Jean-Claude Trichet: Structural reforms in Europe
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the OECD Forum,
Paris, 22 May 2006.
* * *
It's a pleasure for me to be here at the OECD Forum to share with you my views on structural reforms
in Europe. I am particularly honoured to take part in this Forum given the leading role played by the
OECD in shaping global discussions on economic, financial and, especially, structural issues, which
are the topic of my intervention today. I wish also to pay my tribute to the outgoing Secretary General
Donald Johnston for his outstanding leadership and, if he permits me to say that, for his deep
friendship. Let me also welcome the new Secretary General Angel Gurria for whom I have esteem and
confidence since 25 years!
Economic performance of the euro area
I would like first to start with a brief assessment of the euro area's economic performance by recalling
a few facts. Over the last years the euro area witnessed a slight improvement in the utilisation of
labour, which increased on average by 0.2% per year between 2000 and 2004.1 This mainly reflects
the rise in the euro area employment rate from 61.5% in 2000 to 63.6% in 20052 which corresponds to
the creation of more than 11 millions new jobs over the same period and to a decline in the aggregate
unemployment rate from 10.5% to 8.6%. Remarkably, employment growth in the euro area showed
resilience to the economic slowdown at the beginning of this decade, with employment growing on
average by 1.1% over the period 2000-2005, compared to 0.9% in the US.
However, the employment rate in the euro area remains low by international standards: for example,
the employment rate was 71.2% in the US in 20043 and the unemployment rate clearly too high
compared with, for example, the unemployment rate of about 5.0% in the US in 20054. Furthermore,
since the launch in 2000 of the Lisbon strategy, the annual growth rate for the euro area has averaged
1.8% per year (compared to 2.8% in the US), thus remaining behind its main competitor. When
comparing the euro area's economic performance to the US, there is evidence of increasing disparities
in growth. Since the beginning of the 1990s, the gap in per capita income growth between the US and
the euro area has continuously widened - by 0.8% on average per year during the 1990s, increasing
to 1.3% per year from 2002 onward.
The main explanatory factor behind these developments is the diverging trend in hourly labour
productivity growth between the euro area and the US. During the 1980s, hourly labour productivity in
the euro area grew on average by 2.4% compared to 1.3% in the US. In the 1990s, hourly labour
productivity in the euro area increased on average by 1.8%, decelerating to 1.2% in 2000-2004. By
contrast, US hourly labour productivity growth rose from 1.5% to 2.8% over the same periods.
Over a period of 20 years we have been the witnesses of a very significant structural change across
the Atlantic. From the eighties to the first years of the twenty first century the growth of labour
productivity per hour has been multiplied by more than two in the US when it has been divided by two
in Europe. Overall in this respect the relative position of the US and of Europe has changed by a factor
4 to the detriment of Europe!
It seems to be relatively easy to understand why the US has improved its own productivity.
Technological progress in the I.T productive sector in particular has contributed significantly. But even
more important has been the effect on productivity of the diffusion of I.T and of innovation in general in
all the sectors of the US economy particularly the services sector, with a substantial impact on retail
business and on the financial services sector. This is now well documented and research has
considerably improved our understanding of what has happened in the mid nineties with the end of
what has been called the Solow paradox...
On this side of the Atlantic one can understand why we did not observe the same jump in labour
productivity: on the one hand the share of I.T production in the GDP is significantly lower and, on the
other hand, the absence of sufficient flexibility in the economy in general does not permit to benefit
from the rapid diffusion of innovation in general and of I.T in particular in the other sectors of the
economy. To sum it up Europe would still be in the Solow paradox.
But there is a second paradox in the case of Europe or perhaps more than a paradox: a conundrum.
Why is it that not only we did not improve our productivity when the US did it - around the mid eighties
- but that we observed on the contrary a very significant diminishing of our productivity? This
phenomenon seems to me only half understood through traditional explanations: the impact of specific
policies aiming at drawing back to work a significant number of previously unemployed unskilled
workers - with a low level of productivity - that have been launched in several European economies;
and a degree of under-investment hampering the stock of capital allocated to each employee. But it
explains only around half of the diminishing of the labour productivity growth. The other half seems to
be explained by a significant diminishing of total factor productivity which is extremely surprising
because it occurs precisely at the moment of powerful historical surge in science and technology.
There we are at the heart of the conundrum. The conjecture I would propose is that, under certain
circumstances, in a period of very rapid technological and structural changes, the more an economy is
inflexible, the more it resists to these changes, to the extent that far from taking advantages of the
acceleration in progress in technology its "Total factor productivity" growth diminishes in comparison
with what it was in the period preceding the surge of technology. In other words it seems that there is
not only an "opportunity cost" for being inflexible in a period of very rapid technological change - i.e
not seizing the new opportunities offered by the acceleration of changes - but also a "direct cost",
coming perhaps - and there lies the conjecture - from the fact that under the stress of accelerating
changes the economy becomes even more inflexible and hostile to technological progress than in
more "normal times".
The evolution of the "Total factor productivity" growth in Europe seems to confirm that phenomenon.
From an average level of 1.3 % in the 80's it diminished to an annual average of 1.1 % during the 90's
and 0.7 % between 2000 and 2004. These observations are calling urgently for structural reforms, in
particular all the reforms that would augment the flexibility of all markets - labour, goods and services
and financial - in the euro area economy.
The need for structural reforms
Understanding the reasons of these developments is very important. As also stressed by the OECD5,
the lack of sufficient structural reform in Europe is a major cause of the gap in economic growth
between Europe and the US. I will therefore now turn to structural reforms that have the potential to
increase both euro area labour productivity growth and labour utilisation and therefore the long run
growth potential.
The euro area economy is facing a number of important challenges, including rapid technological
change, ageing populations as well as accelerating globalisation. Moreover, the long-term
sustainability of public finances in the euro area should be improved pursuing pension as well as
health care reforms. These challenges will require major efforts to increase the adjustment capacity of
the euro area in general and of workers in particular. The adverse consequences arising from an
ageing population could only be solved by an extension of the working life and/or substantial inward
migration. Other challenges, such as globalisation and increased competition, are also accompanied
by increased opportunities: globalisation provides incentives for firms and workers to excel in what
they do best while outsourcing some goods and services at lower costs on a global scale, providing
consumers with substantial benefits6.
Without aiming to be exhaustive, I should like to highlight some of the key priorities for reform in four
main areas, namely getting people into work, increasing competition, unlocking business potential and
supporting an innovative environment.
First of all, well-functioning labour markets are extremely important in fostering high economic growth.
The divergent pattern displayed by growth and labour utilisation in the US and in Europe has
prompted some economists to suggest the existence of a 'European model' and a 'US model', related
to the trade-off between labour use and productivity.7 One view is that the lower levels of GDP per
capita in Europe reflect European preferences for more leisure. However, we should bear in mind that
lower participation rates are not necessarily solely associated 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 search, early retirement schemes encourage early withdrawal
from the labour market - employment rates for older workers aged 55-64 stood at just 40.2% in the
euro area in 2005 and, according to the OECD, at around 60% in the US - and marginal tax rates that
are too high discourage labour market entry and have a downward effect on average hours worked.
To increase labour utilisation and get people into work, necessary labour supply side measures
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 child
care, may raise participation rates. Furthermore, the use of flexible forms of work such as part-time
and temporary work may also provide further working incentives.8
High unemployment rates in the euro area and in particular high youth unemployment rates,
amounting to 17.8% in 2005, clearly suggest the need to spur labour demand. In this context, there is
a need to promote wage flexibility and to address labour market rigidities. Furthermore, adjustments to
the level of employment protection legislation are needed where they impede the hiring of younger
and older workers in particular.
Regarding the second priority area for reforms that I would like to mention, increasing competition and
establishing efficient and well-functioning product markets is another prerequisite for higher medium to
long-term growth.9 The economic literature generally leads to the conclusion that competition is an
important factor explaining both productivity and price developments10.
A lack of competition harms productivity trends by limiting production efficiency and by reducing the
incentive to innovate. Moreover, increased competition is generally associated with a lower price level
brought about by a reduction in the mark-ups of firms, for given marginal costs. Stronger competition
stimulates a more efficient use and allocation of resources thereby increasing allocative efficiency,
exerting downward pressure on costs and triggering price reductions.
The extension and deepening of the EU internal market is among the policies that are needed to
further improve the functioning of product markets. With service-related activities representing around
70% of value added and employment in the euro area (against almost 80% in the US), more
competition in EU service markets is required. The gap between the euro area and the United States
in labour productivity has widened considerably since the 1990s and some services sector, such as
retail and wholesale trade, account indeed for a large part of this gap: labour productivity growth per
person employed was 0.7% in the euro area in 1996-2002 compared to 5.5% in the US in 1996-2001.
The euro area should step up measures to boost services market competition in order to increase
economic efficiency and economies of scale. This would support a higher level and growth rate of
labour productivity in the services sector and promote a more dynamic economy. Moreover, measures
aimed at increasing services market competition may have a dampening impact on relative price
changes in some services sectors and thus temporarily on aggregate inflation. Overall, a higher level
of competition in the services sector would tend to support more efficient and flexible services
markets, facilitate adjustment processes and increase the resilience of the euro area to economic
shocks11.
In this context, an internal market for services and the adoption of the Services Directive would
constitute an important step forward. It would remove barriers to cross-border provision of services
and make it easier to set up services businesses in other Member States.
In the EU, some progress has already been made in improving the functioning of product markets. For
example, several network industries, like telecommunications and air transport, are now fully or largely
open to competition. And the reforms do pay off: the remarkable labour productivity growth
performance in some 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.
For example, in the telecommunication sector which was largely liberated in the course of the 1990s,
hourly labour productivity grew on average by 8.5% in the euro area over the period 1996-2003
compared to 6.9% in the US. The euro area HICP index for telecommunications fell by 35% relative to
the overall euro area HICP index in the period 1998-2005.
The third prerequisite for higher growth in the euro area is the unlocking of business potential by
creating an entrepreneurial-friendly economic environment. This includes lowering costs imposed by
public sector administrations for existing firms and business start-ups. Let me illustrate this with some
figures. According to the World Bank, in 2004, the average cost of starting a business with up to 50
employees in the euro area (excluding Luxembourg) is estimated to have been around ten times larger
than in the US12. The policy implication of lowering business regulation is that EU countries can help
to raise economic growth by avoiding an excessively restrictive regulatory environment for firms. The
immense importance of this issue is increasingly appreciated by European governments and several
initiatives at national or EU level have started to implement actions for a "better regulation". In March
2006, the European Council called for the establishment of "one stop" arrangements in each Member
which would allow the setting up of company in one week by end 2007. Today it takes on average 27
days to set-up a new business in the euro area compared to 5 days in the US.13
Fourth, to fully exploit productivity potential, the labour and product market reforms just mentioned
need to be accompanied by policies that help to diffuse innovation and technological change.
This includes, inter alia, measures to support innovation by higher investment in research and
development (R&D). In 2004, roughly 1.9% of euro area GDP was spent on R&D compared to 2.8% in
the US. Europe has set itself the target of achieving a share of 3% of GDP by 2010. Analyses made by
the European Commission14 show that if the effects of the increased knowledge investment foreseen
within the Lisbon strategy were added in, the increase in annual EU potential output growth could
reach up to three quarters of a percentage point. Of course, these are just crude calculations, which
can certainly be challenged, but they give a notion of how large the welfare-enhancing potential of
implementing structural reforms is.
Of crucial importance in this strategy are the 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. Additionally, better education and training help to reduce mismatches in
the labour market and allow for a smoother reallocation of workers between sectors and firms.15 The
last decades have already brought about an enormous increase in the level of educational attainment,
the so-called "catch-up effect in education". In the euro area, according to OECD data for 2003, an
average of 73% of those aged 25-34 had attained at least upper secondary education, compared to
only 46% of persons aged 55-64.16 Nevertheless, 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.
In 2005, the US annual expenditure on higher education institutions per student was 22,234 USD,
while in the euro area the equivalent of only about 9,200 USD was spent. Furthermore, we need more
high quality scientists and researchers. In the EU we have about 5.3 scientists and researchers per
1000 workers, which compares to the US figure of 9 per 1000.17
In addition, ICT investment, which is an indicator of the diffusion of innovation, represented 6% of GDP
in the US over the period 2000-2004 compared to only 3% in the euro area. ICT diffusion appears to
be particularly relevant in the services sector given the higher potential for employment creation in that
sector combined with the evidence that there is no apparent trade-off in the medium term between
labour productivity and employment growth at the level of the sector as a whole. As a result, the key
issue for the larger euro area countries is how to increase their future capacity to promote the diffusion
of innovation and, in particular, technological changes in the service sectors, a field in which the
Nordic EU countries have performed particularly well18.
The state of structural reforms
If euro area countries would now summon up their strength and ambitiously push forward with
structural reform, this will support and broaden the improvement in economic activity in the euro area.
This is why the ECB has always encouraged the implementation of structural reform within the Lisbon
strategy. Five years later, progress has been made in some areas - as also indicated by an increase in
the euro area employment rate. Still, all in all the reforms have not been far-reaching enough19.
Against this background, the mid-term review of the Lisbon strategy in 2005 led to a re-launch of the
process by shifting the strategy's focus more strongly on growth and employment. As an outcome of
this process, all EU countries have prepared so-called National Reform Programmes that outline
structural reform steps for the years 2005-200820. These measures are designed to, among other
things, enhance the sustainability and quality of public finances, promote flexible labour and product
markets, support a favourable business environment, and ensure a fully operational EU internal
market, including the markets for energy and services. Applying comprehensive structural reforms is of
particular importance for the euro area countries, in order to increase wage and price flexibility and the
resilience to shocks, facilitate structural adjustment, raise potential output growth and job creation, and
reduce price pressures, thereby facilitating the task of the single monetary policy.
Also the ECB's monetary policy has a role to play in supporting the implementation of structural
reforms. A credible monetary policy aimed at maintaining price stability in the medium term contributes
to a stable economic environment. In a stable macroeconomic context, it is not only easier to single
out where reforms are needed, but the benefits of reforms are also made more visible, thus supporting
their acceptance.
In turn, structural reforms can also have important consequences for the transmission of a monetary
policy which is committed to price stability. In more rigid economies interest-rate changes are
transmitted to prices after a longer delay and structural impediments can prevent the economic
efficiency gains sought through the stability-oriented objective of monetary policy from being fully
realised.
To conclude, the European Union is undergoing an important process of reforms of its
socioeconomic model so as to adapt it to future challenges. The economic strategy is on the right track,
there is a consensus on the appropriate objectives and agreement on the right institutional setting to
be set in place. The next decisive step is now to accelerate the putting into practice of these plans.
The earlier this happens, the earlier economic activity, employment and innovation in Europe can be
lifted to a higher level and standard. I trust that this acceleration of reforms will not only be in the
interest of Europeans, but eventually in the interest of the whole global economy as an economically
stronger Europe will also raise our contribution to economic prosperity elsewhere in the world.
Thank you very much for your attention.