Jean-Claude Trichet: The euro area economy - determinants of growth,
competitiveness and the need for structural reforms
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at an executive briefing
with the Premier Cercle/Wall Street Journal, Brussels, 10 October 2005.
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Ladies and gentlemen,
First of all I would like to thank Premier Cercle and the Wall Street Journal for inviting me here today
and giving me the opportunity to share with you some thoughts regarding a number of issues which I
deem of critical importance for the euro area economy. I would first like to draw a broad picture of
economic growth trends in Europe as compared to the United States; based on this diagnosis, I would
then like to stress how the issues of structural reforms are key to preserve and improve the economic
performance of the European economy.
Assessment of the euro area's growth performance
Let me start with an assessment of the euro area's growth performance. Since the 1980s, real GDP in
the euro area has grown on average at a pace almost one percentage point lower than in the U.S.
Similarly, but even more importantly, per capita real GDP growth over the same period has not only
been lower in the euro area on average, but the gap vis-à-vis the U.S. has also been increasing over
the last decade.
Europe's achievements should, however, not be underestimated. If one considers output per hour
worked, the picture is somewhat different. Output per hour worked in the euro area, which was around
88% of the level of the U.S. in 1980, was equal to the U.S. level in the latter part of the 1990s. Over
recent years, however, the pattern has gradually changed, such that labour productivity is again below
U.S. levels by almost ten percent. I will come back to this shortly.
Despite some catching up in terms of output per hour worked, the level of output per capita has
remained just over two-thirds that of the U.S. since the 70's. The lack of convergence in output per
capita to U.S. levels reflects the weaker performance of the labour market in Europe. This resulted
from a lower level of participation rate, significant reductions in working hours per person employed in
Europe and a higher level of unemployment since the first oil shock. More recently, however, there
have been some positive developments, with stronger increases in European employment than in the
past.
Since 1980, the average number of working hours per person employed in the euro area has been
around 12% lower than in the U.S. The difference has gradually increased and latest estimates
suggest that average working hours in the euro area is currently some 15% below U.S. levels. The
lower level vis-à-vis the U.S. is partly explained by fewer actual working days per year, while the
widening of the gap reflects the shortening of statutory full-time working weeks and the rising share of
part-time employment. In the U.S. these latter determinants have remained broadly stable.
An important question which has featured prominently in the policy discussion is whether lower labour
utilisation in the euro area reflects predominantly preferences or disincentives from tax and social
contribution systems. In this respect, some data show that part-time employment in both the euro area
and the U.S. seems to be partly of a voluntary nature and, per se, might thus reflect individual or
cultural preferences. However, having said this, it should also be borne in mind that households are
influenced by their institutional environment. This includes for example taxes, social security and
pension systems. Such factors are providing disincentives to work.
Let me now continue with more recent developments. While the gap in per capita GDP growth
vis-à-vis the U.S. has remained unchanged , the underlying explanation has changed. Labour
productivity has evolved more favourably in the U.S., whilst labour utilisation has developed more
favourably in Europe. On the latter, I hope and believe that these developments will continue, as the
potential for catching up in this regard is very substantial. Both participation rates and average hours
worked are low in the euro area and unemployment rates are high.
Why has there been a reversal of the catching up process of labour productivity growth vis-à-vis the
U.S. since the mid-1990s? The answer is partly found in the usage of information and communication
technologies, which has had a beneficial effect on labour productivity in the U.S. A word of warning
may be appropriate here as these kinds of comparisons are unfortunately surrounded with
uncertainties due to different statistical practices and statistical measurement problems. Nevertheless,
when analysed by sector, it is impressive to see that, on top of the sectors that manufacture these
technologies, it is the very rapid improvement in the service sectors that are using them - such as
wholesale trade, retail trade, financial intermediation - that explains much of the difference. This
feature of the U.S. economy explains, together with the relatively more unsatisfactory demographics of
Europe, why European growth has been disappointing in comparison with the U.S. during the past
decade.
Let me elaborate a bit on the role of demographic developments for the euro area. The importance of
demographic factors as a source of growth in the euro area has been gradually decreasing over time
during the past three decades. Although in the short to medium run demographic factors are not
projected to become too grave a problem, in the longer run they are likely to become a major source
of concern. In particular, the growth rate of the population of working age is projected to gradually
decline, from current positive rates of around 0.4% per annum, and become negative within one to two
decades in the euro area. As a matter of comparison, the growth rate of the population of working age
has since the beginning of the 1980s averaged 0.5% in the euro area, while the corresponding figure
for the U.S. is 1.1%. This difference has recently increased. The projected changing age structure
moreover implies a gradual ageing of the population. If fertility rates do not rise, the adverse
consequences arising from this particular feature could only be solved by an extension of the working
life and/or substantial inward migration. Forward looking growth accounting exercises show that these
adverse demographic developments would reduce average real GDP growth in the period up to 2010
below 2% and in the period up to 2020 further to around 11⁄2% if no compensation is achieved through
higher contributions from other supply-side factors. Taking into account these unfavourable
demographic developments, only with ambitious and comprehensive reforms therefore, there is some
scope for raising medium to longer-term output growth in the euro area or even simply sustaining the
long term growth potential.
Structural reforms and future challenges
The implementation of appropriate reforms is key for sustaining or even raising medium to longer-term
output growth in the euro area. In particular, there is a need to further boost labour utilisation and
productivity. Back in 2000, the EU's leaders therefore adopted a blueprint of structural reforms - the
so-called Lisbon Strategy - which was to turn the European economy into a highly competitive
knowledge-based economy.
A key objective of the Lisbon strategy is to raise the employment rate. To achieve this, some euro
area countries have started to implement the needed reforms to reduce the disincentives to work that
are currently present in many European labour markets. Unemployment schemes have been
amended and early retirement incentives have been reduced. As a result, the countries that have
introduced measures aimed at increasing flexibility of the labour market witnessed a fall in actual
unemployment rates and consequently in the non-accelerating inflation rate of unemployment - the so
called NAIRU - which is the level of the unemployment rate that does not lead to inflationary
pressures. Moreover, thanks to the implementation of labour market reforms the employment rate
increased in most euro area countries, but the size of the increase differed across countries. In 2004
only three euro area countries met the interim Lisbon employment target of an employment rate of
67% and just one euro area country achieved an overall employment rate higher than 70%. The euro
area-wide employment rate stood last year at 63%, while, for comparison, it stood at 71% in the U.S.
Thus, if the 2010 Lisbon target is to be met, employment rates need to increase much more rapidly.
Boosting labour productivity growth is another central component of the efforts to enhance Europe's
growth potential. Innovation and technological diffusion have an important role to play in this context.
An article in the Economist recently pointed out that "Europe's only chance of preserving its living
standards lies in working smarter than its competitors rather than (..) cheaper".
In a world of pervasive
globalisation and relentless technological change, our future prosperity will indeed depend on our
ability to generate and exploit new knowledge and ideas. A key factor for promoting innovation and
technological diffusion is research and development. Most innovations result from entrepreneurial
activities or investment in research and development. In this field, Europe clearly suffers from a lack of
private investment. The Lisbon strategy set a target that research and development spending should
reach 3% of GDP, two thirds of which should come from private investment. In 2003 expenditure stood
at 1.9% of GDP for the euro area, and only one euro area country currently exceeds the Lisbon target
level. By way of comparison, the U.S. spends 2.8% of GDP on research and development. It is also
important that efforts to achieve the Lisbon target should be accompanied by policies that enhance the
gains from efforts and money spent on research and development.
Productivity growth can also be boosted by more and better education and training. The right skills
and competences are required to reduce mismatches in the labour market and allow for a smoother
reallocation of workers between sectors and firms. So far, investment in human capital development in
Europe is insufficient. For instance, the number of European school-leavers who go on to complete
higher education is inadequate for the knowledge-intensive economy. In the euro area, only Finland
and Ireland have reached a comparable level with the U.S. in this field. Human capital improvements
in these countries came together with a fast development of the sectors within information and
communication technologies. As a consequence, they enjoy a labour productivity growth performance
which is significantly above the euro area average. A comparison with the U.S. illustrates the
knowledge gap very well: in the US, annual expenditure on higher education institutions per student
represent 57.8% of GDP per capita, while in the euro area 35% is spent.
Creating well functioning, competitive and efficient markets is another key aspect of the Lisbon
strategy. In a number of fields clear progress has been made. For example, most network industries
are now fully or largely open to competition, in particular those in telecommunications and air transport
and to a lesser extent in energy markets. And the reforms do pay off: the remarkable labour
productivity growth performance in network industries in Europe over the last ten years provides a
perfect example of the positive impact on labour productivity growth of easing regulations and
fostering competition. We also need to make Europe an attractive place for businesses to operate in.
Here, some progress has been made in the reduction of excessive business regulations, for instance
by reducing the time and costs required to set up a business.
All in all, progress has been made to promote long-term productivity growth and to increase labour
utilisation, but the extent differs widely across countries and policy areas. Although the structural
reforms have been moving in the right direction, they have not been far reaching enough. In fact, we
need to step up considerably the implementation of the necessary reforms in order to achieve the
Lisbon goals. In particular more progress in labour market reforms is needed to attract more people
into labour market and investment in research and development and human capital should be strongly
encouraged.
What needs to be done is rather clear. But how to deliver it in an environment of rapid change is the
more challenging question.
The difficulties faced with delivering the Lisbon Strategy in the first five years may be summarised
under three headings: a lack of focus, a lack of adequate commitment and a lack of incentives. Or, as
"about everything and thus
the Kok report put it in November 2004: The Lisbon strategy had become
about nothing"; "Every body [was] responsible and thus no one". And there was a need for more
'naming, shaming [but also]
famin"'.
In view of these problems, the European Heads of State or Government clarified their position earlier
this year. First, as regards the lack of focus resulting from the plethora of objectives and targets, they
made it clear that the focus of the Strategy is now on growth and employment. Growth and
employment are indeed the key to our future prosperity and the sustainability of our social model.
Second, regarding the insufficiently clear commitment, the Heads of State or Government also clearly
set out the responsibilities of the European and the national level. Since the Member States are
responsible for most of the policy reforms required for achieving the Lisbon objectives, they have now
been called upon to take full national ownership of the Strategy. Countries have been asked to spell
out how they will turn European commitments into real action at home in so-called National Reform
Programmes, which are discussed with their national parliaments and social partners. Let us hope that
this increased national ownership will be instrumental in beefing up the commitment to reform.
As for the third difficulty - namely the lack of incentives at the European level to stimulate reforms, it
remains to be seen to what extent 'naming, shaming, and faming' will be strengthened. Some people
have argued that the Commission should not assume the role of a schoolmaster faming good and
naming bad pupils, and should instead play more a role of the coach. However, I would suggest that
benchmarking Member States' performance can indeed provide incentives for reform and thus shore
up the commitment to reform. Obviously, it can also be useful for a coach to compare his team with
other, better performing teams and to identify the best and most appropriate role models. Is it wrong to
look at how Ireland implemented well focused structural reforms to achieve such a leap in GDP per
capita? Should we ignore how Finland succeeded in raising its employment rate by 7 percentage
points in 10 years? And outside the euro area but following exactly the same monetary policy, does
not Denmark present a remarkable example of a good functioning labour market in a social
environment which has similarities with a number of European continental economies?
The European Union can also contribute in a direct way to the Lisbon goals. Most importantly, the
benefits from the internal market in terms of growth and employment are still to be fully exploited.
Today, the greatest unexploited potential clearly lies in the internal market for services. It is not
through protectionism, but rather by unleashing the forces of competition in goods and services
markets that we can tap the untapped potential of the European economy, fuel the entrepreneurial
spirit and boost innovation.
Moreover, the EU budget can also help to achieve the economic objectives of the Union. In particular,
it can ensure that expenditure is channelled towards growth-enhancing outlays, such as research and
development and the improvement of human capital. Such expenditure will be more beneficial for
Europe's future than other outlays aiming to subsidise certain sectors.
Citizens need to understand the case for structural reform in order to welcome it. Therefore, better
informing Europe's citizens about the reasons for and the benefits of structural reform will be crucial
for the success of the revamped Lisbon strategy. Indeed, a better understanding of the benefits from
structural reforms could raise consumer and business confidence. The ECB, from its side, will
continue to play its role in delivering the message that structural reforms are beneficial for the EU
economy as a whole.
Let me conclude with the words of Antoine de Saint-Exupéry: "L'avenir, il ne s'agit pas de le prévoir,
mais de le rendre possible." ("As to the future, the task is not to foresee it, but to enable it.") We can all
foresee the future challenges of the enlarged Europe: increasing globalisation, faster technological
change and a rapidly ageing population. If we want to enable Europe's future, we need to turn these
challenges into opportunities; more competitiveness, more innovation and more employment.
Thank you very much for your attention.