Viv Davies interviews Daniel Gros for Vox

July 2010

Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/5255]

Viv Davis: Hello and welcome to Vox Talks, a series of audio interviews with leading economists from around the world. I'm Viv Davis from the Centre for Economic Policy Research. It's the 29th of June, 2010 and I'm talking to Daniel Gros, director of the Brussels based Centre for Policy Studies about the Vox eBook he has recently edited with Richard Baldwin on "Completing the Eurozone rescue: What more needs to be done?" I began by asking Daniel, "What went wrong with the Eurozone in the first place?"

Daniel Gros: Actually, everything that could have gone wrong did go wrong. The fiscal constitution of the Eurozone was based on the assumption that no country would be bailed out by the others. And that actually, a bailout would never be needed because the Stability and Growth Pact would prevent countries from running large deficits. And we see that, in the case of Greece, the Stability Pact didn't work. Greece accumulated very large deficits, and we have problem number one.

The second thing that went wrong is that, by creating monetary union, we actually wanted to create an interconnected, integrated banking market. But we forgot that, at that point, banking weakness in any part of the Union would spill over into the entire system. But we didn't foresee any systemic, European wide bank rescue operations. And FBC is now something that is missing that had to be invented very quickly.

So these two key elements were missing. They are actually interconnected: weakness on the fiscal side leads to banking weakness and vice versa. That's why we have now one very big, interconnected mess.

Viv: I see. So does this imply, perhaps, that the basic foundation for the Eurozone was essentially flawed? Many commentators might say, for example, that without a coordinated fiscal policy amongst Eurozone members, the whole concept of monetary union was bound to fail.

Daniel: The design of monetary union was certainly incomplete. That is actually what is done very often in Europe. You build the bicycle, get on it, try to pedal a bit. And if it doesn't work, you add while you are hopefully getting along. Now, this time managed to be different because financial crises require extremely rapid reactions by policy makers, and we see that is very difficult under the current circumstances. It's quite clear that talking about more fiscal policy coordination would really have saved us. This tragedy was not about fiscal policy coordination in the sense of saying, "You, Germany, spend a bit more, France a bit less, and Italy does something different again." This talks about keeping, actually, debt levels under control. Not only debt levels of governments, but also the private sector. Therefore, we need something quite different from just the term "fiscal union."

Viv: Eurozone leaders made what some have called a bold move in May this year, and provide 110 billion Euro bailout package for Greece and a special purpose vehicle to fund future bailouts. Isn't that enough to contain the problem? Or was there a coherent conclusion, perhaps, on what more needs to be done from amongst the authors in the ebook?

Daniel: As we have argued in the book, these measures were needed to prevent total shut down of the European banking system. They could perhaps contain the problem for a while, but they are certainly not sufficient. As we see in the ongoing tension on both the banking market, and the government debt market of a number of countries. Now, just throwing money at a fundamental problem doesn't always solve it and that's the case right here. In the case of Greece, we have a 110 billion package, unprecedented for a country of that size. Does it solve the problem? It just buys time, two or three years. But we know that most markets look ahead, they look ahead much more than two or three years, 10 years, 20 years. And what they see at the end of the adjustment period is not very nice. That's why we have continued problems for Greece to refinance itself, and the Greek saga is certainly not over.

The same for the banking system. This special purpose vehicle which has been created these days legally should be able to provide over 500 billion Euros in financing, unheard of in European history. These sums have never been put together by national leaders. But are they enough? Yet, we don't know because we are discovering a key problem in the case of Spain, for example, is not so much government debt, which is actually quite limited, but is banking debt, and banking problems, not only in Spain, but in Germany, France and other areas.

Therefore, this is an untested vehicle. We don't know whether it will be actually working and we have argued, therefore, that more needs to be done.

Viv: What the book is suggesting is a prioritization of reforms across the Eurozone countries in terms of bank restructuring, fiscal transfers, competitiveness, structural reforms. And other reforms, such as independent fiscal authorities. Could you explain a little bit more about your recommendations?

Daniel: Yes. It is quite clear that the key order of the day is to have stress tests. What does it mean "stress tests?" It means that the national regulators have gone to the banks, seen what they have in terms of credits outstanding on forms in their portfolio, and asked themselves, "What happens if a really bad scenario arrives? Can this bank survive? It doesn't have enough capital.” That has to be done across Europe. It has now been more or less decided to do it for more of the largest banks, which should cover, more or less, the European banking system.

That, of course, will be extremely important to establish confidence in the interbank market. In the interbank market, we expect banks to lend each other at very low interest rates so there must be very little risk that's left. Banks must be sure that their counterparts can provide.

So we have a stress test. The next question is, "What do we do with the results?" Of course, we publish them. But what do we do when we find that a certain bank has perhaps not enough capital to withstand the stress, or just enough capital? How can you force this bank to take on more capital very quickly?

That is a key trend for policy makers now in the very short run. They have said that they will face up to it. But we have to see, first of all, how the stress tests are being conducted and whether there is a credible way to recapitalize banks which need capital very quickly. That has to be done. Without that, the problems will continue and would actually increase. This is the conditio sine qua non for any group. Once the stress tests have been done, the banking system should come down, the interbank market should work again. And the next order of business is, "What country needs actually fiscal transfers?"

The European Union has to distinguish between different countries. Greece is patently over indebted. Many people think they can't service a debt so a solution must be found. It's no good that policy makers say, "We have a nice adjustment program for Greece, Greece can make it. If the markets don't agree, you can't finance the country in the normal way and therefore, something must be done that gives the market some reassurance that Greece can actually pay its debt. The best way might be just to reduce the debt level that Greece is taking. Other countries are in a much better situation. And therefore, I am optimistic actually, that if a solution for Greece can be found, then the remaining fiscal barriers in Europe should be manageable.

Viv: And what is the solution for Greece, do you think?

Daniel: The best way to proceed might be just to recognize that the country needs, for a very long period, some breathing space. So, perhaps one should say to bond holders of Greece, "You have to wait for a bit longer. Greece will give you a zero coupon discount bond for, let's say 10, 20 years. You'll get back the nominal value, but you have to wait for the interest a while." And then I would add to that some sort of warrant which says that the additional interest that Greece is paying will depend on, really, people, because many people in the market say, "We don't believe these growth rates that have been projected officially." So I would say let's make that into a special contract. Greece says that if growth is good, it will pay more to bond holders. And the optimistic ones, they can buy, then, these bonds, and the market will find an equilibrium again.

Viv: Most if not all of these measures that you refer to in the book, in the introduction, with Richard Baldwin, have to be executed at a national level, which will require a considerable amount of national discipline and responsibility. Is it realistic to expect that this can be achieved, given that the Eurozone chain, so to speak, has been shown to be only as strong as its weakest link, i.e., in the case of Greece?

Daniel: For the short term, actually, I'm rather optimistic. The pressure from the markets and the situation is so strong that governments are taking unprecedented measures, in Greece but also in other countries, and actually show some sign of cooperation. Also, think about the stress tests. One year ago, at the height of the crisis, Europe refused to publish stress tests. Now it's being done. So our policymakers can learn. Perhaps it takes some time, but they have learned at least something. For the longer run, it's quite clear that national fiscal institutions would be very useful to have, to constrain national fiscal policy. But it is also clear that we cannot rely on that only. You have to have some mechanism, as one of our contributors called it, "To reduce debtors' blackmail." That is something that the European Monetary Fund, which I proposed sometime earlier, together with Thomas Meyer, an institution which would allow the EU to deal with emergencies, to resolve actual crises. And that is actually what is also being discussed at the official level. I hope that something will come out of that.

Viv: Daniel, I was reading yesterday in the FT that, according to recent research conducted by the Economist Intelligence Unit, world business leaders see a growing risk that the Eurozone could break up in the next three years. Half of the 440 chief executives and heads of banks who were questioned say there's greater than a 50 percent chance of one or more countries leaving the Eurozone by 2013 because of deepening problems of debt amongst the members, and more than a third see at least a 25 percent chance of a complete breakup over the same period. Would you agree that this might be a real possibility, and furthermore, that a continued crisis of confidence in monetary union might even lead to Germany pulling out?

Daniel: These are certainly very tough times for the Eurozone, and unfortunately, one can no longer totally exclude a breakup. But I must remind people that in the 1990s, similar surveys said that a monetary union would never come about. So one has to be a bit careful with these predictions. But it is clear that there's a real possibility that perhaps one or two smaller countries will choose to exit the Eurozone. There's a possibility that the panel is good. But, if you had a messy default in Greece, followed by some policy mistakes in Greece and then an exit of Greece from the Eurozone, would that actually weaken the Eurozone or strengthen it? Investors might actually say, "Ah, the Eurozone is actually imposing tough choices on its member countries. That's a currency which will remain strong. That's a currency I like."

So, if smaller, weaker countries leave the Eurozone, that might actually strengthen it. Would Germany have an incentive to leave the Eurozone? I don't think so, because if Germany were to leave the Eurozone, then German banks would have their claims on the other Euro area countries only in the old Euro, which might be weak, compared to the new D mark, which would be strong. German banks would have to satisfy their own customers in the German D mark, in the new D mark, which is strong. So the German banks would immediately be bankrupt, and the German government would have to save the immediately. So that is not a very winning proposition for Germany, also.

Viv: Daniel, some commentators are of the opinion that it's too late now for tinkering around the edges with national or independent fiscal authorities, and that the only thing that can now possibly save the Eurozone is a much closer political and economic union. Would you agree with that?

Daniel: Yes and no. When I talk about tighter economic or political union, many people have some vague ideas which are not at all helpful. And as one of our contributors, Paul De Grauwe, writes, one has to be realistic. People still feel national first and European second. But one can have some institutions that would actually give us the essence of what we need. We don't need a fiscal policy coordination in the sense that every small fiscal decision has to be vetted and controlled by Brussels. But the key thing is that we have an institution which allows us to say no, to reduce debtors' blackmail. So something like the European Monetary Fund, perhaps even something like this special purpose vehicle that's being created. This vehicle could be used not only to save countries; it could also be used to say no to a country and just save the European banking system instead. That might be a much better way to proceed.

So, in a sense, European leaders have already decided that they're willing to put a lot of money on the table. If they're using this money in a smart way, with institutions which do not only bail out countries, but perhaps also allow the rest of the Eurozone to save its own banks if a country doesn't perform... Then, actually, we could create out of this crisis a system which will be much stronger than before.

Viv: So you, and the book in fact, are optimistic about the future of the Eurozone.

Daniel: I am guardedly optimistic, because we have seen that our leaders, if push comes to shove, they're willing to spend a lot of their financial and political capital to save it. They have taken some first steps, which were needed, not sufficient. They are now about to take another important step in the form of a stress test. If that is done well, then I'm hopeful that this crisis could be salutatory in the end. The stress tests, as I said, are really key. But there, the devil is in the details. They will be out in two or three weeks, so no point in speculating about it. The best way might be to come back once they have been published and actually ask ourselves, "Was that a step forward or backwards?"

Viv: Well Daniel, thank you very much indeed. It's been a pleasure talking to you.

Daniel: OK. Bye bye.

Viv: Bye bye.

Viv Davies interviews Simon Evenett for Vox

June 2010

Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/5162]

Viv Davies: Hello and welcome to Vox Talks, a series of audio interviews with leading economists from around the world. I'm Viv Davies from CEPR. It's the ninth of June, 2010 and I'm talking to Simon Evenett of Saint Gallen University about the recent Vox e book he edited titled "The US Sino Currency Dispute: New insights from economics, politics, and law." I began by asking Simon why he thought the book needed to be written.

Simon Evenett: The US and China have been disagreeing about the size of China's exports to the United States for a long period of time now. And in recent months this manifested itself in a much more acute set of accusations by the United States government and some leading analysts that China was manipulating its currency and had prevented adjustment in its exports through this means. Worse, the Americans have threatened or, at least some Americans have threatened to take trade sanctions against the Chinese imports. And as this dispute escalated, there was a real fear that this would be deeply unsettling at a time when the global economy was trying to recover from the crisis.

The book, then, sought to shed light on the different features of the crisis, and it became clear that there were not just economic issues to be discussed, but also the legality of the Chinese move as well as historical precedent which might help governments and analysts figure out the likely moves by the US and by the Chinese.

So we wanted to put together a comprehensive book which drew from these different perspectives so that readers could get all of the information they needed on this crisis in one place. And in some sense it's one stop shopping for the US China dispute.

Viv: OK, well it seems like a confrontation between the US and China over this issue has so far been avoided. But, do you think such a confrontation is inevitable?

Simon: I don't think it's inevitable, and I think both the Chinese and the American governments have got the good sense not to provoke such a crisis, but they're not the only players here. One has to remember that the US Congress is an important player. The US Congress by rights in the US constitution determines US tariffs. And so the US government, federal government, can say what it likes, but it has to take account of Congress's view here. And that, in some sense, is the challenging wild card which could upset the balance here.

Now, fortunately the Congress has not legislated higher tariffs yet and I think has been persuaded by different people that this would be unwise. But there's certainly a body of people within Congress who think that China has not cooperated on lowering its exports to the United States, and who in the run up to an election might find it politically convenient to advocate stricter measures against Chinese imports.

Viv: Do you think it's an issue which might come to the fore during the G 20 meeting later in the summer?

Simon: It was an issue which was going to be on the G 20's agenda, but because the euro has devalued so much against the Chinese currency, the Chinese are expected and will likely express reluctance to allow their currency to revalue against the dollar, because by implication it would worsen the devaluation compared to the euro, or the euro's devaluation vis a vis the Chinese currency. And as a result, the issue of the Chinese and their currency has gone off the sort of front burner of international economic policy, precisely because the Americans have accepted that the Chinese face a very difficult position vis a vis their exporters and Europe.

Now, should the euro turn around and begin to shrink them again, then I think you can fully expect American pressure to build up again. And don't forget, we have a second G 20 summit in November in Seoul and pressure may well be exerted in the run up to that particular summit. So it may not be this G 20 summit that this issue becomes the most important, but it may be one of the most important at the next G 20 summit.

Viv: Yes. OK, well, perhaps you can give us a brief overview of some of the main conclusions of the book.

Simon: Certainly. With respect to the economics of the case against China, one of the matters which people have examined is the extent to which China's currency is misaligned, or valued incorrectly, or out of line with what it should be. And here the range of estimates for the Chinese misalignment go from 2% 27%. This is the range of, I would say estimates which people would, serious people would go to the wall defending. Now, that range of 2% 27% is just too wide to advise policy makers, and suggests that there's substantial scientific uncertainty as to just how much the Chinese have been manipulating their currency.

The second point that came through in the report was the many authors, including many Chinese authors, argued that revaluing the Chinese currency was actually in China's interests, and that China should so it for its own reasons, not because of US pressure. Revaluing the currency would help limit export increases. It would also help rebalance the Chinese economy towards domestic consumption, and would also help lower the price of imported goods and contribute to lower inflation in China. So for all these reasons, now there are good reasons why the Chinese should allow their currency appreciate against the dollar, and these are independent of the dispute.

We also found in the economic research that when China had let its currency appreciate before, that the competitiveness of Chinese firms responded and improved. So then you might think that currency appreciation puts some Chinese exporters out of business. Well, that may have happened but it also induced many other Chinese exporters to find productivity increases and to improve their products in such a way that overall Chinese export performance improved as a result of this exchange rate appreciation.
And so here, one question one has to ask to the Americans is, "If you feared Chinese exporters now you'll fear them even more after further appreciation of their currency." In short, "Be careful what you wish for."

With respect to the WTO legality of the Chinese exchange rate regime, here the record is very, very unsettled. Many legal analysts are doubtful that the Chinese have violated their WTO obligations. And if they had, they would not be the only parties who have done so, since they are not the only parties who have fixed exchange rate regimes.
Yet at the same time some people argue that the exchange rate regime of the Chinese constitutes or amounts to subsidies for their exporters and as a result is enforceable at the WTO. That matter has not been resolved. With respect to the historical perspectives on this, the record of the US trying to push other countries to reflate their economies is not good or at least not necessarily particularly relevant to this particular case. And as a result there is a strong sense that history does not justify what the US is trying to do at the moment. These are the main findings of the e book that we put out on the US Sino dispute.

Viv: The political economy of these issues suggests to me that we ought to be seeing some substantial lobbying from firms who have interests in international trade. Has there been pressure from them?

Simon: There ought to be very strong commercial interest in making sure that supply chains stay open and that the investments which many Western firms have made in low cost production in China remain viable. Yet interestingly, the lobbying in the US Congress does not appear to reflect this concern. If anything the Congress appears to be very impressed by the fairness arguments, or rather, the lack of fairness as it's perceived, of Chinese policies. And instead counter arguments don't seem to have much bite. And this is worrying because it does suggest that the outsourcing to China may well be jeopardized by a set of tariffs which the Americans could put in place.

Now you could argue, of course, that the American importers from China have assessed the political situation, seen that it's not likely to become too bad and have decided not to put too much effort behind lobbying on this issue. And that they may change their view in the future should pressure on China intensify. And that's an important caveat we should bear in mind.

Viv: And you've spoken a little bit about the message for policy makers, "Be careful what you wish for," et cetera. Could you tell us a little bit more about the main message coming out of the book for US and Chinese policy makers?

Simon: Certainly. For US policy makers, the message very much is re think what the strategy is because the economic logic of it, the diplomatic logic of this does not seem to be particularly wise. Maybe the US federal government has come to that conclusion, and notes that really the issue is how to manage Congress on this issue. With respect to the Chinese there is a strong case for letting their currency appreciate on terms that they find conducive. And this process should begin at some point and that the Chinese should forget any ideas about retaliating against US measures because most of the tools they have for retaliation will harm themselves as much as they harm the Americans, such as selling off their own Treasury bills.

So it really is a call for calm on both sides. And for the Chinese to get on doing with the economic reforms they say they're committed to. And for the Americans to allow that process to happen and not to disrupt it by making big demands on China from time to time.

Viv: And what do you see as being the main implications of this for European Union policy? What should we be pushing for here?

Simon: Well Europe in many respects outsources more to China than America does on some measures. So in that sense the Europeans are very vulnerable to anything which disrupts trade between China and the European Union. The euro of course in recent months has declined against or fallen compared to the Chinese currency. And the Chinese have feared the loss of competitiveness in their own and in European markets. So if anything, the pressure has been taken a little bit off the Europeans in this regard. Should the euro strengthen against the Chinese currency, then I think we will see further thoughts given in Europe to the types of measures which the US Congress is considering.

Viv: Finally, Simon, the world economy has plenty of rules for countries that run substantial or recurring current account deficits. But in contrast, means of adjustment for countries running persistent surpluses are less evident. What are the implications of this and what can or should be done to address it?

Simon: You're right. The global economy effectively has rules on deficit countries. They are the countries which have to go to the IMF and subject themselves to different types of obligations. And these deficit countries in some sense are constrained once they seek the IMF's help. Surplus countries of course have no pressure on them to adjust their policies. And so you end up with a situation where you can have some countries like China facing no serious external pressure to adjust, other than the diplomatic pressure we've discussed earlier, or at least no systemic pressure to adjust. And so they carry on behaving as they are.

Now some might also argue that Germany and Japan fall into this category as well. So it's not just a Chinese phenomenon. China isn't the only country with a trade surplus. And some of us have begun to worry more that the global imbalances question is linked to the lack of symmetry in the pressure to adjust on countries, debtor countries face more pressure than surplus countries. And this in turn raises questions as to whether or not there should be a modification to the International Monetary Fund's rules to encourage surplus countries to adjust.

And that's a topic which that the CPER and the World Bank are collaborating on at the moment and will have an ebook prepared for before the G 20 summit in Canada this month. And as a result, users and viewers may want to download that book when it becomes available and see what suggestions have been put in the public arena for facilitating adjustment by surplus countries as well.

Viv: And that's global rebalancing ebook, is that correct?

Simon: Yes, this book will be on global rebalancing, will be out soon.

Viv: Well, Simon, it's been very interesting talking to you today. Thanks very much for sparing the time.

Simon: Thank you, Viv.