The future of the European Union is rife with uncertainty, after 52 percent of participants in a British referendum voted in favor of the United Kingdom leaving the regional bloc. Brexit’s effect on the economy has been immediate, with the pound sterling falling to historic lows and global and EU growth estimates cut by the IMF and the European Commission. Against this gloomy backdrop, World Policy Journal Editor Emeritus David A. Andelman speaks with Erkki Liikanen, a member of the European Central Bank Governing Council and Governor of the Bank of Finland. Liikanen discusses how Finland has been affected, structural reform, and the continued importance and relevance of free trade and the EU to recovery.
DAVID A. ANDELMAN: Let’s start with the effects of Brexit. After the U.K. referendum, the IMF in its July estimates cut world economic growth to 3.1 percent this year which was a pretty constant downtrend from the 3.7 percent a year ago. The EU figures are much lower, they’re only 1.4 percent this year. So how troubled are you by this trend?
ERKKI LIIKANEN: There are two important economic issues. First, the immediate market impact of the U.K. referendum on global financial markets has been limited, and also European markets have been pretty resilient. This development is in part due to the ample liquidity provided by the central banks, a robust regulatory and supervisory framework and the readiness of policy makers to act if needed. Overall this suggests only limited spillovers from Brexit in the short term. But for the second the medium- to long-term outlook is more uncertain, and Brexit is one of the headwinds we have. In addition, there are risks related to the slowdown of growth in many developing economies and the burden of necessary debt reduction in some countries. The U.K. referendum vote has caused significant uncertainty, but how extended this uncertainty will be depends, of course, on how the negotiations go and how long they will last. The U.K. must decide what they want from the negotiations with the EU member states, the EU member states must find a balanced and just solution. It will not be a simple exercise.
DA: When you say that this will not be simple, what are some of the complications? What can be done to reverse these numbers in your view?
EL: It is too early to say, but the Eurosystem (the European Central Bank and the central banks of Eurozone member states) will assess the situation in the course of the coming months as new economic data arrives. For example, the European Central Bank (ECB) staff forecast for the euro area will come out in September. But of course, in order to increase the potential growth in Europe, ability and will to proceed with the structural reforms is important. By this, I mean for example the need to increase competition in product and labor markets to create a positive environment for business and investment. In Europe, economic growth is lagging behind the United States and some other developed economies. We are positive that we have broad-based but modest growth, but must aim at higher actual and potential growth.
DA: The Financial Times recently quoted Mika Kuismanen, head of forecasting at your Ministry of Finance, as saying that Finland could even fall into recession post-Brexit. As the head of Finland’s central bank, what can you do independently of the ECB to help boost Finland’s growth?
EL: What I have seen happen in Finland this spring is encouraging for future growth. First, we at the Bank of Finland have been supportive of solutions by which confidence has been improved. The labor market organizations, employees and employers have been able to agree on measures which will lead to 4 percent improvement in cost competitiveness on the one hand, and prolong working hours on the other. This agreement covers about 85 percent of the workforce. So it’s one good step, but it’s not enough as there is still need for reform. Further work needs to be done on issues like how to guarantee and fairly manage the flexible implementation of the labor market agreements at the company level. Second, the welfare state is important to Finns, but at the same time the system must be efficient so that it can be financed by the income generated by our economy. The government is aiming to reform the way social and health services are provided to citizens, so that they can be produced more efficiently and we can improve productivity in that sector.
DA: None of these are really monetary solutions, do you have any?
EL: But of course, we are part of the Eurosystem, part of the euro area and the common currency. We in the ECB Governing Council are advocates of structural reforms. In order to reap the full benefits from our monetary policy measures, other policy areas must also contribute, both at the national and at the European level. And the monetary policy has served the Finnish economy well. First, because our loans for households and businesses are normally linked to the short-term market rates, the transition to monetary policy in Finland is particularly efficient. Second, the monetary policy also works for the banking system as our banks are in good shape, well-capitalized with very small numbers of non-performing loans in their balances.
DA: Right. ECB President Mario Draghi has said he was prepared to do “whatever it takes” to stabilize the ship of the European currency. Are you concerned about such comments?
EL: As the ECB Governing Council analyzed last week, the euro area economy is recovering modestly, it is modest but broad-based recovery. Looking ahead, during the forthcoming months, we will get more information on the development of our price and growth outlook. This includes the new ECB projections in September. And then, if we need to act, well, we have the will and we have the capacity to do so. But we need to have all the relevant information. I reiterate that the financial markets have been resilient. The financing conditions have remained highly supportive, which contributes to a strengthening in credit creation. These developments and our current policy stance continue to support our baseline scenario of an ongoing economic recovery and an increase in inflation rates.
DA: Let me ask you a more personal question. Are you beginning to regret Finland joining the Euro?
EL: No, it has been the right decision for Finland. EU membership and the common currency has broad public support. The economic and monetary union has been a major step forward in European integration, and it has served us well. Of course, the flexibility and resilience of an economy belonging to the monetary union strengthens the benefits it can reap. If the countries take care of their own competitiveness and keep the structure of their economies flexible, the better the monetary union serves them. So the benefits of the euro are not independent of the economic policies of member states.
DA: Very good. Why is Finland so resolutely behind the concept of the European Union?
EL: The impact of Brexit to the support for the EU has been very interesting. It seems that support has increased in all EU member states according to some of the most recent polls. This includes countries as different as Denmark (which is outside monetary union), Germany, a core country, and Finland, where economic performance has been lagging behind.
DA: I understand completely. Let me ask you another question. You mentioned free trade being vital to the viability of the European Union, free trade among all of its members, and I assume you mean trade externally as well, right?
EL: This is an important political issue with possible wider consequences. It seems that public opinion in many countries has turned against globalization and free trade. During the last decades, globalization has helped to increase the living standard of hundreds of millions of people, as these people have been taken out of poverty in developing economies. But as a negative side effect the old industries in developed economies have suffered. This may partly explain developments in many countries and also the outcome of the U.K. referendum vote. Therefore, globally open and free trade has been very instrumental to the development of welfare. But there are big challenges in advanced countries where inequality has become an issue. This is a difficult and challenging issue that must be tackled in such a way that everybody can benefit from globalization in the future.
DA: Yes, fair enough. How concerned are you that there seems to be a trend—not only in the United States—but in other countries as well, a feeling that “we have to worry about own house first, and then we worry about the rest of the world”? It sounds almost as if we’re going back to the days of the Smoot-Hawley tariffs, which helped plunge the world into depression back in the 1930s.
EL: The long term benefit for the global economy which comes from open economy and free trade, globalization, has been very significant. But there have been problems in many advanced economies where benefits have not been distributed equally. There should not be such a trade-off. You should be able to continue to promote free trade and growth in the global economy at the same time.
DA: What kind of measures can be used to minimize these negative domestic effects?
EL: Many countries have their social security protection. New approaches are also being elaborated upon. One example from Finland is the establishment of a pilot project by the government related to the basic income policy.
DA: Right, that’s very sensible. Just to wind up, do you have any targets for growth, or interest rates within Finland, within your own purview?
EL: In the early 1990s we suffered from the collapse of our trade with the Soviet Union, global recession and a banking crisis, but we survived due to courageous policies. During the years between 2004 and 2007 Finland was one of fastest growing advanced economies. First we benefited a lot from the rise of Nokia and mobile terminal industry. Nokia is still strong in networks but has lost in mobile terminals. We also had wage bargaining with, pay rises that went too high in 2007 and 2008. In addition, baby boomers are retiring and our exports to Russia have diminished. So what we have learned is that when we have been faced with structural changes, we just need to tackle them at home. We need to be competitive, be innovative, and eventually re-pace our growth. It’s a challenge. It is not related to the Economic and Monetary Union.
DA: Thanks very much, Governor.
This interview has been edited and condensed for clarity.
[Photo courtesy of Jari Jakonen]