Opinion of the Economic and Social Committee on "The EU Economy: 1999 Review"

(2000/C 140/12)

On 2 March 2000 the Economic and Social Committee, acting under the third paragraph of Rule 23 of its Rules of Procedure, decided to draw up an opinion on "The EU Economy: 1999 Review".

The Section for Economic and Monetary Union and Economic and Social Cohesion, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 7 March 2000. The rapporteur was Mr Harry Byrne.

At its 371st plenary session (meeting of 30 March 2000), the Economic and Social Committee adopted the following opinion unanimously.

1. Introduction

1.1. The Commission has launched a new publication under the title EU Economy: 1999 Review which supersedes the former Annual Economic Report.

1.2. The 1999 Review serves two main purposes; firstly to provide a report on recent and prospective economic developments in the European Union and secondly to study specific economic topics which are of particular importance for economic policy - the thematic studies.

1.3. The Committee welcomes the new publication. With the launch of the single currency and the completion of the single market it is becoming increasingly relevant to view the European Union as a single economic entity and to monitor closely any divergence within individual Member States which might threaten the overall economic coherence of the European Union.

1.4. The Committee also welcomes the in-depth analysis provided within the thematic studies of five important areas:

- the origins of European Union unemployment

- the tax-benefit systems and incentives to work

- the long-term economic and budgetary implications of population ageing

- price level differences in the European Union

- the European equity market developments.

2. Economic Situation and Prospects

2.1. The autumn 1999 forecasts for 2000-2001

2.1.1. The autumn 1999 forecasts present a more promising outlook for growth and employment together with continued progress towards convergence.

Main features of autumn 1999 forecasts: - EU-15

>TABLE>

2.1.2. While almost all indicators show a more favourable picture for 1999 and 2000 compared with the spring 1999 forecasts the highlights are:

- 3 % growth forecasts for 2000 and 2001

- a significant increase in investment

- a lowering in government deficits and overall debt.

2.1.3. The employment/unemployment forecasts also show an improving trend albeit at a relatively modest pace.

2.2. The EU Review 1999

2.2.1. The highlights of the review are:

- the successful launch of the euro in eleven Member States

- the slowdown in late 1998/early 1999 has been reversed with assistance from lower interest rates, moderate pay developments and the boost to exports provided by the depreciation of the euro

- inflation has remained under control despite the impact of sharply increased oil prices.

2.2.2. The Commission believes that sound economic fundamentals in the European Union and a brightening external environment justify a positive view being taken of short term economic growth. The main downside risk is of a "hard landing" in the US economy which would again interrupt world expansion as the Asian crisis did in 1998.

2.2.3. The Commission is broadly satisfied with the stability and convergence programmes submitted by the Member States as required under the Stability and Growth Pact although it believes that some Member States should accelerate their programmes.

2.3. The thematic studies

2.3.1. The origins of EU unemployment

2.3.1.1. The Commission concludes that the high and persistent unemployment in Europe has been the result of the interaction of adverse supply and demand shocks with insufficiently flexible labour market institutions and product market regulations. It puts forward the view that overcoming this problem will require:

- sound macroeconomic policies

- policies to improve the overall functioning of labour markets

- economic reforms to improve competitiveness and the functioning of the markets for goods and services.

2.3.2. Tax-benefit systems and incentives for work and job creation

2.3.2.1. The Commission stresses that tax-benefit systems should provide real incentives for unemployed or inactive people to seek and take up work or training opportunities. Against this criterion the Commission concludes that although Member States have started to address this issue progress to date has been inadequate.

2.3.3. The long-term economic and budgetary implications of ageing populations

2.3.3.1. This is not the first time the Commission has focused attention on the implications of increased health and pensions expenditures arising from ageing population. In this commentary it emphasises the potential impact on stability and growth in the European Union of a potential increase of public expenditure of approximately 7 % of GDP due to the demographic changes.

2.3.4. Market integration and price levels

2.3.4.1. The Commission assesses the current degree of price level dispersion in the community in comparison to the US level. Despite some progress in 1985-1993 there is still a significant gap against the US figure and rather surprisingly progress has come to a halt in the post 1993 period.

2.3.5. Key developments in European Equity Markets

2.3.5.1. The Commission analyses the performance of European equity markets which have underperformed the US and Japanese markets. However, the Commission goes on to discuss whether equity markets and particularly the US market are over-valued at present without coming to a definitive conclusion.

3. The Economic and Social Committee's comments

3.1. Unemployment remains the Committee's overriding concern and it has previously expressed the view that the EU must have a medium term growth objective of at least 3,5 % if a satisfactory reduction in unemployment is to be achieved. Nevertheless the Committee welcomes the proposal from the Council Presidency to target a growth rate over the medium term of at least 3 % and hopes that this will be endorsed by the next European Summit on "Employment, Economic reform and Social cohesion - Towards a Europe of Innovation and Knowledge".

3.2. The forecast reduction of unemployment to 8 % by the end of 2001 is a welcome though modest sign of progress. In addressing EU unemployment it should not be overlooked that with the exception of Denmark, Luxembourg, the United Kingdom, the Netherlands, Austria and Sweden, labour market participation rates in most EU Member States are very low relative to the US and Japan; this may arise because some people do not feel it is worth while registering as job seekers due to current high level of unemployment. On the other hand this potential additional workforce could partly offset the effect of population ageing in coming years.

3.3. The Committee notes the forecasts of a 3 % growth in GDP for both 2000 and 2001. This would represent an encouraging recovery from the disappointing 2,1 % outturn estimated for 1999 and in the absence of adverse external shocks including the possibility of a stock market crash, it does not seem unduly optimistic. Moreover, whereas the Committee was concerned last year at the emergence of deflationary tendencies in some countries, these tendencies are less evident today.

3.4. Indeed the Committee agrees with the Commission's assessment that the European Union may be on the brink of a more sustained recovery which could yield much needed stronger growth in employment. This improved employment outlook, however, is contingent on the maintenance of an appropriate policy mix. There is however a real prospect that growth could exceed the 3 % forecast.

3.5. The continued progress being made in economic convergence and the overall improvement in Member States' deficits and overall debt are building a good platform for recovery.

3.6. The Committee notes that the forecasts of necessity refer in the main to the overall euro zone or the EU as a whole. It is important that the differing positions of individual Member States are not overlooked when interpreting general policy guidelines. It is also important to demonstrate the successes achieved by certain Member States in the implementation of economic policies, so one can learn from them. The most impressive case, in this respect, is certainly that of Ireland. Appendix I shows the main features of this success and at the same time constitutes an invitation to the Commission to study this type of analysis in greater detail.

3.7. The Committee draws attention to the fact that an important factor inhibiting employment and output growth in the EU, is the lack of venture capital and start-up finance from the banking sector as compared with the US. Greater access to such funding would impart a much needed stimulating effect on growth especially in the high technology area to which traditional investment criteria no longer apply.

3.8. The more important factor, however, producing an optimistic scenario is the launch of the single currency in eleven Member States. This was a considerable political and technical success. The Governments of the Member States, business as well as consumers should be accelerating their preparations for the full implementation of the euro by 1 January 2002.

3.9. Some commentators have judged the euro a comparative "failure" because of its depreciation against other international currencies since its launch. This, however, is to postulate that the launch rate was the "right" rate rather than just the market rate on the day. In practice the reduced value of the euro would seem to have more appropriately reflected the current cyclical phase of the participating economies, although a further decline would cause fears of a rise in inflation.

3.10. Indeed the reduced value of the euro has probably been the most significant factor in triggering the export led recovery of the euro zone in 1999. It is to be hoped that any recovery in the value of the euro therefore does not outpace the recovery rate of the relevant economies or that inflationary fears do not trigger too rapid increases in interest rates.

3.11. The other positive contributions from the euro come from the stimulus to intra-community trade provided by a trading environment freed from currency risk and the greater transparency in pricing provided by the single currency - it must be remembered that one of the features of the euro zone is the strong dependence on domestic demand which accounts for 90 % of GDP. This is an argument for a faster completion of the single market. The "Cardiff process" is a welcome instrument for realising more flexible goods, services, capital and labour markets. This will enhance Europe's ability to compete in the high technology based industries.

3.12. If, as it is expected, unemployment continues to decline (although there are significant differences between Member States) it is important that appropriate steps are taken to support workers rejoining the workforce. In any recovery the workers who first return to employment are most likely to be those with the highest skills level and who have been unemployed for the shortest time. As progress is made subsequent tranches of workers are more likely to have been unemployed for some time and will require more targeted assistance to reintegrate. Member States - together with social partners - should therefore plan ahead in terms of, for example, skills upgrading. Training and upgrading skill levels must be targeted at existing and likely job vacancies. It should also be recognised that the provision of relevant skills in fact generates the demand for those skills and would contribute to more employment intensive growth. The Committee endorses the Economy of innovation and knowledge called for in the Lisbon summit.

3.13. For the Community as a whole the performance on inflation was very good in 1999. One should not forget, however, that inflation deserves continuing attention and in some Member States an emerging upward trend is already of concern.

3.14. The Commission study of the tax-benefit systems and incentives for work is acknowledged by the Committee as an important contribution to understanding what needs to be done to ensure that lower paid workers are not caught in unemployment and inactivity traps. Although it must be recognised that growth is the key remedy to the lack of available jobs provided the mismatch of skills is also addressed.

3.15. The Commission's findings make it clear that in most of the Member States the tax(1) structure is not favourable for employment, particularly in respect of the lowest paid workers, and can be an inhibition for job creation. Very few Member States have succeeded in lowering the total labour tax wedge.

3.16. The Commission concludes on a more positive note in suggesting that Member States are on their way to intensifying efforts in this area to tackle structural unemployment. While maintaining its commitment to the European social model, the Committee voices its strong support for Member States' apparent determination to move in this direction. In this regard the Committee would urge that every effort is made to integrate the various policy initiatives from the Commission and in particular those associated with economic guidelines (Art. 103) and employment guidelines (Art. 128 of the EC Treaty).

3.17. The Commission's comments on the long-term economic and budgetary implications of ageing populations compliment earlier communications on for example pensions(2). It is an important issue and one with potentially significant implications for Member States' budgetary positions and also one whose effects extend beyond the short-term horizons of the 1999 Review. The Committee endorses the Commission's call for Member States to pursue an integrated reform process based on labour market reforms, attainment of the Stability and Growth Pact objective of a sound budgetary position, and improvements in the sustainability of pension and social security systems.

3.18. The population ageing issue is unusual in that the long-term projections are based not on mere estimates, but on well established trends, i.e. the decline in the birth rate and longer life expectancy. It is also an issue which is not unique to Europe but affects our main competitors as well, albeit to different degrees.

3.19. On taxation, the Committee is concerned that no progress has been made on average in reducing the overall tax burden which may act as a brake on economic growth and weaken the international competitiveness of the Member States economies. The Committee recommends that the Commission undertake a thematic study on the relationship between level of taxation and growth. In addition, the examination of various types of harmful tax competition across the Member States needs still to be followed by action.

3.20. The Commission highlights the need for efficient cross-border retail payment systems for small amounts; there are 31 clearing houses in the highly fragmented European clearing and settlement infrastructure. The Committee believes that urgent action needs to be taken on this issue. Otherwise the benefits of the single currency to citizens would be undermined. This will damage the credibility of the euro at a time when consumer confidence in the European Union needs to be boosted.

3.21. The Committee notes with concern that the progressive price convergence in the period 1985-1993 within the EU has stalled. This would point to some inhibitions to competition. The advent of the single currency should expose this lack of competition, which continues to diminish the gains that should accrue to the consumer.

3.22. Last year the Committee called on the Commission to present medium term scenarios to assist the macroeconomic decision making process. The Committee still feels this is a necessary requirement for the preparation of the Global Guidelines for the economic policy of the European Union and the Member States.

4. Conclusions

4.1. The Committee underlines once more the importance of the annual economic report for the preparation of the Broad Guidelines of economic policy for the Community and the Member States. It hopes that in future the various language versions of the Commission Report will be available more promptly.

4.2. The expected growth rate of about 3 % per annum for the EU as a whole shows that the EU is definitively recovering from the 1998 crisis, which will result in some welcome job creation. The modest reduction in unemployment to 8 %, however, suggests that every effort should be made to enhance the employment intensity of growth, especially in those Member States with the highest unemployment rates.

4.3. The Committee notes that further progress in budget consolidation and reduction of public debt has been made. In the present situation of higher growth this progress could, however, be accelerated especially by efforts in some Member States. The Committee asks the Commission to consider the level and quality of the Member States' public investment (education, transport, etc.), especially for their importance for promoting growth.

4.4. The Committee believes that the euro launch was a success but feels that the creation of the single currency has not yet yielded its full positive impact. The relatively low exchange rate of the euro against the dollar has largely been beneficial for Europe's export position. However, a further decline of this exchange rate should be avoided as oil and other commodities are priced in dollars and rising raw material prices may trigger a rise in inflation. The Committee hopes that as the euro becomes more firmly established, it will be used more widely in international pricing.

4.5. Generally speaking the present employment perspectives are good. This trend could be further enhanced by a continued application of an appropriate policy mix based on price stability, reasonable wage trends and budget consolidation.

4.6. The Committee suggests that special consideration should be given to helping the weakest members of the unemployed back into employment. This would include targeted measures to upgrade relevant skills and a study of the inhibiting impact of the tax-benefit system especially on the low paid. Members States with some success in this area should be examined to see if their policies could be successfully replicated elsewhere.

Brussels, 30 March 2000.

The President

of the Economic and Social Committee

Beatrice Rangoni Machiavelli

(1) This means direct taxes and social security contributions on labour.

(2) See also the ESC Opinion on the "Communication from the Commission - Towards a Single Market for Supplementary Pensions - Results of the consultations on the Green Paper on supplementary pensions in the Single Market"OJ C 368, 20.12.1999, p. 57.

APPENDIX

to the Opinion of the Economic and Social Committee

Ireland: An example of economic policy success

1) The Commission's forecasts of autumn 1999(1) count on the continuation of a very favourable trend as regards growth and employment in Ireland:

Table 1

>TABLE>

More recent information suggests that results could be even better still.

2) This development has allowed Ireland to make up a lot of ground as regards GDP per capita (in purchasing-power parities EUR 15 = 100) as well as employment.

Table 2

>TABLE>

Thus, in terms of GDP/head, Ireland exceeded the Community average and the United Kingdom in 1997 and Germany in 1999.

It should be noted that in Ireland the employment miracle occurred by maintaining the traditionally very strong trend in the increase of productivity per person employed. The increase in employment results therefore from acceleration of GDP growth beyond the trend in productivity.

Table 3

>TABLE>

This distinguishes Ireland from other Member States (particularly ESP and NL), whose performance on employment is good, but where this has mainly been achieved by slower growth in apparent productivity per employed worker.

3) The foundations of Irish success were laid in the mid-1980s.

3.1. It was essentially the fear of an unsustainable growth in public debt and in the interest burden which caused a rethink and a policy of vigorous budgetary consolidation.

This policy was all the more necessary, given that a major part of the public debt was from overseas (in 1987: more than 40 % of the debt).

Table 4

>TABLE>

Budgetary consolidation was essentially effected by reining in public expenditure, which was reduced from more than 50 % to some 30 % of GDP. This was made easier by a reduction in the interest burden as a result of falling interest rates (EMU effect) and public debt. The latter was reduced from more than 110 % of GDP in 1987 to a forecast level of less than 40 %! The public deficit (10,7 % of GDP in 1985!) has been turned into a surplus. Simultaneously, the burden of tax and social security charges was reduced significantly in the course of the 1990s.

3.2. The reduction in taxation and the tax reform played a major part in the tripartite agreements between government, trade unions and employers' organisations. Since 1988 agreements have been concluded four times for three-year periods; the fifth agreement has been negotiated and is in the process of adoption. With regard to wage trends, these agreements have made possible a growth in wage costs per unit of production compatible with a low rate of inflation and a substantial improvement in external cost competitiveness. Simultaneously the growth in real wages was below the rate of productivity growth; that is to say that real wage costs per unit of production fell significantly, which gave rise to a very favourable trend in the profitability of investment. Despite this prudent wage development, real wages were able to rise significantly, which, together with an increase in employment, particularly in the second half of the 1990s, paved the way for strong growth of private-sector consumption and domestic demand.

Table 5

>TABLE>

3.3. Budgetary consolidation and moderate wage increases made it possible to fulfil the Maastricht criteria and to relax monetary conditions. The convergence of interest rates towards the EMU level created conditions which were particularly favourable for growth and employment in the second half of the 1990s.

Table 6

>TABLE>

Following the progress in budgetary consolidation and the re-establishment of competitiveness and profitability to which the wage development has strongly contributed, the relaxation of monetary policy permitted strong growth without endangering price stability.

3.4. Thanks to the favourable trend in competitiveness, growth was driven from the outset by exports. With the reduction of free capacity and the appearance of very favourable monetary conditions in the second half of the 1990s, the high profitability of investment bore fruit: investment has become the true engine of growth (more than 13 % p.a. in 1996-2001).

Table 7

>TABLE>

The share of gross capital formation has risen sharply from around 16 % of GDP in 1992/1993 to approx. 26 % of GDP today. It was possible to finance this spectacular investment ratio increase without particular strain on the current account balance or on long-term interest rates as a result of budgetary consolidation: public savings increased from just under - 5 % of GDP in 1974-1985 to more than + 5 % of GDP at present.

This high investment ratio allows a substantial increase in production potential so that the Irish economy can achieve very high GDP growth rates without, to date, the emergence of major capacity constraints.

Table 8

Savings and investment in % of GDP

>TABLE>

3.5. These macroeconomic components of the "Irish miracle" were backed by an active structural policy. Here the efforts to train the workforce deserve a particular mention in avoiding a situation where strong growth could have been held back by bottlenecks on the labour market; this policy has found its true return since the Irish economy has been creating jobs on a large scale. Reform of tax and of the social security system along with substantial (re-)immigration have also boosted labour supply. The employment rate (% of the population of working age) has risen to 61 % today, as against approx. 52 % in 1986-1990; however, it is probable that sizeable manpower reserves can still be mobilised (the United States employment rate is around 75 %).

Attention should also be drawn to another component of structural policy: the Community Structural Funds. Rather than making a net capital contribution to the Irish economy (the current account balance has generally been in surplus), their action focuses on cofinancing structural policy measures in the spheres of regional development, infrastructure and the labour market. Ireland typifies a country where use of the Structural Funds has made maximum impact, particularly because such activities form part and parcel of a sound comprehensive policy particularly in the macroeconomic field.

Lastly, the substantial tax and parafiscal revenue generated by growth in GDP and employment has been instrumental in facilitating structural reforms in the tax and parafiscal sector.

4) Thus economic policy in Ireland has achieved remarkable results. This policy fully reflects Community recommendations and has even anticipated them. The policy was implemented against a background of social consensus which was all the more remarkable in that the fruits of the effort launched during the second half of the 1980s only burst forth during the 1990s. The scope of this effort and its persisting constitutes "an example of good practice" of the first order in the Community.

Obviously, the question now is whether this positive development can continue.

In this respect, the following comments would appear important.

Although Ireland has caught up spectacularly, its growth potential remains considerable both in terms of labour supply and of job-creating investment (capital widening), as well as in terms of productivity gains.

(i) Ireland still has a significant labour reserve, not just thanks to the increase in the working-age population, but also to the potential further increase in the employment ratio, which is compounded by returning emigrants, in particular from the United Kingdom and the United States.

(ii) Returns on investment are excellent (exceeding the Community average by more than 70 %) and could improve still further with the new tripartite agreement. At the same time, the outlook for demand - which depends on endogenous factors - is good. Given these conditions, investment can create the output capacity and the jobs necessary for growth to continue.

(iii) The already achieved investment rate (approximately 26 % of GDP) and the continuation of investment activity make it possible to implement new technology in the production process on a large scale. Under these conditions, it would seem plausible that the traditionally strong trend in productivity gains could continue.

The risks for the continuation of this growth process are in the possible appearance of bottlenecks in the labour market, inadequate infrastructure, and of a return to inflationary slippage and overheating. These risks highlight the need to boost structural policies, especially as regards the labour market, infrastructure development, environmental protection and budgetary consolidation.

The question of whether the recent upswing in inflation constitutes inflationary slippage does, however, merit an answer based on a detailed analysis.

Two factors appear important here:

(i) A country which is in the catching up phase scores - all things being equal - a higher rate of inflation than its partners, as a result of relative price adjustment between sectors, and in particular of growth in the service sector. This is a market mechanism which should be able to continue as long as the competitiveness of the country is not affected.

(ii) With EMU, a relatively small and open country cannot develop an unlimited autonomous inflation. Cost slippage impacts less on general prices and more on domestic profitability, external competitiveness and ultimately, on the external balance and employment.

Table 9

>TABLE>

Table 9 shows that Ireland is not suffering from a profit squeeze and that the competitiveness and profitability of the economy remain excellent. However, the reduction in the GDP-gap and in the surplus of the balance of payments on current account show that capacity tensions could develop. The continuation of budgetary consolidation, as recommended by the Community, therefore appears appropriate in the current situation.

(1) The figures in this appendix concerning the years 1999, 2000 and 2001 correspond to the Commission's forecasts in autumn 1999.