Professor Richard Portes

17 JULY 2007

  Q147  Chairman: Good morning, Professor Portes, and welcome to the Committee. This session is on the record, it is being recorded for webcast and you will get a transcript of what was said. You have had a copy of the questions; would you like us just to start or is there an opening statement you would like to make?

Professor Portes: Let me give you just a brief background, My Lord Chairman. I am a Professor of Economics at the London Business School and President of the Centre for Economic Policy Research, which is a fibrous network of economic researchers around Europe and beyond. My own expertise is on exchange rates, capital markets and, in particular, European financial markets, and indeed I teach a course at the London Business School on European financial markets. I have been following the monetary union story for 20 years or so, partly through the activities of CEPR researchers. In fact, we had a conference exactly 20 years ago, October, in fact, 1987, in which the basic rationale for a monetary union was set out by Tommaso Padoa-Schioppa, who subsequently, as doubtless you know, became a member of the Executive Board, the first group on the Executive Board of the European Central Bank. CEPR throughout the years has published quite a lot on monetary union, including, fairly recently, work on the trade consequences of monetary union, which is probably the most cited single article (Andrew Rose) in economic policy, probably the most cited single article on the subject. Most recently, however, we have published something by our Research Director, Richard Baldwin, which challenges the Rose conclusions. This is interesting literature. If you want me to talk about the effects of the euro on trade, I can certainly do so. I think, with that background, we can proceed to whichever topics you want to cover.

  Q148  Chairman: That is great. I have got a general question to open with, which is what effect has the introduction of the euro had on individual member countries' economic development? The bit that we keep trying to get a handle on is what has the introduction of the euro zone done for growth, and it also obviously has to do with trade, and we have read the Rose/Baldwin difficulty on that. You can see what a currency union does; what we are trying to get a grip on is whether it actually encourages economic growth and actually increases trade: anything you can tell us about that will be most kindly received?

  Professor Portes: This is not research of my own but I know quite well the research of others on this topic, and indeed I was at a conference, or workshop really, last week, in Cambridge, Massachusetts, at the National Bureau of Economic Research, CEPR's counterpart organisation, which was on this topic. Precisely the topic, in a sense, the way in which you put it, My Lord Chairman, the effects of the euro on growth, on trade and on structural reforms. I think trying to identify effects on growth goes through so many different stages that it is extremely difficult to distinguish. What you can do and what one participant in this workshop claims to have done is identify effects of the euro on structural reforms. Since that has been the mantra of the past ten years, what is necessary for growth and structural reforms, you might think that this is relevant. Alberto Alesina, Professor of Economics at Harvard, has preliminary results, they still are preliminary, but they were quite convincing to the participants in this workshop, which show that there has been a differential effect on structural reforms for the countries of the Euro Area relative to the counties in the EU outside the Euro Area and relative to a wider control group of OECD countries, that there have been positive effects since the introduction of the euro. It is quite clear, the data, the structural break, if you like, as of 1999, which suggest that, despite his, the researcher's, expectations, there really is a clear effect on both labour market reform and product market reform. I think, in some sense, the more important of these is probably product market reform. We have had quite a lot of emphasis, in discussion of these issues, on labour market reform, but I think, in terms of the effect on growth, as opposed to unemployment, wage flexibility and all that, it is product market reforms where the action is, and that is where you can see this effect of EMU most clearly. That is point one. Point two, again coming out of this workshop, which was really extremely interesting, is some new work, this old issue of the effects of the euro on trade. Take it for granted, I think no-one will dispute it, that there is a relationship between trade and growth; that we know. It is hard to get a precise handle on it because of the neutral causation between trade and growth, but we can be pretty sure that more trade goes along with more growth. That said, as you know, not just in the Rose work and the Baldwin work, in the voluminous work done for the Treasury's inquiry into EMU, and so on, there have been different estimates. There is a new set of estimates and they come out with a fairly strong effect, not the 300% differential currency union effect which Professor Rose has found, which no-one believed, even himself, although it was robust econometrically, and so on and so on, but effects which look on the order of, say, 30%, so far. I stress the "so far" because there is a big point here, that I will come back to in a moment before finishing. About 30% on trade, that is to say, extra trade, among the countries in monetary union relative to trade elsewhere in the European Union, without trade diversion, that is to say, without harming the trade of those countries in monetary union with other countries in the EU. The reason why that is proposed in this research, and again these are preliminary results, the reason why this effect is not as strong as some people might have conjectured it to be is simply the lapse of time. It does take time, apparently, and the econometrics support this, without going into details, for these effects to show up; they are showing up, they are showing up gradually but powerfully.

  Q149  Lord Kerr of Kinlochard: Can I test you on this, for just a second. Some argue that a large part of the boost to trade is the result of the lagged effects of the single market programme, 1992, barrier removal, and facilitation of trade. You are pointing to differential effects as between euro zone and non euro zone, but the non euro zone, with the exception of the British and the Danes, had not been in the EU for long. The new Europe is catching up on the single market programme, trying to do it in one go when it joins the EU, so the lagged effects perhaps are further down the track? When you compare your euro zone countries, where the boost to trade has been greater, what are you comparing them with; are you sure it is apples and apples?

  Professor Portes: There are two comparison groups, My Lord. One is the countries which were not in EMU at the outset, in which case Greece is included there as well, so you had four of the 15 then. A second comparison group is a broader group of industrial countries, not just European Union countries.

  Q150  Lord Kerr of Kinlochard: But then they would not have been involved in the single market?

  Professor Portes: They would not have been involved in the single market programme; that is correct. Certainly you could argue that the single market programme, and that is partly the Baldwin story, was more important, but this differential effect seems fairly strong and fairly distinct, in particular, in its timing, in the single market programme. The trade expansion from the single market programme began before the introduction of monetary union and both the timing and the comparison, with admittedly a relatively small control group of other countries, seemed to be, all the same, rather convincing, and seemed to convince not just me but the other people in this meeting last week.

  Q151  Lord Inglewood: Could I come in on one point arising from this, which is that you explained that there was the greater growth in the euro zone and it seems to be taking time. Do you think that it is increasing its pace all the time, or do you think that the graph will flatten off?

  Professor Portes: What I was pointing to was loss of trade, the effects of that on overall economic growth may themselves operate with a lag.

  Q152  Lord Inglewood: I expressed myself badly, but do you think this is going to increase, or do you think it will flatten out?

  Professor Portes: In general, I am optimistic about most things, My Lord, but tempered by the evidence. I think the evidence does suggest, to me, yes, that part of what is happening now is not just, as some claim, a cyclical recovery, there is an element of that, of course, but if that were all that was involved then we would see a different pattern in the European expansion from the US expansion, and so forth, and we do not see that. We do not see a pattern which suggests that this is just a cyclical upturn. There is no doubt that there has been a substantial improvement in economic activity in Germany, as well as a number of other countries in the Euro Zone. I think myself that the prospects are rather good, but that is not controlling for all the other things that can happen in a macro economy. I think the structural reform story is actually quite promising, and for Spain, for example, it is a labour market story, for Germany it has become partly a product market story, and so on. I think, in part, at least, that is quite convincing a response to the constraints, if you like, which are imposed by the euro, and even Italy is beginning to show a little bit of this but with more of a lag.

  Q153  Lord Kerr of Kinlochard: There is another theory, is there not, which says that, again, thinking about lags, the best thing that EMU did happened before EMU was born? The effect on economic and fiscal policies in would-be candidate Member States of the EMU was very striking in the nineties, and the trade effect could have something to do with that. This is not to say it is not to do with EMU; but the theory is that it is to do with the prospect of EMU rather than the policies of the ECB. Is there anything in that?

  Professor Portes: I think that is a reasonable conjecture. We should not claim too much for monetary policy, in any case, and I think that is a common mistake. What EMU involves is simply the imposition of a common monetary policy and a single exchange rate, of course, and the inability to use devaluation, in particular, as a policy tool to compensate for the absence of other policy tools, for the inappropriate use of other policy tools, and that is the limit. One should not exaggerate these things. You are right about the constraints that this imposes on macroeconomic policies; it is evidence in the Italian case but it is also evident—now this is ex post and this comes to the question that is in the notes that I have about the Stability and Growth Pact. People say, "Oh, the Pact was broken as soon as it was tested by a big country," or two big countries, "it broke down and it's now a sham and fiction," and so on and so on. I think this is demonstrably false. I think the Pact has clearly constrained, and there we come back again to the issue that you have just raised, the macroeconomic policies of Portugal, for example, for the good. They needed the constraint, they needed the turnaround, and I think the pressure from Pact and from the peer review and from all that has played a very significant role. Greece is another case, where the Minister of Finance, who, I have to say, used to be my colleague as Professor at Birkbeck College, Georgios Alogoskoufis, has been very effective in appealing to the Pact and using the Pact domestically to help them prove the—and they have done a remarkable turnaround actually, in the fiscal position there. We will get to France perhaps in a moment, you might wish to get to France, but even Germany clearly has felt constrained by the Pact, or, let us put it this way, by all the discussions, by all the work done on showing that fiscal policy had got out of line in Germany, and again there has been a very substantial turnaround.

  Q154  Lord Kerr of Kinlochard: Were you surprised when the new President of France went to ECOFIN to explain that the revised Pact discipline was too tough for France, and that two years' deferment was required; and were you surprised by ECOFIN's reaction?

  Professor Portes: I do not think anyone should ever be surprised by the actions of the new President of France; he is not always predictable, and that is actually a breath of fresh air perhaps. To the subject, no, I was not surprised and I do not think myself that his proposals are as inconsistent with the Pact as the media comment has suggested. The revised Pact has an explicit provision for flexibility when there are substantial reforms being undertaken and we will see whether the reforms that actually are brought in are as substantial as have been proposed. But that is a rationale I think which can be supported, even within the terms of the Pact, and the slightly hysterical reaction from some commentators, including some officials and politicians of other member countries I think is misplaced at this stage. We do not know, it is early to tell, we do not know what the numbers look like, we will know I think fairly soon, we do not know what the actual reforms look like and what the cost of reforms will be, we will know that fairly soon. There has been, I think, an excellent book published in France by Jacques Delpla and Charles Wyplosz about how to get reforms in a vast mature economy; how do you do it? You have got all these vested interests; what can you do: you have got to buy them out, and that is basically the set of proposals that is made in this book. They go across various different sectors, estimating how much it would cost to pay off the taxi-drivers, to pay off the pharmacists, what is the capitalised value of their rates: pay it and say, "Okay, now we have competition." It is perhaps, you might say, at least in certain areas, not totally feasible or not realistic, but the basic principle, I think, is absolutely correct, that you cannot get past those obstacles just by trying to run a steam-roller over them all, or sometimes the President of France has the steam-roller aspect to him. Nevertheless, you do need very often to have transfer payments which compensate people for what they are losing if you have reforms and, now I am going back to the basic point, there is a fiscal cost to that.

  Q155  Chairman: Can I explore this point, because I hope I understood you correctly when you said that one of the things which had contributed to growth in the euro was the structural reforms which had come with the euro, and I suppose one is talking about exactly the kind of things that France is now going to have to do, and people did it presumably because they realised they would have to. Then you said that probably there were not huge amounts to be gained from growth on the labour relations side, with a term with which I am not familiar, that the money lay in the product market reform: what is product market reform?

  Professor Portes: For example, take Germany; significant steps have been taken in dealing with retail shop hours. You might say, this is not serious, this is not a big deal; well, actually, if you look at the sources of productivity growth in the United States over the past ten to 15 years, it is fairly well established now that a big part of the jump in the rate of total factory productivity growth in the US comes from retail distribution. You can localise it; it is in retail distribution, it is in the Wal-Marts and the Costcos and the Targets, and so on, and the greater efficiency of getting products to consumers at substantially lower cost. The reform of shop hours is not the only thing but it is part of a process that is taking place in Germany of shifting towards big retailers, towards a more modern form of retail distribution. This has been relatively slow in France, despite Carrefour and Leclerc, and so on, they are really small relative to the American style, and here too we have had tremendous productivity improvements in the retail sector over the past decade. That is one aspect, My Lord Chairman, of the product market reforms. Another is more generally in competition policy, and here I am distressed by at least the rhetoric which the new President of France has employed in this area, and the concession which was made to him at the recent European Council meeting. I hope that the legal commentators are correct in believing that dropping the reference to competition policy, competitive, whatever it is precisely, dropping that reference in the Treaty revision will not actually emasculate competition policy, because this is central. What we know is we have pretty strong evidence that competition is what drives productivity change, competition that drives out the weak tail of performers and that shifts resources towards the stronger firms. It is in that sort of area, it is competition policy, eliminating a whole range of restrictive regulations, I have talked about shopping hours and the retail sector but you can go across all the professions, for example, not least my own. Oh, yes, if you look in France or Germany the protection of inefficient, really inefficient, university organisation which has direct and identifiable consequences on tertiary education and research and development; that protection is very strong, and President Sarkozy has indicated that is one of his priorities.

  Q156  Chairman: This is true, is it not, yes?

  Professor Portes: I think, rightly so.

  Q157  Chairman: Before I let Lord Kerr in, who wishes I am sure to ask about competition, I am very interested in that point about Germany, because for many years people have banged on, trying to get the German consumer to consume. I have always wondered how they were meant to do it with no shops open; that simple example?

  Professor Portes: This may be a marginal effect but nevertheless it is part of an environment which discourages child-bearing, because if you have children you would like to be able to have more flexibility in when you can go and shop; they put constraints on you, you know.

  Q158  Lord Inglewood: Really I wanted to come back to your comments about Sarkozy, which, as I understand it, you say is a much more friendly approach to the existing structures than British commentators have commented. If you were advising Sarkozy, or even if you were Sarkozy yourself, in the predicament he finds himself in, would you be going in the direction in which he is moving?

  Professor Portes: You are taking me a bit outside the point.

  Q159  Lord Inglewood: I know I am, and you have the right not to reply, but I am just interested, from an economic perspective, where you sit, whether you think this is a way of dealing with those sorts of problems? It is a combination of the bits which he has put in place.

  Professor Portes: I am encouraged by the beginnings, with the exception that I have noted, that I do not think a "pick the winners" industrial policy, with protection, and so forth, is the right way to go about those matters, and we will see how far he pushes that. Elsewhere in the set of reforms, his priorities—they were market reforms and university reforms—I think are absolutely right and very positive. I am quite pleased to see all this. I have had a long-term research and teaching affiliation with an institution in Paris and I spend a fair amount of time there. My wife is French. I am quite concerned by these matters, and I think that the beginnings are good, and he has been making the right appointments. I think perhaps not a lot has been made of the composition of his Cabinet and other ministerial posts; it is really a very fresh crew, with a diversity which was not seen previously, has not been seen in previous French Governments, and all that, I think, is part of it. I would like, at some point, if we may, My Lord Chairman, on this question of reforms, to get to the capital markets, which is something that actually I do research on: we will get there, I am sure.