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Shanmugaratnam: the eurozone needs fiscal, banking, and structural reforms

April 18, 2013

Structural reforms will be critical to getting growth back in the eurozone, Tharman Shanmugaratnam said at Chicago Booth’s Economic Outlook 2013 in Singapore.

Shanmugaratnam, deputy prime minister and finance minister of Singapore, cited a three-part solution to the eurozone crisis that hinges on structural reforms. "People have got to see that pain today can lead to benefit tomorrow, and that doesn’t yet exist," he said.

Political commitments have outrun the ability of economies to pay for them, and the structural drivers of the global financial crisis, which began well before 2008, must be addressed in order to move on from it, he said.

Additionally, eurozone countries will need to reform their fiscal and banking policies, Shanmugaratnam said. "A clear commitment to medium-term consolidation," as well as "cleaning out of bad assets and recapitalizing the banking system" are also important, he added.

Steven J. Davis, William H. Abbott Professor of International Business and Economics and deputy dean for faculty at Chicago Booth, who served as moderator for the event, noted that proponents of the euro had hoped it would facilitate structural reforms. Instead, it "delayed structural reforms in many of the countries that needed it most," he said.

Shanmugaratnam agreed and said that moving to a single currency before establishing fiscal unity may have been "putting the cart before the horse." However, he felt it was not too late to find a path out of the current problems, and the solutions did not have to be socially inequitable. Reforms to labour markets and widespread entitlements would ultimately help the young, who otherwise faced a bleak future.

Responding to a question from Davis, Shanmugaratnam said countries that had coped well with the global economic crisis had studied the experience of the United States. "We learned our tools of the trade from the US and Europe, but they stopped doing what they had thought was important," Shanmugaratnam said.

The "CASH" countries—Canada, Australia, Singapore, and Hong Kong—were more conservative in banking and bank supervision was intrusive, he said. They "did the old-fashioned things, and tried to do them as well as they could." By contrast, lighter regulation in the US from a decade ago led to a burst of leverage and risk-taking by financial institutions.

Davis, who agreed with the DPM’s assessment of the role of risk culture in the crisis, asked whether all societies with influential banking systems have "the wherewithal to build the right kind of risk culture." Although there is a vigorous effort in the US to introduce stress testing, financial institutions increasingly try to anticipate what will meet the Fed’s expectations, Davis said.

One way to mitigate this would be reverse stress tests, Shanmugaratnam said. "Let’s define an outcome that’s undesirable, a place you really do not want to get to, and then ask what scenarios could lead to that." The reverse stress test is a useful exercise that companies are beginning to use more internally, he said.

Turning to immigration, Davis noted the role immigrants have played in both the US and Singapore as sources of talent and economic vitality. "Even in countries where it seems apparent that immigration has been a boon, there’s lots of resistance," Davis said.

According to Shanmugaratnam, the question of immigration policy is "especially acute for small countries, and most of all a country which comprises just one city." Singaporeans are concerned about the quality of their jobs and appreciate the need for foreign workers to sustain economic dynamism, he said.

"But when everyone lives and works within a few Mass Rapid Transit stops of each other, it means having to think very actively about economic strategy as it relates to your society."

— Chelsea Vail