COMMISSION OF THE EUROPEAN COMMUNITIES 
COM(94) 615 final 
Brussels, 13.12.1994 
1995 Annual Economic Report 
(presented by the Commission) 
1995 Annual Economic Report 
Part A: Community-wide trends 
SUMMARY AND CONCLUSIONS 
CHAPTER 1:A STRONGER THAN EXPECTED RECOVERY 1 
1.1 A FAVOURABLE INTERNATIONAL ENVIRONMENT . 1 
1.2 GROWTH AND EMPLOYMENT IN THE EC 2 
1.3 GROWTH PROMOTING FACTORS 5 
1.3.1 Exports 5 
1.3.2 Domestic Demand 6 
1.4 FAVOURABLE OUTLOOK NOT WITHOUT RISKS AND UNCERTAINTIES 10 
BOX 1 THE ECONOMIES OF THE NEW MEMBER STATES . 12 
CHAPTER!: FURTHER PROGRESS IN CONVERGENCE 14 
2.1 THE RECOVERY FAVOURS REAL CONVERGENCE 14 
2.2 NOMINAL CONVERGENCE ON A PROMISING TREND., 15 
2.2.1 Moderate price increases achieved and expected 15 
2.2.2 Insufficient progress in budgetary consolidation 18 
2.2.3 Relatively stable exchange rates 20 
2.2.4 Progress on interest rate convergence 22 
CHAPTER 3: THE MEDIUM TERM TO THE YEAR 2000 23 
3.1 MEDIUM-TERM PROJECTIONS FOR GROWTH AND EMPLOYMENT 23 
3.2 CONDITIONS NECESSARY FOR STRONGER GROWTH AND EMPLOYMENT CREATION 25 
3.2.1. The role of structural policies 25 
3.2.2 Avoiding or overcoming the macro-economic obstacles to growth 28 
3.2.3 Growth and the environment. 31 
CHAPTER 4: THE POLICIES 33 
4.1 MONETARY POLICY 35 
4.2 BUDGETARY POLICY 37 
Part B: Economic situation and policy issues in the individual 
Member States 
BELGIUM 41 
DENMARK 45 
GERMANY 49 
GREECE 55 
SPAIN 58 
FRANCE 63 
IRELAND 68 
ITALY : 71 
LUXEMBOURG 76 
THE NETHERLANDS 79 
PORTUGAL .- 82 
UNITED KINGDOM 86 
13-12-94 
A*-
Summary and Conclusions 
A much improved economic outlook... 
The Community economy is experiencing a strong recovery from the sharp downturn it 
endured over the period 1992-93. Output is growing and the pace of its expansion is 
stronger than had been anticipated. Exports to the rest of the world have been 
increasing rapidly throughout 1994 and the growth impulses coming from the external 
sector have been passed on to investment which is expected to expand vigorously in 
1995 and 1996. Employment is forecast to start growing again leading to a small 
reduction in unemployment over the forecast period. 
The strength of the recovery is also creating favourable conditions for the resumption of 
the catching-up process of the less favoured countries and regions. Progress is also 
expected in relation to nominal convergence, although additional efforts are clearly 
needed with regard to some Member States' deficit and debt positions. 
The outlook for growth, employment and convergence in the Community is therefore 
substantially better than that prevailing at the end of last year when the Commission 
presented its White Paper on "Growth, Competitiveness and Employment". However, 
employment growth in 1995 and 1996 would still only result in a modest reduction in 
unemployment which will still be just below 10 percent in 1996. 
but the policy challenges remain the same. 
The improvement in the economic outlook does not therefore fundamentally change the 
challenges the Community is facing, which remain those of 
i) achieving and maintaining high rates of job creation to substantially reduce 
unemployment and to offer employment to all citizens that so wish; 
ii) achieving the degree of nominal convergence needed for the transition to Economic 
and Monetary Union. 
Meeting these two challenges requires the same policies, i.e.: 
• making the Community more competitive and dynamic; 
• implementing policies aimed at improving the functioning of the labour market; 
• creating the conditions for-an-increasedn the productive capacity of the economy; 
and 
13-12-94 
Al 
-11 
• maintaining a stable macroeconomic framework, in particular through the re-
absorption of the high budget deficits inherited from the recession and the 
insufficient adjustment of structural deficits of the second half of the 1980s. 
Additional efforts are needed to improve employment creation... 
Large efforts are currently being undertaken to improve the dynamism and the 
competitiveness of the Community's economies. These policies will result in faster rates 
of productivity growth and, provided that the right macroeconomic framework is 
maintained and that the labour market responds in a flexible way, in higher rates of 
growth of output and employment. For this result to be achieved, policies should: 
• strengthen the growth potential and the employability of individuals by improving 
education and training; 
• reduce the tensions which might appear on the labour market as unemployment is 
reduced by enhancing, via a consensus approach, flexibility and by increasing the 
effectiveness of public spending in this area; 
• increase the labour content of growth. 
and economic convergence. 
At the macroeconomic level an important challenge will be to maintain a stability 
oriented framework which simultaneously ensures that growth can remain strong over 
many years and that progress is made towards the degree of nominal convergence 
necessary to move to stage III of EMU. 
This implies maintaining conditions where monetary policy is not unduly burdened by 
inappropriate budgetary and wage behaviour. Another macroeconomic challenge which 
must be met is to create the conditions whereby the potential rate of growth of the 
economy increases, thereby facilitating higher rates of output and employment growth 
without inflationary tensions. Increases in investment, structural reforms and the current 
efforts to increase the dynamism of the Community economy are all essential elements in 
this process. 
Butt if they are made, unemployment could be substantially reduced... 
If present efforts to improve the dynamism and competitiveness of the Community 
economy are intensified and if appropriate macroeconomic policies, along the lines 
discussed above, are strictly adhered to,~the current recovery could be transformed into a 
13-12-94 
AC 
ill 
sustainable medium-term process characterised by strong rates of growth in both output 
and employment and better economic convergence. 
The Commission, as well as other international organisations and independent forecasters 
are suggesting that, under these conditions, it is reasonable to expect a growth path of 
between 3 and 3 lA percent in the second half of the present decade. This would lead to 
the creation of about 10 million additional new jobs by the year 2000, thereby reducing 
unemployment to around 7 percent of the active population; which would still, however, 
amount to almost 11 million people unemployed. 
However, while these results look impressive, they do not correspond entirely to the 
objectives of the White Paper and to the expectations of the citizens of the Union. 
These can only be achieved if substantial efforts are devoted to improving the capacity of 
the Community's economy to create jobs for any given rate of output growth. 
and the conditions for EMU achieved 
The inflation situation in a majority of Member States is now broadly satisfactory with 
wage moderation and substantial productivity increases helping to make additional 
progress towards convergence in the rates of inflation. Exchange rates have been stable 
and progress has also been made towards convergence of long-term interest rates. 
Unsatisfactory progress, however, has been made in reducing budget deficits. 
Current forecasts show that the recovery could entail the risk of a resurgence in inflation 
but that this risk is manageable provided policies remain oriented towards stability. 
Budgetary consolidation, on the other hand, could benefit substantially from the 
improvement in the economic conditions. If additional efforts are made along the lines 
agreed in the Broad Economic Policy Guidelines of 1993 and 1994, there is a realistic 
chance of achieving the goal of having a majority of Member States fulfilling the 
convergence criteria by 1996-97. 
This historic opportunity should not be missed 
The most important policy risk surrounding this favourable outlook is that the improved 
economic prospects might lead to a lapse in the determination of policy makers to attack 
the macroeconomic and structural causes of the present high levels of unemployment. 
During the period of strong growth in thesecond half of the 1980s, most Member States 
partly missed the opportunity to consolidate their public finance positions and to 
13-12-94 
Jc{ 
IV 
undertake the necessary structural reforms. Much was done but not enough. Countries 
must learn from this experience and avoid repeating the same errors. 
Provided that the policies agreed in the Guidelines exercises are now speedily and 
assiduously implemented, the Community could be on track to simultaneously achieve 
two very significant economic objectives: 
• creating 15 million new jobs by the end of the decade, thereby cutting the current 
rate of unemployment by half; and 
• entering stage III of EMU according to the timetable indicated in the Treaty. 
13-12-94 
A*-
Chapter 1: A stronger than expected recovery 
The Community economy is experiencing a strong recovery. Exports to the »« nf,h 
VZth^em ™re™"S™PMy*ro«ghou< 1994 thanks to^mto mltets 
jrom me external sector have been passed on to investment which has recovered from 
the very steep decline of 1993 and is expected to expand vigorously t1995^996 
Employment is expected to increase again in 1995 aJl996lad„gtoasmail 
rftc'onm unemployment. The pattern of the recovery and the good^rodltivi^d 
profitability trends suggest that it will be possible for the CommuZeconotivt 
Whence strong rates of sustainable growth over the medium term. * 
1.1 A Favourable International Environment 
World growth continued to expand strongly in 1994. The rate of world economic 
growth excluding the Community increased from 2.5 per cent in real terms in 1993 to 3 
percent in 1994 (see tables 1 and 5). This good performance is expected to continue in 
1995 and 1996 with rates of growth of 3 and 3 '/< percent respectively The 1994 
performance stemmed essentially from the continuing strong evolution of the North 
American economies, the slow emergence of Japan from one of the deepest downturns in 
«s recent history and the on-going very strong expansion Qf the dynamic Asian 
economies. 
The strengthening of growth in the rest of the world in 1995 and 1996 is projected to 
occur desprte expectations of a progressive slowdown in growth in both the US and 
Canada The forecast improvement therefore emanates essentially from stronger 
performances from other industrialised countries such as Japan and from a steady gain in 
the growth momentum of the non-OECD countries as a bloc. 
World import growth in volume terms, excluding the Community, is projected to 
mamtam a hgh rate of expansion. After the sharp pick-up experienced during 1993 and 
1994, when import growth averaged Chart 1 
Growth in Japan, US and in the Community 
I989 I99Q 199I [992 I993 199* 199S I9w" close to 10 percent per annum, 1995 and 
1996 should continue to witness buoyant 
rates of import growth of the order of 
8 percent (see table 1). Import demand 
in the US will continue to grow strongly 
in 1.995-96 but at rates lower than in 
1994 reflecting the impact of cyclical 
13-12-94 
i 
2-
faGtors. The double-digit import growth of 
the dynamic Asian economies in 1994 is 
forecast to continue with rates of growth in 
excess of 12 per cent expected in both 1995 
and 1996. Japan, which is slowly emerging 
from recession, is forecast to increase 
imports by 5.5 and 7 per cent respectively 
over the next two years. While the overall 
rate of world import growth may be slightly 
lower in 1995/96 compared with 1994 this 
must be put in context; rates of import 
growth of 8 percent or more are well above 
the average annual rate of expansion 
experienced during the last two decades. Table 1: World Growth 
GDP/GNP 
(annual real % change) 
World(excl. EC) 
USA 
JAPAN 
DAEa) 1993 
2.5 
3.1 
0.1 
6.3 1994 
3.0 
3.9 
0.7 
7.3 1995 
3.1 
2.7 
2.2 
7.1 1996 
3.3 
2.3 
2.7 
7.1 
IMPORTS 
(annual real % change) 
World (excl EC) 
USA 
JAPAN 
DAEa) 9.4 
10.8 
6.4 
14.9 9.9 
12.8 
11.0 
12.6 8.2 
8.0 
5.5 
12.4 7.9 
6.5 
7.0 
12.2 
European Commission forecasts 
a) DAE: Dynamic Asian Economies 
1.2 Growth and employment in the EC 
In the context of a favourable international environment the Community1 economy is 
witnessing a stronger than expected recovery in economic activity. GDP is now 
estimated to have grown by 2.6 percent this year compared with a decline of 0.4 percent 
in 1993. Exports to the rest of the world, which had helped reduce the size of the 
downturn in 1993, constituted the engine behind the recovery. Investment, which had 
declined significantly in 1993 picked up again in 1994 and contributed positively to 
output growth. In fact, the stronger than expected pace of the recovery results 
essentially from the unexpectedly rapid response of investment and of the other 
components of domestic demand to the growth stimuli coming from foreign trade which 
was also more vigorous than previously 
anticipated. 
The strength of the recovery became 
evident in the summer of this year with 
the release of the growth figures for the 
second quarter of 1994 (see chart 2). 
The Community economy is expected to 
build on this recovery by expanding at Chart 2 
Quarterly rates of growth 
EC4: WD, F, I, UK 
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 
92 | 93 | 94 
1 The term "Community" refers only to the 12 present Members as of December 1994. Because of the Accession of 
three new countries - Austria, Finland and Sweden - at the beginning of 1995 it was decided to include a box (see pages 
12/13) which provides information on the economic situation and outlook for the countries concerned 
13-12-94 
real rates of around 3 per cent in both 1995 and 1996. A characteristic feature of the 
growth process is the convergence of growth rates amongst the Member States: only 
Ireland and Greece are expected to deviate more than V2. a percentage point from the 
average growth rate for the Community during the next two years. 
Table 2: 1 
The Community economy : use and supply of goods and services | 
(annual real percentage change) 
Private consumption 
Government consumption 
Gross fixed capital formation 
of which: equipment 
of which: construction 
Domestic demand (incl. stocks) 
Exports of goods and services b) 
Imports of goods and services b) 
GROSS DOMESTIC PRODUCT 1986-90 
3.7 
2.0 
5.8 
6.9 
4.6 
3.9 
% 
6 
3.3 1991-92 
1.8 
1.6 
-0.8 
-1.6 
0.1 
1.0 
5 
3 
1.2 1993 
-0.1 
0.7 
- 5.5 
-9.1 
-2.0 
-1.8 
IVz 
- Vz 
-0.4 1994 
1.5 
0.7 
2.4 
1.9 
2.9 
2.0 
10 
41/2 
2.6 1995 a) 
2.0 
0.8 
5.7 
7.3 
4.5 
2.8 
7 
6 
2.9 1996 a) 
2.5 
1.0 
6.3 
7.7 
51 
3.1 
6S/4 
6" 
3.2 
a) November 1994 Forecasts b) Extra-Community trade only (estimates) j 
The 1992/93 recession led to a sharp drop in employment in the Community: nearly 4 Vz 
million over the two years in question. During this period, the labour force continued to 
grow modestly notwithstanding a substantial, cyclically-induced, drop in the participation 
Table 3: GDP growth 
(annual real percentage change) 
B 
DK 
D 
GR 
E 
F 
IRL 
1 
L 
NL 
P 
UK 
EC 1993 
-1.7 
1.4 
-1.2 
-0.5 
-1.1 
-1.0 
4.0 
-0.7 
0.3 
0.3 
-1.2 
2.0 
-0.4 1994 
2.2 
4.8 
2.5 
0.4 
2.2 
2.2 
6.0 
2.4 
2.3 
2.3 
1.1 
3.8 
2.6 1995 
2.7 
3.2 
3.0 
1.1 
2.8 
3.2 
5.6 
3.0 
3.0 
3.2 
3.0 
2.7 
2.9 1996 
3.1 
3.0 
3.4 
1.7 
3.2 
3.2 
5.3 
3.2 
3.2 
3.3 
3.2 
2.8 
3.2 
Source: European Commission's November 1994 
Economic Forecasts Table 4: Unemployment 
(percentage of the civilian labour force) 
B 
DK 
P 
GR 
E.. 
F 
IRL 
I 
L 
NL 
P 
UK 
EC 1993 
9.4 
10.3 
7.0 
9.7 
21.8 
10.8 
18.4 
11.1 
2.6 
8.8 
5.1 
10.4 
10.6 1994 
10.0 
10.2 
7.3 
10.2 
22.4 
11.3 
17.7 
11.8 
3.3 
10.0 
6.1 
9.4 
10.9 1995 
9.8 
9.0 
7.0 
10.6 
21.9 
11.0 
16.8 
.11.1 
3.2 
9.8 
6.0 
8.5 
10.4 1996 
9.3 
8.0 
6,4 
10.8 
21.2 
10.6 
15.7 
10.4 
3.1 
9.4 
5.6 
7.6 
9.8 
Source; European Commission's November .1994 
Economic Forecasts 
13-12-94 
4-
Chart 3 
Employment and unemployment in the EC 
% of civilian labour force 
10 I 
8 
6 
4 
2 
0 Unemployment rate 
(left scale) 
ezzai 
Varlatton jn rite number ofempjctyed 
{rlgfrt scaFeJ 
mmm&m i i i i i L J l Ï L 
78 79 80 81 82 83 84 85 86 87 88 89 90 91 91 92 93 94 95 96 
rate. As a result, a large deterioration in the unemployment situation in the Community 
took place, with the numbers out of work, as a percentage of the civilian labour force, 
growing from 8.8 per cent in 1991 to 10.6 per cent in 1993. Given the lags with which 
employment trends usually follow output growth, unemployment in 1994 went on 
increasing and is estimated to have reached a level equal to about 11 percent of the 
civilian labour force (see table 4). 
After three consecutive years of declining labour demand, that resulted essentially from 
recession and the subsequent large-scale reorganisations undertaken by many companies, 
employment is set to increase again in 1995 and 1996. Given the expected increase in 
the labour supply, these increases in employment will not be fully mirrored in reductions 
in average unemployment in the Community. Consequently, the unemployment rate, 
although diminishing, will remain at very high levels during the next few years and the 
concern about the creation of new jobs will continue to have priority in the economic 
policy agendas of the Member States and at Community level. 
The average unemployment rate is expected to fall to 10.4 per cent in 1995 and to just 
below 10 per cent in 1996. Behind these average figures lie large differences in the level 
of unemployment that will not be levelled out in the near future (for example, while 
Luxembourg's unemployment rate is expected to be 3.1 per cent in 1996, Spain will still 
be experiencing a rate above 21 per cent). 
13-12-94 
-5 
1.3 Growth Promoting Factors 
The Community is experiencing a recovery process characterised by an initial export-led 
rebound being followed by investment growth and, subsequently, by a revival in private 
consumption. Extra-Community exports underpinned recovery in late 1993 and early 
1994, thanks to strong extra-EC market growth allied to market share gains. Extra and 
intra-Community trade growth became mutually reinforcing, bolstering a strong 
improvement in confidence. While intra-Community trade in 1995 and 1996 is expected 
to grow as rapidly as the still buoyant rates of growth predicted for extra-EC exports, 
the balance of growth-inducing forces is expected to shift over the forecast period with 
domestic demand, and in particular business investment, increasing in relative 
importance. 
Chart 4 L3.1 Exports 
Fast-growing exports to the rest of the world have been a specific feature of the current 
recovery in the Community, with domestic producers increasingly drawn to foreign 
markets to compensate for the downturn in domestic activity. A geographical 
breakdown of the destination of these increases in extra-EC exports in 1993 and the first 
quarter of 1994 indicates strong export 
growth to virtually all extra-Community 
countries and regions. The strong 
rates of export growth registered from 
the second quarter of 1993 onwards 
reflect the impact of strong import 
demand in most of the Community's 
main export markets: North America, 
Japan, South East Asia, China and 
Latin America. EC: extra-community exports; investment 
and, private consumption 
% change p.a. 
HgJS>S;H;:ii*à>!*^5S$::''"'"'''' 
88 89 90 91 92 93 94 95 96 
The growth in export markets was combined with market share gains achieved following 
competitiveness improvements emanating from both a considerable reduction in the pace 
of wage increases combined with unusually high productivity growth and a real 
depreciation of the EC currencies as a bloc of more than 15 percent over the period 
August 1992 to February 1994. Extra-EC export market growth (non-EC imports 
weighted with the shares in the Community's total exports to non-EC countries) is 
expected to register-annual growth of 7 - 7 14 percent over the forecast period. 
13-12-94 
6-
In relation to the future growth perspectives for individual Member States it is interesting 
to note that intra-EC trade is staging a strong revival. While an accurate assessment of 
the role of intra-EC trade in any ongoing upturn is not possible, given the lack of reliable 
and timely data, it would appear from the available statistical evidence that intra-EC 
trade has picked up significantly in the first half of 1994 following a sharp fall in 1993. 
Intra-EC exports of goods are estimated to grow by about 7 Vz per cent in 1994 and by a 
similar magnitude in both 1995 and 1996. Given domestic demand growth in the 
Community of the order of 2-3 per cent Over the same period, the strength of the 
recovery in intra-EC trade is evidence perhaps of a reduction in internal trade barriers 
driven by the impetus of the 1992 internal market programme. This rebound in trade 
between Member States is an important factor in underpinning the sharp pick-up in 
industrial confidence in 1994. With the expected continuance of strong intra-Community 
trade volumes in 1995 and 1996 this will undoubtedly help to support the impressive 
revival in investment which is projected to occur in these years. 
Tables 
International economic environment 
(real annual percentage changes) 
World output growth excl. EC 
World import growth excl. EC 
Extra-EC export market growth 
Extra-EC exports (a) 1993 
2.5 
9.4 
6.8 
8 1994 
3.0 
9.9 
8.9 
10 Vz 1995 
3.1 
8.2 
7.4 
IVz 1996 
3.3 
7.9 
7.1 
7 
Source: Commission services November 1994 forecasts 
(a) Commission services'estimates 
1.3.2 Domestic Demand 
The growth impulses coming from the external sector spilled over to domestic demand. 
Gross fixed capital formation is estimated to expand by around 2 Vz percent in 1994 and 
is forecast to grow by between 5 V2-6 Vz percent annually in 1995/96, a remarkable 
turnaround on the 1993 decline of over 5 percent. As regards private consumption, it is 
estimated to have grown by I Vz percent in 1994 and is forecast to increase by 2 and 
2 Vz percent in 1995 and 1996. Although significant efforts are being undertaken to 
consolidate public finances, which will result in general government expenditure 
increasing more slowly than GDP over the next two years, public-consumption should 
continue to grow in 1995 and, on the usual no policy-change assumption, even accelerate 
13-12-34 
Charts Community-Survey indicators 
Business confidence 
(monthly figures) Consumer confidence 
(monthly figures) 
6 12 6 12 S 12 6 12 6 12 6 12 6 12 6 12 6 12 6 
| 85 | 86 | 87 | 88 | 89 | 90 | 91 | 92 | 93 | 94 6 12 6 12 6 12 6 12 6 12 6 12 6 12 6 12 6 12 6 
| 85 | 86 | 87 | 88 | 89 | 90 | 91 | 92 | 93 | 94 
slightly in 1996. Finally, stockbuilding, which is estimated to have contributed half of a 
percentage point to the rate of growth of GDP in 1994, is expected to continue to 
contribute positively in 1995/96 but by a smaller amount. Overall, for the Community 
as a whole, domestic demand is expected to grow by close to 2 percent in 1994 and to 
expand by 2 3A and 3 percent in 1995 and 1996 respectively. 
Investment 
As the recovery process deepens, investment is poised to overtake exports as the major 
growth impetus. The White Paper on "Growth, Competitiveness, Employment" 
indicated that the transition to a medium term growth path which could open the 
possibility of a significant reduction in unemployment implied a real growth of capital 
formation of 6-7 per cent p.a. or more. Such growth rates are indeed expected in the 
Community over the next two years. This expected performance would exceed that 
experienced in the wake of the recovery following the 1975 recession and exceed, by far, 
the investment pattern observed during the slow recovery in the first half of the 1980s. 
Several factors are contributing to the improved outlook for investment: 
demand and output in the Community, supported by a favourable external 
environment, has been rising for a number of quarters and expectations for 
continued improvement are well grounded and widespread; 
capacity utilisation rates-rhave risen-significantly-in-reeent months with a number of 
countries reporting capacity constraints in certain export sectors; 
13-12-94 
investment profitability remains healthy despite the depth of the recent recession and 
in addition is expected to improve further in 1995-96; 
a recovery in business and consumer confidence. 
Chart 6 
120 Investment profitability in the EC 
(Net returns on net capital stock) 
60, t ' } ' * • * ' l * * ' * - * * ' ^ ' * » ' * { f i ' } * "1 * ' f ' ' } 
60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 
Business confidence is expected to continue its upward trend with the pickup in demand 
filling order books and eventually inciting companies to expand their productive 
capacities. Improved expectations of recovery, the absence of ERM tensions and the 
growing degree of certainty surrounding the European integration and enlargement 
processes all helped to bring about a strong improvement in the confidence of economic 
agents (see chart 5). This is evident in the results of the recent surveys on. business 
confidence which show a spectacular rebound in sentiment since the autumn of last year. 
The strength of the revival is unparalleled in previous upturns with industrial confidence 
levels now back at the levels reached in 
Chart? 
Nominal short and long-term interest rates 
Community 
mmmm 
Apr ]ul Oct )an Apr Jul Oct )an Apr Jul Oct 
92 I 93 I 94 1988 and 1990. Export volume 
expectations, foreign order books and 
production expectations have all staged 
a strong recovery over recent quarters. 
This recovery in confidence is occurring 
despite the sharp increase in long-term 
interest rates in the Community which 
13-12-84 
-9 
has occurred in the course of the year. Such increases could be expected to have 
negative consequences on investment spending. On balance, however, the negative 
effects pertaining to the latter would appear to have been outweighed by the other 
determinants of investment, such as demand expectations and the cash flow position of 
firms, which have been in a strong position throughout the year. Business profitability 
has, in fact, remained comparatively high throughout the downturn thanks to strong 
productivity increases, resulting from labour shedding, and low rates of increase in wages 
per head. Investment profitability is expected to remain strong in both 1995 and 1996 
with real unit labour costs forecast to decline by 1.4 and 1.2 percent respectively. 
Table6 
Labour productivity 
B 
DK 
WD 
GR 
E 
F 
IRL 
1 
L 
NL 
P 
UK 
EC* 1961-73 
4.3 
3.2 
4.0 
8.1 
6.5 
4.7 
4.3 
5.5 
3.0 
3.9 
6.6 
2.9 
4.4 1974-85 
2.1 
1.5 
1.9 
1.6 
3.2 
2.1 
3.7 
18 
1.2 
2.0 
2.6 
1.6 
2.0 1986-90 
1.9 
1-2 
1.9 
1.0 
i-2 
2.4 
4.0 
2.4 
1.3 
1.1 
4.6 
1.5 
1.9 1991-96 | 1992 
'. 1.8. 
2.3 
1.8 
1.0 
2.1 
17 
3.11 
2.1 
0.1 
1.2 
1.8 
2.3 
1.9 2.3 
1.4 
0.9 
-0.6 
2.0 
2.0 
4.5 
1.8 
0.0 
0.4 
1.7 
1.7 
1.6 , 1993 
-0.3 
2.0 
-0.1 
-1.5 
33 
0.2 
3.3 
2.2 
-1.1 
0.5 
0.8 
3.7 
14 1994 
2.6 
4.7 
3.2 
0.7 
2.9 
2.4 
3.3 
4.0 
0.6 
2.2 
1.5 
3.8 
3.1 1995 
2.0 
1.5 
2.2 
0.9 
1.2 
2.4 
2.6 
2.2 
i.o 
1.9 
2.9 
1.9 
2.1 1996 
2.1 
1.4 
2.2 
1.3 
1.2 
2.2 
2.1 
2.1 
1.1 
1.5 
2.7 
1.7 
2.0 
* excluding the five new German Lander 
Private Consumption 
In 1994, the volume of private consumption increased by 1.5 per cent notwithstanding a 
near stagnation of households' real disposable incomes. This increase was made possible 
by a reduction in the household saving ratio of one percent. This drop in the ratio 
reflects the impact of improved consumer confidence. This confidence has been nurtured 
by increased optimism with regard to the sustainability of the recovery process and by 
evidence in recent months of a small but consistent drop in the rate of unemployment in 
the Community. In addition, successive years of low consumption growth in several 
Community countries have led to the creation of a considerable amount of pent-up 
13-12-94 
10 
Gross private saving: total, households and 
corporate enterprises - EUR8* 
% of G DP at mata pricef demand for consumer durables. Lower 
interest rates and fiscal incentives 
appear to have prompted increased 
expenditure on such items in 1994 
These trends are forecast to continue 
and strengthen into the near future. 
Private consumption is projected to 
increase by 2 per cent next year and 
2 Vz per cent in 1996 against smaller rates of increase in households' real disposable 
income. As a result the savings ratio is forecast to decline by another half a percentage 
point over the next two years. It should be pointed out, however, that this decline in the 
households savings ratio is not a source of immediate concern. This process of 
reduction is essentially one of normalisation following increases in the ratio during the 
years of slowdown and recession in the Community. 
Furthermore, as chart 8 indicates, the trend for total private saving, which is an 
aggregation of household and corporate sector savings, has in fact not changed 
substantially over the recent past. In fact, total private savings are expected to grow 
modestly over the forecast period as a result of the strength of corporate profit growth. 
This overall pattern of declining household saving providing a boost to private 
consumption allied to increasing corporate sector saving which should underpin 
investment activity is in keeping with the balanced growth path to the year 2000 seen as 
desirable by the Commission, built on annual changes in consumption growth of the 
order of 2 Vz per cent and investment of 6-7 per cent. 
1.4 Favourable outlook not without risks and uncertainties 
The overall favourable outlook for growth and the turnaround in labour market 
developments should not lead to reduced attention being given to the risks and 
uncertainties related to economic developments in the immediate future. 
The expected sharp improvement in investment relies not only on better business 
prospects, founded on a favourable demand outlook, but also on the anticipated further 
increase in profitability and on a reasonable relationship between borrowing costs and 
expected reaLxeturns on investment In this context, concerns have been expressed 
13-12-94 
-11-
about the possible effects on the real economy of a continuation of the upward 
movement of long term rates that has occurred since the beginning of 1994. 
Another concern that has been discussed in recent months is the possible effect on the 
outlook for Community exports of renewed dollar weakness vis-à-vis European 
currencies. This would not only affect exports to the USA and countries whose 
currencies are linked to the US dollar but would also be likely to have a negative impact 
on market shares in all other countries. In addition, the present outlook is based on the 
forecast that energy prices would remain relatively stable. Any substantial departure 
from this assumption could have significant negative repercussions. 
Substantial policy risks may also result from the projected strong economic performance 
itself. Progress could be negatively influenced in three main areas: 
i) Firstly, the recovery is creating a positive cyclical contribution to current receipts of 
the public authorities and is thereby automatically reducing the net borrowing of 
most Member States. If governments tend to be satisfied with the improvements 
achieved by cyclical movements the return to sustainable debt levels in the medium 
term would be rendered more difficult, with negative consequences for inflationary 
expectations, long term interest rates and, ultimately, economic growth. 
ii) Secondly, the better than expected performance of the Commumty economy might 
lead to less determined action to improve job prospects and reduce rigidities through 
labour market reforms, which would have grave repercussions on the prospects for 
reducing unemployment substantially in the medium term. 
iii) Thirdly, capacity constraints may start emerging as the recovery strengthens with a 
risk that the monetary authorities may have to adopt a tighter policy course in the 
absence of appropriate budgetary and wage behaviour. It should be stressed, 
however, that this is not an immediate risk with the appearance of inflationary 
pressures not likely to emerge before the end of 1995. The timing of any re­
awakening of price pressures will, of course, be dependent on the speed with which 
the output gap is closed. Significant differences exist, in this respect, between 
Member States. 
While not downplaying the seriousness of these risks, the present momentum of the 
recovery seems strong enough to warrant the relatively optimistic forecasts presented in 
this report. In addition, the progress made in increasing productivity, injmamtaining^and 
improving profitability levels and in enhancing the Community's competitive position 
13-12-94 
12-
suggest the capacity to withstand external developments less positive than those 
presented here. Indeed, it cannot be excluded that the growth path during the next two 
years will be even more favourable than currently assumed if the growth promoting 
factors expected to be at work turn out to have a more significant effect on the economy 
than presently envisaged. 
BOX1 
The Economies of the New Member States 
Enlarging the Union: The three countries scheduled to join the European Union at the 
beginning of 1995 will augment the Union area by a good third (37%) and the number of Union 
citizens by around 6%, whilst Union GDP will increase by 7%. In 1993, GDP per head of 
population measured in PPS was above the EU average in Austria (9%), while it was just below 
average in Sweden and 14% below average in Finland. 
General economic situation: The European Union is the most important trading partner 
for the new member countries, comprising between 47% (Finland) and 66% (Austria) of their 
external trade. Cyclical developments and synchronisation in the Nordic countries have differed 
from the EU, while the correlation of the Austrian and the Union cycle has been particularly 
marked. While the cycle jn Austria slowed down in line with the EU in the early 1990s, 
Sweden's economy contracted sharply after substantial overheating during the 1980s and 
output in Finland slumped after domestic overheating and as previously significant exports to 
the Soviet Union collapsed after 1989. 
Labour market: Historically, all three countries had an outstanding employment and 
unemployment record, compared with most Union countries. In all these countries, incomes 
policies have been highly centralised and extensive labour market measures were in place 
especially in the Nordic countries. The recent economic downturn has, however, pushed open 
unemployment in Sweden from 2% to an unprecedented 8% (an additional 5% are in active 
labour market programmes) and in Finland from 4.5% to an extraordinary 19%. 
Inflation and interest rates: While the Austrian inflation rate (CPI) has been below the 
EU average for a long time due to the peg of the Schilling to the DM, Finland's rate was mostly 
slightly above the Union average and Sweden's inflation used to be substantially above the 
Union average in the 19805^ After the 1992 currency turmoil, monetary policy in the Nordic 
countries has been set to contain inflation. Thus, the underlying inflation rates are under control 
in all the new member countries. Long-term interest ratesjn Austria are presently well below 
the Union average, with those of Finland and Sweden being above, reflecting, inter alia, the 
state of the public finances in the latter countries. 
External balance: The current account balance in Austria has been broadly balanced 
since the early 1980s, benefiting from compensating cyclical movements of its elements. 
Finland's balance deteriorated in 1989 to 5% of GDP due to the slump in exports. The recent 
export-led upswing has reversed this unsustainable deficit to a surplus of some 2%. Sweden 
mirrored Finland on a more moderate scale, as the deficit was mainly due to domestic factors. 
13-12-94 
13 
Public finances: Shares of public expenditures in GDP have exceeded the EU average 
substantially in Sweden and slightly in Austria. In Finland it has exceeded the EU average only 
during the recent recession, while it was markedly smaller before. While the general 
government net financial balance has fluctuated closely around -3% of GDP for 20 years in 
Austria and was moving between +1% and +7% in Finland, swings were marked in Sweden. 
The recent recession has led to a deterioration in Austria's general government deficit by more 
than 2 percentage points to 4.1% of GDP in 1993. The recession had an even more serious 
effect on Finland and Sweden, with deficits of 7% and 13% of GDP, respectively, in 1993.' 
Government debt as a percentage of GDP has risen recently just above 60% in Austria. While 
recession and devaluation of the currency have pushed the gross debt ratio up by 36 
percentage points to some 88% of GDP in Sweden in the period 1990-1994, these factors 
increased the Finnish debt ratio by 58 percentage points to about 72% of GDP over the same 
period. 
Exchange rate policy: All the new member countries pursued fixed exchange rate 
policies prior to the turmoil in European currency markets in the second half of 1992. Austria 
was unaffected by the turbulence and was able to maintain its exchange rate objective, vis-à-
vis the DM in this case. After substantial devaluations of the Finnish and Swedish currencies, 
the Nordic new member countries have opted for floating regimes, which required new 
guidelines for monetary policy. Both Finland and Sweden have chosen explicit inflation 
targets. 
Economic outlook for 1995/1996 
In general, the three new Member States are expected to perform well during the next two 
years, but there are notable differences between them. The new Member States have to 
undertake the same efforts as existing Union Members in order to reach the policy objectives of 
the Community. 
In Austria, exports of goods and investment push real GDP growth close to and then 
slightly above 3% in the period 1994-1996. Price increases remain moderate at 3%, with only 2 
Vz% in 1995, due to lower food prices as a result of accession. As employment increases 
quickly, unemployment should come down some V* of a percentage point to 5 V*%. The 
transfers to the EU budget and adjustment measures push the general government deficit to 
almost 5% of GDP in 1995, before automatic stabilisers reduce it. 
Finland emerges from the deep recession via an exceptionally strong export 
performance, helped by the currency devaluation, which boosts investment in equipment at 
outstanding growth rates above 20% in 1995 and 1996, though mainly in export industries. 
GDP growth of 4 3A% on average during the three years should lower unemployment from 18% 
to a still high 14% in 1996. Inflation remains at moderate levels, as private consumption is still 
subdued relative to capacity in the domestically oriented sector. The general government 
deficit will stay around 5% in 1994 and 1995 due to postponed tax refunds, before it comes 
down to 2 Vz% in 1996. The net transfers vis-à-vis the EU budget should be close to balance. 
Sweden's economic activity is forecast to expand by close to 3% per year through to 
1996. While high export growth and associated investment pulled Sweden out of recession in 
1994, domestic demand gradually takes over as the driving force in the forecast period. 
Inflation, after having been pushed upwards by the currency devaluation, should benefit from 
moderate unit labour cost increases, supplemented, however, by pressure from indirect tax 
increases in the forecast period. Employment, which contracted in 1994 by close to 1%, should 
expand at around 1 Vz% in 1995 and 1996, thereby gradually reducing open unemployment to 
just below 7%. Public consumption is expected to decline in real terms in order to regain control 
of the general government deficit. The deficit peaked at 13 V*% of GDP in 1993 and should 
come down to a still high 7 V*% in 1996. 
13-12-94 
14-
Chapter 2: Further progress in convergence 
Wage moderation, substantial productivity increases and a still relatively low degree of 
capacity utilisation have all helped to make additional progress towards convergence in 
the rates of inflation. The inflation situation in a majority of Member States is now 
relatively satisfactory. Unsatisfactory progress, however, has been made in reducing 
budget deficits. The strength of the recovery is offering an opportunity to step up 
efforts in this area. Exchange rates have been stable and progress hasxilso been made 
towards convergence of long term interest rates. Provided that additional efforts are 
made, especially in the budgetary area, it is now realistic to expect that a majority of 
Member States could meet the EMU criteria by the deadlines set out in the Treaty. The 
strength of the recovery is also creating favourable conditions for a resumption of the 
catching-up process of the less favoured countries and regions. 
2.1 The recovery favours real convergence 
Recent real convergence trends are conventionally examined on the basis of the relative 
position of countries in terms of GDP per capita. However, limiting the analysis to the 
level of the Member States very often masks some important differences between smaller 
geographical units such as regions2. Indeed, disparities between the regions of the 
Commumty in general show a more varied picture than that suggested by an analysis at 
the level of the Member States. Unfortunately, regional data are available only with a 
substantial delay and the 
assessment of recent 
convergence trends real 
must 
therefore be conducted on the 
basis of country data. On this 
basis, progress was mixed in 
1993-94: while Ireland improved 
its relative position in terms of 
GDP per head, that of Spain 
hardly changed and those of 
Portugal and Greece deteriorated 
somewhat. In 1995 and 1996, 
the real convergence process is 
expected to continue for Ireland, 
to resume in Spain and Portugal, 
while the relative position of Table 7: GDP per head 
(PPP, Community = 100) 
B 
DK 
WD 
D 
GR 
E 
F 
IRL 
I 
L 
NL 
P 
UK 
EC(1) 
EC 1980 
106.8 
105.9 
117.8 
64.1 
71.7 
112.8 
62.0 
102.5 
115.6 
107.6 
52.8 
97.1 
100.0 1985 
104.5 
113.7 
118.3 
62.5 
70.1 
111.5 
63.5 
102.9 
119.8 
103.8 
51.1 
100.3 
100.0 1990 
103.6 
105.0 
116.5 
58.2 
74.5 
110.0 
71.1 
103.2 
125.8 
101.2 
55.5 
100.8 
100.0 1992 
107.0 
103.4 
120.1 
105.7 
59.7 
75.1 
108.7 
75.7 
103.8 
127.3 
99.4 
59.9 
95.6 
100.0 
97.6 1994 
105.8 
108.3 
116.1 
104.9 
58.3 
74.9 
108.0 
82.3 
104.3 
129.7 
99.6 
59.2 
99.7 
100.0 
98.1 1996 
105.9 
108.9 
114.5 
105.3 
56.5 
75.3 
108.3 
86.9 
105.5 
128.4 
99.4 
59.7 
99.6 
100.0 
98.5 
(1) Excluding the five new German Lander 
Regional trends are analysed in: European Commission (1994), Competitiveness and cohesion: trends in the regions, 
Fifth Periodic Report on the Social and Economic Situation and Development of the Regions of the Community. 
13-12-94 
15 
Greece is projected to deteriorate further. 
These trends are best assessed against the overall trend in real convergence over the last 
decade which saw a slight widening in disparities between 1980 and 1985 followed by a 
period of narrowing which came to a halt in 1992 due to the slowdown in activity in the 
Community. Spain and Portugal were able to improve their relative positions by 4.9 and 
7.4 percentage points of the Community average respectively since 1986, the year in 
which they joined the Community. An even more impressive performance was 
registered in Ireland, which increased its 
relative position by around 21 percentage 
points of the Community average during 
the same period. Despite a slight 
improvement between 1990 and 1992 
Greece was the only country in this group 
to register a deterioration in its relative 
position compared to the situation 
prevailing in the early 1980s. Inflation convergence in the Community 
Deflators of private consumption, 
thick line = average of 3 best performers +1.5 
1988 1989 1990 1991 1992 1993 1994 1995 1996 
2.2 Nominal convergence on a promising trend 
Following a significant setback during the early 1990s, renewed progress has been made 
towards greater nominal convergence in the Community. However, what has been 
achieved is not yet entirely satisfactory and in order to achieve the targets set out in the 
Maastricht Treaty additional efforts will have to be undertaken. 
2.2.1 Moderate price increases achieved and expected 
The inflation performance of the Community has improved significantly. After a peak of 
5.4 percent in 1991, the average rate of inflation, measured by the private consumption 
deflator, declined continuously and is estimated to have reached 3.1 per cent in 1994. It 
is expected that average price increases in the Community will decline further in 1995 but 
that there could be a modest acceleration in 1996. 
Average inflation in the Community, on the basis of the private consumption deflator, 
was 4.7 percent in 1990, and in terms of the GDP deflator, 5.2 percent. A further 
deterioration in inflation occurred in 1991, with both indices recording inflation at 5.4 
percent. In the case of Germany, the increase reflected the strong growth in internal 
demand resulting from unification-induced public expenditure and tax increases, but 
13-12-94 
16 
several other Member States (France, Ireland, Italy, the Netherlands and the UK) also 
experienced an acceleration in inflation. 
Early signs that inflation was decelerating emerged in 1992 and inflation has been on a 
downward trend since. The private consumption and the GDP deflator recorded average 
inflation at virtually the same rate (4 Vz percent) in 1992, and at 3.9 and 3.7 percent, 
respectively, in 1993. In the course of 1994, additional declines in inflation were 
achieved bringing the figures for the Community as a whole to historically low levels: the 
private consumption deflator is expected to rise by 3.1 percent and the GDP deflator by 
2.7 percent. 
Table 8 
Inflation developments 
(percentage change in the deflator of private consumption) 
B 
DK 
D * 
GR 
E 
F 
IRL 
1 
L 
NL 
P 
UK 
EC12 
GDP Deflator EC12 
Unit Labour costs EC12 1990 
3.6 
2.7 
2.8 
19.2 
6.5 
2.9 
1.6 
5.9 
3.6 
2.2 
12.6 
5.5 
4.7 
5.2 
6.0 1991 
2.5 
2.2 
3.8 
18.5 
6.3 
3.2 
2.5 
6.9 
2.9 
3.2 
11.1 
7.4 
5.4 
5.4 
5.5 1992 
2.1 
2.1 
4.8 
14.6 
6.4 
2.4 
2.8 
5.2 
2.8 
3.0 
9.8 
4.8 
4.6 
4.5 
4.6 1993 
2.6 
1.7 
3.9 
13.6 
5.6 
2.1 
1.6 
5.1 
3.6 
2.1 
7.9 
3.5 
3.9 
3.7 
2.7 1994 
2.6 
1.8 
2.8 
10.8 
4.9 
1.7 
2.8 
4.0 
2.3 
2.3 
5.5 
2.5 
3.1 
2.7 
0.2 1995 
2.5 
2.1 
2.2 
9.5 
4.5 
1.9 
2.7 
3.5 
2.5 
2.4 
4.6 
2.9 
2.9 
2.8 
1.4 1996 
2.6 
2.4 
2.4 
9.0 
4.4 
2.1 
2.7 
3.5 
2.7 
2.5 
4.4 
3.3 
3.1 
3.0 
1.8 
Source: November 1994 forecasts by the Commission services * West Germany for 1990 and 1991 
The reduction in inflation to the low rate recorded this year has been the result of several 
factors. First, actual inflation is still reflecting the effects of the recession; with the 
output gap, by most estimates, remaining wide and price changes having consequently 
slowed down. Furthermore, wage moderation, high productivity increases, a relatively 
low degree of capacity utilisation and the appreciation of Community currencies against 
the US dollar have all had a beneficial impact on restraining inflation. 
13-12-94 
Chart 10 
Inflation in the EC 
(annual percentage changes) 
Deflator of private consumption 
62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 
Nominal Unit Labour Costs 
62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 
import prices 
62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 - 17 
Wage settlements have also moderated in line with 
the deceleration of inflation and in 1994 nominal 
compensation per employee is expected to grow by 
3.4 percent; this compares to an average of around 
7 percent recorded in the period 1990-92 and to 
4.2 percent seen in 1993. Labour productivity, on 
the other hand, is estimated to grow by over 3 
percent this year, reflecting the rapid expansion of 
output and the impact of restructuring measures; 
this productivity growth is not, however, atypical 
of recovery phases. As a result, nominal unit 
labour costs have increased by only 0.2 percent this 
year compared with an average of 4 Vz percent in 
the period 1990-93. Finally, import price inflation 
has averaged around one percent during this period. 
The good inflation performance this year has been shared by virtually all Member States. 
On the basis of the private consumption deflator, inflation appears to have stabilised in 
Belgium at around 2.5 percent, while in three Member States (Denmark, Ireland, the 
Netherlands) it has accelerated marginally since 1993, while remaining low. Marked 
improvements have been made in Germany (down 1.1 percentage points to an estimated 
2.8 percent in 1994), Greece (2.8 percentage points to 10.8 percent), France (0.4 
percentage points to 1.7 percent), Spain (0.7 percentage points to 4.9 percent), Italy (1.1 
percentage points to 4 percent), Luxembourg (1.3 percentage points to 2.3 percent), 
Portugal (2.4 percentage points to 5.5 percent) and the UK (1 percentage point to 2.5 
percent). 
These favourable price trends are expected to continue in 1995 and 1996. Unit labour 
costs are expected to increase somewhat but the projected rates of increase, at 
significantly less than two per cent a year, will remain at historically low levels. Tighter 
demand conditions, however, will allow firms to edge prices up and, after a further slight 
slowing down in 1995, the deflator of private consumption is expected to accelerate to 
3.1 per cent in 1996 (3 per cent for the deflator of GDP). 
Seven Member States are expected to show a broadly acceptable inflation path - within 
the intermediated to 3 per cent range ^eHntheTBroad Guidelines - while the situation in 
the other five remains unsatisfactory, albeit to different degrees. In 1996, Portugal, 
13-12-94 
18-
Spain and Italy, notwithstanding some additional improvement, are expected to be still 
outside the desired range (about 4 Vz percent in Spain and Portugal and 3 Vz percent in 
Italy). In the United Kingdom, the rate of inflation, which in 1994 was well within the 
Guidelines target range, is expected to progressively increase and be above 3 per cent in 
1996. The Greek rate of inflation is projected to decline although the pace of decline 
may be slower than in the recent past. Additional efforts are required in most of these 
countries in a large number of areas but especially with regard to wage behaviour and 
budgetary trends. All Member States, irrespective of their relative success in reducing 
inflation, must maintain policies aimed at securing the objective of price stability. This 
means maintaining a stable macroeconomic framework, conducting prudent budgetary 
and monetary policies and strengthening competition in markets. 
2.2.2 Insufficient progress in budgetary consolidation 
While the recession brought budget deficits to record heights in 1993 (6 per cent of 
GDP), 1994 saw the beginning of a turnaround which is expected to lead to a reduction 
in the Community's average budget deficit to about 4 per cent of GDP in 1996. A large 
part of this reduction, however, will be the automatic result of both the expansion in 
GDP and renewed employment growth on government receipts and expenditure. In 
19963, the average cyclically-adjusted government deficit in the Community is still 
expected to be about 4 % per cent of GDP, which is clearly too high. 
Chart 11 
EC: actual and cyclically-adjusted government deficits 
% of GDP 
86 87 88 89 90 91 92 93 94 95 96 In 1994, budgetary trends have been 
disappointing in several Member States 
(see chapter 4, section 4) and in 
October 1994 the Council, in its first 
application of the new procedure aimed 
at avoiding "Excessive Budget 
Deficits", decided that ten out of the 
twelve Member States were in a 
situation of excessive deficit. 
In particular, in Greece the budget deficit continues to be the highest in the Community 
and remains well above the reference value in the Treaty. In Italy, the budget deficit 
The Commission's forecasts are based on the usual "no-policy-change" assumption. This has importantimpticatrons 
in the case of budgetary policy since most governments will announce inthe course of 1995-measures designed-to 
influence trends in 1996 which could not be incorporated in the present forecasts. Budgetary projections for 1996 
simply extrapolate the effects of measures already in force. 
13-12-94 
19 
remained practically stable for the third year running at the very high level of 9 Vz per 
cent of GDP. Spain and France achieved small reductions in their deficits, which, 
however, remain too high (7.0 and 5.6 per cent of GDP respectively in 1994). 
According to the November 1994 Commission forecasts, the outlook for next year and 
for 1996 suggests that, under current policies, fiscal consolidation will not fully exploit 
the opportunities offered by the emergence of a stronger growth performance, even 
though the projected deficits will be on a downward path. 
Table 9 
B 
DKD 
D 
GR 
E 
F 
IRL 
1 
L 
NL 
P 
UK 
EC General government net 
borrowing (-) or lending (+) General government gross debt 
percentages of GDP 
1994 
-5.5 
-4.3 
-2.9 
-14.1 
-7.0 
-5.6 
-2.4 
-9.6 
1.3 
-3.8 
-6.2 
-6.3 
-5.6 1995 
-4.7 
-3.0 
-2.4 
-13.3 
-6.0 
-4.9 
-2.0 
-8.6 
1.6 
-3.5 
-5.8 
-4.6 
-4.7 1996 
-4.0 
-2.2 
-2.0 
-12.9 
-4.7 
-3.9 
-1.5 
-7.9 
2.0 
-2.7 
-4.8 
-3.4 
-3.9 1994 
140.1 
78.0 
51.0 
121.3 
63.5 
50.4 
89.0 
123.7 
9.2 
78.9 
70.4 
50.4 
68.8 1995 
1387 
78.0 
2) 59.4 
125.4 
65.8 
53.4 
83.7 
126.8 
9.8 
78.8 
71.7 
52.4 
72.7 1996 
136.0 
78.2 
58.9 
' 128.1 
66.1 
55.6 
79.1 
128.6 
9.9 
78.0 
72.3 
53.1 
73.2 
European Commission estimates of November 1994 
1) Government deposits with the central bank, government holdings of non-government bonds and public enterprises 
related debt are expected to amount to 24.4% of GDP in 1994. 
2) The sharp increase in the German debt ratio in 1995 is mainly caused by the take-over by the government of off-
budget unification-related liabilities, the most important of which is the debt of the "Treuhandanstalf. 
For the Community as a whole, net borrowing as a percent of GDP is expected to 
narrow to 4.7 per cent next year and to 3.9 per cent in 1996. In five Member States 
(Denmark, Germany, Ireland, the Netherlands and the UK) the projected reductions in 
general government net borrowing are consistent with the objectives set in the national 
convergence programmes. On the other hand, the projections for Belgium, Spain, 
France, Italy, and^Portugal4ndicate^hat^X)ntmued^effoits~or additional measures are 
13-12-94 
20 
needed to reach these objectives. Finally, the projection for Greece points to only a 
small reduction in the budget deficit from its present very high level4. 
Public debt will grow at a slower pace 
As shown in Table 9, the ratio of government debt to Community GDP has already 
reached worrying dimensions and continues to deteriorate. In the Commission's Autumn 
1994 forecast the debt ratio is expected to increase faster than predicted in the 
convergence programmes in the cases of Greece, France, Italy, and Portugal. Movements 
in the debt ratio which are broadly consistent with the convergence programme estimates 
are projected for Belgium (gradually declining), Denmark (generally stable), Spain 
(rising) and the UK (modestly rising). 
In the case of Germany, it is expected that the debt ratio will peak in 1995, as predicted 
in the convergence programme, and in the case of Ireland, faster economic growth and 
lower deficits will contribute to the debt ratio declining faster than in the convergence 
programme; a similar path is also expected in the case of the Netherlands. Finally, 
Luxembourg's debt ratio is expected to stabilise at below 10 percent of GDP over the 
next two years. 
The projected increase in the debt ratio in 1995 and 1996 provides a measure of the 
adjustment which is necessary in order to put the debt ratio on a declining trend. 
Clearly, some Member States are confronted with substantially greater and more urgent 
adjustment needs than others (Belgium, Italy, Greece) but the need to reduce the debt 
ratio applies to almost all. Since the debt ratio is in most cases so large, all Member 
States are vulnerable to adverse interest rate shocks. 
2.2.3 Relatively stable exchange rates 
Since 2 August 1993, the ERM has been functioning with bands of+/-15 percent. The 
tensions, which characterised the period June 1992 to the summer of 1993, have 
subsided since the August decision and, after some initial downward movements, most 
ERM currencies have now moved substantially back towards their unchanged central 
rates. 1994 to date has been characterised by a continuation of this relatively high degree 
of stability in the ERM. The non-ERM currencies, however, experienced, to different 
degrees, additional depreciations in the course of 1994. 
M he Commission's projections were finalised before the adoption of the 1995 Greek budget. 
13-12-94 
-21 
Chart 12 
Exchange rate stability vis-à-vis the DM 
13-week moving coefficient of variation (standard deviation divided by the average) 
0.04 
WÊÊÊÊÈÊÈ 
0.04 È 
2At$l9& 
This lack of turbulence has been due to the cautious manner in which monetary decisions 
have been taken in Member States and to the general improvement in economic 
conditions which has increased the room for manoeuvre of the authorities. The 
credibility of the central rates have been strengthened by the operation of monetary 
policy and the functioning of the ERM since August 1993. In addition, the re-
introduction of two-way risk into the system has done much to eliminate the sources of 
speculative pressure. 
From the beginning of 1994, a policy of cautiously lowering official or key interest rates, 
in line with cuts in German official rates, has been followed by most Community central 
banks leading to an overall reduction in short-term interest rates throughout the 
13-12-94 
22 
Community. This policy has been facilitated by continued progress in reducing 
inflationary pressures. 
2.2.4 Progress on interest rate convergence 
Convergence of long term interest rates depends closely on the progress towards price 
stability and budgetary consolidation required for exchange rate stability. Progress in 
these two areas led to a narrowing of differentials in the second half of 1993; but during 
the course of 1994 differentials have widened again. This emphasises the need for 
markets to be convinced of the durability of progress in these areas. All in all, 
convergence of long term interest rates presents an encouraging, if not a totally 
satisfactory, picture (see chart 13). 
Chart 13 
12 Long term interest rates 
(average Nov. 93 - Oct. 94) The gradual downward trend in short-term interest rates which occurred in most 
Member States contrasted with developments with regard to the long end of the market. 
Long-term interest rates abruptly changed direction at the beginning of 1994. The 
downward trend in both long term 
interest rates and differentials with 
Germany, which had been a feature of 
developments in 1993, came to an end 
in February 1994. By October, 
nominal long term interest rates 
(benchmark 10 years) were about 250 
basis points (Community average) 
higher than earlier in the year. B DK D GR F IRL I I NL P UK EUR 
This development appears to have been triggered by the rise in US bond yields following 
concerns about future inflationary trends in the US. Internal EC factors, such as the 
implications for inflationary expectations of improving growth prospects, growing 
market concerns in relation to underlying budgetary imbalances in a large number of 
Member States and perceptions of undershooting of the budgetary targets at the end of 
1993, must also share part of the "responsibility" for the significant increases which 
occurred in virtually all Member States. The increases in the individual Member States 
were significantly different reflecting the stage of the cycle in different countries and, in 
some cases, uncertainty about the future evolution of public debt that has given rise to 
inflationary premia. 
13-12-94 
23-
Chapter 3: The Medium Term to the year 2000 
The major task facing economic policy at the present time is to transform the current 
recovery into a sustainable medium-term process characterised by strong rates of 
growth in both output and employment and better economic convergence. The policies 
required to achieve these two objectives are the same. The improvement in the 
economic outlook opens up the perspective of a return to a medium-term growth path 
similar to that experienced in the second half of the 1980s and similar to the path laid 
out in the Commission's White Paper on "Growth, Competitiveness, Employment" as 
being a necessary condition for achieving a substantial reduction in unemployment by 
the end of the present decade. The realisation of this objective demands that present 
efforts to improve the dynamism and competitiveness of the Community economy and 
the functioning of the labour markets are intensified and that appropriate 
macroeconomic policies are strictly adhered to. 
3.1 Medium-term projections for growth and employment 
The nature of the present recovery process in the Community, which was driven initially 
by exports and subsequently by a strong rebound in investment, bodes well for the 
achievement of the main medium-term targets in terms of growth and employment. The 
present upturn offers an opportunity to introduce far-reaching structural reforms that 
allied to consistent macroeconomic policies hold out the possibility of significantly 
reducing unemployment by the year 2000. The current upturn is, in fact, developing 
according to the path envisaged in the White Paper. 
The medium-term projections of the services of the Commission as well as those of the 
IMF and the OECD suggest the possibility of a medium-term growth path of between 3 
and 3 Vz per cent per annum to the year 2000. Such a favourable outcome is dependent 
however on the realisation of the following crucial assumptions; 
• a neutral international environment, in terms of its impact on economic conditions in 
the Community; 
• a stability-oriented monetary policy which will not be burdened by inappropriate 
budgetary and wage behaviour; 
• the continuation of budgetary consolidation efforts in a large number of Member 
States; 
• an evolution of wages similar to that which occurred in the 1980s; 
• the continuation of the structural reform measures undertaken in the past. 
Given the nature of these assumptions, the outcome of the medium-term projections is 
essentially an illustration of the fact that, given the implementation of sound policies, the 
13-12-94 
24-
GDP, investment and employment growth 
in the Community 
1993 1994 1995 1996 1997 1998 1999 2000 achievement of strong and healthy 
economic developments is possible. 
The growth path of 3-3 Vz per cent 
annually until the end of the century 
will, according to the Commission 
projections, be mainly driven by internal 
forces i.e. investment and consumption. 
Investment leads the recovery, 
progressively returning towards growth 
rates of 6-7 per cent over the period 1996-2000. This strong and sustained rate of 
growth results from an ongoing improvement in the profitability of capital, a trend which 
had been interrupted in the early 1990s, and by the increasingly favourable prospects for 
the evolution of final demand. 
With investment growing at a faster rate than total output, the share of investment in 
GDP is expected to increase to around 22-23 per cent in the year 2000. This growth in 
investment will have positive effects both in terms of the additional capacity generated 
and in terms of adding directly to demand and employment creation. Increases in 
employment combined with real wage increases per head remaining positive, but below 
the rate of increase in labour productivity, will support households' real disposable 
incomes and consequently private consumption. The latter is forecast to grow on 
average by about 2 Vz per cent annually over the period to 2000. 
Chart 15 
Unemployment rate in the Community to the year 2000 
% of ctvMan labour force If these investment and consumption 
trends can be realised, a sustained 3-
3 Vz per cent overall growth rate is 
possible over the medium-term. In these 
circumstances, assuming that labour 
productivity trends are maintained at 
their 1974-94 average of about 2 per 
cent per year, these rates of GDP 
growth would involve employment 
growth of 1 to 1 Vz per cent annually. Such employment increases would translate into 
yearly falls in unemployment of between a half and one per cent of the labour force under 
the assumption that the labour supply will grow to the year 2000 at about half a per cent 
a year (resultingj-in equal proportionsy-from demographic factors and an increase in the M 
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 
13-12-94 
25 
participation rate). Unemployment could consequently be reduced to around 7 per cent 
of the active population by the year 2000. 
A rate of unemployment of about 7 per cent of the civilian labour force, while impressive 
compared to recent experience, would not correspond entirely to the White Paper 
objective of halving the rate of unemployment by the year 2000. This can only be 
achieved if, first, the structural measures aimed at increasing the endogenous growth 
forces in the Community are successful and growth can therefore be at the upper end of 
the expected scale of 3-3 Vz per cent. Secondly, achievement of the objective requires 
that policies to increase the Community's capacity to create jobs for any given rate of 
output growth are implemented quickly and with determination. If the above conditions 
are met, then the White Paper objective becomes achievable. These medium-term 
projections illustrate not only that significant progress in reducing unemployment can be 
made but also indicate the nature of the policy challenge ahead and the limits to what can 
be achieved on the basis of present trends. 
3.2 Conditions necessary for stronger growth and 
employment creation 
Sustained rates of growth at the high level mentioned in the previous paragraphs cannot 
be obtained by direct government intervention. Such an economic evolution will depend 
both on the establishment and maintenance of appropriate macro- and microeconomic 
policies and on adaptations in the behaviour of economic agents. Respect for these 
conditions will be essential in ensuring that any such growth process is sustainable, non-
inflationary and respectful of the environment. 
3.2.1. The role of structural policies 
As growth accelerates, the environment for implementing structural adjustment policies 
will become more favourable. Resistance will be reduced to the implementation of 
policies directed towards removing obstacles to competition and other rigidities. 
Furthermore, active labour market policies will acquire a more meaningful perspective 
with recipients of these policy interventions having an increased likelihood of actually 
finding jobs. However, complacency on the part of governments in implementing the 
necessary reforms should not be underestimated in an improving economic environment. 
This reaction, while understandable, would be a serious mistake since opportunities to 
enhance the^dynamism of the Community's economy and its capacity to create jobs will 
rarely be as favourable as at the present time. 
13-12-94 
26 
3.2.1.1 Competitiveness 
Support for structural measures aimed at increasing the endogenous growth forces of the 
Community (such as those put forward in the 1993 White Paper) is strong throughout 
the Member States. Promoting the competitiveness, the dynamism and ultimately the 
productivity of all sectors of the Community's economy is essential to secure its long-
term prosperity. If the appropriate macro-economic conditions are created and effective 
labour market policies are implemented, the structural efforts to improve productivity 
and competitiveness will result in stronger growth and employment creation. 
Given the differences in the nature of the production process, however, the productivity 
gains will be stronger in some sectors than in others. In the former sectors, the 
employment gains for any given rate of output growth will be smaller as a result of the 
faster productivity growth, but this will be offset by strong employment increases in the 
sectors where productivity growth is, because of technical constraints, slower. 
Table 10 
Employment, productivity and relative prices in agriculture, industry and services 
(Belgium, West Germany, France, Italy and the Netherlands; changes in per cent per year) 
Indicator 
Value added 
Employment 
Productivity 
Relative 
prices 1) Period 
1961-73 
1974-85 
1986-90 
1961-73 
1974-85 
1986-90 
1961-73 
1974-85 
1986-90 
1961-73 
1974-85 
1986-90 Total 
4.9 
2.1 
3.1 
0.3 
0.2 
1.0 
4.6 
1.9 
2.1 
-Agriculture 
1.8 
1.7 
1.7 
-4.6 
-2.9 
-3.1 
6.5 
4.7 
4.9 
-0.4 
-2.5 
-2.0 Industry 
5.5 
1.0 
2.4 
+0.5 
-1.4 
+0.3 
5.0 
2.4 
2.1 
-1.0 
-0.4 
-0.4 Market 
Services 
5.6 
3.2 
4.0 
1.6 
1.7 
2.4 
4.0 
1.5 
1.6 
0.7 
0.5 
0.4 Non-market 
Services 
3.7 
2.3 
1.4 
2.2 
2.0 
1.0 
1.5 
0.3 
0.4 
3.4 
3.5 
2.9 
Source: EUROSTAT and Commission services 1) Increase in the deflator of gross value added for the sector relative to the 
increase in the GDP deflator 
The process of job creation in the latter group of sectors will be financed by a transfer of 
wealth operated through changes in relative prices: under the pressure of competition, 
the prices of the products of the sectors with the fastest productivity increases will fall 
when compared to other sectors of the economy; conversely those of the sectors where 
productivity increases are smaller will increase.—This-mechanismrhas^worked"well during-
the 1950s and 60s, as well as in 1985-90 and could thus be revived in the framework of a 
13-12-84 
27 
strong macro-economic growth process. These sectoral shifts are indeed the very 
process by which employment is created in a market economy in the course of 
modernisation, ensuring that the desired productivity increases result not in a net job 
destruction but in the creation of wealth, part of which must be used to cushion the 
social costs of the unavoidable adjustment process. For this process to work effectively 
and yield net increases in jobs, three conditions must be met: i) changes in relative prices 
must be allowed to take place; this means in essence that competition must be allowed to 
operate; ii) policies must be oriented towards accommodating structural adjustment - if 
necessary by cushioning its adverse social effects - instead of hindering it and iii) overall 
economic growth must be sufficiently strong. 
3.2.1.2 Employment 
The present momentum of the recovery should allow a return to a level of output close 
to potential and should entail the elimination of the so called "cyclical unemployment", 
which can be roughly estimated at 1 to 2 percentage points of the peak level (11 per 
cent) reached in 1994. Indeed, the remaining part of unemployment (9 to 10 % of the 
labour force), the so-called "classical" part, can only be absorbed by the creation of new 
physical working posts, i.e. by a strong expansion of productive capacity. This 
condition, however, is not sufficient because classical unemployment is overlapped by the 
inadequacy of a part of the labour force to secure the kind of jobs that will become 
available through the growth process. The size of this overlap, which represents 
structural unemployment stricto sensu, is difficult to assess but the amount of long 
term unemployment (about 45% of the unemployed, i.e. 5% of the active population) can 
be used as a rough approximation. The limit between classical and structural is 
somewhat floating and tensions on the labour market may appear even before it is 
reached. However, this limit could also be made less constraining by adequate labour 
market policies. 
The reduction of unemployment to the rates mentioned in the White Paper will require 
the net creation of 15 million jobs through a combination of strong growth and actions 
aimed at increasing the job content of that growth. Labour market policies can make a 
significant contribution to achieving this goal through three main channels: 
• increasing the employability of workers in general and especially that of the young 
and of the long term unemployed (reducing skills mis-match); 
• avoiding the labour market tensions, also with regard to wages, which tend to 
appear during periodsofhigh growth and employment creation; 
• enhancing the employment content of growth. 
13-12-94 
28-
3.2.2 Avoiding or overcoming the macro-economic obstacles to growth 
The policies to improve both competitiveness and the functioning of the labour markets 
discussed in the previous section would not be in a position to realise their full potential 
unless the growth process in the Community is allowed to develop without encountering 
two major macro-economic obstacles to growth: 
i) an unbalanced policy mix, which might result from tensions between the stability 
objective and inappropriate budgetary and wage behaviour; and 
ii) an insufficient growth of potential output, which could lead to inflationary pressures. 
As regards the firstobstacle, the easing in monetary conditions during the course of the 
past two years shows the extent to which the policy mix has been rebalanced but clearly 
more is needed. The opportunity created by the improvement in the economic outlook 
must be taken advantage of to prevent the re-emergence, for different reasons, of the 
distorted policy mix that has characterised the Community's policy framework over 
recent years. The objective of deficit reduction should be pursued with particular vigour 
in those countries where high public debt ratios have placed an excessive burden on 
monetary policies irrespective of cyclical conditions. There must be a credible 
framework of price stability to which economic agents can adapt their expectations. In 
this respect, the moves in a number of countries to make their central banks independent 
represent a very important step. 
In the foreseeable cyclical circumstances of the next two years, ones of relatively strong 
growth, the reduction of budget deficits necessary to buttress confidence in financial 
stability and to improve the allocation of resources over time is likely to have short-term 
demand effects that go in the direction of restraining inflationary pressures. The need 
for any monetary response to avoid overheating would be correspondingly reduced. 
As regards wage trends, recent developments are displaying greater consistency with the 
intermediate stability objective, set in the December 1993 guidelines exercise, of a rate of 
inflation of no more than 2-3 per cent. The current wage behaviour is similar to the pay 
trends recorded during the expansion phase of the last cycle i.e. between 1982 and 1988. 
At that time, moderate wage settlements contributed significantly to the disinflation 
process which occurred. With regard to the Community's present situation, it is 
essential that the moderate wage evolution experienced in 1994 and forecast for 1995 is 
maintained over the medium-term. This is necessary not only for the maintenance of a 
13-12-94 
-29-
low rate of inflation but for the success of any ambitions to generate an employment-
creating growth performance. 
It is to be hoped that the increasing credibility of the overall policy framework, the 
implementation of the previously mentioned reform measures in the labour market as 
well as the initiation of an active social dialogue process will all help in generating the 
type of outcome which is both socially and economically desirable. Given the extent of 
the jobs challenge to be faced, distributional struggles should be avoided. For the 
foreseeable future, the priority must continue to be the promotion of those macro and 
microeconomic policies which are essential for job creation. 
Economic and Monetary Union will only be achieved if policies succeed in maintaining a 
stable, non-inflationary macroeconomic framework of the type just described. But 
EMU itself, once achieved, will contribute powerfully to the future maintenance of such 
a framework and, through this channel, to growth and employment. 
Regarding the second macroeconomic obstacle, it is necessary to take action to increase 
the Community's potential rate of growth. This has been reduced by the recession and by 
the strong fall in fixed capital formation to around 19 per cent of the Community's GDP. 
Potential output is now growing at an annual rate of around 2 VA per cent. The strong 
growth rates envisaged for the period 1996-2000 cannot be sustained for long unless 
productive capacity follows suit and grows towards the 3-3 Vz per cent range over the 
same period. 
Structural reforms and the current efforts to increase the dynamism of the Community 
economy are essential parts of this process which, at the macro-economic level, requires 
an increase in investment Structural changes may increase the productivity of the stock 
of capital, but progress in this area is inevitably very slow. As a result, the return to 
sustainable higher rates of growth will have to be accompanied by an acceleration in the 
rate of increase in the capital stock. This implies that for a number of years investment 
must increase faster than GDP. 
The increase in investment necessary to maintain strong rates of growth will be the result 
of market forces. But economic policy can help by creating the conditions that will 
allow them to operate more effectively. 
13-12-94 
-30-
Improving business confidence constitutes the 
first requirement in creating a framework more 
favourable to economic activity and 
investment. This calls for a series of actions 
which range from the maintenance of a stable 
macroeconomic environment to the 
determination to continue with the process of 
structural adjustment. Chart 16 
EC : Investment share and rate of 
growth of the capital stock 
% change p.a. % of GDP 
rateefgrowikof 
th*<tfpjtar$<0<!* 
a_i t...i...t * * >• < + > < > t .t « < 24 
22 
20 
18 
64 68 72 76 80 84 88 92 96 Another important determinant of investment 
is capital profitability which depends to a very 
large extent on the distribution of productivity 
gains among capital and labour. During the 
1970s, profitability was negatively affected by 
real wage increases in excess of productivity 
gains. The situation was partly corrected during the 1980s when, for most of the 
period, real wages per head increased in the Community on average by one percentage 
point a year less than productivity. The improvement was interrupted in 1991 and 1992, 
but has since resumed strongly in 1993-94. Further increases in capital profitability are 
needed to encourage investment. This underlines the importance of the maintenance of 
the current trend of real wage increases per head below the rate of increase in labour 
productivity. The trend of the 1980s (one percentage point a year less than productivity 
over the period 1982-89) could constitute a pragmatic benchmark for the years ahead. 
Table 11 
Community1): Real unit labour costs 2) 
(average annual rate of change for the period) 
1961-70 1971-81 1982-90 1991-96 1991-92 1993-96 
0.0 + 0.2 1.1 1.0 0.1 1.4 
1) Excluding the five new German Lander. 2) Nominal unit labour costs deflated by the deflator of GDP; the figures for 
1994-96 are based on the November forecasts of the Commission's services 
To reduce tensions on the market for loanable funds which could result in higher interest 
rates and to avoid excessively large balance of payments disequilibria, an increase in 
investment,- however achieved,-has to be accompanied-by a roughly^eorresponding 
increase in the rate of national saving. The necessary increase in the rate of national 
13-12-94 
-31 -
saving must come essentially from an increase in public saving (reduction of public 
deficits) since the savings behaviour of the private sector (households plus enterprises) is 
relatively stable and, probably, difficult to influence. Budget deficits might have to be 
almost eliminated by the year 2000 as indicated in the December 1993 Broad Guidelines. 
The deterioration in national saving which has taken place in the Community over the 
last 30 years is due almost entirely to the deterioration in the public sector's position. 
Thus, from the perspective of potential long term growth and employment, budgetary 
consolidation is of central importance. 
3.2.3 Growth and the environment 
Strong economic-growth is not in contradiction with the protection of the environment 
provided an appropriate policy framework is put in place. In fact, environmental 
sustainability implies changes in the use of resources and of intermediate and final 
consumption patterns that are far easier to implement in a high growth, high income 
context. 
The policy framework to promote a high growth and employment path discussed in the 
previous sections must be allied to the development of appropriate environmental 
initiatives. It is incumbent on the Member States collectively to analyse the various 
options available in which environmentally sustainable economic growth can be 
generated which contributes simultaneously to a higher intensity of employment use and 
a lower intensity of energy and natural resource consumption. 
The White Paper has put forward for discussion a large number of policies which, if fully 
implemented, would amount to a new Development Model which could be created in the 
Community. Such a model would be characterised by such features as: greater use of 
market-based instruments within the mix of environmental policy instruments; the 
integration of environmental requirements into other policies including economic policy; 
the revision of taxation policies; better integration of economic and environmental 
accounting systems; widespread and quicker implementation of clean technology, and 
finally measures aimed at facilitating the development of new investments and activities 
aimed at enhancing the quality of life and the environment. 
At present, an ongoing discussion on economic growth and the environment is taking 
place within the EcoFin Council on the basis of a Commission communication [COM 
(94) 465 final]-putting emphasis on: the need-to transform the concept of sustainable 
development into a more operational concept by developing adequate statistical 
13-12-94 
32 
indicators; the effective inclusion of environmental costs in market prices; the 
identification and, where appropriate, the elimination of incentives to polluting activities 
and the greater use of environmental taxes and levies in the context of reforming the 
present tax system in a way more favourable to both employment and the environment. 
13-12-94 
33 
Chapter 4: The policies 
Following-up on the recommendations of the White Paper on "Growth, 
Competitiveness, Employment", substantial progress were made in implementing 
policies aimed at increasing the dynamism and the competitiveness of the Community 
economies and at improving the functioning of their labour markets. Progress in these 
areas is reviewed in a number of reports which have been addressed to the Essen 
European Council. Monetary policy has been conducted in a prudent way and interest 
rate reductions have accompanied the decline in inflation while achieving a remarkable 
degree of exchange rate stability. National budgetary policies have been largely 
conducted within the framework of the convergence programmes with results, however, 
falling short of what was desired or what was possible. 
As regards the future, it is essential that structural policies continue to be implemented 
in order to achieve greater dynamism of the economies and better functioning of labour 
markets. Monetary policy should continue its present stability-oriented course, while 
efforts aimed at consolidating budgetary positions must be stepped up. 
Chapter 3 discussed how the various macro- and microeconomic policies interact in 
order to generate a sustainable medium-term process highlighted by strong output and 
employment creation allied to improved economic convergence. The present chapter 
will examine the individual economic policies in order to review progress made in the 
course of 1994 and to assess the likelihood of further improvements occurring in the 
forecast years 1995 and 1996. However, given the large number of recently produced 
reports on policies for improving competitiveness and enhancing the functioning of 
employment systems, it is intended, in order to avoid needless repetition, to restrict the 
focus of the present chapter to monetary and budgetary policies. These competitiveness 
and employment reports have been produced in the context of the annual review of the 
Brussels European Council's Action Plan which has taken place at the Essen European 
Council5. They adequately review progress with regard to the implementation of policy 
initiatives in these areas and put forward recommendations on how these policies can be 
Among the most important documents on competitiveness and the labour market which were submitted to the 
European Council meeting in Essen were the following: 
Employment: 
1. Economic Policy Committee (EPC) Report on "Member States' Progress in Pursuing Policies with a View to 
Employment Creation". 
2. Social Affairs Council Report on "Combatting Unemployment". 
3. EcoFin Council Report on the Employment Situation (based on EPC and Social Affairs Council Reports). 
4. Commission document "Action to Turn Growth into Jobs" (C0M(94)529/2^. 
5. Report on the Reduction in indirect Labour Costs. 
Competitiveness 
1. Report on the Functioning of the Internal Market.(COM (94) 553) 
2. Action Plan on the Information Society. 
3. Report of the Christophersen Group on the Trans-European Networks & the EcoFin Council's conclusions on 
the latter report. 
4. Implementation of the SME part of the Action Plan (SEC (94) 2023) 
13-12-94 
34 
further enhanced to contribute in a more effective way to the achievement of the 
Community's policy objectives. 
On the basis of the documents received and taking note of the improvement in the 
economic situation, the Essen European Council stressed the need to make further 
efforts to solve the structural problems which stand in the way of a better employment 
performance. In particular, the Council called for action in five key areas: 
i) Improving employment opportunities for the labour force by promoting investment 
in vocational training, 
ii) Increasing the employment intensity of growth, 
iii) Reducing non-wage labour costs extensively enough to ensure that there is a 
noticeable effect on decisions concerning the taking on of employees and in 
particular of unqualified personnell. 
iv) Improving the effectiveness of labour market policy. 
v) Improving measures to help groups which are particularly hard hit by 
unemployment. 
The Essen European Council requested the Labour and Social Affairs and Economic and 
Financial Affairs Councils and the Commission to keep close track of employment 
trends, monitor the relevant policies of the Member States and report annually to the 
European Council on further progress on the employment market, starting in December 
1995. 
In relation to competitiveness, the European council, in agreement with the Commission 
report, stressed the importance of the internal market and in particular the need to 
achieve uniform and effective application of the internal market rules. It also stressed the 
need to monitor Community and national law for over-regulation and welcomed the 
Council Resolution of 10 October 1994 aimed at removing legal and bureaucratic 
obstacles in the way of SMEs. The European Council intends also to pay particular 
attention in the future to the competitiveness of the European economy and welcomes 
the Commission's intention of setting up a high level group which will deal with these 
matters and submit appropriate reports. Finally, the European Council endorsed the 
most important recommendations of the report of the Christophersen Group and 
emphasised that the Commission's Action Plan "Europe's Way to the Information 
Society" and the conclusions of the Ministers for Industry and Telecommunications have 
set the agenda^oTi:he^evelopment7of^n^nformation society. 
13-12-94 
-35 
4.1 Monetary policy 
Since the widening of the ERM bands in August 1993 exchange market conditions 
within the Community have generally being characterised by a high degree of stability. 
This has largely been due to the prudent and cautious manner in which monetary policy 
decisions have been taken in most Member States in the course of 1994. Furthermore, 
this exchange rate stability has been achieved without greater volatility in interest rates. 
This reflects, to a considerable extent, a convergence of policies as well as progress in 
inflation convergence among the Member States. In addition, it reflects the 
discouragement of speculation following the widening of the bands and, more recently, 
the bénéficiai impact of the renewed optimism concerning growth on the consistency of 
monetary policies. Such stability should be encouraged further, especially as the capacity 
to grow without inflation over the coming quarters will be narrowing in a large number 
of Member States. 
The process of gradual reductions in short-term interest rates continued throughout the 
first half of 1994. German short rates declined steadily, with other central banks within 
the ERM taking roughly equivalent action. Short-term interest rates reached a low of 
6.2 percent (Community average) in July and in so doing contributed to a more balanced 
policy mix between monetary, fiscal and pay policies. The period of interest rate 
declines, however, came to a halt in the second half of 1994 as it became evident that the 
potential for a strong economic recovery was in place. This led to a cautious approach 
in short-term monetary policy adjustments despite continuing favourable developments in 
relation to price and wage patterns. 
With regard to interest rate differentials vis-à-vis Germany, the latest data show a 
substantial narrowing of the gap compared with the average for 1993, in Belgium, 
Denmark, Spain, France and Ireland. The negative differential in the Netherlands has 
been gradually eliminated while the Portuguese differential of 6 percentage points in 
1993 has persisted. Outside the ERM, the negative differential which the UK enjoyed in 
1993 has now been eliminated. This turnaround has resulted from the fact that UK key 
rates had remained unchanged, until recently, since November 1993. The upward 
movements in UK official rates in the autumn of 1994 were essentially a pre-emptive 
strike, within an explicitly forward-looking monetary policy framework, to avoid a build­
up of inflationary expectations. As regards_Jtaly7_the_pace_of-reduction-,in- rates had 
13-12-94 
36-
slowed down relative to other countries in June/July 1994 with the recent increase being 
introduced to ward off incipient inflationary pressures. 
As regards future monetary policy prospects, for those countries whose monetary policy 
frameworks give priority to exchange-rate stability vis-à-vis the DM, these will, as in the 
past, be strongly influenced by developments in Germany. The Bundesbank is presently 
adopting a cautious stance although the rate of consumer price inflation has fallen in 
recent months and is currently at low levels and despite the fact that money supply 
growth in Germany has been slowing down, albeit from exceptionally high rates, and 
may even be inside the initial target range by the end of 1994. The reason for this 
prudent approach would appear to lie in developments in the real economy which have 
been much stronger than had been predicted earlier in the year. Given the conflicting 
signals coming from nominal and real developments in Germany the most reasonable 
assumption would appear to be a continuation of the trends of the previous months. 
The other Community countries are expected to broadly follow these trends with short-
term interest rate differentials vis-à-vis the DM forecast to narrow in the course of the 
next two years. 
The overall decline in short-term rates in 1994 was in stark contrast with developments 
at the long end of the market. The sharp increase in long-term rates since January 1994 
was partly due to a phenomenon of undershooting at the end of 1993 and partly the 
result of latent inflationary fears related to the anticipated pick-up in economic 
conditions. The increases in long-term interest rates which have taken place so far this 
year can be interpreted as suggesting that the outlook for inflation is uncertain and that 
the risk of accelerating inflation remains prominent. As economic growth is projected to 
accelerate in the coming quarters, it is essential that this risk is minimised. This implies 
that monetary policy will have to tread a cautious path, aimed at establishing stable 
prices and low inflation as an anchor to medium-term inflationary expectations. To 
support this, it will be essential that economic agents see the commitment to low 
inflation as credible. 
With the gradual transition of European central banks to independence during stage II of 
EMU, as stipulated by the Treaty establishing the European Community, monetary policy 
should gain substantial credibility and will, to a greater extent, in the future be able to 
pursue its price stabilisation objective in more favourable conditions. To ensure that the 
latter desired outcome-becomes a"reality~it^will be essential that budgetary and wage 
developments materialise in such a way that the monetary authorities are not forced to 
13-12-94 
37-
excessively tighten the interest rate reins. Clearly, a balanced policy mix, where fiscal 
policy supports the objectives of monetary policy is essential in this respect. 
Furthermore, fiscal consolidation is also necessary in order to reduce uncertainty about 
future inflation developments, associated with the possibility that the burden of debt will 
inhibit the counter-inflationary tasks of monetary policy. Finally, wage developments 
must also be consistent with the price objectives of the monetary authorities in all 
Member States, especially where price trends are projected to continue to be 
unsatisfactory. 
4.2 Budgetary policy 
The conduct of budgetary policy in the course of 1994 was characterised by the need to 
consolidate budgetary positions. All the Member States, with the exception of 
Luxembourg, have now prepared convergence programmes and most of them in the past 
year or so have revised or updated their original programmes setting targets for the 
medium term path of fiscal adjustment. The revision of the early convergence 
programmes was made necessary principally by the severe impact of the recession on the 
public finance performance of the Member States. 
Table 12 
Actual and cyclically adjusted General Government Net Borrowing 
(percent of GDP) 
1993 
Actual C-aclj 1994 
Actual C-adj 1995 
Actual Ç-adj 1996 
Actual C-adj 
B 
DK 
D 
GR 
E 
F 
IRL 
I 
L 
NL 
P 
UK 6.6 
4.4 
3.3 
13.3 
7.5 
5.8 
2.5 
9.5 
-1.1 
3.3 
7.2 
7.7 5.6 
2.3 
3.0 
13.2 
6.7 
4.7 
2.4 
8.3 
-1.6 
2.6 
6.7 
6.0 5.5 
4.3 
2.9 
14.1 
7.0 
5.6 
2.4 
9.6 
-1.3 
3.8 
6.2 
6.3 4.6 
4.3 
2.4 
13.7 
6.1 
4.7 
2.7 
8.7 
-2.2 
3.1 
5.2 
5.8 4.7 
3.0 
2.4 
13.3 
6.0 
4.9 
2.0 
8.6 
-1.6 
3.5 
5.8 
4.6 4.3 
3.8 
2.0 
12.8 
5.3 
4.6 
2.5 
8.3 
-2.6 
3.4 
5.1 
4.6 4.0 
2.2 
2.0 
12.9 
4.7 
3.9 
1.5 
7.9 
-2.0 
2.7 
4.8 
3.4 4.2 
3.7 
2.0 
12.7 
4.5 
4.3 
2.1 
8.2 
-2.8 
3.1 
4.6 
3.9 
EC-12 6.0 5.0 5.6 4.9 4.7 4.4 3.9 4.2 
Note: a negative sign indicates a surplus 
Source: Commission Services, November 1994 Economic Forecast 
13-12-94 
-38 
The acceleration in economic growth in the course of 1994 provided the opportunity to 
recover some of the fiscal ground lost during the previous year. Current estimates 
suggest that in eight Member States (Belgium, Denmark, Germany, Spain, France, 
Ireland, Portugal and the UK) general government net borrowing as a percent of GDP 
has declined in 1994. However, fiscal outcomes fully in line with or better than the 
targets for 1994 contained in the convergence programmes have been realised only in the 
cases of Denmark, Germany, Ireland, Portugal and the United Kingdom. In the 
remaining countries some slippage has emerged or the adjustment achieved fell short of 
the programme plans6. 
Despite the severity of the recession, some progress took place in 1993 in reducing 
structural imbalances. It is disappointing to observe that in 1994 progress in this area 
was negligible. Current estimates indicate that in five Member States (Belgium, 
Germany, Spain, Portugal, the UK) the cyclically-adjusted net borrowing will decline. 
However, it will increase in five Member States (Denmark, Greece, Italy, Ireland, the 
Netherlands), and will remain unchanged in the case of France. 
Seen against the background of the convergence programmes, fiscal developments in 
1994 suggest that additional measures should be initiated in the course of 1995 to take 
advantage of the strengthening economic growth. Most countries are doing something 
in 1995 but more is clearly needed. Given budgetary timetables, however, it will be 
difficult, although desirable, to substantially alter the course of budgetary policy in 1995. 
Because of this it is particularly important that, in preparing their 1996 budgets, 
countries take the necessary adjustment measures to stay on their convergence 
programmes' paths or indeed to do better so as to ensure a faster return to sustainability. 
The present 1996 forecasts do not incorporate budgetary measures yet to be taken. 
In recent months the urgency to foster fiscal consolidation has become more pronounced 
as a result of two new factors: first, servicing the rapidly growing government debt in 
the Community will undoubtedly burden fiscal policy over the medium term; and, 
secondly, the recent increases in long-term interest rates have not only diminished the 
prospects for reducing this burden but also, by the additional pressures they exert on the 
public finances, they bode badly for future interest rate reductions. An additional factor, 
whose importance has now become more widely recognised, and which will burden 
The 1995 Greek budget reports an outturn for 1994 for the central government budget deficit in line with budgetary 
objectives. 
13-12-94 
39 
Chart 17 
General government net borrowing in the EU 
(percentage of GDP) 
5.5 fei 
4.5 
80 82 84 86 88 90 92 94 96 
Outstanding public debt (percentage of GDP) severely the public finances in the longer 
term, is the requirement to finance increased 
pension expenditure in the coming years. 
The projections presented in chapters 2 and 
3 suggest that practically all Member States 
will have to bolster their fiscal consolidation 
plans over the immediate future. Clearly, 
some Member States are confronted with 
substantially greater and more urgent 
adjustment needs than others but the need to 
reduce the debt ratio applies to almost all. 
Since the debt ratio is in most cases very 
large, all Member States are vulnerable to 
adverse interest rate shocks. 
In the two Member States where the debt 
ratio is high and rising and interest payments are a crucial budgetary item (Greece and 
Italy), a determined effort to restore sustainability to the public finances continues to be 
urgent. 80 82 84 86 88 90 92 94 96 
Interest payments as a percentage 
of total public expenditure 
80 82 84 86 88 90 92 94 96 
In the case of Italy, where net borrowing is expected to amount to almost 8 per cent of 
GDP in 1996, little progress is expected in reducing the structural imbalances (see table 
12) and more ambitious fiscal adjustment measures are clearly necessary in order to 
restore sustainability and to reduce the deficit towards the 3 per cent mark set in the 
convergence rules. 
In the case of Greece the fiscal outlook remains difficult. The 1995 Greek budget -
which had not been adopted at the time the Commission's projections were finalised -
contains proposals in line with the profile for the reduction in the budget deficit 
contained in the convergence programme, but continued vigilance will be necessary. 
In Belgium, progress is expected in reducing net borrowing while both the structural 
deficit and burden of servicing the public debt are projected to decline as a percentage of 
GDP. Given the high government debt, this progress needs to be sustained in a medium-
term-frameworkand-the-provisions of the Global-Plan-pertaining-to-the-budget should-be 
fully implemented. 
13-12-34 
40-
According to the Commission's November forecasts, in Denmark and France the 
structural deficit is not expected to post anything but a marginal improvement over the 
next two years, notwithstanding the projected strong economic growth; thus, fiscal 
expansion undertaken by these Member States in recent years is not expected to be fully 
reversed in structural terms. In addition, no structural progress is expected in the case 
of the Netherlands. Nevertheless, both the Netherlands and Denmark are expected to 
experience budget deficits of less than 3 percent of GDP in 1996. 
In four Member States significant progress in reducing structural fiscal imbalances is 
projected. Between 1993 and 1996 the cyclically-adjusted budget balance is forecast to 
decline by one percentage point of GDP in Germany, by over 2 percentage points in 
Spain, Portugal and in the UK. In 1996, however, the respective net borrowing of the 
general government will continue to be above the Maastricht mark of 3 per cent in the 
four Member States except Germany; where it is projected to be at 2.0 per cent of GDP. 
The strength of the current recovery offers a unique chance to carry out the inevitable 
budgetary adjustment with a lower cost in terms of output and employment. A similar 
opportunity in the second half of the 1980s was not fully exploited and it is clearly 
essential to avoid a repetition of the same policy error. For the Member States which 
have already prepared budgets for 1995, the course of fiscal policy has been incorporated 
in the Commission's forecast and, as noted previously, the deviation between the fiscal 
objectives of the convergence plans and the Commission's projections provides a 
measure of the needed adjustment effort to achieve the fiscal targets. 
A strict implementation of the measures announced in the convergence programmes will 
lead to the achievement of the objectives incorporated therein and result in the necessary 
reduction in budget imbalances. 
13-12-94 
U'O (^ 
1995 ANNUAL ECONOMIC REPORT 
PARTE 
ECONOMIC SITUATION AND POLICY ISSUES 
IN THE INDIVIDUAL MEMBER STATES 
12-12-1994 
J) 
-41 
BELGIUM V.-V' 
Economic recovery due to buoyant exports whereas domestic demand remains weak 
The evolution of most economic indicators during 1994 suggests a relatively strong 
pace of recovery; GDP is expected to grow by an estimated 2lA% mainly under the 
impulse of exports, as domestic demand remained rather weak, growing by no more 
than 1%. Private consumption expenditures are expected to rise by about %%; the 
saving rate, which reached in 1993 the historical peak of nearly 22% (in percentage of 
disposable income) due to sagging confidence and the worsening labour market 
situation, decreased moderately in 1994, following the recent marked improvement in 
consumer confidence indicators. Private investment is expected to stagnate in 1994, 
picking-up progressively only as capacity utilisation rates in the manufacturing industry 
increase. Residential investment is estimated to remain rather weak in 1994 due to the 
rise in mortgage interest rates registered sincethe beginning of the year. 
In 1994 exports of 
merchandise goods are 
expected to increase by 
about 7%, basically 
reflecting the 
impressive upswing in 
foreign demand (from 
-2!^% in 1993 to 
approximately 7% in 
1994), together with the 
introduction of some 
degree of wage Table 1 
Belgium: Macroeconomic performance 
| || 1990-92 1993 1994 1995 1996 
GDP growth rate 2.5-1.7 2.2 2.7 3,1 
(%change) 
Total domestic demand 2.5 -1.7 0.9 2.4 2.8 
(% change) 
Employment (% change) 0.5 -3.0 -0.4 0.7 1.0 
Unemployment rate (%) 7.8 9.4 10.0 9.8 9.3 
Inflation (% change) 2-7 2-6 2-6 2-5 2-6 
Balance of current account 1.6 4.6 4.8 5.0 5.2 
(%ofGDP) 
For defintipns, see Table 2 
Source: Commission services, economic forecasts. Autumn 1994 
moderation, following 
the implementation of the "Global Plan". However, the trade balance is expected only to 
improve slightly (from -0.3% of GDP in 1993 to 0.1% in 1994) due to the deterioration 
in terms of trade, and despite the lower dynamism of imports. The surplus in the balance 
on current transactions is expected to remain in 1994 at about 4%% of GDP. 
The evolution in the labour market, particularly since the second quarter of 1994, is also 
favourable, suggesting that entrepreneurial confidence in the sustainability of the current 
recovery improved markedly^ The unemployment rate rose from 7.4% in mid 1991 
(Eurostat definition) 4o 10.1% hi April 1994, since then it has levelled off and is 
12-12-1994 
-42 
expected to decline on an annual average in 1995. As regards employment, a 
particularly encouraging sign is the creation of a significant number of jobs for young 
people in 1994, reducing the youth unemployment rate, ensuing specific measures 
adopted in the "Global Plan" (November 1993). 
Inflation (measured by the CPI) is expected to stay at around 2!/2% in 1994 (i.e. below 
the Community average). However, gross nominal wages per employee are forecast to 
grow by about 3.2%, despite the implementation of the measures taken in the "Global 
Plan" to secure wage moderation. Although the introduction of the "Health Index"1 
limited wage indexation, real wages in the private sector increased on average by 
approximately 1.4%, due to the application of previously agreed wage settlements, 
whereas real wages in the public sector rose by 3% by the second consecutive year. The 
measures decided in the "Global Plan" to secure wage moderation will only be fully 
implemented in 1995 and 1996 with the freeze of real wages in the private sector. 
Fiscal policy in Belgium is conducted in the framework of the convergence programme 
which was initially approved in June 1992, but since twice informally revised (in 
April 1993 TaWe2 
Belgium: Economic policy indicators 
Money Growth 
(% change) 
Government budget balance 
(% of GDP) 
Gross government debt 
(% of GDP) 
Nominal wages per head 
(% change) 
Real wages per head 
(% change) 1990-92 1993 1994 1995 
-6.2 
132.5 
7.0 
4.2 -6.6 
138.9 
4.2 
1.6 -5.5 
140.3 
3.2 
0.6 -4.7 
138.9 
2.8 
0.3 
Source: Commission services, economic forecasts, Autumn 1994 
Definitions 
Unemployment rate: harmonized Eurostat definitions. 
Inflation: private consumption deflator. 
Money growth: broad money (M2/M3) 
Government budget balance: net lending/borrowing of general government. 
Gross government debt: general government. 
Nominal wages: compensation of employees per head. 
Real wages: compensation of employees per head deflated by private 
consumption prices. 1996 
-4.0 
136.2 
3.3 
0.7 and 
June 1994). These two 
revisions consisted of 
adjustments in the deficit 
profile for the period 
1993-1995, while 
maintaining the 3% of 
GDP deficit target for 
1996. Since taking office 
in March 1992, the 
government has taken a 
number of fiscal saving 
packages, involving both 
the Federal government 
and the social security 
sector, in order to fulfil 
the budgetary targets set 
in the (revised) 
convergence programme 
The CPI excluding tobacco, alcohol products, petrol and diesel. 
12-12-1994 
43-
and counterbalance the budgetary effects of the recession. Given the data available on 
the execution of the Federal government budget, pointing to a near stagnation of 
primary expenditures and a strong increase in tax receipts, together with the relative 
success of the measures Chart 1 - Belgium 
Deficit and debt ratios in percentage of GDP 
140 
1980 1982 1984 1986 1988 1990 1992 1994 1996 
•Deficit (left hand scale)—Debt (right hand scale) 
Note: in case historical government debt data do not exactly match the debt definition in 
Regulation (EC) n°3605/93, a break in series is introduced. 
Source Commission services, Economic Forecasts Autumn 1994. taken in the "Global 
Plan" to curb social 
outlays, the general 
government deficit is 
expected to decrease 
from 6.6% of GDP in 
1993, to 5.5% in 
1994.The debt ratio is 
expected to begin 
decreasing in 1995. 
Continuing expansion of activity but persisting problems on employment creation 
Real GDP growth is expected to reach 2.7% in 1995. Exports of merchandise goods are 
estimated to rise by about 6Vz%, reflecting strong foreign demand growth and a 
satisfactory price-competitiveness position. Whereas in 1994 the economic recovery 
was largely export led, in 1995 and beyond domestic demand is expected to play a 
considerably more dynamic role in the economic expansion. Private consumption 
expenditures are estimated to grow slightly above real disposable income in 1995, as 
improved consumer confidence brings about a moderate reduction in the saving rate. 
Firms' investment is expected to increase strongly in that year as capacity utilisation 
rates in the manufacturing industry increase. 
Employment growth generated by the output expansion should allow for a reduction in 
the unemployment rate already in 1995. However, non-wage labour costs in Belgium 
are extremely high even when compared with other Community member countries with 
similar social security systems - in terms of coverage and generosity. The financing of 
the social security system in Belgium is too heavily dependent on labour income 
contributions, distorting factor prices and encouraging the use of more capital intensive 
techniques of production. This distortion affects particularly the lower productive 
12-12-1994 
-44 
segments of the labour force, effectively pricing out of the market many low paid jobs. 
Although some important steps were already taken, particularly with the approval of the 
"Global Plan", to correct this situation, additional measures are needed in order to 
broaden the social security tax base and make its financing less distortionary. 
The economic expansion together with the various saving measures taken in the 
framework of the convergence programme, especially the "Global Plan", are expected to 
reduce the general government deficit from 5.5% of GDP in 1994 to 4.7% in 1995. 
Nevertheless, attainment of the convergence programme deficit target of 3% of GDP in 
1996 will most likely require taking additional saving measures, which are estimated to 
amount to approximately 1% of GDP. 
12-12-1994 
45 
DENMARK 
Strong fundamentals are beginning to exhibit results 
After several years of disappointing growth, the Danish economy experienced a strong 
recovery in 1994. Growth this year is expected to exceed 4% primarily based on the 
upswing in private consumption. Consequently, imports are catching up and the surplus 
in the trade balance is being perceptibly reduced. Because of favourable market growth 
exports are growing at a healthy pace, and the trade balance will thus remain positive 
(around 3% of GDP). A too rapid narrowing of the output gap would suggest some 
danger of overheating which could jeopardise maintaining a low rate of inflation. This, 
however, has not as yet become a problem. Consumer prices rose by only 2% in 
autumn. Unemployment remains the biggest challenge to the Danish economy. In spite 
of high growth figures, unemployment rates did not come down significantly until the 
second half of 1994. 
The turnaround of 
activity occurred in the 
second half of late 1993 
when consumer 
spending reacted to 
improving confidence. 
Confidence indicators 
started recovering from 
their trough in early 
1993. At that time, the 
Danish government 
adopted a programme of 
economic reform 
involving both temporary expansionary fiscal measures to mitigate the effects of the 
recession, in accordance with the Edinburgh conclusions, and structural reform, in 
particular on the labour market, devoted to strengthen the efficiency of the Danish 
economy in the medium term. The strong recovery in confidence since the adoption of 
the programme which even accelerated well into 1994 indicates that the private sector 
gained confidence in the policy approach of providing a fiscal stimulus in the short term 
while committed to a medium term fiscal consolidation strategy. Table 1 
Denmark: Macroeconomic performance 
| 11990-92 1993 1994 1995 1996 
GDP growth rate 1.3 1.4 4.8 3.2 3.0 
(% change) 
Total domestic demand -0.7 0.5 6.9 4.2 3.3 
(% change) 
Employment (% change) 0.0 -0.6 0.1 1.7 1.5 
Unemployment rate (%) 8.8 10.3 10.2 9.0 8.0 
Inflation (% change) 2.3 1.7 1.8 2.1 2.4 
Balance of current account 1.6 3.7 2.6 2.2 2.2 
(%ofGDP) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
12-12-1994 
46 
Chart 1 - Denmark 
The economy driven by confidence in the private sector 
Differences between the percentages of respondents giving positive and negative replies 
15 Indeed, after many years of 
sluggish growth, the Danish 
economy is driven mainly by 
domestic demand growth in 
1994. Both private 
consumption and investment 
reacted positively to the 
expansionary measures. 
Domestic demand growth was 
also supported by a favourable 
financial environment. Lower 
interest rates and buoyant 
bond prices stimulated purchases of consumer durables. However, as financial markets 
have become less supportive and pent-up demand is being gradually satisfied, consumer 
demand growth should normalise throughout next year. Thus, private consumption 
which grows by around 5x/2% in 1994, should grow at a noticeable lower rate in 
1995 (4%) and 1996 (31/2). 1992 
Source: Commission services 1993 1994 
The current upswing in production has led to a rising capacity utilisation rate. Strong 
growth in productivity together with continued moderate wage settlements have a 
favourable effect on profits. Indeed, profit margins can be improved without increasing 
sales prices too much. Given that these fundamentals remain in place, investment in 
equipment should pick up significantly. As the financial situation of the corporate sector 
is expected to improve further, the retarding effect of high interest rates on investment 
of equipment might prove to be of relative little importance. In the short term 
construction could be 
Table 2 
Denmark: Economic policy indicators 
Money Growth 
(% change) 
Government budget balance 
(% of GDP) 
Gross government debt 
(% of GDP) 
Nominal wages per head 
(% change) 
Real wages per head 
(% change) 1990-92 1993 1994 1995 
4.5 
-2.0 
64.3 
4.0 
1.7 14.6 
-4.4 
79.5 
1.9 
0.2 5.4 
-4.3 
78.0 
2.6 
0.8 5.4 
-3.0 
78.0 
2.7 
0.6 1996 
-2.2 
78.2 
3.0 
0.6 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 affected to a larger 
extent while better 
income expectations 
might support 
residential construction 
when the recovery 
matures. 
Despite the openness of 
the Danish economy 
and strong domestic 
12-12-1994 
47-
demand growth, the external situation will remain favourable. Satisfactory market 
growth and favourable competitiveness should prevent a drastic deterioration in the 
external balance although imports have risen at double digit rates in 1994. Favourable 
developments in services and lower net factor payments to abroad will sustain a solid 
surplus of the current account of the balance of payments. 
Economic policies geared to maintain stability 
The widening of the ERM bands has not changed the basic approach of Danish 
economic policy. The authorities maintained their stability oriented policy by keeping 
monetary conditions relatively tight. The stability of the exchange rate was not 
challenged by financial markets and interest rate spreads vis-à-vis Germany have 
narrowed indicating a great deal of confidence into the adopted policy approach. 
Nevertheless, in order to maintain confidence the phase of fiscal consolidation has to 
show the results which are projected in the revised convergence programme of 
November 1994. This programme envisages a step by step reduction of net general 
government requirements to 0.3% of GDP in 1997 (to 3.0% in 1995, 1.3% in 1996). 
According to the Commission forecast, the deficit reduction path is fully on track. In 
1995 the deficit will be around 3% of GDP and in 1996 the 3% threshold will be clearly 
undershot. Given the good cyclical situation the question arises as to what extent the 
consolidation path could be accelerated. This would certainly become a first best option 
if demand were to continue to expand at the now prevailing rates. Otherwise, monetary 
policy's goal of preserving price stability would be put in jeopardy. 
Unemployment remains the Hggest challenge to the Danish economy. While most 
economic indicators are gradually improving unemployment remains high. 
Unemployment is expected to fall from 12.3% (national definition) in 1994 to less than 
10% in 1996 due to the recovery. However, structural problems in the labour market 
will make it more difficult to reduce unemployment further as structural unemployment 
is currently at 8-9%. To increase flexibility in the Danish labour market, a labour market 
reform package was introduced. The reform includes both passive and active measures 
mainly directed at reducing structural unemployment. Firstly, efforts have been made to 
improve education. This together with a leave of absence reform, which allows 
recipients time for education, child care or - less frequently - a sabbatical year while 
maintaining the right to draw 80% of normal benefits (100 percent for educational 
leave) provides more room for active measures. Also, it will no longer be possible to 
stay in the unemployment benefit system by working in various employment generating 
12-12-1994 
-48 
programs and people will be provided with a job offer within 4 years, thereby reducing 
the risk of remaining in long term unemployment. Furthermore, a reform of the 
financing structure of the unemployment benefit system will create a link between 
unemployment and contributions to the unemployment benefit system. Finally a gradual 
reduction of marginal tax rates will improve employment incentives. 
It will be difficult to sustain high economic growth and reduce unemployment 
significantly if the structural problems in the labour market persist. Currently, the 
impact of the labour market reform is not clearly visible but it will, presumably, 
manifest itself in the long run. However, changes in the unemployment benefit system 
and increased wage flexibility are necessary in order to reduce the rate of unemployment 
at which inflationary pressures will emerge. In the second part of November 1994, the 
Danish government and two major opposition parties concluded a budget policy 
agreement, which i.a. implies a reduction of the State budget deficit foreseen in 1995 
and makes adjustments of labour market policies (less generous leave of absence 
schemes, tightening of eligibility and enforcement practices in the unemployment 
benefit system). 
12-12-1994 
49 
GERMANY 
The German economy is gathering pace 
Economic activity in Germany has accelerated in 1994 and is expected to continue 
strengthening thereafter. The basis for higher growth seems to be rising productivity, 
which has enabled German producers to fully participate in the unfolding of world trade 
subsequent to the slow 
growth period earlier 
this decade. At the same 
time it has contributed 
to regaining or 
improving profitability, 
and to reviving 
confidence. Capital 
spending begins to 
react. While the general 
improvement is 
advancing all over Table 1 
Germany: Macroeconomic performance 
GDP growth rate 
(% change) 
Total domestic demand 
(% change) 
Employment (% change) 
Unemployment rate (%) 
Inflation (% change) 
Balance of current account 
(% of GDP) 1990-92 1993 1994 1995 1996 
-1.1 
-1.2 
-1.8 
7.0 
3.9 
-1.4 2.5 
2.1 
-0.9 
7.3 
2.8 
-1.4 3.0 
2.6 
0.5 
7.0 
2.2 
-1.1 3.4 
3.1 
0.8 
6.4 
2.4 
-0.9 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
Germany, substantial 
regional differences with regard to structures and growth remain for the time being. 
Therefore, the two parts of the country will be looked at separately where appropriate. 
Improving profitability drives the west German recovery 
In various respects, the 1993 recession was similar to earlier periods of contracting 
output in west Germany. The accompanying decline in employment was not particularly 
strong, considering the depth of the recession (GDP fell by 1.7%). In fact, productivity 
growth was relatively weak. As earlier, industry was hit hardest amongst all sectors. Yet 
the loss in output was the strongest on record, for the economy as a whole and in 
industry, where real value added fell 6.4% in 1993. Industry had to cope with a fading 
of the unification boom, substantial pay awards and a revaluation of the DM. As the 
economy headed into recession, unit labour costs soared. 
Producers had their profits squeezed. The risk of not being able to stay in business 
triggered rigorous adjustments. The labour shake-out in industry spread to the economy 
at large (see chart 1, left). Substantial restructuring has since allowed for industrial 
productivity to catch up and, coupled with noticeable wage moderation since 1993, has 
12-12-1994 
-50-
made unit labour costs not only to reverse the adverse earlier developments but to fall 
back during 1994 to levels last seen three years earlier (cf. chart 1, right). In this respect 
the 1993 setback is different from its predecessors: the current relief in cost terms is 
Chart 1 - Germany 
Employment and productivity in west Germany 
The labour shake-out. 
Occupied persons in mio .. boosts productivity and dampens ULC 
Unemployed in mio 
26 130 Output per employed in industry; 1985=100 
125 -j_3 month moving average 
1991 1992 1993 
Occupied persons; annual % change 1994 
MMI 
•Total economy 
• Industry î3f! 130 1991 1992 1993 
Unit labour costs (ULC); 1985=100 1994 
1991 1992 1993 1994 1991 1992 1993 1994 
Sources: Commission services, Stetistisches Bundesamt, Deutsche Bundesbank 
more pronounced than after the three previous recessions. This holds also for the 
economy at large, albeit to a lesser extent. Possibly this reflects both recent additional 
efforts to regain flexibility mainly in industry and the higher level of unemployment 
than experienced earlier. 
Thus industry in particular has prepared for recovery and has been able to respond 
positively to expanding international trade. With competitiveness improving and 
profitability rising, the business climate in west German manufacturing crossed the 
watershed between recession and expansion in September 1994. 
In this setting, capital spending has started to expand again. Construction, in particular 
housing which is booming ahead of a scaling back of fiscal stimulus as of 1995, has 
already been quite dynamic earlier this year. From now on, a considerable knock-on 
effect should spur investment in machinery and equipment. This has suffered a setback 
of about one quarter from peak to trough and capacity utilisation is on the rise since end 
1993. 
There will have been more than 2^2 million registered unemployed in 1994, in absolute 
terms-more than anytime since-the 1950s. But^whenthe-recovery^advances^further, the 
first timid signs of a turn-around on the labour market registered since summer 1994 
12-12-1994 
-51 
will become more pronounced, albeit at a moderate pace. Later on, this should gradually 
allow for the consumer, who continues to be restrained by the (un-) employment 
situation, ensuing moderate wage increases and a tight fiscal policy stance, to 
increasingly support a continued upswing. In 1995, GDP growth could attain 2i4%, after 
some 2% in 1994. 
Intra-German convergence is advancing 
The east German economy is making progress. GDP growth is likely to rise to some 9% 
in 1994, up from 5.8% the year before, and should remain buoyant. The region is now 
the fastest growing area in the EC. Contrary to the initial adjustment period, industry 
has been doing better than the economy at large since mid-1992. 
Certainly, east Germany continues to rely on support from outside the region which 
allows domestic demand to exceed GDP by some two thirds. Most of this is fiscal 
transfers. They amounted to more than 4% of German GDP in 1993 and primarily 
supported private consumption. The overhaul of run down housing has been propelled 
by the spring 1993 solidarity pact decision to shift two thirds of the sector's debts to the 
federal government as of 1995. 
There is not only an advancing standard of living, there are also improvements in 
competitiveness. Initially, productivity was driven by massive lay-offs; from the old 
days of artificial full employment to summer 1994, when overall employment seems to 
have bottomed, one third of the 1989 labour force was set free. From now on, 
productivity improvements will primarily rely on the ongoing upgrading of the capital 
stock. Spending on machinery and equipment, too, continues to benefit from 
considerable fiscal incentives. Equipment investment per employee has been stronger 
than in west Germany since 1993. This will help to gradually reduce the productivity 
gap between east and west Germany (cf. chart 2, left) over the years to come. 
The catching-up of eastern wages to western levels is decelerating. Hence eastern unit 
labour costs, which considerably overshot those of western competitors, are gradually 
edging lower. Industry is taking the lead (see chart 2, right). Emerging competitiveness, 
reflected also in improving profitability, albeit on average entrepreneurial incomes are 
still rather depressed, should over time provide the basis to very gradually reduce the 
absorption-production gap and to make the region less dependent on external support. 
12-12-1994 
-52 
Chart 2 - Germany 
Nominal productivity, wages and ULC in east and west Germany 
Rising productivity ... ... and slowing ... help reduce the ULC 
80 
60 Output/head; east in % of west 
40 11 
I .—Total economy * f|||||||||| 
«•Industry* 20 lillllll 80 wage increases ... 
Wages/head; east in % of west 
20 M: 
1991 I—Total economy * | 
•Industry * 60 iiiiil 
40 
1992 1993 1994 1991 1992 1993 1994 
* non-seasonally adjusted 
Sources: Commission services, Statistisches Bundesamt gap 
Unit labour costs; east in % of west 180 
160 
140 1 
120 liiiiii 
100 Total economy * 
«•Industry * 
1991 1992 1993 1994 
Fiscal policy remains geared towards consolidation 
Overall, the growth outlook for the German economy has brightened considerably in 
line with improved competitiveness and profitability. After a 1.1% decline in 1993, 
GDP is expected to grow 2%% this year and some 3% in 1995. Thus an export-led 
recovery should be advancing while fiscal policy is geared towards consolidation. 
Initially, unification resulted in an expansionary fiscal policy stance. To avoid a 
weakening of confidence in German public finances and in view of the Treaty 
convergence criteria, the government enforced consolidation. The 1993 general 
government borrowing requirement was 3.3% of GDP and the government debt ratio is 
expected to rise, from some 40% in 1989, to close to 60% next year when the 
government will have taken on board basically all unification-related debt, which so far 
has accrued off-budget. In line with the German convergence programme of 
November 1993, substantial discretionary measures on both the revenue and 
expenditure sides have become effective in 1994. More is to follow in 1995 with the re-
introduction of the solidarity surcharge on income taxes to help fund the rising interest 
burden. 
12-12-1994 
-53-
Over and above the discretionary measures taken, accelerating growth facilitates the 
rolling-back of the deficit, which could fall just below the 3% threshold already in 1994 
and is forecast to decrease further in the following years. Provided growth accelerates as 
expected, the debt ratio should peak in 1995 at about 60%. The fiscal performance 
would then fully match the targets set in the convergence programme. 
However, given the tight 
fiscal stance (overall 
taxation, i.e. taxes 
proper and social 
security contributions 
will rise to more than 
44%ofGDPinl995, an 
all-time high) and the 
pace of consolidation 
(the primary balance is 
expected to rise to 2% of 
GDP in 1995 after 0% in Table 2 
Germany: Economic policy indicators 
| 1990-92 1993 1994 1995 1996 j 
Money Growth : 10.9 5.7 6.2 : 
(% change) 
Government budget balance -3.3 -2.9 -2.4 -2.0 
(% of GDP) 
Gross government debt : 48.1 51.0 59.4 58.9 
(% of GDP) 
Nominal wages per head : 4.5 3.2 3.0 3.4 
(% change) 
Real wages per head : 0.6 0.3 0.8 1.0 
(% change) ' I ==_ __===== 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
1993), it appears 
important to be ready to 
react, if necessary, to avoid any combination of retarding influences to hinder recovery 
to unfold as predicted. 
Rising long-term interest rates may have contributed to revive investment by means of 
advancing projects earlier in 1994; further rises may well have adverse effects. 
However, inflation is on the retreat and short-term prospects are good: next years' wage 
increases are expected to be still moderate, given the gradual nature of improvements on 
the labour market, and further out higher supply side flexibility achieved by 
restructuring may allow for inflationary pressures to re-emerge less forcefully than 
during earlier upswings. 
Another encouraging fact with respect to the inflation outlook is that M3 is approaching 
its 1994 target-range after important deviations earlier this year. Thus, all-in-all, 
monetary policy seems to have regained some flexibility. This could prove helpful if 
there were to be some weakening of growth, possibly triggered by renewed upward 
pressure on the DM, when the real economy is just about to cope with the levels arrived 
at after the twofold challenge..of the_early 1990s,T.e.JowenGerman-averagaproductivity 
after unification and an effective revaluation of more than 5% in 1992/93. 
12-12-1994 
54 
Advancing on the expected path of ascending growth will facilitate continuing fiscal 
consolidation. This appears to be important for at least two reasons. First, it should 
strengthen confidence and contribute to lower interest rates triggering fiscal crowding-in 
effects. Second, it will, in due course, allow for regaining some room for action. In view 
of the high level of taxation, it could be cautiously used to improve supply side 
conditions. 
12-12-1994 
-55-
GREECE 
Against the background of a weak long term performance and sustained macroeconomic 
imbalances, the Greek authorities in recent years have implemented policies of 
stabilisation and reform. Since 1991 restrictive monetary and fiscal policies have been 
applied and in particular incomes policies have been very tight. The result of these 
policies, together with a worsening external economic environment, was that growth 
slowed and the Greek economy moved into recession in 1993 with very weak growth in 
domestic demand and negative growth in GDP. The decline in real wages, 3.7% p.a. in 
1990-93 and the tightening of fiscal policy combined with real exchange rate 
appreciation led to falling inflation with the private consumption deflator falling to an 
estimated 10.8% in 1994. 
In 1994 there are indications of an improving performance and growth is likely to be 
positive. Thus manufacturing output after a number of years of decline has begun to 
grow while the volume of retail sales is also rising. On the other hand residential 
construction and private sector investment remain weak while public sector investment, 
although weaker than expected, nevertheless continues to be one of the main stimulatory 
forces in the economy. 
Reflecting the weak 
economy there has been 
almost no employment 
growth in the period 
1990-1993 while 
unemployment rose 
from 7% of the labour 
force to almost 10%. 
Employment in 
agriculture and in 
manufacturing has 
continued to decline 
while employment in 
the services sector has expanded. These trends have continued in 1994 but some 
improvement in the labour market can be expected in subsequent years. 
Weakening growth, restrictive policies and structural measures led to falling inflation 
through to early 1994. Thus consumer price inflation fell from a peak of 23.9% in Table 1 
Greece: Macroeconomic performance 
| || 1990-92 1993 1994 1995 1996~ 
l II 
GDP growth rate 1.0 -0.5 0.4 1.1 1.7 
(% change) 
Total domestic demand 1.6 0.4 0.6 1.4 1.8 
(% change) 
Employment (% change) 0.1 1.0 -0.3 0.2 0.4 
Unemployment rate (%) 7.8 9.7 10.2 10.6 10.8 
Inflation (% change) 17.7 13.6 10.8 9.5 9.0 
Balance of current account -5.7 -3.0 -2.5 -2.6 -3.0 
(%ofGDP) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
12-12-1994 
56 
November 1990 to 10.2% in March 1994. However, this downward trend in inflation 
seems to have been interrupted since then given that CPI inflation subsequently rose to 
11% ii October. This development in inflation performance might reflect the ending of 
recession, the rise in real wages and the continued large scale fiscal deficits. 
Efforts to tackle the 
public sector deficits 
have been insufficient 
in the face of rising real 
interest rates and 
growing debt. Thus 
while the primary 
deficit has been reduced 
from 7.9% of GDP in 
1989 to a surplus in 
1994 the general 
government deficit 
remains at over 13% of 
GDP. The interest cost Table 2 
Greece: Economic policy indicators 
' | 1990-92 1993 1994 1995 1996 
Money Growth 14.0 15.2 : 
(% chaige) 
Government budget balance -12.9 -13.3 -14.1 -13.3 -12.9 
(% of CDP) 
Gross f;overnment debt 87.0 115.2 121.3 125.4 128.1 
(%ofGBP) 
Nominal wages per head 13.6 8.6 12.4 10.1 10.5 
(% chaige) 
Real wages per head -3.4 -4.4 1.5 0.5 1.3 
(% chaige) 
For defntions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
of the debt has been rising sharply from 6.7% of GDP in 1989 to an estimated 15% in 
1994. Apart from the continued costs of the deficits two other factors have played a 
significant role in increasing debt servicing costs; firstly, the central government has 
taken over substantial debts from both the wider public sector and from the private 
sector thus increasing the general government debt level and secondly, partly because of 
EC pressures and developments (conditions associated with the 1991 balance of 
payments loan and Community Treaty provisions) the use of administrative devices to 
lower interest costs have been eliminated and the deficits are now financed mostly at 
market interest rates. Reflecting the insufficient fiscal adjustment and the consequent 
high, levels of inflation Greece has the highest levels of nominal and real interest rates in 
the Community. 
The prospects are for a continuation of the modest upswing evident in 1994. The 
recovery will be led by domestic demand and in particular by public sector investment 
driver by the Community Support Framework. Private investment, however, will 
continue to be restrained by high real and nominal interest rates. Exports will gain from 
the recovery in the rest of the Community but because of the wide absolute gap between 
expons^and imports the balance of trade will deteriorate. Domestic demand will be 
12-12-1994 
Chart 1 - Greece 
Real wages and output growth 57-
sustained by growing incomes in both nominal and real terms as both labour income and 
non-labour income rise. 
In 1995 inflationary pressures will 
be mitigated by restrained income 
growth as a result of the public 
sector incomes policy and the 
existing private sector agreement 
which provides for wage increases 
to be based on the official inflation 
target (with partial ex-post 
compensation in 1996 in the event 
of actual inflation being in excess 
of the official target). However, -8 
1986 1988 
Source: Commission services 1990 1992 1994 1996 
underlying inflationary expectations are likely to persist in the absence of vigorous and 
successful fiscal adjustment. 
Crucial to the prospects for Greece is the extent of fiscal adjustment. The revised 
convergence plan, adopted by the government in June 1994, foresees declining deficits 
through the period to 1999. The central government budget proposal for 19952 is in line 
with the profile for the reduction of the deficit in the convergence programme. The 
authorities have expressed their determination to implement the necessary policies to 
achieve the convergence programme targets and if these are implemented effectively 
disinflation might well accelerate which would help to increase the prospects for lower 
rates of interest thus stimulating economic growth and reducing further the fiscal deficit. 
2 Presented on 30 November 1994. 
12-12-1994 
58-
SPAIN 
Stronger than expected economic recovery led by exports 
After having suffered its deepest recession of the last few decades (GDP declined for six 
quarters in a row between the second quarter of 1992 and the third quarter of 1993, 
falling 1.1% in 1993), the economic activity in Spain has since been recovering at a 
pace stronger than previously expected by any forecaster. In fact, GDP is currently 
estimated to have increased by 2.2% in 1994 and is forecast to rise around 3% in 1995. 
The economic recovery has been led mainly by exports, which in 1994 rose at very high 
levels by any historical standards. This seems to be a result of the international 
economic recovery, a gain in competitiveness entailed by the three peseta devaluations 
in 1992 and 1993 and the weakness of domestic demand which fell until the fourth 
quarter of 1993. In the course of 1994 both consumption and investment held up very 
markedly, thus leading to a profile of domestic demand much more supportive of 
economic activity. Although this recovery in domestic demand and the phase down of 
the deterioration in the terms of trade have spurred a sharp rise in imports, the 
contribution of the external sector to GDP growth still remained strongly positive in 
1994. The current account deficit-to-GDP ratio shrank hence further in 1994 to 1.2% 
from 1.9% in 1993 and 3.7% in 1990-92. 
Table 1 
Spain: Macroeconomic performance 
GDP growth rate 
(% change) 
Total domestic demand 
(% change) 
Employment (% change) 
Unemployment rate (%) 
Inflation (% change) 
Balance of current account 
(% of GDP) 1990-92 1993 1994 
2.2 
2.9 
0.1 
16.9 
6.4 
-3.7 -1.1 
-4.1 
-4.2 
21.8 
5.6 
-1.9 2.2 
-0.1 
-0.6 
22.4 
4.9 
-1.2 1995 
2.8 
3.0 
1.6 
21.9 
4.5 
-1.6 1996 
3.2 
4.2 
1.9 
21.2 
4.4 
-1.9 In 1995 domestic 
demand is forecast to 
take the lead on 
supporting economic 
growth, while the 
contribution of the 
external demand could 
turn slightly negative, 
despite a still relatively 
strong growth expected 
For deflations, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 for exports. Investment 
is set to increase by 
more than 5%, as a 
result of better demand prospects, the improvement in the economic and financial 
situation of the business sector and the effects of some structural reforms, particularly 
on the labour market. Private consumption is growing mainly because of higher 
12-12-1994 
-59-
confidence, which brings down the households' savings rate, and increasing 
employment. 
Chart 1 - Spain 
Real wages, employment and productivity 
(% change over previous year) 
1—GDP per employee I ^^^^ ^r ' 
(Real compensation per employee -^N^^- , 
«•Total employment 
I i 1 I 
1990 1991 1992 1993 1995 
' Compensation per employee deflated by the GDP deflator 
Source: Commission services The deepness of the 
economic recession 
compounded with an 
inadequate wage 
behaviour led to a very 
sharp fall in employment 
in 1992-93, when it 
receded by more than 
6%. Chart 1 shows first 
that labour productivity 
proxied by GDP per 
worker has shown an 
unusual, by other countries' standards, counter-cyclical behaviour and second, that 
labour productivity has been much correlated with real labour costs. Indeed, constrained 
by increased competition and until late in 1993 by low total demand, companies reacted 
to increases in wages clearly above inflation, mainly through adjustments in their 
workforce, which in turn featured into high productivity increases. Hence, too high 
wage increases during the recession fed strong labour shedding. In 1994 and, as 
expected, in 1995, a more moderate behaviour of wage costs will contribute to some 
deceleration in labour productivity and better employment prospects. 
A continued and desirable rise in the activity rate, due to the strong growth in 
population in working age and to the medium term trend for a higher participation of 
women in the labour force has contributed to aggravate further the unemployment 
figures. This led to a all time high unemployment rate of 24.6% in the first quarter of 
1994 (according to the labour force survey, EPA). However, as a result of the wide-
ranging labour market reform which entered into force in 1994 and the improving 
economic situation, employment should fall in 1994 substantially less than previously 
expected, followed by significant increases in 1995, though the unemployment rate is 
expected to decrease only by less than a percentage point in 1995. 
12-12-1994 
-60 
Table 2 
Spain: Economic policy indicators 
| 1990-92 1993 1994 1995 1996 
Money Growth 10.8 7.5 5.6 7.0 : 
(% change) 
Government budget balance -4.3 -7.5 -7.0 -6.0 -4.7 
(%ofGDP) 
Gross government debt 46.4 59.8 63.5 65.8 66.1 
(% of GDP) 
Nominal wages per head 8.5 7.2 4.0 3.9 4.2 
(% change) 
Real wages per head 1.9 1.5 -0.9 -0.6 -0.2 
(% change) 
For deflations, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 The recession also led to 
a sharp rise in the 
general government 
deficit, which was 
furthermore aggravated 
by some revenue lags 
and losses in VAT in 
1993. Hence the general 
government deficit rose 
from 4.5% of GDP in 
1992 to 7.5% in 1993. In 
1994, despite some 
control in public 
expenditure, which 
allowed for some reduction in the structural deficit, and the higher than expected 
economic growth, only a limited reduction in the general government deficit is expected 
to have taken place, what is partly explained by lower profits than in 1993 by the Bank 
of Spain (of about 0.6% of GDP). The upward trend in general government debt is 
another factor of concern. It has been rising sharply from past low levels and crossed the 
Treaty reference value of 60% of GDP in 1994. The expected reduction in public deficit 
in 1995. Hue to both fiscal restraint and higher economic growth, will not be enough yet 
to reverse that upward trend in public debt. 
After having receded from 5.9% in 1992 to 4.6% in 1993, inflation, as measured by 
changes in the consumer price index, is expected to remain broadly unchanged in 1994. 
This mainly reflected the sharp acceleration in food price rises which edged up from 
1.1% in 1993 to more than 5.5% in 1994 whereas core inflation (which excludes energy 
and non-processed food) fell by about one percentage point from 5.6% in 1993. The 
stagnation of disinflation in 1994 led almost to a halt in nominal convergence with the 
three EC countries with lowest inflation, which remained at 3.2% in September 1994, as 
compared to 3% in 1993. In 1995 progress in disinflation will be made harder by a 
number of factors such as the economic recovery, the temporary effect of VAT increases 
combined with a reduction in social security contributions and possible deferred 
temporary effects of the peseta depreciation on domestic prices. Hence, further wage 
moderation will be of the utmost importance to allow for continued progress in 
disinflation. 
12-12-1994 
61 
The widening in the ERM bands decided in August 1993, lower inflation and reductions 
in German short-term interest rates allowed the Bank of Spain to continue cutting 
interest rates significantly until August. The intervention rate thus fell from 9% in 
December 1993 to 7.35% in early August 1994. However, after having reached a trough 
in January, slightly below 8%, medium and long term rates have since been rising 
significantly (by about three percentage points until October) in parallel with a similar 
move world-wide. 
The reforms and the challenges ahead 
Whereas the economic recovery seems to be already on sound ground, led more and 
more by private consumption and investment, the soundness of the recovery will hinge 
upon the functioning of the markets and progress in nominal convergence. In 1994 the 
Spanish authorities took some further key steps to improve real and nominal prospects. 
As regards structural reforms, a special reference has to be made to the wide ranging 
labour market reform approved by the government in December 1993 and by the 
parliament in May 1994. Then in July the Spanish government approved a revised 
convergence programme for 1995-97, whose priorities appear reflected in the draft 
budget law for 1995. 
The general philosophy of the labour market reform was to shift much of the 
administrative regulations previously set by the authorities towards bilateral agreements 
between workers and employees. It eased the regulations concerning redundancy and 
working time, allowing companies to adjust working hours better to demand. Moreover, 
it boosted the possibilities of functional and geographical mobility and permitted a more 
flexible wage setting. Interim temporary employment agencies and private non-profit 
job agencies were legalised. New hiring procedures were set, introducing new 
apprentice contracts, vocational training contracts and part-time and temporary 
replacement work. The first results of the labour market reform appear encouraging, 
taking into account the high number of hirings under the new contracts, particularly on 
part-time jobs. 
Further structural reforms are included in the revised convergence programme, which 
updates the 1992 programme. It keeps essentially the same objectives as the 1992 
programme, i.e., to progress both in nominal and real convergence, which requires the 
correction of the major macro and micro-economic disequilibria as two main pre­
conditions. A balanced policy mix, relying on a fiscal consolidation programme, and 
12-12-1994 
-62 
more structural reforms are thus at the centre of the revised programme which covers 
the period 1995-97. 
The revised programme includes a fiscal consolidation scenario aimed at a gradual 
reduction of the budget deficit and at stabilising the debt-to-GDP ratio. The general 
government net borrowing is targeted to fall from 7.3% of GDP in 1993 (more recently 
revised to 7.5%) to 5.9% in 1995, 4.4% in 1996 and 3% in 1997. The debt-to-GDP ratio 
is in turn expected to rise up to 67.5% in 1996 and then just begin decreasing slightly to 
67.2% in 1997. 
After the recent labour market reform, the main thrust of the forthcoming structural 
measures relates to a number of areas sheltered from competition, especially in the 
services sector. Particularly important are some further liberalisation measures 
announced for the telecommunications sector. Moreover the programme makes 
reference to the taking forward of the reform of the education system. Finally, worth 
mentioning is a new law on housing rents, approved by the Parliament in early 
November, which aims at bolstering rent housing supply. 
Despite better economic growth prospects and the mentioned reforms, the authorities are 
still faced with significant challenges ahead. First, despite strong economic growth and 
a more flexible functioning of the labour market, unemployment could remain above 
20% in the next two years. Second, inflation appears to show some downward 
resilience, a phenomenon which could be reinforced by the recovery in domestic 
demand and the temporary effect of a VAT increase combined with a reduction in social 
security contributions. Third, fiscal consolidation cannot rely only in the operation of 
the automatic stabilisers but requires an important reduction of the structural deficit, 
which should be mainly achieved through discretionary measures to cut expenditure 
growth. 
12-12-1994 
63 
FRANCE 
French economy increasingly exposed to external influences, thus behaving more 
cyclically 
The recession of 1992/1993 was the deepest in the post-war period, leading to a 1.0% 
fall in GDP in 1993. The economy is now more integrated into world trade exchanges 
and follows the economic cycle common to most economies in continental Europe. 
While activity was strongly supported by exports, especially to Germany after the 
unification, they declined when activity in continental Europe began to recede. As 
European countries are now entering recovery, French exporters should take advantage 
of the favourable growth prospects of main trading partners. Considerable gains in price 
competitiveness have been made due to productivity growth and wage moderation. The 
effect of the appreciation of the franc should, therefore, no longer negatively impact on 
exports. 
The financial situation of companies and households has improved 
Chart 1 - France 
Confidence indicators 
Differences between the percentages of respondents giving positive and negative replies 
20 
-50 —Industry 
—.Consumer At the end of the 
eighties, as a result of 
an increase of credit 
supply, there had been 
an excessive rise in 
indebtedness, which 
led to a deterioration 
in the personal and 
corporate financial 
situation. As marked 
cyclical behaviour was 
unknown in France, 
the agents' loss of 
confidence, although a general phenomenon in Europe, was particularly strong and 
enduring in France and led to a significant adjustment of behaviour. 
Firms reduced their investment and ran down stocks in 1992 and 1993; taken together, 
changes in stocks and gross capital formation contributed negatively around 
2.5 percentage points to growth in 1993. These adjustments allowed companies to 
reduce financing needs and indebtedness, ultimately building up a healthy financing 1986 1987 1988 1989 1990 1991 1992 1993 1994 
Source: Commission services 
12-12-1994 
64 
capacity. Households' private consumption slowed markedly in 1993, decelerating more 
rapidly than real disposable income. The savings ratio increased appreciably in contrast 
to the normal trend of reduced savings to sustain consumption. The resulting 
improvement in the financial situation was the basis for the recovery in consumption in 
1994. 
The recovery follows a classical pattern 
Table 1 
France: Macroeconomic performance 
| || 1990-92 1993 1994 1995 1996 
GDP growth rate 1.5 -1.0 2.2 3.2 3.2 
(% change) 
Total domestic demand 1.2 -1.8 2.3 3.4 3.4 
(% change) 
Employment (% change) 0.2 -1.6 -0.2 0.7 0.9. 
Unemployment rate (%) 9.5 10.8 11.3 11.0 10.6 
Inflation (% change) 2.8 2.1 1.7 1.9 2.1 
Balance of current account -0.5 1.0 0.6 0.6 0.5 
(% of GDP) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts. Autumn 1994 Having reached its floor 
in the first quarter of 
1993, economic activity 
did not improve 
significantly in the 
following quarters. The 
recovery got underway 
in the first quarter of 
1994 when GDP 
increased by 0.7%. 
While in the first 
quarter stocks 
contributed to growth, 
in the second quarter domestic demand rose by nearly 1.0%. Exports rose strongly over 
the first half of the year and the annual growth rate was close to 3.5%. The business 
surveys carried out by INSEE, the national statistics office, show that the recovery is 
broadly based with demand prospects shaping up well. While GDP growth should be 
less strong in the second half of the year, overall 1994 growth should be around 2.2%. 
Households' spending 
has been temporarily 
supported by fiscal 
measures, notably the 
incentives to replace 
old cars and the 
maintenance of the 
triple school expense 
allowance introduced in 
1993. Private 
consumption will 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 Table 2 
France: Economic policy indicators 
| 1990-92 1993 1994 1995 1996 
Money Growth 5.5 -1.7 3.3 3.8 : 
(% change) 
Government budget balance -2.5 -5.8 ' -5.6 -4.9 -3.9 
(% of GDP) 
Gross government debt 36.9 45.8 50.4 53.4 55.6 
(% of GDP) 
Nominal wages per head 4.6 2.5 2.4 2.8 3.0 
(% change) 
Real wages per head 1.8 0.4 0.7 0.9 0.9 
(%change) 
12-12-1994 
-65 
probably continue rising although less buoyantly than in the second and third quarters as 
households' confidence continues improving. Moreover, employment is growing which 
will lead to an acceleration of disposable income. An improved outlook for employment 
- an increase of wage earners and a simultaneous fall in the unemployment rate - should 
lead to a fall in savings. However, facing uncertainties such as the financing of 
pensions, private consumption might recover at a somewhat lower pace than in previous 
periods of growth. 
Chart 2 - France 
Contribution to the change in GDP 
in % of GDP 
• Private consumption • Public consumption • Investment 
IB Stocks m Exports 
1992 
Source: Commission services 1993 1994 1995 The upswing of external 
as well as internal 
demand and the 
resulting rapid increase 
in capacity utilisation 
rates should lead to a 
strong upturn in 
investment. Surveys 
undertaken by the Bank 
of France show a 
recovery of productive 
investment as early as 
1994 and an increase in 
capacity investment prospects for 1995. After a very slight increase in 1994, investment 
will again become an essential engine of economic growth from 1995 onwards. 
High unemployment will remain a major challenge 
The number of wage and salary earners began to increase with the upturn in economic 
activity (up by 0.8% in the first half of the year in the non-agricultural market sector). 
New jobs, often in the form of fixed-term or temporary contracts, were created mainly 
in market services. The decline in employment in industry (excluding construction) has 
been stopped in the second quarter. Taking the average for the year, the number of wage 
and salary earners might therefore stabilize in 1994. 
The increase of employment from 1995 will have a limited impact on the 
unemployment rate. While the recovery is expected to lead to a 0.7% rise in 
employment in 1995, an appreciable increase in the active population may limit the fall 
in the unemployment rate to around 0.3 points. Thus, economic growth will not be 
sufficient to meet the unemployment challenge in the short term. 
12-12-1994 
66 
As a consequence of the employment situation, the moderation of the rise in wages has 
paved the way for sustaining low inflation. The fall in prices of raw materials and 
intermediate goods also contributed to the earlier moderation of prices. As this effect 
unwinds, consumer prices should increase somewhat more rapidly in 1995 (+1.9%, after 
+1.7% in 1994, on an annual average basis), but overall inflation will remain subdued. 
Budgetary policy to support employment and to reduce deficits 
Besides letting the automatic stabilizers work through during the cyclical downturn, 
economic policy focused mainly on employment and support to private consumption 
and housing. With the recovery of activity, the central government budget for 1995 will 
be targeted to a reduction of the structural component to the deficit. No further personal 
income tax cuts are planned. Policy measures in favour of employment will be 
intensified, in particular, with the continued reduction of employers' social 
contributions. 
Priority is being given to the reduction of general government net borrowing. It is 
planned to cut the central government budget deficit to 4.1% of GDP in 1994 and to 
3.6% in 1995. Increases in expenditure will be limited to the forecast GDP price deflator 
(+1.9%). Tax increases amounting to 0.2% of GDP are planned. The general 
government deficit is targeted to fall from 5.6% of GDP in 1994 to 4.6% in 1995. These 
are above the targets in the convergence programme (5.1% in 1994 and 4.2% in 1995) 
which may mean a lesser than expected effort towards fiscal consolidation given the 
improved growth prospects. The deviation is due to cancellation of public debt in favour 
of members of the "zone franc" (0.3% of GDP in 1994) and to the social security deficit 
which therefore remains paramount. The social security imbalances arise from both 
short-term factors related to the economic situation and structural factors such as 
population ageing. In spite of measures already adopted (Veil Law on healthcare, reform 
of the pension scheme), the social security accounts deficit will amount to 0.75% of 
GDP in 1994 and to 0.65% of GDP in 1995. Notwithstanding the marked slowdown in 
healthcare spending, the implementation of long-term policy measures aiming at 
keeping expenditure in check is required and even an increase in the compulsory levy 
could become necessary. 
Not many choices for monetary policy 
As regards monetary policy, the aim remains the franc's internal and external stability. 
ShoTt=term interestrrates have declined, supporting economic activity. High long-term 
12-12-1994 
67 
interest rates could, however, pose a risk, particularly to the upswing in the housing 
sector, notwithstanding the rising debt service requirements of the public sector. 
Short-term interest rates declined at the beginning of the year and have stabilized at 
about 5.6% (three-month rate), with a differential against the DM rates of around 
50 basis points. As in other countries, long interest rates also increased in France, 
reaching 8.15% in mid-November. The long rate differential against the DM had 
disappeared in the beginning of 1994 but has followed an upward course since the 
month of March; it stood at about 70 basis points in November. While the slope of the 
yield curve is positive since March, the main money supply aggregate (M3) has been 
undershooting the medium-term target (and actually declined through 1994) and real 
interest rates remain at very high levels, considering the very low current and expected 
inflation in France. 
12-12-1994 
68 
IRELAND 
An impressive economic performance in 1994 
Economic developments have evolved very favourably in Ireland in 1994, following the 
stagnation in domestic demand in 1993, due to the very high interest rates which 
prevailed in the early part of the year. A wide range of indicators point to a growth 
outturn of up to 6% of GDP this year. A positive feature of the current outlook is the 
balanced nature of growth. All the components of domestic demand are buoyant which 
is in marked contrast to the past few years when growth was led by the export sector. 
This switch towards the more employment intensive domestic sector is a factor in the 
impressive rise in total employment in the year to mid-April 1994 of 30 000 (+2.6%). 
The good growth conditions are also contributing to better than anticipated public 
finances with the budget deficit outturn likely to remain well below 3% of GDP. 
There are four principal 
factors underlying this 
positive scenario, which 
can be summarised as 
follows. Firstly, the 
confidence engendered 
by the current price and 
budgetary stability and 
the expectation that this 
stability will be 
maintained following 
the moderate wage 
increases agreed by the 
social partners for the period between 1994 and 1996. Secondly, the stronger than 
anticipated recovery in the Community and world economies which has contributed to a 
further pick-up in business and consumer confidence and improved export prospects. 
Thirdly, the current low level of nominal interest rates, which is encouraging a rebound 
in consumer spending and business and housing investment. Finally, the strong re­
bound in private consumption under the impact of rising employment, lower taxation 
and continued moderate real wage growth. Table 1 
Ireland: Macroeconomic performance 
| 11990-92 1993 1994 1995 1996 
GDP growth rate 5.5 4.0 6.0 5.6 5.3 
(% change) 
Total domestic demand 1.7 0.2 6.2 4.8 4.0 
(% change) 
Employment (% change) 1.5 0.7 2.6 2.9 3.1 
Unemployment rate (%) 16.2 18.4 17.7 16.8 15.7 
Inflation (% change) 2.2 1.6 2.8 2.7 2.7 
Balance of current account 1.5 6.5 6.0 6.0 6.3 
(% of GDP) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
12-12-1994 
-69 
Continued good prospects over the medium term 
There are strong indications to suggest that the current buoyant growth conditions will 
continue in 1995 and 1996. The international environment has improved considerably, 
which allied to greater inward investment and recent gains in competitiveness points to 
good export prospects. Domestic factors are also encouraging, with an absence of 
inflationary pressures and the sound public finances providing a stable environment for 
both business and consumers. Within this framework buoyant growth can be expected to 
continue into the medium term. Moreover, it can also be expected to remain well 
balanced with the recovery in domestic demand likely to be maintained. 
Notwithstanding the moderate pay terms agreed by the social partners, real disposable 
incomes should continue to rise owing to low inflation and the absence of the pressures. 
Similarly, low short-term interest rates and much improved employment prospects are 
also expected to lead to improved confidence levels and a fall in the savings ratio. 
Investment is also responding to lower interest rates, better export prospects and 
improved business profitability and annual growth of at least 7% to 8% is well within 
reach. Public consumption is the only component of domestic demand which is 
expected to slow due to much improved wage moderation in the public sector and the 
non-repeat of once-off expenditures in 1994 funded from the proceeds of a tax amnesty. 
Inflationary pressures are 
expected to remain 
subdued with the 
authorities' firm 
commitment to price and 
exchange rate stability 
being underpinned by the 
moderate pay terms 
agreed by the social 
partners. Consequently, 
the change in the private 
consumption deflator 
should remain around Chart 1 - Ireland 
Projected government deficit and debt ratio 
% of GDP 
120 
1987 1989 1991 1993 1995 
•Deficit (left hand scale) —Debt (right hand scale) 
Note: in case historical government debt data do not exactly match the debt definition in 
Regulation (EC) n°3605/93, a break in series is introduced. 
Source: Commission services 
2/4% to 3% in 1994 and 1995. Given the high growth projections, the moderation of 
public consumption growth and the sharp fall in interest rates, further falls in the budget 
deficit to below 2% of GDP in 1995 and 1996 are in prospect. This is conditional, 
however, on a curtailment of the sharp rise in public spending registered in recent years. 
12-12-1994 
-70-
Table 2 
Ireland: Economic policy indicators 
1990-92 1993 1994 1995 1996 Budget deficit levels of below 2% of GDP or even lower are fully consistent with the 
favourable cyclical factors and the need to reduce Ireland's continued high debt to GDP 
ratio. 
A much improved employment performance is attainable 
Notwithstanding high growth, a sustained improvement in employment performance in 
Ireland has proved elusive in recent years. This issue is the focus of the Irish 
convergence programme which aims to complement the continued very satisfactory 
nominal stability with a 
programme of structural 
reforms, leading in turn 
to higher employment 
growth. The switch in the 
composition of growth 
towards domestic 
demand evident in both 
current and expected 
medium term trends is 
contributing to the 
achievement of this 
objective. The significant 
rise in employment in the 
year to mid-April 1994 already points to a welcome change of direction. This process 
can be aided by intensifying the programme of structural reforms currently underway 
competitiveness and employment performance. This better performance will be 
necessary to cater for continued fast labour force growth, as well as to tackle the current 
very high jobless level. Money Growth 
(% change) 
Government budget balance 
(% of GDP) 
Gross government debt 
(% of GDP) 
Nominal wages per head 
(% change) 
Real wages per head 
(% change) 9.2 
-2.2 
95.5 
5.3 
3.0 23.3 
-2.5 
96.1 
5.9 
4.2 10.5 
-2.4 
89.0 
3.5 
0.7 8.5 
-2.0 
83.7 
3.0 
0.3 -1.5 
79.1 
4.0 
1.2 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
12-12-1994 
71 -
ITALY 
In 1994 the economic upswing gained momentum 
In 1994 the Italian economy went through a consolidation of the recovery which had 
already begun in the last months of 1993. The initial impulse to growth came from a 
buoyant export performance, but by the first months of 1994 domestic demand also 
began to pick up. 
The recession-induced restructuring of large parts of both the industrial and services 
sectors, accompanied by an unprecedented labour shedding, boosted productivity across 
the board. The depressed conditions of the labour market together with the preservation 
of the income policy framework defined in 1992 and 1993, determined a very low 
dynamism of contractual wages. The resulting fall of unit labour costs allowed a large 
increase in profit margins, which markedly contrasted with the squeeze recorded during 
the preceding cyclical phase. As a consequence of the increased profitability, the 
downward trend in industrial investment reversed by the end of 1993 and switched to a 
sustained growth already in the first semester of 1994. The recovery in construction 
investment, however, lagged behind due to the persisting stagnation of public works and 
the depressed conditions of the private building sector. 
With some delay with 
respect to the cyclical 
upturn in total output 
also private 
consumption resumed, 
backed by a significant 
improvement in 
consumer confidence 
and a marginal recovery 
in real disposable 
income. The two latter 
circumstances are to be TaWel 
Italy: Macroeconomic performance 
| || 1990-92 1993 1994 1995 1996 | 
GDP growth rate 1.4 -0.7 2.4 3.0 3.2 
(% change) 
Total domestic demand 1.9 -5.6 1.7 2.8 3.3 
(% change) 
Employment (% change) 0.5 -2.8 -1.7 0.8 1.1 
Unemployment rate (%) 10.1 11.1 11.5 10.8 10.1 
Inflation (% change) 6.0 5.1 4.0 3.5 3.5 
Balance of current account -1.8 1.1 2.0 2.6 2.9 
(% of GDP) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
partially credited to the 
fiscal stance which in 1994 became relatively less strict than in the previous two years. 
As a typical pattern of a recovery, the contribution to growth of the external side was 
reduced progressively throughout the year, due to a significant rise in import volumes 
12-12-1994 
72-
from the exceptionally low levels of 1993. However, the export dynamics remained 
sustained, and still exceeded the growth of imports. After the export boom recorded in 
largely 
Chart 1 - Italy 
Import and export volumes -1990-1994 
1990 1991 1992 1993 1994 
I—Imports «-Exports •Balance (right scale) 
I Source: ISTAT, National Accounts due to 1993, 
competitiveness gains 
arising from the lira 
devaluation, a new impulse 
was given in 1994 by the 
recovery in international 
trade (chart 1). The trade 
balance surplus showed a 
further widening with 
respect to 1993, and caused 
the current account surplus 
to improve in spite of some 
deterioration in invisible items. Thus, the external constraint appears to be less binding 
than in previous expansionary phases. 
In 1994 a further, although limited, progress on inflation was accomplished. Consumer 
price increases fell below 4% for the first time in over twenty years. The main factors 
behind this result were the already mentioned slowdown in labour cost and the 
persistence of a significant output gap in the non-export oriented sectors during the first 
stages of the recovery. These factors allowed production prices to renew their descent 
after the upsurge in the first semester of 1993 due to the lagged effects of the 
devaluation. The breakdown in the prices of goods and services shows a still declining 
trend for the latter, thanks to a more competitive environment due to the structural 
changes intervened during the recession, whereas goods prices are either stable or on the 
rise depending on different categories. The outlook for inflation is one in which the 
impact of the weakening of the lira seems to become less relevant, but there are signals 
that some internal pressure due to the recovery might gradually build up and delay the 
pace of further decline in 1995. 
A sluggish recovery in the labour market 
The recessionary phase had a dramatic and unprecedented impact on employment. More 
than one million jobs were lost in 1992 and 1993, 40% of which in industry, 23% in 
agriculture and 37% in services (chart 2). The downward trend in employment stabilised 
in.theJftrst-halfjof. 1994and-rjresumably-reversed.in the following months, but the extent 
of the crisis has been such that a complete recovery of the labour market will require a 
12-12-1994 
-73-
prolonged period of growth. Provisional data on employment trends show a mixed 
picture according to different sectors. Employment in agriculture and industry continued 
to decline in the first semester of 1994. Largely responsible for the decline in industry 
was the crisis in the construction sector, whereas the manufacturing sector did not 
record further losses. The still 
Chart 2 - Italy 
Employment (*) -1991/1994 
(Absolute variations on end-period data) 
-400 f 
-600 •Industry 
O Services 
-•-Total 
1991 1992 1993 1994 (first half) 
(*) Expressed as man-years according to national accounts definition 
Source: I STAT, National Accounts negative trends in agriculture 
and industry were 
compensated by the 
improvement in the services 
sector. A large part of the 
recent job creation is in the 
area of self-employment, thus 
confirming the important 
contribution in terms of 
flexibility that the one-person 
enterprises provide to the 
Italian economic system. The unemployment rate has peaked at 11.6% in April 1993 
and subsequently declined to 11%. This figure would be higher had a significant 
reduction in the labour force due to a discouragement effect not taken place. The latter 
circumstance, suggesting a likely rebound in the labour supply during the recovery, is an 
additional factor that should prevent unemployment from falling rapidly from today's 
levels. 
No progress in the fiscal consolidation process was recorded in 1994 
In 1994 the Italian authorities adopted a softer approach to budget consolidation than in 
the previous two years, officially justified with the desire not to hinder the infant 
recovery. In the medium term economic and financial plan for the years 1994-96 the key 
objective of stabilising the debt to GDP ratio was postponed from 1995 to 1996. Along 
these lines the 1994 fiscal package was centred on expenditure cutting and only minor 
revenue enhancing measures were enacted. Some relevant one-off measures operating in 
1993 on the revenue side were not replaced, allowing a decrease in the fiscal pressure of 
1.2 percentage points. The action on the expenditure side was essentially made of three 
components: i) some piecemeal intervention aimed at reducing the social security 
outlays; ii) a contraction in capital accounts transfers and contributions; iii) a structural 
reform of the public administration. The first component targeted some sensitive areas 
of the budget, but did not represent a comprehensive reform of either the health care or 
12-12-1994 
74-
Table 2 
Italy: Economic policy indicators 
| 1990-92 1993 1994 1995 1996 
Money Growth 7.2 7.8 6.0 7.0 
(% change) 
Government budget balance -10.2 -9.5 -9.6 -8.6 -7.9 
(% of GDP) 
Gross government debt 102.5 118.6 123.7 126.8 128.6 
(%ofGDP) 
Nominal wages per head 8.3 3.7 3.8 4.4 4.3 
(% change) 
Real wages per head 2.2 -1.3 -0.2 0.9 0.8 
(% change) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 the pension system. As for the reform of the public administration, up to now only a 
fraction of its provision have been carried on as intended. 
The overall result of the 
1994 fiscal package 
came short of its 
original targets. The 
general government net 
borrowing grew in 
absolute terms and its 
ratio to GDP remained 
close to the 9.5% level 
of the previous two 
years. The debt ratio 
further increased. Thus 
in 1994 no progress in 
the process of fiscal consolidation was recorded, a circumstance which undermined 
investors' confidence, weakening the lira and lifting interest rates. 
The draft budget law for 1995 aims at reducing the State sector borrowing requirement 
from 9.4% in 1994 to 8.0% in 1995 and 6.6% in 1996. The budget law for 1995 aims at 
reducing the State sector borrowing requirement from 9.4% in 1994 to 8.0% in 1995 
and 6.6% in 1996. The government decided to leave unchanged the fiscal pressure at the 
level of 1994 and to carry on structural changes on the pension system in a separate 
reform project to be designed and approved by June 1995. This circumstance negatively 
affects the fiscal package by seriously limiting the extent of measures with permanent 
effect on the budget. 
In 1994 the general economic conditions improved beyond expectations, and the 
outlook for the next year remains optimistic. This favourable cyclical phase should 
provide an opportunity to pursue budget consolidation with greater determination, as it 
reduces the costs of adjustment and eliminates the dilemma between fiscal consolidation 
and anti-cyclical policy. On the other hand a weak action on the fiscal side would lead 
to a more inflationary growth with the already experienced negative repercussions on 
the lira and a likely tightening of the monetary conditions. The Bank of Italy has 
repeatedly warned that monetary policy is anti-inflation oriented. In August 1994 a hike 
in the_officiaLrates -was—effected in^response to growing inflationary expectations. 
Financial markets are also likely to react negatively to a looser fiscal stance, with 
12-12-1994 
-75-
adverse effects on government's interest expenditure and on investment. This was 
indeed the case in the second half of 1994 when the long term interest rates displayed a 
sharp rise in the differential vis à vis their German and French counterparts. 
In conclusion the major policy challenge for 1995 remains a decisive correction of the 
fiscal imbalances. This objective would also be coherent with a more sustainable pattern 
of economic growth. 
12-12-1994 
76 
LUXEMBOURG 
External demand adds additional strength to growth 
As a small open economy, Luxembourg was able to take advantage of the faster than 
expected recovery in its neighbouring countries. Starting from the favourable situation 
in 1993, when due to the strong internal demand a recession was avoided, the 
Luxembourg economy is expected to grow by approximately 2lA% in 1994, while 
growth might run up to 3% next year. 
The principal contribution to growth in 1994 still came from private and public 
consumption. Private consumption probably grew by 1%%, supported by a relatively 
high real wage growth and the improving economic climate. The healthy public finance 
situation allowed the government to extend real expenditures by almost 1%. The growth 
contribution of investment has fallen back slightly from last year's high level, which was 
brought about by some major projects in the steel and telecommunication sectors. 
Although firm data on the evolution of external trade is currently unavailable, it can be 
expected that the merchandise trade deficit shrank somewhat this year as a result of the 
strong external demand. As usual, this deficit was compensated by a surplus on the 
balance of services and by a net inflow of factor income, creating a healthy surplus on 
the current account. 
Domestic employment 
continued to grow 
rapidly, resulting from a 
further contraction in 
the industrial sector, 
more than compensated 
for by increasing 
employment in the 
services sector (mainly 
in the financial sector). 
However, since most of 
the new jobs were filled Table 1 
Luxembourg: Macroeconomic performance 
| || 1990-92 1993 1994 1995 1996 
GDP growth rate 2.7 0.6 2.3 3.0 3.2 
(% change) 
Total domestic demand 4.5 1.6 1.5 2.1 2.4 
(% change) 
Employment (% change) 3.4 1.7 1.7 1.9 2.1 
Unemployment rate (%) 1.7 2.6 3.3 3.2 3.1 
Inflation (% change) 3.1 3.6 2.3 2.5 2.7 
Balance of current account 30.7 28.8 28.8 28.7 28.3 J 
(%ofGDP) I 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
by foreign workers, the 
average unemployment rate was higher this year than last year. Still, at 3% (Eurostat 
definition), unemployment remained by far the lowest in the Community. 
12-12-1994 
77-
Chart 1 - Luxembourg 
14 
12 
10 Inflation 
1980 1982 1984 
Source: Commission services -:-r^iii^j^:^lir?;l!SV;!T!;:!?;;^^ 
-j_^«^:;^;:g;;iOiSjifa 
^y^m^mmSMmwM —Luxembourg 
—EUR 12-Si 
^^ipissiyssy: 
mmmmm^m&ttw^zm^ww :::;ili::iii:ii!li:l::!:;;:;;!!,;:;i:i:i:;y; 
1986 1988 1990 1992 1994 After the pronounced 
acceleration of inflation to 3.6% 
last year, the consumption price 
index fell rapidly back to a level 
of just over 2% in the third 
quarter of this year. This 
favourable evolution is due to 
the disappearance of the effects 
of higher excise duties and 
increases in administered prices. 
The government is currently 
evaluating the introduction of a number of ecological taxes, which could increase 
inflation by approximately 0.5 percentage point in 1995. 
In the coming years, domestic demand will probably continue to sustain economic 
growth, due to continued real wage growth and the improving economic climate. As in 
the past, important investment projects in the steel and telecommunications sectors will 
push up investment. Given the improvement of the economic situation in the 
neighbouring countries in 1995, the positive growth contribution from external trade 
will probably be maintained. These better growth prospects should permit a further 
expansion of employment. However, the current stock of low skilled, long-term 
unemployed will continue to have problems to re-enter the labour market and foreigners 
will probably have to be engaged again to fill high skill jobs. 
Public finance situation remains healthy 
General government accounts for Luxembourg are only partially available, but current 
information shows that net lending of global government remains in surplus. This 
surplus is the net result of a small deficit for the central and local governments, 
compensated by a significant surplus of the social security sector. Still, general 
government gross debt is rising slightly (because of reserve build-up by local authorities 
and the social security funds) to reach a meagre 9.2% of GDP. Consequently, 
Luxembourg continues to comply to all EMU convergence criteria. 
12-12-1994 
-78-
TaWe 2 
Luxembourg: Economic policy indicators 
| 1990-92 1993 1994 1995 1996 
Money Growth : : : : : 
(% change) 
Government budget balance 2.8 1.1 1.3 1.6 2.0 
(% of GDP) 
Gross government debt 5.4 7.8 9.2 9.8 9.9 
(% of GDP) 
Nominal wages per head 5.6 4.9 4.1 4.2 4.6 
(% change) 
Real wages per head 2.4 1.3 1.8 1.6 1.9 
(% change) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 In 1995, the new 
government will 
maintain the prudent 
fiscal policy of the past. 
Although central 
government 
expenditures will rise by 
6.3%, receipts are 
expected to increase 
even slightly faster 
(6.8%). To promote 
employment and 
improve the economic 
structure of 
Luxembourg, expenditures will be directed more towards public investment; the share 
of investment in total central government expenditures should run up to around 10%. 
The measures that were agreed with the social partners to promote employment, price 
stability and competitiveness will also be further implemented. For 1995 this implies 
that the employers' contributions for family allowances will be suppressed and paid by 
the central government. 
In the second half of 1995, the government plans to introduce a number of ecological 
taxes on waste, packaging and C02 emission. The implementation of the taxes could be 
postponed if the negotiations on the C02 tax on the Community level are not concluded 
by then. In order to avoid negative effects on competitiveness, possible inflationary 
effects through the automatic wage indexation mechanism will be partly or totally 
neutralised. 
12-12-1994 
79 
THE NETHERLANDS 
Recovery faster than expected 
After a relatively mild economic slowdown in 1993, the recovery in the Netherlands 
clearly gained force at a faster pace than previously expected. Supported by the 
surprisingly strong improvement in the neighbouring countries, the Dutch economy 
might grow by as much as 2%% in 1994. For the following years, it is expected that the 
leading role in the recovery will be taken over first by investment (from the second half 
of 1994 onwards) and gradually by private consumption when employment starts 
growing again. This could intensify growth in 1995 to around VA%. 
The robust export evolution is the main contributor to the stronger than expected 
recovery of the Dutch economy. The improvement of exports started already in the 
second half of 1993, which was remarkable given the deep recession in Germany, the 
major Dutch trading partner that accounts for approximately one third of total exports. 
The export specialisation in agricultural products and their derivatives, which are less 
sensitive to cyclical variations, and the small share of the hard-hit manufacturing sector 
explain why the Dutch exports remained relatively unaffected. In 1994, export markets 
grew vividly, especially outside the European Community, and exports remained the 
single most important impulse for economic growth in 1994. However, because of the 
unfavourable composition of the Dutch export package for the recovery phase of the 
economic cycle, and since exporters will probably try to restore profit margins, it can be 
expected that the growth contribution of exports will gradually diminish. 
Table 1 
Netherlands: Macroeconomic performance 
| 1(1990-92 1993 1994 1995 1996 
GDP growth rate 2.5 0.3 2.3 3.2 3 3 
(% change) 
Total domestic demand 2.2 -0.5 1.7 2.8 2.8 
(% change) 
Employment (% change) 2.2 -0.1 0.0 1.3 1.8 
Unemployment rate (%) 7.3 8.8 10.0 9.8 9.4 
Inflation (% change) 2.8 2.1 2.3 2.4 2.5 
Balance of current account 3.4 3.7 4.0 4.3 4.6 
(% of GDP) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 Higher exports lead to 
higher capacity 
utilisation and higher 
profits, which are both 
beneficial for the 
evolution of corporate 
investment. Investment 
in housing by 
households was 
increasing because of 
lower government rent-
subsidies; the perception 
that long-term interest 
12-12-1994 
80 
rates have passed their lowest point also accelerated housing construction. However, the 
completion of some major investment programmes in the energy sector had a temporary 
negative effect on investment in 1994. In the coming years, gross capital formation and 
economic growth will be pushed up by cyclically induced investment, renewed 
investment in the energy sector and the start-up of some major public investment 
projects in railway infrastructure. 
The recovery had an almost immediate positive effect on employment, but 
unemployment figures followed a more erratic pattern. Although it can be expected that 
the continued recovery will reduce unemployment further in the coming years, structural 
measures are still needed to bring down unemployment to an acceptable level. Surveys 
show that consumers do not expect that their financial situation will ameliorate 
considerably in the short run, which can be explained by the moderate wage evolution in 
the Netherlands. Therefore, private consumption will probably remain subdued until 
employment starts growing at a faster pace again. This restrained evolution of costs and 
domestic demand and the solid exchange rate will all contribute to keep inflation at a 
modest level. 
Economic policy focuses on employment, lower tax burden and fiscal consolidation 
General government net borrowing is higher in 1994 than in the previous year (around 
3.8% of GDP compared to 3.3%), partly because of some unrealised savings and 
unbudgeted expenditures, and partly because of cuts in taxes and social security 
contributions to promote employment. However, mainly due to privatisation receipts, 
general government gross debt could decline from 81.4% of GDP in 1993 to 78.9% in 
1994. 
Table 2 
Netherlands: Economic policy indicators 
| 1990-92 1993 1994 1995 1996 
Money Growth 6.4 7.7 4.0 5.0 : 
(% change) 
Government budget balance -4.0 -3.3 -3.8 -3.5 -2.7 
(% of GDP) 
Gross government debt 79.2 81.4 78.9 78.8 78.0 
(% of GDP) 
Nominal wages per head 4.2 3.3 2.0 1.8 2.4 
(% change) 
Real wages per head 1.3 1.2 -0.3 -0.6 0.0 
(% change) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 The new convergence 
programme for the 
period 1995-98, which 
is based on the 
coalition agreement of 
the new government 
(formed last August) 
and the 1995 budget, 
puts the emphasis on 
creating employment 
by reducing the burden 
12-12-1994 
-81-
of taxes and social security contributions and promoting private initiative and 
competition. Based on strict expenditure control (real government expenditures should 
decrease by 0.7% yearly on average), the government deficit would simultaneously be 
reduced from the current level of almost 4% of GDP to a level significantly below 3% 
from 1996 onwards, to allow a continued reduction of the gross debt ratio. 
Chart 1 - Netherlands 
Real GDP (1988 = 100) 
118 
116 
114 
112 
110 
108 
106 
104 
102 
100 
98 
1988 1989 1990 
Source: Commission services | :]—-Netherlands lBlHillllHEfiïï'3 
|| —Western German) |i||p|li|||^|^^ 
M *• France ftliMlESlfH^Jv^ 
i|| e United Kingdom WBttf^ 
j| —EUR 12- IIS Since the coalition 
agreement is based on 
a rather cautious 
medium-term growth 
scenario, it can be 
expected that revenues 
might turn out to be 
higher than expected. 
The government 
intends to use this 
additional budgetary 
room in the first place 
to further reduce the 
general government 
deficit to around 2%, which would have a beneficial effect on the debt ratio. For the use 
of possible further growth windfalls, a choice will be made between further reducing the 
budget deficit and easing the total tax burden. 
The measures the government plans to take to increase employment and labour market 
participation, especially at the lower end of the labour market, include reducing labour 
costs by lowering the burden of taxes and social security contributions and deregulation 
of the product and labour markets. Furthermore, a higher investment share in 
government expenditures will be realised. The planned reform of the social security 
system, which includes a privatisation of the disability and sickness benefit schemes, 
tighter criteria for calls on the system and smaller yearly adjustments of social benefits, 
should help to realise both the reduction of labour market inactivity and fiscal 
consolidation. The Dutch government estimates that between 350 000 and 450 000 
additional jobs will be created in the next four years, 120 000 of which will be the result 
of the measures of the Coalition Agreement. The favourable but hard-to-quantify effects 
of market deregulation are not yet included in this estimate. 
12-12-1994 
82-
PORTUGAL 
Moderate recovery in 1994 under the impulse of strong export performance 
After a decline in 1993, real growth recovered at a moderate pace in 1994. The main 
positive factor sustaining economic activity was a clearly positive performance of 
exports recorded since the beginning of the year, the small open Portuguese economy 
benefiting fully of expanding external demand. 
In contrast, internal demand remained weak, mainly delayed by low consumer 
expenditure. However, in the course of the year, the internal components of demand 
were showing signs of improvement. At the end of the first half of the year private 
consumption was recovering progressively despite falling real wages and a still 
depressed labour market situation; consumer demand was partly sustained by a fall of 
about one percentage point in the saving rate and larger indebtedness of households 
reflecting positive expectations for the coming months. Despite strong export expansion 
and an improvement in business confidence in export-oriented sectors, recovery in 
investment was weak due to still cautious expectations related to domestic demand, the 
need for financial consolidation of enterprises and availability of production capacities, 
particularly in capital goods sectors. Investments in constructions were lacking 
dynamism namely because public investment programmes related to EC Structural 
funds financing started later than expected. 
As imports were contained by the still sluggish internal demand, the trade balance 
improved in 1994; however, despite a sharp increase in tourism receipts, the 
improvement of the current account balance was limited reflecting falling emigrants 
remittances and delayed net transfers of EC Funds. 
Table 1 
Portugal: Macroeconomic performance 
|| 1990-92 1993 1994 1995 1996 
GDP growth rate 2.5 -1.2 1.1 3.0 3.2 
(% change) 
Total domestic demand 4.7 -0.8 -0.1 2.6 3.2 
(% change) 
Employment (% change) 1.4 -2.0 -0.4 0.1 0.4 
Unemployment rate (%) 4.2 5.1 6.1 6.0 5.6 
Inflation (% change) 11.1 7.9 5.5 4.6 4.4 
Balance of current account -1.0 -0.7 -0.4 1.1 1.9 
(% of GDP) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 The unemployment rate 
which had increased 
from 3.9% in the first 
quarter of 1992 to 6.8% 
in the first quarter of 
1994 declined 
marginally to 6.7% in 
the second quarter of the 
year. This increase in 
unemployment and a 
12-12-1994 
-83-
diffused but clear increase of underemployment were transmitted to wage 
developments, giving evidence of flexibility in the labour market. Wages implicit in 
collective bargaining settlements were increasing at 5.2% in the first half of the year, 
decelerating from 7.1% in the whole of 1993. However, the reduction of the coverage of 
enterprises involved in these settlements was reflected in a slower effective increase in 
wages in the whole private sector, implying some reduction in real terms. 
Portugal 
—Eur-12 
m Differential Chart 1 - Portugal 
Inflation differential 
Private consumption deflator, annual % change 
35 
30 
25 
20 
15 
10 
5 
0 Portugal 
••Differential vis-à-vis the best performing Eur-4 (*) 
1980 1982 1984 
(*) Eur4 = B WD F NL 
Source : Commission services 1986 1988 1990 1992 1994 
The declining trend of inflation which was resumed in 1991 continued steadily in 1994 
reflecting the contraction of internal demand and the adjustment of domestic costs, 
offsetting the inflationary effects of the 1992-1993 depreciation of the escudo. However, 
rising import prices of raw materials and agricultural goods led to slight increases of 
prices of tradable goods 
during the summer. In 
October the year-on-year 
increase of the consumer 
price index reached 
5.6%. 
After a period of 
instability in the second 
quarter of 1994 during 
which the markets tested 
the orientation of 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 Table 2 
Portugal: Economic policy indicators 
| 1990-92 1993 1994 1995 1996 
Money Growth 14.2 6.6 7.0 6.0 : 
(% change) 
Government budget balance -5.2 -7.2 -6.2 -5.8 -4.8 
(% of GDP) 
Gross government debt 66.2 66.9 70.4 71.7 72.3 
(%ofGDP) 
Nominal wages per head 17.3 7.4 5.3 5.9 4.8 
(% change) 
Real wages per head 5.5 -0.4 -0.2 1.3 0.4 
(% change) 
12-12-1994 
84-
economic policy, the escudo started a movement of gentle appreciation and interest rates 
eased supported by increased confidence. 
After a sharp deterioration of the general government deficit in 1993 - resulting from the 
negative impact of cyclical factors, particularly on tax revenues, and from structural 
factors- the public finance situation improved in 1994; the deficit was lowered from 
7.1% in 1993 to 6.3% in 1994. Tax collection improved and fiscal revenues, particularly 
from VAT, increased markedly; current expenditures were kept within the 
predetermined ceilings at central government level. However, the deficit of social 
security continued to rise, fuelled by increasing unemployment transfers and weaker 
growth of social contributions. Although interest payments were declining significantly, 
the primary balance of general government in 1994 (total deficit net of interest 
payments) remained slightly negative at the level recorded in 1993. The government 
gross debt ratio to GDP, which had increased in 1993, rose again in 1994 to 70.4% 
Expansion of internal demand will intensify activity growth in 1995 
Real GDP growth will accelerate to 3% in 1995, under the impulse of resuming internal 
demand. Real gross disposable income starting to rise moderately within a context of 
greater confidence should boost consumer spending. Positive investment incentives, 
already under way in 1994 in exporting sectors, should spread throughout all productive 
sectors: the fall in stock levels, progressive decrease in idle capacity and larger order-
books, combined to steadily improving expectations related to internal demand should 
fuel private capital formation. Public investment will expand, sustained by increased EC 
structural funds inflows. Moreover, the completion of a large, export-oriented, foreign 
investment project will strongly increase exports. Inflation is expected to moderate 
further but at a slower pace than in 1994; although in the wake of recovering activity 
some acceleration in wages is to be expected, their increase will remain moderate as 
improvement in total employment will be only progressive. 
The achievement of further progress in fiscal consolidation should continue to be a 
priority for economic policy in 1995. The general government deficit is targeted to fall 
to 5.8% of GDP which does not seem very ambitious in the light of the improved 
growth prospects. According to the budget, the budgetary policy stance is to maintain 
current expenditure firmly under the compulsory ceilings for central government, while 
interest payments should decrease further although less than in 1994. Moderation of 
current outlays is designed in order to accommodate a marked increase in capital 
expenditure. The budget plans a broadening of the tax base; while some taxes will be 
12-12-1994 
85 
reduced, the main rate of the value added tax will rise to 17% from the current 16% rate 
in order to finance a 0.75% decline in the rate of employers contributions to social 
security to reduce indirect labour costs. Indeed, the social security sector is currently the 
major source of the general government imbalances. The government plans to reduce 
further the general government deficit in the coming years towards the 3% of GDP 
target in 1997. 
12-12-1994 
-86 
Chart 1 - United Kingdom 
Private consumption, investment and net exports 
contributions to GDP growth, changes on a year earlier UNITED KINGDOM 
The recovery progresses 
Recovery in the United Kingdom economy began more than a year earlier than in the 
rest of the Community. From its low point in the first quarter of 1992 the output of the 
economy has expanded by about 7% to the third quarter of 1994 and has more than 
recovered the fall in output during the preceeding recession of 1990/1991. In 1994 it is 
expected that GDP growth will average just less than 4%. 
Oil production has been extremely strong and has contributed to the strong rise in 
overall output. Thus while total GDP has grown by 6% in the seven quarters up to the 
third quarter of 1994 non oil and gas GDP has risen by 5.4%. Manufacturing output 
lagged somewhat but 
began to pick up sharply 
in 1994 particularly as 
exports began to respond 
strongly to the recovery 
in the rest of the 
Community. On the 
demand side the upswing 
has until recently been 
led by private sector 
consumption which 
accelerated to a peak 
growth rate of 3.8% 
(annualised) by the second half of 1993. Consumption growth took place against a 
background of high levels of borrowing in the household sector, by historical standards, 
and restrained income growth. Furthermore the growth in consumption was not 
associated with a strong housing market - the housing market remains weak with 
broadly stable prices and declining turnover growth. Thus the rise in consumption has 
been mainly financed through a fall in the savings ratio which, with the exception of the 
first quarter of 1993, has fallen continuously from its peak of 13.3% at mid 1992 to 
9.3% in the second quarter of 1994. % 1 
.—private consumption 
«total investment 
•net exports 
Q1 Q2 Q3 
1992 Q4 Q1 Q2 Q3 
1993 Q4 Q1 Q2 Q3 
1994 
Source: Commission services 
More recently consumption growth has slowed as the tax increases announced in the 
two budgets of 1993 began to take effect and real personal disposable income growth 
slowed. However as consumption growth slowed in the first half of 1994 net exports 
12-12-1994 
-87 
picked up sharply and contributed to a further acceleration of growth. The sharp rise in 
UK net exports was partly due to strong oil exports and falling oil imports while non-oil 
exports accelerated driven by the good competitiveness position of the UK and by the 
upsurge in world trade. 
So far the upswing has showed no signs of emerging inflationary pressures. Indeed retail 
price inflation has 
continued to slow 
through to the third 
quarter of 1994. Strong 
competitive conditions 
in the domestic market 
and the absence of wage 
and other cost pressures 
(rising commodity input 
prices have been 
absorbed) appear to 
have kept inflationary 
pressures under control. Table 1 
United Kingdom: Macroeconomic performance 
| || 1990-92 1993 1994 1995 1996 
GDP growth rate -0.8 2.1 3.8 2.7 2.8 
(% change) 
Total domestic demand -1.2 2.1 2.9 2.3 2.5 
(% change) 
Employment (% change) -1.6 -1.0 0.0 0.7 1.1 
Unemployment rate (%) 8.7 10.4 9.4 8.5 7.6 
Inflation (% change) 5.9 3.5 2.5 2.9 3.3 
Balance of current account -3.1 -1.6 -0.4 -0.4 -0.3 
(% of GDP) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
The employment response to the recovery remains unclear. The employer based survey 
suggests that employment continued to fall through to the third quarter of 1994 (except 
for a rise in the third quarter of 1993) while the household based survey indicates rising 
employment from the second half of 1993 through to mid 1994. The continued fall in 
employment as recorded in the employer based survey is somewhat unusual given that 
the UK is more than two years into recovery. It is possible that the employer based 
survey is not adequately recording jobs in new businesses or rising employment in the 
construction sector. It may also be the case that the employment response to the 
recovery is taking longer to emerge as a result of productivity gains due to restructuring 
during the recession. Furthermore the number of full time jobs continues to decline 
while part time employment is expanding. Both sources indicate falling levels of 
unemployment. 
While the outlook is for more modest but better balanced growth 
The outlook for growth in the UK is for a slowdown to a more modest growth rate than 
that expected for 1994. Two factors lie behind the expected slowdown. Firstly, the surge 
in oil production, witnessed in 1993 and 1994, is assumed to level off so that the 
12-12-1994 
contribution of oil output and net oil exports to growth diminishes. Secondly with a 
further increase in the tax burden in 1995/96 in addition to that of 1994/95 private 
consumption growth is expected to decline before picking up somewhat in 1996 as real 
income growth begins to recover and as consumers adapt to the higher tax burden. 
However the slowdown in growth will be moderated by rising investment and a strong 
export performance. 
Prospects for inflation 
depend on the extent to 
which the economy 
slows down over the 
course of 1994/1995 
and on the behaviour of 
wages. In response to 
the relatively strong 
growth in the economy 
the authorities raised 
interest rates in the 
autumn of 1994 for the 
first time in five years. 
While the half point rise in official interest rates will in itself have little impact on 
economic activity, it represented a signal of the authorities' firm commitment to their 
inflation target ( to keep inflation, as measured by the underlying retail price index, 
within a 1-4% band and to reduce it to the lower half of the band by late 1996 or early 
1997). Table 2 
United Kingdom: Economic policy indicators 
| 1990-92 1993 1994 1995 1996 
Money Growth 7.1 5.8 6.2 6.5 : 
(% change) 
Government budget balance -3.4 -7.8 -6.3 -4.6 -3.4 
(%ofGDP) 
Gross government debt : 48.3 50.3 52.3 52.9 
(% of GDP) 
Nominal wages per head 7.7 4.1 4.1 4.6 5.0 
(% change) 
Real wages per head 1.6 0.6 1.5 1.7 1.6 
(% change) 
For defintions, see Table 2 for Belgium 
Source: Commission services, economic forecasts, Autumn 1994 
Chart 2 - United Kingdom 
Underlying CPI and average earnings 
Changes on a year earlier 
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 
1992 I 1993 I 1994 
Source: Commission services Despite a continuing 
unexpectedly good inflation 
performance with underlying 
retail price inflation falling to 
2% in September 1994, 
average earnings bottomed 
out at 3% in the third quarter 
of 1994 and subsequently 
rose to 33/4% in 1994 
indicating that wage 
disinflation may have ceased 
12-12-1994 
-89 
before price inflation has bottomed out thus allowing real wages to rise. With 
unemployment continuing to fall and assuming that employment will respond to the 
recovery the labour market is expected to tighten somewhat and to lead to some upward 
drift in wages and earnings. Consequently inflation will tend to rise, albeit modestly, as 
the economy continues to grow into 1996. 
The UK government presented an updated convergence programme in February 1994 in 
which a faster rate of reduction in the general government deficit was foreseen as a 
result of further budgetary measures announced in November 1993. Combined with 
continuing growth these measures should confirm the downward trend in the deficit. 
The programme of fiscal deficit reduction also involves ambitious expenditure plans 
which would need to be vigorously enforced. Lower than expected inflation would offer 
scope for even further expenditure reduction. Finally the UK external deficit is not 
expected to worsen despite the recovery and the earlier cycle in the UK than in the rest 
of the Community. 
The main policy challenge in the UK is to maintain the anti inflationary stance in the 
face of a recovery which has not fully impacted on all sectors of the economy. 
Confidence has not yet fully recovered possibly because the housing market continues 
to remain weak. Despite uncertainty about how much spare capacity exists the UK 
economy will have to slow down at some point to a growth rate closer to the potential 
output growth rate if inflationary pressures are to be avoided. It is possible that this may 
require further policy action by the authorities. 
12-12-1994 
ISSN 0254-1475 
COM(94)615flnal 
DOCUMENTS 
EN 01 
Catalogue number : CB-CO-94-683-EN-C 
ISBN 92-77-84052-8 
Office for Official Publications of the European Communities 
L-2985 Luxembourg