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GROWTH OPPORTUNITIES
IN EUROPE
Rappor t udarbejdet af
Copenhagen Economics for Axcelfuture
Priorities for Growth in the EU:
The Main Danish Export Market
Helge Sigurd Næss-Schmidt, May 2015
An economic shock hit the World in 2008 including the countries in the European Union (EU) with EU GDP dropping by over 4 per cent from 2008 to 2009. The impact of
the crisis has been markedly different across EU countries and so has the speed of recovery. Current forecast suggest that EU as a whole may only be back on track by 2018,
i.e. GDP hitting the same structural level given unchanged policies in labour and product markets.
This matters for the Danish Economy. Faster growing markets outside the EU is becoming increasingly important for Danish firms, but the EU market is still projected to
account for around 60 per cent of exports by the end of this decade. So policy measures
aiming to speed up the EU recovery and improve its long term potential matters for the
Danish economy and its firms.
At the national level labour market reforms will be a key to success. Some countries
such as Spain and Italy with notoriously structural problems in their labour markets,
notably high costs associated with adjusting the labour force to actual production has
taken the crisis as an opportunity to reform. Other countries such as France have been
slower to react. As a whole, progress has been patchy with respect to labour market
reforms. By contrast, more reforms have been undertaken across the board to make
business related regulation more growth friendly, including easing conditions for startups.
At the EU level, the focus has been on containing the crisis, especially given the high
risk of contagion related to weak balance sheets for governments and financial institutions, notably in Southern Europe. Banks have been forced to improve their capital
base while governments are being insistently asked to reduce public deficits, preferably
with reforms that boost growth and bring fiscal consolidation at the same time. It
would be fair to say that reform efforts in the banking sector – not the least recapitalisation of banks and focus on bail-in of investors – took a long time to get done. That is
especially when comparing to the US. EU growth has suffered from this belated approach.
Passing a corner in the recovery process, the incoming Juncker Commission has
launched a number of initiatives to refocus on growth potential: (1) a € 315 billion EU
investment plan to mobilise new private sources of finance for infrastructure investments (2) A Capital Market Union to reduce the high reliance on bank financing for EU
firms and tap much more into risk capital products such as bond and equity financing
and (3) some more general relaunch of the Internal Market. There are many good ideas
in these proposals, but as always the devil is in the detail.
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The Main Danish Export Market
1 The EU’s Twin Economic Deficits: Matters for Denmark
The shock that hit the EU economy has been followed by now 7 years of meagre growth
and left the region as a whole with two deficits that have begun to unwind only recently.
First, following bubbles in a number of countries – particularly related to real estate
and consumer spending – a slack development was seen from 2009 and onwards with
substantial underuse of productive capacity (capital and labour). Projections from late
2014 still suggest that the so-called negative output gap, i.e. production below potential, will remain in the order of 1 per cent of GDP by the end of 2016, cf. Figure 1. Furthermore, as discussed below, such projections mask considerable variation across the
EU countries.
Second, the collapse in economic activity has been followed by a marked overall deterioration of public finances. Public debt as a share of GDP in EU has risen as a result of
high net public borrowing, which jumped to over 6 per cent of GDP in 2009 and is projected to stay high in the future, cf. Figure 1 (negative net lending).
Figure 1. Output gaps and government net lending (EU-28)
%
4
2
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
-2
-4
-6
-8
Output gap
Note:
Government net lending to GDP
Output gap of the EU-28 in 2010 market prices. Government net lending to GDP for the EU-28.
Before 2010 net lending is not consistently available for Poland, Lithuania, Greece and Estonia.
These countries are only included in the years where data is available.
Source: European Commission’s AMECO database.
The drop in economic activity has been followed by a massive shedding of labour and
cut-back in investments. Unemployment in 2015 remains around 11 per cent while
investment’s share of total production (GDP) has fallen well below historical norms,
especially in the southern Euro-area countries, cf. Figure 2.
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The Main Danish Export Market
Figure 2. Investments to GDP
National investments to GDP
26%
24%
22%
20%
18%
16%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Euro-area (12)
Note:
Southern Euro-area
Core Euro-area
North America
National investments are defined as gross fixed capital formation at current prices: total economy.
The core Euro-area countries are defined as Germany, France, Austria and Benelux. The Southern
Euro-area countries are defined as Spain, Greece, Italy and Portugal.
Source: European Commission’s AMECO database.
Both the impact of the crisis and the ability of EU countries to re-ignite growth have
been very unevenly distributed across the region. Figure 3 below maps EU countries in
both dimensions (impact of the crisis measured as the increase in the output gap from
2008 to 2009 and pace of recovery measured as the reduction of the output gap from
2009-2016). Somewhat surprisingly, countries that are now facing the most pressing
problems with public finances and weak growth such as France, Italy, Portugal, and
Spain only saw a weak or intermediate slowdown in the their economies from 2008 to
2009 but further reductions in output gap later on. Conversely, countries that were
largely affected in the beginning of the crisis such as Sweden, Ireland and Germany
with output gaps shrinking more than 6 per cent initially have since rebounded. Greece
and Estonia are in their own categories as opposite extremes: Greece with a relative
modest impact at the start of the crisis and a near collapse later, Estonia with by far the
largest impact at the start of the crisis but also the strongest rebound later.
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The Main Danish Export Market
Figure 3. Impact of crisis and strengths of recovery, 20082016
Note:
Initial impact of the crisis is measured as the percentage change in the output gap 2008-2008, and
the strength of recovery is measured as the percentage change in output gap 2009-2019. All are
measured in 2010 market prices. Countries with a black dot use the Euro, countries with a red dot
use a floating currency, and countries with a blue dot use a currency with a fixed (or partly fixed)
exchange rate vis-à-vis the Euro. The grey break even line signifies a return to 2008 output gab
levels. Countries to the north-east of this line (none) perform better relative to their potential than
in 2008. Greece, Slovenia, and Estonia are very far behind.
Source: OECD Economic Outlook no. 96, November 2014.
Five countries – Poland, UK, Sweden and Germany (and the US) – are expected to be
nearly back on track in 2016 in terms of having the same output gap as before the crisis. This is indicated by how close they are to the sloping line in Figure 3, which indicate the combinations of initial changes in output gap from 2007 to 2008 that is exactly compensated by subsequent recovery from 2009 to 2016.
It is worth noting that four of the five countries have floating exchange rates (all countries with red dots in Figure 3 have floating exchanges rates). This may be as much
driven by a higher underlying degree of flexibility in these countries and other specific
factors as their choice of currency regime.
A comparison between Sweden and Denmark provides some insights on this issue. The
floating rate regime of Swede allowed a much quicker recovery of international competiveness than Denmark over the period 2008-2010. This is seen in Figure 4, which
compare the Danish and Swedish real effective exchange rate (REER) from 2007 and
onwards. As seen the REER of Sweden acts as a buffer and depreciate in 2009-2010,
where after it slowly adjust upwards and basically follows the same trend as Denmark
from 2011. The figure also shows how this adjustment process clearly works through
nominal exchange rate (EURSEK).
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The Main Danish Export Market
Figure 4. Real effective exchange rates and the EUR/SEK
REER (2010=100)
EUR/SEK
110
12
105
11
100
95
10
90
9
85
80
2007
8
2008
2009
2010
REER Denmark
Note:
2011
2012
REER Sweden
2013
2014
2015
EURSEK (sec. axis)
The real effective exchanges rate indexes are BIS effective exchange rate (CPI-based), Broad
Indices.
Source: BIS and http://www.investing.com/.
However, very different developments of housing prices may also have played a role in
Sweden getting quicker out of the crisis than Denmark. Housing price busts were some
of the typical amplifiers of the crisis with ‘hard hit countries’ very much characterised
by a boom-bust structure before and after the crisis. The point here is that Sweden
never saw the same boom nor the same bust as Denmark but rather a steady rise over
the last 10 years which have not yet stopped as illustrated in Figure 5. This does not
reflect larger differences in official policy rates but other structural differences in Swedish and Danish housing markets.
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The Main Danish Export Market
Figure 5. Nominal housing prices; Denmark and Sweden
Housing price index
150,0
140,0
130,0
120,0
110,0
100,0
90,0
80,0
70,0
60,0
01.03.2005
01.11.2006
01.07.2008
Denmark
Note:
01.03.2010
01.11.2011
01.07.2013
Sweden
For Sweden the figure shows prices on All properties and for Denmark the figure shows data on All
types of dwellings.
Source: BIS.
The weak state of the EU economy also affects Danish growth. While the share of exports to EU countries has been declining over time, it is projected to remain around
60% until the end of this decade, cf. Figure 6. As a result, slow growth in the EU matters considerably for the ability of Danish firms to sell products and services abroad.
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The Main Danish Export Market
Figure 6. Share of Danish exports to main regions, billion
DKK
Danish Exports by Destination
100%
171
231
164
174
80%
60%
308
396
Rest of the
World
USA
193
226
Rest of the
EU
40%
20%
Neighbouring
countries
0%
2005
Note:
2010
2015
2019
“Neighbouring countries” consists of Germany, Norway, the Netherlands, Sweden, and the UK.
“Rest of the EU” consists of all countries in EU-28 except Germany, the Netherlands, Sweden, and
the UK. Exports consist of goods (airplanes and ships excluded) and services. The data for 2015
and 2019 are based on IMF-projected growth rates of GDP and assume no significant changes in
current accounts, import propensities, or market shares.
Source: Trade data from Statistics Denmark series UHV2 and UHT4S2, GDP data from IMF World Economic
Outlook Database (US dollars, current prices), own calculations.
2 “Never Let a Good Crisis Go to Waste”
President Obama’s first chief of Staff, Emanuel Rahm, has reputedly in the context of
the US economy expressed the view that one should “never let a good crisis go to
waste”. The statement could certainly also be used this side of the Atlantic in the sense
that an economic crisis can provide impetus to change the course of economic policies.
The aim should not only be to create new jobs for those who lost them but also to boost
productivity by increasing the share of the population with gainful employment. That
will allow for a stronger and sustainable increase in real wages.
The potential from such reforms is substantial. The OECD has reviewed the extent to
which the performance of the Euro-area countries could be improved by closing the
gap to regulatory best practices. The results are encouraging. The GDP growth rates
could double towards 2020 if the laggards not only closed their output gaps and found
jobs for those who lost them, but if they were also capable of putting in place economic
policies that were “best in class”, cf. Figure 7. The rise in potential output due to GDP
productivity gains and labour market reforms in 2020 are as large as removing the
2015 slack in the economy.
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The Main Danish Export Market
Figure 7. Growth potential for Euro area countries overall
Index 100=baseline value
for potential output in 2008
120
115
110
105
100
95
90
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Baseline
Note:
Labour market reform
Productivity reform
Actual GDP
Euro-15 area, not EU (data not available for the entire EU). Labour market reform is closing half
the gap to best EU-practice in terms of skills in the labour market and labour market participation
rates, including second-order effects. Productivity reform is an assumed additional 2% higher total-factor productivity in 2020. Index 100=baseline value for potential output in 2008.
Source: OECD Economic Outlook Database (No. 95, May 2014, Long-term baseline projections), output gab
series and real GDP series, Varga and Jan in ‘t Veld (DG ECFIN).
The growth potential is unevenly distributed across countries and with very different
underlying drivers. In Figure 8 we have listed the most important EU countries according to their importance in terms of Danish exports, and the tendency is clear. The
growth reform potentials are lowest for the more important Danish export markets,
namely Germany, UK and Sweden. Furthermore, these three economies are almost
working at normal capacity, having rebounded a lot since the crisis as described above.
Nonetheless, baseline market potential in both Sweden and UK will be supported by,
e.g., positive developments in demographics and above average growth in the working
age population as reflected in OECD growth projections. By contrast, the reform potential is much higher in some Euro-area countries like Greece, Ireland and Italy. That is
even on top of a high expected growth resulting from closing the large current output
gap in these countries. Also countries like the Benelux, France and Austria will have a
relatively high growth reform potential, but they are less important for Danish exports.
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The Main Danish Export Market
Figure 8. Growth potential for important Danish export markets
Potential for Danish export
Growth expectations and potential 2014-2020
25%
4,0%
2,3%
20%
3,1%
15%
10%
3,1%
5%
7,3%
17,7%
3,4%
3,0%
3,9%
16,8%
11,3%
5,8%
United
Kingdom
Benelux,
Austria,
France,
Finland
Ireland, Italy,
Greece
3,1%
5,5%
0%
1,0%
0,0%
Germany
Note:
2,0%
Sweden
Portugal,
Spain
Closing the output gap
OECD baseline growth expectations
Potential of reforms
Potential effect on Danish export (sec. axis)
Closing the output gap refer to the growth related to the closing of the output gap in OECD’s expectations. Potential of reforms include a labour market reform and a productivity reform. Labour
market reform is closing half the gab to best EU-practice in terms of skills in the labour market and
labour market participation rates, including second-order effects. Productivity reform is an assumed additional 2% higher total-factor productivity in 2020. Southern Euro-area countries includes Greece, Spain, Italy and Portugal, and Other Euro-area countries include France, Netherlands, Ireland, Finland and Luxemburg. The potential effect on Danish export is calculated as the
total growth given reforms scaled by the share of Danish export in 2013, where we assume an
growth to export elasticity of 1,5.
Source: OECD Economic Outlook Database (No. 95, May 2014, Long-term baseline projections), output gab
series and real GDP series, Varga and Jan in ‘t Veld (DG ECFIN).
These facts raise the question: has the EU and its member countries used the crisis to
reset priorities in favour of growth-enhancing economic policies? We start with the
individual countries first and then turn to the common policies of the EU.
3 EU National Reform Efforts
A key requirement for EU member states is to improve the functioning of labour markets. Countries in the EU with sustained high unemployment rates such as France,
Greece, Italy, and Portugal are characterised by high degrees of protection against dismissal for so-called permanent employees and much lower degrees of protection for socalled temporary workers, e.g. workers employed on short term contracts with fixed
duration. At the same time, income compensation is low for many workers when they
lose their jobs or at least highly unequal for different types of jobs.
There is a strong case for these countries to adopt labour market reforms such as those
undertaken particularly in the Northern part of the EU during the last two decades. The
results have been substantially higher employment rates and unemployment rates
more equally distributed across the working force. Indeed, there is strong evidence that
the principle of Flexicurity works: employers have the right to match the number of
employees to the amount of goods and services they can sell without excessive severance payments, while the government provides a meaningful safety net in the period
where displaced workers seek alternative employment.
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The Main Danish Export Market
Unfortunately, effective progress on labour market reform has been patchy since the
crisis started, with no overall reduction in the restrictiveness of labour market rules
during the period 2008 to 2013, cf. Figure 9. Overall restrictiveness was broadly unchanged. However, recent OECD surveys indicate a new beginning in reform efforts in
a number of countries including France, Italy, and Spain that all operate dual labour
market systems.
Figure 9. Restrictiveness of employment protection, 20082013
Restrictiveness index
3,5
3
2,5
2
1,5
1
0,5
0
2013
Note:
2008
The scale of the restrictiveness index is 0-6, from least to most restrictive. The index is an average
of sub-indeces for regular employment, temporary employment, and collective dismissals.
Source: OECD Structural Reform data base
Particularly in a context of weak and uncertain growth prospects, policy reforms that
would make it less risky for firms to invest in employment could help the growth process to gather pace. Recent tentative steps in Italy for example are encouraging: new
rules effectively allow employers to recruit new people for up to three years on temporary contracts in nearly all positions, all while broadening the social benefit system. By
focusing reforms on conditions pertaining to the newly employed as opposed to the
existing staff, they can help maintain confidence among the workers who are already
employed, while making hiring of new employees less risky. In this way, employed
workers would not cut back on spending and employment should expand.
Progress in product markets have been more pronounced. Across the EU, state ownership of firms has been reduced (apart from certain banks in countries with severe financial crises) and regulation of network industries such as energy, water, and transportation has become more market-oriented as evidenced by OECD monitoring of reforms in these areas. Conditions for entrepreneurship have also improved, cf. Figure 10
and 11.
10
The Main Danish Export Market
Figure 10. Restrictiveness of product market regulation,
2008-2013
Restrictiveness index
3,5
3
2,5
2
1,5
1
0,5
0
2013
Note:
2008
The scale of the restrictiveness index is 0-6, from least to most restrictive. The index is an average
of sub-indeces for product market regulation and state control through ownership and involvement
in business operation.
Source: OECD Structural Reform data base.
Figure 11. Barriers to entrepreneurship, 2008-2013
Restrictiveness index
3
2,5
2
1,5
1
0,5
0
2013
Note:
2008
The scale of the restrictiveness index is 0-6, from least to most restrictive. The index is an average
of sub-indeces for burdens on start-ups, complexity of regulation, and protection of incumbents.
Source: OECD Structural Reform data base.
Overall, it would seem fair to say that EU member states will need to step up reform
efforts considerably, particularly in the labour market area, in order to realise the potential associated with best country practice.
Fiscal consolidation and growth enhancing reform measures can go well together. For
instance, a measure such as the new Italian rules that incentivise recruitment and preserve or even increases consumer confidence will also improve public finances. Raising
the retirement age for pension systems will reduce public outlays, increase the work
force and boost growth potential. Hence, there is no inherent conflict between improving public finances and boosting short term economic performance if the right policy
design is put in place.
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The Main Danish Export Market
4 Action at the EU Level Focused on Macro and the Financial
Sector
Since the start of the crisis in 2008, economic policy making at the EU level has in
practice focused attention on containment of the crisis.
In the immediate aftermath of the crisis, the EU countries and the US responded
strongly to the global agreements in the context of G20 which suggested that countries
should underpin their recoveries by increasing public spending and allowing tax revenues to decline with economic activity. However, already from 2010 it became clear
that a number of countries that had seen major increases in inflation and foreign borrowing to pay for consumption and real estate booms, started to lose the confidence of
international investors. As a result, borrowing costs for governments went up and they
had to start a consolidation process to stop public debts rising to non-sustainable This
pattern was particularly clear for countries with substantial pre-crisis deterioration of
net foreign asset position problems such as Spain, Ireland and some Baltic states and
for countries with public finance problems prior to the crisis such as Greece and Portugal. (Italy and France moving in this latter group as well)
As a result of the financial crisis, the EU has devoted considerable attention to making
the financial sector more stable and pushing member states to shore up public finances. This has led to an avalanche of regulation initiatives targeting the banking sector,
requiring higher cushions of capital as well as stronger provisions to bail-in private
investors when banks run into trouble. Most assessments suggest that this direction of
policy towards the banking sector has been necessary to safeguard against future financial crises. Yet, in a context of weak growth and weakened banks, the policy focus has
tended to reduce short to medium term growth. For instance, one side-effect of the new
capital requirements is that banks with weak balance sheets have tended to reduce
lending in order to replenish their capital reserves, rather than issuing new equity.
Meanwhile, the ECB as well as other central banks have pursued extremely expansionary monetary policies. As a direct response to the emerging crisis in 2008, official interest rates were cut to 1 per cent or lower by the ECB as well as by the UK, Swedish
and Danish central banks, cf. Figure 12. The rates were then adjusted upwards again
towards 2011, although they remained low by historical levels. With renewed pressures
on the economy and in particular the need to sustain growth in hard-pressed countries
within the Eurozone, the ECB has again cut interest rates aggressively, this time to
levels close to zero, cf. Figure 12. In order to maintain the Danish hard peg vis-à-vis the
Euro, interest rates on deposits with the central bank are now negative, as is also the
case in Sweden. Most recently, the ECB has followed the example from the US and
embarked on a new programme of so-called Quantitative Easing (QE), buying public
and private sector securities in order to push down long-term borrowing costs.
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The Main Danish Export Market
Figure 12. Some EU central banks’ interest rates
%
7,00
6,00
5,00
4,00
3,00
2,00
1,00
0,00
-1,00
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
ECB Main Refinancing Rate
Bank of England Official Bank Rate
Nationalbanken Indskudsbeviser
Sveriges Riksbank Räporenta
Inflation expectations (2%)
Note:
The vertical axis shows the nominal rates. To get an impression of what the real rates might be,
simply think of the 2% line as the horizontal axis. The last observation is May 2015.
Source: Central bank statistics of the various countries.
The ECB’s low interest rate policy has been successful in reducing the cost of obtaining
credit faced by firms, but with one caveat. While the borrowing costs in Germany and
other countries with relative strong government and bank balance sheets have gone
down in tandem with official ECB rates, this has not been the case in Spain and Italy
where the borrowing costs are higher now than in 2011, cf. Figure 13. In other words,
the spread in the costs of financing investment has gone up (shaded area in Figure 13),
with firms in the crisis-prone countries facing the highest costs. The fact that the policy
of low central bank interest rates has not led to low borrowing costs everywhere is
without doubt a factor in the ECB’s decision to by-pass the banks and buy up private
sector debt directly.
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The Main Danish Export Market
Figure 13. Nominal costs of borrowing from banks for nonfinancial firms
%
Cross-country std. dev.
7,0
1,8
1,6
6,0
1,4
5,0
1,2
4,0
1,0
3,0
0,8
0,6
2,0
0,4
1,0
0,2
0,0
2004
0,0
2006
2008
cross-country std dev (rhs)
Note:
2010
DE
ES
2012
FR
2014
IT
NL
EA
The left vertical axis shows nominal interest rates in % p.a. The right vertical axis shows the dispersion of the interest rates across countries, measured as the standard deviation. 3-month moving averages. The last observation is November 2014.
Source: ECB Bulletin 2015:1 Chart B.
As a consequence of the large interest rate spreads and inefficiently operating capital
markets we also still see large differences in the marginal product of capital across the
Euro areas countries, cf. Figure 14. Put very simple, the fact that firms in Southern
Europe face so high financing costs suggest that they are dropping investment with
rates of return that are likely to exceed investment in EU countries with much lower
interest rates.
Figure 14. Marginal efficiency of capital: total economy, 2014
Marginal efficiency of capital
15%
14%
13%
12%
11%
10%
9%
8%
7%
6%
5%
European Union
Note:
Euro-area (12)
Southern Euro-area
countries
Core Euro-area
countries
The marginal efficiency of capital is defined as the change in GDP in year t per one extra unit of
gross fixed capital formation invested in year t-5. All are measured in constant market prices. For
the southern and core Euro-area country groups we rely on simple averages. The core Euro-area
countries are defined as Germany, France, Austria and Benelux. The Southern Euro-area countries
are defined as Spain, Greece, Italy and Portugal.
Source: European Commission’s AMECO database.
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The Main Danish Export Market
By launching its quantitative easing programme (QE), the ECB has focused very much
on the need to avoid a deflation and recession scenario particularly in Southern Europe, but this focus also entails substantial risks.
Firstly, there are doubts as to how effective the additional stimulus will be at this point.
In the US, the combined effect of a very explicit QE policy of buying up securities and
keeping official rates low may have lowered the unemployment rate with 1½ per cent
in 2015 and increased the rate of inflation by ½ percentage point in 2016 (compared to
a “standard” crisis response policy)1. Given the much lower role of capital markets in
the financing of EU firms and the already very low policy rate before initiating the program, the additional effect of ECB’s QE program must be significantly lower than the
effects of the US program, both in terms of getting inflation back towards the target
and in terms of lifting growth.
Secondly, the extremely low interest rate environment has led to a surge in the pricing
of securities, leading to legitimate concerns about yet another asset bubble in the making. It is worth remembering that the expansionary monetary policies in the US following the dotcom collapse in 2001 – and partly also in the EU – was a significant factor in
the financial instability leading to the current crisis2. Equity prices across the globe are
now back in the territory from 20007-2008 as measured by the ratio of equity prices to
GDP cf. Figure 15. At least for the US, these valuations require future returns that –
based on several metrics about future developments – appear unrealistic3. That might
also be the case in the EU.
1
FED(2015)
See our review of the triggers for the current crisis in the CE study for European Parliament(2009).
3
US Treasury, Office of Financial Research(2015), “Quicksilver markets”
2
15
The Main Danish Export Market
Figure 15. Equity prices relative to GDP in global financial
markets, 1991-2015
index (primo 1992 = 100)
300
Stoxx 600 Europe
250
Stoxx 600 North America
200
FTSE 100 UK
150
100
50
Stoxx 600 Asia-Pacific
0
1992
Note:
1995
1999
2003
2007
2011
Stoxx 600 Europe
Stoxx 600 Asia-Pacific
Stoxx 600 North America
FTSE 100 UK
2014
All indexes are measured relative to the total GDP in the countries included in the index, where
GDP is based on moving averages of quarterly GDP in current prices.
Source: OECD, IMF, http://www.stoxx.com/indices/ and http://finance.yahoo.com/.
As a third important point, currency areas as the euro-area where several countries
share a common monetary policy always run the risk of so called monetary stress,
where the policy set by the central bank is not ideally suited for each individual member country at the same time. This problem may be particularly strong in relation to
aggressive monetary policy such as QE programs which may be far from the optimal
policy in countries such as Germany (and Denmark) where the recovery was well under
way and lending rates were already relatively low before ECB’s QE program was initiated.
So the bottom line on monetary policy is that the very low interest environment has
been helpful in boosting growth, but that there are non-trivial risks associated with a
continuation of such expansionary policies for a sustained period of time. How much
does it help getting firms to invest in long term viable projects and how much does it
simply increase prices of existing assets with potential new bobbles as the result? This
risk is most pertinent for countries with a recovery well under way – arguably countries
such as Denmark and Sweden and potentially also Germany within the Eurozone as
well as the US.
Indeed, it may be more productive to deal directly with the remaining balance sheet
problems in banks and private firms in the individual countries rather than to push up
prices of existing assets across the entire EU region. In short, what non-financial firms
and banks may need is more equity rather than more bank loans, thus reducing too
16
The Main Danish Export Market
high debt-to-assets ratios. More about this issue in the section on capital market union
below.
5 Juncker Commission: A Change of Tack
With the main legislative banking regulation proposals adopted and under implementation, the new EU Commission has clearly changed tack, and it is now more strongly
focused on improving structural policies and boosting growth at the same time. There
are three key initiatives:
• Proposing an EU investment plan focused on infrastructure.
• Creating a Capital Market Union.
• Getting the internal market back on track.
The EU investment plan
The EU Commission has proposed an ambitious investment plan4 which has precisely
been motivated by the co-existence of two major economic problems in the EU: the
severity of the economic crisis, most notably expressed as low investments, and a potential large stock of viable investments being held back by a number of factors. Hence,
the EU Commission has proposed an investment plan based on three key principles: (1)
mobilising (new sources of) finance for investments, (2) making sure this finance
reaches the real economy in order to support growth and jobs, and (3) improving the
investment environment.
To unlock private and public investment, the EU Commission and the European Investment Bank have more specifically launched a partnership to increase investment by
315 billion over the period 2015-2017. Designated target areas are infrastructure (notably broadband and energy networks), transport infrastructure in industrial centres,
education, research and innovation, and, last but not least, renewable energy and energy efficiency. In order to implement this strategy, a European Fund for Strategic Investments (EFSI) has been proposed and a joint Task Force (Member States, the
Commission and the EIB) has identified projects worth € 1.3 trillion out of which € 500
billion could be carried out during the next three years.
The challenge now is to make sure that the EFSI actually delivers. Clearly the initiative
has been partly motivated by the fact that budget constrained public governments have
difficulties in funding otherwise viable infrastructure projects in traditional ways.
However, the real success of the programme should be measured on its ability to use
private sector skills, competences and risk management capacities in the construction,
running and funding of large investment projects often in areas where consumers ultimately bear the cost of the activities5. If so the EU can deliver in three dimensions (1)
boost growth now (2) raise productivity (3) improve public finances in the short run by
reducing unemployment while being broadly neutral in the long run as costs are absorbed by the private, not public, sector.
The Capital market union
4
An overview of the objectives, targets and instruments is provided in factsheet 1 and 3 from the European Investment Bank
(2014 a and b).
5
In a recent study for five major Danish institutional investors, the key to successful use of private sector infrastructure
investments were spelt out (Ernst & Young and Copenhagen Economics(2012))
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The Main Danish Export Market
The EU Commission has presented a green paper6 that proposes the creation of a capital market union. The plan is very much motivated by the fact that compared to other
parts of the world, European businesses rely heavily on banks for funding and relatively less on capital markets such as corporate bond and equity markets. Stronger capital
markets would complement banks as a source of financing, and it is intended to “unlock more investment for all companies, especially SMEs and infrastructure … (and to)
… make the financial system more stable by opening up a wider range of funding
sources”6.
Improved access to capital markets is indeed likely both to make European firms more
resilient during times of financial stress and to improve their long term productivity
performance. In a large study of more than 15.000 firms it is found that firms with a
strong equity base and access to long term guaranteed loan financing (for example
corporate bonds) came out much stronger during the recent crises than less solid
firms7. Moreover, there is a strong empirical basis for the assertion that access to risk
capital from capital markets is a requirement for more risky and longer term investments and commitments to boost innovation and expansion of production, markets
and firms with the ability and drive to grow. The US biotech industry offers a particular
compelling evidence for how important improved access to equity financing is for investments in research and development.
In essence then the capital market union should be less about increasing investment as
about improving the quality of investments by reallocating capital to firms with the
strongest potential for growth and productivity increases. Indeed a number of studies
suggest that the biggest gains from improved capital markets come from a shift of investments and employment from larger to smaller firms.
The Capital Market Union is thus really about two separate issues. Removing barriers
to capital provision across borders – which is very much an internal market perspective
– and reducing the costs associated with providing capital market products to mid-cap
firms and potentially also smaller firms: a job to be done both at the national and at the
EU level. The areas to be looked into are many and well known, e.g., insolvency, security and tax law. However, the private sector can do a lot: some countries in the Europe
such as Germany and Norway are leading the way in the area of making corporate bond
financing a real alternative option, even for loans as low as € 10 to 15 million. Earlier
the minimum sizes was around € 75 million. The idea here is to standardise credit ratings, covenant structures as well as insolvency procedures, i.e. to keep agency and
monitoring costs for investors to a minimum.
The EU commission has already announced that it will take initiative in a number of
areas:
• develop proposals to encourage high quality securitisation and free up bank balance sheets to lend,
• review the Prospectus Directive to make it easier for firms, particularly smaller
ones, to tap capital markets
• look at ways to ease funding across borders
6
7
European Commission (2015),”Building a Capital Market Union”
Bruegel (2012), “Still standing: how European firms weather the crisis” and Altomonte et al. (2012), “The triggers of competitiveness”
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The Main Danish Export Market
•
•
•
start working on ways to improve the availability of credit information on SMEs
and thereby ease investors’ decision-making
work with the industry to put into place a pan European private placement regime
to encourage direct investment into smaller businesses
support the take up of new European long term investment funds to channel investment in infrastructure and other long term projects.
A successful policy in the above areas will help member states to identify both national
barriers to expansion of risk capital to small and medium sizes enterprises building on
best practice. At the same time it will help building cross-border providers of financial
services in this area. Development of common standards for credit scoring, simplified
covenants for corporate bonds and solvency procedures can both help push down the
cost of providing risk capital to smaller firms and develop financial specialist capable of
acting at regional or even EU level.
The Single market
While the EU Commission has not yet launched a major re-launch of a big Internal
Market project, a number of key priorities have already been identified. Both the Capital Market Union and the EU Investment plan include key Internal Market components. In addition, it is likely that the EU Commission will focus on a number of “old”
barriers to a well-functioning internal market as recently identified in a study by the
European Parliament on the cost of non-Europe: completing the Digital Single Market
(€ 520 billion), the Single Market for Consumer and Citizens (€ 235 billion), a Transatlantic Trade and Investment Partnership with EU (€ 60 billion) and Integrated Energy
Markets (€ 50 billion) may together add close to € 900 billion of increased productivity
to the EU economy.
Denmark has notable interest in the completion. As a small open country Denmark will
always benefit disproportionally from a more open external trading environment. In
addition, Denmark benefit in particular from increased market access to the US in area
of pharmaceutical products.
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The Main Danish Export Market
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