Odd Lots - Lots More With Isabella Weber on Draghi's EU Competitiveness Report

Episode Date: September 13, 2024

This week, former European Central Bank President and Italian Prime Minister Mario Draghi published a long-awaited report examining ways to make the European economy more competitive. The report comes at a time when there are major concerns about how Europe is stacking up against the US and China in things like electrical vehicles and AI. It also dovetails with long-running debates about German fiscal austerity, economic tensions between various European Union members, energy crises, and inflation. In this episode, we speak with University of Massachusetts-Amherst economics professor Isabella Weber about her takeaways from the report and potential policy approaches to solving Europe's big competitiveness problem.Referenced in this episode:Draghi Says EU Itself at Risk Without More Funds, Joint DebtDraghi’s Call for Joint EU Bonds Hits Wall of German Opposition Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlots See omnystudio.com/listener for privacy information.

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Hello, how are you? It's so good to see you. It's nice to be able to do this in person as well. So I saw, I think you tweeted it, but you're here for an event, right? With Adam Houtes. Yeah, we just had him on. His episode came out today. Oh, okay.

This is like a nice, A nice segue. You're going to be sat right here. I'm not going to read from the notes. I just took some notes on the report because there's so much in there. I don't know. That's good because it's 400 pages and I didn't read all of it. Yeah, exactly.

Joe, is there anything more European than Mario Draghi writing a 400-page report on how to boost European productivity? No, it's perfect. I did a deadlift. One, two, three. Hedge a jimmy. Okay, go. What's the Barges

This is an after-school special Except I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Where's the best squid ink pasta?

These are the important questions Is it robots taking over the world? No, I think that like in a couple of years the AI will do a really good job of making the oddlots podcast and people will say I don't really need to listen to Joe and Tracy

anymore. We do have Cha-ching The poor Perfect guest. You're listening to Lots More, where we catch up with friends about what's going on right now. Because even when the odd lots is over, there's always lots more. And we really do have the perfect guest.

So that report came out this week, and it was sort of long awaited. I think it was delayed in the end, which also seems very European. But it took a year to write, and it's all about how to make Europe more competitive. Right. We talked about this a little bit on a recent episode with Adam 2's, some of the issues. in German. There does seem to be a lot of anxiety about the state of the European economy in general, getting really squeezed on the manufacturing side, the energy side. Growth has been quite mediocre there, particularly if you compare it to the United States. I think there was a good chart in the

Draghi report itself. I was about at one point, European was like 15% as big and the gap is widened versus the United States. It's not good. It doesn't seem good. Oh yeah. Isabella, didn't you tweet that chart? I did. So, no. Looking at that chart, I think we can basically see that with every crisis, there's a bit of a divergence between the U.S. and Europe. And it seems that the U.S. is pretty good at bouncing back. Europe, not so much, which has to do with the fiscal rules, I think. So we are here with Isabella Weber. She is, of course, an economics professor at University of Massachusetts Amherst. And she's been on the podcast a number of times. But it's interesting

to see this report come out and actually touch on a number of times. And it's interesting. topics that you have addressed through your work on pricing and shockflation. Yeah, thanks so much for having me on. It's a great opportunity to talk shockflation in the report. Maybe looking at this divergence, convergence thing, 28, 2020, I think that the energy crisis actually looms very large here. And the notion that was very prevalent in 2022 in Germany, that basically this is just like a little shock that we can easily absorb, that was very dominant in certain economics. I think is now playing out to possibly not be true.

So we kind of start to see the medium-term consequences of the energy shock and just how hard it hit Germany and Europe. The idea of every crisis being a moment where the U.S. and European economies further diverge. And I think, you know, one of the parts of the story is European fiscal constraints. You know, we know about, you know, the recession with government debt, and particularly in Germany, but elsewhere in the fact that none of the countries have their own currency, their own central bank. So I guess basically with every shock, productive capacity diminishes. People, you know, lose their jobs, factories close down. That happens in any economy. And then what

happens is basically in Europe, they sort of accept that their potential is just lower than it was before. Is that basically the story? And then they don't really do anything about it? I mean, in a nutshell, I mean, I would say that in the U.S. has also been a steep learning curve from 2008 to the COVID crisis, right? I mean, the kind of of fiscal ambition that we have seen in the response to the COVID crisis, I think, is a whole notch above of what we have seen under Obama in response to the global financial crisis. I mean, when it comes to the immediate rescue packages in 2020, there was also quite a bit across Europe, right? But then very quickly, Europe returned to the idea that they had to

go back to regular fiscal rules, and that really is thanks to the German government in large parts. I'm speaking with a German accent here. So when we look at the state, the state, stands of the German finance minister on the reform of fiscal rules, and he has been a critical player in preventing that reform. If we look at what the German government has been doing, then in 2023, they kind of declared victory too early on my mind over the energy crisis, which then also meant that they went back to implementing the debt break, which basically tied up their hands, and then we got this constitutional ruling saying that they have to stick with the debt break, that all these accounting ways out that they had found were basically

not constitutional. And then in 2024, they decided again to stick with the debt rule. While Germany is at this point already like the worst performing major economy in the world, and really any macroeconomist would agree, I think, in their right mind that this is a moment to

spend. I wasn't a panel with Jason Furman. Jason and I are not necessarily known to agree on big questions, but we both strongly agree that this is a moment to increase fiscal spending, right? So this is really a German exception to have this extremely conservative fiscal stance in the middle of this crisis.

Wait, can I ask a somewhat personal question? But I think given you're a German economist, and we have German economists on the show, but certainly not every day and not in the week when there is this big competitiveness report. But why is fiscal austerity such a big thing in Germany? Yeah, great question. There was actually an exhibition at the German Historical Museum a little while ago where they were trying to understand why this idea of saving is so deeply rooted in our culture. Yeah, because it's not like there isn't a social safety net in Germany either. So, why? And I mean, savings rates are very high, right? So, I mean, their narrative was basically going back to some ideas of Prussian virtue and then Nazi propaganda that very heavily relied

on like kind of making it a German virtue to save because it was necessary for the war economy. and then after the war that like kind of someone who saves is a good person idea was perpetrated. And then I think there's this kind of equation between personal spending and fiscal spending by the state and this narrative of the Swabian housewife, which is very prominently rooted in people's mind. So if you do polls on whether the debt break is a good thing, most people actually think it is a good thing because it's been preached to them for so long. where by the way, I think this idea of the Swabian housewife is the way how to run a national budget also has a good portion of sexism because it of course refers to the idea that the housewife

doesn't really have authority over the budget, but that it kind of has to ask permission. Right. So passively, except this is the amount of income that you get you, but you don't actually control the amount of income and then you just like, but now figure out how to spend it. Exactly. That's the implication behind that term, which I hadn't, I guess I don't really, I'm not sure if I had heard that term before. It's very, I mean, this idea of the Swabian housewife is all over the German discourse. I think it's a very German thing. And I think no one really thinks about the sexist implication of non-sovereignty over your budget, but it's kind of there. And I mean,

Merkel really like to invoke it, which doesn't make it any less sexist. So there's that, but then there's, of course, also the fact that this has been established as a constitutional rule, right? So now, I mean, beyond all these cultural issues, there's a real issue of politics where basically the ruling government has a coalition of three parties and one party, the FTP, things that the best thing to do is to stick with the fetish of the black zero and the other two parties disagree, but they are not in a position to find the majority in parliament. They're kind of locked into that straight jacket. So you touched on the energy markets earlier, but it's really interesting reading Joggi's

report. I mean, energy is a big component of this. And he talks about things like decoupling energy prices and gas. derivative markets and things like that. Can you talk a little bit more about how that fits into your research? Because I know you've done a lot of work on things like carbon pricing and obviously shockflation, a lot of which comes through higher energy prices. Yes.

So for the whole question of European gas prices, I'm totally aligned with Draghi. And I think that in many ways, actually, his section on prices reads a bit like an implicit commentary on what happened during the gas crisis. So, I mean, he's saying that there are a number of causes for the high gas prices in Europe and the kind of, I mean, gas prices have come down, but there's still a persistent gap between China and the US, right? So of course, there's a lack of resources, which is obvious, but there's also low grid development, low infrastructure investments, which is kind of these like more long run structural factors. Oh, yeah, he talked about permitting reform as well, which is kind of interesting coming from Europe.

Yes. But in terms of the kind of short-run dynamics, which I think is where the commentary in 2022 comes in, he's talking about financial markets having driven volatility, having basically increased volatility in these markets, which I think implies that the prices that we have seen in 2022 were not necessarily prices that were reflecting fundamentals, but that some of these price movements were the reside of animus birds on gas markets where no one really knew what Putin was going to do next. and you basically got a lot of hurt behavior in this situation of extreme uncertainty, which is something that Tom Krebs, a co-author of mine and I have actually argued in a recent study on the price control question where we say, I mean, if you get these prices overshooting in relationship to the fundamentals in this extreme way, then this actually means that taking some of this overshooting out is optimal even from a general equilibrium, like a very conservative, standard economic modeling perspective. And that notion is definitely there in the draggy report in terms of the volatility.

The second point that he makes is that Europe should use its monopsony power in global markets. So it should team up. Yeah, this is like the collective bargaining argument. Yes. So that basically European countries should team up in buying gas and that way be able to get lower prices on the global market, which again was a very, very hot topic in 2022, where basically the rest of Europe was.

really trying to do that. And the German government was quite keen to keep procuring by themselves to make sure that Germany is supplied first. So again, this is kind of a commentary on the last crisis, looking ahead at the next crisis, that we need more coordinated procurement on the European level. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report delivered right to your podcast feed. Bloomberg News Now is a short. four, five-minute audio report on the day's top stories. Episodes are published throughout the day

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When news breaks, we'll have an episode up in your podcast feed within minutes. So you're always getting the latest stories and developments. Get the reporting and the context from Bloomberg's 3,000 journalists and analysts. We're all over the world. Listen to the latest from Bloomberg News Now on Apple, Spotify, or anywhere you listen. Many people seem to agree that the Eurozone is sort of a half-baked project. There's the common currency, but then, you know, there's like fragmented capital markets

and fragmented regulatory schemes, arrangements. setting aside, okay, we talked about energy, which is very important for industry. We talked about the fiscal straitjacket and the constraints that Europe imposes on itself for investment and how that makes it harder. Do you, as an economist, accept the premise that Europe has a competitiveness problem? And one of the other areas that Draghi talks about is like the regulatory environment. And you hear it from tech people. It makes really hard to start a business or do a stuff. startup in Europe because of various rules. Do you accept that component of the premise that there is other aspects of the regulatory environment that make it harder for companies to be at the

global cutting edge against competitors in the U.S. in China and that Europe needs to rethink something? I do agree with that basic premise. Basically, there is a challenge how to rethink the European model to make it competitive moving ahead. And I think that drug is also right in emphasizing that in good parts, this should build on existing strengths. So Europe is still pretty competitive in the whole clean tech sector. I mean, of course, China has become a very major player. They're the most important player, but still there are many technologies where Europe actually is in a good position and where basically the pipeline from innovation to employment and then actually like turning this into successful businesses is where the project fails. And I think trying to tackle

this is spot on. And it's exactly right. I will also say, that the whole discussion around energy prices is of course related to competitiveness. And this is where I would actually add the CO2 price question, which is something that he kind of touches on, but doesn't really go into where I think in the US, I don't know how you see it, but my impression is that the idea of carbon pricing in the US is basically off the table. I mean, the Democrats are not going to do it. And Trump is definitely not going to do it. In China, there's some scope for carbon pricing, but it's really secondary to the kind of investment-led big green state transition strategy. So this leaves Europe alone as a country that is trying to rely on making emission

incentive stuff more expensive. And that, I think, is actually a huge competitive disadvantage in the approach to the green transition. And as we have been arguing in a recent study where we have simulated the inflation impact from carbon pricing could also actually trigger inflation, which then given European inflation governance, which basically relies on interest rate hikes, could create another competitiveness constraint because if you get what we call carbon inflation, inflation triggered by carbon price increases, and you then respond by hiking interest rates, then of course you make the cost of capital even higher, which is one of the points that Draghi points out is a disadvantage for Europe.

The model that is being pursued in the green transition also really matters for competitiveness. And basically what Draghi is saying is that we need more of what the U.S. is doing, right? But he doesn't quite say we need to maybe rethink some of the stuff that we are doing right now. Yeah, I think the cost of capital point is so important. And like the green transition, the way Europe is pursuing it only really works if other countries are kind of doing something similar. And I remember there was this mind-blowing stat. I think it's like five years old now. So it's probably not true.

but I think it's very indicative of the tension that we're talking about. It's not true, but it sounds good. Well, it was true in 2019. It's probably not true now. But I remember, I think it was Citigroup. They put out this report saying that because of the different ways U.S. and European investors were treating and approaching energy companies, it meant that European energy companies had borrowing costs that were 200 basis points more expensive than their American counter.

parts. And what that meant is like maybe it would make sense for like Exxon to buy shell or something. I think they said that somewhat facetiously. But that's the issue here. If Europeans care more about the environment and carbon pricing and that results in a comparative disadvantage, as Isabella pointed out, then that's not helpful to the green transition or the European economy. Yeah. And I think there's kind of a more general gap or unrealized potential in the Draghi report here. because a lot of the things that he is talking about could actually also be used for price stability, right? I mean, he is talking, for example, about buffer stocks. He is actually talking about strategic reserves for.

He's pretty vague on what exactly he wants them for, but he's putting this on the table as one possibility. He is talking about lower energy prices. He is talking about a more coordinated industrial approach. And what we have been arguing is that basically in terms of the inflation governance, there's a huge gap in Europe. because if you get shockflation, if you get inflation that is actually triggered by major supply shocks with systemically significant sectors, and then you respond, the only way to respond is by hiking interest rates. You kind of have a gap. You could have a much more sophisticated toolbox to deal with these shocks. And I mean, a lot of the things that Draghi is talking about in terms of investments,

in terms of strategic reorientation of sectors in terms of resilience, could also be used to make these sectors more resilient to price shocks. right? And I think this is kind of a bit of a missing piece in the past. This reminds me. Joe, do you remember the first time we ever had Isabella on the podcast? Oh, I think we talked about China. Yeah, we were talking about China. And since then, you've done so much work on things like pricing and shockflation. And it feels like there's been a lot more acceptance, certainly in Europe, of things like even price controls. The transition has been like very remarkable to watch. And it's only been a few years.

Absolutely. And I think it's actually quite remarkable how there is some sort of a pretext, both in the US and in Europe, that basically they now need industrial policy because China is doing it. So we can no longer not do it. What is missing from my point of view is that actually China has not just been doing industrial policy as a kind of sector level one of policies, but has actually been thinking about re-industrialization from the perspective of system reform. So it's always been like kind of from this perspective, how do you change the system as a whole, where the price question, inflation question, macro stability questions are integrated with the question of changing specific industries.

And that is actually, I think, something that hasn't quite taken on yet in Europe and the US. Raina Faruha at the FT was recently had this op-ed where she was saying that basically we need much more systems thinking in all these initiatives. that currently run under the label industrial policy, which makes it sound as if it's about specific industries, it's about innovation policy, but really what we need is more of a systemic approach, right? I think the same, I would say, about the Draghi report,

where we have several elements of systems thinking, like when he talks about more coordination and so on, he's kind of walking in that direction, but then he's talking about prices without talking about interest rates and inflation. So kind of this major link where the macroeconomy is missing, which I think comes from a lack of this kind of, like, system thinking. And that is quite interesting to me. And it seems like, I mean, if I look back at the last couple of years and how quickly the discourse has changed, my sense is that this is the next

like kind of cutting edge in terms of how the economic policy debate might actually shift in the vest. It's interesting thinking about this sort of the U.S., Europe and China all have similarities with respect to sort of the challenges or the opportunities of the sort of internal cohesion, right? Because even, you know, China for all these sort of talk about centrally planned and plan out of Beijing, there's quite a bit of competition, is my understanding, between the provinces and their desire to compete against each other for investment and jobs and things like that. I mean, competition in China is absolutely cutthroat in many areas, right? I mean, if you take

the EV sector, like many people are talking now mainly about subsidies, which, of course, in the early phase when basically the Chinese state decided to create an EV industry, there was a lot of subsidies flowing. But right now, we are in a situation where we have a larger number of car companies than we have had since the 1910s or something because there are so many new EV companies that came on the market in China and they are engaged in the most brutal kind of competition that you can imagine. It's basically a competition for survival where it's clear to everybody that at the end of this competition process, there might be, I don't know, three, four, five companies left.

So this is just one example where everybody points to subsidies, but I think it's really also about competition between Chinese players. Another example is if you look at the meat industry, which is something that we have talked about before, then this is an extremely highly concentrated sector in the US and Europe, right? In China, I mean, concentration has started to pick up, but it's still extremely, extremely competitive with many small meat processes producing still pretty large shares of what comes to the market. And to me, when I first went to Beijing, like, as an undergraded student, actually,

just walking around the city, you sometimes come to these streets where the whole street just sells one product. There's a guitar shop street, okay? So there's like one shop next to another that sells basically the same product portfolio, which is the most extreme kind of competition that you can. can imagine. Like, none of them has any scope to move out of this. And this same model we see in a lot of the production towns in China, right, where, I don't know, one town that only does bottoms for shirts. And it's the most important supplier for shirt buttons in the whole world.

There's that famous Christmas decoration town where they just make Christmas decorations. Exactly. And each of these companies has like zero liva. This is actually kind of your ideal of perfect competition as you see it in the textbooks. I'm Francine Lacqua, an award-winning journalist, and I've got a new podcast, Leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from Heads of State to fashion icons about the news of the moment. But I've always been curious, who are these people as leaders? I don't think there's one right way to be a leader. Make decisions.

A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacois wherever you get your policy. podcasts. Tracy, according to Bloomberg, a 2023 piece, in 2019, there were 500 Chinese EV companies, but that's now down to 100. So I guess some are being weeded out. That's interesting. What if Europe's comparative advantage is basically writing think pieces and 400-page reports? Like, maybe they can actually make money by being the global exporter of ideas. The McKinsey.

Yeah. They're much better. They're also much better at, like, vacations and work-life balance and drinking wine at lunch. You've got to figure out how to get someone to pay them for all of that. Yeah. It could become some sort of a Disney park for Chinese and American tourists. Is that what you're envisioning with intellectuals walking around having great ladies? Just, like, observe what it would be like to have a European-style work-life balance. It's not crazy actually the Disney World example.

I mean, Europe is a great place to go setting aside the issue with energy costs and whether, you know, Volkswagen is going to be. competitive. It's a great place to go. I mean, food is great, culture is great, city life is great. Yeah, many things in there. I would like to kind of add maybe one more thought to your question on the cohesion and competitiveness and so on. I think that in this whole debate around external competitiveness and like kind of reshoring, French shoring and so on, there has been a tendency to think like when stuff is national, it will be kind of good for everybody in that country, which is to me a little bit similar to the debate around globalization in the 1990s, where it was like kind of the exact same thing but turn on its head, where it was like, oh, as long as we globalize and we produce

in the most efficient places and everything is free trade, it will be so wonderful and there will be welfare gains for everybody. Expanding the pie is what people used to say. Exactly. Now it's kind of no longer about expanding the pie globally. It's about expanding the national pie. And then there's an assumption that this will be great for everybody. And that is also like a little bit in the Draghi report. I mean, he hinges at saying like, oh, we need to make sure that there's also democratic participation and like consultation with unions and civil society groups and so on as we are making these decision processes to ensure that there is democratic legitimacy, which is, I think, great.

But at the same time, when we look at competitiveness and we actually take inflation into account as one of the dimensions of competitiveness, then we have seen that it's been perfectly possible. for very national companies to profit in enormous ways at the end of the day at the expense of the national competitiveness so that you can get cleavages between the national interests and the interests of individual companies. You can also get cleavages between the interests of companies and workers and consumers and so on, which in the U.S. is probably already a complex problem. I think in Europe is an even more complex problem because you have these different countries that have such different characteristics in terms of their structures.

So if we go back to the car sector and we say, okay, we are going to put tariffs on e-vehicle, so basically protect the European car industry. Then we are really talking about companies from the rich Western European countries, right? It's not like a lot of the Eastern European new member states have internationally competitive car companies right now. So for them it means more expensive cars. In terms of production possibilities, it might mean, some FDIs, but it's not entirely clear that having FDI from Volkswagen, which is about to actually cut jobs in Germany, is better than having FDI from B.D. So there's a bit of a, you know, possible

friction that is completely glossed over when we only think in terms of Europe as a whole. And I think for Europe being this not really integrated unit, this problem is even more severe than in the U.S. context. Yeah, you're back to the old tension between the Eurozone as a whole and the individual members, which used to play out in monetary policy, but maybe now plays out more in industrial policy. Interesting. Yeah, I mean, it still plays out in monetary and fiscal policy, right? I mean, Germany being the policeman of fiscal conservatism is a huge drag for everybody else. One more thing on the whole question of competitiveness and, like, some imagined nation, like imagining Europe as a nation as the unit of analysis, I think it's important to take into

account that many of these European companies are actually totally global companies at this point, right? If you look at, for example, Mercedes-Benz, this is an absolutely global company. It's in a way as Chinese as it is German. They have massive, massive investments in R&D in China. They say themselves that to kind of stay on top of the automobile game, they need to be in the Chinese market because the Chinese consumer is the most demanding consumer at this point. It's a market with the highest degree of innovation in all directions of the experience of moving in a four-wheeled vehicle from one place to another, so that actually, for example, Mercedes-Despense has been coming out against European tariffs on Chinese vehicles, right? So I think this is again, and if you only take

the nation as your unit of analysis, you might actually run into problems. And for the European continent that has been much more, at least with Germany at its economic core, much more relying on exports and actually integrating its own companies into the Chinese market. I think there's also, in a way, something different at stake from the United States that has been running pretty persistent trade deficits with China, right? So just taking the U.S. strategy and then like kind of adapting it to the European context runs the risk of overseeing the different role of European companies in the Chinese economy and the importance of the Chinese market.

and the Chinese innovation ecosystem for some of these core European industries. By the way, Tracy, you know what? Going back to the earlier thing about some of the origins of the austerity obsession or the Schwarznoel, as they call it, I hadn't realized up until recently. I love it when you speak German, Joe. Thank you. I try to throw that in for you. How did I do?

Pretty good. Thank you. That's pretty good. That's pretty good. That's very good. He was like one of the ones who is like directly involved. with the reunification of East and West Germany. He saw firsthand the degree to which Eastern Bloc states had accumulated huge debts to the West,

et cetera, and were major burdens then on the restructuring and they're coming out of that system or the unsustainability of the sort of the system that they had. It makes me wonder, too, whether, like, his experience directly dealing with East Germany and some of these countries also informed his view on just like the utter importance of not accumulating persistent national debts. That's a good point. Yeah, just something I've been wondering about. It's an interesting thought.

But then again, like if we go back to 1990s East Germany, that's probably the purest example of shock therapy, right? Totally. And when we look at the at least initial knee-jerk reaction in Germany to the question of the energy price shock, then of course there has been a change in course and the energy price breaks and so on. But there have been some elements of like kind of energy price shock.

shock therapy. So I'm not sure how much has been learned from the 1990s experience. I guess one point that I think is kind of also important to keep in mind as we look at Europe. It's just the rise of the far right. This is at this point something that I think cannot be glossed over by kind of imagining some sort of homogeneous, democratically minded politicians with liberal Western values or something like that. And in fact, this I think goes to some extent back to the point that was trying to make earlier, we're collapsing the national interests with everybody else's interest, runs the risk of overlooking how certain policies might not immediately benefit certain demographics, which could then fuel the rise of the far right even more. And that's, for me, actually,

one of the considerations why I think that we need to look much more systematically at how these competitiveness considerations, these industrial strategy considerations square with what this actually means for pocketbook politics. Yeah, it's going to be interesting to see whether that more systematic thinking is like the next area of discourse. Lots more is produced by Carmen Rodriguez and Dashel Bennett with help from Moses Ondom and Kale Brooks. Our sound engineer is Blake Maples. Sage Baumann is the head of Bloomberg Podcasts. Please rate, review, and subscribe to Odd Lots and Lots More on your favorite podcast platforms. And remember that Bloomberg subscribers can listen to All of our podcasts add-free by connecting through Apple Podcasts.

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