The European Union and the Russian Federation: Challenges of market building
Speech by Speech by Tommaso Padoa-Schioppa, Member of the Governing Council and of the Executive Board of the European Central Bank, delivered at “Russia in Global Affairs”, Moscow, 28 September 2004
"...Almost a year ago, the Eurosystem, that is the European Central Bank and the national central banks of the euro area, and the Bank of Russia started a major cooperation effort in the field of banking supervision. Financed by the European Union under the TACIS framework, the ECB, nine euro area central banks and three EU supervisory authorities are now sharing with the Bank of Russia their experience in promoting and maintaining a stable financial system. Both sides of this cooperative effort are well aware that the ultimate goal of their project is to improve the functioning of a market economy. ..."
"...Against this background, I would like to explore with you the challenges of market building in a more general context. Market building is indeed at the heart of the economic debate not only within Russia but also in the EU. The EU has started its market building effort almost fifty years ago and is now in the process of completing a Single Market encompassing 25 national economies...."
"...Building domestic markets - Principles
About fifteen years ago Russia and the EU engaged in unprecedented market building projects. The EU decided to complete the Single, Internal Market. Russia began transforming an economy that had been operating for more than seventy years under the principles of central planning, to one following the rules of the market. A widely shared assessment of both projects seems to be the following: much has been achieved, more needs to be done. Why does market building take so much time and why is it so difficult? Of course, political constraints play an important role, as - by definition - any change in society is inescapably linked with the political process. For sure, the building of markets represents such a fundamental change that political obstacles challenge the implementation of the project at almost each step of the process, as there are always groups and coalitions interested in retaining the status quo. To counter this, a strong civil society is needed where different and opposing interests engage in an open public discourse on economic issues in the respective forms of media. From a political point of view this means daring to take steps that may be unpopular in the short-run but serve the long-term goal, but also to delegate implementation to sound institutions free from corruption. From an economic point of view, this is most relevant with regard to the interest of consumers who are usually neglected in favour of entrenched producer’s interests in keeping their traditional rents...
At the same time, however, we have to recognise that market building is inherently difficult, not only made difficult by its opponents. Both the history of developed market economies and economic theory indicate that Adam Smith’s famous “invisible hand” produces the wonder of enhancing “the wealth of nations” only when spontaneous actions of individuals pursuing their self-interest are channelled in, and framed by the Rule of Law. Market imperfections and failures, although often linked to public interference, are primarily caused by externalities and incomplete information, leading to situations where actions of individuals maximising their own benefits may be to the detriment of others. Economists call it “moral hazard” behaviour. For example, undercapitalised banks have an incentive to engage in risky investments as depositors – and not owners – would carry most of the losses in case of failure. Banking supervision aims at countering this moral hazard through minimum capital requirements and by providing banks with incentives to invest funds in a prudent manner."
Global market building"Over the years, the globalised exchange of goods and services has been growing very rapidly in spite of a still inadequate policy side. Expressed as a share of world GDP, international trade rose from about 30 per cent in 1990 to more than 42 per cent in 2003. Similar trends can be observed with regard to international capital markets and factor movements, like foreign direct investment and migration. Although the legal and institutional framework for international transactions is far less developed than in any domestic system, and still inadequate to the need of a strongly based world market economy, it has grown over the years in a positive manner. In the field of trade, the World Trade Organization provides legal ground-rules for international commerce. In the field of finance, cooperation is on a more informal basis, with sectoral Committees, such as the Basel Committee for Banking Supervision (BCBS), or the Committee on Payments and Settlement Systems (CPSS), setting standards that are adopted throughout the world and monitored by the International Monetary Fund. The OECD sets principles on corporate governance and accounting principles are set by the International Accounting Standards Board...."
"Let me finally turn to the monetary aspect of market building. Money is an integral part of any market economy, as it is the instrument people agree to use in order to facilitate the exchange of goods. Money allows transactions on the basis of what economists call the “single coincidence of wants”. Indeed, disagreements on the proper medium of exchange leads to severe efficiency losses in transactions, reductions in output and employment. Periods of high inflation as well as financial and exchange rate crises provide abundant evidence for this.
The key contribution of any central bank to market building is to provide a stable means of payment, a stable currency. Of course, it is not only the central bank’s monetary policy that impinges on monetary stability. Sound government finances and a sound financial sector are of crucial importance as well. This is why so much emphasis was put on stabilisation policies when the centrally planned economies started the process of market building. Privatisation, price liberalisation and improved governance have been of crucial importance, but their beneficiary effects could only be felt in an environment of monetary stability. The same logic has applied in Western Europe, where an intensive debate about the design of Monetary Union had a clear focus on the ECB’s mandate, the maintanance of price stability, and the independence granted to the ECB..."
"...The euro is a floating currency. This is well founded given that the euro area is a rather closed economy. Moreover, euro area trade is diversified, with the United States, the euro area’s most important trading partner, accounting for less than 15 per cent of total trade of goods. Finally, there are no conditions indicating a need for an exchange rate oriented monetary policy. Foreign debt of euro area residents is mainly euro-denominated, and euro area residents hold virtually no foreign currency cash or foreign currency deposits at euro area banks.
In the case of Russia, the analysis leads to a different result. Indeed, for most of the post-Soviet period Russia has pursued an exchange rate policy in which the anchor currency was the EU dollar. There have been good reasons for this. The most important is of course the fact that natural resources – traded in global markets, where prices are quoted and payments invoiced in US dollar – are Russia’s main export item. Moreover, Russia’s financial links with the global economy are mainly US dollar-based. Most of Russian international debt is denominated in US dollars, foreign banknotes and foreign exchange deposits are mainly held in US dollar.
"Between Russia’s trade and financial links, however, there is a clear currency mismatch. As the geographical structure of trade has a European, i.e. euro, bias, the competitiveness of the Russian economy is to a certain extent influenced by movements in the euro-US dollar exchange rate. Assuming that linkages between the EU and Russia will strengthen in the near and medium-term, this currency mismatch may further increase.
To account for this, the Bank of Russia has adjusted its exchange rate policies over the last two years. It is now placing more emphasis on the ruble’s real effective exchange rate which also reflects changes in the euro-US dollar exchange rate. Moreover, there has been a gradual increase of euro-denominated assets in Russia’s foreign exchange reserves.
As you know, there have been repeated calls for a further diversification of invoicing and settlement currencies in EU-Russian trade in favour of the euro. This includes energy trade, as it represents Russia’s major export item to the EU. Against this background, it is no surprise that the possibility for energy exports from Russia to Europe to be invoiced in euro has been featuring prominently in the debate on monetary and financial aspects of EU-Russian relations. "
"Monetary aspects of EU - Russia relations will follow and depend upon progress in other areas of this long-terms process. In this respect I would like to stress that the Bank of Russia and the Eurosystem have entered into a dialogue on the whole range of central banking issues. In late May this year we met for the first High-level Joint Eurosystem – Bank of Russia Seminar in Helsinki, where we discussed monetary and exchange rate policies, trade and financial links between our markets and developments in our domestic banking sectors..."
[Mrt: This happened in 2004, we moved few years forward.]