Council Recommendation

of 15 June 2001

on the broad guidelines of the Economic Policies of the Member States and the Community

(2001/483/EC)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community, and in particular to Article 99(2) thereof,

Having regard to the recommendation from the Commission,

Having regard to the discussion by the European Council on 15 June in Göteborg,

Whereas a Resolution on the recommendation from the Commission was adopted by the European Parliament,

HEREBY RECOMMENDS:

TABLE OF CONTENTS

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I. GENERAL ECONOMIC POLICY GUIDELINES

1. INTRODUCTION

A year ago, in Lisbon, the European Union set itself a new strategic goal for the next decade: "to become the most competitive and dynamic knowledge-based economy in the world capable of sustainable growth with more and better jobs and greater social cohesion". The 2000 Broad Economic Policy Guidelines (BEPGs) set out a comprehensive policy strategy to fulfil this ambition. This strategy consists of growth- and stability-oriented macroeconomic policies and comprehensive economic reforms of labour, product and capital markets. These policies should sustain robust economic growth in the short term, strengthen the basis for future growth in the medium term and enhance the capacity to cope effectively with longer-term structural changes, including the impact of population ageing.

The 2001 BEPGs confirm the existing policy strategy and extend it further in the light of the results of the Stockholm European Council (23-24 March 2001). There it was emphasised that the Union and the Member States are fully committed to the goal of full employment and see it as an important way of meeting the challenge of ageing populations. It was also stressed that the promotion of sustainable development should be integrated in the BEPGs. They have been drawn up against the background of the examination of the implementation of the 2000 BEPGs and the assessment of the economic situation and outlook as presented in the Commission's Spring 2001 Economic Forecasts.

Section 2 starts with a discussion of the economic background to these guidelines and concludes by identifying the main policy challenges in the short, medium and longer term. Section 3 then describes the general policy recommendations which are applicable to all Member States and the Community. Within the overall strategy, policy priorities differ somewhat across Member States due to differences in economic performance, prospects, structures and institutions. Taking due account of them, Part II presents the country-specific economic policy guidelines. The budgetary recommendations are based on the national stability or convergence programmes, their underlying economic assumptions and the Council Opinions thereon. The assessment in 2002 whether these recommendations have been followed will also take into account major changes in the general economic environment.

2. MAIN PRIORITIES AND POLICY REQUIREMENTS

2.1. Recent and prospective economic developments

A markedly less favourable external economic environment - Since early summer 2000, when the previous guidelines were adopted by the Council, the global economic environment has become distinctively less supportive on the back of a number of inter-related forces. While the global slowdown is generally expected to be relatively short-lived, the risks of a less favourable outcome are considerable.

First, throughout the summer, oil prices increased and reached new highs in the autumn. Although they have retreated from their late 2000 peak and slowing global demand reduces the risk of a renewed price hike, oil prices remain relatively high and continue to exhibit a high degree of volatility. Second, and more important, there has been an unexpected sharp slowdown in economic activity in the United States and Japan over recent months. In the United States, some adjustment towards a more sustainable growth path was both expected and desirable, as it could effectively lead to a correction of important imbalances that had built up during the expansion. Expectations centre on a recovery in the second half of 2001 based inter alia on a judicious use of the available room for policy manoeuvre. However, the outlook remains subject to considerable uncertainties. In Japan, the fragile recovery is faltering and the economy remains vulnerable to shocks. The deteriorating external environment is already affecting growth in a number of emerging market economies, mainly through a deceleration of exports. Third, volatility has remained very high on global equity markets and a pronounced correction has taken place, especially in technology stocks, reflecting a downward shift in investors' perception of long-term profit outlook.

Growth in the euro area is holding up rather well - The second year of Economic and Monetary Union was a successful one. In the euro area, economic growth was the strongest and unemployment fell to the lowest level for a decade. Headline inflation accelerated, mainly driven by temporary factors such as energy prices and a weak exchange rate, but inflation is expected to be well below 2 per cent in the medium term. Nevertheless, the growth momentum has been dented, firstly by the negative shock imparted by rising oil prices and, subsequently, by the downturn in global demand.

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Looking forward, despite the downturn in world economic activity, the euro area looks set to continue to enjoy in 2001-2002 relatively solid economic growth of about 2 3/4 per cent and continued job creation while upside risks to price stability have diminished. Strongly improved macroeconomic fundamentals, including sustained wage moderation, and sound policies have fostered a favourable investment climate and steady employment creation. They have engendered a virtuous growth circle that is firmly rooted in domestic demand. While having come down, business and especially consumer confidence remain well above their long-term averages as they continue to be supported by the increased dynamism of the economy. High capacity utilisation, favourable financing conditions and strong profitability support investment demand, while rising disposable incomes, fostered by productivity gains, higher employment and tax reforms, continue to underpin consumer demand.

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Furthermore, the large internal market coupled with the single currency provides a strong and stable base for domestic growth with less exposure to exchange-rate fluctuations. The coming introduction of euro notes and coins on 1 January 2002 will give further impetus to economic integration and will turn the euro into a reality in daily life and make monetary union more visible. Moreover, thanks to progress with economic reforms, the euro area's resilience to external disturbances has been fortified. As a consequence, even if external downside risks were to materialise - in particular if the US economy does not quickly return to solid growth - the above factors will help mitigate the impact on the euro area.

The non-euro-area Member States - After robust economic growth and job creation in 2000, Denmark, Sweden, and the United Kingdom, like the euro area, are being affected by the adverse developments in the world economy. As a result, economic growth is expected to slow to a more moderate pace. Good progress on structural reforms and continuing healthy domestic demand position them well to weather the deteriorating external environment. Inflation in these countries remains subdued at or below the level recorded in the euro area.

2.2. Key challenges ahead

Looking ahead, the EU and the euro area face a number of key challenges in the short, medium, and longer term. A successful response to these challenges will depend on appropriate policy action being taken now.

The short-term challenge: preserving the expansion in growth and jobs - The immediate task ahead is to maintain strong economic performance in a context of less supportive global economic conditions. The EU and the euro area will have to rely increasingly on their own strengths.

Growth- and stability-oriented macro-economic policies and comprehensive structural reforms are crucial to maintain and further enhance internal growth dynamics. They will underpin business and consumer confidence. In this context, budgetary policies should contribute to avoiding excess demand and inflationary pressures, and wage moderation needs to be sustained. This is supporting price stability and can facilitate monetary conditions conducive to economic growth and continued employment creation.

In particular, budgetary policies should continue to be geared to the achievement of budgetary positions close to balance or in surplus. Preserving the hard-won macroeconomic stability and extending it into the future is essential. Pressures to increase government expenditure and reduce taxes could put budgetary positions in jeopardy. Furthermore, wage pressures have arisen in some Member States, sparked by emerging labour market bottlenecks and demands for compensation for the recent increase in headline inflation and past moderation.

Economic and Monetary Union has implied an important regime change that entails additional responsibilities for all major policy actors in making it a success. The single monetary policy is set for the euro area as a whole and the exchange rate can no longer be used to restore lost competitiveness, resulting from a delay in structural change or an inappropriate macroeconomic policy mix.

Governments and Social Partners therefore bear responsibility in contributing to a balanced macroeconomic policy mix both at Member State and euro-area level. The social partners are called upon to continue to act in a responsible manner, thereby enhancing prospects for increased growth and employment.

More generally, there is a need to increase further the resilience of the economy through a judicious combination of structural reforms. More flexible and open markets will enhance the capacity to deal with change and help to absorb the impact of shocks. They will also foster a positive interaction between structural improvements in the economy and entail benefits in terms of macroeconomic performance. In addition, structural reforms can have a positive impact in the short term through downward pressure on prices.

The medium-term challenge: improving the basis for future growth and employment - The growth performance since 1997 has to be seen in a context of a cyclical recovery where slack could be used up. While potential output growth may well have improved over recent years as a result of productivity gains fostered by improved market functioning and new information and communication technologies, it is still considered to be insufficient to sustain growth rates of around 3 per cent over an extended period of time. Sustaining the expansion will therefore hinge on a permanent increase of potential growth.

Policies should concentrate on creating the right conditions for the efficient use of productive and natural resources and for their enhancement over time. In particular, policies should contribute to improved market functioning by addressing market imperfections or failure due to the existence of externalities, market power, imperfect information or the regulatory environment.

The present under-utilisation of human resources should be reduced. Registered unemployment in the EU is still unacceptably high and labour force participation and employment rates are low, especially for older workers and women, and in many Member States far from the targets agreed in Lisbon and Stockholm. The mutual reinforcement of economic and social policies leads through improved employment opportunities to a better use of the human resource potential in the EU. This requires reviewing labour market regulation and institutions to diminish obstacles to labour demand and supply which they may pose. An increase in the level of participation in the labour market, especially for groups that are underrepresented or disadvantaged is also key to social inclusion.

To promote an increase in the labour supply, it is necessary to make sure that the regulatory framework encourages people to enter into or remain in the labour market. In particular, tax and benefit schemes should be further reformed to strengthen financial incentives for people to take up or stay in a job. A switch to focused active policies is needed to enhance the opportunities of unemployed and inactive persons. Active labour market policies also promote social inclusion. The more efficient use of the European labour force as a whole should also be achieved through the reduction of barriers to labour mobility within and between Member States, particularly with a view to tackling skills bottlenecks. Moreover, life-long learning should be fostered with a view to encouraging participation in the labour force and to enhancing the flexibility and adjustment capacity of the labour force.

An increase in labour supply will normally have to be accompanied by capacity-enhancing investment. This includes creating a business environment conducive to investment, supported by adequate public infrastructure and a modern and efficient public administration. Well-functioning, competitive and integrated product and capital markets will contribute by making sure that resources are put to their best possible use. In this context, there is a need to enhance competition in goods and services markets and, in particular, in utilities and financial services. To this end, action at Community level should focus on completing the internal market, especially in services included in the financial sector and in network industries. Member States, for their part, should see to an effective and, above all, faster implementation of the internal market legislation and encourage greater competition.

A central element in the Lisbon strategy is the recognition of the necessity to foster entrepreneurship and innovation in the EU, both of which are fundamental pre-conditions for increasing Europe's potential for growth and, subsequently, its competitiveness, wealth and job creation. Strengthening entrepreneurship and innovation constitutes a key challenge for all Member States.

The promotion of competition within the internal market finds its logical complement in increased competition at world level. This would add important positive effects in raising the European productive potential.

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The European Union should therefore continue to adopt a common commercial policy that favours open world trade and press for a new multilateral trade round within the context of the WTO.

Strong productivity growth and competitiveness in a global context will require ongoing structural change. Europe's transition towards a knowledge-based economy is progressing but shortcomings remain in the relationship between industry and science and the level of private investment in R& D, such that commercialisation of the research effort remains weak. In addition, the supply of qualified ICT personnel and trained researchers is insufficient. Moreover, higher investment in the EU is crucial for a rapid diffusion of innovation (in particular ICT) across the whole economy and thereby for increasing, in the medium-term, the growth potential.

The longer-term challenge: preparing for the impact of ageing populations - The need for growth- and stability-oriented macroeconomic policies and comprehensive economic reforms aimed in particular at increasing labour supply is amplified by the challenge posed by ageing populations that is visible on the horizon. On present trends, the EU's working age population will fall by approximately 40 million people between 2015 and 2050 and the old age dependency ratio will roughly double over the next five decades. The impact on public finances is already beginning to be felt in some Member States.

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Tentative calculations point to increased expenditures on public pensions of the order of 3 to 5 per cent of GDP over the period from 2010 to 2050. In addition, expenditure on health care and care for the elderly is expected to increase substantially. The ageing population will thus have considerable consequences for the long-term sustainability of public finances taking into account the need to provide for universal pensions. As the impact is beginning to be felt, governments need to act now to ensure the quality, adequacy and fiscal sustainability of pensions and of health care for the elderly, and to improve incentives for higher employment. To this end, the current systems and policies need to be reviewed and, where appropriate, be reformed. Structural improvements in public finances need to be achieved to prepare for the coming financial burdens imposed by ageing populations on public finances.

Beyond the immediate financial impact, the ageing of populations has wider implications for economic growth, as a result of the shrinking of the potential workforce and of potentially important effects on the level of aggregate savings. Further growth in living standards will increasingly have to be supported through increases in labour productivity and by raising the employment rate. Promoting investment and the process of capital deepening, thereby increasing labour productivity, contributes to tackle the negative impacts of ageing. In addition, a reduced inflow of young, newly-educated persons into the labour force may hamper skill renewal and thus the take-up of new technology. Increasing new-technology proficiency among young people and fostering life-long learning could help to counteract the effects of ageing on skils.

Member States need to develop comprehensive strategies for addressing the economic and budgetary challenges posed by ageing populations. Strategy measures might include reform of pension and health care systems, and care for the elderly, increasing the effective retirement age, stimulating higher labour supply participation, especially for older workers, setting up and increasing public pension fund reserves and possibly encouraging the expansion of supplementary privately-funded pension schemes (pillars 2 and 3). These strategies should be presented in conjunction with the stability and convergence programmes and be examined in the context of multilateral surveillance, taking due account of the principle of subsidiarity.

Ensuring close policy co-ordination - Close co-ordination among policy actors and continuous and fruitful dialogue between the Council, the Eurogroup, and the ECB, involving the Commission and respecting all aspects of the independence of the ESCB are essential in fostering harmonious economic developments. This also includes early exchange of information and the improvement of common statistics. The effectiveness of policy actions will be enhanced by taking proper account of spill-over effects that become more important as integration intensifies.

This is particularly true for the euro-area Member States. To deal with these challenges and to exploit the full potential of EMU, the authorities of the euro-area Member States are closely co-ordinating their economic policies in the Eurogroup. In accordance with the conclusions of the Nice European Council, the Eurogroup has started to extend the range of mainly structural matters it deals with in order to contribute to the reinforcement of the growth potential of the euro area.

The policy strategy both at macro and microeconomic level to deal effectively with these key challenges is set out in more detail in the next section. Its main components are to:

(i) ensure growth- and stability-oriented macroeconomic policies;

(ii) improve the quality and sustainability of public finances;

(iii) invigorate labour markets;

(iv) ensure efficient product (goods and services) markets;

(v) promote the efficiency and integration of the EU financial services market;

(vi) encourage entrepreneurship;

(vii) foster the knowledge-based economy; and

(viii) enhance environmental sustainability.

3. POLICY RECOMMENDATIONS

3.1. Ensure growth- and stability-oriented macroeconomic policies

Macroeconomic policy plays a key role in sustaining growth and employment and in preserving price stability. Over the short term, it should aim at the continuation of a well-balanced economic expansion and the full realisation of current growth potential. Over the medium term, it should contribute to the establishment of the framework conditions which promote adequate levels of saving and investment to position the economy on a sustained, higher, non-inflationary, growth and employment path.

In the euro area, following buoyant economic activity in 2000, growth is expected to slow down but to remain fairly robust and above the potential rate in 2001-2002 whilst inflation should ease. An appropriate and tension-free macroeconomic policy approach consists of the following elements.

The primary objective of the single monetary policy is to maintain price stability in the euro area. Without prejudice to this objective, it supports the general economic policies in the Community.

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Sound budgetary positions, in line with the Stability and Growth Pact, provide the necessary scope for the full working of the automatic stabilisers without the risk of breaching the 3 per cent of GDP limit for the general government budget deficit. They also have favourable effects on interest rates and contribute to the crowding-in of private investment, to the further reduction of the government debt to GDP ratio thus contributing to preparing for the costs of demographic changes and, by increasing the credibility of the budgetary framework of EMU, to a strengthening of investors' confidence.

As a general principle, it is important that budgetary policies be guided by the need to avoid pro-cyclical stances which lead to exacerbated swings in economic activity, unsustainable structural balances and burden the single monetary policy. Most Member States have reached a minimum budgetary position which allows them to let the automatic stabilisers work without exceeding the excessive deficit limit. This important result must be preserved. Further fiscal consolidation is needed in most cases.

All Member States, within compliance with the Stability and Growth Pact, need to ensure that cyclically adjusted budgetary positions move towards, or remain in, balance or surplus in the coming years. This will create additional room for manoeuvre for cyclical stabilisation, to cope with unexpected budgetary developments, to put government debt on a more rapidly descending trajectory and to prepare for the budgetary challenges associated with population ageing. Based on the latest 2000/01 updates of the stability programmes, following a slight deterioration in 2001, the aggregate euro area budgetary position is set to improve gradually to a balanced position in 2003.

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General government net lending (+)/borrowing(-) in the updated stablity- and convergence programmes

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Source:

Commission services.

The euro area Member States should ensure that their budgetary policies support the price-stability orientation of the single monetary policy. In this context, they should stand ready to use budgetary and structural policies to contribute to domestic price stability and to take into account both the euro-area dimension and the national implications of the single monetary policy in conducting their budgetary policies. In general, Member States should:

(i) meet, as a rule, and in keeping with last year's commitment, budgetary positions of close to balance or in surplus in 2001 so as to achieve a sufficient margin to cope with the impact of adverse cyclical fluctuations; ensure a rigorous execution of their budgets so as to prevent slippage from the stability programme targets;

(ii) prepare budgets for 2002 in keeping with the need to achieve or preserve budgetary positions close to balance or in surplus and to avoid pro-cyclical fiscal policies; where appropriate, further strengthen public finances, especially with a view to securing their long-term sustainability; and

(iii) be ready, in those Member States where overheating risks and inflationary pressures prevail to tighten budgetary policy, to pursue wage moderation and to advance further structural reforms aiming at reducing inflation and contributing to an appropriate macroeconomic policy mix at national level.

Regarding the non-euro-area Member States, monetary policy in Denmark is reserved for the fixed-exchange rate policy toward the euro in the framework of ERM2 which is seen as instrumental to achieve price stability. In Sweden and the United Kingdom monetary policies aim at price stability through targeting inflation. Their successful achievement will help create the conditions for exchange rate stability.

The non-euro area Member States shall also maintain sound budgetary positions in accordance with the Stability and Growth Pact. In general, they should:

(i) maintain budgetary positions in surplus in 2001 and thereby a sufficient margin to cope with the impact of adverse cyclical fluctuations; ensure a rigorous execution of their budgets so as to prevent slippage from the convergence programme targets; and

(ii) prepare budgets for 2002 in keeping with the need to preserve budgetary positions close to balance or in surplus and to avoid pro-cyclical fiscal policies; where appropriate, further strengthen public finances, especially with a view to secure their long-term sustainability.

Wage developments in Member States should reflect different economic and employment situations. Governments should promote the right framework conditions for wage negotiations by social partners. For wage developments to contribute to an employment-friendly policy-mix, social partners should continue to pursue a responsible course and conclude wage agreements in Member States in line with the general principles set out in the broad economic policy guidelines. It is necessary that:

(i) the increase in nominal wages be consistent with price stability;

(ii) the increase in real wages not exceed growth of labour productivity taking into account the need to strengthen, where necessary, and subsequently maintain, the profitability of capacity-enhancing and employment-creating investment;

(iii) wage formation processes that take account of productivity differences (inter alia according to skill, qualification or geographical area) be encouraged.

3.2. Improve the quality and sustainability of public finances

Member States must sustain sound budgetary positions while at the same time improving the quality and sustainability of public finances in line with the report endorsed by the Stockholm European Council. This will ensure that public finances maximise their contribution to growth and employment and the achievement of the objectives agreed in Lisbon and Stockholm, including social cohesion. An appropriate balance and sequencing have to be drawn between running down public debt, cutting taxes and financing public investment in key areas. To this end Member States should:

(i) pursue efforts to make tax and benefit systems more employment friendly, including, where appropriate, a reduction of the overall tax burden, targeted reforms of the tax and benefit systems, especially with respect to low-wage labour, within continued fiscal consolidation, and by improving the efficiency of tax systems (see also Section 3.3);

(ii) promote the quality of public expenditure by redirecting towards physical and human capital accumulation and research and development so as to ensure substantial annual increase of per capita investment in human resources;

(iii) enhance the efficiency of public spending by institutional and structural reforms; in particular introduce or enhance the mechanisms that help control spending, including budgetary procedures;

(iv) improve the long-term sustainability of public finances by pursuing a comprehensive three-pronged strategy: actions to raise employment rates; a fast reduction in government debt; and further reforms of the pension and health system. In order to put pensions on a sounder footing moves towards a greater reliance on funding should also be considered; and

(v) pursue tax co-ordination further so as to avoid harmful tax competition and implement effectively the Council agreement of November 2000 on the tax package.

Just like the Member States, the Community should apply strict budgetary discipline. This must be applied to all categories of the financial perspective, while respecting the inter-institutional agreement on budget discipline and the improvement of the budget procedure; a flexible allocation of Community resources should be exploited in order to enhance the economic impact of the EU budget.

3.3. Invigorate labour markets

The strong employment performance of recent years continued during 2000. This has been due in large part to the favourable macroeconomic conditions, but labour market developments also strongly suggest a reduction in structural unemployment thanks to reforms and policies to improve the functioning of labour markets implemented over the past decade, in particular in the context of the European Employment Strategy. Wage growth has been relatively moderate despite the sharp fall in unemployment, while long-term unemployment has fallen by even more than the overall rate. Nevertheless, there remains ample scope for further progress. In particular, the EU is facing four challenges. Firstly, signs of recruitment difficulties and skill shortages have emerged in a number of Member States, which suggests that the EU may now be approaching the limits of rapid cyclical employment growth.

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Secondly, unemployment is still unacceptably high with large differences across Member States and regions. Thirdly, further large reductions in unemployment and a substantial increase in labour supply will be needed to hit the EU employment targets of 70 per cent overall employment rate and of 60 per cent for women by 2010 as agreed by the Lisbon European Council, including the intermediate targets of 67 per cent and 57 per cent respectively by January 2005, as well as 50 per cent for older workers by 2010, agreed at the Stockholm European Council. Fourthly, as reaffirmed at the Stockholm European Council, the aim should be to create better jobs as well as more jobs, notably via improved education, life-long learning and a better reconciliation of working and personal life.

To meet these challenges, Member States should take advantage of the favourable macroeconomic conditions to make the necessary structural improvements in labour markets and move towards the goal of full employment.

On 19 January 2001, the Council adopted detailed guidelines for employment policies for the year 2001, consistent with the priorities in the 2000 Broad Guidelines of the Economic Policies, as well as Member State specific recommendations therein. In pursuing labour market reforms, Member States should vigorously implement the Employment Guidelines and recommendations addressed to them.

They should, in particular, take the following measures:

(i) promote, in dialogue with the Social Partners, increased participation in the labour market, especially among women and older workers, notably by pursuing equal opportunities, ensuring adequate provision of care facilities for children and other dependants, reforming early retirement schemes and through life-long learning. Similarly, the participation of disabled people, ethnic minorities and migrants should be promoted. Other relevant measures, including pension reforms, are mentioned under public finances;

(ii) ensure that tax and benefit systems make work pay. Reforms should reduce labour taxes and high marginal effective tax rates, especially for low paid workers and address incentive effects, duration, eligibility and enforcement of benefit schemes to make them more employment-friendly;

(iii) bring down obstacles to labour mobility within and between Member States, inter alia through the mutual recognition of qualifications, the adoption and implementation of the directive on occupational pension funds, improving portability of pensions, improving access to European-wide information on job vacancies and learning opportunities in Member States in the context of developing the new European labour markets;

(iv) facilitate occupational labour mobility by improving, in dialogue with the Social Partners, education, training and life-long learning in order to reduce early school leaving and preparing for a successful transition to the knowledge-based economy and improve job quality;

(v) further improve the efficiency of active labour market policies and target these towards those individuals most prone to the risk of long-term unemployment; ensure that benefit systems are complemented by effective assistance for job-seekers to enhance their employability and their job opportunities;

(vi) promote, in dialogue with the Social Partners, more flexible work organisation, including working-time arrangements, and reform the existing regulatory, contractual and legal framework, inter alia, those rules that may hamper access to employment, with a view to combining greater flexibility with security; ensure that any reductions in overall working time do not lead to increases in unit labour costs, and that future labour supply needs are taken fully into account; and

(vii) pursue policy aiming to reduce gender pay differences due to de facto discrimination.

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3.4. Ensure efficient product (goods and services) markets

The creation of the Internal Market and the launch of the euro have fostered competition in EU product markets. This has had a moderating effect on inflation rates and has been a factor in the convergence of price levels between Member States with clear benefits for consumers. Competition has also led to a rationalisation of production, which has contributed to improving the competitive strength of European companies. However, the internal market for services is still hampered by existing barriers, creating obstacles to cross-border activities. Liberalisation has already produced lower prices in the telecommunications sector, and there have been benefits in those countries who have opened up their energy markets. The Council will examine as soon as possible the Commission proposal to fully liberalise electricity and gas for all consumers. Similarly, the opening up of the European economy to world trade has exposed European companies to international competition, which has contributed to increasing the efficiency of European product markets. The European Union continues to be committed to trade liberalisation, and to opening a new trade round within the WTO. While significant progress has been made in the functioning of European product markets, a number of areas remain where further efforts are needed. Member States should:

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(i) fully implement the Internal Market:

- cut the internal market legislation transposition deficits to less than 1.5 per cent before the 2002 Spring European Council;

- eliminate technical barriers to trade, inter alia, through making more efficient use of the European standardisation and application of the mutual recognition principle;

- create an effectively functioning internal market in services by removing regulatory and other constraints on cross-border activities between Member States and market entry; and

- further open up the public procurement market and bring it on-line by 2003.

(ii) reinforce competition, thereby ensuring the delivery of real benefits to consumers:

- accelerate the liberalisation of the network industries (energy, railway, air transport and postal services sectors) while taking account of existing universal service obligations, and security of supply requirements;

- ensure effective independence, adequate capacity and effectiveness of the competition and regulatory authorities and improve co-operation between these authorities both on Community and on Member States level; and

- reduce the overall level of State aid in relation to GDP by 2003 and redirect it away from ad hoc and sectoral aids; increase the transparency of State aid policies.

3.5. Promote the efficiency and integration of the EU financial services market

The EU financial system is integrating progressively under the influence of globalisation, deregulation, technological advances and the introduction of the euro. The efficiency gains from financial integration will be reflected in an improved allocation and lower cost of capital, with beneficial effects on growth and employment creation in the EU economy. However, the remaining obstacles to financial integration prevent potential benefits from being fully reaped. Among the more important of these obstacles is the absence of a clear and consistently applied EU regulatory framework for many areas of financial services. Progress in developing such a framework has been made through a range of actions under the Financial Services Action Plan (FSAP). Implementation of the Risk Capital Action Plan (RCAP) should enhance the availability of adequate financing opportunities for innovative SMEs, whose flexibility and growth potential make them important sources of economic growth and employment. However, progress towards a truly single market for financial services is, at present, too slow. In this respect, it is necessary to:

(i) ensure that the approach in respect of securities markets legislation proposed by the Committee of Wise Men on the Regulation of European Securities Markets as endorsed in the Stockholm European Council Resolution is operational from the beginning of 2002;

(ii) step up efforts by all relevant parties - the Council, the Parliament and the Commission - to ensure full implementation of the FSAP by 2005 at the latest, and in particular to implement key steps for achieving an integrated securities market by the end of 2003, including notably the priorities set out in the report of the Committee of Wise Men on the Regulation of European Securities Markets;

(iii) increase, in addition to implementing the FSAP and particularly in respect of risk capital markets, efforts towards a well-functioning risk capital market by 2003 through implementation of the RCAP, in particular with regard to easing quantitative constraints on institutional investment in equity capital, easing bankruptcy law and developing a fiscal framework more conducive to investment and entrepreneurship; and

(iv) deal effectively with the challenges arising in the field of prudential supervision as a result of increasing cross-border and cross-sector linkages between financial markets and intermediaries; in this respect, the relevant authorities should take the necessary measures to further improve supervisory arrangements across sectors and across borders, in order to ensure that they keep pace with developments in the financial system.

3.6. Encourage entrepreneurship

Strengthened entrepreneurship will increase the EU's potential for growth, competitiveness and job creation. A more favourable environment for business needs to be created in Europe. Businesses and citizens need a regulatory and fiscal environment which is clear, simple, effective and workable in a rapidly changing global market place. Measures to improve the efficiency of the public sector and to limit red tape have been introduced in order to reduce the administrative burden on enterprises. Nevertheless, there is scope for significant further action. European SMEs still consider lack of access to finance an obstacle to start-ups as well as a problem limiting companies' growth potential. Member States should:

(i) create a business-friendly environment:

- further reduce the administrative burden and barriers for business by introducing simpler and more transparent procedures, one-stop shops for company start-ups and by simplifying regulation and business tax systems;

- increase the efficiency of public services, inter alia through benchmarking and the increased use of public tendering, while ensuring that public and private entities compete on a level playing field; and

- simplify and ensure a more uniform application of VAT systems.

(ii) encourage risk-taking through improving access to finance especially for SMEs in their early stages. Particularly important for SMEs is the supply of capital coupled with managerial skills (see also Section 3.5).

3.7. Foster the knowledge-based economy

The European Union's transition to the knowledge-based economy is advancing, but it should be speeded up if the Lisbon strategic goal is to be achieved. Business and citizens need to be encouraged to seize the opportunities offered by the knowledge-based economy.

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In spite of recent progress in ICT diffusion, the EU continues to lag behind the United States in areas such as research and development, investment in new technology, and internet penetration. It is of high importance that the guidance provided by the Stockholm European Council to accelerate economic reforms is brought into life within the agreed period. Increased investments in human capital, R& D and ICT are required in order to strengthen European competitiveness. The establishment of competitive product markets (see Section 3.4) and well-functioning capital markets (see Section 3.5) contribute to a business climate supportive of innovation and risk-taking that will encourage investment. In the area of R& D, the main challenge is to raise private sector involvement contributing to a better commercialisation of R& D results and to the establishment of the European Research Area to facilitate the transition to the knowledge-based economy, it is necessary to:

(i) stimulate R& D and innovation:

- provide adequate framework conditions for business to engage in R& D, inter alia by strengthening intellectual property rights and achieving agreement on how to deliver the Community patent before the end of 2001;

- improve ties between university and business leading to knowledge transfer and a better commercialisation of R& D results;

- enhance collaboration on research and innovation across Europe inter alia by stimulating networks of centres of excellence combining business and academic partners and by promoting mobility of researchers, and through better co-ordination of national research and innovation policies and programmes; and

- ensure sufficient funding for R& D, especially basic research, and establish clear and consistent priorities for public research.

(ii) promote access and use of ICT:

- implement the unbundling of the "local loop" in order to help bring about a substantial reduction in the costs of using the internet;

- ensure a better and more widespread use of internet in schools and complete the necessary training of all teachers by the end of 2002;

- strengthen the regulatory framework for e-commerce (by implementing the electronic signature directive and by adopting in 2001 proposals on copyright, distance marketing, VAT and electronic invoicing);

- stimulate internet use in public administrations; and

- develop and implement a strategy on ICT security.

(iii) strengthen education and training efforts:

- both private and public, in order to increase the supply of trained researchers, to increase the number of highly qualified ICT personnel, and to improve the basic skills, in particular ICT skills, of the population;

- enhance the capabilities of education systems to respond adequately to changes in skill requirements.

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3.8. Enhance environmental sustainability

Challenges like climate change, the depletion of the ozone layer or the preservation of biodiversity show the need for an active environmental policy in order to ensure a responsible use of scarce natural resources and an economic development which is environmentally and socially sustainable in the long run. Commitments undertaken at international level also call for policy action.

The Stockholm European Council has asked to integrate the promotion of sustainable development into the Broad Economic Policy Guidelines. Sustainable Development is a concept that goes beyond a purely economic assessment and strives for improvements in the quality of life by promoting coherent policy actions based on an overarching assessment of their economic, social and environmental dimensions. In doing so, it takes a long-term view, looking at the welfare of both present and future generations. This section focuses on the integration of environmental aspects into economic policy, in particular the use of market-based instruments, as a means of promoting sustainable development.

Government action is often delayed by concerns about possible short-term consequences of policies to protect the environment on economic growth, employment and on the competitiveness of individual firms, sectors and Member States. In this context, Member States should make increased use of market-based instruments in pursuit of environmental objectives, as they provide flexibility to industry to reduce pollution in a cost-effective way, as well as encourage technological innovation. Furthermore, they are often the most efficient means to curb pollution since they lead to the internalisation of external costs in prices. They are therefore a way to implement more consistently the polluter-pays-principle. In this respect, better information and cost-benefit analysis are important. Investment in new, environmentally friendly technology can also be an important source of progress.

Member States should set clear targets and timetables for environmental policies so that business and consumers can adjust smoothly. Gradual but steady and credible changes in the level and structure of tax rates until external costs are fully reflected in prices would minimize structural adjustment problems and support adaptation and innovative solutions by firms. This approach would also minimise the need for exemptions for those firms or sectors that are most affected. Such exemptions often reduce the environmental effectiveness of the measure, distort the tax structure and are difficult to remove at a later date. Establishing a framework for the use of market-based instruments at Community level could help avoid such distortions and underpin the internal market.

Therefore, it is necessary to:

(i) commit to effectively implement the European Sustainable Development Strategy agreed by the Gothenburg European Council;

(ii) introduce and strengthen market-based policies like taxation, user and polluter charges, insurance/liability schemes and tradable emission rights;

(iii) reduce sectoral subsidies and tax exemptions and other measures which have a negative environmental impact;

(iv) intensify the use of economic instruments to curb greenhouse gas emissions and fulfil the requirements of the Kyoto Protocol, and help to decouple economic growth from a range of environmental pressures; and

(v) agree on an appropriate framework for energy taxation at the European level and for the creation of a single internal market for energy.

II. COUNTRY-SPECIFIC ECONOMIC POLICY GUIDELINES

1. BELGIUM

The economy expanded by about 4 per cent in 2000 and real GDP is expected to increase at around 3 per cent in 2001 and 2002. Private consumption, which increased rapidly in 2000, will remain sustained in both years supported by higher household disposable income and increasing employment. Rather dynamic investment should also continue to boost domestic demand. The external sector, however, is expected to turn less supportive of activity in 2001 and 2002. Consumer price inflation, measured by the harmonised index is projected to decelerate from 2,7 per cent in 2000 to just below 2 per cent in 2001 and further down in 2002. Employment should continue to increase in both years supported by still robust activity, wage moderation and the effect of policy measures to promote employment implemented in recent years.

Taking into account the still very high government debt ratio, and the need to prepare for future challenges resulting from the ageing population, budgetary consolidation remains a priority. The labour market is still characterised by a low employment rate, in particular among the older workers, while regional divergences in labour market performance are still too marked. Lack of competition in specific sectors, the excessive regulatory burden on enterprises, and the need to raise the efficiency of the public sector are also important policy challenges.

Budgetary policy

Acceleration in activity in 2000 resulted in more positive budgetary results than expected: instead of a government deficit projected at 1 per cent of GDP, a zero balance in the general government accounts was achieved. The 2000 updated stability programme projects a 0,2 per cent of GDP government surplus in 2001 increasing slightly to 0,3 per cent of GDP in 2002. The budgetary strategy planned in the 2000 update for the period to 2005 relies on the achievement of large government primary surpluses, reaching more than 6 per cent of GDP per year. Control on real primary expenditure is expected to be the main factor of adjustment, following a non-explicit norm of increase at 1,5 per cent per year in real terms for Entity I (federal government and social security). The government debt ratio is projected to be reduced from 110,6 per cent of GDP in 2000 to 101,4 per cent of GDP in 2002. In view of the above, and considering that Belgium is a member of the euro area, budgetary policy should aim to:

(i) achieve a budgetary surplus of 0,2 per cent of GDP as projected for 2001 in the 2000 update of the stability programme, even in the event of slower real GDP growth than projected;

(ii) in the framework of the budget for 2002, contain firmly the annual increase in primary expenditure within the 1,5 per cent limit, in real terms, in Entity I, thus allowing the achievement of the government balance objectives, in particular a primary surplus above 6 per cent of GDP;

(iii) in 2002 and beyond, allocate the budgetary margins, as defined in the 2000 update of the stability programme, in a way consistent with the limit of 1,5 per cent growth of real expenditure; allocate all additional budgetary revenues which might result from better than expected real GDP growth to debt reduction; and

(iv) prepare for the budgetary implications of population ageing by timely reform of the pension system, including the identification of the budgetary resources to be allocated annually to the "Ageing Fund", in the next update of the stability programme.

Labour markets

Labour market conditions in Belgium continued to improve in 2000 bringing unemployment down to 7 per cent. The government is moving toward the implementation of an "active welfare state" characterised, among other things, by a gradual shift from passive policies to a preventive and more active approach to labour market issues. Initiatives have been undertaken to combat unemployment traps. Yet, benefit dependency remains relatively high for some segments of the labour market. The ageing population and the emerging signs of bottlenecks in hiring workers point to a need for further measures aimed at mobilising the non-occupied potential labour force, thereby increasing employment and participation rates. This is one of the main challenges facing the Belgian labour market, which is characterised by a relatively low overall employment rate (60,9 per cent), and in particular for older workers (only 24 per cent for those aged 55-64). The persistence of considerable geographical disparities in unemployment rates points to inadequate labour mobility and insufficient wage flexibility. Although the tax burden on labour in Belgium remains among the highest in the EU, tax cuts, as envisaged by the new Fiscal Reform Plan, are expected to gradually reduce taxation on labour in the years ahead. In view of the above, while vigorously implementing all the Employment Recommendations, the main priorities for Belgium should be to:

(i) on the basis of past reviews, reform further tax and benefit systems to make work pay, in particular, to create adequate incentives for older people to continue to work or re-enter the labour market and to revise the special arrangements exempting older unemployed people (aged over 50) from active job search;

(ii) address the main obstacles to labour mobility and encourage Social Partners to allow wage-setting mechanisms to better take into account productivity and local labour market conditions, while preserving wage moderation; and

(iii) continue to enhance, together with the Social Partners, labour market flexibility by further relaxing conditions for fixed term and temporary contracts and increasing working-time flexibility, while ensuring that any reduction in working time has no adverse impact on unit labour costs and labour supply.

Product markets and the knowledge-based economy

Belgium is a small open economy, with strong competition on goods markets, which has contributed to a high labour productivity in the manufacturing sector and relatively low prices for a country with its standard of living. The liberalisation process in the telecommunications sector is progressing well and several measures have been taken to stimulate the knowledge economy. However, problems of competition persist in some services sectors. The liberalisation in the energy sector is less advanced. Efforts to reduce the regulatory burden on business and to reform the public administration have been announced but only few measures have been taken. In view of the above, the main priorities for Belgium should be to:

(i) increase competition in transport and distribution of gas and electricity and set up independent transportation network managers in these sectors in order to ensure non-discriminatory access; ensure that the planned reform of the railways will increase efficiency and quality of service and reduce the need for operating subsidies;

(ii) increase the transparency of the links between the public and private sectors at the local and provincial level, especially the role of municipalities and their associations in different sectors such as energy, in order to avoid distortions of competition and conflicts of interest; and

(iii) take measures to reduce and simplify the administrative burden on business.

Capital markets

Capital markets in Belgium continue to develop. The equity market has become more integrated internationally with the merger of the Brussels, Paris and Amsterdam stock exchanges in 2000. Similarly, the banking system has been transformed by a series of cross-border as well as domestic mergers and acquisitions in recent years. A reassessment of supervisory structures and procedures is therefore being carried out, the main topics of which are the supervision of securities markets, the decision-making process within the Banking and Finance Commission, and the institutional rapprochement between the latter and the national central bank. The risk capital market has experienced strong growth, characterised by a high level of venture capital investment relative to GDP but also a substantial degree of public-sector intervention. Nevertheless, further development of the risk capital market would be desirable, in particular of the private as opposed to the public venture capital market. Efficiency in the financial system should benefit from a proposed set of legislative actions to improve corporate governance. In view of the above, the main priority for Belgium should be to:

(i) develop further the risk capital market by easing quantitative constraints on institutional investment in equity capital, by establishing a fiscal framework more conducive to investment and entrepreneurship, the latter to be also encouraged by adjusting bankruptcy laws.

2. DENMARK

Following economic growth of close to 3 per cent in 2000, mainly boosted by dynamic investment and strong external demand, the economic expansion is expected to slow somewhat to slightly above 2 per cent in 2001. Whereas growth in both private and government consumption is expected to recover after the weak performance last year, this development is likely to be more than counterbalanced by a much lower rise in investment. Although growth in export markets is assumed to slow in 2001, the unusually strong rise in imports in 2000 - partly linked to the high import intensity of equipment investment and exports - is likely to fade away. Thus, the growth contribution of net exports is expected to strengthen in 2001. In 2002 economic activity is projected to accelerate to close to 2 per cent, primarily as a result of a sustained revival of private consumption.

The growth potential of the Danish economy could be improved by properly addressing the following key challenges: labour supply constraints which, if eased, would also help to avoid bottlenecks in some sectors which might spark a renewed pick-up in pay rises. Competition in several important sectors remains inadequate and, given the size of the public sector, it is important to attain a high level of efficiency in this sector. Also, effective restraint of real growth in government consumption is necessary, in particular in view of the budgetary impact of the ageing population.

Budgetary policy

In 2000, the general government surplus was 2,4 per cent of GDP, higher than expected at the time of the adoption of the budget bill. According to the government's estimates, the budget surplus should increase to 2,8 per cent of GDP in 2001 and decline somewhat to 2,6 per cent of GDP in 2002. The 2000 update of the Danish convergence programme by and large maintains the strategy of moderately declining ratios of primary expenditure and taxes to GDP. However, in 2001, both ratios are expected to increase slightly as a result of government consumption rising noticeably above the target of a real increase of 1 per cent annually and a tax rise by local and regional governments, clearly going beyond the non-binding agreements with central government. In the longer term, projections indicate that Danish general government finances have a capacity to cope with the financial burden of the ageing population. In view of the above, budgetary policy should aim to:

(i) strictly limit the real increase in government consumption in 2001 to the budgeted rise of 1,9 per cent;

(ii) maintain high government surpluses in 2001 and the following years; and

(iii) hold back real growth in government consumption also in the medium term so that the tax burden can decline up to 2005 in line with the government's projections in the updated convergence programme, without jeopardising the capacity of Danish public finances to cater adequately for the ageing population. In particular, more binding commitments from lower levels of government should be sought, while respecting the autonomy of local governments, in order to achieve this.

Labour markets

The Danish labour market performance is one of the best in the Union, including the highest employment rate of over 76 per cent, a relatively low unemployment rate of 4,7 per cent and a good record in active labour market policies. In addition, the eligibility criteria for benefits have been tightened in order to increase effective labour supply, inter alia, recently through the reform of the early retirement schemes in 1996 and 1999, and the reform of disability pension scheme, to be implemented in 2003. However, labour supply has stagnated in recent years, and it will be curtailed by some recent measures, notably, the one-week increase in annual holidays for the private sector, agreed in 2000. As labour supply constraints can be expected to persist, both in the short and longer term, measures to increase the labour supply in general, including that of immigrants, are being taken. In addition, a further expansion in labour supply could be encouraged via tax and benefit reforms, to make the underlying tax-benefit structure more favourable for employment. In view of the above, while vigorously implementing all the Employment Recommendations, the main priority for Denmark should be to:

(i) reduce further the overall fiscal pressure on labour over the coming years, especially through lowering high marginal effective tax rates on low and medium wage earners to make work pay, and thus continue reforms of transfer systems.

Product markets and the knowledge-based economy

The Danish economy is less exposed to international competition than other small Member States. This may be one reason why competition is insufficient in a number of product markets and why consumer price levels are relatively high. Over the recent period, Denmark has seen noticeable improvements in opening up public procurement and in raising the efficiency of public services provision. Competition policy has also been strengthened, introducing merger control and the enforcement of Articles 81 and 82 of the Treaty. Despite R& D expenditures that are above the EU average, Denmark does not measure up to the other Nordic Member States, in part owing to lower business R& D spending and a poorer commercialisation record. A new business policy strategy has been designed to better R& D performance in Denmark. In view of the above, the main priorities for Denmark should be to:

(i) strengthen enforcement of competition rules in those industries where competition has been found to be inadequate; and

(ii) enhance conditions for competition in public procurement, and heighten competitive pressures in public services provision at the local level through benchmarking and increased use of public tendering.

Capital markets

Capital markets in Denmark have been developing under the influence of government policies focused on strengthening financial supervision, improving competitive conditions for financial companies and increasing market transparency. To promote the development of the equity market, Denmark has eased the quantitative restrictions placed on equity holdings of pension funds, thus allowing for investments up to 70 per cent in equity under a "prudent man" principle. Denmark has improved the tax treatment of employee ownership schemes and reformed investment fund regulations by introducing "small cap" investment funds (special innovation funds which specialise in small and innovative companies). Investment in risk capital has doubled since 1998 but remains small when compared to other markets. Therefore, continued efforts to develop the risk capital market would be desirable. Financial-sector regulations are to be gathered in a single legislative framework and supervisory arrangements are to be streamlined. With increased merger activity of large financial institutions in the Nordic region, Danish supervisors have signed a co-operation agreement with their Finnish and Swedish (and Norwegian) counterparts to ensure efficient financial supervision of such cross-border institutions. In view of the above, the main priority for Denmark should be to:

(i) develop the risk capital market by further adapting the fiscal framework so as to facilitate investment and entrepeneurship, the latter to be also encouraged by adjusting bankruptcy laws.

3. GERMANY

Following an extraordinary export boom in 2000, economic growth in Germany looks set to decelerate somewhat in the near term, mainly because slower growth in the world economy will reduce export expansion. Stronger domestic demand is projected to compensate partly for the falling external contribution to growth and will become the main economic driving force. Private consumption, after being restrained last year by rising import prices and the surge in oil bills, will benefit from a reversal of these developments. An additional boost should come from employment growth and the implementation of the third step of the income tax reform on 1 January 2001. At the same time equipment investment is expected to remain robust as a result of a high rate of capacity utilisation. According to the projections of the Commission services, GDP growth is therefore likely to decline to some 2 per cent in 2001, while 2002 should see a slight pick-up to just over 2 per cent. These growth rates should continue to result in higher employment.

Although the economic situation in Germany has substantially improved compared to the 1990s, Germany has not yet generated a strong endogenous growth process. The positive effects of the recent reforms of income and corporate taxation notwithstanding, economic dynamism appears to be held back by inter alia remaining obstacles to faster improvements in the German labour market, especially in the eastern part of the country. While overall wage moderation has improved Germany's competitiveness in recent years, unit labour costs remain relatively high in the "New Länder", where the unemployment rate is twice the national average and which are, as a consequence, dependent on large transfers from the West. Tax and benefit systems contribute to the general unemployment problem, as relatively high marginal income taxes and social security contributions and the simultaneous loss of social assistance payments can leave low-income earners in an unemployment trap. There is a risk that without reforms in the labour market and of the transfer mechanisms growth rates in Germany will remain subdued.

Budgetary policy

Last year, Germany achieved its consolidation target, as the deficit net of UMTS proceeds fell to 1,0 per cent of GDP (1,5 per cent surplus with UMTS). In addition, due to the UMTS proceeds significant progress was made in accelerating debt reduction. According to the 2000 update of the German stability programme, the government deficit should fall gradually to zero by the year 2004. About half of the adjustment burden is based on budgetary improvements in Länder and communes. Deficit reduction should be achieved mainly by reducing expenditures, while the tax burden should fall. The updated stability programme foresees, however, a temporary increase in the deficit to 1 per cent of GDP in 2001 as a result of the tax reform. The long-term sustainability of public finances should be improved by the pension reform. Long-term budgetary risks remain, however, because health care and dependency payment schemes are not yet appropriately dealing with the consequences of population ageing. In view of the above, and considering that Germany is a member of the euro area, budgetary policy should aim to:

(i) attain a general government deficit of 1 per cent of GDP in 2001; to this end, growth of government expenditure in 2001 should respect the projections set in the framework of the November 2000 "Finanzplanungsrat";

(ii) when preparing the budget for 2002, maintain the planned reduction in the general government deficit to 1 per cent of GDP, so as to ensure that the medium-term target of a balanced budget by 2004 can be met; in the event of higher than projected tax revenues these should be used to reduce the deficit below the targeted level;

(iii) reinforce from 2001 onwards the co-ordination of budgetary policy among the various levels of government by strengthening the role of the "Finanzplanungsrat" and, eventually, in the framework of a national stability pact; and

(iv) in order to secure the longer-term sustainability of government finances continue the implementation of the pension reform and start the elaboration of reforms of the health care sector and of dependency insurance, particularly of long-term care for the elderly.

Labour markets

The labour market situation in Germany continued to improve in 2000. Employment growth accelerated, with job creation increasing at a pace not witnessed in the last decade, and unemployment fell to 8,1 per cent. However, the overall improvement has still not reached the eastern part of the country, where employment decreased even further and unemployment remained fairly stable at 16,7 per cent. Significant measures were taken to reduce the tax burden on labour in the recent tax reform. Pension contributions were slightly reduced in 2000. However, the combined effects of tax and benefit systems can still result in disincentives to work. In some fields, the German labour market is characterised by a relatively high degree of regulation. Active labour market programmes (ALMPs), especially in the eastern part of the country, appear to be not always efficient in terms of reintegration into the labour market. The strong regional dimension of unemployment demonstrates the need for further action to enhance mobility and the adaptability of wages. In view of the above, while vigorously implementing all the Employment Recommendations, the main priorities for Germany should be to:

(i) target ALMPs better towards those groups most prone to the risk of long-term unemployment and ensure that training better matches the demands of the labour market. Improve the efficiency of ALMPs, in particular in the New Länder. Continue to encourage the wage formation process to better take into account productivity and regional labour market conditions;

(ii) complement the income tax reform with further reforms of the tax and benefit system to make work pay. Further steps should be taken to reduce the still-high level of non-wage labour costs, in particular for low wage labour; and

(iii) take measures, where appropriate in the framework of the "Alliance for Jobs", to make work contracts and work organisation more flexible and to improve the conditions for life-long learning.

Product markets and the knowledge-based economy

German product markets are open to international competition. Productivity levels are around the EU average but relative price levels are somewhat above what one would expect for a country with its standard of living. Germany has taken several measures to improve the functioning of its product markets, resulting in a better environment for business. In particular, some progress has been made in improving the framework for competition in the professions and handicrafts trade. Furthermore, the tax reform, the streamlining of business support mechanisms and the liberalisation of the telecommunications sector have started to have a positive impact. The electricity market has also been liberalised and a system of negotiated third party access to the electricity grid has been put into place. However, there are still large regional differences in access fees. The gas Directive has not yet been fully implemented into German legislation, thus hampering the introduction of competition. State aids are declining gradually, but levels remain above the EU average. Public procurement rules are still not sufficiently applied by some public authorities. Economic growth in the new Länder has been held back by an underdeveloped business services sector and a lack of innovative capacity, amongst other factors. ICT penetration is rising rapidly and measures have been taken to prevent a digital divide from appearing. A serious shortage of IT personnel has emerged. In view of the above, the main priorities for Germany should be to:

(i) reform the higher education system and reduce shortages of IT personnel through education and training;

(ii) reinforce competition in product markets by further opening-up of public procurement, continuing the policy of gradual reductions in State aid, and continuing to decrease the regulations for the professions and handicrafts trade; and

(iii) make efforts to reduce the large regional differences in the fees for the use of local electricity distribution networks.

Capital markets

In Germany, several actions have been taken to improve the functioning of the regulatory framework for capital markets. In particular, the Fourth Financial Market Promotion Act (Finanzmarktförderungsgesetz) will be tabled as a draft in June 2001 and implemented in 2002. It proposes measures to deregulate stock market law, improve rules on stock market manipulation, and to provide greater legal certainty for futures. Furthermore, Germany has announced a reform of its financial services regulation by creating a single federal agency for the supervision of the banking, insurance and securities sector in order to meet the challenges of the ongoing integration of financial markets. Actions have been taken to rationalise and simplify programmes which aim to make risk capital available to SMEs and start-ups. More generally, the proposed reform of the pension system should further promote capital markets, and a law has been tabled on take over bids. An expert commission has been created to draw up a code of good practice in the field of corporate governance, and a law was introduced to facilitate the introduction of registered shares (Namensaktien). In view of the above, the main priority for Germany should be to:

(i) further develop the risk capital market by continuing efforts to establish a fiscal and regulatory framework more conducive to investment and entrepreneurship.

4. GREECE

Economic activity was buoyant in Greece in 2000 and is expected to accelerate in 2001 and 2002, real GDP rising by around 4,8 per cent in 2002. Strong domestic demand will be supported mainly by investment; investment in construction in particular, is expected to accelerate in view of the preparation for the Olympic Games in 2004. Moreover, lower interest rates, brought by participation in the euro area, should boost activity. The external current balance is expected to deteriorate further under the impact of fast increasing imports induced by strong domestic demand and of slowing export markets for goods. Consumer prices accelerated in 2000 and reached 3,7 per cent (HICP) in December. In line with moderating import prices, inflation is expected to decelerate in 2001 and 2002; however, there are risks of overheating in a context of buoyant activity and easing monetary conditions. The acceleration in economic activity will contribute to improve gradually the labour market situation; still, the rate of unemployment is expected to remain high.

Inflation risks might persist in 2001, requiring appropriate stabilising policy measures. In such a context, budgetary policy will be an important available economic instrument in order to contain inflationary pressures. Wage developments will also be crucial in this respect. Continuing budgetary consolidation efforts are also needed to lower the high level of the government debt ratio and to prepare for long term challenges resulting from the ageing population. Structural reform in the labour, product and capital markets remain priority areas with a view to increasing productivity, facilitating job creation and improving the external competitiveness of the economy.

Budgetary policy

In 2000, the general government deficit was reduced to 0,9 per cent of GDP from 1,8 per cent of GDP in 1999. The 2000 stability programme projects the general government balance to turn into a surplus equal to 0,5 per cent of GDP in 2001 and to 1,5 per cent of GDP in the following year; the budgetary projections included in the programme are based on high real GDP growth assumptions of around 5 per cent in both years. The budgetary strategy is centred on achieving high government primary surpluses reaching about 7 per cent of GDP in 2001 and 2002, while fully benefiting from lower interest payments following the decline in interest rates and in the debt ratio. However, the programme provides for a significant reduction in general government current primary expenditure only in 2002. In view of the above, and considering that Greece is a member of the euro area, budgetary policy should aim to:

(i) ensure that the budgetary target of a surplus of 0,5 per cent of GDP set for 2001 is met and be ready to tighten the budgetary implementation in 2001 should inflationary pressures persist;

(ii) maintain in the budget for 2002 a budgetary stance clearly oriented towards price stability; to this end, respect the government primary surplus objective of 7 per cent of GDP mainly through fast retrenchment in government current primary expenditure applying clear and binding norms;

(iii) pursue the reform of the public sector in order to reduce its size in the medium-term with a view to improving the competitiveness of the economy and to alleviating the burden on public finances; and

(iv) accelerate the implementation of the reform of the social security sector in order to ensure the viability of the system; in particular, initiate in 2001 the reform of the pension system needed to address the challenges resulting from the ageing population.

Labour markets

After a fall in employment in 1999 despite rapid economic activity, employment grew by 1,2 per cent in 2000 allowing a fall in the unemployment rate. Despite this positive development, the labour market in Greece is still characterised by a low employment rate (55,4 per cent in 2000), a high unemployment rate, and a strong degree of labour market segmentation evidenced by high female and youth unemployment. A number of recent measures have aimed at improving the labour market situation, including changes to some taxes and benefits, and the adoption of a second wide-ranging package of labour market measures. Moreover, implementation of active labour market programmes and the modernisation of the Public Employment Service is continuing. Despite recent measures, the labour market still displays a number of rigidities including: complex and heavy regulation; insufficient decentralisation of wage bargaining; and important distortions to labour market incentives. Moreover the educational system should be improved in order to better meet the requirements of the labour market. In view of the above, while vigorously implementing all the Employment Recommendations, the main priorities for Greece should be to:

(i) ensure the full implementation of recent labour market reform packages, and further build upon these efforts by loosening restrictive employment protection legislation in particular;

(ii) eliminate major distortions arising from labour taxes and pension entitlements, thus improving incentives to work to take up work in the formal sector;

(iii) ensure that wages better take into account productivity and local labour market conditions, in particular by making opt-outs included in the territorial employment pacts a practical possibility; and

(iv) increase investment in and improve educational and training systems in order to enhance the skills of the labour force.

Product markets and the knowledge-based economy

Greece is relatively little integrated in EU product markets, not least due to its geographical position. Labour productivity is improving but remains below the EU average. Price levels are below the EU average, but somewhat higher than what one would expect for a country with its standard of living. Reforms in the product markets continue but remain relatively slow. Progress has been made in completing the regulatory and institutional framework for the opening up of network industries, but the pace of liberalisation remains slow, in particular in the gas sector. During 2000, privatisation of state-owned companies continued, but with somehow less vigour than in previous years, and some measures were taken to foster start-ups. The transposition record of internal market legislation remained the poorest in the EU and modest progress was made in improving the business environment. Despite a rapid increase in ICT spending and penetration in recent years, Greece is still a relative latecomer in the development of the knowledge-based society. In view of the above, the main priorities for Greece should be to:

(i) continue to reduce the regulatory and administrative burden on business, enhance the performance of the public administration and improve the coherence of the corporate taxation system;

(ii) take additional measures to increase R& D spending;

(iii) continue to promote the wider diffusion of ICT and the use of e-commerce;

(iv) improve the transposition record of internal market legislation, particularly in the area of public procurement; and

(v) speed up the announced liberalisation of the gas sector, implement the reform of the sea transport sector as announced and reinforce competition in already liberalised utilities.

Capital markets

Capital markets in Greece continue to develop rapidly, assisted by improvements in the regulatory framework and in market infrastructure. More specifically, development of the risk capital market has been facilitated by the creation of a new equity market for SMEs, by the creation of a Fund to foster early-stage investment in SMEs and by further tax relief on capital gains. Nevertheless, further development of the risk capital market would be desirable. Privatisation is enhancing competition in the domestic banking sector. Changes in the structure of the banking system and the process of financial integration with the rest of the EU means that co-operation between supervisors across sectors and across borders is increasingly important. In view of the above, the main priority for Greece should be to:

(i) develop further the risk capital market by easing quantitative constraints on institutional investment in equity capital, by establishing a fiscal framework that is conducive to investment and entrepreneurship, the latter to be also encouraged by adjusting bankruptcy laws.

5. SPAIN

GDP growth maintained a robust pace in 2000, but with a clearly decelerating path in the second half of the year due to the slowdown of domestic demand partially offset by a positive external contribution. Prospects for 2001 and 2002 point to weaker but more balanced growth. In 2001 domestic demand is expected to decelerate further with a modest narrowing of the external deficit, and lower inflation. In 2002, GDP growth is forecast to recover slightly, mainly due to private consumption benefiting from an increase in real disposable income, caused by more favourable price developments, and steady job creation.

Although unemployment continued to decline in 2000, labour market problems remain. The share of fixed-term contracts represents almost one third of total employment. Wide regional disparities in unemployment persist. In addition, price developments in 2000 were worse than expected, due both to the behaviour of more volatile items (energy and unprocessed food) and to an acceleration in underlying inflation. Fiscal consolidation is expected to continue over the medium term as projected in the 2001 updated stability programme, but more decisive steps are needed in order to cope with the budgetary consequences of ageing. Finally, economic policy must take into account the need to foster the knowledge-based society so as to improve the medium-term prospects of the Spanish economy.

Budgetary policy

In 2000 the general government accounts registered a deficit of 0,3 per cent of GDP, 0,9 percentage points lower than in 1999. According to the 2001 updated stability programme, the general government sector is expected to be in balance in 2001 and to reach a surplus of 0,3 per cent of GDP by 2004. The fiscal strategy outlined in the update is similar to the two previous programmes. It relies on restrained growth of primary current expenditure, enabling higher public investment and, after 2002, a reduction in the tax burden. Given Spain's particularly exposed demographic profile and the implied adverse budgetary consequences of ageing, the sustainability of public finances is a matter of concern. With a view to better co-ordinate among the different levels of government and to enhance control over expenditure, a Law of budgetary Stability, intended to establish a balanced budget rule across all sub-sectors of general government is currently under discussion in Spain. As a result, and considering that Spain is a member of the euro area, budgetary policy should aim to:

(i) achieve a budgetary position of balance for 2001 as set in the updated stability programme, especially through primary current expenditure restraint. Moreover, there should be a readiness to tighten fiscal policy further to counterbalance additional inflationary pressures;

(ii) prepare the 2002 budget aiming at the target of the 2001 updated stability programme. Should inflationary pressures persist, any better than expected results in 2001 should be carried forward and fiscal policy tightened further. Additionally, ensure that the fiscal reform envisaged for 2002 is supply-side-oriented and does not jeopardise the stability programme budgetary objectives; and

(iii) increase the public pension fund reserve created in the 2000 Budget Law to at least 1 per cent of GDP by 2004, as envisaged in the latest updated stability programme. Additionally, legislate already in 2001 for a comprehensive overhaul of the public pension system to ensure its future viability.

Labour markets

Labour market performance has improved markedly in Spain over recent years, with strong employment growth and a sharp drop in unemployment, from 24 per cent in 1994 to 14 per cent in 2000. Nevertheless, the country still suffers from very high structural unemployment with severe regional disparities, and a low employment rate, especially among women (40,3 per cent in 2000). Key structural problems include the failure of labour costs to adjust to productivity and local labour market conditions, and low labour mobility, partly owing to housing market rigidities and the operation of certain regional benefit schemes. Recent proposals for reforms of employment contracts would seem to go some way towards addressing rigidities in this area, although the experience of previous reforms suggests that much will depend on implementation. While expenditure on active labour market policies has grown substantially in recent years, less attention seems to be devoted to ensuring the efficiency of such measures, which can play an important role in further reducing long-term unemployment. In view of the above, while vigorously implementing all the Employment Recommendations, the main priorities for Spain should be to:

(i) encourage reform of wage formation in order to better take into account productivity and local labour market conditions, and diminish obstacles to labour mobility, inter alia through improvements to the functioning of the housing market and regional benefit schemes;

(ii) increase investment in and improve education and training, and ensure that active labour market measures are efficient and tailored to the needs of those most prone to the risk of long-term unemployment or those with lower participation rates (in particular women) and to the demands of the labour market; and

(iii) take steps to ensure, with the Social Partners, an appropriate balance between flexibility and security, by means of the effective implementation of recently approved employment contract reforms, with a view to early progress in terms of a reduced share of fixed-term contracts, greater use of the part-time contract and a higher share of female employment.

Product markets and the knowledge-based economy

Although Spain's integration into the European goods markets has constantly increased in the 1990s, the openness of the Spanish economy is still less than that of other large Member States. Similarly, labour productivity is relatively low. In 2000, Spain has taken several measures to improve the functioning of its product markets. The transposition of internal market legislation and the liberalisation of the telecommunications and energy markets have been speeded up; the Community rules on public procurement have been implemented more effectively and the level of State aid has been reduced. Further measures have been taken to reduce the relatively high administrative burden on businesses, especially SMEs. To tackle the problem of the low level of R& D expenditure, a three-year National R& D and Innovation Plan has been launched. However, public expenditure on education is also relatively low compared to other EU countries and internet penetration is the second lowest in the EU. In view of the above, the main priorities for Spain should be to:

(i) take measures to increase the basic ICT skills of the population and to increase the supply of highly qualified research and ICT personnel; and

(ii) continue the implementation of the plan to simplify the regulatory framework for SMEs.

Capital markets

Capital markets in Spain have been characterised by a significant privatisation programme and regulatory measures to enhance transparency. Market efficiency is being improved by the consolidation of several national securities clearing and settlement systems. Consolidation is also underway in the banking sector, which has resulted in increased profitability and has fostered the use of more advanced technology. The risk capital market is expanding due to favourable tax measures and the creation of the Nuevo Mercado but remains underdeveloped, particularly with regard to early stage investment. Therefore, measures to further develop this market would be desirable. In view of the above, the main priority for Spain should be to:

(i) further the risk capital market by further easing constraints on institutional investors which may limit their investment in equity capital, and by establishing a fiscal framework more conducive to investment and entrepreneurship, the latter to be also encouraged by adjusting bankruptcy laws.

6. FRANCE

Despite some deceleration resulting from weaker external demand, economic activity in France is expected to remain sustained: real GDP growth is currently projected to reach slightly less than 3 per cent in both 2001 and 2002. In both years, strong domestic demand should continue to be the main factor underpinning the robust trend in activity which started three years ago; the negative effects on household purchasing power which stemmed from the past surge in oil prices will progressively fade away; at the same time, the tax reductions planned for 2001 and 2002 will contribute to an acceleration in private consumption. In such a context of favourable demand prospects, productive investment is expected to remain dynamic. Expanding economic activity will continue to have a high job content thus enabling the unemployment rate to pursue its rapid decline.

Although unemployment has sharply declined in the course of 2000, it remains high and wage and price developments have remained moderate until now. However shortages are gradually emerging in the labour market. Moreover, the rate of capacity utilisation in the manufacturing sector has reached a high level by historical standards. Whilst these developments do not seem to constrain production as yet, they represent a potential risk calling for appropriate policy measures; the sustainability of the current economic expansion relies on improved supply side conditions, including higher labour market participation, a more favourable environment for investment and increased competition.

Budgetary policy

In 2000, the general government deficit was reduced by 0,3 percentage points to 1,3 per cent of GDP, below the targeted deficit for that year. According to the 2000 updated stability programme, further reductions in the deficit ratio are to be pursued in 2001 and beyond. The public finances are expected to be in surplus in 2004. The French budgetary strategy is based on a tight control of government spending in real terms; in 2001 about half of the margins created by such restraint are projected to be allocated to reducing the government deficit and the remaining to tax relief. In a longer term perspective, government finances will face an increasing burden stemming from ageing of population. A public pension reserve fund was created in 1999 in order to partly cushion the budgetary impact of ageing population. In view of the above, and considering that France is a member of the euro area, budgetary policy should aim to:

(i) achieve in 2001 a general government deficit of 1 per cent of GDP (excluding UMTS receipts) as targeted in the 2000 updated stability programme; to this aim, ensure that the increase in real government expenditure will not exceed the projected 1,8 per cent in 2001;

(ii) in the framework of the budget for 2002, contain government expenditures in real terms within the 1,6 limit set by the government in order to secure the achievement of the 0,6 per cent government deficit target set in the 2000 updated stability programme so as to ensure a surplus by 2004; and

(iii) allocate in 2002 and beyond, as a matter of priority any additional available margin to strengthen the budgetary position in order to prepare for long term challenges, notably the burden for public finances which will result from ageing of population; with a view to securing the long term sustainability of government finances, to make further progress in reforming the pension system.

Labour markets

Recent developments in the French labour market continue to be impressive: in 2000 employment grew strongly by 2 per cent contributing to a marked reduction in the unemployment rate to 9.5 per cent. Wage developments have also been moderate, despite concerns about emerging labour shortages in some sectors and professions, which are likely to be exacerbated by the reduction of working time. Despite good recent performance, the unemployment rate is still high and the employment rate is relatively low, especially for older workers (29 per cent in 2000). There is also a need to increase labour supply, in particular of unskilled workers and older workers. High levels of structural unemployment are due in part to remaining disincentives to work resulting from the tax and benefit system despite recent measures to reduce inactivity traps, and to some rules that may hamper access to employment. In view of the above, while vigorously implementing all the Employment Recommendations, the main priorities for France should be to:

(i) consolidate recent reforms of the tax and benefit system by improving the incentives for older workers to remain in work, and by addressing remaining disincentives to take up part-time and full-time work, in particular for unskilled and low-paid workers. In this context, particular attention should be paid to early retirement schemes and income guarantee schemes;

(ii) monitor closely the positive and negative effects of the implementation of the 35-hours working week legislation to continue to ensure that it does not generate any adverse medium-term effects on wage costs, labour supply and work organisation; and

(iii) reform employment protection legislation with a view to better combining security with greater adaptability to facilitate access to employment.

Product markets and the knowledge-based economy

The French economy is open to international competition. Labour productivity is relatively high. Relative price levels remain somewhat above what one would expect for a country with its standard of living. Progress has been made in promoting entrepreneurship and State aids have been reduced. However, France's record in transposing the internal market directives is the second worst in the EU and network industries are being liberalised slowly. Moreover, despite recent progress, the administrative burden on business remains relatively high. Recently, France has adopted a decree which should open further public procurement and increase its transparency. Finally, ICT penetration is rising rapidly and measures have been taken to prevent digital divide from appearing. In view of the above, the main priorities for France should be to:

(i) step up efforts to liberalise network industries, especially the gas and electricity sectors;

(ii) continue progress made in transposing internal market directives;

(iii) continue the reduction of ad hoc State aids; and

(iv) continue efforts to reduce the administrative burden on business by simplifying procedures and developing new means of electronic communication with the public authorities.

Capital markets

Capital markets in France continue to develop with the equity market, in particular, expanding both in terms of companies listed and market capitalisation. The equity market is further benefiting from the creation of long-term savings plans, while market efficiency is being enhanced by greater transparency and improvements in investor protection. Moreover, the equity market has become more integrated internationally due to the merger between Paris, Amsterdam and Brussels stock exchanges. More specifically, risk capital investment has benefited from a series of measures taken in recent years but venture capital investments remained slightly below the EU average in 1999. Nevertheless, further development of the risk capital market would be desirable. Privatisation of the banking sector is continuing, with the State divesting its share in the last publicly owned bank, the Hervet Bank. Changes are also underway in the supervisory framework, as reflected in the forthcoming merger of the securities regulatory authorities and increased co-operation between banking and insurance supervisors. In view of the above, the main priority for France should be to:

(i) develop further the risk capital market by easing constraints on institutional investments in equities and further adapting the fiscal framework so as to facilitate investment and entrepreneurship, the latter to be also encouraged by adjusting the enforcement of bankruptcy laws.

7. IRELAND

After very high growth in 2000, with the level of output considerably above potential, a slowing in growth is expected in 2001-2002 with labour and other capacity constraints becoming more evident. The slowdown in the US economy and the threat of foot and mouth disease are additional factors contributing to the slowing in growth. Lower export market growth and a higher real exchange rate, coupled with an expansionary budget for 2001 are expected to increase the relative contribution of domestic demand to growth. After a sharp increase in inflation in the course of 2000, the inflation outlook is for a moderate decline in 2001-2002: while some factors that impacted significantly on inflation in 2000 are expected to unwind, domestically-generated inflation is expected to remain relatively high.

High growth since the mid-1990s has translated into strong employment gains and the economy is close to full employment. The task now is to maintain good, sustainable growth by containing inflationary pressures and tackling labour and infrastructure constraints. In particular, the contribution of fiscal policy to achieving these goals without threatening economic stability is a major challenge. Given that the basic pay rises for 2001-2002 in the recently re-negotiated national agreement have been revised upwards in response to higher than expected inflation and the drift over and above these provisions in a tight labour market, avoiding a wage-price spiral constitutes another challenge. The contribution of further measures to increase competition in some sectors and more b