.;- î*£*a COMMISSION OF THE EUROPEAN COMVIUNITIES 
COM(94) 90 final 
Brussels, 23.03.1994 
1994 ANNUAL ECONOMIC REPORT 
(presented by the Coaimlsslon) 
1994 ANNUAL ECONOMIC REPORT 
CONTENTS 
Part A: Community-wide trends 
Section 1: The economy of the European Community in 1993 
1.1 Main economic trends 
1.1.1 Growth performance of the EC and of its main trading partners 
1.1.2 Recession causes further fall in employment 
1.1.3 Convergence situation in the EC 
1.2 The policies 
1.2.1 The inheritance of the recent past 
1.2.2 Budgetary policy 
1.2.3 Wage trends 
1.2.4 Monetary policy 
1.2.5 Structural adjustment policies 
1.2.6 The Edinburgh and Copenhagen Growth Initiatives 
Section 2: The outlook for 1994 and beyond 
Section 3: The policies for more growth and employment 
3.1 Sustaining the recovery 
3.1.1 The current monetary policy stance 
3.1.2 Progress in creating the conditions for lower interest rates 
3.2 Underpinning medium-term growth and employment creation 
Conclusions page 1 
1 
1 
5 
7 
10 
10 
15 
17 
18 
22 
23 
25 
31 
31 
32 
34 
38 
40 
PART B: 
Belgium 
Denmark 
Germany 
Greece 
Spain 
France 
Ireland 
Italy 
Luxembourg 
Netherlands 
Portugal 
United Kingdom Economic situation and policy issues 
in the individual Member States 
43 
48 
52 
58 
62 
67 
73 
77 
81 
84 
90 
94 
22-03-94 
(2) 
1994 ANNUAL ECONOMIC REPORT 
PART A 
COMMUNITY-WIDE TRENDS 
22-03-94 
Section 1: The Community economy in 1993 
1.1 Main economic trends 
In 1993, the period of slow growth or near stagnation, which had started in 1991, 
turned into an outright recession. Last year, Community output declined by about a 
quarter of a percentage point in real terms; only the second time in the 35 year history 
of the European Community that a real decline in GDP was registered. In 1975, in 
the wake of the first oil shock, the GDP drop had been stronger (almost one per cent), 
but - in a more pronounced cyclical pattern - the contraction had been preceded and 
followed by periods of strong growth. The current period of economic difficulties 
follows a long period of steady and satisfactory growth, but, if the forecasts for 1994 
prove correct, the overall loss of output could be larger than that experienced during 
the 1974-75 and 1980-83 episodes. Employment fell by a record amount - 2.4 million 
jobs lost in the course of the year - and unemployment increased at a fast pace 
reaching a level of 10.6 per cent of the civilian labour force. 
Chart 1 
EC : Actual and potential real GDP growth 
65 67 
The recession had also a strong effect on the Community's convergence performance. 
Real convergence stalled and nominal convergence presented a mixed result: 
inflationary pressures abated but budgetary positions deteriorated substantially. 
1.1.1. Growth performance of the Community and its main trading 
partners 
1993 was a year of recession... 
After a period of strong growth leading to a clear-cut case of overheating in the 
second half of the 1980s, the Community's economy lost steam in the course of 1990. 
Under the impact of the policy tightening, essentially through monetary policy, which 
22-03-94 
-2 
had taken place in the Community following the appearance of the first serious 
macroeconomic imbalances and under the impact of the recession which hit the United 
States in 1991 and other important industrialised countries, the Community's rate of 
growth fell substantially below potential from the end of 1990 to the first half of 1992. 
The decline would have certainly been more pronounced had it not been for strong 
growth in Germany. In the second half of 1992, however, the combination of an 
absence of signs of recovery, rising unemployment, continued tight economic policies, 
exchange rate instability and negative political factors provoked a marked 
deterioration in the expectations of economic agents and turned the period of slow 
growth into stagnation and, from the beginning of 1993, recession. 
Table 1 : The Community economy : Use and supply of goods and 
services and main economic indicators 
(annual real percentage change) 
Private consumption 
Government consumption 
Gross fixed capital formation 
Domestic demand (incl. stocks) 
Exports of goods and services a) 
Imports of goods and services a) 
GROSS DOMESTIC PRODUCT 
Inflation (deflator private consumption) 
Employment 
Unemployment (% of active pop.) 
Public deficits (%ofGDP) b) 
Current account bal. (%of GDP) 1988 
4.3 
1.9 
8.7 
5.1 
2.5 
10.5 
4.2 
3.8 
1.5 
9.8 
-3.4 
0.1 1989 
3.2 
1.4 
6.9 
3.7 
5.0 
7.2 
3.5 
5.0 
1.5 
8.9 
-2.7 
-0.2 1990 
3.1 
2.0 
3.8 
2.9 
5.7 
4.3 
3.0 
4.5 
1.7 
8.3 
-4.0 
-0.4 1991 
1.9 
1.5 
-0.3 
1.1 
6.6 
2.5 
1.4 
5.4 
0.2 
8.7 
-4.6 
-1.2 1992 
1.8 
2.0 
0.0 
1.4 
3.4 
4.6 
1.1 
4.6 
-1.2 
9.7 
-5.0 
-1.1 1993 
-0.1 
0.5 
-4.6 
-1.3 
3.6 
-3.1 
-0.3 
3.8 
-1.7 
10.9 
-6.0 
-0.6 
NB: The figures for the public deficit and the current account balance include the five new German Lander from 1991 
onwards. The figures for GDP and its components, inflation and employment/unemployment include the new Lander 
from 1992 onwards, 
a) Extra-Community trade only b) General government net borrowing 
... but the economy may have reached the trough 
However, there are now some encouraging signs which suggest that the decline in 
activity may have levelled off since the summer of 1993. The latest survey results also 
indicate that the Community economy may have reached the trough of the current 
recession. In the last few months, the main economic sentiment indicators have 
moved out of the low levels which had been reached and some of them, especially the 
industrial and construction confidence indicators, are again on a slightly rising trend 
(see chart 15). In summary, Community GDP increased by 1.4 per cent in 1991, by 
1.1 per cent in 1992 and declined by 0.3 per cent in 1993. 
2243-94 
Cyclical downturn in majority of Member countries 
Notwithstanding the strength of the recessionary forces in 1992, a decline of output 
was registered only in the United Kingdom, where the economy had already entered 
into a recession in 1990-91. In 1993, however, most Member countries registered a 
stagnating or falling GDP with the exception of the United Kingdom, which started to 
emerge from a very severe recession, plus Ireland, Luxembourg and the Netherlands. 
The most marked declines occurred in the western part of Germany (- 1,9 per cent) 
and in Belgium (-1,3 per cent). Table 2: 
Substantial declines in output - about Economic growth in the European Community 
one per cent - were registered also in 
France and Spain, while in Greece, Italy 
and Portugal the contraction was about 
a quarter to a half a percentage point. 
Positive rates of growth of about 2 per 
cent were recorded in the United 
Kingdom, where the recovery took hold 
firmly, and in Ireland. The eastern part 
of Germany, sustained by large financing 
flows coming from the rest of the 
country, again registered a substantial 
rate of growth (7.1 per cent). As a 
result, the recorded decline in German 
GDP was reduced to -1.2 per cent. 
Community output developments opposite to those of the rest of the World 
In 1993, the recession in the Community contrasted with an improving performance in 
the world economy. After having practically stagnated in 1991, output in the rest of 
the world picked up slowly and expanded in 1993 by 2.2 per cent. The differing 
European and world performances are essentially due to the recovery in the USA and 
to the substantial growth registered in the non-OECD countries, especially those of 
south-east Asia and of Latin America. Japan and most of the other OECD countries, 
on the other hand, registered unsatisfactory growth figures. The divergence in the 
GDP performances is mirrored in the trade figures. The combined imports of the rest 
of the world increased by more than 8 per cent in real terms, while EC imports from 
the rest of the world declined by about 3 per cent. B 
DK 
WD 
D 
GR 
E 
F 
IRL 
1 
L 
NL 
P 
UK 
EC(1) 
EC 1988 
5.0 
1.2 
3.7 
4.1 
5.2 
4.5 
4.2 
4.1 
5.7 
2.6 
3.9 
5.0 
4.2 1989 
3.6 
0.6 
3.6 
3.5 
4.7 
4.3 
6.2 
2.9 
6.7 
4.7 
5.2 
2.2 
3.5 1990 
3.2 
2.0 
5.7 
-0.1 
3.6 
2.5 
9.0 
2.1 
3.2 
4.1 
4.4 
0.4 
3.0 1991 
1.8 
1.2 
4.5 
1.8 
2.2 
0.7 
2.6 
1.3 
3.1 
2.1 
2.1 
-2.3 
1.4 1992 
1.4 
1.2 
1.6 
2.1 
1.3 
0.8 
1.4 
4.8 
0.9 
1.9 
1.4 
1.1 
-0.5 
1.0 
1.1 1993 
*-1.3 
0.0 
*-1.9 
•-1.2. 
-0.2 
-0.9 
•-0.7 
2.0 
-0.3 
0.7 
* 0.3 
-0.5 
* 2.1 
*-0.4 
•-0.3 
(1) Excluding the five new German Lander 
European Commission estimates of November 1993 except for 
the figures marked with an asterix where more recent 
information has been included 
22-03-94 
4-
The recovery of the US economy, which had entered into recession before Europe and 
Japan, was slower than in the past: a drop in GDP of just above one per cent in 1991 
was followed in 1992 and 1993 by rates of growth of 2.6 and 3 per cent respectively. 
The recovery of employment was also weaker, but in 1993 employment still expanded 
by 1.5 per cent, a figure which compares favourably with the performance of many 
other industrialised countries. The main factors supporting growth were historically 
low interest rates, which supported the restoration of financial equilibrium in the 
private sector, and a continued relatively weak US-dollar which led to a substantial 
increase in exports. In addition, strong growth impulses came from the wide-ranging 
structural adjustment efforts of the business sector, especially industry, which were 
associated with high levels of investment. 
Growth in the industrialised countries : 
EC and the rest of the OECD 
place. The Japanese economy, on the contrary, 
is experiencing a period of very weak 
growth. In 1993, output stagnated for 
the first time since 1974. One important 
factor behind the slowdown was the need 
for firms and households to adjust their 
spending behaviour following the large 
variations in asset prices which had taken 
As in Europe, there are as yet no clear signs of recovery. A small positive 80 81 82 83 84 85 86 87 88 
ft*, of growth of GOP/GNP 90 91 92 93 94 95 
contribution could come from the monetary and fiscal easing which has taken place, 
but the appreciation of the yen will be an important negative force. 
In Europe, the EFTA countries experienced their third consecutive year of output fall 
in 1993 (-1.1 per cent). This was the result of both the weakness of the domestic 
economy and of the decline in their European Community export markets. The 
economies of Central and Eastern Europe continued to be affected by a number of 
factors, including the adjustment programmes undertaken to move to a market 
economy, the collapse of CMEA trade and a severe drought. After a large 
contraction - about 10 per cent in real terms - in 1991, output continued to decline in 
most countries in both 1992 and 1993, though in all of them the decline was smaller in 
1993 than in 1992. A positive rate of growth was registered, however, in Poland. 
22-03-94 
-5 
1.1.2. Recession causes further fall in employment.. 
The 1992/93 recession has led to a sharp fall in employment and a marked increase in 
unemployment. This is due both to the severity of the decline in economic activity 
and to the fact that employment trends have become more responsive to the economic 
cycle (see chart 4). In the second half of the 1980s, satisfactory, but historically not 
exceptional, rates of economic growth led to record rates of increase in employment 
(between 1.2 and 1.7 per cent a year). In 1993, the recession resulted in a decline in 
employment of almost 2 percent (-1.7 per cent), another, unwelcome, record in the 
Chart 3 
Community employment and unemployment 
% of civilian labour force 
12 r? 
10 Unemployment; r$tç 
£Lft.tt„.scaLftl 
(right «aièi* 
J l 1 i I ' > ' J. l 1 J_ § new GerrtaiiSa^M 
- ~ -1 
78 79 80 81 82 83 84 85 86 87 88 89 90 91 91 92 93 94 95 
Community's economic history. Even excluding the eastern part of Germany, where 
the employment losses are essentially due to the wide-ranging adjustment taking place, 
the current recession has cost, until now, around three million jobs. 
Taking into account the expected drop by a further half a point in the current year, the 
employment loss incurred during the present period of economic difficulties is larger 
than those of the two previous economic crises. The total contraction in employment 
over the period 1992-1994 is likely to 
reach 2.7 per cent excluding the 
eastern part of Germany or 3.4 per 
cent if this area is included. By 
contrast, employment declined by 2.4 
percent over the period 1981-1983 
and by only 1.1 per cent in 1975. 
The greater cyclical responsiveness of 
employment to economic trends, Chart 4 
GDP and employment in the EC 
% change pa 
61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 
22-03-94 
Charts Investment profitability in the EC 
(net operating surplus per unit of net capital stock) 
61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 
however, prevented a repeat of the strong deteriorations in investment profitability 
which were experienced during previous recessions which means that, all other things 
being equal, the recovery could be faster and more durable. 
Table 3 
B 
DK 
D(1) 
D 
GR 
E 
F 
IRL 
I 
L 
NL 
P 
UK 
EC(3) 
EC Employment m 
(annual percentage change) 
1988 
1.5 
-0.6 
0.8 
1.6 
2.8 
0.9 
*0.0 
0.9 
3.1 
1.6 
0.1 
3.2 
1.5 1989 
1.6 
-0.6 
1.5 
0.3 
3.4 
1.3 
*0.9 
0.1 
3.7 
1.9 
1.0 
2.5 
1.5 1990 
1.4 
-0.5 
3.0 
1.2 
3.2 
1.0 
*2.9 
0.8 
4.3 
2.3 
0.9 
1.1 
1.7 1991 
0.1 
-0.9 
2.6 
1.3 
0.5 
0 
*0.3 
0.8 
4.3 
1.5 
0.9 
-3.1 
0.2 1992 
-0.4 
-0.1 
0.9 
-1.7 
2.1 
-1.9 
-0.5 
*0.5 
-0.9 
1.9 
0.8 
-0.6 
-2.2 
-0.6 
-1.2 1993 
*-1.4 
-1.0 
•-1.7 
•-2.0 
0 
-4.3 
-1.4 
*0.7 
-1.5 
1.1 
-0.8 
-1.9 
-1.3 
*-1.7 
M.7 Unemployment (2) 
(as percentage of the civilian labour force) 
1988 1989 1990 1991 1992 1993 
10.2 8.6 7.6 7.5 8.2 9.4 
6.4 7.7 8.1 8.9 9.5 10.4 
6.3 5.6 4.8 4.2 4.5 5.6 
5.8 6.8 8.1 
7.7 7.5 7.0 7.2 7.5 7.6 
19.3 17.1 16.2 16.4 18.2 21.5 
9.9 9.4 9.0 9.5 10.0 10.8 
17.3 15.7 14.5 16.2 17.8 18.4 
10.9 10.9 10.0 10.1 10.3 11.2 
2.0 1.8 1.7 1.6 1.9 2.6 
9.3 8.4 7.5 7.1 7.2 8.8 
5.7 5.0 4.6 4.0 3.9 5.0 
8.5 7.1 7.0 8.9 10.2 10.5 
9.8 8.9 8.3 8.7 9.4 10.5 
8.9 9.7 10.9 B 
DK 
D(1) 
D 
GR 
E 
F 
IRL 
I 
L 
NL 
P 
UK 
EC(3) 
EC 
(1) European Commission estimates of November 1993 except for the figures marked with an asterix where more recent 
information has been included. (2) Harmonised Eurostat definitions (3) Excluding the five new German Lender 
Given these employment trends, unemployment continued to increase rapidly. 
Notwithstanding a slowing down in the average rate of increase in the labour force, 
22-03-94 
7-
unemployment in the European Community increased by 0.4 percentage points in 
1991, by 0.7 points in 1992 and by more than a full point (1.1) in 1993. 
The average rate of unemployment for the Community stood in 1993 at 10.6 per cent 
and was therefore practically back to the previous record level reached in 1985. The 
wide dififerences in the individual performances of the Member States persisted and 
actually increased. In Spain unemployment rose to over 21 per cent and in Ireland to 
over 18 per cent. In Germany the corresponding rate was less than 6 per cent for the 
western part of the country and about eight per cent for the country as a whole. 
1.1.3. Convergence situation in the Community 
The current economic difficulties have also had a profound effect on: 
• real convergence, the long term process of narrowing the differences in standards 
of living, and 
• nominal convergence, the improvement in the individual performances in terms 
of inflation and public finance positions which is necessary for the transition to 
Economic and Monetary Union. 
Real convergence: catching-up process stalled 
Of the four poorest Community countries only 
growth rate of economic activity in 1993 and 
thus improve its relative position. In the 
other three countries output contracted: in 
Greece slightly less than the Community 
average, in Portugal close to, and in Spain 
somewhat more than, the average. As a 
result, no significant changes could be 
registered for these countries in their relative 
positions in terms of GDP per head (the 
indicator usually used to approximate real 
standards of living). Unemployment, on the 
other hand, increased in all these countries 
including Ireland (see table 3). The 
deterioration in this respect was very strong 
in Spain where unemployment increased by 
more than 3 percentage points whereas in the Ireland was able to achieve a positive 
Table 4: 
GDP per head * (PPP, Community = 100) 
B 
DK 
WD 
D 
GR 
E 
F 
IRL 
I 
L 
NL 
P 
UK 
EC(1, 
EC 1985 
104.7 
114.2 
118.9 
51.3 
70.5 
112.0 
64.8 
102.6 
120.3 
104.4 
51.4 
100.9 
100.0 1990 
104.1 
106.2 
117.3 
47.2 
75.0 
110.7 
71.3 
102.3 
126.6 
101.9 
55.9 
101.4 
100.0 1992 
107.0 
104.9 
120.3 
104.9 
48.9 
75.7 
109.7 
75.4 
102.9 
128.9 
100.2 
60.7 
96.2 
100.0 
97.3 1993 
106.2 
105.8 
117.4 
104.0 
49.0 
75.7 
109.2 
77.4 
103.6 
130.1 
100.2 
61.1 
98.9 
100.0 
97.7 
* GDP figures may over/underestimate a country's 
command over its income. 
(1) Excluding the five new German Lander 
22-03-94 
(3) 
8-
other three countries the increase was smaller than that registered in the Community as 
a whole. 
Progress in nominal convergence mixed 
The recession had mixed effects on the nominal convergence performance of the 
Community: on the one hand, it provoked a new deterioration in the average 
budgetary position but, on the other, it contributed to the reduction of inflation. 
While past budgetary trends are reviewed in greater detail in the next section, some of 
the main features can be underlined here. Between 1991 and 1992 five Member 
countries were able to reduce their budget deficits as a percentage of GDP 
notwithstanding the economic slowdown. In 1993, however, general government net 
borrowing expressed as a percentage of GDP increased in many Member States. The 
public debt/GDP ratios also increased throughout the Community. 
Table 5 Significant progress was achieved on inflation. After its peak of 5.4 per cent in 1991 
the private consumption deflator fell to 4.6 per cent in 1992 and to 3.8 per cent in 
1993 despite the modest acceleration in import prices in 1993 and the impact of 
various indirect tax increases. 
Lower energy prices made a 
significant contribution. A better 
result was only achieved in 1987 
(because of the fall in the price of oil) 
and during two years in the 1960s. 
The average of the three best 
performing countries also declined 
from 2.4 per cent in 1991 (IRL, B, 
DK) to 2.1 per cent in 1992 (DK, B, 
F) and to 1.8 per cent in 1993 (DK, 
IRL, NL). The trend of the deflator 
of GDP was very similar (5.3 per 
cent, 4.6 per cent and 3.6 per cent 
respectively during the three years 
1991 to 1993). Impressive as these 
comparisons are, they should not lead 
to complacency given that the 
decline in inflation has been achieved B 
DK 
WD 
D 
GR 
E 
F 
IRL 
1 
L 
NL 
P 
UK 
EC Inflation 
(Deflator of private 
consumption) 
1991 
2.5 
2.5 
3.8 
18.4 
6.3 
3.0 
2.3 
6.9 
2.9 
3.4 
11.1 
7.4 
5.4 1992 
2.1 
1.9 
4.0 
4,8 
14.9 
6.4 
2.4 
2.6 
5.4 
2.8 
3.0 
9.7 
4.8 
4.6 1993 
2.8 
1.4 
3.4 
4.0 
13.7 
4.7 
2.3 
* 2.0 
4.4 
3.6 
2.1 
6.7 
3.4 
3.8 Budget deficit 
(General government net 
borrowing) 
1991 
*-6.8 
-2.2 
-3.5 
-3.2 
-16.3 
-5.2 
-2.1 
-2.0 
-10.2 
-1.0 
-2.5 
*-6.6 
-2.7 
-4.6 1992 
*-7.1 
-2.6 
-2.3 
-2.6 
-13.2 
-4.6 
*-3.8 
*-2.3 
-9.5 
-2.5 
-3.5 
*-3.3 
•-6.3 
-5.0 1993 
*-7.0 
-4.4 
•-2.8 
•-3.3 
-15.5 
-7.2 
*-5.5 
*-2.3 
•-9.4 
-2.5 
-4.0 
*-7.1 
-7.6 
•-6.0 
European Commission estimates of November 1993 except for 
the figures marked with an asterix where more recent 
information has been included 
22-03-34 
Chart 6 
Inflation in the EC 
(annual percentage changes) 
Deflator of private consumption 
64 67 70 73 76 79 82 85 88 91 94 
Import prices 
64 67 70 73 76 79 82 85 88 91 94 after a very long period of below potential 
growth. 
Some encouragement can be drawn from the 
fact that wage trends, especially towards the 
end of 1993 and at the beginning of 1994, 
are moderating (see chart 11). In 1993, 
nominal compensation per employee is 
estimated to have increased by 4.1 per cent 
for the Community as a whole. This figure 
is much lower than those recorded in the 
1970s and in the 1980s when inflation was 
higher, but it is also substantially lower than 
those recorded in the 1960s. The 
comparison with this last period, however, 
has lost much of its relevance since the high 
nominal wage increases of those years were 
made possible by high rates of increase in 
productivity. 
In 1993, the rate of inflation increased only in Luxembourg and Belgium and this was 
due to a large extent to the consequences of indirect tax increases. Particularly 
successful in reducing the rate of inflation were Portugal, the United Kingdom, Italy 
and Spain, countries where the rate of inflation was above the Community average in 
1992. Five Member States recorded encouraging rates of inflation of between two 
and three and a half per cent while 
Denmark experienced a rate of 1.4 per 
cent (see table 5). Germany, which is EC: inflation and wages 
(deflator of private consumption and nominal wages per head; 
excluding the new German Lander; annual % change) 
still suffering from the inflationary 
consequences of unification, plus Spain 
and Italy recorded rates of inflation of 
between 4 and 4.7 per cent. The rate 
of inflation remained well above the 
Community average in Portugal and 
especially in Greece. Although Greece has made considerable progress in reducing its 
inflation during the past three years, the divergence of its price trends from the 
Community average continues to be pronounced. 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 
22-03-94 
- 10 
1.2 The policies 
During the course of 1993, policy makers were confronted with very difficult choices. 
On the one hand, the worsening of the recession and the concomitant increase in 
unemployment were calling for a substantial stimulus to activity. On the other, the 
worrying budgetary situations in most countries and the resilience of inflationary 
pressures in some were suggesting the need for caution. The widening of the ERM 
margins in August added a new dimension to the debate through the effective removal 
of the exchange rate constraint. 
The discussions in the European Council meetings in Edinburgh, Copenhagen and 
Brussels and the initiatives that were decided on these occasions show that 
employment and growth again became the priorities for concern in the Community. 
This was reflected in the conduct of macroeconomic policy especially with regard to 
the budgetary decisions taken by Member States. As a result of the decisions of 
governments and central banks, the overall stance of macroeconomic policy in the 
Community eased significantly. However, the heavy inheritance of the previous years 
prevented economic policy from becoming as supportive to demand as the depth of the 
recession would have called for. 
At the same time, the severity of the situation increased the awareness of the need to 
improve the functioning of the Community's economy through determined action in 
the area of structural policies. Substantial progress in this respect took place, 
especially in countries where resistance to change had previously been strong. At the 
Community level, such concern led to the elaboration by the Commission, with 
contributions from all the Member States, of the White Paper on "Growth, 
Competitiveness and Employment" which was endorsed by the Brussels European 
Council and transformed into an action plan to revitalise the economy. 
1.2.1 The inheritance from the recent past 
The stance of economic policy in the course of 1993 was largely shaped by the very 
unbalanced situation existing at the end of the previous year. In turn, this was the 
result of past policy decisions to such an extent that it is useful to retrace the events 
that led to the situation existing at the end of 1992. 
i) 1987 to mid-1988. Between 1987 and 1988, the overall stance of economic 
policy in the Community became expansive. Monetary policy was loosened in the 
22-03-94 
-11 
course of 1987 in response to the abating of inflationary pressures, the relative 
weakness of economic activity and in application of the Louvre accord aiming to 
prevent further falls in the value of the dollar vis-à-vis the European currencies. 
An additional substantial loosening took place towards the end of 1987 as the 
authorities attempted to prevent the sharp fall in share values from negatively 
affecting consumption and investment. 
Table 6: Interest rates in the European Community * 
Short-term 
interest rates 
Long-term 
interest rates 
long-term minus 
short-term 
real short-term rates 
real long-term rates 1987 
8.4 
9.0 
+0.6 
5.0 
5.5 Dec. 
1987 
8.0 
9.4 
+1.4 
4.7 
6.0 May 
1988 
7.5 
9.0 
+1.5 
4.2 
5.6 Dec. 
1988 
9.5 
9.1 
-0.4 
.5.0 
4.6 Oct. 
1989 
11.3 
9.8 
-1.5 
5.8 
4.4 Dec. 
1989 
11.7 
10.2 
-1.6 
6.1 
4.7 1990 
11.4 
10.9 
-0.5 
5.4 
4.9 1991 
10.8 
10.2 
-0.6 
5.5 
4.9 May 
1992 
10.7 
9.6 
-1.1 
5.6 
4.6 Dec. 
1992 
11.0 
9.6 
-1.8 
7.1 
5.8 
* Weighted averages for the Community. Real interest rates are computed using the consumer price index. 
Budgetary policy also supported economic activity. Between 1987 and 1988, the 
cyclically adjusted budget deficit for the Community as a whole deteriorated by 
about half a point (see table 7)1. This average figure is the result of a 
discretionary loosening of budgetary policy in a majority of countries. In most 
cases, the discretionary loosening took the form of cuts in fiscal receipts and was 
largely the result of medium-term considerations. 
This overall economic policy stance can be explained by the widespread fear that 
the stock exchange crash might halt the hesitant recovery which had been under 
way for some time. Indeed, the forecasts for 1988 produced at the turn of the 
year by many private and public organisations were quite gloomy. In the case of 
the European Community, the forecasts were suggesting growth of no more than 
one and half per cent (the outturn was 4.2 per cent). 
ii) Mid-1988 to end of 1989. The authorities' policy reaction was probably very 
effective in preventing the stock exchange crash from affecting confidence. 
1 In view of the difficulties to account correctly for the influence of the economic cycle on revenue and expenditure, 
these figures are to be treated with caution. However uncertain the absolute figures may be, the direction of the 
change remains significant. 
22-03-94 
Chart 8 12 
Short-term interest rates and Yield curves in 
the Community and in Germany since 1987 
(monthly rates) 
^i&ariyx: 
JAJOJAJOJAJOJAJOJAJOJAJOJAJOD 
1987 I 1988 | 1989 | 1990 | 1991 | 1992 | 1993 
* Long term rates less short term 
However, it also stimulated an economy which was in a better state than the 
economic evidence available at the end of 1987 suggested. Thanks also to 
factors such as the internal market programme, better investment profitability, 
financial liberalisation and the delayed effects of the reduction in oil prices, the 
pace of economic activity accelerated significantly. The recorded rate of growth 
in the Community in 1988, 4.2 per cent, was the strongest since 1976, and is 
estimated to have overshot potential output growth by about one and a half 
percentage points (see chart 1 and table 8). 
In response to the unexpected dynamism of the economy and to counter the risk 
of renewed inflationary pressures, monetary policy was tightened throughout the 
Community from mid-1988 onwards. Budgetary policy, on the other hand, was 
only moderately tightened as many countries continued to implement previously 
announced tax cuts. Notwithstanding the monetary tightening, the economy 
continued to grow at a pace higher than potential growth. Capacity utilisation 
reached a record level and inflationary pressures started to increase. Fuelled also 
by a strong increase in import prices, inflation recorded a significant acceleration: 
5 per cent in 1989 against 3.8 per cent in 1988. 
iii) In 1990, budgetary policy became very expansionary with the estimated cyclically 
adjusted budget deficit deteriorating by 1.7 points of GDP and the actual deficit 
22-03-94 
13 
deteriorating by 1.3 points. This deterioration was due not only to developments 
in Germany, where the unification-induced surge in spending came on top of the 
tax reductions resulting from the last portion of the tax reform decided in 1988, 
but also to the attempts of the governments of many other Member States to 
counter the first signs of the incipient economic slowdown. Wage trends, which 
had remained relatively under control up until the previous year, reacted to the 
acceleration in inflation and as a result wage increases per head accelerated 
strongly (7.4 per cent against 5.8 per in 1989; see table 9). 
Table 7: Main budgetary trends in the European Community (% of GDP) 
Budget deficit 
Cyclically adjusted 
budget deficit 
Cyclically adjusted 
receipts 
Cyclically adjusted total 
expenditure 1987 
-4.0 
-3.6 
44.7 
48.2 1988 
-3.4 
-4.1 
43.4 
47.4 1989 
-2.7 
-3.9 
43.1 
47.0 1990 
-4.0 
-5.6 
42.6 
48.2 1991 
-4.6 
-5.7 
43.7 
49.5 1992 
-5.0 
-5.7 
44.5 
50.1 1993 
-6.0 
* -5.9 
* 45.8 
* 51.7 
Including the new German Lander from 1992 onwards * European Commission estimates of November 1993 
Table 8: Indicators of output and labour market tensions (EC) 
Actual less potential rate 
of growth (1) 
Capacity utilisation 
Unemployment rate 
Inflation (GDP deflator) 1987 
0.5 
82.6 
10.4 
4.0 1988 
1.5 
84.0 
9.8 
4.3 1989 
0.6 
85.6 
8.9 
4.9 1990 
0.0 
85.0 
8.3 
5.2 1991 
-1.4 
82.1 
8.8 
5.3 (2)1992 
-1.6 
80.4 
9.7 
4.6 1993 
-2.6 
77.6 
10.9 
3.6 
(1) Potential rate of growth approximated by the rate of growth of the capital stock (2) Including the new German Lander 
from 1992 onwards 
iv) 1991-1992. In the light of these developments monetary policy became even 
more restrictive in 1991-92 notwithstanding the emerging weakness of activity, in 
part reflecting the world-wide recession of 1991. This resulted largely from the 
fact that i) financial integration and the quest for exchange rate stability had led to 
a situation where monetary conditions in the Community were strongly influenced 
22-03-94 
14-
by conditions in Germany and ii) the latter was the country where the gap between 
actual trends and the monetary authorities' objectives was the largest. 
However, the cyclical positions of Member countries diverged. In West Germany 
economic activity remained buoyant and the needs of unification induced a new, 
strong, discretionary deterioration of the budget deficit in 1991. In the rest of the 
Community, however, activity was weakening while budgetary policy was 
becoming moderately restrictive as some governments tried to rein in runaway 
expenditure. Under these circumstances, authorities in the rest of the Community 
lowered short term interest rates. The credibility that policy coordination, the 
EMS parity grid and EMU prospects had acquired allowed these divergent trends 
to continue for many months. 
By mid-1992, however, doubts about the credibility of the existing ERM parity 
grid became visible. With the political difficulties surrounding the ratification of 
the Treaty on European Union acting as a catalyst, this situation led to the ERM 
crisis of September 1992. At the same time, the Community economy plunged 
into recession. 
Table 9: Inflation, wage and profitability trends (European Community) 
Inflation (Deflator of private 
consumption) 
Nominal wages per head 
Real wages per head 
(deflator of private 
consumption) 
Nominal Unit Labour Costs 
Real Unit Labour Costs 
(deflator of GDP) 
Profitability (1961-73=100) 1987 
3.6 
5.4 
1.7 
3.6 
-0.4 
82.7 1988 
3.8 
5.6 
1.8 
2.8 
-1.4 
87.7 1989 
5.0 
5.8 
0.7 
3.8 
-1.0 
91.2 1990 
4.5 
7.4 
2.7 
6.0 
0.7 
90.0 1991 
5.4 
7.0 
1.5 
5.7 
0.4 
88.5 1992 
4.6 
7.0 
2.3 
4.6 
0.0 
88.2 1993 
3.8 
4.1 
0.3 
2.7 
-0.9 
86.3 
Including the new German Lander from 1992 onwards 
v) At the end of 1992, policy makers were forced to face the recession starting from 
a very unbalanced policy situation whose main features were: 
22-03-94 
15 
Very worrying budgetary positions with budget deficits increasing in most 
countries and debt/GDP ratios increasing in all. 
Wage trends were beginning to adjust to the changed economic conditions but 
wages per head were still increasing at a rate clearly incompatible with the 
authorities' stability objectives. 
Finally, monetary policy, notwithstanding a cautious start towards an easing 
process, remained very tight: interest rates were high, especially in real terms (see 
table 6), and the yield curve was inverted and strongly negative. 
1.2.2 Budgetary policy in 1993 
Chart 9 
Outstanding gross public debt and general 
government net borrowing in the EC 
(percentage of GDP) 
Public ictebt Due to the widespread recession, no Member State could reduce its budget deficit 
(general government net borrowing, national accounts definition which includes 
central government, regional and local authorities and social security) as a percentage 
of GDP in 1993. Seven countries, namely Denmark, Germany, Greece, Spain, 
France, Portugal and the United Kingdom 
registered considerable increases in their 
deficits (see table 10). Particularly large 
were the deteriorations recorded in Portugal, 
Spain and the United Kingdom. In Italy the 
deficit was contained by rigorous fiscal 
measures. A number of Member States 
chose to acknoledge the seriousness of the 
economic downturn and allowed the 
"automatic stabilisers" to operate, resulting in 
some deterioration in their budgetary 
positions. Some countries, for instance 
France, the United Kingdom and Denmark 
even took discretionary action to support 
demand, although the room for manoeuvre 
was very limited. In addition, all countries 
proceeded to review their spending programmes with the aim of switching expenditure 
towards those programmes which had the strongest effects on growth and 
employment; public investment being the obvious example. In this respect, it is worth 
noting that public investment increased from 2.6 points of GDP in 1988 to 3 points in 
1993 notwithstanding the pressure on public expenditure exerted by the recession. :•:+:•:*:•:*:•:< ::4-v+>:*::<:^::<:-:<:-:<:-:<-:-:<-: •<•::( ::c--n:-:t:-:t:-:t::i::i::i 
70 72 74 76 78 80 82 84 86 88 90 92 
22-03-94 
(4) 
16-
Chart 10 
Total expenditure and current receipts in the EC 
% of GDP Budgetary slippage led to sharply rising 
debt/GDP ratios in most of the Member 
countries. On average, the debt ratio 
increased by almost 10 percentage points 
from 56,5 per cent in 1989 to 65.9 per 
cent in 1993. This automatically 
created a growing interest burden for 
national budgets. This type of 
expenditure already represents more than 11 per cent of total public expenditure and 
around 5V& per cent of GDP. However, in 1993 the gradual reduction in interest rates 
helped to mitigate this. While interest payments had increased by almost 14 per cent 
in 1992, the increase was only 4 per cent in 1993. 
Table 10 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 
B 
DK 
D 
GR 
E 
F 
IRL 
I 
L 
NL 
P 
UK 
EC General government primary 
balance (excluding interest payments) General government net borrowing 
percentages of GDP 
1991 
3.9 
5.1 
-0.5 
-3.5 
-1.2 
1.0 
5.6 
0.0 
-0.4 
3.6 
1.7 
0.3 
0.4 1992 
4.3 
4.2 
0.7 
0.4 
-0.4 
-0.5 
4.9 
1.9 
-1.9 
2.7 
4.3 
-3.0 
0.4 1993 
3.7 
3.1 
0.1 
-0.5 
-2.2 
-2.2 
4.2 
2.0 
-1.7 
2.3 
-0.4 
-4.5 
-0.9 1991 
* -6.8 
-2.2 
-3.2 
-16.3 
-5.2 
-2.1 
-2.0 
-10.2 
-1.0 
-2.5 
* -6.6 
-2.7 
-4.6 1992 
* -7.1 
-2.6 
-2.6 
-13.2 
-4.6 
* -3.8 
* -2.3 
-9.5 
-2.5 
-3.5 
* -3.3 
* -6.3 
-5.0 1993 
* -7.0 
-4.4 
* -3.3 
-15.5 
-7.2 
* -5.5 
* -2.3 
* -9.4 
-2.5 
-4.0 
* -7.1 
* -7.6 
* -6.0 
European Commission estimates of November 1993 except for the figures marked with an asterix where more recent 
information has been included 
During 1993 it became clear, in Member States, that the scope for a budgetary 
stimulation of the economy had been exploited and that any action in this direction 
would have seriously affected policy credibility and would have had more negative 
than positive effects on the economy as a whole. 
Table 11 
22-03-94 
- 17-
B 
DK 
D 
GR 
E 
F 
IRL 
1 
L 
NL 
P 
UK 
EC Gross public debt (1) Interest payments 
percentages of GDP 
1991 
(2) 129.5 
(3) 64.2 
42.1 
(4) 103.9 
45.2 
35.5 
97.0 
101.4 
(5) 6.2 
79.0 
69.4 
35.8 
57.0 1992 
(2) 131.9 
(3) 68.4 
44.8 
(4) 110.2 
48.2 
39.5 
94.5 
108.0 
(5) 7.3 
79.7 
61.7 
41.8 
60.9 1993 
(2) 138.4 
(3) 80.6 
48.9 
(4) 121.2 
55.9 
44.1 
99.0 
118.1 
(5) 10.0 
81.4 
66.4 
(6) 48.8 
65.9 1991 
10.6 
7.3 
2.8 
12.8 
4.0 
3.1 
7.7 
10.2 
0.6 
6.2 
8.3 
3.0 
5.0 1992 
11.2 
6.8 
3.3 
13.6 
4.2 
3.4 
7.1 
11.4 
0.6 
6.2 
7.6 
2.9 
5.4 1993 
10.7 
7.5 
3.5 
15.0 
5.0 
3.7 
7.3 
12.0 
0.8 
6.3 
6.7 
3.1 
5.6 
European Commission estimates. (1 ) General government consolidated gross debt at nominal value; (2) Social security 
debt not included; (3) Government deposits with the central bank, government holdings of non-government bonds and 
public enterprises related debt amounted to 17.8% of GDP in 1991, 20.1% in 1992 and 27.3% in 1993; (4) Military debt 
not included. Various balances outstanding with the banking sector not included for 1993 (5) Not consolidated. Social 
security debt not included (6) End of financial year (31 March 1994) 
1.2.3 Wage trends 
Wage trends moderated substantially during the course of 1993. The average increase 
in nominal wages per head for the year as a whole was 4.1 per cent against 7 per cent 
in 1992 (see table 9). Given that productivity continued to increase, even if at the 
cost of employment reductions being larger than the fall in output, this implied a 
substantial deceleration in unit labour costs which are estimated to have increased in 
1993 by 2.7 per cent against more than four per cent in 1992. Thus, average 
Community trends improved substantially on the performance of the two/three 
previous years, yet they still did not quite reach what was required for the achievement 
of the authorities' stability objective. In addition, if compared to the developments in 
the 
EC: inflation and wages 
(deflator of private consumption and nominal wages per head; 
excluding the new German Lander; annual % change) 
fOttCSStS 
90 91 92 93 94 95 Community's main competitor 
countries, wage increases in the EC were 
still relatively high. 
In some Member States, however, wage 
developments were less satisfactory. In 
Greece, the rate of increase in nominal 
wages per head remained at the same high 
22-03-94 
18 
level of 1992 (above 11 per cent); however, in inflation-adjusted terms wages fell. In 
Spain and Portugal, wage increases slowed down compared with 1992 but were still 
well above the Community average and clearly incompatible with rising 
unemployment. On the other hand, Denmark, France and Italy recorded average 
wage increases significantly below the Community average. 
Notwithstanding the recession, real wage costs per head increased, even if only slightly 
(+0.5 per cent in real terms). Since their increase fell short of productivity increases 
by about a percentage point, their trend contributed to improving investment 
profitability. Indeed, the average outcome for 1993 was in line with the rule of thumb 
suggested both in the White Paper and the Economic Policy Guidelines (real wage cost 
increases per head one percentage point below productivity increases). 
Towards the end of the year, signs appeared which suggested that wage increases 
were moderating further and that the conflict between wage trends and price stability, 
which had been a distinctive feature of the policy mix of the 1990-92 period, could be 
disappearing. 
1.2.4 Monetary policy 
For the Community as a whole, monetary conditions eased significantly during 1993 
both before and after the new ERM crisis of July. Short-term interest rates also fell 
in most countries and, even though inflation was declining, real short term rates fell (a 
reduction of more than four points in nominal short term rates and about three and a 
half points in real short term rates; December 1993 over December 1992, Community 
average, see table 16). Long term yields also continued to decline in nominal terms 
but yield curves became much less inverted than had been the case at the beginning of 
the year. 
These trends were not continuous during 
the course of the year. Indeed, for several 
countries there was considerable volatility 
both in interest rates and in exchange rates 
as periods of turbulence continued to 
afflict the ERM. The year began with 
very heavy pressure on the French Franc 
which eased after a repeat of the previous Chart 12 
EC: Real short and long term interest rates 
OL (Quarterly figures; Interest rate* tots current rate of Inflation) 
1973-IV 197S-N 1977-tV 1979-IV 198HV 198WV 198S-IV 1987-N 1989-IV 1991-IV 1993-IV 
22-03-94 
19 
Chart 13 
Interest rates in some 
Member States 
Short term 
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct 
91 ! 92 I 93 September's joint declaration of support 
for the parity by the French and German 
governments and central banks. But 
French short-term interest rate 
differentials remained high throughout 
the first quarter of 1993. At the end of 
January, after a period of intense market 
pressure, the bilateral central rates of the 
Irish pound were reduced by 10 per cent. 
Immediately afterwards, the Danish krone 
came under very heavy pressure. 
However, concerted intervention and a 
reduction in Bundesbank interest rates 
calmed the foreign exchange markets. 
In the Spring, after the French general 
elections were over and the new 
government had reaffirmed the "franc fort" policy, pressures on the French Franc 
eased rapidly, allowing differentials vis-à-vis the DM to fall and, by late June, to 
become negative. Indeed, short rates were below German levels in all other narrow­
band countries except Denmark (whose remaining positive differential was very small). 
In the wide band, however, the Spanish Peseta and the Portuguese Escudo were again 
devalued in May, the former currency by 8 per cent and the latter by 6.5 per cent. 
During July, generalised tension developed linked to market perceptions of weak or 
declining activity, rising unemployment and/or worsening public finance situations in a 
number of the countries whose monetary policies were tied to those of Germany. In 
such circumstances, markets believed that the countries concerned would have had 
difficulty in conducting a prolonged defence of the narrow bands via increased interest 
rates. 
At the beginning of August, the decision was taken by the authorities to widen the 
ERM bands to +/- 15% for all participating currencies2 without changing the central 
rates. The widening of the bands had the effect of re-introducing an effective two-way 
risk into the system. Markets had to assess the sustainability of the monetary policy 
stance in each country on the grounds of fundamentals, undisturbed by a need for 
exceptionally high interest-rate differentials. Initially, several currencies depreciated 
The Dutch and German authorities announced a bilateral agreement, outside the ERM framework, to maintain their 
currencies within bilateral bands of +/- 2Vi%. 
22-03-94 
20 
significantly against the DM. Subsequently, reductions in German interest rates 
allowed reductions in other ERM countries. 
Table 12: Nominal effective exchange rates (quarterly figures; 1992-1= 100) 
B 
DK 
D 
GR 
E 
F 
IRL 
I 
NL 
P 
UK 
EC 1992-111 
102.14 
103.59 
103.42 
95.68 
99.90 
103.72 
102.57 
100.06 
102.12 
102.41 
100.78 
105.79 1992-IV 
104.18 
106.07 
105.53 
92.76 
92.33 
106.05 
105.19 
88.58 
104.49 
101.65 
88.39 
98.59 1993-1 
104.27 
107.34 
105.68 
90.35 
92.38 
106.35 
99.73 
81.62 
104.88 
100.10 
86.79 
95.03 1993-11 
103.61 
106.47 
104.60 
88.46 
87.20 
106.02 
96.23 
82.30 
104.29 
96.39 
88.76 
93.87 1993-111 
101.04 
101.52 
104.43 
85.76 
81.15 
102.70 
93.07 
80.57 
104.35 
90.42 
89.79 
90.13 1993-IV 
100.54 
103.07 
105.13 
84.07 
80.81 
103.52 
94.32 
77.83 
105.17 
89.29 
89.85 
89.93 
Relative to their 20 (9 for the EC as a whole) most important trading partners 
Cyclical conditions in some of these countries showed signs of relative improvement 
vis-à-vis Germany, differentials declined and most former narrow-band currencies 
returned, by the end of 1993, to within their former bands. This development, i.e. the 
fact that the authorities concerned did not feel it appropriate to use the additional 
room for manoeuvre opened up by the August decision, has positive implications for 
economic and monetary cooperation. 
Outside the ERM, the pound sterling 
reached a trough in late January following 
a reduction in interest rates to 6 per cent 
but subsequently recovered fairly steadily 
throughout the rest of the year. A further 
cut in UK interest rates took place in 
November in a context of declining 
interest rates elsewhere in Europe. The 
Italian Lira experienced sharp fluctuations 
during the course of the year, mainly 
limited to market perceptions of the 
impact of political events. Table 13: 
Monetary and credit targets in 1993 
D 
F 
E 
I 
UK M3 
M2 
M3 (new) 
M3 
ALP + CP 
ALP 
PSCE (1) 
M2 
M4 
M0 Target 
4.5 - 6.5 
4 - 6.5 
4 - 7 
4.5 - 7.5 
5 - 7 
3 - 9 
0 - 4 Outcome 
(annual rate) 
8.1 (Dec) 
0.0 (93-IV) 
-1.5(93-IV) 
8.1 (Dec) 
7.5 (Dec) 
8.6 (Dec) 
7.9 (Dec) 
4.9 (Nov) 
5.8 (Dec) 
(1) Domestic credit to the private sector 
22-03-94 
21 -
The turbulence in the ERM was one factor contributing to contrasting developments in 
monetary aggregates. Of the Community countries that set targets for the aggregates, 
there was overshooting in Germany, Spain and (outside the ERM) Italy, while there 
was a very substantial undershooting in the case of France. In the overshooting 
countries, the link between the aggregates and final variables (underlying inflation 
slowed in all three countries while activity was flat or falling) appeared to be less 
strong than in the past; but in France the undershoot (after allowing for special factors) 
appears to have been also related to a weakness in the growth of nominal income that 
probably continued into the final quarter of the year. 
Chart 14 Exchange rates in the Community 
Percentage change in the value of Community currencies 
vis-à-vis the DM since September 1992 
5, 
SEP NOV JAN MAR MAY JUL SEP NOV JAN SEP NOV JAN MAR MAY JUL SEP NOV JAN 
22-03-94 
22-
1.2.5 Structural adjustment policies 
Member States have recently taken important measures in the field of structural policy. 
In particular, various countries started or continued privatisation programmes (Italy, 
France, Spain, Belgium, Ireland, Portugal), reduced or re-orientated subsidies 
(Germany and Ireland) or lifted administrative and legal barriers to market entry 
(Greece). 
Various countries have undertaken bold steps to improve training programmes and to 
target them more towards school-leavers and the unemployed (United Kingdom, 
France). Almost all countries have taken measures to help small businesses. These 
measures range from fiscal incentives, to start-up help and to the simplification of 
administrative procedures. Italy has taken important measures aimed at improving the 
functioning of its public administration. 
Measures related to the labour market and labour costs have also been taken. In 
Spain, structural reform, especially of the labour market (for instance the legalisation 
of private employment agencies), is an important element in government policy 
considerations. In Italy, the abolition of the indexation of wages ("scala mobile") in 
1992 was followed in July 1993 by an agreement that future wage developments must 
be consistent with agreed inflation targets as well as a number of measures to increase 
the flexibility of the labour market. In Belgium, the "Global Plan" has introduced a 
new index for the adaptation of wages (the "health index" which excludes tobacco, 
alcohol and petrol prices) as well as a real wage freeze for 1995-96. In Germany, the 
social partners have agreed to an extended timetable for the equalisation of wages 
between the eastern and western part of the country for some key industrial sectors. 
In order to improve labour supply, some relevant aspects of the social security system 
were tackled. More stringent eligibility requirements for payment of pensions 
(increase of retirement age and/or qualifying period) were introduced in France, Italy, 
Portugal and the United Kingdom and stricter rules regarding payment of 
unemployment benefits were enforced in Belgium and Spain. In order to reduce the 
high level of social security contributions, employer's charges for certain categories 
were cut in Belgium, France, Ireland and Spain. The United Kingdom has launched a 
scheme designed to encourage employers to invest in developing their training 
strategies so that the skills of the workforce are improved. 
22-03-94 
23 
Although some of these measures will bear fruit only in the medium term and although 
structural measures are especially unpopular in times of recession, Member States have 
to continue these structural adjustment efforts in order to allow for a smooth 
development of the economy and the labour market in the years to come. The 
decision of the Brussels European Council to establish an action plan based on the 
White Paper will contribute to a more effective implementation of structural reform 
both at the national and the European levels. 
1.2.6 The Edinburgh and Copenhagen Growth Initiative 
The Edinburgh Growth Initiative was launched by the European Council in December 
1992 as a reaction to the slowdown in economic activity in the early 1990s. It was 
created as an instrument to promote economic recovery and employment via 
investment, for instance in physical infrastructure in the areas of transport, energy, 
communications and environment, with the priority being given to the development of 
Trans-European Networks (TENs). It was geared to exploit all possible margins for 
manoeuvre in national public budgets and to boost the confidence of economic agents 
without departing from the objective of medium-term budgetary consolidation. 
Progress in relation to the Growth Initiative has been closely followed by the EcoFin 
Council and the Copenhagen and Brussels European Councils of June and December 
1993. These reviews have confirmed the broad strategy to be followed. Firstly, the 
measures taken in relation to the Growth Initiative must be consistent with the 
medium-term requirements of the Treaty on European Union. Secondly, they must 
strike a balance between providing a short-term stimulus to economic activity without 
jeopardising longer term growth prospects and finally, they must include a combination 
of measures at the Community and national levels. 
In 1993, loans of almost ECU 3,4 billion were granted to 59 projects under the 
temporary lending facility of ECU 8 billion (including the additional ECU 3 billion 
agreed by the Copenhagen Council) established by the European Investment Bank. 
The total investment involved in these projects is estimated at ECU 29,1 billion. 
Progress towards the establishment of a European Investment Fund has been slower 
than expected, but substantial progress has been achieved in accelerating investment 
under the new Cohesion Fund's financial instrument. Following the submission of 
eligible projects by the four countries concerned by the Cohesion Fund, the 
22-03-94 
(5) 
-24 
Commission approved total appropriations of over ECU 1500 million in respect of 
more than 230 projects. 
With the establishment of the new generation of "Community Support Framework", 
ECU 8 billion will be available for investment in 1994 from the Union's structural 
funds. The need for increased resources for SMEs has been addressed through the 
adoption by the Council of a new multi-annual action programme involving overall 
expenditure of ECU 112,2 million of which ECU 85 million represents new support 
decided in the framework of the growth initiative. Furthermore, the Copenhagen 
European Council provided for additional loans of ECU 1 billion under the EIB 
temporary lending facility for measures to improve the job creation potential of SMEs, 
with an interest rate subsidy linked to employment creation. Unfortunately, the 
implementation of this measure has encountered some obstacles which have delayed its 
effects. 
22-03-94 
-25 
Section 2: The outlook for 1994 and beyond 
At the beginning of 1994 there are signs that the sharp deterioration in confidence and 
in other survey indicators, which occurred in the first half of last year, has been 
arrested and in some cases has even shown some improvement. While some of the 
evidence is conflicting, the overall impression is that the Community may well have 
reached the trough of the recession. The latest indicators, however, provide little 
evidence of a rapid upturn. At the end of last year, the Commission services had 
forecast Community GDP to grow by a modest 1 VA per cent in 1994 and about 2 per 
cent in 1995. Despite the considerable risks characterising the outlook, the evidence 
which has become available in the interim does not suggest any need to modify this 
projection. 
On the basis of the above Commission projections, the jobless total will continue to 
grow in both forecast years reaching 11% per cent in 1995, the highest recorded rate 
in Community history, before starting to decline. Inflation is expected to be reduced 
further, while progress towards reducing budgetary deficits will be slowed down by 
the slow pace of the recovery. 
Table 14: The Community economy : Use and supply of goods and 
services 
(annual real percentage change) 
Private consumption 
Government consumption 
Gross fixed capital formation 
Domestic demand (incl. stocks) 
Exports of goods and services b) 
Imports of goods and services t>) 
GROSS DOMESTIC PRODUCT 1993 
-0.1 
0.5 
-4.6 
-1.3 
3.6 
-3.1 
-0.3 1994 a) 
0.3 
0.5 
2.0 
1.0 
5.7 
2.6 
1.3 1995 a) 
1.3 
0.4 
4.5 
1.9 
5.8 
3.9 
2.1 
a) Forecasts b) Extra-Community trade only 
The figures presented in table 14 reflect the mid-point of a wide range of possible 
outcomes. The uncertainties attached to these forecasts are particularly high on this 
occasion given that the Community's economy is apparently close to a turning point 
and therefore that consumer confidence, notoriously difficult to predict, will play a 
major role. Small changes in the saving behaviour of households can produce 
significant variations in the rate of growth of private consumption, which is by far the 
largest component of total demand. A worse than expected outcome could emerge if 
22-03-94 
26 
Chart 15 
EC: Survey indicators 
Consumer confidence 
6 12 6 12 6 12 6 12 6 12 6 12 6 12 
| 87 | 88 | 89 | 90 | 91 | 92 | 93 6 12 6 12 6 12 6 12 6 12 6 12 6 12 
| 87 | 88 | 89 | 90 | 91 | 92 | 93 
investor confidence does not begin to appear in a form more convincing than it does at 
present. On the other hand, a stronger recovery could materialise if the Community's 
export performance improved substantially and/or the present tentative signs of upturn 
were to prove sufficient to rekindle consumer confidence. In both cases, investment, 
which is expected to pick up somewhat because of cyclical factors and because of 
lower borrowing costs, could be stimulated further. The subsequent paragraphs will 
assess the relative strengths of the growth depressing and promoting factors which are 
inherent in the Community's short term outlook and will stress the high degree of risk 
in terms of accurately predicting the likely course of events in the Community over the 
next two years. 
Growth depressing factors 
A pessimistic viewpoint could be justified by the continuing influence, although 
admittedly diminishing, of some of the main recessionary forces of the last two years: 
tight monetary conditions, the difficulty of EC firms to profit from a relatively benign 
international economic environment and the continuation of low levels of confidence 
amongst economic agents, especially consumers. 
Despite the reductions which have taken place in the course of 1993, short term 
interest rates remain high given the cyclical position of the Community's economy. A 
continued cautious monetary easing in 1994 appears to be largely discounted by both 
consumers and investors so that a process of accelerated cuts in borrowing costs may 
be required in order to provide the basis for an upswing in economic sentiment and 
22-03-94 
-27 
activity. Such an acceleration could take place if the current trend towards a 
reduction in inflationary pressures were to be confirmed over the coming months. 
Furthermore, while the outlook is for a gradual strengthening in world output and 
trade growth in 1994 and 1995, and while the Community's external competitiveness 
in both cost and non-cost terms remains relatively weak, Community exporters might 
not be able to fully benefit from this strengthening. Continuing low levels of business 
and consumer confidence could also be a constraining factor on growth in 1994 due to 
the ongoing uncertainty generated both by high and rising rates of unemployment and 
the credibility damage inflicted by currency upheavals to the prospects for EMU. 
In addition to the ongoing influence of a number of the growth-constraining factors of 
previous years, one additional specific factor could take on an increasingly important 
role in 1994 and 1995. Given the alarming pace of deterioration in the budgetary 
situation in some Member States, a number of Member States have either announced 
or started to implement ambitious budget consolidation programmes in the closing 
months of last year. These programmes are essential to put countries' budgetary 
positions on a more sustainable and firm footing following the sharp deteriorations 
which have occurred over recent years and are a vital precondition for the re-
establishment of a robust medium-term growth path in the economies concerned. 
While the longer-term benefits are not in doubt, it is not clear the extent to which the 
demand-dampening impact of such fiscal retrenchment strategies in the short-run can 
be offset by any potential crowding-in effects resulting from lower interest rates and 
increased levels of confidence. To the extent that these programmes can convince 
economic agents that the authorities have it within their power to reduce budget 
deficits, the crowding in effects will be stronger. 
Growth promoting factors 
A more optimistic viewpoint could be justified by a more sanguine assessment of the 
behaviour of consumers, based, for instance, on the progress made in reducing the 
indebtedness of households. Their savings ratio could drop by more than expected 
and private consumption could recover more strongly thus creating a virtuous 
consumption/investment circle. Even in the absence of such a development, 
investment could improve faster than predicted. Following a decline of over 4!/2 
percentage points last year, fixed capital formation is currently forecast to grow by 2 
per cent in 1994 with a further strengthening to 4Vi per cent forecast for 1995. A 
22-03-94 
28 
large number of factors could combine to produce a stronger investment-driven upturn 
in the Community: 
• following some years of contraction, a revival in investment levels is likely for 
purely cyclical reasons; 
• moderation in both employee compensation rates and in nominal unit labour costs 
has made a substantial contribution to investment profitability, which is now 
higher than at the same point of previous cycles (see chart 5); 
• the coming on stream of projects resulting from specific incentive schemes to 
switch public expenditure towards infrastructure investment and other growth 
promoting capital investments; 
• a stronger than expected improvement in Community competitiveness as a result 
of a lower increase in unit labour costs and/or a lower than expected effective 
exchange rate of the Community's currencies; 
• expectations of a more benign domestic demand environment as a result of more 
favourable trends in the areas just mentioned combined with moderate and 
decreasing energy prices; 
• improved external demand prospects as a result of the dynamism of some 
important economies and of the completion of the GATT agreement. 
An acceleration of the present trend towards lower borrowing costs would combine 
favourably with these factors and could lead to a faster than expected recovery. 
With regard to the improved external 
demand prospects mentioned above, it is 
important to examine the overall trends in 
relation to world output and trade as well as 
examining the performance of individual 
countries or groups of countries. Firstly, it 
should be underlined that the outlook for 
world output growth in 1994 and 1995 has 
become a little more favourable in recent 
months. This increased optimism emanates 
essentially from the more dynamic than 
expected performance which has become 
evident in the case of the United States and 
Canada. In overall terms, output growth for 
the world, excluding the EC, is expected to Table 15: World Growth 
GDP /GNP (annual real % change) 
EC 
USA 
JAPAN 
EFTA 
WORLD 1991 
1.4 
-0.8 
4.4 
-0.5 
0.8 1992 
1.1 
2.6 
1.3 
-0.3 
1.7 1993 
-0.3 
3.0 
-0.1 
-0.4 
1.6 1994 
1.3 
3.5 
0.8 
1.7 
2.6 1995 
2.1 
2.6 
2.8 
2.9 
3.1 
IMPORTS (annual real % change) 
OECD 
DAE a) 
LDCb) 
World 
exc. EC 
WORLD 1.5 
14.1 
10.0 
1.8 
3.0 3.6 
10.3 
14.6 
6.2 
5.0 1.0 
13.8 
12.2 
8.4 
3.4 5.0 
12.3 
8.8 
8.5 
6.4 5.2 
12.2 
8.9 
8.0 
6.5 
European Commission forecasts 
a) DAE: Dynamic Asian Economies 
b) Less Developed Countries (excluding DAEs, OPEC and 
the countries of Central and Eastern Europe) 
22-03-94 
29 
be about a quarter of a percentage point higher for both 1994 and 1995 than expected 
at the time of the Autumn 1993 forecasts, with three percent now being forecast for 
the present year and three and a half percent envisaged for 1995. With regard to 
world trade the present view is also more optimistic than that which prevailed in 
October/November of 1993 and again as with GDP growth the main explanatory 
factor is the performance of the United States. Not only is the growth performance of 
the United States expected to be higher than in 1994 and 1995 than previously 
thought, its import propensity is also expected to increase. In overall terms, world 
trade excluding the EC, measured by import volumes, is assumed to increase by eight 
to eight and a half percent over the forecasting period which is roughly one percentage 
point higher than the assumption underlying the Autumn 1993 forecast. It is 
important for Community exporters to more actively exploit these additional external 
opportunities which are evidently emerging. 
Medium-term projections point to a wide range of outcomes 
The available medium to long-term projections for the Community show that a wide 
range of outcomes is possible. If economic trends in 1994 and 1995 develop as in the 
central scenario of the Commission's economic forecasts, there will be a good 
probability that the rate of growth could reach 3 per cent by 1996 and that 
unemployment could start falling. This outcome is conditional on the expected 
gradual strengthening of exports, investment and consumer confidence, but even more 
so on the avoidance of some pitfalls. The first is that the conflict between price 
stability objectives and wage behaviour, which has now almost entirely disappeared, 
does not arise again. The second is that the authorities' ability to take control, over 
the medium term, of the budgetary situation becomes and remains credible. This is 
important in order not to overburden monetary policy, to maintain a balanced policy-
mix with low interest rates, to maintain confidence and to get under way the necessary 
process of increasing national savings. 
But even if these errors are avoided and the Community's economy returned to a 
growth path of around three per cent, this will be difficult to maintain and the expected 
reduction in unemployment will be small unless the potential rate of growth is also 
increased. To achieve the objective of reducing substantially the rate of 
unemployment, the White Paper underlined the need to act decisively to strengthen the 
dynamism of the Community's economy, to increase its potential rate of growth and to 
make growth more employment intensive. 
22-03-94 
-30-
The dynamism of the Community's economy will be strengthened by the full 
exploitation of the possibilities offered by its internal market, by the maintenance of an 
open trading system, additional efforts to improve training systems and research efforts 
and by the rapid completion of the planned infrastructure networks (TENs). In 
addition, there is a continued need to reform the legal and institutional framework in 
which the productive process takes place with a view to adapt it to market needs, to 
the new international and technological environment and to the need of making growth 
environmentally sustainable. 
Increasing the potential rate of growth of the Community depends on creating the 
conditions which will bring about an increase in the rate of growth of the capital stock 
and, by necessity, an increase in the share of investment in GDP. As the White Paper 
has stressed, this depends on many factors, some of which cannot be controlled 
directly by policy makers, but requires in any case a further increase in investment 
profitability and an increase in national savings. These two trends depend in turn on 
real wages continuing to increase less than average productivity and on the public 
sector returning to positive rates of saving which implies substantially lower budget 
deficits. 
A more employment intensive growth pattern will require action in a large number of 
areas which have been indicated in the White Paper. In particular, efforts will have to 
be continued to improve the efficiency of labour markets, to give them greater 
flexibility, to adapt working time to the needs of employers and employees, to review 
the effects on employment of the arrangements to finance social security and to reduce 
as far as possible non-wage costs on the lowest wages and on those of young workers. 
22-03-94 
31 
Section 3 The policies for more growth and 
employment 
The White Paper on "Growth, Competitiveness and Employment" clearly indicated 
that to substantially reduce unemployment the Community needed to return to 
sustained rates of growth and to strengthen the capacity of the European Economy to 
create jobs. In so far as the latter area is concerned, the framework defined in the 
White Paper will serve as a reference for Member States' policies and the Commission 
will be monitoring the progress made. 
To achieve a stronger rate of growth, the Economic Policy Guidelines adopted last 
December by the Community have confirmed the macro-economic part of the strategy 
presented in the White Paper which was aimed at: 
i) sustaining the recovery without putting at risk the prospects for sustained growth 
in the medium term; 
ii) increasing the dynamism of the economy and its potential rate of growth so as to 
be able to reach and sustain stronger rates of growth. 
3.1 Sustaining the recovery 
The current economic situation of the Community calls for very difficult policy 
choices. As noted in section 1, the Community's economy taken as a whole, appears 
to have reached the trough of the recession but the recovery is, and indeed is expected 
to be, hesitant and slow. Supply conditions are better than at the same point of 
previous cycles but demand expectations remain very subdued. Exports towards the 
rest of the world appear to be picking up but their small relative weight (about 10 per 
cent of GDP) makes it unlikely that very strong growth impulses can be expected from 
this direction. Investment is showing some signs of improvement but it is unlikely to 
pick up strongly until overall demand prospects clearly improve. 
Across the Community, the general consensus view among the relevant authorities is 
that the room for manoeuvre is limited. The unsatisfactory budgetary situation is 
largely due to the fact that fiscal policy has not only been used to counter the effects of 
the recession but has started from a position of structural imbalance. The conclusion 
in the jointly agreed Economic Policy Guidelines is that further slippage in the present 
situation could only produce very short term benefits, which in all likelihood would be 
22-03-94 
(6) 
-32-
more than offset by the adverse reaction in financial markets and a further weakening 
of confidence. 
Wage increases have slowed down considerably and this has contributed to lower 
inflation and improved competitiveness and profitability. Despite possible downward 
pressure on aggregate demand, the general view in Member States is that the risk of 
some future wage and price inflation cannot be entirely ruled out. Inflation in the 
Community at 3 V2 per cent (deflator of private consumption) in 1994 represents a 
considerable improvement on the recent past but more is needed to achieve the 
Guidelines' target and the aim of squeezing inflation out of the system remains a 
priority. Again success on this point will improve expectations and serve to boost 
confidence. 
At the same time, there is a strong commitment to measures aimed at improving 
market functioning to increase the dynamism of the economy and to offset any 
disincentives to increase productivity which might result from a policy of wage 
restraint. 
Under these conditions, the White Paper had reached the conclusion, implicitly 
confirmed by the Guidelines, that the most significant contribution economic policy 
could make to sustaining the recovery was to continue to make progress towards 
eliminating the conflict between the stability objective and wage and budgetary 
behaviour. This would allow short term interest rates to fall even more than presently 
expected and would have substantial positive effects on the behaviour of both 
consumers and business. This is particularly important since the easing of monetary 
conditions in the Community has not yet proceeded to the point at which the stance is 
consistent with a strong recovery in activity in the Community, especially in the light 
of the budgetary retrenchment in prospect for 1994 and beyond in many Member 
States. The following paragraphs will discuss the present stance of monetary policy 
and the progress achieved in creating the conditions for lower interest rates. 
3.1.1 The current monetary policy stance 
Short-term rates of interest, as noted in section 1 above, fell significantly in late 1992 
and into 1993. Indeed, in a period of just over a year (September 1992 to October 
1993), short rates in Germany, the ERM anchor country, fell by around 375 basis 
points while on average in the Community they fell by more than 500 basis points 
22-03-94 
33 
between September 1992 and January 1994. These are large and rapid reductions in 
historical terms, yet short term interest rates are still too high given the cyclical 
position of the Community's economy. The reduction in short rates have been made 
possible in Germany by clear evidence of a substantial downward trend in underlying 
inflation (evident for some time in producer prices and now increasingly translated into 
moderate wage settlements and decelerating consumer price movements) and, 
elsewhere in Europe, by inflation rates that in several countries are already consistent 
with a medium-term price stability standard and continue to trend downwards. 
Table 16: Recent interest-rate developments in the Community 
Short term interest rates 
Long term interest rates 
lona-term minus short-
term 
Real short -term rates 
Real long term Dec 92 
11.0 
9.6 
-1.4 
7.1 
5.8 Feb 93 
10.2 
8.8 
-1.4 
6.4 
5.1 Apr 93 
9.2 
8.7 
-1.2 
5.6 
5.1 Jun93 
8.1 
8.1 
0.0 
4.7 
4.7 Aug 93 
7.9 
7.4 
-0.5 
4.2 
3.8 Oct 93 
7.5 
7.0 
-0.5 
4.1 
3.6 Dec 93 
6.9 
6.6 
-0.3 
3.6 
3.3 Jan 94 
6.7 
6.5 
-0.2 
3.2 
3.0 
Weighted averages for the Community, short term: 3 months rates; Long-term: 10 years ; real rates deflated using the 
consumer price index 
Monetary policy should continue the course that was followed with a considerable 
degree of success in 1993. One indicator of that success was the much-reduced 
degree of inversion of the yield curve while long rates were falling. The main effect 
on the yield curve of a continuation of 1993 monetary policy trends would probably be 
a further pivoting effect, with short rates continuing to fall and with long rates little 
changed. 
Against this background, the strength of economic growth in the United States and the 
consequent probable tendency of US short rates to move upwards might go together 
with a further upward movement in the value of the dollar. Given the rapid US 
growth rate and the sluggishness - as yet - of the European economy such a 
development would not be inappropriate for either party. 
However, it should be recalled that the significant reductions in short-term interest 
rates in Europe in 1993 depended not only on progress in disinflation but also on some 
progress towards the establishment of better prospects for medium-term budgetary 
22-03-94 
-34-
consolidation. That requirement still remains, while a continuation of the declining 
trend in interest rates and, thereby, an improvement in growth prospects will help the 
process of reducing budget deficits (in several countries, these had risen in 1992/93 
not only as a result of the automatic impact of recession, but also because attempts 
were made to provide budgetary support to activity). However, the countries in 
which budgetary problems may represent an independent barrier to a further easing of 
monetary conditions are often those in which there is a need for further progress in 
disinflation. 
3.1.2 Progress in creating the conditions for lower interest rates 
Favourable developments have appeared in the trends for costs and prices over recent 
months. Wage trends appear to have moderated substantially and the outcome for 
1994 might even be lower than was suggested by the forecasts completed at the end of 
last year. These forecasts pointed to a reduction in the rate of increase in 
compensation of employees per head from 7.0 per cent in 1992 to 4.1 percent in 1993 
and to about 3 XA per cent this year. Given an expected increase in labour productivity 
of about 1 XA percent this year, partly due to labour shedding, the average increase of 
unit labour costs in the Community should decelerate to below 2 percent, the lowest 
rate in the Community since 1960 and broadly consistent with the Community's 
inflation targets. In addition, the evidence which has become available after the 
completion of the forecasts suggest that the outcome might even be slightly better. If 
confirmed, these indications suggest that a considerable step towards consistency with 
the stability objective of the monetary authorities is being made. 
However, as with all average outturns, individual country performances differ 
markedly. According to the available forecasts, nearly half of the Member States are 
expected to register increases of less than 3 to 3 V2 per cent, a trend which must be 
maintained and improved in 1995 and beyond. A number of countries, however, 
continue to show rates of increase clearly inappropriate to a situation of rising 
unemployment and incompatible with the price stability target of the Community (no 
more than 2 to 3 per cent by 1996). In Spain, compensation of employees per head is 
forecast to increase by 5!/2 percent this year despite the severe fall in economic activity 
and the sharp rise in unemployment. In Portugal, wage increases were forecast to 
grow by 6 V2 percent in 1994 which is less than half the rate in 1992, but still close to 
twice the Community average. The most recent information suggests that the 
deceleration could be even more pronounced. Overall Spain and Portugal are 
22-03-94 
35 
Chart 16 
Estimates of the origin of the changes in the 
public deficit of the Community as a whole 
diacrattonary expected to register declines in their rates of 
wage increase of between 1 1/2-2 
percentage points. Greece, on the other 
hand, is forecast to have a rate of increase 
of close to four times the Community 
average. However, it should be pointed 
out that recently announced 1994 wage 
increases in Greece for central government 
staff are below the rate of predicted inflation as opposed to the assumption of real 
increases embodied in the Autumn 1993 forecasts. If the government can hold the 
line on public sector pay, and on the assumption that the recently negotiated 
agreements in the private sector will be effectively implemented, rates of increase in 
compensation of employees per head could be VA-2 percentage points lower in 1994 
than previously thought. 1994 11 
Encouraging signals have also come from Germany where important pay agreements 
pointing in the right direction have been reached. If the trend is continued in the 
forthcoming agreements, the outcome for 1994 could even be significantly better than 
the forecasted 3 per cent. A global agreement both for the public and the private 
sector has been reached in Ireland: wages should increase by about 2 XA per cent a year 
in the period 1994-96. Several pay deals of between 2 and 3 per cent for 1994 have 
also been concluded in some important sectors in the United Kingdom and average pay 
increases are quite low. 
Price trends are also rather satisfactory. The forecasts point to a new deceleration in 
the rate of increase in the deflator of private consumption to 3.5 per cent this year 
against 3.8 per cent in 1993 and 4.6 in 1992. For 1995 a new deceleration to a rate of 
3.2 per cent is forecast. This suggests that the Community and most Member States 
are on course towards meeting the target agreed in the Economic Policy Guidelines of 
achieving a rate of inflation of no more than 2 to 3 per cent by 1996. Indeed, also in 
this case, the most recent figures suggest that the outcome could be even better than 
this forecast. The appreciation of the dollar, if sustained, might add a few decimals to 
the rate of inflation, but this is likely to be more than offset by the probable better 
wage outcome and weak energy prices. Very positive signals are also coming from 
producer prices in many countries. 
22-03-94 
36-
Most countries are expected to record rates of inflation consistent with the guidelines* 
target or very close to it. The pace of price increases remains unsatisfactory, 
however, in Greece (where the rate of inflation is declining, but at a slow speed) and 
to a much lesser extent in Portugal. Additional efforts might be desirable in Spain and 
Italy. The measures that some of these countries have taken to reduce costs and 
which were presented in the above paragraphs should also produce positive effects on 
the rates of inflation. 
The budgetary picture is more difficult to assess. The first recommendation 
concerning budgetary policy of the Economic Policy Guidelines was to prevent any 
further deterioration in the budget deficits in 1994 and to carry forward the process of 
deficit reduction. All countries, except Denmark and Ireland, are attempting a 
discretionary tightening of policy and are aiming to reduce deficits in 1994. Success 
in reducing total deficits in 1994, in accordance with government plans, will depend 
not only on the scale and effectiveness of the discretionary adjustment measures being 
introduced, but also on whether the recovery in economic activity proceeds as 
expected and on the savings on interest payments to be achieved from lower interest 
rates. The depth of the recession and the slow pace of the recovery will limit the 
improvement in the deficits of several countries. Indeed, cyclically adjusted estimates 
suggest that practically all countries will be reducing their structural deficits this year. 
For the Community as a whole this reduction is expected to amount to about three 
quarters of a per cent of GDP, but more than half of this improvement is likely to be 
offset by the direct effects of the enduring weakness in economic activity. Most 
countries appear to have taken significant steps to check the increase in current 
expenditure. Public sector pay, in particular, is increasing substantially less than the 
rate of inflation. 
Looking more closely at the budgetary situations of the individual Member States in 
relation to the guidelines, the prospects for 1994 are generally more encouraging than 
in 1993 but the adjustment efforts will have to be pursued in most cases over several 
years. The guidelines stressed that an immediate strong pursuit of the consolidation 
process was especially necessary for Member States with very high and rising public 
debt ratios. In this respect, in both Belgium and Italy the appreciable discretionary 
tightening already carried out in 1993 is being pursued further in 1994 with positive 
results, even though growth is likely to remain relatively weak. But given the 
seriousness of their debt positions these efforts may need to be reinforced by additional 
measures if there is any slippage from targets. In Greece, by contrast, the measures so 
22-03-94 
-37-
far announced do not appear sufficient to achieve a significant correction and without 
a substantial additional adjustment there is a danger that interest payments will put 
upward pressure on the already very high deficit. 
The guidelines also recommended that the consolidation process should intensify in 
those Member States with high budget deficits and which are expected to face a 
relatively favourable economic situation in 1994. With the recovery clearly established 
in the United Kingdom (in advance of the continental European economies), the 
British government presented two budgets in 1993 (in March and in November) which 
introduced a significant fiscal tightening based on strict public expenditure control and 
substantial tax increases (being phased in over two years). In Denmark, the 
government has introduced a tax-cutting fiscal stimulus which will lead to a 
deterioration in the budget deficit this year, but it has followed this policy in the 
context of a medium-term strategy for budgetary consolidation and has already 
announced tax increases for 1995 and beyond. Ireland is likely to be the fastest-
growing Community economy in 1994, and its budget deficit is already low and its 
debt ratio over the last number of years has been on a declining trend, thus allowing 
room this year for a modest budgetary relaxation (tax cuts for the lower paid). 
Luxembourg is in an even more favourable budgetary position and is not faced by the 
consolidation needs confronting most of its Community partners. 
Most of the other Member States are looking for some improvement in their deficits in 
1994 through tight budgetary control, as recommended in the guidelines, but they are 
not seeking a major correction in budgetary imbalances in the current year because of 
the continuing weak state of their economies and concerns about the possible short-
term impact on demand and the recovery of an over-abrupt fiscal tightening. In such 
circumstances, as stressed in the guidelines, it is especially necessary to establish 
credible medium-term strategies for deficit reduction over the next few years. France, 
Germany, Portugal and Denmark have recently presented new or updated convergence 
programmes, and other countries, especially those whose earlier budgetary strategies 
have been knocked off-track by the recession, also need to restate their objectives and 
how they intend to achieve them. As suggested in the guidelines, credibility can be 
enhanced by announcing measures now which will take effect in future years as the 
recovery strengthens; measures of this kind have already been announced on the tax 
side by, for example, Germany, the United Kingdom and Denmark, and several other 
countries have announced reforms likely to have a strong impact on various categories 
of social spending over future years. 
22-03-94 
38-
The expected better growth performance next year warrants a bolder step towards the 
necessary medium-term budgetary consolidation. It is urgent that all countries revise 
their convergence programmes to take into account the most recent changes in the 
economic environment and thus establish a credible perspective for the return to 
sounder public finance positions. The Economic Policy Guidelines indicate that in 
1995 budgetary policy should aim towards making public finance situations sustainable 
again. They also indicate that this means action towards reducing budget deficits to 
the reference value indicated in the Treaty on European Union (three per cent of 
GDP). Most Member States are still far from this target. The situation in this area 
will be reviewed under the "excessive deficit procedure" (art. 104c), which will be 
applied for the first time this year, and will need to be addressed in the 1994 Economic 
Policy Guidelines. 
3.2 Underpinning Medium Term Growth and Employment 
Creation 
Over the medium-term, the task for policy makers in all Member States must be to act 
prudently in order to ensure that the conditions are created which will permit the 
achievement of strong, employment-creating, growth over the medium to longer-term. 
These conditions involve, above all, the maintenance of a stable macro-economic 
framework which reduces the uncertainties affecting the decisions of economic agents 
and helps to reduce real long term interest rates. 
The outlook presented earlier suggests that there appears to be a reasonable chance of 
achieving a rate of growth of about three per cent by 1996. This rate will be slightly 
above the Community's potential rate 
National Saving in the EC _ , , , • . 
of growth, but this need not give cause 
for concern since a substantial degree 
of slack has opened up during the 
current recession. But from the 
following year onwards, 
notwithstanding the possibility of using 
some of the slack created during the 
current recession, the Community's rate 
of growth will be constrained by the pace of growth of its productive potential. 
Economic policy must therefore, as indicated in the White Paper and in the Guidelines, 
aim to improve it. 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 
22-03-94 
-39 
Recent wage trends are also encouraging in this respect. Since real wages are likely 
to stagnate in 1994 while productivity is expected to pick up somewhat (an increase of 
about one and a half per cent) real unit labour cost reductions will provide a positive 
contribution to investment profitability. Eleven of the 12 Member States are forecast 
to show declines or stagnation with regard to real unit labour costs with Greece 
forecast to be the exception by showing an increase of 3/4 of a percentage point. 
According to the latest available forecast, these trends are expected to continue in 
1995 and to result in a trend close to the rule of thumb suggested in the White Paper 
(real wage increases per head equal to productivity increases minus one point). 
The main contribution budgetary policy can make to an improvement in medium term 
prospects consists in the return to positive rates of public saving as a way of increasing 
national saving. Again this objective figures prominently in the Economic Policy 
Guidelines. Trends in this area cannot be assessed yet, as the effects of budgetary 
consolidation will show clearly in the actual budget figures only when the recovery is 
fully under way. However, as already noted in the previous section, the information 
available suggests that not enough is being done in the direction of setting in place 
credible medium-term consolidation strategies. 
Progress towards a more competitive Community economy is also taking place. As 
noted in section one significant steps are being taken by the Member States and 
important developments are under way at the Community level. In the light of the 
White Paper proposals presented by the Commission, the Brussels European Council 
of December 1993 adopted a short- and medium-term action plan consisting of : 
• a framework for Member States' actions; 
• accompanying measures at Community level; and 
• a monitoring procedure. 
The plan calls for action at the level of the Community, the Member states and the 
individual enterprises. To monitor the implementation of the plan, the European 
Community, each year beginning in December 1994, will take stock of the results of 
the action plan and will take any measures deemed necessary to put the plan back on 
track. The Commission will present an interim report to the European Council at 
Corfu in June 1994. An intensive work programme for the follow-up of the action 
plan and the White Paper during the first half of 1994 has been established and similar 
arrangements will be necessary during the next presidencies. 
22-03-94 
(7) 
40 
Conclusions 
The conflict between the stability objective, on the one hand, and budgetary and wage 
behaviour, on the other, which has been a feature of recent years appears to be 
becoming less acute. The unbalanced policy mix which has resulted from this conflict 
bears a large responsibility for the slow growth of 1991-92 and for the recession of 
1993. Significant progress has been made in the course of 1993 and in the first 
months of 1994 in bringing about wage trends compatible both with price stability and 
with a situation of rising unemployment. Inflationary pressures also appear to be 
abating. Progress towards reducing budget deficits, however, is less clear cut with 
practically all Member States taking active steps to consolidate budgetary positions, 
but with actual progress being hampered by the weakness of economic activity. 
The progress which has been made in the course of 1993 and in the first few months of 
1994 has allowed a substantial rebalancing of the policy mix with interest rates 
declining substantially. Notwithstanding the reductions which have taken place, 
however, short term interest rates remain too high for a period of recession. 
The most recent available information suggests that a modest recovery could take hold 
soon. In all likelihood it will be led by a modest pick up in exports to the rest of the 
world, where economic conditions are significantly better than in the Community, and 
by a revival of investment. It would help if European exporters directed their 
attention increasingly towards the emerging dynamic economies where additional 
export opportunities clearly exist. Private consumption is expected to recover at a 
later stage once growth will be strong enough to halt the rise in unemployment. The 
pattern of the expected recovery (investment growing faster than consumption), 
disappointing as it may be in terms of the rapidity of the turn around, will help the 
sustainability of growth and bodes well for the return of the Community's economy to 
rates of growth of more than 2 per cent next year and more than 3 per cent in 1996. 
Current trends raise the hope that the recovery will go hand in hand with a resumption 
of the nominal convergence process. Barring unforeseen circumstances, the target of 
a rate of inflation between 2 and 3 per cent by 1996 appears realistic for the 
Community as a whole and for a majority of Member States. Achieving the objective 
of bringing budget deficits towards the 3 per cent mark by 1996/97, on the other hand, 
appears to require additional efforts which will have to be implemented in line with the 
return to more robust rates of growth. These efforts are necessary to ensure a 
22-03-94 
41 -
balanced policy mix and to open the way to a prolonged period of growth thus 
reducing unemployment from 1996 onwards. 
Past experience suggests that the return to higher rates of growth will imply a 
resumption of the process of real convergence. In the past, the catching up countries 
have almost always benefited more than proportionally from general improvements in 
economic conditions throughout the Community. Furthermore, in the years ahead the 
efforts of these countries will be supplemented by interventions by the Community's 
structural funds much larger, in nominal and real terms, than at any time in the past. 
A substantial reduction in unemployment requires that growth remains both strong and 
employment creating for many years. This calls for determined structural adjustment 
efforts and a careful macroeconomic management. 
Structural adjustment must aim at making the labour market more effective and at 
modifying various aspects of the "employment systems" so as to make growth more 
employment creating. Again the White Paper constitutes a very useful basis for 
actions in this area. In particular, active labour market policies are necessary to make 
sure that the current cyclical increase in unemployment does not consolidate into 
structural unemployment. Improved training possibilities must maintain, and possibly 
increase, the skills of those who are either losing their jobs or run the risk of being in 
this situation. 
Structural policies must also aim at making the Community economy more competitive 
and more dynamic. The White Paper "Growth, Competitiveness and Employment" 
has indicated a series of actions necessary to achieve this goal. 
• Member States, who are competent for most of the necessary actions, should act 
without hesitation. In particular they should pay attention not to reduce their 
efforts once growth becomes strong again. Good economic periods may make 
structural reform appear less urgent, but they are also the periods when reform is 
easiest to implement and is likely to bear fruit in the shortest time. Action while 
economic conditions remain difficult and unemployment continues to increase is 
more difficult, but in certain cases it can contribute significantly to improving 
economic agents expectations and may therefore be necessary. In any case, it is 
important to impress on economic agents that action will be taken, even if only 
when growth will be stronger. 
22-03-94 
-42 
• The Community must implement rapidly the actions defined in the Action Plan 
agreed at the European Council meeting of December 1993. The Trans-
European Networks assume a particular importance in this respect. 
The actions which aim at making the Community economy more dynamic and more 
competitive will tend to accelerate the rate of increase in the productivity of those in 
work. This makes it all the more urgent to take actions to bring into the labour 
market those who are now excluded, encourage job creation in the sectors which offer 
the greatest employment potential (local services, leisure, culture, environment, etc.) 
and to ensure that the rate of growth of the economy remains strong. 
Macroeconomic policy will have to aim at making sure that: 
i) strong investment activity leads to an increase in the stock of capital and thus 
contributes to increasing the Community's potential rate of growth; this calls for 
an additional improvement in investment profitability to be obtained, to a large 
extent, through real wage increases falling short of productivity increases. 
ii) national saving rises at least in line with the increase in the share of investment in 
GDP; this requires substantial improvements in public saving which should lead to 
budget deficits being reduced, in the long term, to less than one per cent of GDP. 
iii) in the medium term, actual output growth does not significantly exceed the 
potential rate of growth, which would make growth unsustainable (the errors of 
1988-89 should not be repeated); the weight of any stabilisation that may become 
necessary must be borne by budgetary policy. 
iv) the policy mix becomes, and remains, balanced with monetary policy oriented 
towards the maintenance of price stability while the other instruments support 
growth without being incompatible with the former. 
Continued implementation of the policies put forward in the White Paper and 
recommended in the Broad Economic Policy Guidelines will open up the perspective 
not only of achieving the Community's objectives for growth, employment and 
unemployment reduction, but also of achieving in most countries a convergence 
performance which will allow their transition to stage III of EMU before the end of the 
decade. 
22-03-94 
1994 ANNUAL ECONOMIC REPORT 
PART B 
ECONOMIC SITUATION AND POLICY ISSUES 
IN THE INDIVIDUAL MEMBER STATES 
PARTB: ECONOMIC SITUATION AND POLICY ISSUES IN 
THE INDIVIDUAL MEMBER STATES 
BELGIUM 43 
DENMARK 48 
FEDERAL REPUBLIC OF GERMANY 52 
GREECE 58 
SPAIN 62 
FRANCE 67 
IRELAND 73 
ITALY 77 
LUXEMBOURG 81 
NETHERLANDS 84 
PORTUGAL 90 
UNITED KINGDOM 94 
-43-
BELGIUM 
Economic activity stabilised in the second half of 1993 
After the good economic performance in the late 1980s, economic activity in Belgium 
slowed down in the early 1990s, and has weakened considerably further since the 
second half of 1992. All major components of domestic private demand and exports fell 
in the first half of 1993 and then stabilised in the rest of the year at a low level; as a 
result real GDP is expected to have contracted by about V/2% in 1993. Although the 
unemployment rate in Belgium remained below the Community average, it has risen 
uninterruptedly from 7.5% of the civilian labour force in 1991 to about 9.5% in 1993. 
Private consumption, which had been the most dynamic component of demand in both 
1991 and 1992, contracted in 1993, particularly the demand for consumer durables, 
reflecting to a large extent sagging confidence as households' saving rate peaked at a 
historically high level. The continuous deterioration in the labour market situation in the 
past two years also had a negative impact on confidence. Enterprise investment declined 
in 1993 for the third consecutive year, reflecting slack capacity and unfavourable 
economic prospects, together with the completion of major industrial projects in 
previous years. Residential construction, which had performed well in 1992 when it 
benefited from lower mortgage rates, also contracted in 1993. 
The information available suggests that export volumes of merchandise goods 
decreased in 1993. The accumulated deterioration in price-competitiveness registered 
since 1990, due both to the effective nominal appreciation of the Belgian franc and to 
lack of wage moderation, are the main causes behind the loss in market shares in 1992 
and 1993. Available data on the balance of current transactions of the Belgian and 
Luxembourg Economic Union (BLEU) in 1993, on a payments basis, point to an 
increase in the current surplus, mainly reflecting the rise in the balance on interest 
income due to Luxembourg investment funds, and the improvement in the balance on 
merchandise trade as imports of goods seem to have declined more sharply than 
exports. 
Inflation in Belgium - measured by the CPI - is still below the Community average, 
although it edged up somewhat in 1993, from 2.4% in 1992 to 2.8%, due mainly to 
increases in indirect taxes together with the tapering off of the favourable impact of 
energy import prices in 1992. Nominal wages in the private sector are estimated to have 
22.3.94 
-44 
increased by about 4% in 1993, reflecting real wage increases of around 1%, which 
were mainly awarded at sector and enterprise levels. However, real wage increases in 
the public sector in 1993 are put at around 4.5%, which has not helped the process of 
fiscal consolidation. 
Chart 1 • Belgium 
General government deficit and the public 
debt ratio % of GDP % of GDP 150 
130 
* 110 
1970 1975 1960 
•Deficit (left-hand scale) 
Source: Commission services 1985 1990 
-Debt (right-hand scale) Worsening economic 
conditions and insufficient 
control over social security 
spending were the main 
factors responsible for the 
unsatisfactory budgetary 
outcome in 1993. The 
general government deficit 
remained at about the same 
level (7% of GDP) as in 
1992, thereby overshooting 
the (revised) convergence 
programme target for 1993 
of 5.8% of GDP 0). 
Although some progress was achieved during the year in curbing excessive spending in 
several areas of social security, namely on unemployment benefits and health care, the 
deviation from the programme targets was essentially caused by the widening deficit in 
the social security system. 
Until the widening of the ERM intervention margins in August 1993, the hard currency 
policy was highly successful in reducing interest rate differentials with the DM across 
the maturity spectrum. Only briefly in February/March 1993, when markets were 
worried about budgetary developments, did the negative short-term interest rate 
differential with the DM turn positive. However, in the period last year between August 
and mid-November (roughly coinciding with the preparation of the Global Plan), and 
despite the unwavering commitment of the monetary authorities in support of the BFR 
1 During the budgetary control exercise of March/April 1993, the target annual path for the reduction of the 
general government deficit was slightly revised, although compliance with the EMU deficit criterion of 3% of 
GDP by 1996 remains the ultimate goal. The revised convergence programme deficit targets for 1994 and 
1995 are 4.7% and 3.6% of GDP, respectively. 
22.3.94 
45-
parity (2), the currency remained under severe strain, (its depreciation vis-à-vis its 
central parity against the DM at one point reached 6.6%). Since the presentation of the 
Global Plan, the BFR has strengthened, re-entering the former narrow margin of 2.25%, 
while short-term rates have declined by about 3 percentage points between September 
of last year and the beginning of 1994. 
Chart 2 - Belgium 
Short-term interest rate differential and 
the BF/DM bilateral exchange rate 
Exchange rate Interest rate differential (basis points) 
Apr Jul 
1992 Source; Commission services -100 The trough of the economic 
cycle was attained in the 
first quarter of 1993. Since 
the Spring of 1993, 
economic activity recovered 
at a slow pace, with 
economic indicators 
improving considerably at 
the end of 1993. The main 
factors which are expected 
to foster economic recovery 
in 1994 are the anticipated 
upswing in the European 
economy and the continuing 
easing of monetary policy in Europe. Inflation is expected to rise slightly in 1994, 
reflecting further increases in indirect taxes at the beginning of the year. However, and 
in the framework of the Global Plan, the impact on wages of higher indirect taxes 
through the indexation mechanism will be partially neutralised from 1994 onwards by 
the introduction of a new reference index (the "Health index", which excludes from the 
CPI a number of products, e.g. tobacco, alcohol products, petrol and diesel). 
Fiscal consolidation is paramount for the credibility of overall economic policy 
In the framework of the convergence programme approved in June 1992, Belgium faces 
in coming years the major challenge of successfully pursuing the process of fiscal 
consolidation initiated in the 1980s. Given the recession and the prospect of a slow 
recovery, the task of redressing the Belgian public finance situation requires a thorough 
re-evaluation of policies, in particular in areas such as social security in order to curb 
2 Between August and October, the short-term interest rate differential with the DM (monthly averages) was 
wider by between 260 and 340 basis points than before the crisis. 
22.3.94 
(8) 
-46-
excessive growth in spending. The action called for in the broad economic policy 
guidelines to reduce budget deficits and put the public debt ratio on a sustainable 
downward path is especially urgent in the case of Belgium. 
On 17 November 1993, the Federal Government introduced a series of important 
measures, in a document entitled: "Plan global pour l'emploi, la compétitivité et la 
sécurité sociale", to pursue and strengthen the fiscal consolidation process. In 
particular, the plan proposes measures to balance the social security accounts in the 
medium term, thereby seeking to restore full credibility to the process of fiscal 
consolidation and hence to the hard currency policy. 
The saving measures included in the Global Plan - aiming to balance the social security 
accounts - amount to approximately 1% of GDP in 1994 (about BFR 70 billion), rising 
to 1.3-1.4% of GDP in 1996 (BFR 110 billion) (3). The bulk of the fiscal consolidation 
effort falls on the expenditure side, namely the pledge to cap at 1.5% per year the 
growth in real health-care spending between 1994 and 1996. This is a very ambitious 
goal as health-care spending grew by about 6% per year between 1989 and 1992. The 
increase in real wages (and pensions) in the public sector might continue to be excessive 
in 1994 despite the reduction in public employment. 
Another major concern of the Global Plan is the improvement of the competitive 
position of enterprises which has deteriorated in recent years. This is to be achieved 
through the introduction of a modified CPI - the "Health index" - for the wage 
indexation mechanism and the freezing of real wages in the 1995-96 period (4). 
In order to redress the "balance of incentives" towards employment creation, the Global 
Plan includes a series of important measures consistent with the approach recommended 
in the broad economic policy guidelines in this area. A number of programmes are 
introduced which decrease employers' contributions conditional on creating jobs or 
implementing work-sharing schemes, the latter in the framework of a "Plan 
•* In April 1993, an important package of fiscal saving measures had already been adopted, the impact of which 
was estimated at about 1.5% of GDP (BFR 114 billion) in a full year. 
^ As regards 1994, the Government only recommends to the social partners that the real wage increases agreed 
for that year should instead be used to promote employment. Real wage increases in the private sector in 1994 
are estimated at around 1%. 
22.3.94 
-47 
d'entreprise" (5). The reduction in employers' social security contributions is being 
particularly targeted on low paid jobs, the hiring of young unemployed people, and the 
first wholly unemployed worker engaged by an independent. In order to guarantee the 
budgetary neutrality of these measures, indirect taxes are raised by an estimated 
BFR 30 billion (about 0.4% of GDP). 
^ The "Plan d'entreprise" reduces employers' social security contributions by BRF 100 000 per year for each new 
(part-time) employment "created" through work-sharing. 
22.3.94 
48 
DENMARK 
Economic slowdown but stable nominal developments 
In 1993, the Danish economy witnessed a disappointing rate of economic growth. 
While GDP stagnated, unemployment continued rising, reaching a record level at the 
end of the year. In contrast, nominal macroeconomic variables performed well. The 
inflation rate is among the lowest in the Community (1,5% in December 1993), the 
current account balance is recording a solid surplus (approximately 3,5% of GDP) and 
the public sector deficit, although widening, has not yet reached the levels experienced 
in other Community countries. After the temporary weakening in the aftermath of the 
exchange market turmoil in July 1993, the exchange rate is now back to the former 
ERM narrow band and the short-term interest rate differential vis-à-vis the DM declined 
to 130 basis points at the end of the year. 
Chart 1 - Denmark 
Confidence indicators 
(Difference between the percentage of respondents giving 
positive and negative replies) The main factor explaining the 
unsatisfactory growth 
performance has been weak 
domestic demand with, in 
particular, protracted weakness 
of consumer spending and a 
significant decline in private 
investment. Moreover, the 
growth performance was affected 
by the external environment. The 
currency depreciations of 
important trading partners and 
the recession in many European 
countries led to a contraction of 
exports (-5% in 1993). However, the recorded fall in imports was even sharper (-9%) 
and so the external side offset part of the impact of the fall in domestic demand on 
output. 
Unemployment continued rising at an accelerating pace. The unemployment rate, at 
12V4% (national definition; 10,4% at the end of 1993 on the harmonized Eurostat 
definition), is the highest since the 1930s, and is the biggest challenge facing the Danish 
economy. An important cyclical component adds to high structural unemployment - the -25 
1989 1990 
Source: Commission services 
22.3.94 
49 
NAIRU is estimated to be around 8-9%. The remarkable disinflation process made 
further progress in 1993. Actual inflation is flat and unit labour costs are rising 
moderately. However, the gradual improvement in competitiveness which was 
experienced in the early 1990s was interrupted by the first EMS turmoil in September 
1992 when important Community partner countries (and Sweden) devalued their 
currencies. 
Preserving stability and responding to economic downturn 
The conduct of economic policies has been determined by the twofold aim of, firstly, 
preserving and strengthening the nominal stability achievements of the past years and, 
secondly, of mitigating the effects of the recession on the real economy and on the 
labour market. 
Monetary policy successfully defended the exchange rate during the exchange market 
turmoil in September 1992 by increasing short-term interest rates and thus accepting a 
sizeable interest rate differential vis-à-vis the DM. Continued uncertainties on exchange 
markets during the first half of 1993 determined the conduct of monetary policy with 
the effect that interest rates in Denmark remained undesirably high during a period of 
economic recession. The widening of the ERM fluctuation bands loosened the formal 
constraint on monetary policy. The authorities allowed a temporary deviation of the 
krone from its central rate, but made clear that they would continue their "hard 
currency" policy strategy. The krone is now back within the former narrow ERM band. 
During the process of kroner strengthening, the Danish authorities cautiously lowered 
short-term interest rates, and the short-term differential with the DM narrowed 
substantially. It has now reached pre-crisis levels. Long-term average bond yields have 
steadily declined last year and the differential of the 10-year benchmark bond yield with 
the DM has narrowed significantly. More recently, however, bond yields have started to 
increase and the long-term interest rate differential with the DM has widened again. 
22.3.94 
50 
Chart 2-Denmark 
Interest rates 
1992 
Source; Commission services 1993 1994 Fiscal policy responded more 
actively to the economic 
downturn. First, automatic 
stabilizers, which react strongly 
in Denmark, were allowed to 
work fully and, second, a fiscal 
package was introduced in 1993 
containing both discretionary 
fiscal measures and structural 
measures mainly designed to 
improve labour market 
behaviour. The adopted 
programme was a reflection and 
in full accordance with the 
Edinburgh growth initiative. The discretionary measures are equivalent to \xh% of 
GDP in 1994. They include cuts in marginal tax rates, advancing of public investment, 
measures to stimulate the housing market and measures to expand education and 
retraining programmes. The temporary loss of revenue from tax cuts is planned to be 
recouped through increases in taxes and social contributions in the period 1995-98. 
Therefore, the fiscal stimulus provided in 1994 will fall in subsequent years, thus 
allowing the progressive reduction of the budget deficit. 
The success of this policy will depend upon the behaviour of the private sector. A 
strengthening of private sector confidence in response to programme would indeed lead 
to the desired revival of both investment and consumption. For the time being, 
confidence indicators and short-term prospects indicate some revival in private sector 
activity and economic growth prospects have improved for this year. A recovery in 
major trading partner seems equally important to sustain a favourable growth pattern as 
the fiscal stimulus can only mitigate the short-fall in demand temporarily. 
The main elements of the structural part of the programme concern labour market 
measures intended to reduce structural unemployment. Passive and active labour market 
measures will seek to ensure that people receive an early job offer in order to prevent 
them from being trapped in long-term unemployment, and in cases where no permanent 
job has been found the unemployed will have to join public schemes work in order to 
receive unemployment benefits. 
22.3.94 
-51-
Active labour market measures will be restructured and improved. The educational 
efforts for employed and unemployed will be strengthened. Furthermore, increased 
access to leave of absence (of up to one year), for the purpose of further education on 
personal reasons will be provided. Additionally, financial incentives for unemployed 
persons to become entrepreneurs and more room in the educational system will be 
created. All in all these measures should improve labour market flexibility. 
The Danish government presented its first convergence programme in February 1994. 
The convergence programme describes medium-term growth prospects and the efforts 
being made to achieve convergence. The programme is based on the broad guidelines 
and the main element is the fiscal package introduced in May 1993. The main goals of 
the programme are fiscal consolidation and the reduction of unemployment; in 
particular the Danish authorities underline their commitment to meeting the 
convergence criteria. 
Given the seriousness of the economic recession in Europe, Danish economic 
performance has been relatively favourable. Priority has been given to maintain nominal 
stability, while during 1993 the importance of labour market problems have been 
recognised and started to be adressed through structural reform. The policy choice of 
using fiscal policy as the short term stabilizing instrument is not without risk and 
success will depend largely upon a recovery in the rest of the Community. 
22.3.94 
52 
Chart 1 - Germany 
Real GDP growth in 1993 
GDP shrinks as the western recession outweighs eastern growth 
annual % change FEDERAL REPUBLIC OF GERMANY 
The German economy adjusting to unification 
In 1993, GDP in the whole of Germany fell by 1,2% (in West Germany the decline was 
1,9%). In 1994 growth will probably be in a range of 0,5% to 1%. At present expansion 
in eastern Germany is constrained by the difficult economic situation in the western part 
of the country and in the short run there remain uncertainties about the likelihood of a 
major self-sustained 
recovery. Growth 
performance in the 
whole of Germany will 
be affected by the 
short-term effects of 
fiscal consolidation and 
depressed disposable 
income of households, 
possibly well into 1995. 
However, further 
monetary easing will 
provide support to the 
resumption of growth. 
In addition, export performance, which has already recovered during 1993, should 
progressively improve together with competitiveness and so should overall growth 
dynamism. The major problem in the meantime will be unemployment, already at 
4 million in the whole of Germany (more than 10% of the labour force according to the 
national definition; 8% on the harmonized Eurostat definition). Unified West M 
C = Private consumption, G = Govt, consumption, I = Investment, X = Exports, M =lmports 
Source: Statistisches Bundesamt 
Due to the substantial public transfers to East Germany - currently at some 5% of GDP 
per year - a small surplus in the general government balance before unification (1989: 
0,1% of GDP) has turned into a sizeable deficit (2,6% of GDP in 1992, 3,3% in 1993). 
This figure, however, was approximately half of total borrowing by the public sector in 
the broad sense (including the Treuhand and railways). The government reckons that, in 
1995, when all these earlier borrowings will have been taken over by the government, 
the public debt/GDP ratio according to the Treaty on European Union will be around 
the 60% benchmark. 
22.3.94 
-53 
Savings measures seem, nevertheless, to be gaining credibility and public borrowing 
could be on a declining trend. This improvement of the outlook for government 
borrowing and the expected reduced pressure on prices have allowed the Bundesbank 
to gradually, albeit cautiously, ease its monetary policy. 
Chart 2 - Germany 
Rising budget deficits . 
in % of GDP Fiscal developments 
.. mainly due to higher public spending 
in % of GDP 
55 .,,,.,..••..,,.,,,,..,..„ 
50 
45 
Extended PSBR 
1989 W Government expenditure 
/ 
1991 1992 1993 1989(1) Tax/soctat security contributions 
1991 1992 1993 
(1 ) 1989 West Germany only 
Sources: Commission services, Statistisches Bundesamt (general government) 
Deutsche Bundesbank (extended public sector borrowing requirement) 
The trade surplus, which declined by some DM 100 billion (to DM 50 billion in 1993) 
after unification, will remain substantial in 1993 and 1994, but partly because of weak 
imports. The positive trade balance does not make up for the traditional deficit in 
invisible trade, however, in particular so because the surplus on factor incomes is 
expected to dwindle, especially due to net payments of capital income abroad following 
large inflows of capital in the last few years. 
Slow recovery in West Germany after deep recession 
In 1993, the West German economy seems to have reached the trough of the recession. 
Total output fell 2,5% below the peak reached in early 1992. From the spring of 1993 
onwards output and orders began picking up and the second and third quarters saw 
modest GDP growth. The improvement was slow, however, and some indicators 
pointed to stabilisation at a low level rather than a genuine recovery. In the course of 
1993 business confidence improved but later in the year GDP and industrial production 
contracted again. GDP for the whole of 1993 fell by 1,9%. 
22.3.S4 
54-
The strongest reduction was in investment; equipment investment fell by as much as 
15%. Total domestic demand was 2,6% lower than in 1992. Net exports provided some 
positive contribution to growth, but only because imports fell even more than exports 
(by 9,5% and 6,1% respectively) (6). The performance of private consumption was the 
surprise as it stabilised at the level of the previous year in spite of a considerable erosion 
of households' real disposable incomes (because of job losses, wage moderation and 
higher social security contributions and taxes). This relative stability of consumption 
was to a large extent supported by a dip in the household saving ratio to 12,3%, below 
the level of previous recessions. 
The labour market situation has been worsening very rapidly in 1993. Employment has 
been falling since it peaked at 29,4 million in September 1992, after several years of 
strong growth. At the end of 1993 the unemployment rate (national definition) stood at 
8,l%o (Eurostat: 6,0%). Industrial employment was particularly hard hit. Relatively slow 
productivity improvements and high wage rises had caused unit labour costs to rise 
steeply relative to competitor countries. Large scale rationalisation is now taking place 
in order to restore the competitive position of German industry. More than 
500 thousand jobs (net) in manufacturing disappeared in 1993; unemployment will be 
one of the major problem areas of the next couple of years. 
In early 1994, the German economy faces considerable uncertainty. Some further 
output contraction in particular at the beginning of the year cannot be excluded while 
the outlook for the rest of 1994 may be more promising. Domestic demand will remain 
depressed, especially in the area of private consumption as real disposable household 
incomes will deteriorate again although this could possibly be cushioned by a further fall 
in the saving ratio. Government consumption is also expected to remain flat (in real 
terms) as a result of fiscal consolidation. The downward trend in total capacity 
utilisation could bottom out, but investment growth will be modest. The domestic 
demand component which should provide a positive contribution to growth seems to be 
residential construction, benefiting from the low level of long-term interest rates (and 
possibly also from the continuous rise in rents). The possibilities for a recovery driven 
by exports seem to have improved in view of a returning to a sounder footing in 
important partner countries; export orders rose visibly during 1993, especially towards 
These trade data should be regarded with caution. The introduction of the new recording system for intra-EC 
flows at the beginning of 1993 may have caused both exports and imports to be underrecorded, but imports to 
a greater extent (see box). 
22.3.94 
55-
the end of the year. Therefore West German GDP could expand again in the course of 
1994. 
Notwithstanding this improving background employment will fall further and 
unemployment could rise to more than 9% (or more than 7% on the Eurostat definition) 
of the labour force in the current cycle. Inflation - now mostly driven by services, rents 
and fiscal and administrative charges - is easing. Import prices, which were on a 
downward trend throughout 1993, are no longer declining. Although this might involve 
some inflationary risk, the dampening effect of domestic factors seems much more 
important in the current circumstances (e.g. low capacity utilisation and wage claims). 
Wages actually reacted to the change in economic climate and wage rises can be 
expected to slow further. Moreover, the one-off tax increases should not permanently 
affect inflation. 
Economic upswing in East Germany driven by public transfers 
East Germany's present steady growth performance is still strongly supported by 
transfers from the western part of the country. Meanwhile, locally produced output has 
sharply declined since unification. Employment has decreased from 9,5 million to 
6 million and is expected to fall a little further up to 1995. Unemployment is the result 
of the restructuring that is required and reflects generally low productivity and an 
overall lack of competitiveness. Although output is now growing again and productivity 
performance is improving, output per person employed is still only some 45% of the 
West German level. At the same time wage costs are already more than two thirds of 
those in West Germany, causing unit labour costs to be approximately 50% higher. 
Employment in the public sector (roughly half the number of those in public 
employment in western Germany compared with less than a quarter of the number of 
inhabitants) will have to decrease considerably in the years to come. Future job losses 
will, more than in the past, result in open unemployment which is projected to rise up to 
1995, albeit at a much lower pace than in the past. 
Output is growing in a number of manufacturing sectors, but employment continues 
falling in all sectors except construction. A promising sign is the high rate of 
investment. For the most part investment is taking place in infrastructure (railways, 
telecommunications etc.) and construction, but business investment, especially in the 
services sector, is now also strongly picking up, admittedly from a low level. This 
should gradually allow for self-su stained overall growth. 
22.3.94 
56-
Inflation in East Germany, close to 9% in 1993, has been mostly driven by price 
increases of services and rents, largely resulting from the gradual deregulation of 
administered prices (rents, transportation, energy). Producer prices rose by a little less 
than 1% in 1993 and are not expected to accelerate in 1994. Inflation is expected to 
converge gradually to the West German rate. 
Economic policy focuses on fiscal consolidation and structural reform 
In early 1994, the German economy seems at a cross-roads and policy makers are 
facing serious dilemmas. Fiscal consolidation is imperative for regaining confidence and 
long-term credibility, as emphasised in the broad economic policy guidelines. Measures 
to this end are now being implemented, but their inevitable contractionary effect in the 
short term comes at an unfortunate time in the cycle. As to monetary policy, a further 
reduction of short-term interest rates seems desirable for domestic purposes and 
feasible in the light of the reduced risk of inflation. The rise in consumer prices, in early 
1994 a little more than 3%, is coming down and the "underlying" rate of inflation is by 
any measure already very close to the Bundesbank's 0-2% objective. The downward 
pressure on inflation is further illustrated by producer prices which have remained 
practically unchanged for more than a year. Against this background, the renewed 
acceleration of M3 growth at the end of 1993 and early in 1994, seems surprising. It 
was, however, strongly influenced by special factors. 
In November 1993 the German authorities presented their updated convergence 
programme, setting out government measures for enhancing the German convergence 
effort and improving medium-term growth prospects. Most of these measures form part 
of two major fiscal packages introduced in 1993: the Federal Consolidation Programme 
and the Programme for Savings, Consolidation and Growth. 
The Federal Consolidation Programme was adopted in Spring 1993. It settles, first, the 
allocation of the debt related to unification which has so far been dealt with off-budget. 
In 1995, all unification-related items will entirely be accounted for in the budget and the 
re-introduction of the "solidarity" tax surcharge (worth some 1% of GDP) is envisaged. 
The second major issue settled in the Federal Consolidation Programme concerns the 
incorporation of the new Lander into the regular fiscal framework of the Federal 
Republic from 1995. The reshaped revenue sharing system will provide for additional 
funds to flow from the western Lander and the Bund to the East German states. 
22.3.94 
57-
The Savings, Consolidation and Growth Programme was adopted in late 1993. It 
marked a shift in government policies in that it emphasised spending cuts, rather than 
revenue rises, in order to help to achieve the fiscal targets for 1994 and beyond. 
Envisaged savings amount to some DM 25 billion in 1994, rising to more than 
DM 30 billion in 1995. They concern mainly unemployment benefits, but also salaries in 
the public sector, subsidies, social benefits and family allowances. 
Despite unsatisfactory developments in M3, a continuation of the Bundesbank's policy 
of cautious cuts in interest rates is expected by markets, in the context of subsiding 
inflationary pressures and the prospects of further declining inflation rates. The timing 
of monetary policy moves might depend on the performance of the DM on exchange 
markets. However, some downward correction in the DM's effective nominal external 
value should be seen as a return to normal rather than as a matter of concern. 
With respect to structural issues the German authorities have put much stress on the 
need for greater flexibility on the supply side and the improvement of economic 
structures. In September 1993 they presented their views and policies in a policy report 
on Germany's future attractiveness as a business location (7). Among the points dealt 
with figured greater flexibility in the labour market and of working-hour regulations, an 
opening up of the liberal professions and improved functioning of product markets (e.g. 
energy). In order to improve the international competitiveness of German banks the 
Bundesbank reduced the minimum reserve requirements substantially (becoming 
effective in March of 1993 and 1994). 
Bundesminister fur Wirtschaft, Bericht der Bundesregierung zur Zukunflssicherung des Standortes 
Deutschland, September 1993 
22.3.94 
-58-
GREECE 
Stabilization efforts and weak demand improve inflation and external position 
Greece experienced a slowdown in economic activity in 1993, with output estimated to 
have remained approximately flat. Official estimates suggest that the level of domestic 
demand was broadly unchanged in 1993 compared to the previous year. A rise in 
private consumption was offset by a fall in investment particularly in public investment 
as a result of a DR 230 billion cut in the public investment budget. The weak economy 
has had adverse consequences for budgetary consolidation and, as a result, prospects 
for nominal convergence have been set back. However, inflation and the external 
accounts showed improvement. 
The labour market has gradually deteriorated. Employment remained flat, although 
employment in manufacturing has declined. Wage growth decelerated further in 1993. 
Incomes in the whole economy have risen by 12.1%, the combined result of the public 
sector incomes policy and the private sector wage agreement negotiated in May. 
However, real disposable income declined by 0.4%). 
Greece's external accounts improved slightly in 1993, with the current account deficit 
representing 3.5% of GDP compared to 4.4% of GDP in 1992. This improvement is 
due partly to the decline in domestic demand which led to a fall in imports and partly to 
higher Community transfers. The trade deficit stabilised in absolute terms and the 
external sector made a positive contribution to GDP in 1993. 
Greece made progress in bringing the inflation rate down from 19.5% on average in 
1991 and 15.9% in 1992 to 14.4% in 1993, according to CPI data. The gains made on 
inflation are mainly due to the slowdown of the economy and to the decline in real 
incomes, especially in the public sector, which have affected demand. However, the 
decline in inflation has been modest, due to the continuing depreciation of the drachma, 
to the overshooting of the targets of the monetary programme which has increased 
liquidity above planned growth, and to apparent inflation expectations associated with 
continuing fiscal imbalances. 
22.3.94 
59-
Chart 1. Greece 
% change, CPI Inflation 
80 81 82 83 84 85 86 87 88 89 90 91 92 93 
Source: Commission services The nominal effective 
depreciation of the drachma 
in 1993 was 9.6% against 
20 industrial countries' 
currencies and 6.9% against 
other Community currencies, 
compared to 7.7% and 8.4% 
respectively in 1992. There 
was a serious overshooting 
of monetary targets in 1993: 
M3 grew at a rate above 
15% compared with the 
target band of 9-12%8. 
Public finances severely hit by economic slowdown 
The most important development in 1993 was the overrun in the fiscal deficit. The 
central government net borrowing requirement (excluding capitalised interest) rose to 
14,2% of GDP, about 6% of GDP above the planned^ deficit. This overrun was 
principally due to a large shortfall in budget revenues and to a small overrun in 
expenditure. 
Factors underlying the fiscal imbalances in 1993 were the decline in economic activity, 
the reform of the personal and corporate tax code (Law 2065/92) which failed to realise 
the projected rise in tax declarations and the widening of the tax base, continuing tax 
evasion (especially in VAT following the abolition of customs controls), and increased 
primary expenditures in the approach to the October elections. 
The financial position of the wider public sector also deteriorated in 1993. The 
deterioration was particularly pronounced in the area of public enterprises, while the net 
borrowing target for public entities (social security organisations) has been respected. 
Credit to the public sector is expected to have increased by some 12% as compared with the target range of 
5% to 7%. 
22.3.94 
60-
The debt of the central government at the end of 1993 is estimated at DR 23 278 billion 
or 138.8% of GDP9. Because of the very large public debt financing needs marginal 
interest rates on government borrowing remained high throughout the year: interest 
rates on one-year Treasury bills passed from 22.5% in December 1992 to 20.5% in 
December 1993. Deflated by the CPI inflation rate, real interest rates for the 12-month 
Treasury bill have stayed relatively high, at 8.4% in December 1993. Interest payments 
in the ordinary budget amounted to 13.6% of GDP in 1993, up from 10.5% of GDP in 
1992. 
Chart 2 • Greece 
Net Borrowing Requirement and Interest Payments(*) 
(Central government) % GDP The prospects for 1994 are not 
bright. In the real economy, 
domestic and foreign demand 
could contribute to modest 
output growth in 1994, the 
former through an increase in 
infrastructure construction 
activity, and the latter through 
the recovery of international and 
of the European economy. 
Private consumption could also 
slightly increase. The increasing 
borrowing needs of the public 
sector will inhibit the decline in 
interest rates, thus slowing a recovery in private investment. Incomes policy announced 
early this year projects an increase in the wages in the central government of 7.8% over 
the year, at a lower level than the expected inflation rate; however, it is not yet clear 
whether nominal wage arrangements in the private sector will be in line with inflation 
perspectives. On the other hand, social security contributions increased by 2.75% in 
January. Consequently, real wages and real disposable incomes are expected to 
decrease, in the public sector, continuing the trend observed since 1991. 85 86 87 88 
Source: Budget Statement, various issues 
(*)lncludes postponed interest 
This estimate includes debt owed to the Bank of Greece which has not previously been included in official 
Greek debt figures and is not yet included in the general government debt figures in Part A of this report. 
22.3.94 
61 
Fiscal adjustment: a necessary but not sufficient condition towards convergence 
The macroeconomic outlook for 1994 and beyond is dominated by fiscal prospects. In 
order to establish the conditions for output recovery and real incomes growth, real 
interest rates must decline from the persistently high levels of the past three years. In 
turn, the key condition for this is the decline in the risk premium on government 
borrowing which is associated with the continuing fiscal imbalances. Furthermore, a 
determined fiscal correction would not only foster expectations that future budgetary 
imbalances will be contained, thus dispelling prospects for high levels of future taxation 
and encouraging private investment, but also, the portfolio crowding out observed 
during recent quarters would be reduced, making room for an increased level of private 
investment to be financed by domestic saving. 
In the framework of the broad economic policy guidelines adopted by the Council in 
December 1993, all the efforts of macroeconomic policy will have to concentrate on the 
correction of fiscal imbalances. The challenge for Greece's economic policy, starting in 
1994, will be to prevent further deterioration and resume the process of public deficit 
reduction. Given the size of current fiscal problems, the efforts will have to be pursued 
over several years in order to put Greece's public debt position in a sustainable position. 
A determined budget deficit and public debt reduction is the necessary condition for 
substantial interest rates reduction, price stabiliy and exchange rate stabilisation, and 
thus, for real and nominal convergence as provided by the Union Treaty. 
However, if fiscal adjustment is necessary for Greece to start moving towards 
convergence, it is not a sufficient condition. Policies aimed at reforming the institutional 
setting and the restructuring of the economy will be necessary if the full potential of the 
Greek economy is to be realised. Among the changes required will be the improvement 
of the quality of services offered to business and households by the wider public sector, 
through increased competitition and privatisation, and the reform of business factor 
costs to improve the competitiveness of the economy and the trade balance through 
increased export activity and substitution of domestically produced goods for imports. 
22.3.94 
-62-
SPAIN 
Economic activity bottomed out in mid 1993 but prospects are for a slow recovery 
In the past two years Spain was hit by its deepest recession of the last few decades. 
GDP declined for four quarters in a row between the third quarter of 1992 and the 
second quarter of 1993. According to provisional data, GDP reached a trough in the 
second quarter of 1993, but it rose (quarter-on-quarter) at only a very mild pace in the 
third quarter. 
The 1992-93 recession in Spain and the current low level of economic activity are 
similar to those in most other European countries. Investment, which slumped from a 
growth rate of 6.9% in 1990 to a sharply negative figure in 1993, has accounted for 
most of the weaker trend in domestic demand and GDP. Private consumption has been 
weakening very markedly since the second half of 1992 and also recorded a negative 
figure in 1993, an unusual feature in Spain. The peseta depreciation and the very 
depressed domestic demand led to a substantial improvement in the external accounts in 
1993. 
Short-term prospects are for a gradual shift from external demand to domestic demand 
growth. Domestic demand has probably begun to rise early in 1994, while the positive 
contribution from the external sector is expected to weaken, particularly due to the rise 
in imports stemming from the recovery in domestic demand. 
In 1993, the peseta depreciated approximately 13% against the DM. The 8% 
devaluation of the currency in May and the widening of ERM bands in August, by 
relaxing the exchange rate constraint, provided greater leeway for a reduction in official 
interest rates. Following the devaluation, the Bank of Spain lowered its key intervention 
rate in a series of steps from 13% to 9% on 3 December, the lowest level since 1977. 
This drop, which was mirrored in both short-term and long-term nominal rates, was the 
main factor behind the considerable drop in inflation-adjusted short-and long-term rates 
during the same period. By the end of the year, the latter recorded values of 3.8% and 
2.9%, respectively. The continued reduction in interest rates after the widening of ERM 
bands in August has, however, been compatible with a stable peseta exchange rate. 
22.3.94 
-63-
Wage increases compounded recessionary trends and partly offset the impact of the 
peseta devaluations 
The three devaluations of the peseta between September 1992 and May 1993 allowed 
for significant gains in competitiveness in 1993, making room for a positive contribution 
of the external sector to GDP growth which softened significantly the extent of the 
recession. The poor working of the labour market has however hindered the possibility 
to take full advantage of these competitive gains. Despite the severe fall in economic 
activity and the sharp rise in unemployment, wages have not adjusted to the situation on 
the labour market and continued to grow in real terms. 
Chart 1 • Spain 
Nominal wage growth and inflation 
annual % change 
85 86 87 88 89 
* Including safeguard clause agreed on previous year 
Source: Ministerio Economia (Sintesis de indicadores econômlcos) As a consequence of the 
poor working of the labour 
market and of rigid wage 
behaviour, companies have 
reacted to lower demand 
through strong cuts in 
employment. This 
aggravated the already high 
level of unemployment. The 
rise in unemployment has in 
turn contributed to job 
insecurity among a large 
share of the work force and 
has played a role in the 
general loss of confidence among consumers. This partly explains the deepness of the 
recession and has contributed to delaying a recovery in private consumption and, 
indirectly, in investment. 
Moderate progress on inflation, sharp deterioration in public accounts 
The cyclical downturn has had a dampening impact on inflation. Despite the increases in 
indirect taxation, the depreciation of the peseta and continued stickiness in services 
prices, inflation decelerated significantly in the second half of 1992 and in early 1993. 
However since then, while price increases for non-tradeables have slowed down 
significantly, less progress in tradeable goods and sharp increases in non-processed food 
in particular interrupted the disinflation process, leading to an average CPI inflation rate 
22.3.94 
-64-
of 4.6% in 1993. Progress in inflation cannot be taken for granted to continue in 1994. 
The delayed impact of the peseta depreciation on domestic prices together with the 
expected recovery in demand can push prices up further. Moreover, if insufficient wage 
moderation persists, price expectations would worsen. 
The figures for the budget deficit show a sharp overrun in 1993. After a general 
government deficit of 5.0% of GDP in 1991, 4.6% in 1992 and a target of 3.6% for 
1993, as included in the budget law, the official estimate for 1993 is now put at 7.2% of 
GDP (chart 2). Three major factors explain the very pronounced deficit overrun of 
1993. First, the downswing in economic activity was sharper than expected (the 
cumulated GDP outturn for 1992 and 1993 is -0.1% against an expected growth of 
4.3%» in the two budget laws). Second, there were some revenue lags and losses related 
to the removal of customs on 1 January 1993. Third, a less important factor was a 
régularisation of non-recognised debts originated in the preceding years which also had 
some impact on the 1993 deficit. 
Chart 2 • Spain 
in % of GDP Public deficit 
1986 1987 1988 
Source: Commission services 1989 1990 1991 1992 1993 These deficits have sharply 
pushed up public debt 
which reached 55.6% of 
GDP at the end of 1993. 
Stabilisation of the debt 
ratio has become more 
difficult as this now 
requires a positive primary 
balance, whereas the latter 
has become increasingly 
negative in recent years 
Tackling unemployment through structural reform 
Spain has continuously experienced, for more than a decade, the highest unemployment 
rates among the Community countries largely as a consequence of a malfunctioning 
labour market. To deal with the problem, the Spanish government approved last 
December a wide ranging package of structural reforms, in line with the convergence 
programme and with the recent broad guidelines for economic policy. 
22.3.94 
-65 
The package comprises two draft laws and a decree-law. The first draft law reforms the 
workers' statutes (Estatuto de los trabajadores). It intends to ease regulations on 
working hours, firing requirements and job mobility (geographical and functional). The 
second draft law authorizes temporary placement agencies. Finally, the decree-law on 
urgent measures to foster employment legalizes private job agencies, sets new hiring 
procedures with new contracts for apprentices, part-time and temporary replacement 
work, and extends the time-span of temporary contracts coming to its term next year. 
These reforms can be seen as entailing sweeping changes which aim at reducing 
rigidities in the labour market and fostering the responsiveness of real wages to the 
economic situation. In the short term, this higher flexibility may have a perverse effect 
on unemployment, with a related budgetary cost. However, in the medium term, it is 
expected to improve competitiveness, encourage investment and foster employment 
creation. 
Budgetary redress hinges upon economic recovery and fiscal discipline 
In the very unfavourable context described above, the targets of the convergence 
programme presented in April 1992 had to be set aside, especially those regarding fiscal 
consolidation (deficit of 1% of GDP by 1996). The Spanish authorities are currently 
revising the medium-term path of fiscal consolidation to make it more realistic. 
The 1994 target for the general government deficit has been set at 6.4% of GDP 
(0.8 points lower than in 1993) while the draft budget for 1994 aims at reducing the 
central government deficit to 5.7% of GDP, i.e., 0.5 percentage points below the 1993 
estimated outturn. The reduction in the central government deficit is to come mainly 
from expenditure cuts, both on public consumption and social transfers. In particular, 
the wage bill has been frozen, unemployment benefits have been reduced and pensions 
are to be increased at the rate of expected inflation, instead of being based on past price 
increases. The deficit target could, however, turn out to be optimistic unless a 
significant recovery in economic activity occurs. In dealing with the budget deficit, 
there is a need for greater control in public expenditure. 
Another fundamental problem concerns the medium-term development of the deficit. 
Two aspects call for special attention. One relates to the extent of the welfare system. 
Though Spain still lacks the degree of social protection of other developed countries, 
social expenditure has grown very substantially since the early 1980s. As a 
consequence, the tax burden has also risen markedly. Trimming the budget deficit may 
22.3.94 
-66 
require a re-evaluation of social expenditure in the light of the country's financing 
capacity and of a more selective access to social benefits. 
A second important issue relates to the relationships between the different layers of 
general government. The decentralisation process has implied some overlapping of 
activities between the central government and the regional and local authorities. 
Moreover, the central government can only influence budgetary developments at the 
lower levels of public administration indirectly. After several years of budget overruns, 
a sounder stance now appears to be prevailing at the level of the Autonomous 
Communities, but in contrast the local authorities seem to face new difficulties. Further 
improvements in the co-ordination between the different layers of public administration 
would contribute to better control and efficiency of public finance. 
22.3.94 
67-
FRANCE 
Slowly coming out of the recession 
For the first time since 1975 French GDP declined in 1993 (by 0.7%). After a sharp fall 
at the end of 1992, French output shrunk further in the first quarter of 1993, dragged 
down by the weakness of domestic demand. Since then, some signs of slight 
improvement are appearing. The French economy has been reacting more sensitively to 
the cyclical downturn in the Community than during previous recessions. 
A marked fall in foreign demand affected exports. While in 1992 exports still 
contributed significantly to economic growth, they fell in 1993. Some loss in 
competitiveness at the end of 1992 relative to some European main partner countries 
were compensated only in the second half of 1993 by the improvement of 
competitiveness vis-a-vis non-European countries. Even a decline in export prices in 
manufacturing industry, reducing profit margins on export markets, did not prevent this 
unsatisfactory performance. More generally, the consequences of the depreciation of 
some important trading partners from September 1992 interrupted momentarily the 
period of improving competitiveness through a low rate of inflation which resulted in 
large market share gains in 1992. 
Chart 1 • France 
-15 Confidence indicators 
(Difference between the percentage of respondents giving 
positive and negative replies) The external performance did 
not fail to have its effects on 
the domestic economy. After 
the September 1992 exchange 
market turmoil confidence 
indicators dropped sharply and 
the threat of a severe recession 
became apparent. Moreover, 
still high interest rates further 
subdued domestic economic 
activity, discouraging 
borrowing and therefore 
private consumption and 
investment. The easing of 
monetary policy in Europe in the course of 1993 and the retreat of speculative pressures 
in the EMS after the substantial widening of the ERM fluctuation bands in August, -45 
7 8 9 10 11 12 1 2 3 4 5 
1992 | 
Source: Commission services 6 7 
1993 8 9 10 11 12 1 
1994 
22.3.94 
68 
contributed to some improvement of the French economic environment in the second 
half of the year. 
Investment was particularly hard hit, following the strong increase in corporate 
investment in the second half of the 1980s. Its decline, some 30% in industry over the 
period 1991-1993, could reduce the growth rate of potential output in manufacturing. 
As a consequence of the drop in confidence and a deteriorating labour market 
performance, consumers reduced their spending in particular on consumer durables. 
The saving ratio increased sharply at the end of 1992 and declined only moderately 
during 1993 as confidence improved slightly. The growth in disposable income was 
restrained by wage moderation in the private sector. However, large social transfers and 
rising wages in the public sector prevented real disposable income from falling. Without 
the positive contribution of public expenditure, households' consumption would have 
been even weaker. 
Weak economic growth had its impact on the labour market. The labour market 
situation has continuously worsened since early 1991. Unemployment was at a record 
level at the end of 1993 (3.3 million people, or a rate of 11,2% on the harmonized 
Eurostat definition) and continues to rise. The recession mainly explains this trend, but 
structural factors have contributed to the unsatisfactory development. For example, the 
youth unemployment rate amounted to about 23%. Given modest growth prospects a 
reduction in unemployment cannot be expected during 1994. 
The inflation performance improved again in 1993. Inflation has been kept under 
control by moderate wage development and particularly by imported stability as a result 
of the French exchange rate policy. Consumer prices increased by about 2% and the rise 
would have been even smaller in the absence of the increase in indirect taxation. 
However, in manufacturing industry, unit labour costs continued rising because of a 
marked slowdown in productivity growth. With increased price competition on 
domestic and foreign markets profit margins in French manufacturing industry were 
reduced substantially as a result of the fall in production and export prices. 
The trade balance recorded a surplus in 1993 (about FF 90 billion), mainly resulting 
from declining imports and an improvement in the terms of trade. It is doubtful if the 
recorded surplus in the trade balance can be maintained once the domestic recovery 
gains momentum and imports start to rise again. However, while exports declined in 
22.3.94 
69 
1993, competitiveness of French industry remains quite good and exports should benefit 
from a general recovery in foreign markets. 
Endogenous growth prospects remain uncertain in the short term. Given the slow 
growth profile likely in some important partner countries, e.g. Germany, a strong 
export-led upswing cannot be expected. Capacity utilisation remains low and the profit 
situation is not supporting capital-widening investment. Rising unemployment might 
prevent a strong fall in the saving ratio even if monetary policy continues along its path 
of cautious easing. In addition, fiscal policy is now aiming at medium-term 
consolidation and might have less supporting effects on demand in the short term. 
Domestic demand is therefore likely to remain subdued in the first part of this year, but 
may recover gradually in the second half. 
/ 
Chart 2-France 
General government deficit 
in % of GDP 
6 $ 
1986 1987 1988 
Source: Commission services 1993 The slowdown in French 
economic activity has led to a 
major deterioration of the 
State budget deficit from 
1,9% of GDP in 1991 to 
4,4%o in 1993, with a primary 
deficit exceeding 1% of GDP. 
The loss in fiscal receipts and 
also increasing public 
expenditures aiming at 
supporting economic activity 
have widened borrowing 
needs. The rising public debt 
resulted in a very sharp 
increase in interest charges (by 12%). The budget deficit would have been even larger if 
privatisation proceeds had not been allocated to finance budgetary expenditures, 
particularly current outlays. Financial receipts collected during the previous 
privatisation programme (1986-1988) were mainly devoted (two-thirds) to debt 
consolidation. 
The financial equilibrium of the French social security system (régime général) 
deteriorated in 1993 as a result of cyclical and structural factors. The latter have their 
origin especially in the progressive ageing of the French population which is affecting 
pension expenditure, and also health expenditure. A set of short-term (health insurance) 
22.3.94 
70 
and long-term (pension scheme) measures were adopted in order to consolidate 
expenditure. Moreover, larger fiscal resources were allocated to limit the social security 
deficit: the CSG (contribution sociale généralisée) was increased from 1,1% to 2,4%, 
corresponding to about FF 25 billion in 1993 and tax on fuels was raised too. As a 
result of these measures, the social security deficit which amounted to 
FF 57 billion in 1993 will probably decline to close to FF 40 billion in 1994. Taking into 
account unemployment insurance and local authorities' financial imbalances, the French 
general government net borrowing was about 5V6% of GDP in 1993 according to the 
most recent official estimate. Therefore, together with the measures that have already 
been taken, a clear upward swing in economic activity will be necessary to start to 
restore sound French public finances. This is the aim of the French convergence 
programme adopted in November 1993, which provides a medium-term strategy for 
achieving budgetary consolidation in France during the second stage of EMU. 
French economic policy has been primarily concerned with maintaining a large degree 
of nominal stability while attempting to mitigate the economic slowdown. Monetary 
policy has been devoted to preserving the DM-FF exchange rate. After temporary 
tensions on the exchange markets during which French short-term interest rates were 
increased markedly, the widening of the ERM bands in August 1993 enlarged the room 
for manoeuvre of monetary policy. As confidence in the FF strengthened, nominal 
interest rates were lowered sharply. Nevertheless real interest rates are still high in view 
of the sluggishness of the economy, indicating a cautious approach towards monetary 
easing. Against the background of these cautious interest rate reductions, in late 1993 
the FF was back within the former narrow band. 
Given the priority of the exchange rate objective, the Banque de France's monetary 
target (an increase of 4-6% in M3) was considerably undershot in 1993: by the end of 
the year, the aggregate was in effect showing no increase. Part of the undershooting can 
be attributed to "technical factors" such as the issue of the Balladur bond and portfolio 
shifts in general but it must also be related to the weakness of nominal GDP in France 
and to interest rates relatively high given that weakness. For 1994, the Banque de 
France has only slightly modified its targeting procedures: the importance of M3 has in 
practice been somewhat downgraded (medium-term target of 5% a year instead of an 
annual target range) and total domestic credit has been introduced as a "privileged 
indicator". The government retains the authority to decide on the exchange-rate régime 
and the franc-DM link will continue to be of major importance for monetary policy 
decisions. 
22.3.94 
-71 
Adoption of a medium-term strategy of fiscal consolidation 
Fiscal policy has been used as the cyclical stabilizing instrument during the recession. 
The automatic stabilizers were allowed to work to the full extent and discretionary 
measures were also taken to stimulate the economy. The effects of previously adopted 
cuts in taxation and weak domestic demand squeezed tax revenues. Given the 
significant deterioration of the public sector deficit, there now exists little scope for 
continuing this process. 
In order to strengthen fiscal credibility, the French authorities have adopted a medium-
term strategy of fiscal consolidation which is embodied in the convergence programme. 
The planned restoration of healthy public finances in France is in line with the European 
Council's broad economic policy guidelines for 1994, aiming at improving conditions 
for growth. The convergence programme aims at a reduction of the general government 
deficit to below 3% of GDP in 1997 mainly through expenditure restraint and a reform 
of the social security sector. Budgetary expenditure should not increase in real terms 
implying that the consolidation target (a reduction by a half percentage point of GDP in 
each of the coming years) might prove a quite ambitious challenge. 
The success of this consolidation strategy will crucially depend upon a revival of private 
sector-led growth as fiscal policy will change from a supportive to a restrictive stance. 
A favourable external demand environment and a significant improvement in private 
sector confidence seem to be the main preconditions for a favourable growth scenario. 
The contribution of monetary policy would consist in a continuation and perhaps 
acceleration of easing in order to compensate for the shift in fiscal policy. 
Wage developments will have to continue to contribute to both re-establishing external 
competitiveness and improving profit margins. However, in order to influence private 
sector expectations positively wage moderation should be accompanied by greater 
flexibility in particular as regards the possibilities to employ low productivity workers. 
As suggested in the broad guidelines' recommendations on the reduction of indirect 
labour costs and on policies in favour of employment, structural policies in 1993 were 
principally devoted to removing rigidities in the labour market and corporate sector. 
Cuts in social security charges on low-skilled workers and other measures increasing 
flexibility of working time were adopted. Employment is hampered by the still high level 
of labour costs in the case of unskilled workers resulting from the existing rules on 
22.3.94 
72-
minimum wage (SMIC). The French government has opted for progressively reducing 
employers' social security contributions on low wages. This measure is part of a 
recently adopted medium term law in favour of employment. Other rigidities will be 
removed by improving vocational training (particularly apprenticeships) and flexibility in 
the organisation of work. In this perspective, settlements on working time on a yearly 
basis will be encouraged. A recovery of employment is all the more necessary also with 
respect to consolidation of public expenditure. In 1993 large amounts of budgetary 
resources have been allocated to support the labour market, particularly in the form of 
subsidised part-time jobs in the public sector, at a budgetary cost of FF 15 billion. 
Moreover, structural reform has been enhanced by the start of a large programme of 
privatisation which has been well received by financial markets which see scope for an 
improvement in the efficiency of the enterprises to be privatised. 
22.3.94 
-73-
IRELAND 
The January devaluation required a cautious macroeconomic policy stance 
Chart 1 - Ireland 
% of GDP Budget Deficit 
1980 1982 1984 1986 1988 
General government net borrowing as a % of GDP 
Source: Commission services 1990 
tightening given the impact of the slowing economy 
policy remained similarly oriented towards stability 
short-term facility (STF) being determined by falls 
stability of the pound within the ERM. A firm macroeconomic 
policy stance was needed in 
Ireland in 1993 to 
strengthen credibility in the 
wake of the devaluation of 
the pound in January. 
Hence, fiscal policy 
remained firmly focused on 
maintaining control over the 
budget deficit. While the 
January 1993 budget did 
project a mild deterioration 
in the deficit to about 314% 
of GDP, this implied a fiscal 
on the public finances. Monetary 
with cuts in the Central Bank's 
in market interest rates and the 
This policy stance - complemented by the strengthening of sterling - successfully re­
assured financial markets of the continued stability orientation of economic policy. 
Following the 10% devaluation of the currency's ERM central rate on 30 January the 
pound stabilised quickly within its new ERM bands. The Central Bank of Ireland 
reintroduced the short-term facility (STF) rate at 13.75% which subsequently was 
reduced in a series of steps to 7%, the lowest level since the introduction of the facility 
in 1979. From September the Irish pound appreciated steadily (mirroring sterling) and 
by end year was the strongest currency in the ERM grid. Furthermore, the eventual 
outturn for the budget deficit, at just over 2% of GDP, was substantially lower than 
market expectations and the official forecast. 
22.3.94 
74-
Chart 2-Ireland 
annual % change Inflation Moderate output growth, low inflation but continued very high unemployment 
Given the constraints presented by the policy stance outlined above, growth in output 
continued at a respectable pace in 1993, particularly compared with the falls in output 
in most Member States. Nonetheless, the estimated outturn of around 2% represents a 
sharp slowdown on the 
corresponding figure of 
almost 5% achieved in 
1992. This slowdown was 
largely due to the sharp 
deceleration in the growth 
in the volume of exports. 
The other components of 
demand failed to fully 
offset this slowdown. 
Private consumption 
remained relatively weak 
despite continued strong 
growth in real disposable income owing to fears of unemployment and the carry-over 
of high interest rates from 1992. Private investment was similarly affected by interest 
rates and only a major boost to the public capital programme prevented a sharp fall in 
total investment. Finally, public consumption was constrained by the need to keep the 
budget deficit in check. I960 1982 1984 
Private consumption deflator 
Source: Commission services 1986 1988 1990 1992 
The expected acceleration in inflation following the January devaluation failed to 
materialise - a trend seen in several other Member States whose currencies also 
devalued. The private consumption deflator is now expected to have risen by only 
about 2% compared to a forecast range of 3% to 4%. Several factors underlie this 
better than expected performance. Firstly, Ireland's effective exchange rate did not 
depreciate signficantly relative to its pre-ERM crisis level, owing to even more 
substantial devaluations in several other Member States. Secondly, substantial stocks 
had been accumulated when the pound was strong which combined with strong retail 
competition restrained price increases. Thirdly, pay rises for 1993 had already been 
decided under the existing agreement on incomes policy. Fourthly, exchange rate 
(post-devaluation) and commodity price developments were favourable. Finally, and 
perhaps most importantly, the firm stance of macroeconomic policy and the slowdown 
in growth restrained inflationary pressures. 
22.3.94 
75-
Superficially, labour developments suggest that some progress was achieved in 1993. 
The average annual level of unemployment in 1993, as measured by the live register, 
emerged at about 294 000 compared to a budget estimate of 309 000. However, while 
data is still scarce, this lower than anticipated level is probably attributable to an 
upsurge in emigration, changes in eligibility conditions for unemployment benefits and 
an increase in training programmes rather than strong employment growth. Moreover, 
at around 18% of the civilian labour force this still represents an unacceptable level of 
unemployment and emphasises the enormity of the challenge facing policy makers in the 
years ahead when labour force growth can be expected to continue at about 2% 
annually. 
Impressive nominal stability needs to be complemented by accelerated structural 
reform 
The challenge facing the Irish authorities in 1994 is to build on the strengths and room 
for manoeuvre created by the success on the nominal front and to turn the focus of 
policy more strongly towards unemployment. A number of policy considerations will 
crucially determine their success or failure in meeting this challenge. 
There are clearly deep structural rigidities underlying both the current level of 
unemployment in Ireland and the failure of the strong output growth of recent years to 
be translated into sufficiently increased employment. The government-commissioned 
"Culliton Report" performed a valuable service in identifying these rigidities and 
highlighting the need for their urgent reform. The government are continuing the 
necessary programme of reforms. It is essential that this programme is speedily and 
effectively implemented. The commitment to follow the "general guidelines" on 
Community economic policy agreed by the EcoFin Council in December should assist 
this process. 
Reform of the taxation system has a crucial role to play in tackling the structural 
rigidities currently preventing a better employment performance. The continuing fiscal 
consolidation of recent years has been achieved partly at the cost of a rise in the burden 
of direct taxes. This burden impacts heavily on lower paid workers and is widely 
credited with having major disincentive effects on labour supply. The improved fiscal 
position in Ireland now presents an opportunity to intensify the necessary tax reforms. 
The recent budget has made some further progress in this respect and the commitment 
to further reforms in future budgets is welcome. 
22.3.94 
76-
Ireland has followed a centralised pay bargaining system over the past six years which 
has made a valuable contribution towards consolidating economic and social stability. 
However, future wage developments should afford a higher priority to employment and 
competitiveness. Real wage growth in Ireland over the period of the two previous 
agreements has been substantially above the Community average. The economy's job 
creation needs would be better served by more moderate pay developments, particularly 
in the public sector where wage growth has been strongest. In this respect there has 
also been recent encouraging progress with the government and social partners agreeing 
to moderate pay rises for the period from 1994 to 1996. 
Investment growth in Ireland has been relatively stagnant in recent years. Encouraging a 
higher level of private investment is a priority. Consideration also needs to be given to 
the scope for switching public spending towards increased public investment which has 
borne the brunt of spending cuts over the past decade. The investment opportunities 
presented by the substantially increased structural and cohesion funds must also be 
efficiently exploited. 
22.3.94 
77 
ITALY 
Recession continued in 1993 despite large contribution of real net exports to GDP 
growth 
The recession starting in mid-1992 continued throughout most of 1993 and at the end 
of the year no definite signs of cyclical upturn had yet appeared. After the prolonged 
slowdown in growth from 4.1% in 1988 to 0.9% in 1992, real GDP declined in 1993 by 
around 0.5% according to latest estimates. The recession would have been much deeper 
but for the contribution of real net exports, which partially offset the persisting fall in 
domestic demand. While economic activity may have bottomed out by the end of 1993, 
expectations are for only a slow recovery in 1994 (1.6% GDP growth, according to 
official figures), with momentum gaining in the second half of the year. 
The fall in domestic demand, initially resulting from an unusually sharp decline in fixed 
investment, deepened because of a significant reduction in private consumption (-1.8% 
on average in 1993), a behaviour never recorded in previous post-war recessions. 
Consumers' expenditure has been heavily affected by the decline of disposable income, 
which was due to the fall in total employment, the reduction in real per capita 
compensation and the increase in the tax burden. At the same time, the contraction in 
total investment that preceded the recession at the beginning of 1992 intensified in the 
first part of 1993. Fixed investment is estimated to have fallen by more than 8% in real 
terms on average in 1993. 
Chart I • Italy 
Current account balance 
(Lit. 000 billions) 
83 64 85 86 87 
*Estimates of Commission Services 
Source: Bank of Italy 88 89 90 91 92 93* The response of the Italian 
trade balance to the 
devaluation of the lira after 
the departure from the 
ERM in September 1992 
has been extremely rapid 
and positive. Since then, the 
depreciation of the lira 
significantly exceeded the 
losses in competitiveness 
recorded in the previous 
three years. In nominal 
effective terms the average 
22.3.94 
78 
depreciation of the Italian currency in 1993 was around 20% in comparison with the 
pre-crisis level. Notwithstanding the deterioration in terms of trade, the nominal trade 
balance did not show any perverse J-curve effect, whereby a real depreciation of the 
exchange rate worsens a balance-of-trade deficit initially, only to improve it over time. 
By contrast, the trade balance moved into positive figures in the first months of 1993 
and strongly improved in the remainder of the year. Preliminary estimates on volumes 
indicate that in 1993 average imports fell by between 8 and 10%, while exports 
increased by the same rate. 
Cyclical impact on labour demand compounded by severe restructuring in 
manufacturing and services sectors 
While employment in Italy was traditionally characterized by low responsiveness to 
output fluctuations, the current recession has heavily affected labour market conditions. 
A number of institutional reforms introduced in the last ten years substantially reduced 
private labour market rigidities, but also fiscal constraints have recently prevented the 
public sector from playing a role of employment stabilizer. The cyclical impact on 
labour demand has been compounded by severe restructuring involving first the 
manufacturing sector and then the private services sector. In 1993, employment losses 
are estimated to have been over 600 000, of which almost a half were in services and a 
third in manufacturing. The unemployment rate, according to the national definition, 
rose from 9.4% to 11.3% between January and October 1993 and reflected, once again, 
substantial differences in the regional distribution of unemployment, with a rate of 
18.9%) in the South, 9.8%) in the Centre and 6.9% in the North. 
Inflationary impact of devaluation dampened by falling demand and wage 
moderation 
The large depreciation of the lira has only slackened, but not halted the progress in 
disinflation. In 1993 the average rise in consumer prices was 4.2%, which is below the 
official target for inflation (4.5%) and represents the lowest rate in twenty-five years. 
Falling domestic demand and structural factors contributed to contain domestic 
inflationary pressures. However, behind these results has also been wage moderation, 
essentially due to the institutional changes introduced between 1992 and 1993 in the 
wage formation mechanism, which substantially removed the risk of a wage-price spiral. 
The reform of the wage setting mechanism started in 1991 and completed in July 1993 
has greatly changed industrial relations and reinforced incomes policy as a decisive 
22.3.94 
79 
instrument to curb inflation. The rules for wage settlements have been completely 
reshaped: the economic 
effects of the Chart 2-Italy 
(annual % change) Inflation contracts 
bargained at national level 
have to be consistent with 
the target inflation rate; 
firm-level wage increases 
will be rigorously linked to 
productivity gains and 
improvements in 
competitiveness. The new 
regime constrains the wage 
evolution to the disinflation 
path set in the goverment 
targets, and replaces the 
previous indexation mechanism. Since mid-1992, the rate of growth of per capita wages 
has been outpaced by the inflation rate. The rebound in measured productivity, obtained 
through reduction in employment, helped to reduce unit labour costs, which fell by 
0.5 percentage points in the first three quarters of 1993. 
Progress in fiscal consolidation in spite of the recession 86 87 
Source: Eurostat 
Chart 3-Italy 
Deficit and Debt as a % of GDP 
State Sector definitions 
% of GDP There has been a very 
significant adjustment effort 
in the public finances in the 
last two years. The budget 
for 1993 was a landmark, 
both in the size of the 
planned correction relative 
to underlying trends (close 
to an estimated 6% of 
GDP) and in the willingness 
to tackle structural fiscal 
problems. Reforms were 
introduced in the fields of 
public employment, 
pensions, health care and local authority finances. These efforts were to some extent 1986 1987 1988 1989 1990 1991 1992 1993 1994* 1995* 1996* 
ES Deficit (left hand scale) —Debt (right hand scale) 
Note: New State Sector definition applies as 0(1992. 
Source: Treasury, official targets (September, 1993) lor 1994 to 1996 
22.3.94 
80 
overshadowed by the recession which hampered the pursuit of fiscal adjustment and 
increased its cost. Nevertheless, an improvement of the order of 1% of GDP was 
achieved in the primary budget surplus in the state sector account in relation to 1992. 
At the same time, the exchange rate regime followed since the departure of the lira from 
the ERM allowed a steep fall in interest rates (from a peak of 15% in September 1992 
to below 7.5% at the end of 1993 for the net yield on 3-month Treasury bills) and thus 
helped contain the total deficit relatively close to its targets. Although interest rates are 
expected to remain low, the persistence of a risk premium vis-à-vis other EU countries 
points to the need to hasten deficit reduction and to the danger that significant slippages 
from the deficit targets might reverse the declining trend of interest rates. The progress 
achieved so far in fiscal consolidation must therefore be continued in 1994 and beyond. 
Last year also marked a turning point in privatization; the long-awaited process of 
dismantling the large state involvement in the economy has started to achieve some 
concrete results. The strategy pursued privileges the objective of swift and irreversible 
privatizations rather than maximization of proceeds from the sales. Total revenues from 
the sale of public enterprises are estimated at some 5% of GDP, but a significant 
proportion will be needed for restructuring operations, thus the direct impact on public 
debt is going to be very small. 
Prospects for convergence reinforced by structural reforms 
Economic policy in the last two years correctly adressed the major structural problems 
of the Italian economy. The implementation of these reforms will allow the convergence 
process of the Italian economy to rest on a more solid foundation. Fiscal consolidation 
should be continued vigorously, as recommended in the broad policy guidelines, so that 
the stabilization and subsequent decline in the debt to GDP ratio is achieved soon. The 
inflation differential from the three best-performing Member States, currently at 
2.5 percentage points, must be narrowed. Although the large output gap along with 
wage moderation has helped contain the inflationary pressures arising from the currency 
depreciation, the hoped-for recovery will require the anti-inflationary commitment to be 
built in a context of exchange rate stability. A scenario of healthy recovery in economic 
growth and employment, along with steady progress towards convergence, includes 
income and monetary policies to control inflation and a budgetary policy to achieve 
fiscal consolidation. This policy mix will help to ensure exchange rate stability. 
22.3.94 
-81 
LUXEMBOURG 
Growth supported by internal demand 
Over the last decade, Luxembourg has consistently accomplished a better economic 
performance than most other European countries. The estimated growth for 1993 of 
around 3/4% continues to compare favourably with the other Member States. The 
improving external environment should permit GDP to increase by approximately 2% in 
real terms in 1994, still considerably less than the average growth rate of around 4% in 
the period 1983-92. 
The relative resistance of the Luxembourg economy to the European recession in 1993 
is a consequence of the strength of domestic demand. An increase in private investment 
of 5.5% represented the principal contribution to growth in 1993. This figure is mainly 
the result of a big state-supported renovation program in the steel sector and the 
launching of a new Astra telecommunications satellite; public gross capital formation 
receded. Private consumption rose by about 1% and was sustained by wage increases 
higher than in the neighbouring countries, driven by close-to-full employment in the 
labour market. Because the expansion of employment in the services sector more than 
compensated for the continued decrease in the traditional steel sector, total employment 
continued to rise, albeit at a slower pace than in the previous years. Since the number of 
foreign workers is increasing faster than the creation of additional employment, 
domestic unemployment has risen a little to around 2.5% (Eurostat definition), although 
it still remains by far the lowest in the Community. 
In contrast to most other Member States, inflation is not declining in Luxembourg, but 
remains lower than the European average. The relatively high real wage growth, 
combined with higher excise duties and increases in costs for medical care and other 
administered prices are responsible for this evolution. 
As a result of the strong internal demand combined with weak external demand, the 
merchandise trade deficit widened in 1993. As usual, this was compensated by a surplus 
on the services balance and by a net inflow of factor income, creating a healthy surplus 
on the current account. 
If the improvement of the economic situation in the neighbouring countries is confirmed 
in 1994, the negative growth contribution from external trade could be eliminated. The 
22.3.94 
82 
level of domestic demand will be sustained by the increase of private consumption, due 
to a relatively high real wage growth, and of public consumption; investment is likely to 
fall back a little, because of the completion of some major investment projects. As a 
result gross domestic product could grow by 2% in real terms. Without major indirect 
tax increases in 1994, inflation might fall back to just over 3.2%. 
Public finance situation remains healthy 
After the reform of the tax system in 1991, which included a reduction of direct taxes 
only partly compensated by higher indirect taxes, the government accounts are no 
longer in surplus. The rapid increases of public expenditures, especially on health and 
pensions, further weakened the public finance position. Still, Luxembourg continues to 
comply with the EMU convergence criteria on public debt and deficit. 
To prevent a further deterioration of the public deficit, the government has reduced the 
budget norm from 3.5% to 1.5%. This norm gives the admissible real increase in central 
government expenditures (social security excluded), based on medium-term growth 
prospects. In combination with the expected increase in wages, as generated by the 
automatic wage indexation system, this results in the allowed nominal increase of 
central government expenditures. The application of this norm still results in an 
expected growth of nominal expenditures of the central government (social security 
included) of 6.8%, which implies a real increase of more than 3%. The reduction of this 
growth rate is proving to be very difficult since the major part of spending is rigid and 
regulated (wages, previous engagements of the central government in the social security 
system). Still, the government should try to revise some of these automatic expenditure 
mechanisms to prevent a worsening of the still healthy public finance situation. 
Central government revenue is estimated to increase by 6.8% in 1994, with similar 
contributions from direct and indirect taxation. A major part of the higher indirect tax 
receipts is explained by the increased proportion of the common receipts of the 
economic union between Belgium and Luxembourg. The part for Luxembourg is to be 
increased from 12.8%) to 15.7%. 
In the social security sector, the further implementation of the reform of the health 
insurance system, which was initiated in 1992, limits the state's contribution to 39% of 
total revenues of the system. This was necessary to prevent a further fiscalisation of the 
system. As a consequence of this reform, it might be necessary to increase private social 
22.3.94 
-83 
security contributions. Health expenditures will be limited by negotiating a fixed budget 
for each hospital. Together with the improving economic environment, which generates 
higher tax receipts, these measures could lead to a small reduction of government 
borrowing in 1994. 
22.3.94 
-84 
NETHERLANDS 
Deep recession avoided but recovery will be slow 
In contrast to most other countries in continental Europe, the Netherlands were able to 
avoid a marked recession in 
Chart 1 - Netherlands 
annua! growth rate Real GDP 
Netherlands 
•West-Germany 
•France 
SEUR12-
1989 1990 
Source: Commission services 1991 1992 1993 1993 and real gross 
domestic product probably 
remained about equal to the 
year before. This apparent 
resistance of the Dutch 
economy to the deep 
recession in Germany is 
remarkable, considering the 
openness of the country and 
the close economic and 
monetary integration with 
Germany. 
Private consumption has been the main contributor to growth in 1993. After a small dip 
in the first quarter, caused by anticipatory purchases of durable goods in the last quarter 
of 1992 in advance of higher indirect taxes, consumption recovered promptly and grew 
by approximately 1% over the year. This can partly be explained by higher than 
expected real wages because inflation was over-estimated when the long-term wage 
contracts were negotiated. However, the strong consumer spending mainly originated 
from lower saving, possibly caused by low long-term interest rates. 
For the first time in 10 years, real gross capital formation was lower (by some 3.5%») 
than in the previous year, as a result of lower capacity utilisation and weak order 
positions. While government investment, non-subsidised residential construction and 
investment in equipment were stable or still showed some progress, non-residential 
construction and investment in transport equipment (especially trucks) receded sharply. 
The small share of the hard-hit manufacturing sector in Dutch GDP (only 17.8% of 
value added in 1992) also helped to shelter the Dutch economy from a deeper 
recession. The automotive sector, which was probably most affected in the current 
recession, is almost absent in the Netherlands. The Dutch specialisation in agricultural 
22.3.94 
85 
products and their derivatives, which are less sensitive to cyclical variations, further 
helped to isolate the Netherlands from the recession in its neighbouring countries. 
This specialisation pattern also allowed Dutch exports to remain relatively unaffected by 
the fall in demand from the major trading partners. This was realised at the cost of a 
strong decline in profitability in the exporting sector. Import volumes were about 1% 
lower than the year before (,0) reflecting the decline of investment. The combination of 
steady exports and falling imports led to a current account surplus of around 2% of 
GDP. 
Chart 2 - Netherlands 
30 annual growth rate Unemployment 
20 Hi 
15 £r—Netherlands 
•West Germany 
-•-France 
EUR 12 Unemployment, which had 
been constantly abating since 
1984, rose sharply from 
6.8% in 1992 to 8.2% in 
1993 (Eurostat definition). 
Compared to other countries 
such as France and 
Germany, it took a long time 
in the Netherlands before 
unemployment started rising 
in response to the lower 
growth. A first explanation 
for this phenomenon is that 
the economic downturn in 
the Netherlands started later and was more moderate than in most other countries. The 
sudden increase in unemployment also points to earlier labour hoarding, caused by the 
institutional framework in the Netherlands. Indeed, the costs of the rigorous legal 
procedures that have to be followed to lay off employees postpone necessary labour 
market corrections. Finally, because of the recent changes to the disability scheme, 
which were aimed at reducing the number of hidden unemployed in this scheme, more 
people registered as unemployed than before. 1989 1990 
Source: Commission services 1993 
10 As in other EC countries, there are considerable uncertainties about the development of intra-EC trade during 
1993 following the abolition of internal customs frontiers and the introduction of the new INTRASTAT 
recording system. See box on "Reliability of intra-EC trade statistics in 1993". 
22.3.94 
86 
The activity slowdown, combined with the strength of the Dutch guilder, has brought 
down inflation from a peak of 4.4% at the beginning of 1992 to an average of 2.1% in 
1993. A cut in the highest VAT rate by one percentage point to 17.5%) at the end of 
1992 and the recent wage moderation also contributed to lower inflation. 
The credibility of the peg of the Dutch guilder to the German mark never came 
seriously under pressure despite the economic downturn and the turmoil in the ERM. 
Under a bilateral agreement with Germany, the Netherlands even maintained the pre-
August 1993 fluctuation margin of 2.25%, while the other currencies moved to a 15% 
band. The continued strength of the Dutch guilder, leading towards the end of 1993 to 
an appreciation of 0.6% above its DM parity, permitted the monetary authorities to 
regularly cut interest rates independently of the Bundesbank. This produced a negative 
short-term interest rate differential with the DM for most of the year under review, 
reaching a maximum of-100 basis points on 3-month euro-deposits in June; after the 
August events in the exchange markets the differential widened again to -60 basis points 
in December. 
Despite the relatively good performance in 1993, the recovery in 1994 will be slow and 
growth will probably be below 1%. Both consumers' and producers' confidence 
indicators have bottomed out in the second half of 1993, but remain at low levels and 
no clear upswing is in sight. Domestic components of GDP will remain very subdued 
while the specialisation pattern of Dutch exports will not allow full advantage to be 
taken of a possible economic recovery in the rest of Europe. 
Growth expected for 1994 will be insufficient to create additional employment, so the 
unemployment rate will continue to rise to more than 9%. This will put additional 
pressure on social partners to limit wage increases in their negotiations. Inflation will 
benefit from lower wage settlements, but higher excise duties and government-regulated 
gas prices will broadly offset this. 
22.3.94 
87-
Fiscal consolidation continued in 1993, but some easing in 1994 
Despite the lower than expected economic growth in 1993, the central government 
deficit has been reduced to 3.6% of Net National Income(n), slightly below the target 
set in the coalition agreement of October 1989. This was achieved because additional 
measures were taken in Spring 1993 and was also due to higher than expected revenues 
amounting to 0.7% of GDP which occurred in the final part of the year. 
In the original budget for 1994, the government decided not to compensate for 
expected lower tax receipts, caused by the adverse economic environment, to avoid 
possible deflationary effects of further budget cuts or tax increases. The budget 
objective was relaxed from 3.25% of NNI to 3.9% of NNI. Nevertheless, to arrive at 
this result, real expenditures have to be reduced, excise duties raised and part of the 
expected proceeds of the privatisation of the state-owned telecommunications company 
will be used. The most important structural expenditure cut comes from freezing the 
level of government salaries and social security benefits. When it became clear that 
revenues in 1993 were considerably higher than expected, the government decided in 
February 1994 to use these budgetary opportunities to improve employment through a 
reduction of the collective burden of taxes and social premium payments, starting from 
July 1994 and getting to its full extent in 1995 when the package will amount to 
approximately 1% of GDP. Part of the additional revenues is used to reduce the central 
government deficit to 3.75% of NNI in 1994, but no further improvement is envisaged 
before 1997. 
While the original target for 1994 in the convergence programme of March 1992 was 
set at 2.4% of GDP, the government now expects a deficit of 3.6% of GDP. Although 
the difficult economic circumstances explain part of this loosening of the target and it 
still remains one of the lowest deficits in the Community, the effort to reach the 3.0% 
EMU objective before 1997 should be continued; this is especially important for the 
evolution of government debt, which continues to increase slowly from its present level 
of 81% of GDP. 
11. The official Dutch deficit objective is the deficit including financial transactions, based on cash receipts, 
expressed as a percentage of Net National Income (NNI). This deficit was 4.3% in 1992, compared to a 
deficit of 3.5% of GDP using the EMU deficit concept. 
22.3.94 
-88-
Government takes measures to promote employment 
In its 1994 budget, the government proposes a three-pronged offensive to create jobs 
and strengthen the economy, in line with the recommendations of the broad economic 
policy guidelines. Firstly, a new infrastructure improvement programme up till 1998 
was announced. These additional public investments will be financed by part of the 
privatisation proceeds and windfall gas revenues. Secondly, the government is urging 
the social partners to moderate wages. A freeze of nominal wages for 1994 is already 
accepted by the trade unions in the public sector; employers and trade unions in the 
private sector agreed to limit wage increases, after a government threat to impose a 
global nominal wage freeze. The government also intends to give the possibility to 
employers to hire people at wages below the minimum agreed for the sector, but still 
above the national minimum. Finally, the government announced a number of measures 
to promote job creation. A fiscal incentive for research and development expenditures 
will be introduced and the wealth tax on enterprises will be reduced. Furthermore, the 
basic income tax deduction for job-related expenses will be raised. This increase of the 
income gap between employed and unemployed should provide a greater incentive for 
people on social benefits to return to the job market. The additional fiscal package of 
February 1994 also lowered non-wage labour costs for employers and reduced taxes for 
small and medium sized enterprises. 
Although these measures will have some beneficial effects on employment, they will not 
be sufficient to stop the rise in unemployment in the short term. Additional structural 
measures in the social security system will be necessary, to create an appropriate 
incentive structure to increase labour market participation. Some far-reaching reform 
proposals have been made by a parliamentary commission last year, and measures along 
these lines should be part of the agenda for the next government after the upcoming 
national elections. 
22.3.94 
-89-
Reliability of intra-EC trade statistics in 1993 
Because of teething problems of the new INTRASTAT system, which records trade data within the 
European Community, current figures are still preliminary and probably not very reliable. After the 
realisation of the Single Market in January 1993, customs-based data were no longer available. As a 
consequence, a new system was introduced relying on data from both importers and exporters. There is 
no doubt, that the introduction of this new system has entailed distortion in the time series; intra trade 
flows are underestimated in both directions. The distortion occurred in a period of recession and 
subdued trade; it is difficult to isolate reasonably the statistical effect of the change of the statistical 
system from the slow-down of the underlying trends in trade. 
It seems that in most Member States the distorting problems observed are of a more transitional nature. 
INTRASTAT figures for the months following the first quarter of 1993 are showing a certain return to 
normal. Nevertheless one may not exclude that, for the time being, there are still factors which tend to 
lower the level of statistical results. Eurostat and Member States have started detailed analyses in order 
to assess the quality of INTRASTAT data and to cope better with possible distortions due to the new 
statistical system. 
Intra-Communitv trade, values. Ql/1992-02/1993 (billion ECU) 
Ql/92 Q2/92 Q3/92 Q4/92 Ql/93 Q2/93 
Arrivals 185.1 183.0 166.5 182.0 159.9 161.2 
Dispatches 181.4 178.2 161.9 176.0 166.7 166.1 
Difference 3.7 4.9 4.6 6.0 -6.8 -4.9 
Q1-2-3-4/92 have not been adjusted for re-exports. 
Source: EUROSTAT, provisional, based on data provided by Member States, for some Member States, 
estimates have been made. Arrivals are CEF, dispatches FOB. 
The problem can be illustrated by comparing Dutch and German bilateral trade data. Following the 
most recent Dutch data (until July 1993), Dutch export value to Germany remained flat compared with 
the previous year. However, German official sources show that in the first six months German imports 
from the Netherlands were 25% lower than the year before. 
Contrary to INTRASTAT, the Community figures referring to the period before 1993 dot not cover, for 
example, re-exports to other Member States of goods imported from third countries and released for 
free circulation in the Member States of re-export. Such flows are of great importance especially in the 
case of the Netherlands, Belgium and Germany. This distortion in the "customs figures" has been 
overcome in the new system; thus a meaningful comparison of INTRASTAT data with data of previous 
years requires adjustments. 
The above could imply that provisional estimates for net exports, and therefore GDP growth in 1993, 
as presented in this report, are too favourable. 
22.3.94 
90 
PORTUGAL 
Sharp deceleration of economic activity in 1993 accompanied by progress with 
disinflation 
In line with developments elsewhere in the European Community, economic activity in 
Portugal was characterized in 1993 by a contraction in GDP, led by a substantial 
deceleration of internal demand. Continuing the prolonged slowdown of economic 
growth since 1990 (4.4% in 1990, 2.1% in 1991 and 1.1% in 1992) real GDP is 
estimated to have declined by around 0.5% last year. As a result of the cyclical position 
of the economy and some difficulties in the process of tax collection, the general 
government deficit recorded a sharp increase in 1993, well above the budget forecast. 
Inflation declined further, a development to which the weakness of the economy has 
also contributed. Furthermore the situation in the labour market eased considerably and 
nominal wages recorded a large deceleration. 
The evolution of GDP in 1993 was marked by developments on domestic demand. In 
particular private consumption by residents recorded a sharp slowdown to a rate of 
1.5% as gains in real wages were much smaller than in the previous years and 
unemployment increased. The weakness of economic activity, compounded with the 
decline in profit margins and the level of real interest rates, contributed to a decrease in 
total gross fixed capital formation and, particularly, of investment by private sector 
enterprises. 
Since 1992 the employment situation (close to full employment in the previous years) 
has been deteriorating, a trend that was reinforced last year, due to not only cyclical 
factors but also the ample process of industrial restructuring which is taking place in 
both the private and the public sectors. With some delay to the marked easing in labour 
market conditions, wages in 1993 have displayed an impressive deceleration in both 
nominal (from around 15% to 8%) and real terms (from 4'/2% to l!/2%). To a large 
extent these developments suggest that the Portuguese economy continues to enjoy a 
substantial degree of real wage flexibility, which should prove to be an important 
advantage in efforts to achieve simultaneously real and nominal convergence. 
22.3.94 
-91-
Chart 1 - Portugal 
Inflation 
annual % change 
| —CPI Portugal 
—CPIEUR12 
Difference from 3 best membei states 
86 87 
Source: Eurostat 88 89 90 91 92 93 In 1993 inflation was 
significantly reduced. The 
rate of increase of 
consumer prices fell from 
9.5% in 1992 to 6.8% last 
year, mainly as a result of 
the weakness of economic 
activity and the pronounced 
slowdown of internal 
demand. The deceleration 
of wages certainly also 
played a role. These factors 
seem to have more than 
offset so far the impact on 
inflation of the depreciation of the escudo following the upheavals in the EMS since the 
summer of 1992. The escudo has lost about 12% vis-à-vis the ECU, but the real 
depreciation of the escudo vis-à-vis the other Member States has remained limited to 
about one half of the nominal depreciation, allowing an improvement in Portugal's 
competitive position. 
Public finances were severely hit in 1993. In the presence of much weaker than 
expected economic activity the authorities allowed the automatic stabilizers to work 
instead of adhering to the targeted budget deficit (4.2% of GDP, down from 5.2% in 
1992). In addition, the revenue shortfall problem seems to have been compounded by 
an increase in VAT avoidance following the abolition of customs controls on imports 
from other Community countries, together with the surfacing of structural problems in 
the overall tax collection process. As a result of all these factors, and despite some 
success in controlling non-social security expenditure the budget deficit turned out to be 
around 8% of GDP. 
The gradual recovery from recession of the European economies which now seems 
likely will certainly have an important impact on a small open economy like Portugal. 
The marked increase in public (and also private) investment co-financed by the 
Community Structural Funds will also play a positive role. Furthermore and assuming a 
non-accommodating exchange rate policy, continuation of disinflation is likely although 
at a gentler pace than in recent years. On the domestic side the main doubt regarding 
22.3.94 
92-
economic recovery in the current year seems to concern the behaviour of private 
consumption, in a context of increasing unemployment and sluggish wage growth. 
The need to consolidate the public finances and the revised convergence programme 
Achieving further progress in convergence remains the main challenge for Portugal. 
This means continuing to pursue stability while securing a growth rate above 
Community partners, in line with the broad economic policy guidelines. However, 
convergence is taking place in the context of a process of deep structural adjustment. 
Chart 2 - Portugal 
General government deficit and the public 
debt ratio % of GDP % of GDP 
90 91 92 93 
Hi Deficit (left-hand scale) —Debt (right-hand scale) 
Source: Commission services The envisaged path towards 
convergence is displayed in 
the revised Portuguese 
convergence programme 
(1994-1997). Public 
finances are to be brought 
back to the convergence 
track with the budget deficit 
declining steadily from 
1995 onwards; for 1994 an 
accommodative fiscal 
stance will be followed (the 
budget deficit is targeted at 
about 7%) given the 
prospects of only a mild recovery. Achieving the medium-term public finance targets set 
in the revised convergence programme will require a rigorous implementation of the 
fiscal consolidation strategy. A significant reduction of public finance imbalances is not 
only necessary for the purpose of allowing Portugal to respect the criteria set for 
participation in EMU. It is also decisive to achieve, in a sustained way, both real and 
nominal convergence. 
Disinflation is to be based on a non-accommodating exchange rate policy aiming at a 
stable escudo vis-à-vis the main ERM countries. Domestic wage developments should 
support this approach, which is in line with the Community broad guidelines for wage 
moderation. In this vein, nominal wage increases in the public sector in 1994 are 
expected to be in the 0-3% range while in the private sector a similar development will 
most likely occur. 
22.3.94 
-93-
The Portuguese economy has been subject to ample structural changes in particular 
since accession to the Community in 1986. This process is leading to a reduction in the 
size of the agricultural sector, a restructuring of industry both in the public and private 
sectors, the liberalization and modernization of the financial system and the contraction 
of the importance of the public sector in the economy. Notable changes are taking place 
in industry. The latter has benefited from the emergence and development of new 
sectors (e.g. transport equipment, electrical goods), led by foreign direct investment and 
whith a dynamism which contrasts with the rest of industry. The traditional export 
activities, based on labour-intensive technologies, have been losing importance and 
should continue to face difficult challenges in the future. As for the remaining economic 
sectors, industry is adjusting in Portugal to an economic environment in which 
exchange rate stability is the prevailing rule. 
The inflow of Structural funds foreseen for the 1994-99 period will be a major support 
to the ongoing process of structural adjustment. The Community support framework 
will be used primarily to improve the long-run global competitiveness of the economy 
through investment in physical (including infrastructures) and human capital. Upgrading 
the qualifications of the labour force, through professional training and education, 
would allow a smoother adjustment process. Further reform of the labour market, 
namely the promotion of a higher degree of regional labour mobility, which requires the 
development of an effective housing market in Portugal, would certainly prove 
beneficial. 
22.3.94 
-94-
UNITED KINGDOM 
A developing upswing 
By the end of 1993 the recovery in the United Kingdom was well established, following 
a recession that had been sharper and earlier than in the rest of the Community. 
Beginning in mid 1992 the upturn, particularly for non oil GDP, was at first slow and 
uncertain but during the course of 1993 there were some signs that the pace of growth 
was accelerating; the year-on-year growth rate rose from 1.4% in the first quarter of 
1993 to 2.6% in the 4th quarter. Non-oil GDP growth has been somewhat weaker than 
overall growth through the year but it too accelerated towards the end of the year. At 
the same time inflation remained subdued, so that the economy entered 1994 with a 
growth rate close to its trend rate with inflationary pressures seeming dormant. 
Chart 1 - United Kingdom 
Saving ratio and real disposable Income 
106 
105 
104 
103 
102 
101 
100 
99 
98 
97 
96 
95 
94 1990=100 
ESsaving ratio (right-hand scale) 
—RPDI (left-hand scale) 16 The upswing has been led 
by domestic demand and in 
particular by private 
consumption which by the 
4th quarter of 1993 was 
growing at an annual rate of 
over 3%. Consumption 
growth largely resulted 
from a fall in the saving 
ratio. Having declined to 
historically low levels 
during the preceding boom 
in 1988-90, the household 
saving ratio was restored 
during the recession and reached an above average level of 13% by mid-1992. From 
early 1993 the saving ratio began to fall and by the 3rd quarter was 2l/2% points down 
from its peak. Consumption growth was also helped by a somewhat better employment 
performance than expected although rather less so by developments in real personal 
disposable income which has remained broadly unchanged since end 1992. Gross fixed 
capital formation has yet to make a significant contribution to the growth of domestic 
demand. 2 3 4 12 3 4 1 
| 1989 | 1990 | 
Source: Commission services 2 3 4 1 
1991 | 2 3 4 12 3 
1992 I 1993 
22.3.94 
95 
Exports have also been contributing to the upswing. Trade data in 1993 have been 
erratic and uncertainties have increased with the changed recording system resulting 
from the implementation of the single market from 1 January 1993 (see box). The 
overall picture would appear to be one of modest export and import growth. From the 
3rd quarter of 1992 to the 3rd quarter of 1993 exports grew by around 3% in volume 
while import growth was just over 2%. Sharp recorded differences in trade 
developments with the Community and non-Community areas reflect partly the 
recession in Europe, in contrast to growth elsewhere, and partly statistical disturbances 
caused by the changed recording system. 
Inflation remains more subdued than expected particularly in the light of the 
devaluation of sterling subsequent to its exit from the ERM. The headline index for 
consumer prices fell to an annual rate of 1,2% in June 1993, the lowest level since 
1964. Subsequently it rose to 2,5% in January 1994. The underlying rate, i.e. 
excluding the impact of interest rate changes on mortgage payments, remains under 
3% representing the best UK inflation performance in two decades. Behind this good 
inflation performance lies a continued fall in the growth rate of average earnings and 
wage settlements leading to falling unit labour costs, intense competition at the retail 
sales level as well as the cautious relaxation of monetary policy. As a result of the fall 
in unit labour costs and the lower level of sterling, compared to the previous year, the 
competitiveness of the UK improved sharply. 
Chart 2 • United Kingdom 
Output and employment (*) 
% change over previous year 
Output 
787980 818283848586 87 
(*): non-oil GDP compared with workforce 'm employment (s.a.) 
Source: Commission services 89 90 91 92 93 A feature of the UK economy 
in 1993 was a turnaround in 
unemployment which was 
both earlier and sharper than 
expected. From its peak in 
January 1993 unemployment 
had fallen by over 200 000 by 
the end of the year with the 
unemployment rate down 
from 10.6% to 9.9% (10.3% 
on the harmonized Eurostat 
definition). Employment rose 
marginally in the second 
quarter and more strongly in 
22.3.94 
96 
the third quarter. 
The UK enters 1994 with better short-term prospects than most of the other Member 
States; continued growth in output is expected with inflation remaining under control. 
On the other hand the UK also faces uncertainty concerning the sources of future 
growth. The recovery in 1993 has been substantially based on domestic, and in 
particular, consumer demand which has expanded largely through a reduction in the 
household saving rate. This has occurred despite the overhang of financial imbalances 
associated with the previous inflationary upswing. While the personal sector debt 
problems have been significantly reduced on a flow basis (i.e. the interest costs of debt 
have fallen very substantially) the stock of debt remains close to its historically high 
levels. This increases the sensitivity of the personal sector to monetary policy - though 
this will be modified by the recent shift towards fixed rate mortgages - but it could 
also be expected to have some impact on saving behaviour. Hence the question is 
whether the continuing large stock of debt, assuming house price increases remain 
modest, will not put a floor on the fall in the savings rate. This combined with the 
weight of tax increases and possibly a fall in real personal disposable income would 
suggest that the outlook for consumption growth would be subdued and that sustaining 
the recovery in the UK may well require that exports and investment contribute 
increasingly to growth. 
The prospects for export growth are enhanced by the expected turnaround in the 
European economy and by continued growth in America and Asia (Japan excepted). 
However, the rather full pass through of price rises (in domestic currency terms) on 
exports following the devaluation of sterling and the subsequent, partial, reversal of 
the depreciation could be moderating influences. The fall in investment has flattened 
out in 1993 largely due, however, to a significant rise in public sector investment; 
private sector investment continued to fall through to the second quarter of 1993. 
While investment continues to be a lagging variable, the prospects for future growth in 
private investment will depend on a continuation of the expansion of internal and 
external demand. Overall the UK should continue to grow faster than the other large 
Member State economies in 1994. 
22.3.94 
97 
Measures taken to improve the fiscal outlook 
As the recession deepened and remained prolonged the UK fiscal position deteriorated. 
Measurement of the impact of the cycle on deficits can only be approximate but it is 
clear that prolonged and sizeable deficits, whatever their initial source, eventually 
become increasingly structural in nature and increasingly difficult to reverse. In the 
case of the UK four years of increasing deficits had brought a degree of intractability 
to the UK fiscal position (as was illustrated in the UK convergence programme, 
presented to the Eco/Fin Council in July 1993, which foresaw general government 
deficits remaining above 3% of GDP to beyond 1997/8 unless a rapid growth rate of 
3^2% was achieved). In the event the two budgets of 1993 (March and November) 
between them improved considerably the medium-term fiscal outlook, with the general 
government deficit now expected to reach the Maastricht 3% reference value by the 
financial year 1996/7. 
Chart 3-United Kingdom 
Public sector borrowing requirement 
% or GDP 
10 
8 --,. 
6 -The two budgets were 
notable for tax increases 
pre-announced to apply in 
later years, thus not directly 
impinging on the fragility 
of the recovery, particularly 
in the early part of 1993. 
The overall impact of the 
discretionary changes in the 
budgets was expected to 
reduce the deficit by 2.4% 
GDP in 1995/6. This represents a substantial medium-term adjustment in line with the 
Community's broad economic policy guidelines. While most of this adjustment will 
consist of increases in tax revenues, there are also substantial cuts in planned 
expenditure implying a reversal of the upward trend in public expenditures in recent 
years and a very tight control which may be difficult to sustain. m Budget March 1992 
„„„„„„„„, •Budget Mareh198S 
^|H W Budget November 1998 
1993-94 1994-95 199546 199647 
Source: H M Treasury, Financial Statement and Budget Report 199746 
Although risks remain for the future 
The size of fiscal adjustment due in 1994/5 and subsequent years does raise the issue 
of the appropriate stance of policy and the impact on the economy. While the pre-
announcement of tax increases and other changes was designed to avoid dampening 
22.3.94 
98 
down the rather slow recovery in 1993, the question of the impact in 1994 remains. 
Tax increases taking place from April 1994 amount to UKL 8.4 billion (1.2% GDP) 
and it is not clear how much of a risk there is to the upswing. Hence careful judgement 
is required concerning the appropriate stance of policy overall in the face of the fiscal 
tightening. 
Monetary policy has been set in the context of maintaining inflation on a downward 
course. To this end the authorities have adopted a direct inflation target with regular 
monitoring by the monetary authorities. The direct targeting of inflation implies 
careful policy judgement about the future course of inflation and during 1993, even in 
the face of a somewhat unexpectedly good inflation performance, the UK authorities 
took a cautious approach to monetary policy. No doubt the authorities were influenced 
by a recognition of the lagged impact of the sharp falls in interest rates which occured 
since the UK left the ERM in September 1992. Indicators of longer-term inflation 
expectations and inflation performances suggest that the credibility of the monetary 
policy framework grew steadily during the course of 1993. 
While the current inflation performance in the UK is among the best in the 
Community, at least in headline terms, nevertheless there is a need to take account of 
the risks which could be realized through the course of the upturn. One uncertainty in 
UK policy concerns the extent of the gap between potential and actual output, i.e. in 
judging the risks which the developing upturn could lead to in terms of inflationary 
pressure. There might also be some concern about possible restoration of margins; 
with producer output prices having risen more strongly than retail prices and evidence 
of severe price competition at the retail level. However the squeeze on profit margins 
will have been moderated (or even offset) by the good productivity performance. 
Nevertheless the indications of a rise in employment and the normal cyclical effects on 
productivity could lead to a greater pass through of cost and price pressures as the 
upswing develops. There is also some uncertainty about wage behaviour, although on 
the basis of previous cyclical behaviour, wage pressures are unlikely to be a factor in 
the course of 1994. All of these factors, in the context of a monetary policy which 
targets the inflation variable directly would argue in favour of a degree of caution in 
monetary policy decisions. 
22.3.94 
ISSN 0254-1475 
COM(94) 90 final 
DOCUMENTS 
EN 01 
Catalogue number : CB-CO-94-099-EN-C 
ISBN 92-77-66700-1 
Office for Official Publications of the European Communities 
L-2985 Luxembourg