Jean-Claude Trichet: The need for structural reforms in Europe
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, on the occasion of the
Jean Monnet Lecture of the Lisbon Council's Board of Economists, Brussels, 4 June 2007.
* * *
I would first like to thank the organisers for inviting me in the occasion of this Jean Monnet Lecture of
the Lisbon Council's Board of Economists. It is both a privilege and a pleasure for me to be here
today, to share with such a distinguished audience my views on the need to further structural reforms
in Europe.
Opening a lecture series named Jean Monnet, is even more than that for me. Jean Monnet was at the
very heart of the foundation of European Union. The reading of his Memoirs is profoundly inspiring.
Today perhaps he would say again - I am only changing the tense of his verbs - : "Ceux qui ne
voulaient rien entreprendre parce qu'ils n'étaient pas assurés que les choses iraient comme ils
l'avaient arrêté par avance se condamnaient à l'immobilité. Personne ne pouvait dire la forme
qu'aurait l'Europe où nous allions vivre demain car le changement qui naît du changement est
imprévisible » ; « Those who did not want to start anything because they were not ensured that things
would go exactly as they had planned were condemning themselves to remain immobile. Nobody
could say what Europe would be tomorrow because future changes that are triggered by today's
changes are unpredictable". The setting up of the single currency has been a remarkable success,
acknowledged in Europe as well as across the entire world. However, to fully exploit the benefits of the
euro, Europe needs to face important challenges that require major policy measures.
In 2006, real GDP in the euro area grew by 2.8%, which is the highest rate since 2000. Along with the
recent economic recovery, hourly labour productivity growth has accelerated and employment growth
remained positive. These positive developments are very encouraging, but this is no time for
complacency. Europe still has some way to go, if it wants to cope with globalization and meet the
challenges of rapid technological changes and ageing population. This is true at the level of Europe as
a whole as well as at the level of each particular economy. Economic research has demonstrated the
major role of structural reforms in explaining cross-country disparities in economic performance1. If all
European countries summon up their strength and reinforce their push forward with structural reform,
the improvement in economic activity presently observed in Europe will be broadened and made
sustainable in the long run. This is why the ECB has always encouraged the implementation of
structural reform within the Lisbon Strategy. Six years after the launch of the Lisbon Strategy in March
2000, the 2006 Implementation Reports of the euro area countries' National Reform Programmes for
the period 2005-2008 confirm the awareness of governments to step up the pace of reform and the
strong commitment by all countries to deliver effective measures. In March, the 2007 Spring European
Council stressed the significant progress in implementing the renewed Lisbon Strategy for Growth and
Jobs in most European countries. At the same time it also called on Member States and EU
Institutions to reinforce their actions in particular to boost employment, strengthen the internal market,
improve significantly competitiveness and create better framework conditions for research and
innovation.
Against this background, I will first review the past economic growth performance of the euro area,
focusing on some of the underlying factors of potential output growth, namely labour resource
utilisation (or labour supply), hourly labour productivity and demographic trends, in particular in
comparison to the US. Then I will elaborate on the reforms which I see as particularly essential in
making Europe fit for the future.
The economic performance of the euro area since the mid-1990s.
When comparing the euro area's economic performance with that of the US, from the mid 1990's
onward euro area output growth underperformed. Since 1996, the annual growth rate for the euro area
has averaged 2.1% per year2 compared to 3.3% in the US. What are the fundamental causes of this
unsatisfactory low trend growth in the euro area? The answers can be found by looking at the factors
that determine potential or long-term economic growth, namely: the degree of labour utilisation,
productivity growth and the demographic trends.3
The euro area witnessed a considerable improvement in the employment situation4. The euro area
overall employment rate significantly increased from 58% in 1996 to 64.4% in 20065, accompanied by
a decline in the annual average unemployment rate from 10.7% to 7.9%. Since the beginning of the
EMU in 1999 the euro area has witnessed an increase of more than 12 million in the number of people
employed. The rise in the overall employment rate in the euro area over the last ten years has been
mainly due to an increase in the female and older workers employment rates, partly driven by the
progress made by structural reforms in some European countries. This improvement in the
employment situation is also reflected in the contribution of workers to economic growth. The degree
of labour utilisation reflects the extent to which the labour force in an economy actually contributes to
the production process and therefore has a direct influence on output growth. For the euro area,
labour utilisation grew on annual average by 0.4% [percentage changes] between 1996 and 20066
[compared with 0.1% in the US] when defined as the total annual hours worked divided by the total
population.7
Although this is a very encouraging fact, which shows that the positive employment effect we
witnessed over the last ten years has significantly helped us to counteract the growth differential to the
US, one has to remain aware of the inferior starting position of euro area countries. These
improvements did not cancel out structural weaknesses of labour markets.
First of all, despite the important progress recorded, the overall employment rate in the euro area
remains low by international standards [64.5% in the euro area compared with 72% in the US in 2006]
and the unemployment rate is still clearly too high [7.9% compared with 4.6% in the US on annual
average in 2006 and 7.1 % to be compared to 4.5 % in April this year]. Also to be noted in 2006, the
number of annual hours worked in the euro area was 1604 compared to 18048 in the US. This clearly
suggests that there is still considerable room for improvement as regards increasing the level of labour
resource utilisation in Europe.
Second, while the prime-age male employment rate in the euro area is comparable to that observed in
the United States, when we look at the youth, female and older worker employment rates, the
disparities remain important. In 2006 the female employment rate was 56.5% in the euro area and
66% in the US, the older workers employment rate was 41.7% in the euro area and 61.8% in the US,
the youth employment rate was 37.1% in the euro area and 54.2% in the US. These figures appear to
be consistent with an "insider-outsider" characterisation of the European labour market, where
structural impediments prevent those groups "at the margin" of the labour market from entering and
participating in it.
Productivity is the other major factor determining growth. Over the last decade, the diverging trend in
hourly labour productivity growth has indeed been the main reason explaining the growth differential
between the euro area and the US. According to the last figures available, during the 1980's and the
first half of the 1990s, hourly labour productivity in the euro area grew on average by 2.4%, then it
decelerated to 1.3% on average between 1996 and 2006. By contrast, US hourly labour productivity
growth rose from 1.3% to 2.1% over the same period.
Several causes have been mentioned to explain this downward trend in the euro area. Specific
policies aiming at increasing employment particularly in the unskilled segment of the labour market
may have contributed to the observed slowdown in labour productivity growth. However, this apparent
trade-off between labour utilisation and productivity is likely to be a temporary phenomenon that
should progressively fade, when the economy reaches a higher "equilibrium" labour/output ratio. In this
respect, it is worth mentioning that the US managed at the same time to increase both labour input
and labour productivity.
There is indeed another major reason that explains the big difference in the rate of labour productivity
growth in Europe compared with the US, which in my view is a major policy issue, namely the fact that
the European economy does not take advantage as does the US economy of all the opportunities
offered in particular by the advances of science and technology including, but not exclusively, in the
ICT sector. More generally, restructuring of the productive sector and re-engineering of the production
processes appear to be more difficult in a relatively significantly less flexible economy like the
European one, having a negative influence on total factor productivity.
A number of international institutions and academics have highlighted the major role of innovation and
ICT in the revival of labour productivity growth in the US.9 Over the last 10 years, total R&D
investment in the euro area accounted for 1.8% of GDP and the ICT sector represented as much as
20% of this amount, while in the US, 2.6% of GDP was spent on R&D and the ICT sector represented
as much as 30% of this total.10 Similarly important seems to be the effect ICT diffusion has had on
productivity in the US economy, particularly in some market service sectors intensively using ICT
technology, although the exact contribution is obviously hard to quantify.11 ICT investment, which can
be used as a proxy of ICT diffusion, represented on average 4% of GDP in the US or 29% of total
investment from 1996 to 2005 compared with only 2.3% of GDP or 16% of total investment in the euro
area.12 At the sectoral level, it appears that the gap in labour productivity growth between the euro
area and the US has been mainly driven by the wholesale and retail trade sectors as well as the
financial sectors. In the wholesale and retail trade sectors, hourly labour productivity significantly
accelerated in the US from 0.7% to 2.6% over the periods 1980-1995 and 1996-2004, while at the
same time it decelerated in the euro area from 2.3% to 0.1%. In the financial sectors, over the same
periods, hourly labour productivity growth has also accelerated in the US and has been roughly 4
times higher than the growth rate observed in the euro area over the period 1996-2004. [In the
financial sectors, over the periods 1980-1995 and 1996-2004 hourly labour productivity grew by 0.7%
and 2.6% respectively in the US and in the euro area it grew by 0.1% to -0.6% respectively].13
The structural characteristics of the US economy - a more flexible labour market, a higher degree of
competition in product markets and lower barriers to entry for new firms - were more conducive to
exploiting the opportunities provided by new technologies, than the more rigid and less competitive
structures of Europe.
Finally, let us not forget the demographic change occurring on both sides of the Atlantic. Indeed,
Europe's long term growth performance has also been constrained by the low rate of increase of its
population and the ageing of its society. Since the mid 1990's, population in the euro area has been
growing at a rate of just 0.4% compared to 1.1% in the US. This aggregate result should however not
9
See Oliner and Sichel (2002), "Information technology and productivity: where are we now and where are we going?",
Federal Reserve Board. See also Jorgenson, D., M.S. Ho and K. Stiroh (2002), "Information Technology, Education, and the
Sources of Economic Growth across U.S. industries", mimeo. See Pilat, D., F. Lee and B. van Ark (2002), "Production and
use of ICT: a sectoral perspective on productivity growth in the OECD area", OECD Economic Studies No 35. See
GomezSalvador, Musso, Stocker and Turunen (2006), "Labour productivity developments in the euro area", ECB Occasional Paper
series No 53.
10
European Commission.
11
It is important to mention a number of caveats related to the measurement of labour productivity in the service sectors.
Indeed, data on hourly labour productivity and ICT, especially in the service sectors, are surrounded by considerable
uncertainty and caution is therefore required when interpreting the results. In addition there are alternative explanations that
may explain the labour productivity growth acceleration in the US in some services sectors such as higher entry rate,
organisational changes and restructuring in the US, increasing efficiency and therefore accelerating TFP growth. See C.
Denis, K.Mc Morrow, W. Roger and R. Veugelers "The Lisbon Strategy and the EU's Structural productivity problem"
European Commission 2005.
12
OECD.
13
EUKLEMS database.
BIS Review 58/2007
cover the important role immigration has had in supporting economic growth in some euro area
countries. However, what is worrisome is that at the same time, the gap in population growth has been
even larger with regard to growth in the working age population [the working age population grew on
average by 0.3% in the euro area over the period 1996-2006 compared to 1.4% in the US], which
manifests that Europe has a more acute problem of population ageing. I will deal with some of the
policy implications of ageing later on in my presentation.
The need for further structural reforms in Europe
Overall, this brief assessment of the underlying causes of Europe's relatively disappointing longer-term
growth performance provides a mixed picture of the European economy. Of course, I focused on a
specific set of supply-side determinants of economic growth. Economic growth is also influenced by
other factors, including the macroeconomic policy framework. The lack of sufficient structural reform in
Europe is however, in my view, a major cause of the difference in the growth potential in Europe
compared with the US and with some other advanced industrialized economies. All in all, it appears
that the overriding policy concern for Europe is how to simultaneously achieve solid employment and
productivity growth. I should stress that the implementation of the reforms on the Lisbon agenda, by
easing labour and product market rigidities, by permitting the full completion of the single market, by
enhancing education training and research and development and therefore by improving productivity
growth will also improve the effectiveness of monetary policy by facilitating price stability.
I will now turn to those structural reforms identified in the Lisbon agenda that have the potential to
increase both euro area labour productivity growth and labour utilisation, and therefore the long-term
growth potential of the European economy.
It is clear that such major structural reforms are not easy to achieve, but pursuing resolutely such
reforms is especially needed in the current environment, where the European economy is facing a
number of important challenges, including rapid technological change, ageing populations as well as
accelerating globalisation.
For instance, ageing will not only put pressure on public finances by driving up ageing-related
expenditure, but will also bring down the potential growth rate of Europe if no reforms take place.
According to the European Commission's and ECB projections, the impact of ageing populations
alone could reduce on average potential output growth in Europe by nearly half by 2040, if structural
reforms are not carried out.14
All in all, these challenges will require continuity in the policy of reforms to increase the output growth
and adjustment capacity of the economy of the euro area in general and the flexibility of all its markets.
There is a unique opportunity for European governments to take advantage of the present favourable
growth developments to push ahead with the structural reforms that have been already agreed upon
but are still far from being achieved. Without aiming to be exhaustive, I should like to highlight some of
the key priorities for reform in four main areas, namely:
•
Getting more people into work,
•
Increasing competition,
•
Unlocking business potential,
• And finally, supporting an innovative environment.
Getting more people into work
First of all, well-functioning labour markets are extremely important in fostering higher economic
growth. The differences in labour market developments, especially with regard to the level of labour
utilisation, between the US and Europe has prompted some economists to suggest the existence of a
"European model" and a "US model", related to the trade-off between labour and leisure.15 One view is
that the lower levels of GDP per capita in Europe reflect a European preference for more leisure time.
However, we should bear in mind that lower participation rates are not necessarily associated solely
with personal preferences, but are also triggered by the legal and regulatory environment, tax systems
and social institutions. Benefit systems that are too generous discourage job searching, early
retirement schemes encourage early withdrawal from the labour market and marginal tax rates that
are too high discourage labour market entry and have a downward effect on average hours worked.
Necessary measures to increase labour utilisation or labour supply include the reform of tax and
benefit systems to address these problems and increase incentives to work. Measures aimed at
reconciling motherhood with professional life, such as the provision of childcare, should also raise
participation rates. Furthermore, the use of flexible forms of work such as part-time and temporary
work may also provide further working incentives.16
High unemployment rates in the euro area and in particular unacceptable high youth unemployment
rates clearly suggest the need to spur not only labour supply but also labour demand. In this context,
there is a need to reduce labour market rigidities restricting wage differentiation and flexibility.
Adjustments should be made to employment legislation where it impedes the hiring of younger and
older workers in particular.
The experience of European countries which have undertaken some courageous and successful
reforms show that it pays off. In particular Denmark, Ireland and the Netherlands - which, by the way,
are all three, de jure or de facto for Denmark, in the euro area - have achieved success in reducing
unemployment and stimulating job creation, despite significantly different economic conditions.17 In
2006 the unemployment rate in these countries stood below 4.5%, while their overall employment rate
was above or close to the US level, namely 72 %. To achieve such remarkable success, these
countries reformed their tax and benefit systems by reducing for example tax wedges on labour
income and by carrying out a stricter enforcement of job search rules and a better surveillance of
eligibility. They also increased, when and where needed, the flexibility of their labour market.
Increasing competition
What all these countries also have in common is a significant reduction of product market regulation.
This leads to the second prerequisite for higher medium to long-term growth: increasing competition
towards establishing efficient and well-functioning product markets.
Most studies point to the potential that improving competition has to increase employment in the
medium and long run, and to boost productivity trends by improving production efficiency and by
enhancing the incentive to invest and innovate. The links between competition and productivity growth
are now both theoretically and empirically well-established. The ECB and the Eurosystem as well as
the Commission have been working in this domain of research.18
In the EU, some progress has been made in this regard. For example, several network industries, like
telecommunications, are now fully or largely open to competition and the hourly labour productivity in
this particular sector significantly accelerated from 4.9% to 8.4% over the periods 1980-1995 and
1996-2004 [By comparison in the US, hourly labour productivity grew by 3.4% and 4.4% over the
same periods in the telecommunication sectors].
A lot remains however to be done: the extension and deepening of the EU internal market remains a
priority. It is essential to ensure full implementation of Community directives, where greater efforts
need to be made, for example on the effective opening of energy markets. More should also be done
to improve access to public procurement contracts or to ensure effective competition in services.
Let me now focus more specifically on the financial sectors. Financial integration is indeed, of key
importance for the ECB, given the relevance for the conduct of the single monetary policy. Despite
significant progress in recent years, financial services integration appears not yet to have reached its
potential and competition seems insufficient in some areas, leaving European consumers unable to
take full advantage of the benefits of the EMU and the Single Market.19 This seems also to have
constrained the economic performance and the development of these sectors in the euro area as
illustrated by their disappointing labour productivity growth performance.
More generally speaking, evidence indicates that the reallocation of capital from declining industries to
industries with high investment opportunities and high productivity is faster in countries with developed
financial markets.20 For these countries, investment is also more responsive to technical innovation.21
These findings suggest that countries with more liquid capital markets and a developed banking
system are growing faster on average. Some authors have calculated that if the average size of capital
markets in the EU was bigger - in the US for instance this size is around 450% of GDP instead of
220% in the EU (based on an overall indicator measuring total financing in the economy by
aggregating bank credit to the private sector, stock market capitalisation and the outstanding amount
of domestic debt securities issued by the private sector) - then annual GDP per capita growth in the
EU could be positively influenced.22
At this stage of my presentation, I would like to stress that the euro area countries will be the more
equipped for the increased globalised economy the more they are able to exploit the benefits of EMU
and the EU internal market. In this regard, existing impediments to the internal market for goods and
services need to be removed and financial integration further fostered. Further efforts in the fields of
product market deregulation and liberalisation are required to raise product market competition - at
the EU and national level. This would enable more efficient production structures associated with a
more competitive price setting.
In this context, the adoption of the Services Directive by the European Parliament in February 2006
constitutes a step forward in the right direction. But let me also stress that the mere adoption of
Internal Market directives does not automatically produce benefits. Once adopted, directives must be
transposed into national law and enforced in order to produce benefits and Member States have the
primary responsibility for these tasks.
Unlocking of business potential
A third prerequisite for higher growth in the euro area is the unlocking of business potential by creating
an entrepreneurial-friendly economic environment. Europe needs more new and thriving firms willing
to reap the benefits of opening markets and to embark on creative or innovative ventures for
commercial exploitation on a larger scale. It is increasingly new and smaller firms, rather than large
ones, that are the major providers of new jobs.23 The contribution from firm dynamic processes to
aggregate labour productivity growth and innovation also plays a major role, in particular in high-tech
industries. All in all, an entrepreneurial-friendly economic environment would imply less red tape for
small and medium-sized enterprises to help them develop at home and across borders, as well as
positive action to ease access to the finance they need. As regards risk capital markets, venture
capital financing is also crucial. Without these funds, many new and innovative companies will simply
not emerge. Europe is significantly lagging behind in this field, as venture capital financing in Europe
remains only a fraction of what it is in the US relative to the size of their economies. According to the
European Innovation Scoreboard 2006, the innovation gap of Europe with the US is significantly
explained by the superior US performance in early-stage venture capital availability.
The decisive importance of having an entrepreneurial-friendly economic environment is increasingly
appreciated by European governments, and several initiatives at national or EU level have started to
implement actions for "better regulation". The call by the European Council for the establishment of
"one-stop-shop" arrangements in each Member State by the end of 2007, which would enable a
company to be set up in one week was a symbolic but important orientation.
Supporting an innovative environment
Fourth, to fully exploit productivity potential, the labour and product market reforms I just mentioned
need to be accompanied by policies that help innovation and technological change. This includes,
inter alia, measures to support innovation through higher investment in research and development
(R&D). The immense importance of this issue, and the great opportunities provided by investment in
research, are also increasingly appreciated by European governments and firms. A large majority of
Member States now have specific strategies in place for stimulating both the quantity and quality of
R&D activity. [Without aiming to be exhaustive, I should like to mention "The pact for Research" in
France, the Science Budget 2004 in the Netherlands, The Strategy for science, technology and
innovation 2006-2013 in Ireland and the "Ingenio 2010" in Spain]. Nevertheless, the European
Commission's 2006 Annual Progress Report on Growth and Jobs shows that while many Member
States expect to increase their R&D spending, Europe will fall short of the 2010 overall EU target of
achieving 3% of GDP. The efforts of European countries to increase R&D investment are still
insufficient and Member States should make a stronger commitment to R&D and innovation. Particular
attention should be paid to increase public R&D spending efficiency by facilitating for instance the
cooperation between the public and private sector. As regards private R&D investment, more
attractive conditions for technology-intensive markets should be created. This includes for instance a
better use of public procurement, a more innovation-friendly regulation and stepping up the provision
of targeted fiscal incentives to the private sector. The European Commission estimated that an
increase in the share of R&D expenditures in GDP from 1.9% in 2004 to 3% by 2010 would result in
an increase of 1.7% in the level of GDP by 2010. It goes without saying that it is not only a quantitative
issue and that at the same time the efficiency of research an development in terms of industrialisation
is crucial. In the longer term, GDP could be up by 4.2% in 2015 and 7.0% in 2020, equivalent to a
growth surplus of nearly 0.5% per year.24 To make these measures most effective, they need to be
accompanied by efforts to improve the labour force's level of education and expertise.
The impact of education on growth may be related to innovation, as well as the adoption of new
technologies. Policies aimed at improving human capital are usually considered to be of the utmost
importance in this field.25 One possible explanation, commonly mentioned in the literature, is that the
diffusion of innovation and new technology is associated with learning costs that decrease over time,
as a function of the increasing number of users. More wide-spread knowledge about how to exploit
new technology is therefore speeding up the rate of diffusion.
All in all, meeting the challenges of technological progress and ensuring the labour force's
employability and flexibility, requires that human capital is continuously adjusted to labour market
needs through improved education and training, as well as lifelong learning.
The last decades have already brought about an enormous increase in the level of educational
attainment, the so-called "catching-up effect in education". In the euro area, according to OECD data
for 2004, an average of 74% of those aged from 25 to 34 had attained at least upper secondary
education, compared to only 45% of persons aged from 55 to 64.26
However, so far investment in human capital in Europe is still clearly inadequate for a
"knowledgeintensive" economy. In 2003, the US annual expenditure on higher education institutions represented
2.9% of GDP, while in the euro area it only represented 1.2%.27 The gap is mainly a result of greater
private funding. European universities should be allowed and encouraged for instance to seek
complementary private sources of funding and legal, and other barriers to public-private partnerships
between universities and businesses should be removed. A better and more effective education
system, as estimated by some research of the European Commission, might add as much as 0.3 to
0.5 percentage points to the annual EU GDP growth rate.28
Before concluding, there is one more policy issue I would like to mention: fiscal policy challenges and
more specifically the quality of public finances. Indeed, a lot of structural measures, I mentioned have
fiscal implications. It is therefore essential, in the context of indispensable sound fiscal policies fully in
line with the Stability and Growth Pact, to reduce public spending inefficiency in order to facilitate the
reorientation of public expenditure towards productivity-enhancing physical and human capital
accumulation. In this domain we should also never forget that the countries of the European Union as
well as the countries of the euro area have today a level of public spending as a proportion of GDP
which is largely superior to the level of all major global industrialized competitors. This is hampering
our growth and job creation in the present highly competitive global economy.
Conclusion
Europe is in the process of reforming its economy so as to adapt to the challenges of globalisation,
technological change and ageing. Significant progress has already been achieved as reflected by the
significant rise in employment growth.
Monetary Union has been effective - and hugely successful - in supporting growth through a credible
monetary policy achieving price stability in the medium-run, lowering of financing costs for a number of
euro area countries through a reduction of risk premia and in giving impetus to further resolute
European integration, particularly in financial markets, and further reduction to the barriers to
competition. That said, we have the tool in our hands to address more fully the challenges I
mentioned: the Lisbon strategy, as refocused and reaffirmed by the European Council. The challenges
ahead of us are a reminder that European integration is a dynamic process and that it will bring about
deeper structural transformations. As a matter of fact, the historical process of European integration is
moving steadily forward and will require our utmost effort and commitment for years to come. I am
thoroughly optimistic for the future of Europe.
Thank you very much for your attention.