Opinion of the Economic and Social Committee on "Coordination of economic policies as a consequence of EMU"

(2001/C 139/13)

On 2 March 2000 the Economic and Social Committee, acting under Rule 23(3) of its Rules of Procedure, decided to draw up an opinion on "Coordination of economic policies as a consequence of EMU".

The Section for Economic and Monetary Union and Economic and Social Cohesion, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 12 December 2000. The rapporteur was Mr Nyberg.

At its 379th plenary session (meeting of 1 March 2001) the Economic and Social Committee adopted the following opinion by 87 votes to one.

1. Introduction

1.1. EU economic integration has made considerable progress, thanks to the single market and the introduction of the single currency. This has also created new opportunities for a successful economy. Now that the effects of those political decisions are starting to be felt, however, the outstanding problems become clearer. How can the single market and the single currency be best exploited for growth and employment?

1.2. Through its dedicated Observatory, the ESC regularly issues opinions on how the single market is progressing. Final completion of the single market is a pre-requisite for the success of all other policies. Several ESC opinions have also addressed various aspects of the single currency. They describe the difficulties which have arisen during the convergence process, including unemployment and missed growth targets, but also the achievements made in reining in inflation and the budget deficit. This now provides an excellent opportunity to achieve sustained growth and boost employment. The continuous friction over fluctuating exchange rates has ceased for the euro 12 - to the benefit of cohesion - and been replaced by discussions of euro exchange rate trends. The present opinion attempts to complement earlier opinions by looking specifically at the need for further coordination of macro-economic policy as a consequence of the introduction of the euro.

1.3. In opinions from March 1998(1) and March 2000(2), the Committee refers to the exchange rate fluctuations in the dollar and the yen: "The fact that over the last 20 years the rate of the ecu against the dollar has fluctuated between 1,7 and 0,6 would suggest that recent trends are far from exceptional". The following diagram illustrates the euro's fluctuation against the dollar thus far. Although the increases in the value of the dollar are not unique as far as size is concerned, they have happened very quickly. This, however, is not a matter for the present opinion.

Figure 1: The value of the euro in relation to the US Dollar

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Source:

ECB Monthly Bulletin (October 2000).

1.3.1. Another aspect mentioned in the 1998 opinion was that a positive effect of monetary union was "that the external dependence of the Member States will diminish greatly as the bulk of trade between the participating countries will be transacted in euros. The external value of the euro will therefore be much less significant than hitherto ...". This was reiterated in an opinion on the economic situation 2000(3): "it must be remembered that one of the features of the euro zone is the strong dependence on domestic demand which accounts for 90 % of GDP". This was developed further in an opinion on Europe as an economic entity - a political challenge(4).

1.3.2. The year 2000 opinion(5) also remarks that the ECB's current anti-inflation policy could "slow down the economic turnaround that had only just begun in some countries". This is the starting point for our discussion of the importance of economic policy coordination. The discussion is also underpinned by the fact that "unemployment remains the Committee's overriding concern and it has previously expressed the view that the EU must have a medium-term growth objective of at least 3,5 % if a satisfactory reduction in unemployment is to be achieved"(6). The Committee considered it important to coordinate political processes(7) in "an appropriate macroeconomic policy mix, embracing fiscal, monetary and wages policy, in order to create a climate of confidence to stimulate consumption and investment and thus to boost employment in a durable way"(8).

1.3.3. An opinion on EMU and cohesion(9) discussed how stronger competition resulting from EMU would yield productivity gains, but with a potential risk of job losses. "However, if EU players manage to coordinate their economic policies, demand could be sufficiently healthy. Should this be the case, the net impact on employment could be positive". One effect of EMU which makes it easier for the Member States to implement such an active policy is the lower interest rate, which reduces the interest payments on the national debt and thus improves the balance sheet.

2. Background

2.1. We start from the premise that EMU is a reality. We do not intend to discuss possible constitutional changes such as the distribution of power between the ECB, the Council of Ministers and Parliament. On the basis of the Maastricht rules and convergence criteria, together with the pact for stability and growth, we will examine how economic and political coordination can enhance the benefits of EMU(10). The Amsterdam Treaty and the Lisbon Council are also important factors here.

2.2. In accordance with the provisions of the Treaty, the ECB conducts interest rate policy. In practice, it sets the short rate to meet its inflation targets, but it also takes account of growth and employment, in so far as the price stability objective is not affected(11).

2.2.1. The ESCB(12) controls the common currency reserves and, consequently, the euro exchange rate instrument. However, the (euro 12) Council of Ministers must be informed if the instrument is to be used. How this interplay actually works in practice perhaps warrants specific discussion.

2.2.2. In order to achieve the third stage of EMU - the introduction of the single currency (the euro) - convergence criteria were adopted for the Member States to follow. For those Member States which have not yet proceeded with the third stage, the criteria are, in the main, still valid.

2.3. For the 12 countries which have adopted the euro, however, interest rates and inflation are no longer just features of national policy objectives, since the ECB sets the targets according to average levels. For the ECB, inflation must be kept below 2 per cent. The Council requires the euro exchange rate to be monitored. National policies still have to respect the budgetary balance and national debt aspects of the convergence criteria. These are now enshrined in the Stability and Growth Pact. With regard to national debt, the upper level is still 60 % of GDP. The budgetary balance criterion has been tightened considerably. While the maximum permissible deficit remains unchanged (- 3 per cent of GDP), the Pact contains a reference to the desirability of a balanced budget or a budget surplus. The reason is stated clearly - so that there will be sufficient resources to stimulate the economy during an economic downturn without risking reaching the - 3 per cent threshold. In reality, the EU does not set any budgetary balance target as such; the objective is to create sufficient resources to stimulate the economy during an economic downturn.

2.4. Article 99 of the Treaty formally requires the Member States to coordinate their economic policies: "Member States shall regard their economic policies as a matter of common concern and shall coordinate them within the Council". With regard to Member States' anti-recession policy, there is in fact only one lower threshold (- 3 % of GDP), with the possibility of sanctions as long as it is not just a temporary blip in GDP. With regard to the budget surplus, the aim is to build up the necessary financial reserves as soon as the economic situation allows. Here neither the Treaty nor the Pact set any fixed criteria or sanctions. The desired trend for the coming year is worked out using the Broad Economic Policy Guidelines (BEPG). These are not formally binding rules, but they have already proved to be a strong influence over economic policy.

3. The players and what they can achieve

3.1. With the entry into force of the Maastricht Treaty, the Ecofin Council became the most important player in EU economic policy. The convergence criteria laid down requirements for both these areas. The instruments used are the BEPG, and the corresponding convergence and stability programmes. National governments have control of economic policy instruments such as national income and expenditure. But these do not only impact on economic developments; they are also affected by them in turn. This means that a policy which is intended to dovetail with these programmes can both overshoot and undershoot the target, depending on economic trends.

3.2. On 1 January 1999, the ECB assumed sole responsibility for monetary policy, which formally became a common monetary policy. The principal instrument is the short-term interest rate. However, shared responsibility for the exchange rate remains. We will return later to the ECB's "control" over interest rates and economic trends.

3.3. Incomes policy is the third strand of broad economic policy. This is the prerogative of the national labour market partners, sometimes in cooperation with governments. There are several examples at national level showing how social pacts, for example, have been used to achieve a solid basis for employment and growth. The first signs of de facto coordination between the social partners can also be seen at EU level. Although incomes policy is framed at national level, the European organisations have an important role to play in discussions with the ECB, the Ecofin Council and the European Parliament. The Cologne process formally recognised discussions - covering both technical and political dialogue - between governments, the ECB and the social partners.

3.4. Wage trends in neighbouring countries have become more important than was previously the case. It is no longer enough to ensure proper coordination of wage bargaining between the national partners. Attention must also be paid to what is happening at European level.

3.4.1. With the common monetary policy, more flexible wage bargaining procedures are needed when one country's economic cycle is out of step with the rest. There are examples of the social partners agreeing on funds to deal with such situations, whereby money is set aside from wage settlements during good times for use when times are bad. When government finances are healthy, there is a further opportunity: the State can temporarily top up social insurance contributions for the social partners, to help prop up wage levels during a downturn.

3.4.2. Countries used to be able to resort to devaluation to deal with more long-term changes in competitiveness. Now that this is no longer possible, new methods need to be developed. Another option could be lower wage increases than in other countries. In a common currency area, however, this has the same negative effect as devaluation, i.e. the onus to adapt is partly offloaded onto other countries. If several countries engage in a wage-cut battle to regain competitiveness, we would be back to the situation caused when devaluation was used for the same purpose. This must be avoided at all costs.

3.5. On the contrary, incomes policy must be both responsible and dynamic, if it is to help achieve continued growth. Consequently, productivity is the only appropriate criterion for wage bargaining. Productivity gains which are higher than the eurozone average provide grounds for better wage settlements. Conversely, weaker productivity gains in the long term must be reflected in national wage settlements. Policies to boost productivity would, of course, be desirable here. Training policy and increased investment are key planks in such a policy. Given the greater degree of policy coordination required as the EU economies knit together, it would be wrong to embark on more decentralised wage bargaining procedures.

4. EMU and interest rate policy

4.1. Interest rates and the money supply affect demand in the economy. The Central Bank controls these by varying the interest rate. The higher the interest rate, the weaker the demand, and vice versa. The ECB's main yardstick for economic activity is the inflation rate. This year's large oil price rises pose a dilemma for the ECB, as the overall inflation rate is no longer an indication of domestic activity.

4.2. Apart from the direct domestic impact of interest rate changes, foreign financial investors can also be tempted by the high interest rates, and consequently high yield. In order to achieve this, they buy euros. The result is that the exchange rate rises. The reverse occurs when interest rates fall in comparison with other currency areas. Thus, the exchange rate is also linked to interest rates and the money supply. An excessive money supply results in inflationary pressure; market players will then try to dispose of their holdings in euros, and the exchange rate drops. Labour, goods and services become cheaper for the outside world, but at the same time, import prices rise.

4.3. In the short term, nominal price and wage movement will be sluggish. On the other hand, the ECB refi rate can be used effectively to stimulate or limit demand in the economy, as it directly affects short-term interest rates. As the table below shows, there is a strong correlation between refi and short-term rates.

Figure 2: The short-term rate and the ECB's refi-rate

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* The money market rate for 01/99 and 04/99 is a yearly average. The figures for 09/00 refer to the refi rate as of 6 September and the market rate as of 8 September.

Source:

ECB Monthly Bulletin (September 2000).

4.4. Long-term rates are affected by the short-term rate and economic policy expectations. As the diagram below illustrates, the relationship between the refi and long-term interest rates is not the same as that above. On the contrary, in some months long-term rates have fallen as the refi rate has risen. This shows that the financial markets believe that monetary policy will be tightened, in order to avoid inflationary pressure. The risk premium and interest rates are therefore lower than they would have been if monetary policy was expected to be loosened up, with greater risks of inflation and overheating.

Figure 3: The long-term rate and the ECB's refi rate

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* The money market rate for 01/99 and 04/99 is a yearly average. The figures for 09/00 refer to the refi rate as of 6 September and the market rate as of 8 September.

Source:

ECB Monthly Bulletin (September 2000).

4.5. Although the ECB is officially independent, in practice it is not able to dictate policy alone. World exchange markets are dominated by the US dollar, and international capital can be transferred immediately. Different investment yields in Europe and the US impact directly on capital flows. The ECB cannot therefore merely take account of the demands of the economic situation in the EU when setting interest rates. Lower interest rates and capital yields in the EU lead to flights of capital to the USA(13). Figure 4 shows the different real rate trends in the USA and in the eurozone recently. The impact of the financial market's heavy international dependence has to be balanced out against the desire to boost the economy through low interest rates, given that investment capital is needed to achieve that stimulation.

Figure 4: Real rate trends in the euro-area and in the USA

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Source:

Economic Outlook 67, OECD 2000.

4.5.1. What seems to give most cause for concern in the current statistics is the impact on the exchange rate, which affects both overall competitiveness and inflation through higher import prices. If we look at earlier fluctuations between the US dollar and European currencies, we see that they have been even greater than those seen in 1999 and 2000. This means, on the one hand, that fluctuations are normally large and often change direction fast and, on the other, that the impact on inflation can be appreciable.

4.5.2. Thus the ECB's ability to manage the economy is affected by the economic situation and economic policy in other countries, the USA in particular. In other words, there are not three, but at least four, players - the ECB, the Ecofin Council, the social partners and their counterparts in the USA. There are increasingly calls for measures to make economies less vulnerable to the violent fluctuations of the international financial market.

4.6. However, the interest rate is not only decisive for future inflation trends - it also crucially affects economic activity within the economy. There is a strong link between inflation and the economic cycle. If all the Member States had the same inflation rates and were at the same stage of the economic cycle, then an interest rate policy to keep inflation at the desired level would also suit the prevailing economic policy in all those countries.

4.6.1. This is not the case. The difference in economic cycle and rates of inflation in the various Member States is the main reason why EMU and a common monetary policy cannot work properly unless it goes hand in hand with economic policy coordination. Economic policy is needed as a short-term correction to the common monetary policy. The kind of policy this coordination should lead to depends entirely on the current differences between the countries.

4.6.2. The big difference compared to the previous situation, now that there is a common monetary policy, is that, instead of being based on the national inflation rate, it is now based on the average inflation rate (calculated according to individual countries' GDP).

4.6.3. The worst possible way to coordinate would be to establish a single common economic policy for all participating countries. Any such harmonisation would exacerbate the problems which the common monetary policy causes where there are differing inflation rates and economic cycles.

4.6.4. On the contrary, coordination must mean agreeing on the domestic economic policy differences which can best counteract the negative impact of a common monetary policy on countries which deviate. If each country were simply left to act as it sees fit in a given common monetary policy, then conflict can be expected since, given the close economic ties in the EU, one country's policies affect all the other countries. Coordination efforts must therefore allow recommendations to be made for each country, and factor in the likely effects of the policy on the other countries. The policy must go one step beyond wholly voluntary cooperation, and embrace proper coordination.

5. The great significance of the single market

5.1. The Commission, the Council and the ESC have pointed out that EU GDP is circa 90 % domestic. With enlargement, the EU's external trade as a percentage of GDP will fall even further. In the long term, relations with the rest of the world in terms of international competitiveness trends - which are decisive for the 10 % of trade with the rest of the world - will be of vital importance. In the shorter term, the other 90 % provide scope for economic policy coordination to compensate for some of the common monetary policy's impact.

5.1.1. For the eurozone, the Commission has produced figures (1999 Annual Economic Report) to shed light on the degree of openness towards the rest of the world and on the interdependence of the then 11 countries. Here, the four countries which were not in the euro-area in 1999 are included in the "rest of the world". Trade with the rest of the world accounts for 13 % of the collective GDP of the euro-area countries. Trade between the 11 countries - which from a euro-perspective should be seen as internal trade - accounts for a similar percentage of GDP. There are, however, significant differences from country to country. Dependence on internal trade is, then, much more an EU than a euro phenomenon.

5.2. There is considerable dependence on EU internal trade as a whole. Internal cross-border trade makes up approx. 16 % (export) and 15 % (import) of the EU area's GDP. The share varies widely from country to country, with the smaller countries quite naturally having the largest share.

Table 1: EU domestic trade as a percentage of GDP

>TABLE>

Source:

European Economy No 69.

5.3. The combination of external independence and internal dependence means that the economic policy of an EU country affects the rest of the world to a very small degree. With regard to trade patterns, for most countries external influence is also slight. On the other hand, one country's economic policy has a major impact on the other EU countries.

5.4. We asked the Danish "Erhvervsrådet"(14) to use its highly respected econometric model for the euro area to help us to appreciate the scale of the interaction. The table below thus calculates the impact of a 1 % GDP increase in public investment.

Table 2: Increase in public investment

The total effect in the third year (2000-2002)

(Austria, Ireland, Portugal and Luxembourg are not included in the model)

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Source:

Economic Council of the Labour Movement, Denmark.

The figures show the impact on GDP and employment after three years. Unfortunately, it was only possible to include 7 of the 12 euro countries in the survey. Had all 12 been included, the effect would have been greater. Part A of the table shows the effect of unilateral action on the country itself. Part B shows the effect of increased investment in all 6 of the other countries surveyed. Increased investment in Germany, for example, boosts GDP in the other countries by an average 0,2 %. Finally, part C gives the figures for coordinated expansion, when all 7 countries increase their public investment together. The impact on GDP is thus roughly twice as great as when a country acts in isolation.

5.5. The table gives a clear picture - without attaching too much importance to the accuracy of the figures - of how coordinated action enhances policy effectiveness. It also shows that one country's economic policy can benefit other countries at the same stage of the economic cycle, whilst making things more difficult for countries which are at a different stage of the cycle.

6. Coordination is increasing rapidly

6.1. The European Council has on a number of occasions argued for closer coordination of economic policy. Since the Community budget as a share of collective GDP is very limited, there is virtually no scope for it to provide economic stability. However, there are circumstances in which the EU can help countries which are experiencing considerable economic difficulties(15).

6.2. Since the Helsinki Council (December 1999), the basic principles for coordination of national policies have been: 1) Subsidiarity - while budget policy must be governed by the Treaty and the stability and growth pact, there is scope for national political choices. 2) The various players - ECB, the social partners and governments - are independent. 3) The Member States have a duty to consider economic policy as a common concern (Article 99).

6.3. Coordination is restricted to the policy's general framework, and this includes the requirement to avoid damaging competition. On the other hand, "best practice" is an important part of the process of learning from each other's achievements and failures.

6.4. There is already a raft of coordination methods: exchanges of information, "best practice" discussions, basic common policy rules, "peer review" and joint actions. The specific policy area will decide which options are available. What is lacking is a common policy orientation to provide a better grip on this package of measures.

6.5. The economic guidelines provided for in Article 99 of the Treaty are the current starting point for coordination. The guidelines must also take on board other processes (Luxembourg, Cardiff and Cologne) and they both round off one year's political proceedings and start the next. Over the years, the Broad Economic Policy Guidelines (BEPG) have become more specific and have focused more on structural issues. The reports presented by the Commission, among others, in connection with all these processes, in particular prior to the introduction of the BEPG, provide a blueprint for how economic policy coordination can be implemented. In order to put this policy on a sounder footing, there will have to be better, quicker input of data from the Member States.

6.6. In addition to the formal Treaty and pact provisions, the Euro-12 ministers regularly discuss their opinions of budget policy. The ESC believes it is important that the role of the Euro-12 ministers - i.e. those responsible for guiding that policy - should be clarified further.

6.7. The results of the Cardiff process are being incorporated into the BEPG, and since 2000, coordination of the employment ministers' work provided for under the Luxembourg process has been taken further, so that the ministers now discuss the BEPG. Macroeconomic dialogue has created opportunities for discussion to improve coordination of monetary, economic and wage-related policies. In addition to this, the Lisbon Summit provided fresh impetus when it launched annual summits to discuss employment and the information society in particular.

6.8. A report from the Ecofin Council to the Helsinki European Council describes various steps to improve coordination, including by means of indicators and benchmarks. The first step involves devoting more time to reaching a consensus on the cyclical and structural aspects of budget policy. More reliable statistics are needed to achieve this.

6.9. More specific BEPG are the next step. Moreover, they should focus more on long-term objectives and pay greater attention to implementation. The specific plans for each country must be detailed and comparable, so that it is possible to monitor the way they are put into practice. When the presentation of national budgets does not coincide with the submission of convergence and stability plans, it should be ensured that they tie in as closely as possible with these plans. The consequences of an ageing population must also be factored into these plans and budgets. Effective coordination must also be underpinned by openness and a willingness to take advice and change policies.

6.10. These recommendations will be essential in ensuring the Member States can implement the policy effectively.

7. Differences in the economic cycle

7.1. Discussions of the problems which might arise within a common currency area have been dominated by the "asymmetric shocks" issue(16). These are certainly possible, but the experience of recent decades shows rather that the shocks (e.g. oil price rises) which occur affect most countries, i.e. they are symmetric, with impact varying only to a small degree. Finland's loss of trade with Russia is perhaps the nearest we have to an asymmetric shock. A safeguard in the form of EU assistance provided for under the above-mentioned Article 100(2) is available for extreme situations in which only one or a couple of the Member States are affected.

7.2. While asymmetric shocks are unusual, discrepancies between national economic cycles are of considerable consequence. This is the crux of the common monetary policy's need for economic and political coordination. In order to decide the type of coordination needed, and which is likely to be most effective, more information is needed about the actual variations in economic cycles.

7.3. We have studied the economic cycle variations between EU Member States over the last few years. On the one hand, we can look into how big the variations are normally, and whether they are sometimes large and sometimes small; and on the other, how the variations in one country compare to the others. Is it always the same countries which lead the economic cycle, and others which always deviate most? There are several ways of measuring the economic cycle in a country. We chose the simplest: variations in GDP.

7.4. The diagram below is based on OECD figures, and shows that economic cycles in the euro-area countries have tended to converge in recent years. However, some countries do deviate from this pattern, e.g. Ireland, Finland and, in the wake of re-unification, Germany. Convergence is probably a consequence of the single market and the convergence criteria, and this shows their importance for a future economic policy, where economic policy and coordination can generate higher growth and employment.

Figure 5a: Real GDP changes

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Figure 5b: Real GDP changes

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Source:

OECD.

8. Automatic stabilisers

8.1. If there are no new policy decisions to deal with a national economy that is out of step, that economy will anyway eventually catch up with the others via an inbuilt adjustment mechanism. The problem is that it takes too long, and the process has negative side effects. When the economy is doing well, higher levels of economic activity lead to inflation. Owing to dependence on international markets, competitiveness is compromised, and this eventually causes a reduction in economic activity. For the EU countries, the bulk of this adjustment comes through the single market. Moreover, a price-led adjustment in the eurozone would be accompanied by a tighter monetary policy, which would constrain economic activity in general.

8.2. Since this sort of price mechanism works through negative effects on employment and growth, and since these largely come via other countries, this type of adjustment is not acceptable. Instead, increases and cuts in public sector revenue and expenditure have traditionally been used to speed up the process and bring the economic cycle back to "normal". However, our economic systems have been designed to include various inbuilt mechanisms which, if exploited to the full, automatically cope with the adjustment needed where there are minor variations in the economic cycle. These include the following important examples:

- Unemployment benefit. The fact that the unemployed can maintain part of their previous disposable income during a period of unemployment, softens the negative impact on demand when unemployment rises.

- Labour market programmes to encourage the unemployed to maintain their skills compensate for the negative impact on the market during times of unemployment. The labour supply and employment rates are basic preconditions for growth; hence the need to ensure there is a sufficient labour supply at the ready when the economic cycle changes.

- Progressive taxation and welfare safety net. These limit exclusion and, consequently, any fall in purchasing power. They depress demand during an economic upturn by transferring resources to the public sector.

- Income-related allowances and, for example, inexpensive childcare, likewise help to maintain purchasing power during an economic downturn, and reduce state expenditure during an upturn.

- Skills levels. In times of structural change, skilled workers find it easier to retrain in jobs where there is a shortage of manpower, with the result that there is a good supply of skilled labour for when the economy improves.

- The purpose of buffer funds - as used in Finland (and for which the social partners are responsible) - is that they are amassed when times are good, and used when they are less good. This is done by setting aside part of a wage settlement when the economic cycle is good, and using it to cover a share of labour costs when there is a downturn. The advantage with this kind of system is that real wage increases are more even over time, and it does not result in inflationary pressure.

9. The right economic solution is not always politically viable

9.1. With EMU, interest rate policy is not affected by upcoming general elections. Conversely, interest rate policy is not independent of day-to-day political considerations - particularly in the run-up to a general election - then it will seldom be the correct policy for the economic cycle. When the economy is strong in the run-up to a general election, the government has little scope to use economic policy to introduce the economic restrictions the situation requires. Politicians prefer to win the election rather than manage the economy properly and lose. It is difficult to find an opposition which would not be prepared to exploit the situation to criticise a restrictive economic policy. If all elections took place when there was a downward trend in the economy, then the politically desirable would also be the best solution from an economic point of view. But the reality is quite different. When several EU countries now have a balanced budget or even a budget surplus, cutting taxes in the run-up to an election regardless of the general state of the economy could be a good political tactic. The Council should therefore provide greater incentive for what is currently a desirable political development.

9.2. After the Lisbon European Council, the Commission presented a number of possible economic policy rules appropriate to the current situation. Previously, there had long been talk of the need for tax cuts. In these rules the Commission says that the current economic situation is not conducive to such changes, but that if any are nevertheless planned, certain Commission guidelines should be respected. The current strong economic performance means that the different economies can scarcely cope with any further stimulation without leading to inflation. The Commission points out that the current situation provides ample reason to work for the long-term objective of boosting the treasury so that the economy can be stimulated in a later economic downturn. Even given a different economic situation, income tax cuts in particular must be considered in relation to the national debt and future demographic trends. Such tax changes can only be part of a package of social security system reforms. All this is contained in the Commission's report on public finances, which, at the time of writing, has not yet been formally addressed by the Council.

10. Coordination guidelines

10.1. There are then, many reasons for stepping up economic policy coordination, and all coordination options should be based on a common core of principles. The ESC believes that this coordination should take the following direction:

10.2. Firstly, "direction" is the important thing here, and whether it is restrictive or expansionary, rather than exactly what measures should be taken. Given the same economic cycle, a change in revenue could be the correct measure both economically and politically in one country, while in another, changes to government expenditure in the opposite direction could be more appropriate. If tax cuts are preferred in two countries, then it might be more appropriate to cut income tax in one country, and cut VAT in the other. Direction, then, is the key factor, whereas the actual measures takes second place.

10.3. Secondly, in addition to direction, a further joint assessment must be carried out before specific measures are launched. The assessment should focus on the extent to which various measures affect all the Member States. The particular economic cycle will decide whether to select those which have a considerable impact on the others, or those which have little impact. If most countries are in the same situation, coordination should involve choosing measures which have a big impact on other countries. A different VAT rate, for example, could be more effective in such a situation since this impacts directly on private consumption (as it affects disposable incomes) and consequently also impacts on imports. Large-scale adjustments to public expenditure, however, only impacts indirectly and to a lesser degree on private consumption and imports. If, on the other hand, a country is "out of step" with the others then it can decide to review this type of expenditure which only impacts on other countries to a modest extent

10.4. Thirdly, in view of these considerations, it should be left to the Member States to discuss their choice of measures. The absence of joint decisions need not, however, mean there is an absence of joint discussions at Council level. Such discussions should be central to efforts to frame a coordinated economic policy. Since, politically, it is considerably more difficult to enshrine this in the Treaty, it should be possible to achieve it via the existing structure. The formal arrangements are less important than the actual form coordination takes. Moreover, a knowledge base must be compiled to illustrate the effectiveness of various measures in different economic cycles, thus enabling Council of Ministers discussions to be informed by the good and bad experiences of individual countries.

10.4.1. It is consequently very important to bear in mind that an instrument can be effective in one country, without necessarily being so in all the others. Because of factors such as the structure of the industrial economy, the size and shape of the welfare system, and the extent of economic inequality, a measure can be effective in one economic context but not in another.

10.5. Fourthly, the main concern is the impact on the economic cycle itself, since the aim of economic policy coordination is to boost the joint impact of economic and monetary policy on stability, growth and employment. While there may be other reasons for wanting more similar economic systems, the rules for the annual coordination of economic policy should not make these a priority. The reasons may be levels of taxation and expenditure, and the allocation of different forms of taxation and expenditure. Such changes can only be part of the fixed coordination structure we are recommending here if they have direct bearing on economic policy itself.

10.6. Such connections do exist. If, for example, the intention is to narrow the variations in VAT rates, and consequently reduce the scope for VAT fraud, this can be done gradually by exploiting the fact that different countries are at different stages of the economic cycle. An individual country experiencing a period of prosperity and with a lower than average VAT rate should therefore opt for a higher rate. A country experiencing an economic downturn and with a high VAT rate should likewise take the opportunity to cut it. This and other examples show that a coordinated economic policy can also have a long-term impact on overall economic coordination, and help reduce the discrepancies which can also lead to problems for the single market.

10.6.1. One area where economic variations should particularly be harnessed to iron out differences is taxes where the tax base can move easily between countries. A country with a booming economy and low taxation on income from capital, low corporation tax and also low taxes on environmentally hazardous activities, should exploit this to iron out the tax discrepancies. Conversely, a country with high levels of taxation in these areas, and with a deflated economy should take the opportunity to lower them. The positive side effects of this type of policy shift will in future be a more level playing field and more similar fluctuations in the economic cycle.

10.7. Finally, it is worth reiterating the fact that all these discussions about coordination of economic policy take for granted that restraint will be exercised when times are good. In the absence of restraint, we would be back to the situation of the 1990s when the need to restore some order to the public finances made it impossible to spend aggressively during a recession. Restraint should not, however, be practised to excess. The growth opportunities provided by an economic boom must be exploited. A balance must be struck between exploiting the scope for expansion and avoiding the emergence of bottlenecks which give rise to inflationary pressures.

10.8. We would call on all economic policy players - governments, the ECB, the Commission and the social partners - to draw on the above analyses and recommendations to develop economic policy coordination in the EU, and allow the favourable climate created by EMU to achieve its full potential for growth and employment.

Brussels, 1 March 2001.

The President

of the Economic and Social Committee

Göke Frerichs

(1) OJ C 157, 25.5.1998, p. 65.

(2) OJ C 117, 26.4.2000, p. 23.

(3) OJ C 140, 18.5.2000, p. 44.

(4) OJ C 284, 14.9.1998, p. 60.

(5) OJ C 117, 26.4.2000, p. 23.

(6) OJ C 140, 18.5.2000, p. 44.

(7) The Cardiff Process on structural policy, the Luxembourg Process on labour market policy, and the Cologne Process on macroeconomic dialogue.

(8) OJ C 209, 22.7.1999, p. 53.

(9) OJ C 368, 20.12.1999, p. 87.

(10) The pact formally comprises the Amsterdam Council Resolution of June 1997, the Regulations on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies (1466/96), and on the excessive deficit procedure (1467/97).

(11) Article 105 of the Treaty: "The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2".

(12) European System of Central Banks.

(13) Cf. ESC Opinion on Challenges posed by EMU to financial markets, OJ C 367, 20.12.2000.

(14) Economic Council of the Labour Movement.

(15) Article 100(2): "Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by exceptional occurrences beyond its control, the Council may, acting unanimously on a proposal from the Commission, grant, under certain conditions, Community financial assistance to the Member State concerned".

(16) OJ C 368, 20.12.1999.