In her first speech as president of the European Central Bank, Christine Lagarde addressed an audience of bankers. However, her speech was more aimed at the governments of the EU member states than at the bankers present. She insisted that European governments need to boost innovation and growth with higher rates of public investment. She is seeking to persuade European governments to change the economic policy mix.
She was indirectly telling governments that increasing public spending in today’s current economic circumstances is not a bad thing to do. She is fully conscious of the need not to increase public debt, but she is equally aware that reining in the fiscal deficit at all costs did not bring the desired results.
She also stated that the tariff war between the US and China should be seen as an opportunity to strengthen the internal market of the EU. The reasoning is quite simple really. If it becomes more difficult to export to China and the US, then companies within the EU need to sell more of their products to other EU member states, to maintain current activity levels and possibly increase them.
This would imply strengthening the purchasing power of persons living in the European Union to increase consumer demand. The increase in consumer demand within the EU would provide more opportunity for internal growth, accelerate recovery from the economic slowdown, and aid the functioning of the eurozone. Her recipe is not to simply put more money into people’s pockets, but to stimulate economic growth through more public sector investment that would create employment.
The eurozone needs to invest to grow its own market and economy
Lagarde’s speech also had a strong political undertone. She described such an economic strategy as way of investing in a common future, that is based on higher productivity, increased digitisation, and greener economy. A stronger internal market is also expected to incentivise increased private sector investment. She also called for a strengthening of the internal market for services, banking and capital markets.
The role of public capital and recurrent expenditure in the strengthening of the internal market cannot be underestimated. Thanks to fiscal austerity measures, public sector investment in the eurozone remains significantly below the levels of 10 years ago. This has hurt the potential of the eurozone economies, with the result that, even where there was an economic recovery, this remained rather fragile.
The ECB has sought over the last decade to provide liquidity in the market through its quantitative easing programme. The indications are that Lagarde will continue with the accommodative monetary policies of her predecessor, Mario Draghi. Whereas before, exporting companies in the eurozone had other countries to export to, notably China and the US, the tariff war between the two countries has caused a slowdown in these economies.
As such eurozone exporters need to look inwards into the eurozone to keep up. This is why Lagarde is claiming, and rightly so, that the uncertain global economic environment should be seen as an opportunity and not a threat.
Although this message may be aimed at all eurozone economies, it is primarily aimed at those economies that have been running budget surpluses. Although no country was singled out, it is Germany that she was mainly referring to. Germany is the largest economy in the eurozone, is seen as the economic locomotive of the EU, and has performed well in recent years, in spite of a tight fiscal policy, by exporting more all over the world.
The economic policy mix needs to change to take account of the fact that international trade can no longer be relied upon to act as a source of growth. The eurozone needs to invest to grow its own market and economy. To achieve this, eurozone governments need to understand that there is a common problem which requires a common response. The extent to which Lagarde’s advice will be heeded remains to be seen.