The future of economic governance in the the EU - European Union Committee Contents

Examination of witness (Question Numbers 146-169)

Sir Martin Jacomb

16 NOVEMBER 2010

  Q146  The Chairman: Colleagues, let us resume with Sir Martin Jacomb. First of all, I thank Sir Martin for coming this morning and for his patience, sitting at the back and listening to the previous discussion, which was so interesting. Sir Martin, you may not have heard my preliminary remarks before, but these buildings and these rooms are not for modern politicians or witnesses, so I would be grateful if you could speak near to the microphone so that we can hear you. We will be preparing a transcript of the discussion and we will send that to you with the hope that you will be able to look at it to see that it is correct. If you have further thoughts at a later time, or if we are unable—as in the last session—to get to all the questions, we would be most grateful if you would write any supplementary essay on what you might want to say. In the mean time, we are very grateful for those that you have already submitted. I should say to colleagues who have received Sir Martin's written contribution that we will be supplementing that with the remainder of that which he has given us. With that in mind, may I ask the first question? Do you think that that the arrangements for fiscal and monetary policy in the euro area provide sufficient scope for achieving the optimal mix of fiscal and monetary policy and, if not, how can this be improved?

  Sir Martin Jacomb: My Lord Chairman, first of all, many thanks for asking me here. Secondly, I would like to apologise for the paper being so discursive.

  The Chairman: Not at all.

  Sir Martin Jacomb: Before I answer your question, I must say that I cannot possibly compete with your previous witnesses because I am not an economist; I am a practical person still engaged in this field. I am chairman of Canary Wharf—as it says here—which houses a lot of businesses in the financial sector. I am also chairman of the Share Centre, which is a retail stockbroker. I must also say that the issue facing the European Union is how to avoid serious unemployment, which is already growing rapidly in Ireland, for example, among people under 25 and will grow further unless remedial action is taken. The only way to address that is connected with the very last question that you asked the previous witnesses: how to ensure that the whole of the European Union remains competitive. Unless it is competitive, there is no way that employment is going to be maintained. So far, since the Union started, the concentration of policy has been internal to make sure that all members of the European Union compete internally on level terms through the working time directive, paternity and maternity leave and so forth. The worst mistake was the creation of the euro, because it was obvious from before the euro was introduced that a fixed exchange rate imposed irrevocably on areas of widely different economic performance could not possibly do anything other than progressively impoverish the poorer regions. The reason for that will be absolutely clear to your Lordships. In answer to your question, arising out of that, is that once you have a fixed monetary policy that does not suit big or significant areas within the fixed currency zone, you cannot reconcile sensible monetary and fiscal policies. The result, which we are now seeing, is most unfortunate. The only course of action that I can see that would act in a remedial way would be to dismantle the eurozone in an orderly and planned way. But I am a realist and I do not see that happening because the political imperatives to keep it going are too great. That is why I concentrate on trying to find every other way of ensuring that the eurozone remains competitive. That is where I get on to the subject of bank regulation to try and ensure that banks can lend freely to productive industries throughout the European Union. I do not think I have helped you very much, but that is my standpoint.

  Q147  The Chairman: Notwithstanding that, and your disarming comments at the beginning, do you think that the ECB bond purchase programme has demonstrated that running fiscal and monetary policy separately is dead?

  Sir Martin Jacomb: What it has shown is that, in the long run, that is no solution. That programme was very sensible, and no doubt rationally introduced, but it is a palliative and not a cure for the problem of the inability to run the two policies coherently. So I am afraid that not only is it not going to provide a permanent cure but it is also extremely dangerous because it runs the risk of obscuring the need to address the issue of possible defaults among European eurozone government bonds. That includes another great danger. A large numbers of banks around the eurozone and elsewhere hold these bonds, which are now coming closer to potential default. So I think it was a palliative, not a permanent cure, and to that extent, like all palliatives, is in the end dangerous.

  The Chairman: Lord Woolmer.

  Q148  Lord Woolmer of Leeds: Could I pick you up on that point, Sir Martin? Effectively, you identify two issues: the current emphasis on fiscal and debt financial problems and the underlying gap in competitiveness between the member states.

  Sir Martin Jacomb: Yes.

Lord Woolmer of Leeds: You say that dealing with the former might discourage moves towards improving the latter.

  Sir Martin Jacomb: Yes.

  Q149  Lord Woolmer of Leeds: I have two questions. First of all, could you elaborate on that? Why would dealing with the current fiscal financial debt crisis, which has to be done in some way, discourage future moves to improve competitiveness? That is my first question. Perhaps you could deal with that first and then, depending on your answer, I might go on to the second.

  Sir Martin Jacomb: Once you provide a mechanism for a country that should not be borrowing so much on the open market to enable it to do so at reasonable rates of interest, you allow it to continue a fiscal policy that is not appropriate to the development of competitiveness in the country—as has happened in Ireland, the current example in the news. The country goes on borrowing without addressing what really needs to happen, which is making the productive sector of the economy productive. That is the reason; it obscures the correct remedial mechanism of the markets.

  Q150  Lord Woolmer of Leeds: That leads to my second question. Dr Mayer, in the previous evidence session, said that the answer to that is that dealing with the fiscal and financial crises appropriately should lead to establishing the necessary disciplines on cost and competitiveness that the weaker competitive countries in the European Union need. He is almost implying that the eurozone is a precondition to providing the disciplines for some member states to improve their competitiveness. You almost imply in your paper that, if some member states stay in the European Union, they are doomed never to be able to tackle that problem because they do not have the means—for example, a exchange rate—by which they could become competitive. So my question is: for member states that are weaker in competitive terms, are you saying that dealing with the financial crisis will not really deal with their underlying problems?

  Sir Martin Jacomb: Yes, I am, my Lord. The historical evidence that I infer from what I read about economic events is that, once a region within a single currency area becomes uncompetitive, nothing can alleviate its competiveness status. The poverty can be alleviated by transfers from the centre if the Government can afford to transfer massive resources to the weaker area, but it can never again become competitive. What happens when it becomes uncompetitive is that the able managers leave and go to more economically successful areas, and the area progressively declines. You can see that in Italy, for example, which had a single currency imposed on it at the time of the Risorgimento when southern Italy became uncompetitive for the first time and the managers all left and went to Turin and Milan. So the idea that discipline can provide the necessary background to ensuring that uncompetitive areas again become competitive is just not practical. It would be nice to think that you could wave a wand and all wages could be reduced simultaneously, simulating the effect of devaluation, but that cannot in practice occur. Being a mere practical person and not an economist, I do not think discipline alone can provide the necessary answer. I do not know whether that helps at all.

  Q151  Lord Woolmer of Leeds: Latvia, outside the eurozone, and Ireland, inside, have engaged in, and are engaged in, wage cuts. Do you think that will prove to be potentially largely helpful but not fundamental?

  Sir Martin Jacomb: Yes, I do. I think it helps a tiny bit, but not fundamentally. You can see what happens in the case of Ireland. I am speaking now from probably a rather inaccurate memory, but I think the unemployment rate among people under 24 in Ireland is already over 30%. The requirement that is apparently being imposed—that they increase their tax rates to get alleviation with regard to their bond indebtedness—is bound to make them less competitive. I think you can see what damage that kind of discipline can do. The number one enemy, as I said at the outset, is unemployment.

  Q152  Lord Haskins: Sir Martin, you used the word "palliative", but I was brought up to believe that devaluation was a chronic palliative and part of the chronic decline of this country, and that everybody's world would be devalued. It was only when we stopped devaluing that we actually started getting a bit of stability into the thing. Is devaluation not just yet another palliative?

  Sir Martin Jacomb: Yes, it is a palliative, provided that the other requirement that should accompany devaluation is not present. If that other requirement is present, it is not a palliative. That other requirement is a lot of spare capacity. When devaluation occurs— when there is a lot of spare capacity in the productive economy—it is not a palliative and it can indeed restore the prosperity and employment within a country. There are examples of that as well: Argentina being one, of course. It was a palliative in the UK as practised over the period about which you are talking, but that was because it always occurred when there was insufficient spare capacity.

  Q153  Lord Haskins: And lack of investment.

  Sir Martin Jacomb: Yes. And lack of investment because of that.

  Q154  Lord Vallance of Tummel: This is really a comment on competitiveness. If you look at this in the context of world markets, then I would suggest that relative labour costs and productivity within Europe are not a first-order question because we are not going to be competitive on labour costs versus the BRICS and so on. Perhaps the key to competitiveness lies elsewhere in skills, education, intellectual property and even culture and tradition. I wonder how this bears on the future of the European Union, or indeed the eurozone.

  Sir Martin Jacomb: I agree with you that even if we had substantial reductions in labour costs, we still would not be competitive with the Far East, but we would be nearer to it. It is interesting to observe that in the case of General Motors, for instance, labour costs were ludicrously out of line with the labour costs in Japan, for example. As a result of taking that enterprise into the public sector and imposing, with the agreement of the unions, a completely different approach, with radically lower labour rates for people newly employed by General Motors, they have been able to take $2,000 out of the cost of every automobile they make. Through that they have made themselves much more nearly, if not actually, competitive. I agree with your fundamental point that in this country our own salvation has to come through education and the exploitation of other assets that we have. However making labour costs much more nearly competitive is an absolutely essential part of it.

  Q155  Lord Jordan: Sir Martin, you have made it clear that any crisis resolution mechanisms should not be used to shield uncompetitiveness, but what about the other perpetrators in these crises—the investors? Do you agree with Dr Annunziata, who said that any route out of the crisis should impose a cost on the creditors, who have played their part in causing the crisis?

  Sir Martin Jacomb: I firmly believe in not obscuring risk. If you do obscure risk, people can borrow amounts, and at rates, which they should not be able to. To that extent, sovereign risk should have been made much clearer at the beginning, before people started buying these bonds and before the ECB started buying them and taking them on to its books at face value. I think it would have been much better to allow the market to recognise the reality that people who buy bonds that cannot be repaid should suffer a loss. I believe in people suffering a loss if they buy bonds that cannot be repaid. I deal in risk.

  Q156  Lord Moser: Sir Martin, in your evidence you say, "Defaults by Governments of the eurozone can and probably will occur". That was a good prediction. It was many, many years ago when you took that view. We have had Greece. Today we have Ireland on the front page, and Portugal not far behind. What we as a committee have to think and talk about quite hard is whether there is a managed process that should be followed when a default happens. What should the Governments of the countries involved do, and what are the impacts on the eurozone generally? Could you talk about that a bit?

  Sir Martin Jacomb: When it is clear that the country cannot repay its debts and is going to suffer a restructuring or even a default, the really important thing is to arrive at a conclusion quickly and to work out a process that is going to be followed quickly so that it can be put into effect quickly. One of the major enemies in this situation and which we are suffering from this very day is uncertainty about the outcomes of these events. That stifles the working of the bond market, which is extremely harmful to productive enterprise. Orderly but rapid decisions on how this should be handled are of the first order. I heard the previous witness refer to what happened to the Latin American countries at the time of the progressive prospective default there and the issue of the Brady bonds. What happened there was that, very rapidly, people in the key positions realised that a tidy, elegant solution was needed quickly. They did that and produced the decisions that led to the substitution of the Brady bonds for the bonds that the banks held. And that is what is needed now. The present situation is deeply harmful.

  Q157  Lord Moser: If we have a country that is in such trouble—take Ireland now—should it withdraw from membership of the European Union?

  Sir Martin Jacomb: Yes, if that could be done elegantly, but I do not think it is actually going to occur because the political imperatives, unfortunately, seem to take priority. I believe—perhaps because of my background—that that is the wrong priority. I think the top priority should be how to remain productive and keep unemployment down. If my priority was undertaken as the right priority, the euro should be dismantled—not just in one country—but in an orderly way so that all the less successful countries were able to revert to their own currencies and manage their own monetary and fiscal policies.

  Q158  Lord Moser: Do you think the euro should actually be dismantled?

  Sir Martin Jacomb: Yes, I do think it should be dismantled. Yes, I think it was a mistake.

  Q159  Lord Moser: That would be the end of the euro?

  Sir Martin Jacomb: Well, it would be the end of the euro as we now know it. It might be preserved by a group of nations, particularly the stronger ones. However this is I am afraid, theoretical because the political imperative is going to prevail.

  Q160  Lord Moser: Very quickly, I think you were here when Dr Mayer talked about a new institution, a European monetary fund, which he thought was the right ultimate solution. I asked him whether that was like the IMF and he said IMF-plus. Do you have a quick view on that?

  Sir Martin Jacomb: I do not think that would be the right solution. In this country we have rich and poor regions and we spend more than 40 per cent of our gross national product redistributing money from the rich to the poor regions through Civil Service wages and nurses and soldiers and so on. That preserves employment while allowing the rich parts of the country to go on being productive. However, you cannot do that within the European Union because it would not be practical or politically acceptable for the rich countries to finance the poor countries in that way. Whatever institution you have, it is not going to cure the problem, I am afraid. I realise my views on the dismantling of the euro are impractical. That is why I concentrate on such practical steps as can be pursued to preserve productivity and that is why I come back to the banking sector, which is at the moment also paralysed.

  Q161  Lord Haskins: I want to get on to a thing that constantly bemuses me about the crisis. The markets today are certainly aware of the difference in lending money to Ireland, Greece and Portugal. Why were they not aware three years ago when all the indicators—housing boom in Spain, Ireland and Britain—indicated that those countries should have been paying more for the money than they did? Why did the markets not pick that up and is there any way of making sure in future—they probably will actually, as they have burnt their fingers—that they will pick it up?

  Sir Martin Jacomb: I wish I could tell your Lordships what the true answer is. As long as markets believe that there will be a political bailout, they will act on that basis. There has been a belief, since the ECB initiated its programme of bond purchases—that is, until very recently—that there will be always be a political bailout.

  Q162  Lord Haskins: But that was not the case in the UK, for example. And yet the UK was also able to borrow at these advantages rates.

  Sir Martin Jacomb: That is because people believed that this country, ultimately, will manage its economic affairs sufficiently well to be able to repay its bonds so there has never been a serious question in the markets about the ability of the United Kingdom to repay its debts.

  Q163  Lord Haskins: However, the Governor of the Bank of England made some very alarming comments last May about this.

  Sir Martin Jacomb: I used to serve on the board of the Bank of England so I am not going to engage in that.

  The Chairman: Let us pass to Lord Vallance. I am conscious that others do want to contribute and with your permission, Sir Martin, we will run over for about 10 minutes if you are able to stay with us.

  Lord Vallance of Tummel: Sir Martin has just answered the question I was going to ask.

  Q164  Baroness Hooper: Do you think that one of the practical steps you refer to could be the establishment of a permanent crisis resolution mechanism? If so, what form should it take?

  Sir Martin Jacomb: I am not certain. That could comprise two things. Internationally, there could be a proper resolution regime for banks that fail. I think one of the important things in my view is to try and ensure that we get away from the idea that some banks are too big to fail. That does require a proper global resolution regime for banks that have to go to their central banks for liquidity, which is to me a bank failure. I do think there should be that, but it has to be on a global basis because banking is a global business. As to the resolution mechanism within the eurozone for its bonds, we are too far along into this crisis for that to be effective. It may emerge, but it serves no purpose at this stage. We are too far into it.

  Baroness Hooper: What about the role of the ECB?

  Sir Martin Jacomb: This is a public hearing, so I must be guarded in what I say, but I think the ECB has done a great deal to try to ensure that the euro works, but the brief that it has been given is not workable. I think their policy of ensuring that the central banks of the eurozone countries had the liquidity they needed by buying the bonds seemed like the right thing to do at the time, but it did not provide a solution to the problem that led for the need for it.

  The Chairman: The next question is from Lord Trefgarne and we will finish off with a question from Lord Marlesford.

  Q165  Lord Trefgarne: Sir Martin, you have talked about the importance of competitiveness of industry, not just in this country but right across the Union. You pointed to the importance of competitive wage rates to make that work. Is not the real contributor to competitiveness productivity? And is not productivity at least as much dependent upon investment, for example in modern plant and machinery, as upon low wage rates?

  Sir Martin Jacomb: It very much is. I completely agree with that, but we are starting from where we are. You do not get a wave of investment just by wishing that it was occurring. You have to ensure that the business in which the investment is going to take place is already competitive. In Germany, for example, in the post-war period, when they had the good fortune of not having to spend any money on defence and so forth, the overwhelming fashion—if you can call it that, as it is not a fashion really—within German manufacturing industry was to reinvest a very high proportion of the profits in the business to ensure that the products were the best and the productivity was the highest, so that they could compete with anywhere in the world. We have seen the result today and we see it every day on the roads and in kitchens and everywhere. I agree with you, but I do think industry has got to be competitive to attract investment and that does require competitive labour rates.

  Q166  Lord Trefgarne: But it also points to the importance of the banks lending more than they are at the moment.

  Sir Martin Jacomb: Very much so. I deeply regret what has happened, and I am not just talking about banks in this country. If you were running a bank in this country, which no one in their right mind would now want to do, you would find yourself absolutely preoccupied with worrying about what the capital requirements were going to be, what the liquidity requirements were going to be, what the structure of the bank was going to be—whether it would be allowed to engage in securities business, for example—and you would be on your guard not to risk of lending too much or allow capital ratios to diminish too much. I think this is very harmful. It is in this prevailing atmosphere that we have enquiries and proposals and so forth leading to a hiatus really.

  Q167  Lord Marlesford: Sir Martin, can I go back to your point on the bailout, which is pretty crucial, because it links the sovereign debt crisis with the banking debt crisis. You can have a sovereign debt crisis from a country being unable to finance its normal borrowing requirements because it is regarded, for one reason or another, as unsound. Equally this situation can arise because a country takes on the debt of its banks which have not performed properly. Is it therefore better that, certainly given that you have a eurozone, bank rescues, if they are to happen, are done by the European Central Bank, or some other body, rather than national Governments? The whole question of bailout—Maastricht had the no-bailout clause—is perceived as having gone. Professor Goodhart, last week said that actually there has not been a bailout because he says that if you lend money at a commercial rate of interest that is not a bailout, but I think that the moral hazard is still perceived as existing and that is likely to make the extension of a sovereign debt crisis always liable to spill over into a fresh banking crisis.

  Sir Martin Jacomb: I am not sure that I am going to be able to answer your question, but I think there is a direct connection between sovereign debt restructuring and the health of banks, because these bonds are to a very large extent held by banks and they are not immune from the need to write them down. I think it is a very dangerous situation that we are in, but if it is done in an orderly way and people can see that it is not going to be an endless process, I think it could be handled, but it needs to be addressed quickly and openly. I do not think I have answered your question, I am afraid. There is a very direct connection between the health of banks and the sovereign debt crisis, but I would not ever disagree with Professor Goodhart. I think he is always right.

  Q168  Lord Marlesford: So you would agree that there has not actually been a bailout. And so the moral hazard to some extent should not really exist.

  Sir Martin Jacomb: Well, I am not sure I agree with that inference. The fact that there has not been a bailout does not mean that there will not be one.

  Q169  Lord Marlesford: The no-bailout clause warned lenders that there would not be a bailout—that goes back to the point about unwise lending.

  Sir Martin Jacomb: That is right.

  The Chairman: Sir Martin, your contribution today has been influenced by the leitmotif of being practical. We are very grateful for your practical comments. I am reminded of the one economics joke that I know—the description of an economist who sees something working in practice but worries that it will not work in theory. We are most grateful for your comments today. They are most helpful to our studies. As I mentioned earlier, we will send a transcript. Would you correct that for us? Would you add or supplement anything you think you have not touched on today? My apologies again for having you come on late and delaying you. We are most thankful. With that I close the session.

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