Growth Prospects in the EU: Inside or Outside the euro area?

Thorvaldur Gylfason

Tenth Anniversary Conference of the Viessmann European Research Centre, Wilfrid Laurier

University on Challenges for the European Union Beyond 2011

Waterloo, Ontario, CanadaOctober 5, 2011

1. Small can be beautiful A banking lesson from Barbados

2. Confluence of regulation and stabilization: Canada, US, and Europe

Reduced volatility – stabilization with regulation! – does not hurt growth

3. Synchronization of periphery and core in Europe, and some convergence

From synchronization to growth Lessons for Canada?

Canada had no major bank

failures during Great

Depression, and did not

establish its Deposit

Insurance Corporation until

1967

Change in Canada’s per capita GDP from year to year 1871-2003 (%)

Source: Maddison (2003).

Perhaps bank regulation during

and after Great Depression also

helped stabilize GDP

Standard deviation of per capita GDP fell from 6.6% 1871-1945 to 2.3% 1947-2003 Yet per capita GDP growth remained virtually the

same (2.1% vs. 2.2%) In postwar period, active stabilization was the

norm plus careful federalfederal rather than decentralized financial supervisionfinancial supervision

Canada’s banks are universaluniversal, offering both commercial and investment banking services Even so, recent financial crisis passed Canada by Firewalls between commercial banking and

investment banking were not in place in Canada

How about the U.S. next

door?

Change in US per capita GDP from year to year 1871-2003 (%)

Perhaps bank regulation during

and after Great Depression also

helped stabilize GDP

Roosevelt-era firewalls between

commercial banking and

investment banking (Glass-

Steagall Act 1933)

Source: Maddison (2003).

Standard deviation of per capita GDP fell from 6.4% 1871-1945 to 2.4% 1947-2003 Yet per capita GDP growth remained virtually the

same (2.3% vs. 2.1%) From the 1960s onward, active stabilization

was the norm, as was federal as well as local financial supervision from 1933 until 1980suntil 1980s

Automatic stabilizers helped From 1870 to 1914, federal expenditures

decreased from 5% of GDP to 2%, rising back to 5% by 1929

From 1945 to date, federal expenditures doubled from 10% of GDP to 20%

From 1980s on, banks again

became trouble makers,

beginning with the S&L crisis

1982-87

Paul Volcker, Chairman of the Fed 1979-87, said 8 December 2009 at a conference organized by the Wall Street Journal: ““I wish someone would give me one shred of I wish someone would give me one shred of

neutral evidence that financial innovation has neutral evidence that financial innovation has led to economic growth – one shred of led to economic growth – one shred of evidence.”evidence.”

He added that in the US the share of financial services in value added had risen from 2% to 6.5%, and then asked: ““Is that a reflection of your financial Is that a reflection of your financial

innovation, or just a reflection of what you’re innovation, or just a reflection of what you’re paid?” paid?”

Change in German per capita GDP from year to year 1851-2003 (%)

Perhaps bank regulation during

Great Depression also helped

stabilize GDP

Regulation came easily to

Europe, as did macroeconomic

stabilization

Stefan Zweig (1942)Die Welt von Gestern

Europe: Same story

European periphery vs. core Canada vs. US

From 88% in

1980 to 82% in 2009

Greece: From

95% in 1980 to

85% in 2009

More recent trends

European periphery vs. core Canada vs. US

From 88% in

1980 to 82% in 2009

European periphery vs. core Canada vs. US

From 88% in

1980 to 82% in 2009

European periphery vs. core Canada vs. US

From 88% in

1980 to 82% in 2009

More convergence in Europe than in North America

Correlation of annual per capita growth rates of GNI with euro area

Pre-euro period1961-1999

Post-euro period 2000-2009

Greece 0,63 0,76 Iceland 0,19 0,68 Ireland 0,03 0,72 Portugal 0,68 0,86

Source: Computations based on World Development Indicators 2011.

Even Iceland adjusted, without the euro

Meanwhile, growth correlation between Canada and US decreased from 0,73 to 0,66

Peripheral

countries

adopted the

euro hoping

for synchronizati

on

Another type of convergence

Correlation of annual per capita growth rates of GNI with euro area

Pre-EEA period1961-1994

Post-EEA period 1995-2009

Greece 0,63 0,63 Iceland 0,19 0,63 Ireland 0,19 0,70 Portugal 0,70 0,83

Source: Computations based on World Development Indicators 2011.

Meanwhile, growth correlation between Canada and US decreased from 0,74 to 0,69

Synchronization in Greece came with the euroFore more, see

Bjarnason

(2010), The Political

Economy of

Joining the

European Union:

Iceland’s Position

at the Beginning

of the 21st

Century

Since 2000, Greece, Iceland, Ireland, and Portugal have grown more in sync with the euro area, as was hoped and intendedIreland caught up, Portugal converged,

Greece lagged behind, Iceland converged from above

In Canada, no such synchronizationMeanwhile, though, Canada lagged behind US

But Canadians live 2,5 years longer, up from 1,5 years in 1980, and, with their European-like Gini index, share their national income more equally

Flexible exchange rates do not clearly set Canada apart from Europe’s peripherySweden vs. Finland: Same story

So, there is more to life than exchange

rates

The euro is not solely an economic

project

Since 2000, Greece, Iceland, Ireland, and Portugal have grown more in sync with the euro area, as was hoped and intendedIreland caught up, Portugal converged,

Greece lagged behind, Iceland converged from above

In Canada, no such synchronizationMeanwhile, though, Canada lagged behind US

But Canadians live 2,5 years longer, up from 1,5 years in 1980, and, with their European-like Gini index, share their national income more equally

So, flexible exchange rates do not clearly set Canada apart from Europe’s peripherySame applies to Sweden vs. Finland

In Greece, the cost of starting up a

business is 50 times higher than in

Canada

Since 2000, Greece, Iceland, Ireland, and Portugal have grown more in sync with the euro area, as was hoped and intendedIreland caught up, Portugal converged,

Greece lagged behind, Iceland converged from above

In Canada, no such synchronizationMeanwhile, though, Canada lagged behind US

But Canadians live 2,5 years longer, up from 1,5 years in 1980, and, with their European-like Gini index, share their national income more equally

So, flexible exchange rates do not clearly set Canada apart from Europe’s peripherySame applies to Sweden vs. Finland

In the euro area, the cost of starting

up a business is 15 times higher than

in Canada