Examination of Witnesses (Questions 80-88)
Professor Michael Wickens
3 JULY 2007
Q80 Lord Cobbold: It is relatively
new, it has been revised once and it needs perhaps a slightly
greater degree of flexibility in the light of experience?
Professor Wickens: It is not very encouraging
though to see that, in the light of experience, the changes that
were made have gone in the wrong direction.
Q81 Lord Kerr of Kinlochard: It sounds
to me as if you should accompany President Sarkozy to ECOFIN next
Monday, where he appears to be going to make a case which you
will like, Professor, that the rules need to be further relaxed.
I must say, it seems to me the crucial rule is "no bail-outs";
that is at the core of the idea. If I am the new Finance Minister
of Ruritania, a member of the euro zone, I have just got in, I
am tempted to reduce taxes and raise debt, and to believe that
all will be fine because the ECB will stand behind me for ever.
I need to believe that is not true. I need to believe that they
will not bail me out if the markets go for me. In order to have
something to give credibility to that ultimate sanction of "no
bail-out", you do need some sort of agreement, rules of the
game, as Lord Cobbold would say, surely?
Professor Wickens: Yes, I agree. It is certainly
true that if we look at the role of capital recently, there has
been a dramatic change in the extent to which countries borrow
from other euro countries, and that is important for stabilisation.
I think I had a figure somewhere, which I seem to have mislaid,
but I think it has gone from something like 15% of national borrowing
to something like 60; that is an enormous change in the reliance
on other European countries, and that must be good for stabilisation.
Also it reflects the fact that sovereign debt is not thought to
be likely to be defaulted on. We notice also that bid/ask spreads
have been reduced considerably, and this shows that there is greater
liquidity for governments to borrow from the private sector. Also
we have seen that the risk premia have fallen on government debt,
which is another sign, I think, that there has been greater certainty
about the abilities of governments to be able to sustain their
debts. All of this supports the argument that we can sustain a
high level of debt in the short term. The markets have looked
at the situation and they seem quite confident that the system
is working well. I do not think that loosening these debt criteria
is going to make life that different. I think markets would be
quite sanguine about that. In fact, they might even like it, because
hopefully it will allow these countries to continue to grow faster.
Chairman: That is very interesting. Lord Jordan.
Q82 Lord Jordan: Has the European
Union's enthusiasm for enlargement led to a situation where the
entry criteria for the euro zone are just a reflection of a country's
ability to join the currency area, and are there elements in those
criteria which you feel are really harmful, as a starting-point?
Professor Wickens: Most countries, of course,
want to join in order to be able to get the benefits of lower
borrowing costs; most countries that join face very high interest
rates relative to the rates they would face once they are in the
EU, and they want the benefits of trade. Then the country is required
to meet the inflation criteria, the SGP criteria, and for some
countries that is a difficult thing to do. The only concern that
I have seen expressed is that the inflation criterion is too strict,
that countries have got to meet the rates in the best three inflation
countries rather than the average; that might be too tough. The
countries in Europe obviously want to join the EU and they are
willing to pay the price, so to speak, of stabilising their economies
in order to do so. I think the answer is that in a way it is something
which is outside the control of the EU, because once countries
want to join and they have satisfied the criteria it is difficult
to keep them out. I think that is the message, even though obviously
there are other consequences, which could be quite costly.
Q83 Lord Jordan: Is not there a case,
therefore, for making the criteria even more difficult?
Professor Wickens: All one wants really is that
countries which join should not default on their debt. I think,
provided that is true then the spill-over effects to other countries
are relatively small. As a result of the expansion, of course,
what we have seen in Europe is globalisation within Europe; all
the problems of globalisation that we talk about are in Europe.
Jobs have been lost to new countries which have come in, because
they have got lower wage costs, so that is a cost to workers,
but the benefit to the consumer has been lower prices. All the
while you have the tension between the benefit to the consumer
as opposed to the worker. We have also seen labour mobility within
Europe and I think labour mobility again has benefits, in that
it keeps wages down. But obviously it raises costs to everyone
else, in terms of the pressure on resources—as we have seen.
Somehow or other, what we have got to do is get the benefits of
this at the same time as managing the downside, and I think the
downside is quite high, in the short term, but maybe, in the long
term, those costs will tend to disappear.
Q84 Chairman: We wanted to ask you
about the impact of the expected enlargement of the euro zone.
This was not a sensible question because if very small countries
join it cannot be going to make any difference, but would you
like to attempt the question in terms of, if Poland or some other
really large country joins, what would you expect to happen to
the function of the euro zone economy and the management of monetary
policy in the euro zone?
Professor Wickens: It is true. If a country
comes in—to deal with the last point first—with a
high inflation rate then the average inflation rate in the whole
euro zone rises and therefore interest rates will have to be raised.
Of course, that can only make the position of Germany—low
inflation countries—worse. So it is clear that you have
to have fairly strict inflation criteria for entering countries.
I think that is fairly obvious. If we look at the case of Poland,
what is offered is the opportunity of cheap labour, as I was mentioning
before. A lot of German companies, for example, have moved to
Poland. A lot of production now takes place there; this has harmed
German jobs. If you look at the UK, in 1960 something like 66%
of UK GDP was produced by manufacturing industry and now it is
down to 15; and the same sort of thing has happened in the US.
What we have observed is that countries like the UK—high-income
countries—specialise increasingly in hi-tech goods and services.
Poland and many of the other recent accession countries are still
in manufacturing mode; they are still providing us with cheap
goods, they are not competing in services; they are also providing
us with labour because people in those countries recognise that
they are getting relatively low wages, want to have high wages
immediately and want to move. As a result of this, we are seeing
a lot of migration taking place. This is globalisation, which
we talk about in terms of the world, but is occurring in almost
exactly the same way within the EU. So if you think globalisation
is a good thing you will certainly be keen on expanding the EU.
Q85 Lord Cobbold: What about a single
world currency?
Professor Wickens: I do not think a single world
currency would be something I would support. And I think it would
be a long way ahead.
Q86 Lord Cobbold: Slightly relating
to that last comment, how do you see, in the global economy context,
the exchange rate of the euro versus the dollar being adversely
affected by a Chinese surplus, a switching from reserves, and
do you think this is a problem which is going to affect the economy
of the Union?
Professor Wickens: I think the evidence is that
there has been very little real exchange rate adjustment for the
EU in recent times. Again, if one looks at China and the United
States, the Chinese economy has been very good for the consumer
because it has provided cheaper goods; you could argue it has
been bad for the producer because it has meant that more goods
are produced in China than are produced in Europe. This will only
increase the trend towards specialisation in services and hi-tech
activity, and away from production using standard technology.
If you look at the United States, we have got the completely opposite
problem. The United States has run a large trade deficit, and
that has been good for Europe, in the sense that we have been
able to sell more goods to the United States as a result. The
United States probably has had to run a large trade deficit because
the world demand for its assets is so strong. Because the balance
of payments has got to balance, the only way you can offset the
huge capital inflow is to have a large current account deficit,
in other words, a large trade deficit. To some extent, that is
inevitable. If there is a correction to the exchange rate in China,
so that the renminbi appreciates and the dollar depreciates, we
are going to reverse some of those things. More expensive goods
will be worse for the consumer but better for the European producer;
a lower dollar will be worse for the European exporter but will
be better for all those goods which are priced in dollars in the
world. As always happens with these things, it really depends
on who we are talking about. Interestingly, traditional economic
analysis always measures welfare in terms of the consumer rather
than the producer, so if you look at the benefits for the consumer
you would welcome what has been happening in China and probably
you would prefer to have a lower value of the dollar.
Q87 Lord Jordan: Is not the cost
gap in China's manufacturing and Europe's manufacturing so large
that any appreciation of China's currency would hardly dent that
competitive edge?
Professor Wickens: I think that is right. We
have been gainers, as consumers, from China, as I have mentioned,
and I think it is very unlikely that the Chinese Government will
allow the renminbi to appreciate substantially to make any significant
difference. There is not much that the EU can do about it. I remember
being at an ECB meeting when it was announced at the start of
the meeting that the ECB was intervening in the foreign exchange
market, and I thought to myself at the time: I bet that does not
have any effect. It turned out that it had an effect for about
half an hour; so there is not much that the ECB can do to control
the euro exchange rate.
Q88 Chairman: It falls to me to thank
you very much for coming, Professor Wickens. We found your paper
most interesting, and if there are any other papers you would
like to put in, in evidence, we would be very glad to receive
them. We are most grateful to you for coming to talk to us today.
Professor Wickens: Thank you very much. You
have added a large number of very useful questions that I can
pass on to my students in the future.
Chairman: Good. Thank you.
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