2
Revised transcript of evidence taken before
The Select Committee on the European Union
Financial Affairs Sub-Committee
Inquiry on
COMPLETING EUROPE’S ECONOMIC AND MONETARY UNION
Evidence Session No. 3 Heard in Public Questions 27 - 44
Witnesses: Martin Sandbu, Janet Henry and Sebastian Barnes
Henning Christophersen
Members present
Baroness Falkner of Margravine (Chairman)
Lord Borwick
Lord Butler of Brockwell
Lord Davies of Stamford
Lord Haskins
Baroness Kingsmill
Lord Lawson of Blaby
Earl of Lindsay
Lord McFall of Alcluith
Lord Shutt of Greetland
Lord Skidelsky
________________
Martin Sandbu, the Financial Times, Janet Henry, Global Chief Economist, HSBC, and Sebastian Barnes, Economic Counsellor to the Chief Economist, OECD
Q27 The Chairman: Welcome to the European Financial Affairs Sub-Committee’s inquiry into Europe’s economic and monetary union. You will have in front of you a list of Committee members’ interests. This is a formal evidence-taking session of the sub-committee. A full transcript will be taken. This will be put on the public record in printed form and will be on the parliamentary website. You will be sent a copy of the transcript, and you will be able to revise any minor errors. The session is on the record; it is being webcast live, and will be subsequently accessible via the parliamentary website. Mr Sandbu, Ms Henry and Mr Barnes, I will start the session with a general question, and Committee members will pick it up as they go along. Do not feel it incumbent upon all three of you to answer every question. You bring varying strengths and experiences to the table, but do feel free to come in when you wish to say something.
I want to start by asking you for your assessment of the Five Presidents’ Report and the actions introduced in the short term as well as the longer term. In reflecting on that, I was hoping you would also think about the sustainability of the eurozone overall. I also ask whether, in the period referred to in the Five Presidents’ Report up to 2025, you see the eurozone still being in the form envisaged and as we know it today. I am going to start with Mr Sandbu. Would you like to take that up?
Martin Sandbu: Thank you for inviting me. The premise behind both the work happening in the eurozone on further integration and all the debates surrounding it is that the eurozone, or any monetary union, is unsustainable in its current form without a deeper fiscal and political union. That is the premise behind the Five Presidents’ Report, the further integration process and the official agenda of the eurozone.
I am in the minority of people who believe that that premise is false and that the eurozone’s economic stagnation has to do with unforced policy errors, partly awfully bad economic aggregate demand management and an unwillingness to countenance losses by creditors to sovereigns and banks, and that those were avoidable policy mistakes without which we would be in a much better place and would not need to talk about further integration of the eurozone.
Given the intellectual premise that guides the deliberations in the eurozone, the Five Presidents’ Report is where we are. A very brief assessment from my perspective is that, first, this is a committee work and, as such, it has some inconsistencies and infelicities. Let me mention just a few examples. There is a push for convergence. We are told about convergence between and within EU eurozone countries. It is said on one page that this does not mean everyone has to do the same but that they should all converge in terms of incomes, but a couple of pages further on it says there needs to be a definition of best standard policies towards which member states should be held.
There is talk of economic convergence within eurozone countries, which is linked to the idea of a social market economy, social Europe and so on. At the same time, there is a focus on competitiveness, which seems to be defined as reining in labour costs, i.e. lower wages, and it is hard to see how that is compatible with what they also call convergence within countries. Therefore, there are a number of inconsistencies and ill-defined and ill-thought-out concepts.
Another point is that, to the extent there is sharp substance in this, I think everyone is better served by reading some of Mario Draghi’s speeches rather than the Five Presidents’ Report itself, because the main ideas really come from there. I would commend to you Draghi’s Helsinki and Sintra speeches on the need for centralised power over structural policies in the eurozone, and his Jackson Hole speech from a while back on the need for a common fiscal stance in the eurozone, which he has not really talked much about since. Those are the two chief ideas in the Five Presidents’ Report.
I think the need for a common fiscal stance for the eurozone is a very good idea. I think the need for convergence in structural policy, which, despite some of these inconsistencies, really means that countries should be held to similar policies, is a bad idea, in part because we do not know very well what sort of structural policies lead to growth, and because the policies that are right for an individual country will differ from those that are right for a different country.
Janet Henry: On the first point, I have a slightly different take on the source of the problem. It is much more basic and one that I think we are all very much aware of, namely that the euro was a political project to start with. It was never an optimal currency area and there were always going to be problems, and now we need to come up with a political solution. That is what is set out broadly in this report. My assessment of this report is that it is a continuation of the previous Presidents’ reports that we have had over the course of the past few years, which in many ways were insisted upon by Mr Draghi, to take up Mr Sandbu’s point. He was the one who originally asked for a road map towards future integration to give him the cover to deliver much more monetary stimulus and address some of the systemic risks to the eurozone.
The report sets out what needs to happen. The bigger question is whether it is ever capable of being delivered, especially given that it will require treaty changes and in turn referenda in certain countries. I am sure we will come on to some of those issues.
In terms of recent initiatives and the European Commission report, the initial step towards a common fiscal stance is critical to all this. It feeds through into the issue of the longer-term sustainability of the eurozone, which was the question you asked at the beginning, because it seems to me that everything is quite path-dependent. If, over the next decade, we were still to have a very strong global economy, there is some hope that the eurozone can export its way out of some of its current problems, but at the moment I still think that, without central fiscal co‑ordination that takes a view of the whole eurozone, rather than allowing national Governments to run fiscal policies that are not necessarily consistent with the needs of the eurozone as a whole and can have negative spillovers, we will be at risk of exerting some longer-term deflationary pressures on the eurozone. We will go into this in a little more detail.
Q28 The Chairman: Mr Barnes, I know that you are speaking today in a personal capacity, but could you also comment on the OECD’s Going for Growth, which is supposed to explain what kind of structural policies are needed?
Sebastian Barnes: I will turn to that last. In terms of my own comments—here we have three economists and three opinions—and coming back to the original question, the most likely scenario for the euro area is to continue essentially muddling through, which is what has been happening so far. That is really a path for steady decline, at least in relative if not absolute terms. Growth and inflation today are very weak. I expect growth to remain fairly weak in the medium term, based on the kinds of reports we see here. There is an obvious risk that a more catastrophic outcome could happen, but the central scenario based on this report is essentially to continue muddling through, because a lot of the fundamental problems of the euro area are not addressed in this report. For the short term, it is very weak, and for the long term there is lack of detail about how to get to its vision.
Starting from where Martin Sandbu was, I agree with him that moving to a centralised fiscal system is neither desirable nor feasible now, but one area where it is essential for the good operation of the monetary union to have greater integration is on the financial side. A huge amount of progress has already been made, but in my view the one thing of substance in this report is deposit insurance, which we have seen is a very live topic. That is essential for two reasons. First, the euro area crisis was essentially not a fiscal one in origin but a financial one; it was due to the build-up of excessive financial imbalances and debt in countries in the euro area. That in itself was linked to a lack of meaningful financial integration, so from a crisis management point of view this financial aspect deserves much more attention than it gets in this report.
Secondly, the real problem in Europe today is lack of growth, partly because Europe has a very poorly performing financial system, not just in the cyclical sense because of the credit cycle but also in the structural sense. Bank finance is still far too dominant, and in many countries far too limited. That is why I think this report is inadequate.
I will make two brief points, one on the fiscal side. The one substantive suggestion is the creation of a European fiscal board. I have some concerns about that, because the system is already very complicated, with many rules and many institutions. I do not see the value of adding one more, and I can expand on that later.
Another point Martin Sandbu made was about the impact of structural reforms being uncertain. Going back into OECD mode, I recognise that they are uncertain, but we do know a lot about them. We also know—this is very important—that the benefits of structural reforms depend a lot on demand conditions. Too often, particularly in the European context, it has been the view that structural reforms will somehow miraculously generate growth. They will over the long term, but we need the right demand conditions as well.
Q29 Lord Borwick: On the Five Presidents’ Report, there are many plans for the future of the euro area. What are the implications of them actually achieving it, for the non-euro area?
Janet Henry: I will start with a positive note on that. A prosperous eurozone is absolutely essential to the future prosperity of the UK economy. The truth is that 40% of our exports go to the eurozone. Therefore, if we can achieve a lot of the things in the Five Presidents’ Report and it can deliver a prosperous eurozone in the coming decades, that is something from which the UK can benefit in a very big sense. If the eurozone is going to go into a continued very weak growth environment and this is the best of the recovery, that will be a permanent drag on the outlook for UK external demand at a time when UK growth is very unbalanced. The size of the current account deficit is at record levels, and that will deliver some negative implications over the longer term. That is one of the implications. One of the other ones in the latest report of the European Commission is the need to speak with “a common voice”. One clarification they made was to say that this refers to the eurozone rather than the EU, so presumably this would not alter the UK’s role as a permanent member of the IMF board. It seems that we would still have that, and that goes along with sterling still being a reserve currency.
To pick up Sebastian’s comment regarding financial integration, this is something from which the UK economy, as an exporter of financial services and provider of financial services, would benefit as part of that integration process. But there are potential concerns—maybe that is a matter my colleagues can pick up—regarding the UK having a seat at the table and the ability to influence decision-making on eurozone laws that could impact the UK.
Martin Sandbu: Fiscal policy has spillovers across borders between countries that trade with one another, regardless of their currency arrangements. There is a spillover from the eurozone fiscal stance, and monetary policy for that matter, to Britain and other non-euro countries. If that stance is better, that is probably a good thing, so, to the extent these proposals will lead to getting the overall fiscal stance to a more optimal point, that would be a good thing.
On the general move towards integration, to the extent it happens, the more policies you have in common and the more institutions you build to tie yourself together, inevitably the greater the community of interest that will grow around that, and that will alter the balance of power in the broader councils of Europe. It seems to me that that will inevitably lead to a loss of influence over European affairs across the board for non-euro countries.
Lord Lawson of Blaby: I am not going to comment on a number of the things that have been said. I would just like some elucidation. All three of you have said that what the eurozone needs are a common fiscal stance and financial integration. Can you tell me precisely what is meant by a common fiscal stance and by financial integration?
Sebastian Barnes: On financial integration, ultimately the eurozone should be going towards something that looks like what you have in one country: that is, common standards, common regulation, a common backstop and, more importantly, looking beyond regulation, a system that functions like it is one system. You would have some banks that would really be present in a meaningful way across the euro area. One of the big problems running up to the crisis was a lack of risk management. All the risks were concentrated in the same place. Irish banks basically lent to people in Ireland, so when the bubble burst in the housing market in Ireland all the risk was still in that country. If it had been diversified across the euro area, it would have made very little difference to anyone. That is what I mean by financial integration and financial development.
Q30 Lord Lawson of Blaby: I want to pursue this further. Financial integration means mergers of banks in different countries, so their lending is more spread out. I am not sure it would make a lot of difference. How do you promote that?
Sebastian Barnes: At the moment, there are lots of barriers to doing that, particularly regulatory ones. The steps that have been taken in terms of moving to a single supervisor make a huge difference, but an awful lot of regulations still stand in the way. One idea some people have promoted is to have a separate 29th regime where banks could incorporate at European level, and then you really would start to create European banks, because all the corporate governance and consumer protection regulation is very national-specific. That is why there are not many bank with branches abroad. Typically, when a bank moves across a border it will buy another bank, so it inherits all of that kind of stuff, but that limits this process. The regulator does not look at concentration of risk in this way, so there is a kind of distortion. If you are a perfectly diversified bank, you are treated in the same way as one having all its assets in the greater Dublin area. That does not make a lot of sense.
Lord Davies of Stamford: This one has been resolved by common supervision.
Sebastian Barnes: I think it goes a long way to doing that. Deposit insurance is one of the big steps that would be needed.
The Chairman: We are coming to that later in our discussion.
Sebastian Barnes: I disagree a little on the importance of a common euro area fiscal stance.
Lord Lawson of Blaby: What does it mean, anyway?
Sebastian Barnes: I guess the idea is that, in the same way in which you think about a country’s fiscal stance, there should be a decision in the euro area about whether on average across the euro area it is expansionary or contractionary.
Lord Lawson of Blaby: This is old-fashioned Keynesian policy, is it not? It is not what we do in this country. What the Government are concerned about—it is particularly difficult to know what the Labour Party believes at the present time—is to reduce the deficit. It is not manipulation in the old-fashioned Keynesian way, which never worked anyway. That is where you are, and that is the view of the authorities in the European Union.
Sebastian Barnes: There is also a distinction between discretionary policy and the automatic stabilisers.
Lord Lawson of Blaby: We are talking about discretionary policy.
Sebastian Barnes: I think that distinction works very nicely in the textbook, but in reality it is very hard to distinguish between those two things.
Lord Lawson of Blaby: No, it is not. I have done it.
The Chairman: Let us hear from Mr Barnes.
Sebastian Barnes: However one defines it, I do not think a common fiscal stance is really necessary. In normal times, monetary policy should provide area-wide macroeconomic management, and fiscal policy is, as I think Lord Lawson is advocating, essentially setting a medium-term path and allowing the automatic stabilisers to work around that. You do have exceptional times, of which this is one, and maybe you want to do something different, but I am not sure that needs to be hard-wired into the legislation.
The real issue is about spillovers from one country to another. There are two types of spillover. There is the Greece-type spillover, where you run policy very poorly and that leads to a systemic crisis. There should be something in place—regulations, mechanisms and co‑ordination—to stop that happening. On the wider spillovers between countries, it is very hard to manage it at a common level. If every country acted in its own interests in the same way you would not need this, but, moving beyond that, it is really an issue of macroeconomic imbalance, not fiscal policy per se. It is very challenging in practice to have any kind of co‑ordination on this.
Janet Henry: Maybe “common fiscal stance” is the wrong expression; it is much more about a co‑ordinated fiscal stance, and the risk of negative spillover effects is one reason why a co-ordinated stance is needed. Even if we think about what the eurozone looked like before the crisis, to some degree there was a free rider problem, because everyone benefited from Germany’s very strong credit rating and the fact that just before the crisis it was in a much stronger fiscal position. Then we had the sovereign crisis; now we are in a QE world, and fiscal dynamics are not driving market implications to the same degree they did before the crisis.
As for the need for a common fiscal stance, there is a set of European rules regarding deficits and debt burdens. Governments typically find it difficult to stick to them. At the same time, some Governments, such as Germany’s, have a national rule to run effectively a balanced budget. Germany running a balanced budget, rather than perhaps a looser fiscal policy in a way that might lower its current account surplus, which could be more beneficial to the rest of the eurozone, you could have a different policy mix within the eurozone. Therefore, a lot of what is needed is just co‑ordination of fiscal policies across eurozone member states so that they think about growing the whole pie rather than having a deflationary influence on the rest of the Eurozone by the actions of one government.
Martin Sandbu: I agree that we should speak of it as a co‑ordinated and not common fiscal stance. I agree it is not necessary, but it would be economically beneficial because it would allow you to get an optimal, or closer to optimal, fiscalmonetary policy mix. That is why Draghi called for it in his Jackson Hole speech two years ago, because he perceived, as many other monetary policymakers did, that he was running out of monetary road and so monetary policy could not take the full burden of increasing aggregate demand in the recession in which the eurozone found itself at the time.
On financial integration, I agree that the key is risk-sharing or risk dispersion. The comparison with the US is very often made. In the US, about 80% of regional or local GDP shocks are spread out before they hit local consumption; in other words, local consumption varies only by about 20% of the size of local GDP shocks. Most of that—some 60% or three-quarters—of the total smoothing happens through private financial channels, not through fiscal risk-sharing, which is why I believe it is a mistake to think that the eurozone needs large fiscal risk-sharing in order to survive. It could do what the US does, which is to have large private risk-sharing. It means that, regardless of the details of how, investors or private agents in one country are exposed to the GDP of another country. It is as simple as that. There are a lot of ways in which you could imagine that happening, and I do not think policymakers should necessarily have an opinion on which way is best. Surely, one crucial precondition for that is that investors do not fear that the currency will be redenominated, in which case you have absolutely no incentive to stay exposed to a country that might leave.
Lord Butler of Brockwell: I want to follow up with Janet Henry and Martin Sandbu a question that Sebastian Barnes answered. You have talked about the importance of a co‑ordinated fiscal stance and greater financial integration. On the basis of your assessment of the realistic prospects of those things, do you expect the economic and monetary union in 2025 to be muddling through in the way Mr Barnes suggested it would, or not? What do you expect will have happened to the eurozone by 2025, on the basis of your realistic assessment of how likely the necessary conditions for it will be achieved?
Janet Henry: I broadly agree. Ten years from now, I would expect the eurozone still to be muddling through. We will probably go through renewed signs of strain, and often it is signs of strain that will take us to the next stage of integration. There might be some political difficulties along the way. It is not just the fear of catastrophe that can be used to take us forward; we will need to have a more positive narrative about the reasons why the eurozone works better together going forward. It will require much more work in a lot of circles. I think that at the moment, while they are coming together with the reports, there is still a sense in Europe that what is set out in this report will not be easy to achieve. Perhaps some may be hoping that they will not have to go the full distance on a lot of these because we will be able to muddle through without new signs of strain. Ultimately, I think we will still be muddling through.
Lord Lawson of Blaby: I was interested in the parallel Mr Sandbu drew with the United States. It is very useful because that is an example of a large monetary union, if you like, but the fiscal thing that is important in the United States is that it is not a common fiscal stance. What is important is that federal taxation and expenditure are both key: in other words, there is a common fiscal policy in the sense of revenue and expenditure, and many people might think that needs to happen to make a success of European monetary union. You talk about a common fiscal stance in a neo-Keynesian way. I think Keynes would have rejected it altogether, but you do not mention what really matters: fiscal union, which is what the United States is, as well as monetary union. I am just surprised.
The Chairman: Very briefly, Mr Sandbu, although you will be able to pick up some of that as we go on.
Martin Sandbu: The large federal budget in the US has three economic functions. First, it ensures a fiscal common stance to the extent that is a share of the economy. Secondly, it does fiscal risk-sharing to some extent—that is to say, transfers from those having a good time to those going through a rough patch, but over time that is revenue neutral. The third function is fiscal redistribution from the rich to the poor, which can be a permanent redistribution. I think the economic arguments for the sustainability of the monetary union relate to the fiscal stance and fiscal risk-sharing. As to permanent fiscal redistribution from rich to poor, there may be an issue about political sustainability of monetary union. I do not think there is a good economic argument that redistribution from the rich to the poor is necessary.
Of course, the US had a functioning monetary union for a good 150 years before it had much of a federal budget at all. As late as 1936, the federal budget was about 5% of GDP, and that was with the New Deal spending. It was really the war and the Great Society afterwards that created the federal budget we know today.
Q31 Lord Davies of Stamford: There has been quite a wide disparity in the economic experience over the past few years of eurozone countries. Some of them are doing very well. Obviously, Germany and the Baltic states are doing pretty well; Spain and Ireland, two of the bailout countries, seem to be doing rather well. Others are doing much less well. What conclusion do you draw from this disparity in terms of the structural nature of the economies, or the fiscal policies being pursued, or the extent to which markets have been liberated and deregulated? In your view, what explains this very different performance?
The Chairman: Mr Barnes, we have already covered a bit of the Irish situation. Do you want to pick up one or two of the key points?
Sebastian Barnes: Frustratingly, in each case, there is a specific set of reasons, but I think there are some general points that you can draw out. One is the way that fiscal consolidation was managed. Countries that did it early and credibly in a neat way got a lot of benefits. For example, Ireland was relatively ahead of the curve. You can see that the market interest rate fell much faster than in some of the other countries that struggled to get there. Therefore, having sound fiscal institutions that can deliver is very important. The state of the financial sector has been critical and that is holding back a lot of countries, and that is partly to do with how rigorously the financial system has been cleaned up. Ireland did not get it right first time, but eventually it had a very comprehensive solution, which has been helpful.
The final and perhaps most important thing is the inherent capacity of the economy to grow and particularly to export. Ireland’s export performance has been extraordinary, partly through good luck but partly because it managed to restore competitiveness very quickly. Wages were cut. It is basically an attractive economy to be located in. People are dynamic and well educated, and it is a good place to do business.
In other countries, some reforms have been helpful. Spain’s export performance, despite many headwinds, has been very successful as well, which I think points to some sound economic fundamentals. Spain also carried out important labour market reforms, which, although against the backdrop of very high unemployment, came at the right moment in encouraging new hiring as soon as demand came back. External demand started driving it. Those are some of the common factors.
The Chairman: Ms Henry, I ask you to respond only if you disagree with what has been said.
Janet Henry: I draw a comparison with what it means for the rest of the eurozone. We have to bear in mind that Ireland had about the most flexible labour market in the eurozone before the crisis. It was because of that flexibility in the labour and product markets that it was able to undergo the internal devaluation that made it regain competitiveness quite quickly. I think that, when the crisis first hit, fiscal consolidation was perhaps less important; it was much more about being able to regain competitiveness. Ireland has a unique structure with a massive US dollar-based export business and a high exposure to the UK and US, which obviously had a strong recovery. In the case of Spain—
Lord Davies of Stamford: Greece undertook very considerable internal devaluation. That did not produce the same results.
Janet Henry: But Ireland had a massive export sector as a share of GDP, whereas in the case of Greece it was largely oil-related in terms of products and tourism. It was not able to benefit in terms of export markets, nor did it have flexible labour markets.
The Chairman: You were going to talk about Spain.
Janet Henry: You need to view Spain’s recovery in the context of the recession that preceded it. Looking at the eurozone today, the aggregate is still not back at pre‑crisis levels. The level of GDP is still below pre‑crisis levels. Spain’s level of GDP is still 5% below pre‑crisis levels because it had such a deep recession. That is not to downplay the structural reform efforts put in place by the Spanish Government to liberalise the labour market, with wage indexation and so on, and to make the labour market more flexible, but it still has over 20% unemployment. This is where a fiscal role for the eurozone could come into play. I think there would be big objections to permanent fiscal transfers, but there could be an element of a fiscal stabilisation fund which rewards countries delivering reforms, because that was the way the peripheral programmes like Ireland’s and Portugal’s worked. When they were in the adjustment programme and given financial support, they delivered the structural reforms, whereas perhaps some of those countries with bigger structural problems have delivered a lot less on the structural reform front over the course of the past couple of years.
The Chairman: You are talking about a kind of EU Marshall plan.
Janet Henry: There are elements of similarity.
The Chairman: I want to bring in Lord Haskins and then Lord Skidelsky on implementation of EU rules.
Q32 Lord Haskins: The eurozone had rules right from the beginning. The problem is that local politicians have chosen to ignore them or not apply them. At the beginning, in the setting up of the eurozone, there were some pretty credible criteria for countries joining it, which were immediately ignored in two or three cases at that time. On the stability pacts, some quite sensible disciplines were to be applied, which again were ignored even by the French and Germans. First, if those rules had been applied properly, would we be in a different position? Secondly, if those rules were inadequate, will the new rules be any better, and will they be implemented?
The Chairman: Mr Sandbu, of course that is relevant to your book.
Martin Sandbu: The stability and growth pact consisted of rules that were bad but toothless. After the crisis I think they have been made worse but given teeth. There would not have been much difference, even if the fiscal rules had been stuck to, because most of the crisis did not involve a fiscal crisis. There was the Greek case, but of course Ireland entered the crisis with a public debt to GDP ratio of about 25%; Spain was at 36%. They were well within any of the rules.
I do not think it would have been much better. The problem now is that the rules are a little more binding but not necessarily better; they are probably worse, in that they do not allow for an appropriate overall co‑ordinated fiscal stance where those that have to cut, cut, but those who do not can expand to keep overall aggregate demand adequate.
Lord Davies of Stamford: I did not think it was the first time they had these structural and cyclical deficits.
Martin Sandbu: Indeed, and that is one illustration of how there is quite a lot of interpretive room for manoeuvre inside the rules. We see that with the Commission communication back in January on how it would interpret the rules in light of structural reforms being undertaken, and so on. It is quite clear that, if you look at the letter of the rules, there are many ways to judge what count as the correct policies towards these medium-term objectives. Indeed, one could imagine a much more traditionally Keynesian interpretation that the goal of the rules is to make it sustainable in the medium run. You do that not by squeezing GDP but getting growth going, and that means increasing the deficits before cutting them harsher later. That is, logically speaking, quite consistent with the rules, but that all depends on the politics. That is why—to pick up Lord Butler’s question—policymakers will muddle through, but that is not necessarily a bad thing and, depending on the politics of whoever is in power five years from now, things might be practised in quite a different way.
Sebastian Barnes: The way the question was posed was: would things be different without the rules? I think things would be worse without the rules. I think they increase the focus on sustainability, and in the current period, since the “Six-pack”, “Two-pack” and Fiscal Compact, governments are taking them more seriously, partly because they see they have more teeth. However, the rules are essentially a mess; they are very complicated and in parts poorly thought-through, and that raises a question about sustainability of the rules going forward. It is the experience of advanced economies that when they have a downturn and the deficits blow out, and then governments tend to close the deficits. The problem is that they do not move towards surplus in the upswing. There has been an increasing debt trend in basically every developed country. If you want to reverse that, fiscal discipline has to apply in the good times. There is a risk that, because of the flaws in the rules, in good times they will be ignored again and ineffective. That is partly because there are political pressures to ignore them, but also because the economics of the rules are sometimes very hard to defend.
To come back to the point raised by Lord Davies, although it is now based much more on the concept of structural balance, the measurement of it suffers from very severe problems. It suffered very severe problems before the crisis. The only two countries that have consistently met those kinds of requirements were Spain and Ireland, but we all know now that that was unsustainable, and essentially the Commission has not made any changes to the methodology that led to that. They use a measure of potential output that is incredibly cyclical. That will give misleading signals in bad times when it requires countries to consolidate. Therefore, if they get hit by a negative shock they should allow the automatic stabilisers to work, but the structural balance will go into massive deficit and then government have to take pro-cyclical corrective action. In good times, even though the situation is unsustainable and governments have lots of cyclical revenues, the structural balance measure will tend to tell you that things are fine, and many governments will settle for that.
The Chairman: Should there be better rules to deal with the good times to direct Governments in the good times?
Sebastian Barnes: I think one of the most positive developments is away from these headlines. One relates to having better statistics. It is not a very exciting issue, but it would be important in the case of Greece, for example. Much more substantially, the development of national independent fiscal councils—I sit on one—is a very positive development, because essentially you need a culture change. You need real ownership of the public finances to counter the short-termism that can emerge within the political system. In my experience at least, that seems to be a very promising way of getting a culture of thinking about the public finances in the medium term, which is what you need. They have to be careful that the rules do not interfere with setting good policy, and they can support it.
Janet Henry: I completely agree with what Sebastian has said, but I would add a point regarding the sanctions procedure. This relates to enforcement. The eurozone has chosen to have a sanctions procedure but it has never imposed one, which means that the rules themselves lack credibility. It is not just the fiscal rules but the macroeconomic imbalance procedure and the asymmetric way in which it is applied, which is: deficits bad, surpluses good. Therefore, a current account deficit of 4% of GDP is considered to be a problem, but a current account surplus has to go beyond 6% of GDP before it is considered a problem. Germany running on an 8% of GDP surplus has not been heavily criticised, or been the subject of action to address it. I agree there needs to be rules. Things might have been worse without some of the rules, but they need to be sensible and credible.
Q33 Lord Skidelsky: Can I pick up the current macro-imbalances? One of our witnesses talked about a mercantilist German core and the deflationary impact of that. Of course, the use of the word “mercantilist” is interesting, because it was the chief aim of the mercantilists to run a permanent export surplus, which David Hume, in a famous essay on the balance of trade, said was self-defeating, but that seems to be the German aim. Of course, in a fixed exchange rate system, the adjustment mechanism is somewhat different, but the question I want to ask you is: do you see any chance of Germany’s current account surplus disappearing over the medium term?
Martin Sandbu: I would like to make two points in answer to that. One is that current account asymmetries, as I prefer to call them, can often be a very good thing. It makes perfect economic sense for an ageing and rich country to export capital to a younger and poorer country, which presumably has greater potential for growth. The large current account surpluses and deficits in the eurozone in the run-up to the crisis were not bad in themselves, but they were bad because the capital imported in the periphery was badly invested or, in the case of Greece and Portugal, not invested at all but consumed. In Ireland and Spain, it was invested in houses nobody wanted. It is not necessarily the magnitude that is a problem but how it is used. I think the eurozone would be wise to try to return to a situation of permanent capital exports and imports, although perhaps not as large as they were.
In preparation for this meeting, I looked up the latest figure on the German current account surplus, or the trade surplus which largely accounts for it. The German statistical bureau has the January to September figures for this year. They show a surplus of about €186 billion. That puts them well on course to being a bit over 8% of GDP for 2015 as a whole. That is a very large surplus; it is the largest in the world in absolute terms.
Out of that, how much is with which group of countries? Out of the €186 billion, €130 billion is with countries not just outside the eurozone but outside the EU. This is part of the story that Germany has succeeded in selling a lot to China, for example. That leaves €55 billion of the surplus with the rest of Europe or the EU. Out of that €55 billion, how much is with eurozone countries? The answer is €6 billion out of €186 billion. Therefore, to all intents and purposes, the current account surplus with the rest of the eurozone has disappeared. Those people who thought that that surplus was a particularly harmful problem for the rest of the currency union should presumably say that the elimination of it has been a very good thing and a boost to growth on the periphery. I do not hear them say that. As I have just explained, I am a bit more agnostic about what these balances should be, but, to the extent that there was a problem, it is no longer there.
Lord Skidelsky: The fact that the imbalance with the eurozone has shrunk to €6 billion means that the capital exports increasingly go to the countries that are running balance of trade deficits with Germany. That means that you do not get the capital export mechanism in the eurozone that you were talking about earlier; in other words, deflation just goes on in a more roundabout way.
Martin Sandbu: That is the problem. I think the elimination of the imbalance is as much a problem as the existence of it. I do not think countries like Greece and Spain should be in current account balance; it would be good for them to import capital and invest it properly to grow faster.
The Chairman: I am going to turn to Lord Butler on financial integration, and in the few minutes left we will deal briefly with capital markets union. Would you speak to the question as briefly as possible?
Q34 Lord Butler of Brockwell: We touched on this a little earlier. What is your assessment of whether the three-stage approach in the Five Presidents’ Report, given that it is opposed by Germany, presents a realistic prospect of achieving financial integration?
Martin Sandbu: I do not think so.
Lord Butler of Brockwell: That is the sort of short answer we want.
The Chairman: We are talking here specifically about deposit insurance.
Lord Butler of Brockwell: That is one of the stages.
Martin Sandbu: To add one longer sentence, capital markets union matters a whole lot. That is not really a key point in the Five Presidents’ Report; it is mentioned. That is where the action really is, more than deposit insurance.
Lord Davies of Stamford: Is it going to happen?
Martin Sandbu: We are going in that direction, but, in terms of degree, there is a very long way to go. As I am sure you know, the financial systems of Europe and the US are about the same size relative to GDP. In Europe, three-quarters is bank lending; in the US, one-quarter is bank lending and the rest is capital markets. It is a very long way to go.
Lord Butler of Brockwell: Given Janet Henry’s position in HSBC, I would be particularly interested in her reply to this point.
Janet Henry: I just make the point that I sit in global research at HSBC, behind very strictly enforced Chinese walls. I am not a decision-maker at HSBC. I think it is an incomplete banking union if it does not have an element of common deposit insurance, but German resistance is clear, without certain prerequisites being in place. It certainly sees it as something that would require treaty change, and we all know that anything to do with treaty change will take a very long time to come through.
I think deposit insurance is quite critical at least to show there is something in place to deal with asymmetric shocks, or a shock within a country, in the eurozone. We cannot go back to the situation where one country with a massive financial or banking problem can shake the eurozone on the scale that we saw during the financial crisis. We probably will get some element of deposit insurance coming through, not to the full extent required. It will probably take 10 years before it is in place, and there will be some uncertainty in the interim, but I agree with Martin that it is the capital markets union that is more important.
Sebastian Barnes: My response also spans Lord Skidelsky’s question as well. A key issue is that countries that run very large surpluses feel that they are in a much stronger position than those that run large deficits. Germany has done very little in terms of reform in recent years. Some of the reasons it has an excessive current account surplus are to do with the lack of reform and the structural features of its economy. While its economy has been performing very well it sees very little need to engage with these kinds of processes, although its financial system is not as great as one would expect it to be. Maybe in a different conjuncture, Germany will see the benefits of co‑operating more clearly than it does today.
Q35 Earl of Lindsay: You have just said that capital markets union is of greater importance. Do you want to expand on exactly why that is?
Martin Sandbu: In my view, it is because the more equity-like your financing, the more you can expect that the investments will take proper account of the risks involved, and the easier it is to deal with them in a crisis where bad risks materialise. There is an interesting comparison to be made between Greece and Bulgaria, which had a much larger current account deficit than Greece but had a sharp but short crisis. Its current account deficit was financed through direct foreign investment—actually, not portfolio equity—but the point is the same. Debt is problematic; bank debt is even more problematic. It is very hard to deal with if something goes wrong.
The key to capital markets union is that capital market debt is more like equity than bank debt, and capital market equity is equity and that is a better way both to direct investments and resolve failed investments.
Janet Henry: I would agree with that, but a lot needs to be put in place before you can have a fully integrated capital markets union, especially as a lot of it is aimed at improving finance to SMEs. To go back to Martin’s point, only about 10% of US corporate finance is provided by the bank lending and nearly 90% of eurozone corporate finance is provided by the banking system. If you are going to have cross-border capital market issuance, you have to have common schemes for things like insolvency. You may even need common taxation of savings and investment instruments. It will take a long time to put this in place, but it is about spreading economic risk across the eurozone. It still poses questions regarding financial stability risk. There is still a role for financial sector supervisors and banking supervisors that would need to be put in place. We saw what happened even in the US where they have very large capital markets. It did not mean that there was no financial crisis; it was just not as concentrated perhaps in the banking system.
Earl of Lindsay: Will it be achieved?
Janet Henry: Will capital markets union be achieved? I think we will see progress on capital markets union. I am a bit more optimistic about the speed of progress on capital markets union. A lot of work has been done on this and there are very clear ideas of how it should happen and what needs to come into place. There is perhaps less political resistance to it than to some of the fiscal integration issues.
The Chairman: On that optimistic note, thank you very much indeed, Mr Barnes, Ms Henry and Mr Sandbu. This concludes today's first public evidence session.
Examination of Witness
Henning Christophersen, Senior Partner, Kreab, and former Deputy Prime Minister of Denmark
Q36 The Chairman: Good morning, Mr Christophersen. Welcome to the European Union Financial Affairs Sub-Committee’s inquiry into Europe’s economic and monetary union. We are delighted to welcome you here. You are former Deputy Prime Minister and Finance Minister of Denmark. It is our pleasure to have you giving evidence to us. You have a list of interests that have been declared by Sub-Committee members. This is a formal evidence-taking session of the Sub-Committee. A full transcript will be taken. This will be put on the public record in printed form and will be on the parliamentary website. You will be sent a copy of the transcript, and you will be able to revise it in terms of any minor errors. This session is on the record and is being webcast live, and it will be subsequently accessible via the United Kingdom parliamentary website.
In starting this session, what is your assessment of the Five Presidents’ Report? Could you also give a general evaluation of the sustainability of the eurozone? We know that the Five Presidents’ Report envisages a series of stages leading up to 2025. Could I ask you whether you think the eurozone will survive in its current form?
Henning Christophersen: First, I would like to thank you for the invitation to attend this meeting and be a witness. For me, it is a great privilege and pleasure, as I hope it is for you, but let us wait and see.
I have read the report from the presidents: Mr Schulz, Mr Juncker, Mr Draghi and Mr Dijsselbloem. Some work still has to be done; it is only the very beginning of a long process. They foresee that what they have outlined as options should be finalised around 2025. They do not speak about changes of the treaty, but I could come back to that question at a later stage.
I think they have divided their options into four parts. First, they want member states to improve convergence and the structures of their economies to bring them closer to one another, and improve employment and things like that. In the next step they speak about how to establish a genuine financial union with integrated finance for an integrated economy. The third part speaks about the need for better fiscal union. There are many different options in that chapter, because better fiscal union also means you will have to converge the fiscal legislation of the member states. One example is to create a common basis, not necessarily a common rate, for corporate tax, and that part has been a little actualised by all the discussions we have seen about how some member states have tried to circumvent the good idea of having genuine fiscal union by giving special treatment to certain companies, mainly from third countries.
Finally, there is the whole question of democratic accountability, and that could lead to a long discussion. I am ready to go into that, because I do not think you can do all these things without changing the way the institutions are working. In the first instance, the Presidents are proposing an inter-institutional agreement, but I think that after 2025 we would have to see how this could be transformed into amendments to the Treaty of Rome. That itself is a difficult matter. Does it mean that the EMU is a separate part of the treaty, or is it open to everybody? We could come back to that.
I still believe there are a lot of issues they should have addressed, but for political reasons they have not done it. There is the whole question of the budgetary consequences of their proposals. Should there be a separate budget for the eurozone? That is what some Governments have in mind. Who should take care of that? Today, the eurozone does not have a separate budget. Some smaller expenses are paid out of the general budget because the Commission is doing work as part of the troika, but it cannot go on like that. If you really want to have more substantial financial support for member states encountering difficulties, you need a separate budget, and what will be the institutional consequences of that? That is one more thing they have not addressed.
Q37 The Chairman: We will pick up several of those very interesting things you have pointed out as we go through the session.
In light of the fact that the United Kingdom and Denmark are in a very particular situation given the eurozone, what are your views on the implications of the proposals in the Five Presidents’ Report for these two countries in particular?
Henning Christophersen: There are three opt-out countries. Two of them, the UK and Denmark, have a protocol, and then we have a de facto opt-out country, Sweden. Sweden has decided to have a floating currency. If you have a floating currency rate vis-à-vis the euro, you cannot join the European exchange rate mechanism for two years, and, if you have not done that, you are not eligible for the EMU. Therefore, we have two legal and one illegal, if I may use that expression, opt-out countries. I am half-Swedish, so it is not a chauvinist remark. The Swedes have been very clever in the way they have been doing this. The Commission could have taken Sweden to the Court of Justice and said this was a violation of the treaty, but they have not done so for political reasons.
So there are three opt-out countries, but ones with different consequences. My country has decided to have a fixed currency rate vis-à-vis the euro. I introduced that myself in 1982 when I was Minister of Finance. I think Lord Lawson will remember that. We decided to have a fixed rate vis-à-vis the ECU, as it was called at that time. Later on it became the German mark, and finally it became the euro. Therefore, the Danish currency can deviate from the central rate of the euro by only 0.3%. That is not very much, but they have been able to stick to that. They have a special arrangement with the ECB whereby the ECB is obliged to intervene in favour of the Danish currency if there are problems. There are no problems for the time being. On the contrary, there has been a huge inflow of foreign currency into the Danish central bank. At a certain moment in the summer our currency reserve was about 750 billion Danish crowns, which is €100 billion. That was because some people in the capital markets thought that, after Switzerland left the fixed rate vis-à-vis the euro, Denmark would do the same, but the Danish central bank, with full political support by all parties, decided to stick to the ECU system we established in 1982. So the fixed exchange rate for the Danish currency vis-à-vis the euro is the anchor of Danish macroeconomic policy.
In Sweden you have another kind of opt-out. They are using the currency rate, but, at the same time, the inflation rate as the guiding principle for monetary policy, and the UK has a third way of handling these things. So it is very difficult to say that these three countries are on the same line. That is not the case. Denmark is in theory an opt-in country; Sweden is a stay-as-we-are country; and the UK is perhaps an opt-out country. I do not know. I will not make any remarks about the upcoming negotiations between the EU 27 and the UK, but you cannot really compare the three countries. In Denmark my compatriots are satisfied with the present regime, and they want a strengthening of the macro-economic programme for member states. They have no problems with the present situation.
The Chairman: Coming to the politics of it, particularly given what happened in last week’s Danish referendum on justice and home affairs, are you able to say briefly whether you think that the Five Presidents’ Report in any way threatens Denmark’s interests?
Henning Christophersen: It was not discussed at all. The Danish referendum was mainly the result of a discussion about the interpretation of the Danish constitution. What are the rules for the transfer of sovereignty to the European Union?
The Chairman: That is a very active question in Denmark, is it not?
Henning Christophersen: It has become so, but now you see that most of the political parties, also the No parties, are trying to find out how Denmark could still stay in Europol and use 21 of the legal Acts which are part of the home and justice chapter. The UK is using more than 130, so the UK is much more European than Denmark in this respect, but we will wait and see. The Danish Prime Minister will be in Brussels on Friday to discuss these matters with Mr Tusk and Mr Juncker. I will be there on Friday and will have a talk with these people to find out what will be the road for the Danish Government. It is a very difficult situation, but it is mainly a question about the interpretation of the Danish constitution.
Q38 Lord Lawson of Blaby: First, may I say how good it is to see you again, Mr Christophersen? We have known each other for a long time. I think it was more than 30 years ago that we sat alongside each other in the ECOFIN council meetings when you were the Danish Finance Minister, so it is good to see you again. There is a widespread belief, which I think is correct, that the European Union has a bureaucratic surplus and democratic deficit. I would like to focus on the democratic deficit, because this will become more acute if the integration path of the eurozone countries is pursued as the Five Presidents’ Report and many other people in the European Union would like to see. What do you feel needs to be done to create some kind of democratic accountability to overcome the problem of the democratic deficit?
Henning Christophersen: Now I will say something you cannot find in the report. I think it will be necessary at a certain moment to make the Euro Council a genuine European institution, subject to the supervision of part of the European Parliament where members come from the euro countries. You need to separate the work of the Commission and transfer the euro-related work to the secretariat at the Euro Council, because it is strange that for the time being euro bailout countries are under the supervision of a Commission that also represents non-euro member states. In my view, you need to split the work of the Commission and transfer the euro-related work to a secretariat of the Euro Council, which should be made a genuine institution subject to the supervision and control of that part of the European Parliament that is elected by the euro countries.
Lord Lawson of Blaby: I am not quite clear. By “Euro Council” you do not mean the European Council, but something that does not exist as an institution.
Henning Christophersen: Yes, as long as they discuss euro-related issues. There are many other issues that have to be discussed by all 28 member states.
The Chairman: Another of our witnesses has raised that option. The big question that arises there is that, if you are setting up different institutional structures for the eurozone, in terms of the eurozone budget should you have non-eurozone countries contributing to run those institutions?
Henning Christophersen: No. I think the eurozone countries and the Euro Council, as an institution with its own secretariat under the supervision of the elected eurozone members of the European Parliament, should have its own budget. That is what Mrs Merkel and President Hollande are speaking about. You need some substance, and you cannot continue with the present methodology where you spend part of the EU budget that is financed by everybody on euro countries. We have seen that. It is not much; it is about €20 billion in guarantees, but you have to separate these two things. Then there will be no problems with the opt-out countries.
Lord Lawson of Blaby: But there might be another problem. I am not sure I fully understand what you are proposing, but it looks rather more like a duplication of bureaucracy than the introduction of democracy.
Henning Christophersen: No. “Bureaucracy” is a strange word to use. You can have an efficient or an inefficient bureaucracy. Many years ago Reich Chancellor Otto von Bismarck was asked, “What do you think about the bureaucracy in the new countries you have taken on board?”. He said, “I will tell you one thing. If I am told tomorrow that the end of this world is very near, I will without any hesitation move to Mecklenburg because I know that everything of importance for Mecklenburg will happen with a delay of at least 100 years”. You can have inefficient bureaucracy, but I know the ECOFIN council very well and that part of the Commission is working. I have some good friends who are working in the troika system. We must no longer call it the troika system; the Greeks do not like it. Call it the inter-institutional system. The Commission is working in a strange way on this, because it is a combination of a Commission service, which is a service for all 28 member states in agreement with the IMF, where you have many other countries involved, working on the euro countries. My view is that that is not sustainable. You must have a separate bureaucracy, if you call it that, working efficiently on the euro countries, with the necessary machinery, financed by a separate budget for the eurozone. That budget must be approved by the European Parliament and the Euro Council, and they must have their mandate from national parliaments to do it. In my view, that is the most logical way out of the present mess. I do not know whether you should put “mess” into the record.
Lord Lawson of Blaby: Oh, yes. It is a four-letter word, but it is acceptable.
Q39 Lord Shutt of Greetland: How do you think the current economic prospects and problems of individual countries impinge on the plans for further reform of economic governance set out in the report? In addition, we had a trio of people before us a few months ago and one thing they kept saying was that the euro would muddle through. Is it your view that the euro will muddle through in respect of all the euro states?
Henning Christophersen: It will continue to exist. The rate of the euro vis-à-vis the dollar and other main reserve currencies has not really been affected by the euro crisis. It has to a certain extent been affected by the move by the ECB to loosen monetary policy, but it has not really had an impact on the rate of the euro. It is clear that there are big differences we have to overcome between the rate of unemployment in the euro countries and non-euro countries. In my country it is on its way down; we have reached 6% unemployment for all registered people. In some other countries it is much closer to 25%. Youth unemployment in Spain is 30% or 35%, and it is the same in Greece. You cannot continue with that big difference and lack of convergence. That has very much to do with the completely different systems of labour legislation. It is extremely difficult in France to dismiss people and for a company to reduce employment. We have seen the problems with ferry boats in the channel. One victim was the Danish shipping company DFDS. Finally, they were allowed to buy it but it cost them a lot of money. There are other problems in France that have a big negative impact on the willingness of foreigners to invest in that country. It is different here in the UK and in Germany. In Denmark you can dismiss people from one day to another. You can give them a letter on Friday afternoon saying, “Don’t come here any more; goodbye. See you when we need you”. That has been accepted because we have a rather generous unemployment benefits system. Therefore, the state is financing a large part of the costs of the dismissal of people, but in other countries you do not have that system.
You also have different tax levels and the age at which you can get your pension. In France, for some jobs—locomotive drivers—you have the right to draw a pension when you are 50; in Denmark you must be 67. I do not know what it is in the UK, but the report points out lack of convergence as an important area where we should start work, and then we can see how we can strengthen the financial and fiscal parts of the Union. The fiscal part is very, very difficult. I was a member of the convention and praesidium for the Lisbon treaty, together with John Kerr, Valéry Giscard d’Estaing, Giuliano Amato and others, in what finally became the Lisbon treaty, which was also ratified by this House. For fiscal co‑ordination you need unanimity.
Lord Davies of Stamford: On your point about the widely varying unemployment rates in the European Union, it seems to show that the labour market is not clearing. You have 25% unemployment in Spain and 5% unemployment in Germany and Denmark. If those figures are correct, why does 25% of the adult population in Spain not move to Denmark, Germany or here, where there are lots of job vacancies? They are moving from Poland and Romania, but perhaps not from Spain. Why is that?
Henning Christophersen: I am chairman of a metro company. We are building metro systems, and for the time being we have projects to the value of €7 billion. That is going very well, but we have many Italian, Portuguese, Irish, British and French staff members. You have some linguistic problems in Europe that you do not have in the United States. That is one problem. We are spending millions of euros translating all kinds of manuals into 10 different languages: for example, Portuguese, English and Swedish.
There are also other traditions in some countries. In Spain, for example, young people stay at home and live with their parents. They feel they have an obligation to support their parents. It is not so easy to move away as it is in other countries. To be frank, if you go to Denmark, Sweden or the UK, perhaps taxation is lower and social benefits are higher, so in some parts of Europe there is an ambition to move. We do not have so many Poles in Denmark, but we have always had Poles, or people of Polish origin. We have for the time being 50,000 Polish workers. They have no problems getting a job because they are doing a lot of things Danish workers do not like to touch. You have the same situation in Germany. You have a lot of people from the former Yugoslavian Federation in Germany who are ready to do the work that Germans do not want to touch, because they prefer to work for Mercedes Benz or Volkswagen—or at least they preferred to work for Volkswagen.
Q40 Lord Borwick: There is a notable gap between the implementation of EU rules and the writing of them. That seems to have been the history for a long time, starting off with the euro, for example, and the introduction of Greece into the eurozone. How can you get the Governments of the individual states to stick to the rules they have agreed at European level?
Henning Christophersen: Now I will tell you one thing about the creation of the euro. I was responsible for the implementation of that part of the Maastricht treaty until January 1995. There was a very big discussion—Lord Lawson will remember it—between the French and the Germans. The French were in favour of something the Germans are now in favour of but at that time rejected. The French talked about the need for “gouvernement économique”, or economic government. They said it was not sufficient to have a central bank and common currency; there should also be a common fiscal and macroeconomic policy. That was rejected by the Germans. A good friend, Theo Vaigel, told me, “Yes, but we in Germany do not want the French and others to water down our strict fiscal policy; that is up to us to decide, so that must be done by each member state itself”. The French said, “No, it’s very important to have it”. Personally, Delors and I were in favour of continuing that discussion because we felt they had a point. It was not because he was French but we felt they had a point. They had a point because some years later Theo Vaigel said, “We thought that only five, perhaps six countries would join the euro from the beginning: Benelux, France, Germany and perhaps Denmark and nobody else. Now we have discovered that there are 11 candidates for membership because the Italians, Spanish, Portuguese and Greeks have decided to join, together with the Finns. How can we be sure that they will also implement the convergence criteria when they have joined? We must have a stability pact”. Therefore, Theo Vaigel and the Germans came up with the idea—but it was a little too late—of a stability pact. That stability pact did not have a very rosy life when Monsieur Chirac and Mr Schröder together decided to suspend the 3% deficit. In my view, that was a major catastrophe because it led my friends in the Netherlands, Belgium, Luxembourg and Finland to say, “If the bigger ones can do it, we can also do it. Why should there be this difference between big and small countries?”. I think it was one of the errors of the construction of the euro that there was no genuine concept of the development of a real financial and fiscal policy.
Lord Borwick: But will this change in the future? Will countries in future stick to the rules that are being produced now?
Henning Christophersen: That is what they propose in the report. In 2025 the four pillars should be established: better convergence; better financial union; better fiscal union; and then better democratic accountability. They do not say it in the report, but the logic of it is that by 2025 at the latest it would be a good idea to make treaty changes that can live up to these promises. You should not underestimate the importance of changes in the treaty. All member states are following the treaty every day. We accept the ruling of the Court of Justice of the European Union. We normally follow the decisions taken by the Competition Commissioner, even if they go against the national interests of our country. So I think there is a good chance, but it must be possible for the Commission and Council to implement these things. That is where the role of the Euro Council comes in as an institution. Today we should not forget that the Euro Council is only an informal group of countries. It does not really have a role in the treaty. It is a group of countries working together, but it does not have the role of an institution.
The Chairman: What you are saying is that, for economic governance to work as envisaged by the Five Presidents’ Report, the report is pointing implicitly, not explicitly, to separate eurozone institutions.
Henning Christophersen: Yes. I think that the result will be a two-layer Union, but we should not forget one thing. With the exception of Sweden and the UK, all the other countries want to join the eurozone. We will see if the new Polish Government will stick to that position and Mr Kaczynski will accept the commitment made by Mr Tusk. The personalities are perhaps not on the best speaking terms, but let us forget about that. So far Mr Kaczynski and his party have not said they do not want to join the euro.
Q41 Lord Butler of Brockwell: May I ask you about financial integration? Do you think that the three-stage process in the Five Presidents’ Report towards banking union is a realistic proposal, particularly given the opposition of Germany?
Henning Christophersen: The first two stages have been implemented. There is better supervision, and part of that supervision is done by the European Banking Authority located in the City of London. If my British friends had followed my advice when we discussed the Maastricht treaty, the UK could have got the ECB located in London, but there was no interest in that. I said to Lord Lamont, “It is an option. I think you should look at that. We could move the ECB to London. It would be better to have it there than in Frankfurt. In London they could do the interventions, and it would have a much bigger impact on the financial markets of the world to have the ECB here rather than in Frankfurt”. But it was not of interest at that stage. However, the EBA is here. Then we have the European resolution directive—the rules for how to dissolve a bank and get rid of all the problems. That has been approved, but because it is a directive it is not yet fully implemented by member states. It has been approved by the Council of Ministers and the European Parliament, but because European directives normally take two years to be transferred into national legislation it can take a year or 18 months before the resolution directive is enforced 100%.
The outstanding question is the European deposit insurance scheme. The EDIS proposal was one of the proposals made by the Commission on 21 October. The Germans and Dutch are not so happy about it—I will explain why in two minutes—but that is now a proposal that will have to be discussed by the Ministers and the European Parliament. The reason the Germans and Dutch are not so happy about it is that they say it introduces common financing of banking crises, so the wealthier member states will have to finance the recapitalisation of less profitable banks in some member states. I will not mention names, but we all know what I am speaking about.
Lord Butler of Brockwell: If it is eventually agreed, do you expect Denmark to take part in it?
Henning Christophersen: I think we would be interested because, if you look at the banking landscape of Denmark, some of the banks are far too big for a country of our size. I have been a member of the supervisory board of Danske Bank for 30 years and I know a bit about it. It was unfortunate that we bought a bank in Ireland and another one in Belfast. We should not have done that. We bought Sampo Bank in Finland; we bought banks in Estonia and Latvia. We are the owner of Fokus Bank in Norway, and we are the owner of the third-largest bank in Sweden. Our total balance is much larger than could be absorbed if there were problems with that bank. During the banking crisis the Danish central bank had secretly to make clear that of course Danske Bank would have unlimited access to the borrowing capacity of the central bank outside Denmark. They could do that because our currency reserves were as big as they were, but, seen from a purely fiscal point of view, it is far too big to take that risk. We have another big bank called Nordea. Nordea is a Swedish, Finnish, Danish and Norwegian conglomerate and is nearly as big as Danske Bank in Denmark. It is the biggest bank in Scandinavia. I know that if you speak to the Nordea people—I know the CEO and members of the board—they would also like the Nordic countries to participate in the banking union. Some people are even talking about the option that, if Sweden and Denmark do not want to participate, Nordea will move its headquarters to Helsinki.
Q42 The Chairman: Do you think the UK should take part in any element of banking union and, if so, why do you think this is important?
Henning Christophersen: Is it right that sometimes you have had a banking problem: for example, Royal Bank of Scotland and Barclays?
The Chairman: Indeed.
Henning Christophersen: I mention two but there are others. Why should you not be interested in banking union?
The Chairman: Which elements do you think we should go for?
Henning Christophersen: Banking union will give better access to a deeper financial market. I remember when the crisis began. It began in the United States, and then Lehman Brothers went broke. The question we asked in our supervisory board—it was asked everywhere—was: “Who here in Europe is sitting on the toxic sub-prime loans? We must be careful to whom we lend money and extend credit lines”. Within 48 hours the internal banking market in Europe was on strike; it was nearly impossible to raise credits, because everybody said, “We must be cautious”.
The Chairman: Contagion spread.
Henning Christophersen: Yes.
Q43 Earl of Lindsay: How important do you think capital markets union is to what the Five Presidents’ Report wants to achieve?
Henning Christophersen: The presidents mention capital union, and now we also have a communication from the Commission. I think it was published on 30 September of this year. The main reason is that they see capital union giving access to a deeper and more integrated capital market, with more converging financial products. So it could make it easier for companies everywhere, including those outside the eurozone, to get access to credit lines. Small and medium-sized companies would get better access. The argument is that it would be a market with a deeper volume of available credits. I have not seen a counter-argument. If I was sitting in the City of London, I would be very much in favour of that.
Earl of Lindsay: Do you see a deeper market being a more resilient landscape for economic and monetary union in terms of asymmetric shocks, for instance?
Henning Christophersen: Yes, but it could also be a good thing for non-members. I do not really understand the problems of the UK in this respect. I understand other UK problems. I understand the problems about bureaucratic rules on how financial products should be designed, used and controlled: for example, the crazy idea to split banks into investment banks and normal banks. I do not think it is going to work because it is not too difficult to circumvent such a construction. I can see some problems, but they are not only UK problems. You would also find certain reservations in the Netherlands, and even in Germany and Italy, about some parts of the planned legislation. But as for the banking union as such, I do not really see a counter-argument for non-euro countries. Even if you want to continue with your own currency I do not see the problem—but perhaps I am wrong.
Earl of Lindsay: Are there any concerns or problems that you or we should have about capital markets union in terms of other consequences that might flow from it?
Henning Christophersen: There is one thing already mentioned in the report: the lack of good co‑operation between the European Union and international financial institutions. That is a real problem. Take the IMF. Who is representing the 28 member states in the IMF? It is not even each of them, because each of them belongs to a special group. For example, the Netherlands, Luxembourg and Austria are bound together with Ukraine in the IMF. Some other countries working in the IMF belong to the same elected group as Afghanistan, Iraq and places like that.
One of the real problems for the EU perhaps and the involvement of IMF in bailout operations is the old-fashioned structure of the IMF. That is small but it could be a bigger problem for Europe, because at a certain moment in time some of the bigger economies outside Europe would say, “Enough is enough. The purpose of the IMF is not to help European countries that should be able to help themselves”.
Q44 Lord Davies of Stamford: I want to ask again about capital markets union. We have had quite a lot of evidence in this Sub-Committee that capital markets union is a very important prospect, if we can achieve it, from the point of view of both economic stabilisation, which involves risk-sharing by investors and, therefore, is an automatic stabilisation mechanism, and also improving firms’ balance sheets and enabling them to raise more equity, with close-to-equity instruments and so forth, not merely being dependent on bank debt. All those theoretically sound very attractive. As a former investment banker, I always look at markets from the point of view of potential investment demand. We have not explored this question at all from that point of view. The question is whether investors will have an appetite to buy Portuguese or Latvian bonds or potentially Romanian equities, if Romania joins the eurozone and so forth. It occurs to me that Denmark must have a lot of experience in this area. It is a small country and its investors, institutional or private, must always have had diversified portfolios going outside Denmark, because you cannot find all the risks you might want in a diversified portfolio within a small economy. Do you have any comments on developing investor demand for a more widely diversified range of portfolio instruments?
Henning Christophersen: Equity has been a more popular and interesting option in Denmark than it has been. That is because large parts of state-owned industry have been privatised. You can take DONG, for example. It is a big oil and natural gas company. It was owned by the state until five years ago and now one of the big owners is Goldman Sachs. It is owned by other private companies, pension funds and investment funds, and the state is now preparing the further privatisation of DONG so it will sit back perhaps with 15% or something like that. You can take the Danish telecom company TDC. It was originally owned by municipalities and the state. Now they are no longer shareholders; everything has been privatised. You can take the airport of Copenhagen. That was originally a state-owned airport; now the main shareholders are the Canadian teachers’ pension fund, with an office in Amsterdam. You can take what we are doing in Greenland and many other activities that have been privatised. Therefore, the supply of equity in the Danish market is better than it has been, but you are completely right. Many Danes are investing outside Denmark. We are investing so much that it makes a very good contribution to our account balance. We are getting about €20 billion a year in dividends from foreign investments.
Lord Davies of Stamford: A lot of that is private portfolio equities, is it?
Henning Christophersen: Yes.
Lord Davies of Stamford: It is not just direct investment by Novo, AP Møller or United Breweries.
Henning Christophersen: Yes, but you also have other investors. There are big shipping companies. For example, 8% of all the containers on the sea—
Lord Davies of Stamford: Maersk. That is what I meant. A lot of this will be direct investment by major Danish multinationals like the ones I have just mentioned. It would be interesting to know how much of that is portfolio investment.
Henning Christophersen: Many are investment funds. Danske Bank is taking care of my money; it puts it into a portfolio for me, and I have nothing to do. We have low-risk, middle-risk and high-risk options. I think the point about equity is a very valid one, because, if you compare the continental market with the Anglo-Saxon market, you will see that in the United Kingdom, the United States and Australia, much more capital comes from equities. The continental tradition has been to let the banking system finance investments, and I see that as another benefit of banking union. You will make it more usual for continental companies to finance their investments via equity.
The Chairman: Thank you so much, Mr Christophersen. We have slightly overrun. We greatly appreciate your coming to see us. This now concludes our public evidence session.