Jean-Claude Trichet: Structural reforms in the euro area
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the Council on
Foreign Relations, New York, 24 April 2006.
* * *
It's a pleasure for me to be here at the invitation of the Council on Foreign Relations to share with you
my views particularly on structural reforms in the Euro Area.
Economic performance of the euro area
Let me 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 an 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, being accompanied by a significant
decline in the aggregate unemployment rate from 10.5% to 8.6%3. 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.4
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 20045 - and the unemployment rate is still much too high
- compared with, for example, the unemployment rate of about 5.0% in the US in 20056. Furthermore,
since the launch in 2000 of the Lisbon strategy - a comprehensive agenda of structural reforms aimed
at profoundly transforming the EU - the annual growth rate for the euro area has averaged 1.8% per
year7 (compared to 2.8% in the US), thus remaining somewhat behind its main competitors. When
comparing the euro area 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 onward8.
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
growth was increasing at an annual rate of 2,5% in Europe as compared to 1,3% in the USA. During
the 1990s, hourly labour productivity in the euro area grew on average by 1.8%, decelerating to 1.2%
at the beginning of this decade. By contrast, US hourly labour productivity growth rose from a yearly
average of 1.5% in the 1990s to 2.8% in the present decade. These disparities can broadly be
explained by technological progress and the diffusion of innovation. For example, Total Factor
Productivity (TFP) growth, which is rightly considered as a pertinent proxy of technological progress,
significantly declined in Europe from an annual average of 1.1% during the 1990s to 0.7% between
2000 and 2004, while it accelerated from 0.7% to 1.2% over the same periods in the US. In addition,
ICT investment, which is a good indicator of the diffusion of innovation, represented 6% of GDP in the
US over the period 2000-2004 compared to 3% in the euro area.9
The need for structural reforms
The lack of sufficient structural reform in Europe is, in my view, 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. These structural reforms must aim at what the Netherlands' former Prime
Minister, Wim Kok, once summarised as "Europe needs more people in work, working more
productively".
Looking ahead, the euro area economy is facing a number of important challenges, including rapid
technological change, ageing populations as well as accelerating globalisation. These challenges will
require major efforts to increase the adjustment capacity of the euro area in general and of workers in
particular.
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.10 One view is that the lower levels of GDP per
capita growth 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 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 200511 and at around 60% in the US12 - 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
would contribute to raising participation rates. Furthermore, the use of flexible forms of work such as
part-time and temporary work would also provide further working incentives.13
High unemployment rates in the euro area and in particular high youth unemployment rates,
amounting to 17.8% in 2005, stresses the need to spur not only labour supply but also labour
demand.14 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.
Increasing competition towards establishing efficient and well-functioning product markets is another
prerequisite for higher medium to long-term growth.15 A lack of competition harms productivity trends
by limiting production efficiency and by reducing the incentive to innovate. In the EU, some progress
has been made in this regard. 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 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.16
Policies that are needed to further improve the functioning of product markets include the extension
and deepening of the EU internal market. With service-related activities representing around 70% of
value added and employment in the euro area (against almost 80% in the US), much more
competition in EU service markets is required. Overall, a higher competition in services markets would
promote a more dynamic economy, increase the growth potential of Europe and of the Euro Area and
create more jobs. On 16 February 2006, the European Parliament approved a draft directive aimed at
a free market for services in the European Union. This is welcome as it goes in the right direction even
if we would have preferred a bolder move.17 I would stress particularly the necessity of a very rapid
and expeditious implementation of the new directive on services. Not only because as I have already
said the reason why Europe is lagging behind the US in terms of productivity increases is very much
due to poor behaviour of the services sector in this respect, but also because improving productivity in
"nontradables" would permit Europe to contribute more efficiently to a cooperative solution of global
imbalances.
The third prerequisite for higher growth in the euro area is the unleashing of entrepreneurial potential
by creating a business- and 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 US18. The immense importance of this issue is increasingly
appreciated by the successive EU presidencies and European governments and several initiatives at
national or EU level have started to implement actions for a "better regulation".
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. The US spends 2.8% of GDP on
R&D.19 Europe has set itself the target of achieving a share of 3% of GDP by 2010.
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. 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.20 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 55-64.21 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 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's 9 per 1000.22
The state of structural reforms
If euro area countries 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 so-called
Lisbon strategy, which was set in place by a meeting of the European Council of Heads of State and
Government, in Lisbon in May 2000. 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 enough.
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 2005-2008.
These efforts are welcomed by the ECB. The potential gains to be reaped are substantial. A recent
study published by the Netherlands Bureau for Economic Policy Analysis finds that if Europe would
reach the objectives set in the Lisbon strategy (for example, full implementation of the internal market
for services, a reduction of administrative burdens, improvements in human capital as well as R&D
and employment targets), EU GDP could be higher than otherwise by 12 to 23% and employment by
about 11% by 2025.23
Other important findings relate to investment in the knowledge-based economy. Analyses made by the
European Commission24 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. Over a ten year period, this would imply an increase
in the GDP level of up to 7 or 8%. Of course, these are just crude calculations, which, however, give a
notion of how large the welfare-enhancing potential of implementing structural reforms is.
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 and solidly
anchoring medium and long term inflation expectations contributes decisively 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 and convincing, thus supporting their
acceptance.
To conclude, the European Union and the Euro Area are in the process of reforming its economy 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. It is now
Implementation
decisive that these plans are put into practice. is the key word today. The earlier this
happens, the earlier economic activity, employment and innovation in the EU can be lifted to a higher
level.
I am just coming back from Washington where I participated in the G7 and IMFC meetings. We have
reaffirmed that the adjustment of global imbalances was a shared responsibility requiring participation
by all regions in this global process. And with the help of the IMF we have listed the main areas where
the global partners should concentrate their actions to do their "homework". US, Japan, emerging Asia
- particularly China, oil producing countries have a lot of serious work to do. As far as Europe is
concerned, I would say that all the reforms I have mentioned and called for, in our best European
interest, are also full part of what we have agreed to do to contribute to the orderly adjustment of
global imbalances. I said that 'implementation' was now the key word. It is the key word at the
European level as well as the key word at the global level. We all know what to do. We all know that
each of us should do it in his/her own self interest. And we also know that a resolute and cooperative
implementation by all partners would preserve more effectively and efficiently sustainable growth and
job creation at a global level. We all count on the IMF to exert appropriate surveillance and remind all
of us of the global superior interests that are at stake.
I thank you for your attention.