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Last weekend, Mario Draghi, the former European Central Bank president and ex-prime minister of Italy, gave a dinner speech to a convention of European economists in Paris. It’s an important speech, which could be as agenda-setting for EU policy discussions as Draghi’s report on the bloc’s productivity, which this autumn shook up European political leaders with its stark warnings. Do read the new speech in full. Below I discuss what jumped out at me.
The speech reprises two key lessons of the Draghi report: in order to fix its productivity lag vis-à-vis the US, the EU needs to boost public and private investment, especially into high-tech sectors, and to remove the obstacles that fragment the effective size of the pan-European market. But Draghi is not content with hammering in his existing messages. I have heard economists present at the speech begin to talk of “Draghi plus” to describe the novel idea “super Mario” has now played into the debate: an analysis of aggregate demand that is, in the European policy context, original and even a little heretical.
The speech goes a long way in putting much of the blame for Europe’s growth shortfall on the weakness of domestic demand since the global financial crisis — which quickly morphed into a Eurozone sovereign debt crisis. From the speech:
From 2009 to 2019, the collective cyclically-adjusted fiscal stance in the euro area averaged 0.3%, compared with -3.9% in the US. And if we look at primary deficits in absolute terms, measured in the 2023 euros, the US government injected 14 times more funds into the economy, 7.8 trillion euros in the US and 560 billion in the euro area.
This analysis does not, to put it mildly, command consensus among EU policy leaders, at least not in their public deliberations. Draghi comes close, if not all the way, to endorsing sustained high demand pressure — or what is at times somewhat flippantly called “running the economy hot” — as an important ingredient of supply-side or productivity growth. Or in the man’s own words:
. . . the euro area experiences longer periods where the economy is operating below potential — and this inability to maintain demand pressure then feeds back into productivity growth.
Why is this? Draghi rehearses the main mechanisms studied in the economics literature: research and development expenditures are procyclical, and are in turn associated with innovation (where Europe is lagging). He cites a study finding that one-fifth of productivity growth can be attributed to how expected demand creates incentives for companies to innovate.
If the role of demand pressure on the supply side gained centre stage in the policy debate, that would already be something. That is especially true because Draghi blames weak domestic demand partly on active EU policy choices rather than mere bad luck. But the key contribution of his speech is to link this idea to well-accepted analyses of how and why the EU’s growth strategy needs to change.
He argues, for example, that the continued fragmentation of the single market blunts the effect that greater demand pressure would have on productivity growth. That is partly because of the direct brake on growth opportunities these cross-border frictions constitute, and partly because they mean a larger part of any reinforcement of domestic demand leaks out to other economies. The implication is that the EU needs a combined growth strategy: shift spending towards investment through better capital markets, reduce internal trade frictions and boost domestic demand (especially investment demand) all at the same time.
This means abandoning the existing model of relying on exports for growth based on low wage growth to defend market share. But as Draghi suggests, the return of Donald Trump to the US presidency may mean the old model is dead anyway.
One could make all kinds of objections to the realism of these recommendations, starting with the difficulty of finding money: the French and German governmental crises both derive from the inability to find broad political agreement over budgetary questions (the actual budget in Paris, the debt and deficit rules in Germany). Draghi has some answers, which will no doubt be highly contested. One is too attractive for comfort: since structural reforms and strong domestic demand reinforce one another, there is a free lunch on offer. Others include interest savings through lower borrowing and an estimated $100bn-a-year additional headroom for public investment spending under EU fiscal rules if all countries opt for a seven-year, rather than the default four-year, fiscal adjustment period.
But the point here is more fundamental. Until now, the very idea that inadequate domestic demand is a root cause of EU economic sluggishness has been largely banished from the policy discussions that have mattered. Active disagreement over how to best boost domestic demand, no matter how fierce, would mean the premise that it matters had become commonplace in EU governing circles. That would be a Copernican revolution indeed.
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Publish date : 2024-12-19 03:00:00
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