Towards Economic Dynamism

Speech by Chris Huhne MEP delivered to the European Liberal Democrat and Reformist Congress on Wed 16th Oct 2002

Let me start by saying that I am an optimist. The changes brought about by the introduction of the euro are continuing to sweep through the European economy. They will in due course lead to quite surprising and dramatic improvements. And it will take time.

Structural change is never easy. Many vested interests have to be tackled. And its effects never come about quickly. But let no-one be in any doubt that such structural change works. Look at my own country, widely regarded at the end of the seventies as the sick man of Europe. Change was painful, but change has worked. Although British governments made many mistakes, Britain is no longer declining relative to other EU economies and the first signs of some real catch-up are there, twenty years after the reform process began.

No British politician would argue that we should turn the clock back. The icons of our battles for structural change look like harmless eccentrics. Arthur Scargill the miners' leader recently secured less than 1 per cent of the vote in the London assembly elections.

Not only does change work, but nothing else works. The promise of socialism has too often been to offer a false security. Security guaranteed by stricter rights against dismissal or discipline. What easier promise is there to make! You pass a law to protect voters from the consequences of the market. But if you raise the costs of firing, you also raise the risks of hiring. Saving old jobs means fewer new jobs. And then the old jobs go in the next crisis anyway, and are gone forever. Far better to have companies reacting steadily to competitive pressures, improving their products and services, cutting their costs and staying in the marketplace. Providing secure jobs in the only way that is really secure. By winning in competitive markets. The liberal approach to the economy is the only way to ensure safe jobs, rising incomes and security. The only safety is in constant change.

The euro is a catalyst for change like no other. It is affecting every major market in the European economy. It is bringing competing companies head to head that were previously protected by distance and currencies. Despite the transitional problems of the conversion to the euro in some countries, overall since 1999 it has delivered more competition, lower prices and less inflation. One recent survey found that prices here in Britain are 12 per cent higher than prices for the same basket of goods and services in the euro-area, so the euro is clearly working to benefit consumers in the euro-area.

By squeezing prices, it is also squeezing profits. And businesses are having to become more efficient. Investing, merging, producing on a continent-wide scale. They can borrow from euro capital markets more cheaply and on a larger scale than ever before. But it is noticeable that the smaller euro-area countries have embraced change far more readily than the big ones. Spain, Ireland, Finland and the Netherlands are star performers when it comes to reductions in unemployment and labour market flexibility. But Germany, Italy and France seem as mired in their old ways as ever.

There is nothing in euro-area arrangements to stop countries having low unemployment: the Netherlands has an unemployment rate half the British level, and a third of the French level. Yet the Dutch have not abandoned the commitment to a social safety net, to excellence in education and training, or to the Rhineland model of capitalism. It is surely time the euro-area's big member states used the Lisbon process to learn a little from the smaller member states. No not learn a little, learn a lot.

Of course, not all problems are problems on the supply side. This year, demand in the euro-area has grown too slowly and there have been unfavourable comparisons drawn with the US and the UK. But it is worth recalling why this has happened. Both Britain and the United States have introduced major budget boosts to their economies last year and this year. But those budget boosts were nothing to do with stabilising their economies: Britain wanted to deal with the legacy of neglect of public services that will be only too obvious to those of you who struggled here on the railways. President Bush was committed to a tax cut that had nothing to do with the business cycle. So both budget boosts were undertaken for other reasons, but luckily happened to hit at the right moment and support activity.

They were a felicitous accident, and must not be elevated into a belief that fiscal policy can or should be used actively to stabilise the economy. History tells us that budget changes end up merely pushing the economy in the direction it was going in anyway. Anti-recession measures arrive when they are no longer needed. They arrive in time for the upturn, and then help turn it into a boom.

The best fiscal policy is in fact to run a budget balance through the cycle that is sustainable, and to let the budget reflect the changes in the economy. When the economy booms and tax revenues rush in, run a surplus. When the economy goes into recession and tax revenues dry up, run a deficit. Don't attempt to offset these movements, or you will make the business cycle more extreme.

This is essentially what the Stability and Growth Pact is meant to ensure: aim in the medium term - through the business cycle - at close to balance or in surplus. Then you will be able to let the budget deficit expand in recessions to offset demand weakening. This is a perfect Keynesian policy. The only problems arise - as they have now done in Germany, France, Italy and Portugal - when countries fail to respect the rules in the good years, and thereby reduce their room for manoevre when the recession comes.

Germany would not today be looking at a 2.9 per cent of GDP deficit, but at a 1.8 per cent of GDP deficit if it had not cut taxes in 1999 and 2000. Those tax cuts, camouflaged by the buoyant revenues of years of upturn, are causing today's problems. That is why we propose an additional target to reinforce the pact of a structural balance, to highlight problems early. And we ask the Commission to ring the alarm bells whether the ministers say so or not.

What of those who now want to relax the 3 per cent? In my view, it would not be appropriate to increase the 3 per cent limit. There must be some limit on deficits in a common currency area, because deficits spill over into interest rates that affect everyone. And there cannot be one rule for big countries and another for small ones. Nor Mr Chirac can there be one rule for French-speaking countries and another rule for everyone else. Certainly, the treaty states clearly that excessive deficits should take account of low public debt and public investment. But a tough limit there has to be if the joint venture is to be underpinned. The most important objective, though, is to make sure that the SGP emerges stronger, better, more credible.

There is also a quid pro quo for tough and responsible fiscal policy, which is that the monetary arm has to be responsive to emerging problems. The European Central Bank has come in for a lot of criticism for being too slow, and much of it is unjustified. The ECB has not been obsessed with its monetary indicators, as it has repeatedly ignored overshooting. It has not blindly aimed at its inflation target, since it began cutting interest rates when inflation was still rising last year and was over its 2 per cent ceiling. It has also made clear that it is aiming at a 1 to 2 per cent inflation rate, which is insignificantly different once the inflation measure is taken into account to the UK 2.5 per cent target. So it is just as concerned about deflation as inflation. Overall, its interest rate cuts have brought euro-area interest rates to historically low levels in real terms: they currently range between 1.1 and 1.5 per cent against an average 4.8 per cent in the nineties and 4.3 per cent in the eighties.

Where the ECB can be faulted is that it could have reacted a little more quickly in the last six months, and it now faces a considerable challenge over the next year. But there need be no fundamental change in its modus operandi to take this on board: the treaty in fact requires the governing council to act by a simple majority. Unfortunately, the ECB until now always operates by consensus, and as we all know, decisions taken by consensus take longer than those taken by majority vote. The ECB should take votes, and it should also be better at explaining the balance and results of those votes. It should publish the votes of individual members.

Let me finish by making one final point about economic dynamism in Europe, and it is related to enlargement. There is a seductive view that enlargement does not really matter for the ten early candidate countries, because they have all the benefits of industrial free trade already. So if one member state - the Netherlands perhaps or France - blocks the accession of a large country like Poland, the world would continue without any serious consequences. This is dangerous and arrant nonsense. The applicant countries have been travelling hopefully for thirteen years towards EU membership, and to be told that they cannot join would be a crushing and demoralising blow with incalculable consequences both for public opinion and for the efforts of the political elite.

The economic effects would also be grave. Many investors invest in central and eastern europe because of access to the single market, and that would not be affected. But they also invest because they believe that these low income countries are fundamentally different to the low income countries of Latin America or Asia: they are committed to the Copenhagen criteria and hence to the rule of law. That commitment to due process and property rights is the first condition that any foreign investor insists upon, and it is precisely that framework afforded by the EU that would be removed if we were to dash their hopes of full membership.

Just remember what happened in Slovakia when the government of Vladimir Meciar undermined the civil rights of the Hungarian-speaking minority. It was EU pressure - and most importantly the threat that membership would not proceed - that protected that minority. It was EU pressure that put Slovakia back on the right track. Without that pressure, Slovakia could easily have tumbled into the ethnic strife that was such a disastrous feature of Bosnia and Kosovo. And let me remind any French or Dutch people thinking that a veto on enlargement is a soft option. When the shooting started in the Balkans, it took French and Dutch troops to help stop it. There are no soft options when it comes to democracy and stability.

Without EU membership and all the political guarantees that it brings - with only free industrial trade - these countries will be substantially less attractive to investors. They will lose foreign direct investment, and the cost of borrowing on the financial markets will increase sharply. Any EU country that blocks enlargement now will make a generation of enemies in central and eastern europe, and will bear a heavy responsibility for whatever damage the fragile democracies of those countries then sustain.

Most importantly of all, economics is not a zero sum game whereby one person wins what another person loses. The increased prosperity that enlargement can bring to central and eastern europe will also create markets for us: after all, almost all the candidate countries now have balance of payments deficits with us so that they are buying more from us than we are buying from them. Enlargement, like the Euro, is another essential catalyst for economic change in our countries as well as in the east. If we block it now, we will be hurting our own prospects for prosperity every bit as much as those of the candidate countries. We must not lose our nerve. We must keep on track. Both for their sakes and ours.