European Communities WT/TPR/S/177 
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I. ECONOMIC ENVIRONMENT 
(1) MAIN CHARACTERISTICS  
1. The 25 Member States of the European Communities (EC-25) cover a land area of 
3.9 million km2 and have a combined population of 459.5 m illion, of which 68% resides in the euro 
area.  Germany is the most populated country, followed by France and the United Kingdom;  France 
is the biggest in surface, followed by Spain and Sw eden;  and Malta is the smallest in both area and 
population.  In 2005, the EC-25 had a GDP of €10,844 billion, while its per capita income in nominal 
terms amounted to €23,500.  In terms of per capita income, Luxembourg ranks first, followed by Ireland and Denmark (Table I.1).
 1 
Table I.1 
Selected indicators, 2005 
 
Area Population   
GDP  per capita Share in gross value added 
(2004) 
(per cent)  Share of 
agricultural 
employment 
 ('000 km2) (million) Euro  PPSa  Agriculture, 
hunting, 
forestry and 
fishing Industryb Services % of civilian 
working 
populationc  
(2004) 
EC (25) 3,894.3 459.5 23,500.8 23,500.8 2.1 26.5 71.5 5.0 
EC (15) 3,154.0 385.4 26,584.1 25,468.1 2.0 26.2 71.8 4.0 
Euro-zone 2,458.0 310.9 25,666.4 25,012.2 2.2 26.6 71.1 .. 
Austria 84.0 8.2 30,033.0 28,691.5 1.9 30.3 67.8 5.5 
Belgium 31.0 10.4 28,545.2 27,544.6 1.0 24.8 74.3 2.2 
Cyprus 9.0 0.7 17,909.1 19,549.8 3.1 20.3 76.6 5.1 
Czech Republic 79.0 10.2 9,629.3 17,142.4 3.3 37.9 58.8 4.4 
Denmark 43.0 5.4 38,475.5 28,873.8 1.9 24.0 74.0 3.3 
Estonia 45.0 1.3 7,824.9 13,048.6 4.3 28.9 66.9 5.5 
Finland 305.0 5.2 29,660.5 26,374.4 3.1 30.2 66.7 5.3 
France 544.0 60.6 28,236.3 26,341.8 2.5 21.3 76.3 4.3 
Germany 357.0 82.5 27,240.9 25,279.9 1.1 29.1 69.8 2.4 
Greece 132.0 11.1 16,350.0 19,565.5 5.7 21.2 73.1 12.6 
Hungary 93.0 10.1 8,697.8 14,381.5 3.9 30.8 65.2 5.3 
Ireland 70.0 4.1 39,015.4 32,649.9 2.5 37.5 60.0 6.4 
Italy 301.0 58.5 24,241.9 24,246.4 2.5 27.3 70.2 4.2 
Latvia 65.0 2.3 5,545.0 10,901.1 4.1 22.6 73.3 14.6 
Lithuania 65.0 3.4 6,010.4 11,883.8 5.9 32.7 61.5 16.3 
Luxembourg 3.0 0.5 64,449.5 56,987.0 0.6 16.8 82.8 2.1 
Malta 0.3 0.4 11,131.6 16,292.5 2.5 23.7 73.6 2.3 
Netherlands 34.0 16.3 30,782.3 28,940.2 2.1 23.9 74.0 2.7 
Poland 313.0 38.2 6,301.2 11,620.8 5.1 31.0 64.0 17.6 
Portugal 92.0 10.5 13,984.7 16,691.1 3.3 25.1 71.7 12.1 
Slovak 
Republic  49.0 5.4 6,927.1 12,949.3 3.9 35.1 60.9 5.1 
Slovenia 20.0 2.0 13,702.9 18,938.0 2.5 35.2 62.2 9.7 
Spain 505.0 43.0 21,012.2 23,068.4 3.5 29.1 67.3 5.5 
Sweden 411.0 9.0 31,957.0 27,736.7 1.8 27.7 70.5 2.5 
United 
Kingdom 244.0 60.0 29,458.9 27,181.8 1.0 24.1 75.0 1.3 
a In euros, measured on the basis of purchasing power standards (PPS). 
b Including construction. 
c Employment in agriculture, hunting, fishing, and forestry. 
Source:  Eurostat (2005) Yearbook .  Viewed online a t: http://epp.eurostat.cec.eu.int;  and DG Agriculture (2005), 
 Key Agricultural Statistics , Table 2.0.1.2, Brussels.  
                                                      
1 If measured in purchasing power stan dards, the Netherlands ranks third.  WT/TPR/S/177 Trade Policy Review 
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2. Services (including construction) is by far the mo st important sector in terms of contribution 
to gross value added (GVA) and employment in th e EC.  In 2005, the sector accounted for 77.7% of 
the EC-25's GVA and employed 77.1% of its labour fo rce;  in the euro area, the corresponding figures 
were 77.6% and 77.9%.  The share of services in GVA tends to rise significantly with Member States' 
level of income, ranging from 58.7% in th e Czech Republic to 89.2% in Luxembourg.2  
Manufacturing contributed 20.4% to the EC-25' s GVA in 2005, and employed 17.8% of the 
population.  The EC's share in world manufactures value added has been declining, reflecting the redistribution of international manufacturing activiti es and particularly the vertical decomposition of 
manufacturing processes.
3  This reduction is not a recent phenomenon but an on-going process, 
implying deeper structural changes in light of the intensity of international competition.  Agriculture, 
hunting, forestry, and fishing accounted for 1.9% of GVA in 2005, but employed 5.0% of the labour 
force.  The contribution of mining and quarrying to GVA is marginal.  
3. Twelve EC Member States have the euro (€) as their common currency (the "Euro area").4  
The Maastricht convergence criteria for adopting the euro are:  price stability (i.e. the average 
inflation rate should not exceed by more than 1.5 pe rcentage point that of, at most, the three best 
performing Member States);  sustainable fiscal pos ition (public deficit not exceeding 3% of GDP or 
close to that limit, and the ratio of general govern ment debt to GDP not over 60% or declining at a 
"sufficient pace" towards that level);  exchange rate stability through participation in the Exchange 
Rate Mechanism II (ERM II)5, respecting the normal fluctuation margins without severe tensions for 
at least two years;  and low interest rates (the average nominal long-term interest rate should not 
exceed by more than two percentage points that of, at most, the three best performing Member States).  
On 21 December 2005, the regulations on the introduc tion of the euro were amended to enable 
countries to join the euro zone in subsequent ph ases.  Apart from a number of technical adaptations, 
the amendment allows for different cha ngeover scenarios for individual countries.6  The common 
monetary policy is managed by the Eurosystem, wh ich consists of the inde pendent European Central 
Bank (ECB) and the National Central Banks (NCBs) of the Member States that have adopted the euro. 
4. Sweden and the ten new Member States (NMS-10) ,which have a derogation, are expected to 
adopt the euro, after fulfilling the Maastricht convergence criteria7, while Denmark and the United 
Kingdom retained their national currencies through an  "opt-out clause".  Slovenia plans to join the 
                                                      
2 European Commission (2006a). 
3 EC enlargement has enhanced th is process through the delocalization of industries based on 
comparative advantages. 
4 The twelve countries where the euro is currently le gal tender are:  Austria, Belgium, Finland, France, 
Germany, Greece, Ireland, Italy, Luxembourg, the Neth erlands, Portugal, and Spain.  See Council Regulation 
(EC) No 974/98 on the introduction of the euro in the eleven Member States establ ishing the euro area on 
1 January 1999;  Council Decision 2000/427/EC on the introduction of the euro in Greece in 2001;  and Council Regulations (EC) 974/98, 1103/97 and 2866/98, and their amendments. 
5 The ERM provides the framework for coordination of exchange rate policies.  It was formed in 1979 
in an attempt to create a zone of exchange rate stability, a prerequisite to the introduction of the euro.  A new exchange rate mechanism (ERM II) came into force on 1 January 1999, aimed at ensuring that Member States 
outside the euro area, but participating in the mechan ism, align their policies towards stability and foster 
convergence, which should help them in their efforts to adopt the euro.  At the same time, the mechanism is intended to help protect the Member States adopting the euro from unwarranted pressures in the foreign 
exchange market. 
6 Council Regulation (EC) 2169/2005. 
7 Unlike Demark and the United Kingdom, Sweden does not have an opt-out clause and is therefore 
expected to adopt the euro at a later stage. Having a derogation means that a Memb er State is exempt from 
some, but not all, of the provisions relating to price stability, sound public finances, and eventual adoption of the euro. 
 European Communities WT/TPR/S/177 
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euro zone on 1 January 20078;  Cyprus, Estonia, Latvia, and Ma lta no later than 1 January 2008;  
Slovakia on 1 January 2009;  and the Czech Repub lic and Hungary in 2010. However, Latvia and 
Hungary are currently reconsidering these target dat es.  Poland and Sweden have not set target dates.9  
Meanwhile, the Baltic states, Cyprus, Malta, Sloveni a, and Slovakia joined ERM II between June 
2004 and November 2005.10   
5. The Economic and Monetary Union (EMU) is  a unique policy framework.  It has a 
centralized monetary policy framework, but decentr alized fiscal policies, left to the national 
authorities of each Member State, on the basis of th e Stability and Growth Pact (SGP).  Adopted in 
1997, the SGP is aimed at ensuring sound fiscal polic ies as a means to strengthen the conditions for 
price stability and for robust and sustainable growth conducive to employment creation.  It consists of 
three elements:  a political commitment to the full and timely implementation of the budget surveillance process;  preventive elements to deter b udget deficits beyond the 3% reference level;  and 
dissuasive elements for Member States to take corrective actions.
11  The SGP was reformed in 2005, 
with changes to both its preven tative and corrective elements.12  The emphasis on the fundamentals of 
fiscal sustainability in setting medium-term budgetary  objectives strengthened the preventative arm,  
whilst changes to the corrective arm relate to defining "excessive de ficits" and the modalities for their 
correction.  To this end, the changes allow for a more comprehensive economic assessment of 
budgetary developments in the implementation of th e excess deficit procedure (EDP).  The reformed 
SGP also provides for a set of "other relevant f actors" that the Commission and Council may take into 
account when deciding on the EDP.  These factor s include developments in the medium-term 
economic position (potential growth, cyclical  conditions, and policy implementation) and 
developments in the medium-term budgetary position (public investment, quality  of public finances, 
fiscal consolidation in "good times", and debt sust ainability).  In particular, a one-year deadline for 
corrective measures can be extended by an additional year (based on other relevant factors) and steps 
in the EDP can be repeated if effective action has been taken by the Member State concerned in 
compliance with the initial recommendations.   
(2) RECENT ECONOMIC DEVELOPMENTS  
6. Economic performance in the EC has been positive, despite an increase in oil prices by almost 
45% in euro terms.  Annual output growth was 2. 4% in 2004 and 1.7% in 2005 in the EC-25, and 
1.9% and 1.4%, respectively, in the euro area.  In 2006 (on a quarter-to-quarter basis), real GDP 
growth accelerated to 0.8% in the first quarter and 0.9% in the second quarter in both the EC and the 
euro area.  However, performance at the national le vel was relatively dispersed.  Denmark, Greece, 
Ireland, Luxembourg, Spain, and all new Member States, except Malta, had growth rates over 3% in 2005, while output growth in Germany, Italy, and Portugal was below 1% (Table I.2).  Against the 
                                                     
 
8 Estonia and Lithuania originally also planned to join the euro area in January 2007.  While Estonia, 
due to its high inflation rate, did not apply for admission to the euro area, Lithuania's application to join was 
rejected, also on grounds of a too high inflation rate.  While Estonia has set 2008 as a new target date for euro adoption, Lithuania still has to decide. 
9 EC document COM(2005) 545.  
10 European Commission (2006f).  
11 The SGP aims to enforce fiscal disciplines as a permanent feature of the EMU.  It specifies the 
procedure to be followed in case a Member State breac hes the 3% public deficit limit, on the basis of the 
Excessive Deficit Procedure (EDP), as laid down in the EU Treaty.  The EDP includes a possibility for the 
Council to impose a penalty, which initially would take the form of a non-interest-bearing deposit with the 
Communities, but it could also be converted into a fine if the excessive deficit is not corrected within two years. 
12 Council Regulation 1055/2005 amended Regulation (EC) 1466/97, and Council 
Regulation 1056/2005 amended Regulation (EC) 1467/97.  The new Code of Conduct on the content and format 
of the stability and convergence programmes, endors ed by the ECOFIN Council on 11 October 2005, also 
provides guidelines for Member States in drawing up  their programmes and facilitating the examinations.   WT/TPR/S/177 Trade Policy Review 
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backdrop of income losses caused by negative terms of trade, mainly resulting from oil price 
increases, growth-supporting domestic factors ga ined the upper hand, most notably improved 
financing conditions and wider profit margins.13   
Table I.2 
Key macroeconomic indicators, 2004-05 
Country 
 Real GDP 
growth rate Inflation rate  
(HICP annual 
change) General 
government 
debt 
 (% of GDP) General 
government 
balance 
 (% of GDP) External 
current 
account  
(% of GDP)  Unemployment 
(% of labour 
force) 
 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 
EC-25 2.4 1.7 2.1 2.2 62.4 63.4 -2.6 -2.3 0.1 0.0 9.1 8.7 
EC-15 2.2 1.5 2.0 2.1 63.4 64.6 -2.6 -2.3 0.5 0.4 8.1 7.9 
Euro area 1.9 1.4 .. .. .. .. -2.8 -2.4 0.8 0.3 8.9 8.6 
Austria 2.4 1.9 2.0 2.1 63.6 62.9 -1.1 -1.5 0.3 -0.5 4.8 5.2 
Belgium 2.6 1.2 1.9 2.5 94.7 93.3 0.0 0.1 9.3 7.6 8.4 8.4 
Cyprus 3.9 3.8 1.9 2.0 71.7 70.3 -4.1 -2.4 -4.5 -3.5 4.7 5.3 
Czech Republic 4.7 6.0 2. 6 1.6 30.6 30.5 -2.9 -2.6 -5.7 -6.1 8.3 7.9 
Denmark 1.9 3.1 0.9 1.7 42.6 35.8 2.7 4.9 2.0 2.7 5.5 4.8 
Estonia 7.8 9.8 3.0 4.1 5.4 4.8 1.5 1.6 -10.2 -13.2 9.7 7.9 
Finland 3.6 2.1 0.1 0.8 44.3 41.1 2.3 2.6 7.6 4.2 8.8 8.4 
France 2.3 1.2 2.3 1.9 64.4 66.8 -3.7 -2.9 1.0 0.3 9.6 9.5 
Germany 1.6 1.0 1.8 1.9 65.5 67.7 -3.7 -3.3 2.2 2.3 9.5 9.5 
Greece 4.7 3.7 3.0 3.5 108.5 107.5 -6.9 -4.5 -7.3 -6.4 10.5 9.8 
Hungary 5.2 3.6 6.8 3.5 57.1 58.4 -5.4 -6.1 -7.2 -9.0 6.1 7.2 
Ireland 4.5 4.7 2.3 2.2 29.4 27.6 1.5 1.0 -1.3 -1.4 4.5 4.3 
Italy 1.1 0.0 2.3 2.2 103.8 106.4 -3.4 -4.1 -0.8 -1.4 8.0 7.7 
Latvia 8.5 10.2 6.2 6.9 14.6 11.9 -0.9 0.2 -6.6 -8.2 10.4 8.9 
Lithuania 7.0 7.5 1.2 2.7 19.5 18.7 -1.5 -0.5 -5.2 -6.9 11.4 8.3 
Luxembourg 4.2 4.0 3.2 3.8 6.6 6.2 -1.1 -1.9 11.8 8.2 5.1 4.5 
Malta -1.5 2.5 2.7 2.5 76.2 74.7 -5.1 -3.3 -2.0 -5.7 7.3 7.3 
Netherlands 1.7 1.1 1.4 1.5 52.6 52.9 -1.9 -0.3 2.9 3.3 4.6 4.7 
Poland 5.3 3.2 3.6 2.2 41.9 42.5 -3.9 -2.5 -2.7 -2.0 19.0 17.7 
Portugal 1.1 0.3 2.5 2.1 58.7 63.9 -3.2 -6.0 -7.3 -5.7 6.7 7.6 
Slovakia 5.5 6.0 7.5 2.8 41.6 34.5 -3.0 -2.9 -8.0 -0.9 18.2 16.3 
Slovenia 4.2 3.9 3.7 2.5 29.5 29.1 -2.3 -1.8 1.4 -0.4 6.3 6.5 
Spain 3.1 3.4 3.1 3.4 46.4 43.2 -0.1 1.1 -2.4 -2.8 10.6 9.2 
Sweden 3.7 2.7 1.0 0.8 50.5 50.3 1.8 2.9 5.3 6.4 6.3 7.8 
United Kingdom 3.1 1.8 1.3 2.1 40.8 42.8 -3.3 -3.6 -1.7 -1.7 4.7 4.7 
.. Not available. 
Source: Eurostat online information.  Viewed at:   http://epp.eurostat.cec.eu.int.  
7. Among domestic demand components, private i nvestment revealed the most unambiguous 
signs of a strong upturn, growing by 4.2% in 2004 and 3.0% in 2005.  However, consumer spending 
was less encouraging, with a nnual growth declining from 2.0% in 2004 to 1.5% in 2005.  The 
sluggish expansion in private consumption has to be viewed in the context of continued slow growth 
                                                      
13 DG Economic and Financial Affairs (2006b).   European Communities WT/TPR/S/177 
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in disposable incomes, the key determining factor  to household spending.  On external demand, 
EC-25's exports benefited from buoyant world trade;  their growth rate peaked at 7.1% in 2004 and 
was 5.1% in 2005 (Table I.3). 
Table I.3  
Growth in real GDP  and expenditure components, 2001-05 
(Percentage changes; base year: 1995) 
 2001 2002 2003 2004 2005 
EC-25: 
GDP 2.0 1.2 1.3 2.3 1.7 
Domestic demand 1.5 1.0 1.8 2.3 1.8 
  Household 2.2 1.5 1.7 2.0 1.5 
  Government 2.1 2.6 2.2 1.5 1.6 
  Gross fixed capital formation -1.0 -2.1 1.8 4.2 3.0 
Exports 3.6 1.8 1.7 7.1 5.1 
Imports 2.2 1.3 3.3 7.2 5.6 
EC-15: 
GDP 1.9 1.1 1.1 2.2 1.5 
Domestic demand 1.5 0.9 1.7 2.2 1.8 
  Household 2.1 1.4 1.5 1.9 1.4 
  Government 2.0 2.5 2.0 1.5 1.6 
  Gross fixed capital formation -0.8 -2.1 1.9 3.7 3.1 
Exports 3.4 1.6 1.2 6.6 4.7 
Imports 2.1 1.1 2.9 6.7 5.5 
Euro area:  
GDP 1.9 0.9 0.8 1.9 1.4 
Domestic demand 1.2 0.4 1.5 1.8 1.7 
  Household 2.0 0.8 1.2 1.5 1.3 
  Government 2.0 2.4 1.8 1.2 1.4 
  Gross fixed capital formation -1.5 -2.9 2.0 3.3 2.9 
Exports 3.7 1.7 1.1 6.8 4.2 
Imports 1.8 0.3 3.1 6.7 5.3 
Note: Seasonally adjusted data. 
Source: Eurostat online information.  Viewed at:  http://epp.eurostat.cec.eu.int.  
8. There has been a trend to income convergen ce between the EC-15 and NMS-10.  Growth 
rates in the NMS-10 have been higher than in th e EC-15, although more volatile.  Thus, per capita 
incomes in NMS-10 and EC-15 are now much closer  than they were in the late 1990s, NMS-10 
income increased to more than 50% of the EC-15 level, on average, in 2005, from 44.3% in 1997, 
when enlargement prospects crystallized in the Commission's Agenda 2000.  The catch-up process, 
which is led by the manufacturing and services sectors, is particularly impressive in the Baltic states, but also in Hungary and Slovenia.
14   
9. The labour market in both the euro area and th e EC-15 proved relatively resilient during the 
economic slowdown in 2001-03.  Specifically, employment growth accelerated to 0.6% in 2004, from 
0.4% in 2003, and increased to 0.7% in 200515, owing to structural reforms in both the product and 
labour markets over the last decade, including more employment-friendly wage development and 
improved matching.  The reforms also resulted in  lower long-term unemployment rates and shorter 
average duration of unemployment spells.16  Unemployment in the EC-25 peaked at 9.1% in 2004 
before decreasing to 8.8% in 2005.  The unemployment rate in the euro area also fell, from 8.9% in 
2004 to 8.6% in 2005.  Yet, new and some old Member States still experience high unemployment.  
                                                      
14 European Commission (2006g). 
15 European Commission (2006g). 
16 DG Economic and Financial Affairs (2006a).   WT/TPR/S/177 Trade Policy Review 
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In 2005, the highest unemployment rate was reco rded in Poland (17.7%), followed by Slovakia 
(16.3%), and Greece (9.8%).  Ireland and Luxembour g recorded the lowest unemployment rates in 
2005, at 4.3% and 4.5%, respectively (Table I.2).  However, the Commission concluded that the EC was unlikely to attain the Lisbon and Stockholm employment targets
17, except for female 
employment, unless all Member States urgently pursue comprehensive labour market reforms.  
Reforms to enhance productivity also need to be  stepped up as the growth in hourly labour 
productivity has slowed down in many countries since 2000, with negative rates being recorded in Italy, the Netherlands, and Portugal in 2003.
18   
10. The primary objective of the ECB is to maintain  price stability in the euro area (defined as 
year-on-year increases in the euro area Harmonized  Index of Consumer Prices (HICP), below but 
close to 2%).19  Influenced by increasing energy prices, in flationary pressures intensified during most 
of 2005 in the EC and in the euro zone.  EC-25 inflation, as measured by the HICP, rose from 2.1% in 2004 to 2.2% in 2005
20;  the highest rate of 6.9% was recorded  in Latvia, and the lowest in Finland 
and Sweden (0.8%).  Seven EC-25 countries had rates below the 2% reference value in 2005 
(Table I.2).21  
11. After the interest rate cut in mid-2003, the ECB kept its key interest rates at the historically 
low level of 2% during 2004 and most of 2005.  It raised key interest rates to 2.25% on 6 December 2005, 2.50% on 8 March 2006, 2.75% on 15 June 2006, 3.0% on 9 August 2006, and further to 3.25% on 11 October 2006, and further to 3.5% on 7 December 2006.
22  The average long-
term interest rate in the euro area was 3.4% in 2005 and 3.8% in October 2006. 
12. Between 2000 and 2004, the euro appreciated signi ficantly against major currencies, in both 
nominal and real effective exchange rates terms, reaching the peak in 2004.  The nominal effective 
exchange rate appreciated by 4.1% in 2004, then depreciated by 1.4% in 2005.  A similar trend was 
observed with the real effective exchange rate, which appreciated by 3.74% then depreciated by 
1.80%.  In particular, the euro appreciated agains t the U.S. dollar almost continuously in 2004, to 
US$1.2439, and to US$1.2441 in 2005 (Table I.4).23 
13. Although some Member States made progress in improving their budgetary situation, debt 
ratios have remained high and long-term sustainability in the EC is not yet secured.  Fiscal deficit to 
GDP in the EC-25 fell from 2.6% in 2004 to 2.3% in 2005, and from 2.8% to 2.4% in the euro zone.  Excessive deficits were identified by the Commissi on in 2002 for Portugal, and in 2003 for Germany 
and France.  Eight more countries were added in  2004:  Greece and the Netherlands, as well as the 
Czech Republic, Cyprus, Hungary, Malta, Poland, and Slovakia after their accession.
24  In 2005, the 
                                                      
17 The Lisbon and Stockholm Councils in 2000 and 2001 set a series of specific employment and social 
policy targets to be met by 2010. 
18 During 2000-03, hourly labour productivity and the total number of hours worked increased in the 
EC-15.  However, at the national level, the total number of hours worked declined in Denmark, France, Germany, the Netherlands, and Swed en;  it increased in Belgium, Italy, Luxembourg, and Portugal, but 
productivity declined (European Commission, 2005), Second Report on the Implementation of the 2003-05 
BEPGs. 
19 European Central Bank (2004). 
20 In the context of a modest recovery and lingering weakness in labour markets, core inflation was 
expected to fall close to 1.5% over the medium term, with the ECB seeing a modest acceleration beginning in 
2007.  Headline inflation would still be around 2% in 2005 and moderate to 1.75% in 2006 (IMF, 2005).  
21 The Czech Republic, Denmark, Finland, Fran ce, Germany, the Netherlands, and Sweden.  
22 Key interest rates refer to those on main refina ncing operations (MRO).  ECB online information.  
Viewed at:  http://www.ecb.int/sta ts/monetary/rates/html/index.en.html 
23 The euro effective exchange rates take into account a broad group of 42 countries (EER-42).   
24 DG Economic and Financial Affairs (2005a). European Communities WT/TPR/S/177 
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fiscal deficit to GDP ratio exceeded the 3% limit in  four euro area countries (Germany, Greece, Italy, 
and Portugal), and in the United Kingdom and Malta ;  it exceeded 5% in Hungary (Table I.2).   
Table I.4 
Euro exchange rates, 1998-05 
(Period averages) 
 Effective exchange rate (EER) of the euroa 
(1999 Q1=100) ECU or euro 
exchange rateb 
 EER-23 EER-42 (U.S. dollar) 
 Nominal Real Nominal Real  
1998 100.7 101.0 96.7 99.3 1.1211 
1999 95.9 95.9 96.5 95.8 1.0658 
2000 86.1 86.0 87.9 85.8 0.9236 
2001 86.7 86.8 90.4 87.0 0.8956 
2002 89.2 90.4 94.8 90.9 0.9456 
2003 99.9 101.7 106.6 101.6 1.1312 
2004 103.8 105.9 111.0 105.4 1.2439 
2005 102.9 105.2 109.5 103.5 1.2441 
a The nominal and real effective exchange rate indices of the eu ro are based on weighted averages  of bilateral euro exchange ra tes.  
The weights capture third-market effects and are based on trade in manufactured goods with the trading partners in the periods 
1995-97 and 1999-01, with the indices being linked at the begi nning of 1999. The EER-23 group of trading partners comprises 
the 13 non-euro area EC Member States;  plus Australia;  Canada ;  China;  Hong Kong, China;  Japan;  Norway;  Singapore; 
Republic of Korea;  Switzerland;  and the United States.  The EER-42 includes 19 additional countries and covers about 90% of 
extra-euro area trade in manufactured goods.  Real rates are obt ained by deflating the nominal ra te by consumer price indices 
(HICP for EC countries, CPI elsewhere).  For more information, see the ECB Monthly Bulletin , September 2004 (Box 10), and 
ECB Occasional Paper No. 2.  
b Until December 1998, rates for the ECU;  from January 1999, rates for the euro. 
Note: A positive change denotes an appreciation of the euro. 
Source: ECB (2004), Statistics Pocket Book , May 2006. Viewed at:  http://www.ecb.int/pub/pdf/stapobo/spb200605en.pdf. 
14. The ratio of government debt to GDP in the EC -25 increased by one percentage point in 2004, 
to 63.4% in 2005, while in EC-15 it rose by 1.2 percentage points to 64.6% over the same period.  In 2005, public debt remained above 60% of GDP in Austria, Belgium, Cyprus, France, Germany, 
Greece, Italy, Malta, and Portugal.  The Commission  indicates that the persistent high debt resulted 
from many Member States giving low priority to budgetary consolidation, notably in pension and 
healthcare reforms.
25  Another cause has been weak ec onomic growth, and the ongoing transition 
process in the NMS-10.  Several Member States (Aus tria, France, Germany, Italy, and Sweden) have 
reformed their pension systems in recent years and reduced the projected increase in future pension 
expenditure.26  Nevertheless, efforts to address concerns about long-term fiscal sustainability are still 
required in the majority of Member States.27   
                                                      
25 The pressures on fiscal deficits are also associat ed with ageing populations.  The old-age dependency 
ratio (persons aged 65 or above to th e persons in working age 15 -64) is forecast to more  than double, from 25% 
in 2003 to over 50% in 2050.  This in turn will put a heavy burden on age-related public spending, e.g. pensions, 
healthcare, and long-term care.  The Council decided that a three-pronged strategy should be followed to 
address the economic and budgetary consequences of ageing:  increasing employment rates, reducing public debts, and reforming pension and healthcare systems (DG Economic and Financial Affairs, 2005a). 
26 DG Economic and Financial Affairs (2006c). 
27 DG Economic and Financial Affairs (2005a). WT/TPR/S/177 Trade Policy Review 
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15. The EC's Lisbon Strategy was reformulated in March 2005.28  More focus on growth and 
employment, and national ownershi p via national action plans are the key elements to relaunch the 
Lisbon reforms agenda.  Broad economic policy guidelines (BEPGs) focus on the contribution of 
economic policies to the Lisbon strategy, through both sound macroeconomic policies and vigorous 
economic reforms.29  The guidelines identified three main prio rities for policy action:  growth;  labour 
market flexibility;  and sustainable public finan ces.  The second report on the BEPGs indicates that 
Member States show mixed progress in implementing the guidelines.30  Relatively good follow-up of 
the country-specific recommendations has been noticed in Belgium, Denmark, Ireland, the 
Netherlands, Finland, and the United Kingdom, wh ile progress is considered limited in other 
Members.  Implementation in the NMS-10 is going in th e right direction, albeit at a different pace.   
16. The reforms appear to have improved the overall business environment and enhanced 
competition within the EC.  On the other hand, refo rms are considered limited in the transition to a 
knowledge-based economy, as demonstrated by a substa ntive and persistent gap between the EC and 
the United States.  The speed of internal market integration has also slowed down, with limited 
progress on the transposition of internal market direct ives and a high level of infringement cases.   
(3) TRADE PERFORMANCE AND INVESTMENT  
17. EC merchandise trade and services imports grew le ss than the global average in 2004, while 
services exports grew slightly more than the worl d average.  EC external trade growth remained 
moderate in nominal terms due to the marked depr eciation of the U.S. dollar against the euro and 
partly due to the already high level of its internal trade.31  The EC's current account turned from a 
surplus in 2002 (0.1% of GDP) and a balance in 2003 to a deficit in 2004 (0.1% of GDP), following 
its enlargement.  Preliminary data show that the ex ternal current account deficit increased further, to 
nearly 0.9% of GDP, in 2005.  The current account de ficit in the euro area was equivalent to 0.3% of 
GDP in 2005.  In percentage of GDP, Luxembourg had the largest current account surplus in 2005 
(8.9%), followed by the Netherlands (6.5%), Swed en (6.1%), and Germany (4.1%).  The largest 
deficits in the same year were registered in Ma lta (13.2% of GDP), followed by Latvia (12.5%), 
Estonia (10.9%), and Portugal (9.3%).32  The services account surplus in  the EC-25 increased slightly, 
from €42.7 billion in 2004 to €47.8 billion in 2005.33  The EC is the world's biggest recipient and 
supplier of foreign direct investme nt (FDI), accounting for around ha lf of global FDI stocks (inward 
and outward).  It is also a net investor in the rest of the world.   
(i) Trade in goods 
18. The EC's merchandise trade growth was strong at the turn of the millennium.  However, there 
was only slight growth in merchandise exports, and a small decrease in imports during 2000-03.  
Exports expanded by 20.3% in 2004 and 10.3% in 2005, while imports grew by 20.1% and 14.2%.  
The EC's trade account has been in pe rsistent deficit, generally considered  to be at a sustainable level.  
                                                      
28 In March 2000, the Council, in Lisbon, set out a ten-year strategy to make the EC "the most 
competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with 
more and better jobs and greater social cohesion".  The Lisbon Strategy sets certain broader objectives to be 
attained by 2010.   
29 In 2004, the BEPGs were updated to accommodate EC enlargement.  In 2005, the EC adopted BEPG 
for 2005-08 (DG Economic and Financial Affairs, 2005b). 
30 DG Economic and Financial Affairs (2005a).  
31 WTO (2005). Trade between EC-15 Member States increased only slowly throughout the 1990s but 
this has been more than outweighed by strong trade growth among the EC-25.   
32 Eurostat (2006b).   
33 Eurostat News Release , Euro-indicators , March 2006. European Communities WT/TPR/S/177 
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The deficit amounted to €75.6 billion in 2004 and € 134.4 billion in 2005.  The EC had a considerable 
trade deficit with Asian countries, while its larg est trade surpluses were registered with North 
America.   
19. The EC remains the world's leading trader, acc ounting for 18% of world merchandise trade in 
2004.34  It was the largest merchandise exporter and sec ond largest importer, with extra-EC exports 
and imports of €969 billion and €1,032 billion, resp ectively.  Individually, Germany ranks first in 
global merchandise exports, France fifth, the Netherlands sixth, Italy seventh, the United Kingdom eighth, and Belgium tenth.  Germany is the world's second largest goods importer, France fourth, the United Kingdom fifth, Italy seventh, the Netherlands eighth, and Belgium ninth.  Among the 
NMS-10, Poland is the largest merchandise trader, ranking 31st in world exports, followed by the 
Czech Republic and Hungary;  Poland, the Czech Re public, and Hungary are also the three largest 
importers among the NMS-10.
35 
20. The United States has traditionally been the EC's  most important trading partner, but its 
significance has declined over the years.  In 2005,  the share of EC-25 goods exports to the United 
States fell to 23.5% (down from 27.4% in 200036), and its share of goods imports to 13.9% compared 
with 20.4% in 2000 (Chart I.1, and Tables AI.1 a nd AI.2).  During the same period, the EC's trade 
surplus with the United States grew steadily to €91 billion.  Switzerland is the second most important destination of EC merchandise exports (7.8% of th e total in 2005), and China remains the second 
most important source of EC goods imports (13.4% of the total in 2005, up from 7.4% in 2000).  
While Japan's share in both exports and imports of  goods has weakened some what, the importance of 
the Russian Federation as an EC trading partner h as increased steadily.  Since 2000, the EC's largest 
trade deficits have been with China, Russia, Japan , and Norway.  By region, the main destination for 
exports from the EC-25 was North America with a 25. 7% share in 2005, followed by Asia and other 
European countries.  In the same year, 35% of the EC's imports were sourced from Asia, while 
imports from other European countries accounted fo r 17%.  Imports from and exports to Africa and 
the Middle East have increased in absolute and relative terms. 
21. The bulk of EC-25 merchandise exports in 20 05 was machinery and transport equipment 
(44.4% of total exports, down from 46.6% in 2000), followed by chemical products (14.9%), and other consumer goods (9.6%) (Chart I.2 and Table AI .3).  Import patterns have changed slightly in 
recent years, with the share of primary products rising and that of manufactured goods declining, 
mainly due to the rapid growth of energy pro duct imports.  In 2005, EC-25 merchandise imports 
consisted primarily of machinery and transport equipment (31.8% of  total imports, down from 37.3% 
in 2000), mining (25.2%, including fuels), and ot her consumer goods (9.4%) (Table AI.4).   
 
                                                     
 
34 The United States ranked second with 17%, followed by China (9%), Japan (8%), and Canada (4%).   
35 WTO (2005).   
36 In order to ensure comparability, trade data for 2000 in this and the following paragraph include 
NMS-10 extra-EC-trade. WT/TPR/S/177 Trade Policy Review 
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0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%200020012002200320042005Chart I.1
Direction of merchandise trade, 2000-05
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%200020012002200320042005(a) Exports
(b) Imports
Source:   WTO Secretariat calculations, based on UNSD, Comtrade database (SITC Rev.3).Switzerland Middle East OtherChina Turkey United States
Japan Other America Russian federation
Norway Africa Other AsiaSwitzerland Middle East OtherChina Turkey United States
Japan Other America Russian federation
Norway Africa Other Asia
 European Communities WT/TPR/S/177 
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0%20%40%60%80%100%
2000 2001 2002 2003 2004 2005
0%20%40%60%80%100%
2000 2001 2002 2003 2004 2005Chart I.2
Structure of merchandise trade, 2000-05
(a) Exports
(b) Imports
Source:   WTO Secretariat calculations, based on UNSD, Comtrade database (SITC Rev.3).Agriculture Chemicals Other electrical machines
Other semi-manufactures Fuels Transport equipment
Non-electrical machinery Other primary products Textiles and clothing
Office machines Iron and steel OtherOther electrical machines ChemicalsAgriculture Other semi-manufactures Transport equipment
Mining Textiles and clothing Non-electrical machinery
Iron and steel Other Office machines
 WT/TPR/S/177 Trade Policy Review 
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(ii) Trade in services 
22. The EC-25 is the world's leading services trad er;  in 2004, it accounted for 27.8% of global 
services exports and 24.5% of imports.37  EC-25 services exports were valued at €396,864 billion in 
2005, an increase of 9.4% over 2004, and imported services were worth €349,106 billion, up by 9.1% 
from 2004 (Table I.5).  Individually, the United Kingdom is the world's second largest exporter of 
services, followed by Germany and France.  In te rms of services imports, Germany ranks second in 
the world, the United Kingdom third and France fifth.  Among the NMS-10, Poland is the largest trader in services (ranking 34th in the world's exports  and imports in 2004), followed by Hungary and 
the Czech Republic.
38 
Table I.5 
Trade in services, 2003-05 
(€ million) 
 EC-25 Exports EC-25 Imports 
 2003 2004 2005a 2003 2004 2005a 
Total (extra-EU)  333,392 362,681 396,864 296,387 319,908 349,106 
Transportation 78,134 92,255 100,914 71,179 78,813 84,589 
  Sea transport 39,358 49,451 : 34,680 39,138 : 
  Air transport 28,495 32,047 : 25,676 28,277 : 
  Other transport 10,282 10,756 : 10,825 11,399 : 
Travel 61,916 67,011 71,331 75,361 79,890 86,468 
Other services 190,851 200,544 221,577 146,921 158,085 174,855 
   Communication services .. 6,298,721 6,992,206 .. 6,983,032 7,456,017 
   Construction services .. 9,525,647 11,654,972 .. 6,002,772 6,473,526 
   Financial services (excl. 
insurance) .. 25,483,473 30,975,374 .. 11,115,635 14,479,876 
   Computer and information 
services .. 17,620,509 17,620,279 .. 7,938,310 8,552,565 
   Royalties and licence fees .. 19,438,355 23,099,338 .. 28,367,934 30,058,587 
   Other business services .. 95,479,992 109,889,136 .. 77,423,670 87,645,272 
Services not allocated 2,491 2,870 3,041 2,927 3,121 3,194 
Main trading partners        
United States 110,596 116,284 122,103 101,109 105,110 113,070 
Switzerland 43,781 43,934 48,365 33,047 34,013 35,772 
Japan 16,678 18,927 19,487 10,114 10,328 11,657 
Norway  11,374 12,961 .. 8,390 9,164 .. 
China  6,843 8,786 .. 4,999 7,264 .. 
Russian Federation 7,530 8,222 .. 5,829 6,650 .. 
Canada 7,221 8,062 8,580 6,705 7,225 7,734 
Singapore 5,884 7,257 .. 4,226 4,499 .. 
Hong Kong , China 6,204 7,177 .. 4,410 5,171 .. 
Australia 5,374 7,026 .. 4,814 5,096 .. 
Korea (Republic of) 4,344 5,623 .. 2,729 3,288 .. 
South Africa 3,795 4,223 .. 3,890 3,939 .. 
    Table I.5 (cont'd) 
                                                      
37 It was followed by the United States (19.6%), Japan (7.2%), China (4.1%) and Canada (3.2%).   
38 WTO (2005). European Communities WT/TPR/S/177 
 Page 13 
 
 
 EC-25 Exports EC-25 Imports 
 2003 2004 2005a 2003 2004 2005a 
Turkey 3,202 3,875 .. 8,410 9,517 .. 
Brazil 3,378 3,737 .. 3,444 3,415 .. 
Mexico 3,495 3,507 .. 2,974 2,725 .. 
India 2,842 3,433 .. 3,033 3,813 .. 
a Provisional 
.. Not available. 
Source: Eurostat online information.  Viewed at:  http://epp.eurostat.cec.eu.int. 
(iii) Foreign direct investment 
23. The EC-25 is the world's largest recipient and supplier of FDI.  In 2004, it accounted for 
45.2% of inward FDI stock, up from 37.6% in 2000.  Similarly, it accounted for 53.3% of global outward FDI stock in 2004, up from 49.5% in 2000.
39  It is a net investor in the rest of the world.  In 
2005, EC-25 FDI outflows and inflows were equivalent to 1.2% and 0.7% of its GDP, respectively.  
Between 2003 and 2005, the United Kingdom, France, and the Netherlands were the main single net 
investors, while most of the NMS-10 were net FDI recipients (Table I.6).  Foreign direct investment inflows to the NMS-10 have been particularly vi brant, motivated both by access to expanded markets 
and comparative advantages.
40 
24. After a decline in 2004, FDI inflows and out flows increased strongly in 2005, by 23% and 
18% respectively.41  As a result, the EC-25's net FDI increased from €20.1 billion in 2003 to 
€82.8 billion in 2005 (Table I.6).  
Table I.6  
FDI inflows and outflows, 2003-05 
(€ million) 
 2003 2004 2005a 
 Outward flows Inward flows Outward flows Inward flows Outward flows Inward flows 
EC-25 135,512 115,366 128,935 56,854 152,541 69,789 
Austria 916 2,268 3,019 516 3,827 855 
Belgium .. .. 2,768 8,985 9,562 8,598 
Cyprus 124 203 216 .. 183 417 
Czech Republic -16 1,051 583 779 519 522 
Denmark -1,778 -1,666 .. .. 1,605 1,774 
Estonia 22 116 24 157 175 29 
Finland -1,715 741 644 223 -2,247 464 
France 14,562 10,646 2,376 990 19,381 12,526 
Germany 2,085 6,928 -1,033 553 11,293 2,431 
Greece .. .. 192 154 674 51 
Hungary 950 -687 303 1,631 697 482 
    Table I.6 (cont'd) 
                                                      
39 UNCTAD (2005).  
40 European Commission (2006g). 
41 The 2004 downturn could partly be explained by a change in the system of compilation of balance-
of-payments statistics introduced in April 2003 (UNCTAD, 2005). WT/TPR/S/177 Trade Policy Review 
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 2003 2004 2005a 
 Outward flows Inward flows Outward flows Inward flows Outward flows Inward flows 
Ireland 1,120 -1,270 5,987 -11,977 1,930 -4,652 
Italy 2,030 1,273 519 2,485 6,067 1,616 
Latvia 23 119 72 167 75 238 
Lithuania 19 81 33 169 143 245 
Luxembourg 31,034 36,764 6,857 20,236 16,034 13,955 
Malta .. .. .. .. .. .. 
Netherlands 20,114 -1,119 5,556 -6,511 10,029 6,109 
Poland 101 1,064 297 552 376 1,450 
Portugal 4,179 5,803 1,049 2,163 -742 -447 
Slovakia .. 25 1 25 65 280 
Slovenia 99 618 120 62 464 -48 
Spain 6,717 7,174 11,633 2,151 10,523 2,882 
Sweden .. .. 6,115 4,688 15,644 10,697 
United Kingdom 41,097 6,895 59,227 8,704 55,516 16,939 
a Provisional 
.. Not available. 
Source : Eurostat online information.  Viewed at: http://epp.eurostat.cec.eu.int. 
(4) O UTLOOK  
25. In November 2006, the Commission's forecasts i ndicated an increase in the 2006 GDP growth 
rate to 2.8% in the EC-25 and 2.6% in the euro area, up from 1.7% and 1.4% in 2005.42  However, 
economic growth is expected to decline slightly to 2.4% in 2007 and 2008 in the EC-25, and to 2.1% 
and 2.2% in the euro area.43  Overall, recovery in the EC since the downturn in 2001-03 will be 
underpinned by the strengthening of domestic demand, notably an increase in investment in equipment and private consumption.  External dema nd will also be spurred by the expansion of the 
world economy, with world output growth expected at  more than 5% in 2006, while global growth is 
set to ease somewhat in 2007-08. 
26. According to the Commission's autumn forecast, the EC-25's unemployment rate is to reach 
8.0% in 2006, before edging downw ards to 7.6% in 2007 and 7.3% in 2008.  Expected unemployment 
rates in the euro area are 8.0% in 2006, 7.7% in 2007, and 7.4% in 2008.  Employment growth is expected to reach 1.4% in 2006, generating some  1.9 million new jobs in the EC-25, and should 
remain robust at a yearly rate of close to 1% in 2007 and 2008.  The Commission predicts price 
stability in the EC-25, with gradually declining in flation rates; it anticipates a 2.3% HICP inflation 
rate in 2006, 2.3% in 2007, and 2.0% in 2008.  In flation rates in the euro area are forecast to be 
slightly lower, at 2.2% in 2006, 2.1% in 2007, and 1.9% in 2008.  
27. Upside and downside risks to the short-term growth outlook for the EC-25 and euro area in 
the Commission's forecast seem to be fairly balanced.  In particular, the importance of external factors 
                                                     
 
42 DG Economic and Financial Affairs (2006b). 
43 The expected slowdown in 2007 has to be seen in the context of slower global GDP growth and the 
planned budgetary operations in Germany, which will in crease the standard VAT by 3 percentage points on 
1 January 2007.  The latter could bring forward substantial household consumption and housing investment from 2007 to 2006 (DG Economic and Financial Affairs, 2006b).  European Communities WT/TPR/S/177 
 Page 15 
 
 
clearly increases over time.  In 2006, the risks appear  slightly tilted to the upside, as the forecast may 
underestimate the current momentum of growth, both in side the EC and in the rest of the world.  In 
2007, the risks are more skewed to the downside.44 
                                                      
44 DG Economic and Financial Affairs (2006b).