CESifo, a Munich-based, globe-spanning economic research and policy advice institution EEAG European Economic Advisory Group THE AUTHORS on the European Economy Torben Andersen Professor of Economics at the Department of Economics and Business Economics, Aarhus University. Former chairman of the Aarhus University Danish Economic Council. 2016 | No.15 Giuseppe Bertola Professor of Economics at Edhec Business School, Nice, on extended leave from Università di Torino where he has been Professore di Edhec Business School, Economia Politica since 1996. Former editor of Economic Policy. Università di Torino EEAG Vice-Chairman John Driffill Professor of Economics at Birkbeck College, University of London. Formerly, Director of the ESRC research programme on ‘World Birkbeck College, Economy and Finance’ from 2004 to 2010. on the European Economy University of London EEAG Chairman Harold James Professor of History and International Affairs, Claude and Lore Kelly Professor of European Studies, and Director of the Program in Princeton University Contemporary European Studies at Princeton University. 2016 Hans-Werner Sinn Professor of Economics and Public Finance at the University of Munich and President of the CESifo Group. Ifo Institute and University of Munich WHAT NEXT? MACROECONOMIC CONDITIONS AND OUTLOOK Jan-Egbert Sturm Professor of Applied Macroeconomics and Director of the KOF INTERGENERATIONAL FAIRNESS Swiss Economic Institute, ETH Zurich. President of the Centre for KOF, ETH Zurich International Research on Economic Tendency Surveys (CIRET) and Editor of the European Journal of Political Economy. TUNING SECONDARY EDUCATION DENMARK: TOO GOOD TO BE TRUE? WESTERN BALKANS: COMING TOGETHER Branko Uroševic´ Professor of Finance and Operations Research and Director of the International Masters in Quantitative Finance (IMQF) programme University of Belgrade at University of Belgrade. Advisor to the Governor, National Bank of Serbia. EEAG European Economic Advisory Group on the European Economy 2016 EEAG Report on the European Economy ISSN 1865-4568 Publisher and distributor CESifo Group Munich Poschingerstraße 5 81679 Munich, Germany Phone: +49 (0)89 9224-0 Fax: +49 (0)89 9224-1409 www.cesifo.org Reproduction permitted provided source is quoted and copy is sent to the publisher Suggested citation EEAG (2016), The EEAG Report on the European Economy, CESifo, Munich 2016 EEAG European Economic Advisory Group Foreword FOREWORD World economic growth faced a number of fresh challenges in 2015, in- cluding the decline in oil and commodity prices, the slowdown in emerging market economies, and an initial interest rate hike by the US Federal Reserve System. Despite the turmoil, the European economy continued to recover, although the improvement remains weak and fragile, with yet an- other flare-up of the euro crisis in Greece. The EEAG scholars, focusing on the future, pose the question of What next? As is its tradition, the 2016 EEAG Report begins with an analysis of the business cycle situation in the major economies around the world, including a forecast for this year. In- depth chapters then delve into several topical issues. Chapter 2 addresses the demographic challenge faced by some EU countries, which is being ex- acerbated by labour mobility in the union, calling for a common solution to restore both cohesion between EU members and intergenerational fair- ness in society. Chapter 3 focuses on the need for tuning secondary educa- tion, a need starkly illustrated by the high levels of youth unemployment in Southern Europe. Practice-oriented dual education, standardised – and thus comparable – tests and greater coordination at the European level are all identified as key strategies. Chapter 4 offers an in-depth analysis of the feasibility of taking Denmark as a role model for implementing political reforms effectively. Denmark, it turns out, is not too good to be true. Finally, Chapter 5 explores developments in the Western Balkan countries, which are in the process of coming together and seeking a sustainable rela- tionship with the EU. The European Economic Advisory Group at CESifo, which is collectively responsible for all parts of the report, consists of a team of seven econo- mists from six countries. This year the Group is chaired by John Driffill (Birkbeck College) and includes Torben M. Andersen (Aarhus Uni- versity), Giuseppe Bertola (EDHEC Business School), Harold James (Princeton University), Jan-Egbert Sturm (KOF Swiss Economic Ins- titute, ETH Zurich), Branko Uroševi´c (University of Belgrade) and my- self (Ifo Institute and University of Munich). The members participate on a personal basis and do not represent the views of the organisations they are affiliated with. I would like to express my gratitude for the valuable assistance provided by researchers and staff at CES and Ifo who helped to prepare this year’s report: Nadjeschda Arnold and Christopher Weber (assistants to the group), Atanas Hristov, Nikolay Hristov and Andreas Steiner (economic forecast), Lisa Giani Contini and Julio Saavedra (editing), Christoph Zeiner (graphics), Katharina Pichler and Elisabeth Will (typesetting) and Ines Gross (cover). I also wish to thank Swiss Re for hosting our autumn meeting. 1 EEAG Report 2016 Foreword Given that I am about to retire, upon reaching the mandatory retirement age of 68, I wish to take this opportunity to thank all those who have con- tributed over the years to develop the EEAG Report into a true European undertaking with a non-partisan approach aiming at serving Europeans as a whole. Hans-Werner Sinn President, CESifo Group Professor of Economics and Public Finance Ludwig Maximilian’s University Munich Munich, 22 February 2016 EEAG Report 2016 2 Contents CONTENTS Recommendations for Europe 6 Summary 8 Chapter 1 Macroeconomic Conditions and Outlook 14 The industrialised countries remained in recovery mode in 2015, while growth in emerging markets slowed down markedly, with Latin-America and Russia even slipping into recession. Favourable business cycle conditions in the United States and Britain, together with moderate growth in the euro area, had a stabilising influence on the world economy. Fluctuations in the price of oil and other commodities led to very heterogeneous developments in emerging economies, with India’s growth rate exceeding that of China in 2015. Demographic trends and China’s growing reliance on domestic demand are expected to lead to further long-term declines in its structural growth rate, which should nevertheless remain stable in 2016. Chapter 2 Intergenerational Fairness 54 The idea of a contract between generations forms the bedrock of an equitable social order, stability and sustain- ability. In many countries the public sector is now expected to replace the family by funding education and pen- sions, but social welfare models are facing major challenges. This chapter looks at how to preserve intergenera- tional fairness by tackling issues like demographic ageing, rising healthcare costs, blocked housing, labour market flexibility and emigration. Chapter 3 Tuning Secondary Education 70 Education is one of the most controversial issues in Europe. Reforms can have major short-term budgetary ef- fects and a strong influence on longer-term growth and inequality trends. This chapter reviews differences across Europe in the orientation of curricula, in school autonomy and private education, and in teacher management, with a special focus on the secondary education level. It interprets current reform tensions and asks whether and how country-level policy choices may benefit from supranational EU-level coordination. Chapter 4 Denmark: Too Good to Be True? 85 The Danish welfare state and flexicurity labour market model have a reputation for functioning efficiently, but is this assessment justified? How can the strong economic performance of a small, open economy be reconciled with a large public sector and a high tax burden? And how can such an economy cope with challenges like ageing and migration? Chapter 5 Western Balkans: Coming Together 99 What measures are required to promote the creation of a vibrant regional economy in the Western Balkans? How can the region become a development pole, instead of a potential source of instability? This chapter outlines key aspects of the Western Balkans’ economic transformation in the 15 years since the break-up of the former Yugoslavia and explores reform options for building a brighter future. Authors: The Members of the European Economic Advisory Group at CESifo 3 EEAG Report 2016 Contents TABLE OF CONTENTS Recommendations for Europe 6 Summary 8 1. Macroeconomic Conditions and Outlook 14 1.1 Introduction 14 1.2 The current situation 14 1.2.1 The global economy 14 1.2.2 United States 17 1.2.3 Asia 17 1.2.4 Latin America and Russia 20 1.2.5 The European economy 21 1.3 Fiscal and monetary policy 25 1.3.1 Fiscal policy 25 1.3.2 Monetary conditions and financial markets 29 1.4 The macroeconomic outlook 34 1.4.1 Assumptions, risks and uncertainties 34 1.4.2 The global economy 36 1.4.3 United States 37 1.4.4 Asia 38 1.4.5 Latin America and Russia 39 1.4.6 The European economy 39 Appendix 1.A: Forecasting tables 45 Appendix 1.B: Ifo World Economic Survey (WES) 48 2. Intergenerational Fairness 54 2.1 Introduction 54 2.2 Generational conflict and class conflict 56 2.3 “Bank Papa”: how the dual labour market creates dependence 58 2.4 “Hotel Mama”: property ownership 60 2.5 “Bank Grampers”: pensions 63 2.6 Paying for grampers: medical insurance 65 2.7 Running away