the policy challenge that can make change a reality.

At the start of this speech, I talked about how often forecasts through the crystal ball have turned to broken glass. Well, if you’re going to forecast at all, it’s best to forecast often. Eventually, by luck alone, you have to be right. So, I’ll end with my own forecast, emerging Europe’s best days are still in front of it – however unlikely that may look now – but only if the integrationists win their battle. It’s our job to help them.

Thank you.