We have had a significant improvement in the health of the financial sector over the last decade.
You can see that the percentage of non-performing bank assets in banks that are supervised by the single supervisory mechanism has fallen quite significantly.
Return on equity has grown and even the worst banks are getting into better territory, but it is still not a completely healthy picture for the banking system in continental Europe.
When we went into the crisis one of the things that we thought would be a great way to prevent future crisis from happening was to break the bank sovereign nexus.
This is where banks tend to be heavily invested in the sovereign bonds of their own country and so if the country gets into a problem you end up with a banking crisis and likewise if you have a banking crisis, because it is all linked to one country, you end up having a sovereign crisis as well.
"It is still not a completely healthy picture for the banking system
in continental Europe."
Unfortunately, we don’t have a huge improvement in this area and that is a risk factor for Europe.
If you look at the Euro area, close to 65 per cent of all equity investments in each country are held in that same country and somewhere around 50 per cent of bonds. This is a very high number particularly in some of the smaller Euro area countries.
The idea that Belgian insurers are holding 65 per cent of their assets in Belgian instruments rather than diversifying more is rather surprising.
The same is the case in terms of sovereign bond holdings and there is more home bias now than before the crisis.
As an economist that doesn’t make any sense from a risk management perspective. Perhaps it does from an information management point of view, but this is certainly going to be a challenge.
The US is an exception as it has less home bias than it used to. That is in part because other people are making a flight to safety when things get bad in emerging markets you tend to see assets flow into the US.
If we had a downturn today, the starting point in terms of indebtedness is much higher than it was 10 years ago.
Does this mean that we won’t be able to have fiscal response if we have another downturn? The answer is most likely no, but we have less fiscal space than we had.
"The idea that Belgian insurers are holding 65% of their assets in Belgian instruments rather than diversifying is surprising."
At the IMF, we have been going around Europe over the past couple of years telling countries that times are good now and so they should be trying to build those fiscal buffers.
Unfortunately, the countries who most need to save don’t and those that don’t need to do so, do. We end up in a situation where we are not in the best position to respond to the next crisis.
In terms of the productivity challenge that we are facing, the first one is economic growth and it is no surprise that economic growth is much slower now in the euro area, US and UK over the last decades compared to the 1990s and 2000s partly due to the recession.
The UK has had almost no productivity growth for a decade compared to an average of more than 1.5 per cent between 1990 and 2005.
This is a huge challenge for sustaining future economic growth, particularly if you aren’t going to get any growth from labour, plus the impact on productivity and capital investment.
"The UK has had almost no productivity growth for a decade."
The UK isn’t isolated, as you see the same patterns in the US and euro area. Therefore, there are challenges within the Euro area in particular to investment in other parts of the world. In 2018, investment in the Euro area is only back to its pre-crisis level.
We won’t have as much population growth in the future, so the labour force will be smaller. We are going to have less productivity growth and not as much capital investment. These three factors are considered traditionally as driving the economy so that presents clear challenges for economic growth.
The numbers of those in prime working years between 15 and 64 is increasing around the world, but already in decline in Europe and the US. This will be a challenge as to how we support more pensioners in the future, and where we look for the workers and skills when we don’t have the means.
"The US has seen a dramatic increase in income inequality."
The increase of income inequality and the political problems this can create poses another challenge. The US has seen a dramatic increase in income inequality, while Europe and Asia have seen less dramatic increases.
This has implications for economic growth, but also for the politics of populist movements.
More developing economies are falling behind the developed world, so there is an income distribution issue not only within countries but between countries.
Finally, climate change risks present their challenges as well.
