Europe is in a severe downturn and may well be entering the worst recession in its history, but will this have a big impact on the economies of China and Macau? Not according to Professor Robert Mundell who spoke at a seminar on the European debt crisis' impact on East Asia at the University of Macau recently. Mundell explained that the global financial crisis is not going to have a big effect on China or Macau from here on, as this region has already experienced some of the effects regarding the negative growth in European countries. Lower imports and investments are two of them.
But what should Asia be doing to avoid the eminent risk of a similar crisis? First we need to understand how Europe has reached such a fragile situation. From the 1960s to the 1990s, European countries started to develop their democratic systems, Mundell explains. These democratic regimes led to social policies – principles that affected the living conditions of the society through distribution and access to goods and resources – which included for example, retirement pensions, financial support for the elderly, and health and educational funds. Despite being an attempt to benefit society, these kinds of social measures also incurred a lot of expenses along the way, sinking southern European countries into debt as the lack of financial control worsened.
"In the last three decades they have kept piling on these social measures, social welfare policies that countries like those in Europe, with an aging population and not much population growth, cannot finance", says the 80-year-old Canadian professor.
Southern European countries have gone on increasing their spending and now they know they are in trouble because their debts are too high and people will not buy their bonds.
One thing that is certain is that China wants to – and has to – improve its social measures. But in order not to follow the example of Europe, it has to do this in a moderated way. Even with the economy in Mainland China growing, Mundell offers a cautionary word to the biggest Asian tiger.
"China has to improve its social welfare but it cannot go too far, otherwise that is unsustainable."
Something similar to Japan is what he recommends the mainland authorities. While European countries spent money on a variety of social policies, Japan, despite being a major economy back in the 1980s, did not spend its revenues on social measures, and thus did not put itself in a position of excessive expenditure.
Mundell is optimistic about China's economic development. While he believes the economic recovery of Europe and the US will be slow, China will continue to have good economic performance, he forecasts. Even so, China has to count on people to contribute to the financial system of the country and cannot rely only on the government to put money into it.
Notably, this is currently the case of Macau Mundell points out, and this should not continue. In Macau, the executive is currently drafting a Central Provident Fund, part of the double-tier social security system the MSAR government is going to introduce to support local residents in their retirement. While the first tier mainly aims to provide basic protection for employees for situations when they lose their jobs or suffer from illness, the second tier is to encourage residents and their employers to accumulate savings through monthly contributions. But for the first three years of the system, only the government will inject money. Furthermore, there are no guarantees that this situation will change after three years, as this current system is still being evaluated.
These social policies cannot be eternal Mundell advises.
"Taking from some to give to others is something that cannot be done forever", he says.
Instead, the professor advocates the imposition of a ceiling for this type of social spending and the creation of a Social Security Fund where contributions are made by all. The contributions must be made from household savings and there should be a limit to the contributions made by the government, he says.
"The expenses must have a limit and cannot go beyond that which the economy supports", Mundell explains.
In Macau, the situation of the Central Provident Fund is still being analyzed but the law suggests that the system only provides for voluntary contributions without further ensuring that at the end of this period they will be made mandatory. In China, as in Macau, the average life expectancy is rising and that increases the length of time pensions and retirement funds will be needed to last. Given what has happened in Europe, the question is how will it be in Macau, especially when the low contributions made by employers and labor organizations indicate a possibility that the Social Security Fund will actually go bankrupt.
Last year the Government released a report that showed the Fund could register a deficit of MOP170 thousand in 2014, with a possibility of bankruptcy in 2020. Prof. Mundell is certain the health of the euro will improve in the future and despite the entire crisis that surrounds the euro zone nowadays, the currency is not going to be abandoned.
"Europe has the second best currency in the world, there is no way they want to lose the euro because they gain so much from it", he says.
Mundell speaks not only as the father of the currency, but as an expert on economics when explaining what a great success the euro has been. He recalls the time the euro came into effect and recalls in 1999 that its value was US$1.18. Currently it is already valued at US$1.32.
"The euro celebrated 10 years and is in better shape than when it started. In 1999 it replaced the yen as the number two currency in the world and now it is still the second strongest."
In these ten years, Mundell says the euro has helped Europe. So why is the euro zone in such a fragile condition? The Nobel Laureate describes what is happening in Europe not as a "euro crisis" but as a "debt crisis" resulting from the excessive expenditures of countries like Spain, Portugal, Italy and Greece.
"Those countries were poor but they started to act like rich ones spending almost the total of their GDP."
Mundell assures that there is no advantage for countries to leave the euro currency and he actually does not believe that this is going to happen. He says he does not think the euro crisis is going to get worse than it currently is, even though it is not yet over. Instead he believes in the recovery of the euro zone, but for this countries have to stop providing so many social welfare measures, even though it will be a hard political decision to make.
"You cannot have social policies if you have a shrinking labor force. We cannot forget that on average people used to only live until 65 but now they can live until age 82. That is a happy state but it also means the extension of retirement age and pensions", says Mundell.
Furthermore, countries need to strengthen their financial discipline, so Mundell suggests issuing European bonds and treasury bills in the euro zone, not only to compete with US bonds but also to deal with the single currency sovereign debt problems.
As for mainland China, there are only two things the professor suggests: do not lend money to Europe – because that will leave European countries poorer than they are now – and encourage domestic consumption.
While China's exports have declined recently, its overall economy remains on a steady growth path. In Mundell's opinion, China should adjust its economic structure to boost and encourage consumption and domestic demand.
For Macau, he suggests what has been discussed a lot lately: the diversification of the economy that "is in great shape but is also unsteady".
Furthermore, in order to prevent the impact of European debt crisis on the region, Hong Kong and Macau should maintain the existing monetary policy regarding the indexation to the US dollar. A fixed exchange rate is a wise choice, he believes.
As a final note, is he still proud to be known as the father of the euro, give the criticisms it has received as it grows and matures?
"Whenever the euro is a great success people do not call me the 'father of the Euro'", he says smiling. "Only when they see it is in bad shape, then they start to call me the 'father of the euro', because success has many fathers but failure is an orphan."
Professor Mundell won the Nobel Memorial Prize in Economic Sciences in 1999 for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas. He is the author of numerous works and articles on economic theory of international economics. He is known as the father of the theory of optimum currency areas and formulated what became a standard international macroeconomics model. Not only was he the pioneer of the theory of the monetary and fiscal policy mix, but he also reformulated the theory of inflation and interest. The Mundell International University of Entrepreneurship in the Zhongguancun district of Beijing, People's Republic of China, is named in his honor.