COMMUNICATION FROM THE COMMISSION ON THE IMPLEMENTATION OF THE 2002 BROAD ECONOMIC POLICY GUIDELINES (presented in accordance with Article 99 (3) of the EC Treaty) {SEC (2003) 33}

PART I

General Assessment1)

1) Commission Communication

TABLE OF CONTENTS

EXECUTIVE SUMMARY

1. Introduction

2. Overview of key policy areas

2.1 Ensure growth and stability-oriented macroeconomic policies

2.2 Improve the quality and sustainability of public finances

2.3 Invigorate labour markets

2.4 Re-ignite structural reform in product markets

2.5 Promote the efficiency and integration of the EU financial services market

2.6 Encourage entrepreneurship

2.7 Foster the knowledge-based economy

2.8 Enhance environmental sustainability

3. Summary assessments of implementation by the Member States

3.1 Belgium

3.2 Denmark

3.3 Germany

3.4 Greece

3.5 Spain

3.6 France

3.7 Ireland

3.8 Italy

3.9 Luxembourg

3.10 The Netherlands

3.11 Austria

3.12 Portugal

3.13 Finland

3.14 Sweden

3.15 United Kingdom

// EXECUTIVE SUMMARY

The 2002 BEPGs confirmed the well-established economic policy strategy // This Communication relates the progress made in response to the Broad Economic Policy Guidelines (BEPGs) adopted in 2002, a year marked by the successful introduction of euro notes and coins. The 2002 BEPGs set out and confirmed the economic policy strategy aimed at contributing to the achievement of the Treaty's fundamental objectives and the Union's policy agenda agreed upon by the European Council in Lisbon and Stockholm. This policy strategy has taken shape over recent years and has become well-established. Sound macro-economic policies coupled with continuing efforts to improve the functioning of our economies through comprehensive structural reforms on labour, product and capital markets should help to strengthen the recovery in the short term, increase potential growth in the medium term, and successfully deal with longer-term structural and sustainability issues. Such policies would also help to strengthen economic and social cohesion. This Communication offers an overall assessment of the implementation of the policy recommendations set in the 2002 BEPGs, while an assessment per Member State is given in the accompanying working document of the Commission services. Following up on the Council's agreement on streamlining of policy co-ordination procedures of 3 December 2002, this "Implementation Report" is being presented as part of the first Implementation Package in support of and together with the Commission's Spring Report.

The following key messages emerge.

Recovery failed to gather momentum // Following the slowdown in 2001, growth started to recover in early 2002 but failed to accelerate thereafter. Already weak domestic demand was depressed by a further collapse in confidence following accounting scandals in the USA, further slides in stock prices and rising international tension. Despite weak economic growth, employment creation has continued albeit at a weak pace and the rise of the unemployment rate - for the first time since 1996 - has been only marginal. Headline inflation has been slow to come down, reflecting the upsurge in energy and fresh food prices, but also, and more importantly, persistently high core inflation, especially on account of the services sector.

Macroeconomic policy was broadly adequate but was complicated by sticky inflation // Whereas earlier in 2002, expectations centred on a tightening of monetary policy to stem inflationary pressure linked to the expected recovery, against a background of slowly receding inflationary pressure and continued subdued economic growth monetary authorities kept monetary policy on hold until well into the autumn, before proceeding to a further easing towards year-end. For the EU as a whole, the fiscal policy stance was broadly neutral if not slightly expansionary. Wage increases showed little sign of coming down against the background of weak economic activity and the continued slow growth in labour productivity. Whilst supporting household purchasing power, sustained wage growth also contributed to the stickiness of high core inflation and an erosion of profit margins which, if not reverted in the context of a subsequent cyclical recovery in productivity, could weigh on investment.

Budgets deteriorate as automatic stabilisers operate, but also because of discretionary loosening in some Member States that can ill afford it // Budgetary positions deteriorated clearly in 2002 as automatic stabilisers acted to cushion weak economic activity but also, in some instances, on account of discretionary loosening. In several Member States coping with still high structural deficits, progress towards achieving budgetary positions of close to balance or in surplus stalled or moved into reverse, forcing the Commission to take action in the context of the Stability and Growth Pact. Following the issuance of early warning recommendations to Germany and Portugal early in 2002, it activated the Excessive Deficit Procedure for both Member States in the autumn. A recommendation for an early warning to France was also issued in the autumn. Some of the other Member States that had already achieved structural budget positions close to balance or in surplus, clearly failed to maintain them (Ireland and Austria).

Quality and sustainability of public finances - some progress but long-run sustainability far from secured // The strains on budgets notwithstanding, public investment was generally maintained or slightly increased except in Germany, Greece, and Portugal. Germany, Spain, Italy and Portugal took measures to improve control over public spending. While the pension reforms undertaken in 2002 by Portugal, Greece, Finland and the UK are a step in the right direction, the long-run sustainability of public finances is in most Member States far from secured (particularly so in Belgium, Germany, Greece, Spain, France, Italy, Austria, and Portugal). In particular, the failure to move more decisively towards sound budget positions in Germany, Greece, France, Italy and Portugal is very worrisome in this regard. Similarly, the failure of Greece and Italy to secure a steady reduction in their still high government debt ratios is a source of concern.

Labour markets - increasing signs that structural reforms start to pay off in terms of increased resilience are no excuse for inaction as there remains a real need to step up the pace of labour market reform to achieve the Lisbon objectives // Reform efforts in the second half of the 1990s have contributed to stimulating employment, amongst others through increasing the job content of growth, and strengthening the EU economy. Labour markets performed rather well in 2002 given the weak economic growth as reflected by continuous employment growth and only a marginal increase in the unemployment rate. To some extent, this relatively positive performance seems to be due to some labour hoarding, which might take its toll this year. Nevertheless, these are also first tentative signs that labour market reforms of recent years are starting to pay off. Against this background, it is disappointing to note that the pace of further reform in 2002 remained slow and that there is as yet little - if any - sign that the warning in the 2002 BEPGs that the pace of reform would have to be stepped up to achieve the Lisbon objectives - a message subsequently repeated in the draft Joint Employment Report (JER) - has been heeded. While most Member States made some progress in adapting tax and benefit systems to make work pay and encourage the search for jobs, measures were generally piecemeal and focussed on the tax side, rather than addressing the combined effects of taxes and benefits. The Barcelona European Council's call to raise the effective average age at which people stop working by about 5 years by 2010 has yet to be followed up by comprehensive active ageing policies including energetic reform of pension and early retirement schemes. Whereas monitoring of the efficiency of active labour market policies is generally speaking inadequately developed, Sweden, Denmark and Finland and, to a lesser extent Germany, Spain and the UK, took measures to strengthen monitoring. There is little evidence that Member States have taken action to abolish barriers to geographical mobility. A few Member States (France, Italy, and Portugal) have introduced new measures to promote flexibility on the labour market, and in this context there is an increasing trend to better balance security with flexibility in labour markets. Member States generally responded to emerging bottlenecks in labour markets due to skill mismatches by further adjusting vocational training systems and lifelong learning strategies. Similarly, to promote female labour force participation, several Member States took further measures to increase childcare facilities (Germany, Spain, Ireland and Luxembourg) and strengthen financial incentives (Belgium, Spain, and Ireland).

Product markets - full implementation of the Internal Market remains difficult, good progress has been made on harmonising competition policies but competition in the liberalised network industries is still insufficient // Progress over the past year in terms of the full implementation of the Internal Market has been disappointing. Only five Member States (Denmark, the Netherlands, Finland, Sweden and the UK) meet the European Council's target of a transposition deficit of 1.5 per cent or less by the spring of 2003, while three Member States (France, Greece, Portugal) have a deficit of more than double that target. Moreover, the stubbornly high number of Internal Market infringement proceedings, particularly in France and Italy, shows that the full application of Internal Market legislation leaves much to be desired. Furthermore, progress in eliminating remaining barriers to trade and cross-border service activities remains very slow. On the other hand, good progress has been made in strengthening competition and regulatory authorities. The downward trend in State aid continued (except in Denmark, Ireland, Luxembourg, and the Netherlands) and the share of horizontal aid increased on account of falling ad hoc and sectoral aid. The liberalisation process in the network industries has continued, but the market share of incumbents remains high. Competition is still insufficient even if the benefits to consumers of liberalising the telecommunication and energy sectors are starting to be felt. While the Council reached political agreement on the electricity and gas package, access to port services and the Single European Sky Package, it is disappointing that it has so far failed to agree on the revised financial regulation and guidelines for Trans-European transport networks, public service contracts for passenger transport, and airport slot allocation.

Capital markets - encouraging progress in implementing the FSAP since Barcelona should be maintained; a similar acceleration is needed for the RCAP // Encouraging progress has been made in integrating financial markets and the ambitious objectives set by the Barcelona European Council for 2002 will be largely achieved. This positive new momentum should be maintained in order to secure full implementation of the Financial services Action Plan by the 2005 deadline. Progress in implementing the Risk Capital Action Plan has continued, but would need to be stepped up in all main policy areas identified therein. Several Member States took steps to consolidate financial supervision across sectors, but further improvement in cross-border co-ordination will be crucial. Initiatives were launched in order to help identify ways in which barriers to efficient cross-border clearing and settlement could be removed. They will have to be followed up by concrete proposals and decisions.

Entrepreneurship -slow improvement in the business environment, but achievements vary considerably between Member States and policy areas // Several initiatives have been taken at both Community and national level to improve the business environment and encourage entrepreneurship. The regulatory environment is improving in all Member States. A number of Member States (including France, Italy, Austria and Portugal) took measures to reduce the typical time and cost involved in setting up a new company, to alleviate administrative burdens, and to stimulate competition in certain sectors. Reforms to increase public sector efficiency were undertaken in Belgium, Denmark, Portugal, and Sweden, and government services are increasingly being made available online. Corporate tax rates were lowered in France, Ireland, the Netherlands and Portugal, while the corporate tax system in Greece was simplified. All Member States made progress in implementing the European Charter for Small Enterprises.

The knowledge-based economy - slow catching up on ICT usage, but important gaps remain in business R&D and patenting // While the EU is slowly catching up with the US in terms of ICT usage, gaps in terms of patenting and business R&D remain large and persistent. Against the background of repeated calls from the European Council for rapid progress, the Council's failure so far to agree on the Community Patent is a clear disappointment. Internet usage continued to increase. Some Member States acted to improve education, in particular by strengthening the vocational training in order to respond adequately to changes in skill requirements. Several initiatives were taken to facilitate the transfer of qualifications and skills for academic and professional purposes.

Environmental sustainability - various measures have been taken // Increased competition in electricity and gas markets should help strengthen the effectiveness of market-based instruments, but rail freight market opening progresses only slowly. Existing energy and/or carbon taxes were increased in Germany and Sweden, whereas the Netherlands, France and the UK took other measures to promote environmental protection. Solid progress was made towards adopting the Commission's proposal for an EC emissions trading scheme, whereas the UK's greenhouse gas emission trading system came into effect and the Netherlands advanced in preparing for setting up such a system. No progress was made in reducing environmentally pernicious subsidies and tax exemptions.

Rather than reacting to the slowdown by redoubling efforts to invigorate the economy, policy inertia and backtracking are widespread // Despite progress in some areas, the overall picture that emerges from this review is rather disappointing. The reaction to the slowdown in economic growth is characterised by policy inertia and backtracking. Once more, the failure to act more decisively on public finances when growth was favourable takes its toll. Once again, governments display insufficient resolve in pushing through badly needed structural reform to instil the dynamism into the economy that is needed to move decisively towards the Lisbon goals. It is necessary to match words with action and develop a new sense of urgency. Rather than relying on externally driven economic expansion, the EU should rely much more on its domestic strengths. It needs urgently to strengthen the necessary growth-supportive, supply-side framework conditions. Structural reforms can be growth supportive also in the short run through positive effects on confidence.

1. Introduction

The EU's medium-term economic policy strategy is laid down in the Broad Economic Policy Guidelines (BEPGs) and was most recently updated in June 2002. [1] Besides the pursuit of sound macroeconomic policies, it aims at comprehensive structural reform. It should facilitate flexible responses to changing economic conditions in the short run whilst strengthening the productive capacity of the economy over the medium run. The policy strategy can, however, only bear fruit if fully implemented.

[1] See Council Recommendation of 21 June 2002 on the BEPGs, published in Official Journal No L 182 of 11 July 2002.

This Communication assesses the extent to which effective policy action has been taken in response to the guidelines. It thereby provides for a key input for the multilateral surveillance of the economic policies of the Member States and the Union as envisaged by Treaty Article 99 (3). It is also an important stepping stone for the preparation of the next BEPGs. Following up to the Council's agreement of 3 December 2002 on the streamlined approach, this "Implementation Report" is being presented in January as part of the first Implementation Package in support of and together with the Commission's Spring Report. Its earlier presentation should allow for a better follow-up on implementation ahead of the Spring European Council in March focusing on the follow up to the Lisbon strategy. In the light of the latter's general political orientations, the Commission will present subsequent policy guidance in early April in the form of its Guidelines Package, comprising the BEPGs, the Employment Guidelines and the related employment recommendations.

The BEPGs policy strategy

1. Ensure growth and stability-oriented macroeconomic policies.

2. Improve the quality and sustainability of public finances.

3. Invigorate labour markets.

4. Re-ignite structural reform in product markets.

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

6. Encourage entrepreneurship.

7. Foster the knowledge-based economy.

8. Enhance environmental sustainability.

This Communication is complemented by a working document of the Commission services that provides an in-depth assessment of the implementation of the recommendations on a country-by-country basis. The evaluation integrates the findings of other co-ordination processes and draws upon relevant structural indicators developed to monitor progress on the Lisbon strategy. However, issues of environmental sustainability are not included in this document due to a lack of systematic and comparable reporting on developments in Member States.

Nevertheless, the conclusions presented should be interpreted with caution. The guidelines were adopted only a short while ago, and since then relatively little new information has become available and the information that is available is partially of a provisional nature. [2] Even so, where considered sufficiently reliable, new information has been taken as much as possible on board. This explains why there are sometimes small differences in data and assessments relative to earlier reports, such as the Commission's draft Joint Employment Report (JER). The earlier presentation of the Implementation Report has accentuated this problem. Furthermore, many recommendations in the BEPGs have a medium- and long-term nature, particularly those relating to structural reforms. Their implementation cannot yet be assessed in a conclusive way at this stage as the full effect of policy action takes more time to materialise.

[2] The report is based on the Commission's autumn 2002 economic forecasts and data available on 20 December 2002.

2. Overview of key policy areas

2.1 Ensure growth and stability-oriented macroeconomic policies

2.1.1 Economic background

As the recovery failed to gain momentum ...

Following a promising pick-up in growth in the first quarter of 2002, the 2002 BEPGs reckoned with a further strengthening of the recovery, which would bring the EU economy's growth rate back to rates close to or above potential in the second half of 2002 and into 2003. In the event, however, some of the downside risks to the main growth scenario have in fact materialised. Mounting uncertainty, fuelled by continuing stock market losses and global political tensions, seems to have undermined the confidence needed to underpin the pick up in private consumption and international trade that was expected to sustain the acceleration in economic growth. As a result, expected growth over 2002 as a whole is scaled down by half of a percentage point to below a meagre 1 per cent. The still expected acceleration of growth in 2003 will also be much less pronounced.

Despite weak economic growth, labour markets continued to show remarkable resilience. While slowing down considerably, job creation continued to outpace job losses so that - on balance - employment continued to grow. As a result, and contrary to earlier expectations, unemployment in the EU is now expected to have only slightly increased in 2002 by 0.2 percentage point to 7.6 per cent of the labour force.

Inflation has been slow to come down and there remain differentials between Member States. The upsurge in oil prices and, at the beginning of the year, fresh food prices linked to, respectively, international tensions and bad weather, played a role. But core inflation has also been rather resilient, especially on account of price increases in services. Factors behind the latter are the delayed pass-through of past increases in import prices, lower productivity gains and lower competitive pressure in the services sector than in the non-energy industrial goods sector, a gradual shift in the composition of demand towards services, increases in administered prices, declines in the downward contribution of deregulation, some impact stemming from the euro cash changeover in some specific services as well as the cyclical rise in unit labour costs. [3]

[3] Eurostat estimates the impact of the euro cash changeover on euro area inflation in the first half of 2002 to be in the range of 0.0 to 0.2 percentage points. Estimates of national statistical institutes indicate that in some Member States the impact may have been slightly higher.

... macro-economic policies have remained broadly neutral.

Macroeconomic policies have been accommodative in view of the weak economic growth conditions.

Following the four interest rate cuts during 2001 as inflationary risks resided in connection with decelerating economic growth, monetary policy in the euro area was kept on hold during most of 2002. In the early part of 2002, it was widely expected that the next move of the ECB would be to tighten in view of resurgent inflationary pressure and the prospect of accelerating growth. In the event, however, the failure of the recovery to gather momentum and the progressive unwinding of the impact of earlier shocks contributed to a lowering of inflationary risks. Against this background, it was not until early December 2002, that the ECB decided to cut its key interest rates by 50 basis points. The strengthening of the euro vis-à-vis main trading partners' currencies since the second quarter will help to restraining inflation, supporting real disposable household income and shifting final demand towards the domestic side. Outside the euro area, the Danish central bank followed the ECB in first keeping monetary policy on hold and subsequently in cutting key interest rates by 50 basis points in early December. In Sweden, the two-step increase in policy interest rates by 50 basis points in the spring of 2002 was subsequently reverted in mid-November and early December. In the United Kingdom, monetary policy was kept on hold throughout 2002.

While the overall budgetary policy stance has been broadly neutral in the euro area, the lack of budgetary consolidation in the past, and the outright loosening in the current juncture in some of its Member States that can ill afford it has put the macroeconomic policy framework under strain, and has likely prevented a more appropriate policy mix. The clearly expansionary budgetary policies in Denmark, Sweden and the UK cause the overall budgetary policy stance in the EU to have been slightly expansionary. Nominal budgetary positions deteriorated generally as automatic stabilisers acted to cushion weak economic activity. Wage increases, having been relatively high given lacklustre growth, have supported household purchasing power. Provided that recent increases in unit labour costs are reversed in the context of a subsequent cyclical recovery in productivity, current wage trends would still appear to be consistent with the maintenance of price stability and job creation over the medium-term.

>REFERENCE TO A GRAPHIC>

>REFERENCE TO A GRAPHIC>

2.1.2 Budgetary developments

The 2002 BEPGs recommended Member States to: (i) achieve or maintain budgetary positions of close to balance or in surplus over the economic cycle and ensure the respect of such medium-term objectives by 2004 at the latest; (ii) ensure appropriate financing of tax reforms, avoid pro-cyclical fiscal policies and allow automatic stabilisers to operate in full while ensuring a rigorous execution of their budgets; and (iii) further strengthen public finances with a view to secure their long-term sustainability.

Budgetary developments in 2002

Contrary to what was expected, budgetary positions deteriorated in 2002 for the second consecutive year. This was partly because of the work of automatic stabilisers in response to a slower macroeconomic recovery than assumed in the 2002 BEPGs, but also because expenditure overruns and/or unfunded tax changes in several countries (e.g. Germany, France, Ireland, Italy, Austria, Portugal, and Finland) led to deterioration in their underlying budget position. As a result, the actual budget deficit for the euro area for 2002 is estimated at 2.3 per cent of GDP.

For all Member States, with the exception of Finland, Spain, Belgium, Denmark and the UK, the budgetary outcome was substantially worse than projected in the stability and convergence programmes submitted at the end of 2001, when the government deficit for the euro area was envisaged to be 1.1 per cent of GDP in 2002 (see Table 1). Portugal and Germany failed to respect the 3% reference value in 2001 and 2002 respectively and the Commission has therefore initiated the Excessive Deficit Procedure. The Portuguese government deficit, while being clearly reduced, may still prove to be in excess of the 3% limit in 2002 as well. A number of other countries failed to make substantial progress towards achieving (e.g. France, Italy, Greece) or maintaining (e.g. Ireland, Austria) budget positions close to balance or in surplus.

Given the persistence and severity of the slowdown in 2001 and 2002 and the budgetary slippage that occurred in several Member States, which led to higher budget deficits than expected in the BEPGs, it became clear at the end of 2002 that the achievement of the medium-term objective at the latest by 2004 (as agreed in the BEPGs just a few months before) was very difficult to ensure without jeopardising the recovery. The Commission and Ministers concurred in October 2002 that those Member States which have not reached the close-to-balance or in surplus objective needed to pursue a continuous adjustment of the underlying balance by at least 0.5 per cent of GDP per year in the next years.

Budgets for 2003

In adopting their budget laws for 2003, Members States were guided by their commitment to avoid excessive deficits and to achieve and maintain the medium term target of the Stability and Growth Pact. Accordingly, the nominal and underlying balances for the euro area are expected to improve in 2003, although marginally. However, among the Member States with important government deficits the Commission's autumn 2002 economic forecast indicates that the adjustment in the underlying balance could fall short of 0.5 per cent in Greece, France, Italy, and Austria, pointing to a need to accelerate consolidation, also to secure their long-term sustainability. On account of the significant divergence from budget targets in 2002 and because of a nominal deficit of 2.9 per cent of GDP in 2003 projected in the Commission's autumn 2002 economic forecasts, perilously close to the 3% excessive deficit reference value, the Commission recommended the Council to issue an early warning to France.

>REFERENCE TO A GRAPHIC>

2.1.3 Wage developments

The 2002 BEPGs recommended: (i) that the increase in nominal wages be consistent with price stability; (ii) that the increase in real wages not exceed labour productivity growth; and (iii) that national labour institutions and bargaining systems allow wages to evolve according to productivity and skills differentials.

Aggregate wage developments

Overall, the increase in nominal wages by about 3 per cent in 2002 is broadly in line with medium-term price stability. However, as in 2001, in combination with the cyclical slowdown in apparent labour productivity growth, it is estimated to have contributed to a further increase in nominal unit labour costs. While being slightly lower than in 2001, the still rather high increase of about 2½ per cent in 2002 has contributed to persistently high core inflation.

The relatively steady increase in nominal wages, reflecting in part previously concluded multiannual agreements, has also allowed for a rather steady increase in real wages and supported household purchasing power. However, being slow to come down in response to the slowdown in productivity, real wage growth has continued to exceed labour productivity growth. The resulting further increase in real unit labour costs has weighed on profitability.

On a country level, nominal wage increases were comparatively strong in Greece, Ireland, the Netherlands and Portugal, i.e. countries with comparatively tight labour markets and/or relatively high inflation. Real unit labour costs rose particularly in Italy, Luxembourg, the Netherlands and Finland.

Wage differentiation

In 2002, no new major policy initiatives have been taken to promote national labour institutions and bargaining systems that allow wages to evolve more closely in line with productivity differentials.

>REFERENCE TO A GRAPHIC>

2.2 Improve the quality and sustainability of public finances

The 2002 BEPGs recommended Member States to: (i) make tax and benefit systems more employment friendly; (ii) promote the quality of public expenditure; (iii) enhance the efficiency of public spending; (iv) improve the long term sustainability of public finances; (v) reform pension policies so as to safeguard the adequacy of pensions, maintain the financial sustainability and meet changing social needs; and (vi) pursue tax coordination and implement the Council agreement of November 2000 on the tax package.

Tax and benefit systems

Progress continued in making tax and benefit systems more employment friendly (see Section 2.3).

Quality and redirection of public expenditure

Public expenditures can be more efficiency enhancing through a reduction of the interest burden and a re-direction of primary expenditure, amongst others to increase investment in key areas (such as R&D, and human capital) to underpin future competitiveness and growth. In 2002 interest payments continued to fall in several Member States but not at the same speed as in the first years of EMU. In some countries (Germany, France) they are expected to stay at the same level as the previous year and for Austria they will be likely higher.

Public investment in the EU has been very stable over recent years (see Table 3) against a background of the cyclical swings in private investment. Nevertheless, a significant decline, in spite of the contributions received from the Community's structural and/or cohesion funds, appears to have taken place in several countries with unsound budgetary positions such as Portugal, Greece, and Germany. In contrast, public investment continued to increase as a share of GDP in those countries with sound budgetary positions.

>REFERENCE TO A GRAPHIC>

The composition of public expenditure did not change much during 2002. Social transfers still represent the greatest share (34.5 per cent of total expenditure in the EU, see Table 4), unchanged from the previous year. It reflects in part the role of automatic stabilisers, since unemployment related transfers are likely to have increased somewhat during the current economic juncture. However, for some countries this could reflect a relatively high structural public expenditure on pensions that might partially crowd out other social transfers and/or public investment in physical and human capital. In the EU as a whole, public investment (as a percentage of total public expenditure) decreased marginally from 4.9 per cent in 2001 to 4.8 per cent in 2002 for the first time after several years. The share of interest payments decreased marginally from 7.6 per cent in 2001 to 7.4 per cent in 2002.

A thorough assessment of the quality of public expenditure is hampered by the lack of timely and comprehensive data. Member States should pursue an improvement in data quality, through a detailed classification of the destination of public consumption.

>REFERENCE TO A GRAPHIC>

Public expenditure efficiency and control

Member States continued to apply budgetary rules and procedures to improve efficiency and control. These rules vary and include multi-annual budgets, expenditure rules with explicit limits on the annual growth rate and agreements between different levels of government. However, the observed slippage from the fiscal targets shows that the enforcement of these rules is weak. The mechanism to control public spending at sub-national level remains a key issue for several Member States. Germany introduced this year a Domestic Stability Pact, where an inter-governmental (among different government levels) Council can make recommendations on how to achieve fiscal discipline. In Portugal the Budgetary Stability Law (effective from 2003) sets more stringent limits (although temporary) to net borrowing across all levels of general government and in case of non-respect of borrowing ceilings, the budget law can sanction an automatic reduction in state transfers proportional to the actual deviation. In Spain new rules will apply from 2003. Accounts should at least balance at all government levels and the possibility to run deficits is restricted to temporary and exceptional situations. Italy is improving controls on the dynamics of expenditures of different central government bodies.

The impact of public expenditure on economic and social goals is difficult to assess. Expenditure efficiency relates to the links between inputs (mainly money, but not solely) and output. A proper assessment would require better information, notably on measures of the input (policies and expenditure) and output (objectives met), and a detailed microeconomic assessment of specific policies.

Long term sustainability and reforms of pension policies

All Member States are committed to take the necessary measures, and in particular pension system reforms, to assure long term sustainability. During 2002 some Member States implemented reforms that are expected to limit the impact of ageing populations on public spending (Portugal) or that will strengthen the contribution base (Finland). Other countries continued to speed up reform processes started in the past years, such as those directed at improving incentives for longer working lives, lowering future replacement rates in public schemes and promoting the development of private pension provision through tax incentives and grants.

However, these reforms alone are not sufficient to guarantee long term sustainability in all EU countries. The long-run sustainability of public finances is in most Member States far from secured (particularly so in Belgium, Germany, Spain, France, Italy, Austria, and Portugal). It is also vital to raise employment levels and to pursue overall sound public finances to prepare for the impact of ageing. Several Member States have still not achieved budget positions that are close to balance and further delays in reaching the Stability and Growth Pact requirement will have long-term consequences for the sustainability of public finances.

There would appear to be a need for stronger commitment to reduce debt levels in several Member States with high government debt ratios, such as Italy and Greece. In Italy, the slow pace of debt reduction came to a halt and it is expected to stay around 110 per cent of GDP. Greek government debt would be close to 106 per cent of GDP, the same level as in 1998. These trends do not show a satisfactory rate of reduction, that could bring debt levels below the 60% reference value before the impact of ageing takes place (i.e. in 15 to 20 years).

Tax package

Taxation remains a source of fragmentation across the Internal Market. Having to comply with 15 different tax systems comes at a cost and acts as a break on growth and employment. It is therefore regrettable that, following its November 2000 agreement on the tax package, the Council failed to achieve full agreement on the tax package by the end of December 2002. The Code of Conduct Group continued its work with regard to the elimination of harmful business tax regimes and will soon proceed to an initial evaluation of the adequacy of proposals to dismantle them. Subsequent to the political agreement on the text of the Directive on taxation of savings income within the Community in December 2001, an agreement has been reached on the standard format to be used for exchange of information.

2.3 Invigorate labour markets

The 2002 BEPGs recommended Member States to: (i) adapt tax and benefit systems to make work pay; (ii) improve the efficiency of active labour market policies; (iii) bring down obstacles to geographical mobility; (iv) safeguard employability and facilitate occupational mobility; (v) promote flexible work organisation and review employment contract regulations; and (vi) remove barriers to female labour force participation.

The labour market has shown some resilience in the current slowdown. Employment continued to increase in the EU as a whole in 2002, albeit at a much lower rate than in the previous five years. While the impact of the slowdown could be felt in all Member States, employment growth varied considerably, from 2.8 per cent in Luxembourg to 1.3 per cent in Spain and Ireland, whilst in Germany employment contracted by 0.5 per cent. Unemployment has picked up moderately in the EU so far, displaying the usual lag with respect to GDP growth. Here, too, the differences across Member States are sizeable. For almost half of the Member States, the average unemployment rate in 2002 was not higher than in 2001. Reduced rates of long-term unemployment since 1999 (see Graph 3) continue to reflect structural improvements in the labour market. In 2001 (2002 data are not yet available), the overall employment rate was 64 per cent, 1.7 percentage points higher than in 1999, before the start of the Lisbon strategy; and it increased over the period 1999-2001 in all, but one, Member State (see Graphs 4-5). Over the same period, the female employment rate increased by 2.1 percentage points to 54.9 per cent (see Graph 6). The employment rate of older workers increased by 1.5 percentage points to 38.6 per cent (see Graph 7). However, almost all of those Member States in which it declined in 2001 already had rates below the EU average, a fact that clearly points to structural problems that need to be overcome in order to achieve the Stockholm target of 50% by 2010.

Overall, Member States made some progress with labour market reform in 2002, but the reform momentum does not seem to have increased as compared to last year. However, in the current weak economic conditions, there is a particular need to vigorously pursue such reforms, in particular since bridging the gaps vis-à-vis the intermediate employment rate targets for the EU (67% overall and 57% for women by 2005) remains an important challenge.

>REFERENCE TO A GRAPHIC>

>REFERENCE TO A GRAPHIC>

>REFERENCE TO A GRAPHIC>

>REFERENCE TO A GRAPHIC>

>REFERENCE TO A GRAPHIC>

Tax and benefit systems

Improving incentives to take up work or to stay in employment remains a serious challenge in most Member States, in particular in view of low employment rates of older workers and ageing populations. While some progress was made in 2002, measures taken were generally piecemeal; no comprehensive reforms of taxes and benefits to make work pay were launched. Most Member States continued to favour measures on the tax side, rather than addressing the combined effects of taxes and benefits. Pensions and early retirement schemes received surprisingly little attention, given the agreement at the Barcelona European Council to raise the effective average age at which people stop working by about five years, by 2010. A major reform of the pension system was introduced in Greece, and Finland took further steps in pension reform, however with long transition periods, which implies that the impact on labour market activity is likely to be slow. Several Member States cut taxes on labour (France, Denmark, Italy), while others continued to implement tax reforms agreed earlier. Belgium took measures to streamline the various tax incentives for recruiting specific groups of workers. Italy decided to allow private job placement services; and the UK merged the employment service with the benefit administration for working age people. Similar employment service reforms have been put forward by the "Hartz" Commission in Germany. In Spain, the job-search obligation and mobility requirements attached to unemployment benefits were strengthened, and in Luxembourg, eligibility for disability benefits was tightened.

Active labour market policies (ALMPs)

Activation measures that are well targeted to the needs of individuals and of the labour market can be an important contribution to prevent cyclical unemployment from becoming long-term unemployment. Spending on ALMPs amounted to an average of around 1 per cent of Member States' GDP in 2000, but, with a few exceptions, the effectiveness and efficiency of these measures are not regularly monitored. Significant improvements in this area were again made by countries that already have a strong culture of monitoring the effectiveness and efficiency of ALMP spending, such as Sweden, Denmark and Finland. A small number of other countries also took limited measures in this area (Germany, Spain and the UK).

Geographical and occupational mobility, and skills

Several Member States face important regional disparities in labour market performance. Few new measures were taken to encourage the regional mobility of workers. Spain has started to address disincentives stemming from inconsistencies in the benefit system. Other barriers to mobility, such as rigidities in housing markets, have not received any particular attention.

The mismatch of skills offered and required in the labour market also continues to hold back employment. Member States generally continued to respond to the challenge of bottlenecks with adjustments to their systems of vocational training and with lifelong learning strategies; and the slowdown has eased short-term labour market tightness to some extent. The two Member States (Greece and Portugal) that had received individual recommendations to enhance the skills and productivity of the labour force made some progress with such reforms.

Flexibility and modernisation

In many Member States, part-time and flexible working hours and work organisation, typically implemented by social partners, continue to be a priority. In France, new flexible working time provisions partly compensate for the global working time reductions. Italy and Portugal expect to pass bills shortly introducing new forms of employment contracts and extending the possibilities for fixed-term employment, respectively, while Spain is seeking to make very short-term contracts less attractive, and in this context there is an increasing trend to better balance security with flexibility in labour markets. Reforms of employment protection legislation (EPL) have received little or no attention. In Austria, the system of severance pay was extended and made more conducive to mobility, while the level was reduced. Partial measures in the field of EPL and dismissal costs were also taken in Spain and announced in France.

Barriers to female labour force participation

Difficulties in combining work and care activities, as well as labour market re-integration after career breaks, continue to weigh on female labour market participation. A number of Member States have taken measures to improve the availability of childcare facilities, and ten have set targets in that respect. However, little attention was given to care for other dependants. Others have targeted tax-benefit reforms towards improving incentives for women to take up work (Belgium, Spain, and Ireland) and several Member States (Belgium, Germany, Austria and the UK) are gradually implementing an alignment of the statutory retirement age of female and male workers. Despite growing awareness of the issues involved, there is no evidence that Member States have addressed the underlying factors leading to a gender pay gap.

2.4 Re-ignite structural reform in product markets

The 2002 BEPGs recommended Member States to: (i) fully implement the Internal Market (increase transposition rate, eliminate technical barriers to trade, create an effectively functioning Internal Market in services and further open up the public procurement market); (ii) ensure effective competition (ensure effectiveness of the competition and regulatory authorities, secure less and better State aid); and (iii) accelerate reforms in the network industries (encourage market entry, ensure freedom of choice of energy supplier, build new infrastructure and open up transport markets).

Progress over the past year in terms of the full implementation of the Internal Market has been rather disappointing with a slight fall in the IM transposition rate and slow progress in eliminating remaining barriers to trade and cross-border service activities. On the other hand, good progress has been made in harmonising competition policies across Europe. The liberalisation process in the network industries has continued, but the market share of incumbents remains high. Competition is still insufficient, but progress has been made in the telecommunication and energy sectors in particular and in those sectors the benefits to consumers of liberalisation are starting to be felt.

Implementation of the Internal Market

For the first time since 1992, both the total trade to GDP ratio and the share of foreign direct investment flows in GDP declined in 2001, which could be indicative of a slow-down in the process of European economic integration. The degree of price dispersion between EU Member States declined from 15.3 per cent in 2000 to 14.8 per cent in 2001, a level comparable to the one observed in the late 1990s. Price dispersion within the euro area remained constant at around 12 per cent.

The rate of transposition of Internal Market directives has fallen slightly from 98 per cent in November 2001 to 97.9 per cent in November 2002, indicating that Member States have reduced their efforts in this area (see Graph 8). Only 5 Member States (Denmark, the Netherlands, Finland, Sweden and the UK) have at present met the target of 98.5 per cent. Looking at the implementation of Internal Market legislation, the total number of Internal Market infringement proceedings remains high, particularly in France and Italy.

>REFERENCE TO A GRAPHIC>

The speed with which new product standards are being developed and the efficiency with which the mutual recognition principle is applied has not increased significantly. A continued lack of awareness of the principle of mutual recognition and the perceived costs of applying it in practice still hinder market entry in most if not all Member States.

The Commission recently published a comprehensive inventory of barriers to cross-border service activities by businesses and consumers. [4] Such barriers can include, for example, the length, complexity and duplication of administrative formalities and the existence and use of discretionary powers by local authorities. On the basis of the inventory, which shows problems affecting all Member States, the Commission intends to propose measures for eliminating the barriers identified.

[4] The State of the Internal Market for Services, COM (2002) 441 final.

The value of public procurement calls for tenders published in the Official Journal as a share of the total value of public procurement in 2001 (15 per cent) was unchanged in comparison with the previous year. Germany continued to lag behind with a 6 per cent share. Public procurement is increasingly brought online. In 2002, Denmark, Germany and Ireland have made particularly good progress in this respect. In addition, political agreement has been reached on the principal points of the public procurement legislative package, but the package has not yet been formally adopted.

Competition and regulatory policies

Measures have been taken to improve the effectiveness of competition policies. In all Member States, except for Luxembourg and Finland, national competition authorities now have powers to enforce Articles 81-82 of the EC Treaty, which deal with agreements between enterprises and abuse of dominant positions. Some Member States (including Greece, Ireland, Portugal and the UK) have taken measures to increase the resources and operating capacity of their competition authorities, while others (Belgium, Denmark, Spain, Ireland and Portugal) have reinforced their regulatory authorities. At EU level, action to modernise the application of competition rules has advanced well. A new Regulation modernising the enforcement mechanisms of Article 81 and 82 of the EC Treaty was adopted in November 2002 and in December 2002 the Commission presented to the Council a proposal for changes to the Merger Regulation

In 2000, State aid (excluding aid to agriculture and fisheries) exceeded 1 per cent of GDP in Belgium, Denmark, Germany and Luxembourg. However, aid levels as a percentage of GDP continued their downward trend in all EU Member States with the exception of Denmark, Ireland, Luxembourg and the Netherlands. At the same time the trend in the share of aid to horizontal objectives is up in all Member States with the exception of Austria. The Commission State aid Scoreboard and Register are contributing to the transparency of State aid policies. The Commission is examining ways of assessing the effectiveness of State aid as a policy instrument.

Structural reforms in the network industries

Rules for a competitive communication sector are in place, with agreement having been reached on all elements of the telecommunications regulatory package. However, at the end of 2001 the incumbent's market share in local calls remained high (i.e. above 80 per cent) in many Member States, which helps explain the only marginal price decline for such calls. In some countries market shares of incumbents remained high even for long- distance calls. Despite these figures the competitive situation is improving as carrier pre-selection is now fully implemented for local calls.

In 2002, the liberalisation of the electricity market continued with increases in the degree of legal opening in Belgium, Greece, Spain, Ireland, Luxembourg, the Netherlands and Portugal. In gas, the degree of legal market opening increased in Austria, Denmark, Ireland, Luxembourg, the Netherlands and Spain. Nevertheless, competition in the energy sector, as measured by the market share of the incumbent or by the degree of switching by gas and electricity users, remains limited (see tables 5 and 6).

>REFERENCE TO A GRAPHIC>

One reason is that energy markets are not yet sufficiently integrated at the Union level. However, political agreement has been reached in the Council on the electricity and gas package, including agreement on a date for opening up of markets for household customers as well as on a transparent and non-discriminatory tariff system for cross-border transactions. Moreover, progress has been made in raising the level of electricity interconnections between Member States.

>REFERENCE TO A GRAPHIC>

Some improvements have been registered as well in the efficiency of the use of the interconnection infrastructure (between France and the UK, Greece and Italy, and to some extent between Denmark and Germany) with market-based mechanisms being increasingly used for its allocation. Nevertheless, capacity allocation and tariff setting mechanisms remain largely inefficient and continue to limit competition. Denmark, Germany, Italy, the Netherlands, Austria, Sweden and the UK have opened up their rail freight network to competition for domestic services. However, it looks likely that most Member States will not have fully transposed the first railway infrastructure package by its date of entry into force, 15 March 2003. Moreover, there is no agreement yet in the Council and Parliament on the revised financial regulation and guidelines for Trans-European transport networks, the Second Railway Package, public service contracts for passenger transport and airport slot allocation. To end on a positive note, agreement was reached in Council on the Postal Services Directive, on the Single European Sky package and on a common position on access to port services.

2.5 Promote the efficiency and integration of the EU financial services market

The 2002 BEPGs recommended Member States to: (i) step up efforts by all relevant parties to ensure full implementation of the FSAP by 2005 and by 2003 for securities markets legislation; (ii) intensify efforts to implement the RCAP by 2003; (iii) further improve arrangements to deliver efficient cross-border / cross-sector co-operation for prudential purposes; and (iv) encourage the removal of barriers to efficient cross-border clearing and settlement.

Implementation of the FSAP

The process of financial integration is progressing. Of the original 42 legislative and other measures in the Financial Services Action Plan (FSAP), the centrepiece of the Community's efforts to integrate European financial markets, 32 have now been completed. The ambitious objectives set by the Barcelona European Council for 2002 will be largely achieved. Among the eight measures identified for adoption before the end of the year, six have been adopted (the Regulation on International Accounting Standards, and the Directives on collateral, distance marketing of financial services, insurance intermediaries, financial conglomerates, and market abuse). The proposed Directives on prospectuses and pension funds have been slightly delayed and the adoption of the Directive on Pension Funds is now foreseen for March and of the Directive on prospectuses for June 2003. The legislative measures that have been adopted by the Council must now be transposed into law in the Member States. The current pace of progress in implementing the FSAP needs to be maintained if the deadline of 2005 for full implementation is to be met. All outstanding measures must be adopted at EU level by mid-2004 at the latest, so as to allow sufficient time for transposition at the Member State level. In order to monitor the impact of FSAP measures going forward, the Commission is developing a set of indicators that will focus on quantifying trends in integration and efficiency within the EU financial market.

Implementation of the RCAP

The risk capital market has experienced a severe correction since mid-2000. On a structural level, the EU risk capital market faces a range of regulatory, fiscal, and legal/administrative constraints. The Risk Capital Action Plan (RCAP) was designed to address these constraints and progress in implementing the Plan has continued in 2002. In addition to progress in setting up a pan-EU regulatory framework through the relevant aspects of the FSAP, Member States have undertaken a number of reforms at national level. In some Member States (Denmark, Germany) regulation of investments by institutional investors has become less based on quantitative constraints in favour of a prudent-man approach. Several Member States (Italy, Netherlands, and Spain) have reduced the period for the discharge of residual debt by bankrupts and have eased other regulations denying a second chance to failed entrepreneurs. With respect to improving the fiscal framework for risk capital investment, most Member States have implemented tax measures that should foster, among other things, the risk capital market. Such measures include reduction in corporate tax rates, tax incentives for those establishing new businesses, tax relief on research and development expenditures and overall investment costs. Several Member States have also taken measures to adapt the fiscal framework in favour of employee financial participation schemes (Denmark, UK). However, despite the adoption of some measures, the fiscal regimes in most Member States continue to discriminate in the treatment of interest costs and dividend payments. In general, much has been done to remove the existing barriers to an efficient EU risk capital market, but faster progress seems necessary in all of the main policy areas identified in the RCAP.

Arrangements for cross-border / cross-sector co-operation for prudential purposes

A number of Member States have reformed their arrangements for financial supervision in 2002 so as to increase cross-sector co-operation. In Austria, the newly established Financial Market Supervisory Authority (FMA) will supervise all financial institutions and markets. In Germany, the three separate supervisory offices for banking, insurance and securities trading have combined into a single agency, the Federal Financial Supervisory Agency (BAFin). In Ireland, a single regulatory authority for the financial sector has been set up within the reformed central bank. In Belgium, the existing three supervisory authorities will be reorganised and headed by a Financial Services Authority. In the Netherlands, supervision is being reorganised along the lines of policy objectives instead of by sector. In France, the proposal to merge the two financial markets authorities was reactivated. As Member States are following different models of consolidated financial supervision and as financial markets integration is progressing, improved cross-border co-operation will be crucial. One of the aims of the ECOFIN Council's proposal to extend the 4-level regulatory approach (so-called 'Lamfalussy procedure') to banking, insurance, and financial conglomerates is precisely to boost regulatory convergence between the Member States.

Efficient cross-border clearing and settlement

Despite ongoing signals of market consolidation (e.g. the merger between Crest and Euroclear), current arrangements for cross-border clearing and settlement are complex and fragmented, imposing unnecessary costs and risks on investors. The Commission issued a consultative Communication in May 2002 aimed at gathering views on the priorities for action. A second Giovannini report (presently in preparation) will focus on removing the barriers identified in the first report, examining the public policy aspects of likely developments in the clearing and settlement architecture and examining some of the possible "models" for clearing and settlement in the future.

2.6 Encourage entrepreneurship

The 2002 BEPGs recommended Member States to: (i) create a business-friendly environment (improve tax and regulatory environment, increase efficiency of public services, reduce barriers to cross-border economic activity); (ii) take action on the European Charter for Small Enterprises; and (iii) improve access to finance.

Several initiatives have been taken at both Community and national level to improve the business environment and encourage entrepreneurship. However, achievements vary between countries and the different areas concerned.

Business environment

The regulatory environment is improving in all Member States, though more needs to be done in order for the cumulative impact of many small improvements to be felt. At EU level, the Commission is now introducing its new impact assessment system and is implementing its action plan on better regulation. A number of Member States (including France, Italy, Austria and Portugal) have taken measures to reduce the typical time and cost required for setting up a new company, to alleviate administrative burdens, and to stimulate competition in certain sectors.

Significant reforms to increase the efficiency of the public sector were undertaken in Belgium (new managerial rules and benchmarking, e-government), Denmark (increased use of public tendering), Portugal (rationalisation of structure of central government) and Sweden (development and use of benchmarking data base). Increasingly government services are being made available online (see section 2.7).

The Final Report by the High-level Group of Company Law Experts on accounting standards and rules on corporate governance was published. This report will be the basis for company law reforms at EU level. Furthermore, the Commission launched a debate with the Member States on long-term comprehensive solutions for company taxation in the European Union. In 2002, statutory corporate tax rates were lowered in France, Ireland, Luxembourg, the Netherlands and Portugal, while the corporate tax system in Greece was simplified. Finally, the adoption of the Directive for VAT on e-commerce should contribute to improving conditions for e-business (see also section 2.7).

European Charter for Small Enterprises

In 2002, all Member States made progress in implementing the recommendations of the European Charter for Small Enterprises. Most Member States took measures to reduce the time and costs required for setting up new enterprises, to further develop education and training for entrepreneurship, to facilitate business e-commerce and to improve the regulatory and legal environment for businesses (see above). Little action was, however, undertaken to improve representation of small businesses' interests.

Access to finance

Access to finance remains a problem for small and medium-sized enterprises in particular. This problem has been exacerbated by a decline in venture capital investment and the financial difficulties that some banks are experiencing. Within the framework of the Risk Capital Action Plan most of the Member States have developed programmes to promote entrepreneurship and innovation.

2.7 Foster the knowledge-based economy

The 2002 BEPGs recommended Member States to: (i) stimulate R&D and innovation (improve framework conditions, encourage knowledge transfer from universities, enhance collaboration across Europe, adopt the 6th Research Framework Programme); (ii) promote access and use of ICT (speed up the development of the European broadband network, stimulate internet use); and (iii) strengthen education and training efforts (in order to improve educational attainments, the capacity of the education and training system to adapt, and the transparency of diplomas and qualifications).

While continuing to lag behind the US in terms of the knowledge-based economy, there are signs that the EU is catching up (e.g. in ICT usage). However, gaps in terms of business R&D and patenting appear persistent. Internet usage in the EU continues to increase. The challenge is now to further accelerate the broadband rollout. Improving the efficiency of the education system remains a priority. In addition, Member States have strengthened the vocational training aspects of education in order to respond adequately to changes in skill requirements.

Research, development and innovation

The Commission has launched discussions with Member States and businesses about how to take R&D spending from the current 1.9 per cent of GDP towards the 3% target set by the Barcelona European Council. The focus is on improving the framework conditions for R&D and innovation. At the same time, increased attention is being devoted on how to more effectively use existing financial resources in support of R&D and innovation. Such efforts will contribute to a rise in productivity levels (see Graph 9).

Within the framework of the European Research Area initiative, progress has been made in co-ordinating national research activities, for example on Aids/HIV research. The recently adopted 6th Research Framework Programme should reinforce this trend. Agreement on the Community Patent, on the other hand, has not yet been reached. Greece, Italy, Austria, Portugal, Sweden and the UK have taken measures to improve the links between universities and business.

>REFERENCE TO A GRAPHIC>

Information and communication technologies (ICT)

Local competition in the telecommunications market is essential for the further development of the ICT sector in Europe. In legal terms the local loop has been unbundled in all Member States. However, effective competition in telecommunication services using the local network of the incumbent is still deficient in practice (see section 2.4). The rollout of "broadband services" - i.e. the high-speed transmission of voice, data and video signals - has been slower than expected and is still characterised by significant dominance on the wholesale market by the incumbents. In 2001, broadband penetration was relatively high in Belgium, Denmark, Germany, the Netherlands, Austria, Finland, and Sweden. The eEurope 2005 Action Plan, which was approved by the June 2002 European Council in Seville, seeks to promote the development of broadband services and internet use in general.

As a result of increased ICT spending and a decline of internet access costs, internet access rates have continued to rise albeit at a lower rate than in 2001. By mid-2002, 40 per cent of EU households had internet access, up from 36 per cent in 2001. However, there were still major differences between Member States. Spain, France and Portugal appeared to be catching up to the EU average, but Greece failed to do so. Internet access in schools increased as well. The ratio of students per online computer improved from 25 in 2001 to 17 in 2002, but differences between Member States are substantial. The initial eEurope targets of connecting all schools to the Internet and of training a sufficient number of teachers are nearly achieved. Internet penetration in businesses is far higher than the household rate. Nevertheless, the amount of business actually carried out online remains modest. Fifty-five per cent of basic public services were available online in April 2002 compared to 45 per cent in October 2001. In this domain the Benelux countries, Germany and Austria are the laggards.

Education and training

For the EU as a whole, public education expenditure declined slightly from 5.2 per cent of GDP in 1995 to 5.1 per cent in 2000. However, its share in total public spending rose by 1 percentage point over that same period. In contrast to the US, the level of private investment in education is very low. For example, private spending on third level education in the EU is only 0.2% of GDP compared to 1.6% in the US. Private expenditure on educational institutions is less than 0.5 per cent of GDP in all Member States except for Germany, Greece and Spain. The focus on education and training policies in some Member States appears to be more on the need for reforms of the education and training systems in order to increase efficiency, than on increased spending. Indeed, some Member States invest less than others in education and training and yet achieve better results. Most Member States have strengthened the vocational aspect of education, inter alia in order to provide alternatives to those students who might otherwise drop out of the education system. The EU has introduced several instruments, aimed at facilitating the transfer of qualifications and skills for academic or professional purposes. The European Credit Transfer System, which facilitates student mobility, continues to expand, even beyond Europe. Moreover, steps are being taken to introduce European bachelors and masters degrees within the framework of the Bologna process.

2.8 Enhance environmental sustainability

The 2002 BEPGs recommended Member States to: (i) provide impact analyses considering the social and environmental consequences of policy measures; (ii) increase competition to increase effectiveness of market-based instruments; (iii) introduce and strengthen policies based on economic instruments in order to appropriately integrate externalities and mirror resource use; (iv) prepare for the introduction of emissions trading at EU level more generally, prepare appropriate measures and policies to deliver the Kyoto obligations, in particular aiming at more efficient management of energy and transport demand; (v) encourage the disclosure of environmental information in the annual accounts of companies; (vi) reduce sectoral subsidies and tax exemptions and other measures, which have a negative environmental impact; (vii) agree on an appropriate framework for energy taxation at the European level; (viii) implement measures targeted on energy use, including in transport, to enhance energy efficiency.

Impact assessments

The Commission has identified in its 2003 Work Programme a number of major proposals for which it will carry out an assessment of their economic, social and environmental impacts before presenting them to Council and Parliament. To help Member States implement strategic environmental assessment as required by directive 2001/42, the Commission intends issuing a guidance document in 2003.

Strengthening effectiveness of market-based instruments

Structural reforms in product markets, namely those related to a liberalisation of network industries (see section 2.4), are expected to make enterprises more responsive to price signals on the input side, and to compete on prices, quality and innovation rather than on publicly protected or provided rents. Moreover, these reforms should also increase customer choice. Both should help to let economic agents respond more flexibly to price signals and to switch to less environmentally-harmful energy sources and/or modes of transport. However, progress on both structural reforms and the setting of adequate price signals has been rather modest in 2002 given the magnitude of the environmental challenges.

Pricing in environmental costs

Germany and Sweden increased existing energy and/or carbon taxes as part of their tax-switching policies. Austria is planning to introduce similar measures. Belgium, the Netherlands, Italy and Spain adjusted their vehicle taxation systems to take account of environmental criteria and France offered tax breaks for buying cleaner cars, and for household insulation. Finland has announced a staged increase in its tax on waste going to municipal landfills. Sweden is increasing its waste and gravel taxes. The UK's levy on raw material aggregates came into effect, as did its greenhouse gas emission trading system. However, some design features of this voluntary scheme would not be compatible with the upcoming EC emissions trading scheme (see below).

Several Member States (France, Italy, Sweden, United Kingdom) introduced reduced rate of excise duty for alternative road fuels, mainly biodiesel. These national measures should be seen in the context of the Commission proposal for reduced taxation of biofuels, on which the Council reached political agreement. Luxembourg and the Netherlands joined the group of countries offering tax reductions on low-sulphur road fuels, anticipating the introduction of mandatory standards across the EU from 2005. Belgium is taking similar action to reduce the sulphur content of fuel used in household heating.

Spain and Denmark announced reductions in the level of subsidy to electricity generated from renewable sources, and Denmark also abolished some of its environmental taxes. The Netherlands is restructuring its support for renewables to improve its targeting and avoid "overstimulating" some types of renewable energy production.

Emissions trading

Following the ratification of the Kyoto Protocol, the Council and Parliament made solid progress towards adopting the Commission's proposal for an EC emissions trading scheme by concluding the first reading by the end of 2002. Together with the forthcoming Commission proposal on linking credits from Joint Implementation and the Clean Development Mechanism to the EC emission trading scheme, this should deliver an important part of the emission reductions required cost-effectively. As preparation for implementing the EC emissions trading scheme, the Netherlands initiated work on how to allocate emission allowances to individual companies.

Disclosing environmental information

Member States have generally taken steps to inform companies about the Commission recommendation relating to disclosing environmental information in company accounts. Typically, this has been done through industry associations or accountancy bodies, but some (Denmark, Spain) have fully or partially included the recommendation into domestic law, while others (France, Germany, Greece, Portugal, United Kingdom) may do so.

Reducing subsidies and tax exemptions with a negative environmental impact

Germany continues to reduce subsidies to coal mining and has announced its intention to reduce exemptions for manufacturing industry from some ecological taxes. The Commission is not aware of any initiative of other Member States to reduce sectoral subsidies and tax exemptions and other measures, which have a negative environmental impact.

Community framework for energy taxation

Finally, the Council has continued to discuss the draft directive restructuring the Community framework for the taxation of energy products but did not reach agreement by December 2002. The main outstanding issues are the possibility of setting national levels below the new minimum levels of taxation, arrangements for the taxation of diesel used for commercial purposes, the duration of transitional periods for other energy products.

Targeted measures to enhance energy efficiency

Improved energy efficiency has been an important part of the EU energy policy agenda for several years and remains so. Recent EU legislation on energy efficiency in buildings and the proposal on Combined Heat and Power generation will both enhance energy efficiency in coming years, particularly in Member States that have so far given less attention to the possibilities in these areas. Germany introduced tighter energy efficiency standards for new buildings.

3. Summary assessments of implementation by the Member States

An in-depth assessment of the implementation of the country-specific recommendations is provided in the accompanying working document of the Commission services. On the basis of the assessment given therein, it would appear that overall, Denmark, and Sweden have given the best follow-up to this part of the BEPGs. They are closely followed by Belgium, Greece, Spain, Ireland, the Netherlands, Portugal, and the United Kingdom,

whereas the range is concluded by Germany, France, Italy, Luxembourg, Austria, and Finland.

Looking at individual policy areas, it appears that Denmark and Sweden have given the best follow-up to recommendations on public finances, whereas Germany, France, Italy, and Austria appear to be in the opposite corner. As regards labour markets, Sweden has given the best follow-up, whilst the follow-up given in Germany and Austria would appear least satisfactory. On recommendations relating to product markets, entrepreneurship and the knowledge-based economy, Denmark and the United Kingdom would appear to have given the best follow-up, whereas the reverse is true for Luxembourg and Finland. The others occupy the middle ground.

Table 7 provides a summary overview of the assessments on the progress made in response to the country-specific recommendations in the BEPGs. An important caveat applies. The country-specific recommendations, taking account of the specific situation per Member State, may be more demanding in some cases than others. Therefore, they may be more difficult to fulfil in some cases than in others. Furthermore, it should be stressed that from the assessments on how well Member States responded to these recommendations, it cannot be inferred how Member States compare in terms of absolute performance and the improvements therein. This would require a much more in-depth analysis, including much more up-to-date information.

>TABLE POSITION>

3.1 Belgium

Belgium is among the Member States that, in overall terms, are considered to be in a middle group as it comes to follow-up to the country-specific parts of the BEPGs. Some progress was made in following up to the public finance recommendations, notably as regards the maintenance of a balanced budgetary position. A resumption of budgetary consolidation in 2003, as requested by the BEPGs is currently not expected. While the further steady decline in the debt ratio in 2002 is positive, the measures which have been taken in 2002 to preparing for the budgetary implications of ageing (notably by allocating fiscal revenues to the Ageing Fund) are insufficient to ensure long-term sustainability.

Some progress was made in implementing the labour market recommendations. In particular, action was taken to promote continued participation of older workers in the labour market, but stronger measures will be necessary to curb the early withdrawal. To a lesser extent, actions were taken to increase female employment rates. Little action was taken to promote geographical mobility or to achieve a proper balance between flexibility and security. The impact of the scheme allowing temporary leave (time credit system) on the employment rate is not yet clear.

Finally, some progress was also made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Notably, action was taken to reduce the administrative burden for companies and to improve the efficiency of public administration. As a step towards increasing competition in electricity and gas markets, the government officially designated an independent transport system operator. Little action was taken to address the distortions of competition created by the lack of transparency resulting from the involvement of local authorities in some service sectors.

3.2 Denmark

Denmark is among the Member States that, in overall terms, are considered to have given the best follow-up to the country-specific parts of the BEPGs. Good progress was made in following up to the public finance recommendations, notably as regards the implementation and respect of the tax freeze by all levels of government and the targeted restraint of real growth in government consumption.

Some progress was made in implementing the labour market recommendations, with measures having been taken to further reduce the tax burden on labour and the presentation of a proposal for labour market reform focusing on increasing the efficiency of labour market policies.

Finally, good progress was also made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Notably, measures, such as a reform of the competition law, were taken to reduce the number of sectors characterised by weak competition. The government also presented a strategy for increasing competition from the private sector in the provision of public services. The electricity and gas markets will only be fully liberalised in 2003 and 2004 respectively but a decision was taken to remodel the support to renewable electricity in order to allow for more competition in this sector.

3.3 Germany

Germany is among the Member States that, in overall terms, are considered to have given the least effective follow-up to the country-specific parts of the BEPGs. Only limited progress was made in following up to the public finance recommendations, notably because of failure to fulfil the 3% of GDP government deficit reference value, uncertainties pertaining to the magnitude of the resumption of budgetary consolidation in 2003, and the limited effectiveness so far of measures to contain the rise in health care expenditure. Encouragingly, however, the changes to the law on budgetary procedures have already become effective as from mid-2002 rather than only from 2005 onwards.

Limited progress was also made in respect of implementing the labour market recommendations. While steps have been taken in response to recommendations to intensify efforts to make work pay, to improve the efficiency of Active Labour Market Policies (ALMPs), to promote flexible work organisation, and to remove barriers to female labour market participation, progress to date is considered to be clearly insufficient. No new measures were taken to promote wage developments that allow for differentiation according to productivity developments and skills differentials. Monitoring and evaluation of the effectiveness of ALMPs needs to be urgently improved.

Finally, some progress was made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. In particular, measures were taken to improve students' educational achievements and to promote the inflow into university education. The steps taken to ensure effective competition on electricity and gas markets are still insufficient. Finally, no progress was made to raise the transposition rate of Internal Market directives and to increase the value of public tenders published in the Official Journal.

3.4 Greece

Greece is among the Member States that, in overall terms, are considered to be in a middle group as it comes to follow-up to the country-specific parts of the BEPGs. Some progress was made in following up to the public finance recommendations. A modest reform of the pension system was introduced, but doubts remain as to whether this reform will be sufficient to address the medium-term challenges. While measures have been taken to ensure that the budgetary stance does not contribute to inflationary pressures, to control primary spending and to ensure a steady decline in government debt, they are considered to be insufficient.

Some progress was also made in respect of implementing the labour market recommendations. Most progress in this area was made on the improvement of educational and vocational training systems so as to enhance the skills of the labour force and meet the needs of the labour markets. Action was taken to reform public pension systems so as to encourage the labour market participation of older workers and to improve work incentives through tax/benefit reforms, but this is not yet considered to be sufficient.

Finally, some progress was also made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Progress is relatively satisfactory as regards efforts to promote the transition to the knowledge-based economy and to improve the business environment. Less progress has been made in opening up the energy sector to competition and no progress was made in raising the transposition rate of Internal Market directives.

3.5 Spain

Spain is among the Member States that, in overall terms, are considered to be in a middle group as it comes to follow-up to the country-specific parts of the BEPGs. Some progress was made in following up to the public finance recommendations. A balanced budget position was maintained thanks to expenditure containment and better than expected tax collection. Furthermore, the personal income tax reform is considered to enhance incentives to work and save whilst not putting at risk the current fiscal consolidation. On the other hand, no significant steps were taken in response to the recommendation to review the public pension system in a comprehensive way so as to promote its long-term viability.

Some progress was also made in respect of implementing the labour market recommendations. In particular, steps were taken to encourage increased female labour force participation, inter alia in the form of extending a scheme of reduced social security contributions and additional financial support for childcare facilities. Measures, though yet considered to be insufficient, were also taken to improve active labour market policies, to diminish obstacles to labour mobility, and to ensure a proper balance between flexibility and security. No new measures were introduced to allow wages to better reflect regional productivity and skill differentials.

Finally, some progress was also made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Progress was relatively satisfactory as regards initiatives to increase skilled human capital and to support the adoption of new technologies in enterprises. Several measures were taken to ensure effective competition in the telecommunications and gas sectors, and some measures have aimed at preparing the electricity sector for full liberalisation. Several initiatives were announced to reduce the administrative burden on business but they have not yet been adopted. Little action was taken to remove regulations having a restrictive effect on competition in retail distribution.

3.6 France

France is among the Member States that, in overall terms, are considered to have given the least effective follow-up to the country-specific parts of the BEPGs. Only limited progress was made in following up to the public finance recommendations. While it appears that the 3% of GDP government deficit reference value was not breached in 2002 and some measures were introduced to limit expenditure increases, no sufficient decline in the 2003 deficit was aimed at. So far, the government has not yet proceeded to the recommended comprehensive reform of the pension system. However, it has committed itself to do so in the first half of 2003.

Some progress was made in implementing the labour market recommendations. In particular, action was taken to address adverse medium-term effects of the 35-hour working week and, to a lesser extent, to consolidate reforms of the tax and benefit system. Reforms to employment protection legislation were announced. On the other hand, the implementation of a coherent active ageing policy remains a challenge.

Finally, some progress was also made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. In particular, measures were taken to reduce the administrative burden on business and facilitate the use of the internet in school. However, steps taken to liberalise the energy sector appear to be insufficient and no progress was made in the transposition rate of Internal Market directives, which is the worst in the EU.

3.7 Ireland

Ireland is among the Member States that, in overall terms, are considered to be in a middle group as it comes to follow-up to the country-specific parts of the BEPGs. Some progress was made in following up to the public finance recommendations. While the fiscal stance in 2002 is likely to have been expansionary rather than broadly neutral as recommended, some measures were taken to improve expenditure control and new ones announced at the end of 2002.

Some progress was made in implementing the labour market recommendations. Action was taken to increase the participation of women in the labour market and, while there is an aim to set wages in line with productivity, this has not always been achieved.

Finally, some progress was made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. While measures were taken to increase competition in the network industries, it appears that further reforms may still be needed, in particular, to reduce the market share of incumbents. Some measures were taken to address government regulations which may impair competition, while no progress was made to raise the transposition rate of Internal Market directives.

3.8 Italy

Italy is among the Member States that, in overall terms, are considered to have given the least effective follow-up to the country-specific parts of the BEPGs. Only limited progress was made in following up to the public finance recommendations, notably because there has been no clear path of deficit reduction and doubts remain whether current steps of tax reform are consistent with reaching a close-to-balance budgetary position. Moreover, no new measures were taken to address critical aspects of the current pension system.

Some progress was made in implementing the labour market recommendations, with measures having been taken to implement the recent labour market reform package and reduce the tax burden on labour. No new measures were taken to increase labour force participation of women and older workers.

Finally, some progress was made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. In particular, efforts to reduce the administrative burden for businesses have been sustained and some action was taken to support innovation and IT use and to increase competition in the service and energy sectors. No progress was made to raise the transposition rate of Internal Market directives.

3.9 Luxembourg

Luxembourg is among the Member States that, in overall terms, are considered to have given the least effective follow-up to the country-specific parts of the BEPGs. Some progress was made in following up to the public finance recommendations. Planned spending growth for 2003 is in keeping with what was recommended but some rigidities in current expenditure appear to remain an issue.

Some progress was also made in implementing the labour market recommendations, with measures having been taken to increase the national employment rate especially for older workers and women.

Limited progress was made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. In particular, no decisive progress was made as regards the reforms of competition legislation and public procurement. A limited number of measures have been implemented to reduce the still relatively high administrative burden for businesses and to develop e-government while no progress was made to raise the transposition rate of Internal Market directives.

3.10 The Netherlands

The Netherlands are among the Member States that, in overall terms, are considered to be in a middle group as it comes to follow-up to the country-specific parts of the BEPGs. Some progress was made in following up to the public finance recommendations. It is estimated that the budgetary stance in 2002 did not contribute to inflationary pressures, even though public sector wage increases remained high, and measures were taken to prevent a deterioration in the 2003 government balance.

Some progress was also made in implementing the labour market recommendations. New measures have been planned to make work pay, but tangible results have yet to materialise. Social partners and government have not yet reached an agreement on the reform of the disability scheme. The focus of the envisaged reform is on reducing the number of new claimants.

Finally, some progress was made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Steps were taken to enhance competition in some service sectors while future efforts are envisaged to support the use of ICT at schools and to raise the number of science and technology graduates. Finally, the administrative burden on business was somewhat reduced, but few further measures were introduced to develop the still relatively low level of e-government.

3.11 Austria

Austria is among the Member States that, in overall terms, are considered to have given the least effective follow-up to the country-specific parts of the BEPGs. Progress in public finances was limited. Austria took some measures to reduce structural expenditures, but a balanced budget in 2002 was not achieved, rather the budgetary position weakened substantially to a deficit of 1.8 per cent of GDP. Tax reductions were not matched by additional expenditure cuts And in the public pension system, no new reform steps were taken or planned.

Progress in labour market reforms was limited. No new measures were taken to speed up reform of tax and benefit systems with respect to older workers. The government is now relying on allowing the 2000 pension reform to take effect. The old-age part-time scheme turned out to be much more costly than expected.

Finally, some progress was made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Substantial additional financial resources were allocated to R&D expenditure. New measures were taken to reduce the administrative burden on business and an extensive reform of the public procurement legislation has been carried out. However no progress was made to raise the transposition rate of Internal Market directives and the regulatory framework in the telecommunications sector was not improved.

3.12 Portugal

Portugal is among the Member States that, in overall terms, are considered to be in a middle group as it comes to follow-up to the country-specific parts of the BEPGs. Some progress was made in following up to the public finance recommendations. While the deficit has come clearly down in 2002, the general government deficit may still prove to be in excess of the 3% government deficit reference value in 2002. The government remains committed to sustained budgetary consolidation with a view to achieve the medium-term objective of a balanced budget. The rectifying budget introduced last June is being strictly implemented. This has reduced the dynamics of general government expenditure. Progress has also been achieved in the area of pension reform, although further measures are needed.

Some progress was made in labour market reforms, including the implementation of the new national Lifelong Learning strategy. Following discussions with the social partners, a draft law, which includes a two-year limit for the expiry of collective agreements and greater flexibility of working time, could be adopted in Parliament at the beginning of 2003.

Finally, some progress was also made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Several measures were taken to improve the education and training of the population, to promote business involvement in R&D and to develop the use of ICT in SMEs. Some effort was made to enhance competition in liberalised utilities but the protocol establishing a common Iberian electricity market has been delayed. The current relatively high level of state aid remains under review. Finally, no progress was made to raise the transposition rate of Internal Market directives.

3.13 Finland

Finland is among the Member States that, in overall terms, are considered to have given the least effective follow-up to the country-specific parts of the BEPGs. Finland has made some progress in the area of public finances. The government surplus in 2002 is estimated at 3.6% of GDP. Central government expenditure exceeded the original target for 2002 by 1.0 per cent in real terms and, moreover, that of the spending ceiling, agreed in March 2001, by 3.1 per cent in real terms. The overrun in 2002 was mainly caused by additional discretionary spending on various welfare services. Furthermore, according to the 2003 budget, expenditure in 2003 will exceed the government spending guideline agreed in March 2002 by about 0.4 per cent in real terms. However, the government has taken some measures to improve budgetary discipline of the local authorities. Also it has agreed, together with social partners, on a significant reform of private pension schemes.

Some progress has been made in labour market reforms. Tax reductions lowered the tax rate for low and medium wage earners by about 1 percentage point in 2002. The government expects that proposed measures for 2003 will further reduce the tax burden on labour by about 1 percentage point. An overhaul of ALMPs was introduced to target measures better to individual needs.

Finally, limited progress was made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Some measures have been taken to enhance competition for public services. The time necessary for the registration of new companies seems to have been recently reduced, but no significant concrete action can be reported in this area. No new measures were taken to give the Competition Authority further powers to apply Articles 81-82 of the EC Treaty.

3.14 Sweden

Sweden is among the Member States that, in overall terms, are considered to have given the best follow-up to the country-specific parts of the BEPGs. Good progress was made in implementing the public finance recommendations. The tax cuts, corresponding to some 1.1 per cent of GDP, implemented in 2002 were in line with the 2002 BEPGs. The public finances are expected to be in comfortable surplus in 2002. Central government expenditure ceilings have been respected in each year since their introduction in 1997 and this has helped contain expenditure and strengthen credibility of sound public finances. However, the budgetary margins incorporated in the ceilings for 2003 and 2004 were narrowed further in the Budget Bill for 2003.

Good progress has been made in implementing the 2002 labour market recommendations with further reforms to tax and benefit systems to promote work incentives, such as the increase of basic tax allowances and lower marginal tax rates for some wage earners. Sweden has also markedly improved the targeting of traditional labour market programmes. It has improved the mix of the remaining programmes focussing more on quality than on quantity.

Finally, some progress was made in respect of the recommendations on product markets, entrepreneurship and the knowledge-based economy. Competition in public service provision at the local level remains limited, although some further measures to enhance competition have been introduced, like a law that allows private companies to challenge public sector procurement decisions. Some measures were taken to reinforce competition in the food and construction sectors and to a lesser extent in the pharmaceutical sector.

3.15 United Kingdom

The United Kingdom is among the Member States that, in overall terms, are considered to be in a middle group as it comes to follow-up to the country-specific parts of the BEPGs. Some progress was made in implementing the public finance recommendations. Public investment after recent slippage to plans, is rising well and is planned to rise strongly in the latest official projections, as recommended. The public finances are expected to move sharply into deficit in 2002 both on account of below trend growth and a rise in discretionary expenditure. In 2003, a further small deterioration in both the nominal and cyclically-adjusted deficit is forecast.

Some progress was made in implementing the 2002 labour market recommendations. Although the whole range of active labour market measures, partly targeted at disadvantaged areas, have not yet been fully evaluated, figures on the basic outcomes suggest a potentially positive but small impact on improving employability. Measures to provide work-focussed support for all benefit claimants have been introduced. However, there appears to be little incentive for those who