Business | SYMPOSIUM ON EUROZONE

Experts examine eurozone economy

by Minoru Matsutani

Staff Writer

The European economy is in a complicated situation as deflationary risks loom and the effects of quantitative easing are questioned. Other factors add to the risk as Russia, a resurgent power that wields strong influence on the eurozone, is suffering from economic sanctions over its actions in Ukraine.

Economic and political experts from Europe discussed the eurozone economy and geopolitics in a symposium “Europe’s Economic Revitalization and Geopolitical Risk,” organized by the Keizai Koho Center in Tokyo on Nov. 14.

Russian way

The first speaker, Thomas Gomart, a senior research fellow at the French Institute of International Relations, delivered a presentation on Russia’s diplomacy. Gomart was unable to attend in person, but his video message was shown.

Gomart quoted Russian President Vladimir Putin as saying at an APEC meeting in November, “Cooperation between China and Russia is extremely important.”

Gomart said the remark represents the focus of Russia’s diplomacy.

“Russia presents itself as a Euro-Pacific Power,” he said, adding that Russia wants to take advantage of its geographical location to gain economic benefits from Asia while retaining influence on Europe.

The “Look East” policy came as Russia’s relationship with the U.S. and Europe has deteriorated dramatically after the economic sanctions many countries imposed on Russia for its military aggression in Ukraine caused the Russian ruble to plummet.

“The real challenge (for Russia’s diplomacy) is to manage a balance between East and West,” he said.

He also pointed out that Russia turned to the East in seeking buyers for its natural gas in Asia, namely China.

Russia and China share some similarities as both have experienced communism and both have increased military spending significantly in recent years.

They, however, also have some differences. China wants to attain primacy in East Asia and usurp U.S. influence in the region, while Russia wants to invest in its nuclear capability in the region, while maintaining a decent relationship with the U.S. to maintain its presence in the region, he said.

Even though Japan has a security agreement with the U.S., Japan needs to maintain a steady relationship with Russia to keep a good balance, he said.

The relationship between Japan and Russia is very important in terms of the energy sector, he added.

Europe similar to Japan?

The second presenter was Cinzia Alcidi, head of the Economic Policy Unit at the Centre for European Policy Studies, who made a presentation, titled “Who is afraid of Japanese decade(s)?”

In her presentation, she explained why Japan’s experience matters in finding out what Europe can do to deal with its economic situation. Basically, Japan has already experienced what is likely to happen in the region, she said.

She pointed out a rising debate in Europe about the risk of Japanization as the European economic situation is becoming similar to Japan’s lost decades — an economic downturn that began with the bursting of the bubble economy in the early 1990s.

Both Japan and Europe experienced burst housing bubbles, but the effects have lingered longer in Japan than in Europe, she said.

Japan and Europe both suffer bad balance sheets in banks and other companies. Europe needs to clean its banks’ balance sheets as Japan did, she said.

“I know it’s easier said than done, but when balance sheets are bad, you have to clean them up,” she said.

She also mentioned the increase in debt as a percentage of GDP is another similarity between Japan and the region, using a graph to show the trend from 1995 to 2014. The curve, though, is steeper for Japan than Europe.

Aging populations are another thing in common as the ratio of working-age people to pensioners is expected to decrease in the eurozone at a pace similar to the one Japan has experienced, her data showed.

Meanwhile, there are some differences as well, with a chart of nominal GDP of Japan and the eurozone showing Japan’s GDP has been flat or has decreased a little since 1995, while the eurozone’s has constantly risen over the same period. In real GDP, the charts show similar upward curves, but Japan’s is a little steeper since late 2000.

Productivity trends also reveal differences as Japan’s total factor productivity went down and hovered lower from 1990 to the late 1990s, exactly the period when Japan suffered the burst of the bubble economy. Since around 2000, Japan’s total factor productivity went up more steeply than that of the eurozone, which had been constantly rising since 1990. In the chart in which total factor productivity was 100 for Japan, eurozone and the U.S. in the base year 1990, that of Japan and the European region crossed around 2013, the first time Japan’s productivity exceeded the that of the eurozone.

She also pointed out the employment rate did not drop during Japan’s recession, while that of the eurozone kept falling from around 2008, the beginning of the global recession.

“The puzzle about Japan’s experience is that the Japanese standard of living has not severely deteriorated during the lost decades,” she said.

The eurozone can take lessons from Japan’s experiences in implementing measures such as fiscal policy, structural reforms and monetary policy.

However, on fiscal policy, countries that need an increase in fiscal spending to stimulate their economies do not have the money to do so, while countries that can do not want to use it, she said.

On structural reforms, the eurozone has had many talks on the issue, but “not much has been done,” she said.

On monetary policy, she discussed whether the European Central Bank should implement quantitative easing. Quantitative easing has some unwanted side effects such as currency depreciation and she said she is not convinced quantitative easing is the best way to tackle current economic difficulties.

In conclusion, the lessons for the eurozone are that policies must be bold, whatever they are. Otherwise, there will be no effect, she said. Also, monetary policy is not the solution to all problems and should be implemented alongside other measures.

She concluded by saying that “Japan’s lost decade was not completely lost,” and “a Japanization scenario for the eurozone may be worse than it was in Japan.”

Financial integration in Europe

Silvia Merler, an affiliate fellow at the Brussel-based think tank Bruegel, was the third speaker, delivering a presentation titled, “Financial integration and disintegration in the eurozone; How it happened and how to remedy it.”

Since the birth of the euro in 1999, there have been three phases of the European currency union experiment; financial integration, financial disintegration and responses, Merler said.

First, monetary unification induced strong financial integration within the eurozone and capital started to flow freely across borders as banking activity increased.

But the euro debt crisis of 2010 resulted in a major reversal of the financial integration achieved over the previous decade. During the financial disintegration phase, eurozone members were divided into the troubled and less troubled, as banks shifted focus to domestic markets from foreign markets within Europe.

During the responses phase, the European Central Bank created universal rules to restore banking health and formed a so-called banking union.

She pointed out that capital flows within the eurozone had expanded after the currency unification and shrunk after the crisis.

Loans and banks’ debt holdings across borders within the eurozone had been increasing rapidly until the crisis. Since 2010, eurozone banks have been massively retrenching within domestic borders, and there has been a re-domestication of banks assets, she said. Cross-border loans and debt holdings have dropped dramatically.

As a result, European banks have increased the holdings of their domestic government debts, she said, showing graphs representing government bond holdings of domestic and foreign institutions in Greece, Ireland, Italy and Spain. Holdings by foreign institutions peaked between 2006 and 2009 in the four countries.

But the charts for German and French government bonds show very different trends — foreign holdings have been increasing while domestic bank holdings have been decreasing.

Under such conditions, the southern European countries are vulnerable to deterioration of banking health and sovereign debt.

“There is a seemingly unbreakable vicious circle and a decade of financial integration is almost lost,” Merler said.

Hence, the idea of a banking union is in place and is an ongoing process. In response to the crisis of the late 2000s, the European Commission has proposed to form a banking union by introducing 28 new rules to better regulate, supervise and govern the financial sector so that in the future, taxpayers will not be on the hook when banks make mistakes.

The banking union operates under the so-called single supervisory mechanism, which will cover 6,000 eurozone banks. The European Central Bank can call in the direct supervision of any bank at any time and is exclusively responsible for authorizing and withdrawing the authorization of all credit institutions in the euro area.

In conclusion, Merler said bank creditors need to be more involved in the sharing of the burden than they were during most of the last five years to credibly break the link between banks and sovereigns. The ECB also should not shy away from resolving nonviable banks and governments should support the effort to restructure and bring the banking system back to health. “The main message is that we need overall consistency to make everything work,” she added.

Q&A

Following the presentations, public broadcaster NHK senior commentator Yoshimichi Momose moderated a Q&A session.

Momose asked why Alcidi is skeptical of the effect of quantitative easing.

Alcidi responded by saying that it was “not clear if it works.”

In the eurozone, quantitative easing is more complicated because the eurozone is a group of many countries and thus complicated political constraints exist, she said.

Whether quantitative easing will take place or not will depend on how well the German economy goes, she said.

“However, if the situation gets worse,” the ECB has to act on it, she said, adding that there will also be risks when quantitative easing ends.

Merler said quantitative easing is inevitable because “frankly, there is no other option.”

She also mentioned the north-south division in the eurozone existed before the crisis but nobody was aware of it until then. The division is a big issue and must be addressed accordingly, she said.

On the issue of Ukraine and Russia, Alcidi said the Ukrainian economy is close to collapsing and the country must be saved. She also said energy security is a key issue between Russia and Europe and economic sanctions imposed on Russia are backfiring on the eurozone, which depends on Russia’s natural gas.

Merler agreed that the Ukrainian economy is near collapse.

The two panelists welcomed the decision by President of the European Commission Jean-Claude Juncker to spend €300 billion on infrastructure investments next three years.

“It’s a very important shift,” Merler said of the shift of the sentiment of financial authorities from reducing spending to maintain financial health to increasing spending to stimulate the economy.

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