Opinion of the Economic and Social Committee on 'Employment and the euro` (98/C 407/48)

On 27 January 1998 the Economic and Social Committee, acting under Rule 23(3) of its Rules of Procedure, decided to draw up an Opinion on 'Employment and the euro`.

The Section for Economic, Financial and Monetary Questions, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 14 July 1998. The rapporteur was Mr Geuenich.

At its 357th plenary session (meeting of 9 September 1998) the Economic and Social Committee adopted the following opinion by 115 votes to two, with five abstentions.

CONDITIONS FOR THE SUCCESS OF EUROPEAN MONETARY UNION IN EMPLOYMENT POLICY TERMS

1. Introduction

1.1. In assessing the employment impact of European monetary union, it is important to distinguish between short- and long-term effects. In particular, the major drive by a number of European countries to curb public spending in a bid to meet the 3 % deficit criterion may be said to have put a damper on economic growth in some Member States over the past few years. Employment trends were also correspondingly poor. These adverse short-term effects on growth may well still overshadow the start of European monetary union.

1.2. However, the resultant slow-down of the economy reduced tax revenues and increased social security costs, thus enhancing pressure on public budgets and generally leading to higher deficits. In this respect, therefore, a conflict existed between monetary and fiscal criteria. To meet the self-imposed deficit targets, finance policy necessarily held back the economy, with major consequences for both growth and employment. The impact of these fiscal restrictions may be expected to ease when European Monetary Union has got going.

1.3. Short-term effects may also be felt as a result of the fixing of exchange rates against the euro. Exchange rates should have a largely neutral effect on competition, but this could be undermined by short-term exchange-rate speculation - although there is no sign of that at present. However, a more serious problem could be posed by the fact that while, to all intents and purposes, nominal exchange rates within the EU are stable, they are changing in real terms. Germany, in particular, has finally made itself more competitive by cutting unit labour costs; this has come at the expense of its EU partners. However no further exchange rate adjustments are expected by the time European monetary union is launched on 1 January 1999. The countries participating in the first wave will not therefore start off on a level playing field as far as competitiveness is concerned. The resultant effects may well take some time to run their course.

1.4. Wage and labour market policies have traditionally been handled by a triad of parties. The national central bank (NCB), has often been vested with the power over monetary policy with foreign exchange rate and short-term interest rates, while the parliament and the government are in charge of fiscal policies including the education and the social system. Wages and salaries are negotiated between employers and trade unions.

1.5. In the longer term, the impact of European monetary union on growth and employment depends on the direction and coordinated practice of European wage, monetary and financial policy. It will thereby become clear whether the benefits of European monetary union in terms of lower transaction costs and nominal interest rates, enhanced competition and improved price transparency for consumers will not be offset by added risks, possibly because the extended currency area is less able to adapt in the wake of disturbances.

1.6. The analysis does not take account of the overall impact of the European single market and the free movement of labour and capital. These factors in particular have intensified inner-European trade, generated higher direct foreign investments and triggered off migration - and will continue to do so. This opinion, however, focuses solely on the employment implications of the introduction of the euro.

2. General remarks

2.1. Wage developments and convergence in the run-up to monetary union

2.1.1. Since the mid-1980s, the gap between nominal wage increases in Europe has narrowed with the process of European economic convergence. This contrasts with the situation even in the mid-1970s, when monetary and wage policy in the various different countries of western Europe responded in very diverse ways to rising import prices in the wake of the oil price shocks.

2.1.2. While some domestic economies returned immediately to a stability-driven course, in others, both wage rises and inflation remained high. In those countries seeking price stability, inflation in the immediate aftermath of the rise in oil prices diverged only slightly, before quickly returning to convergence. This development was reflected in broadly constant exchange rates between the currencies of these countries.

2.1.3. It was not until the early 1980s that a markedly new trend emerged across Europe. Although inflation again picked up in response to the renewed rise in oil prices, it dropped considerably from around 1985 onwards as the result of tight monetary policy coupled with slack demand. Prices were thus rising at increasingly similar rates across Europe and variations between inflation rates became noticeably less pronounced. The 1990s were marked by the impact of German unification and the joint efforts of European countries to meet the Maastricht criteria. In terms of both rates and dispersion, the convergence process on the inflation front has continued since the early 1990s in preparation for the establishment of a single currency. With six months to go before the scheduled launch of monetary union, prices and incomes are now rising at almost identical rates across the EU.

2.1.4. The closer alignment of inflation rates was not repeated on the unemployment front. A whole range of different reasons may be advanced for Europe's high unemployment rate. This begs the question: how far has the gap between Europe's labour markets actually narrowed? In the long term, is convergence of inflation rates really enough to secure successful monetary union, where, possibly, this can only be achieved under the pressure of divergent unemployment rates?

2.1.5. In the short term, divergent unemployment rates may be compatible with a single currency. However, if no real convergence sets in the long run - or if a new adverse supply-side shock should lead to even further divergence on the labour market - a demand for transfer payments between the Member States would appear inevitable. Political instability within monetary union is a possibility. To prevent this happening and head off the introduction of additional transfers, labour market flexibility must, over time, become broadly similar in the participating countries. The situation is developing along almost identical lines in the non-participating countries too.

2.1.6. In institutional terms, the procedure for setting wage levels varies widely in the countries of the EU. This is not so much true of the level at which wage bargaining is conducted but applies more to how trade unions are organized (unions with links to political parties or unitary trade unions covering a particular sector or occupation) and the degree of macroeconomic coordination involved. It is thus impossible to clearly classify European wage-setting procedures.

2.1.7. With the launch of European monetary union, wage policy takes on a crucial role in the individual EU Member States. The sharing of sovereignty in respect of monetary policy and the abolition of national currencies means that, in future, while the extent to which wage policy is geared towards stability may vary, differences between individual countries in inflation rates of tradable goods will become well-nigh impossible. NCBs will no longer have the power to let the currency depreciate in order to compensate for excessive wage and price developments and governments will be constrained in their fiscal policies by the EMU convergence criteria. As a result of this wage demands above the increase in productivity and targeted inflation may well generate an upward trend in unemployment.

2.1.8. In order not to jeopardize regional competitiveness, nominal pay increases in a market with full monetary integration are restricted by expected domestic advances in productivity and increases in unit labour costs in other countries. Under European monetary policy, whenever stability is undermined by wage policy, the downside is felt immediately in the form of rising unemployment and loss of regional competitiveness. This contrasts with the situation under national monetary policy, where there is a considerable delay in impact, as higher inflation is tolerated first before a restrictive course of action is pursued. The pressure for rapid adjustment is thus increased.

2.2. Labour market adaptability

2.2.1. One of the fundamental demands in the creation of a single currency in Europe is to make the labour market more adaptable. With the demise of the exchange rate as a buffer between different domestic economies, wage policy, now more than ever, ought to be flexible enough to compensate for disturbances which hit different individual countries in different ways. Defined in very general terms, the level of labour market flexibility determines the speed with which a domestic economy can adjust to meet an external disturbance. That said, a whole range of areas may be involved here, such as wage flexibility and flexible working time, geographical and skills mobility and institutional arrangements. In future increasing importance is likely to be attached to linguistic flexibility, i.e. the ability to communicate in a number of different languages. However, as far as the issue of labour market flexibility in a single currency area is concerned, wage policy adaptability to real and nominal disturbances is particularly important, since exchange rate variations can also only influence relative wage costs between countries.

2.2.2. Procedures for setting wage levels still vary considerably across the EU. Although unemployment has held down wage rises across the board, the ability to respond to changing situations has undoubtedly varied, with probably even more pronounced differences in adapting to long-term changes in productivity and varying rates of price increases. Divergent developments on prices and unemployment reflect this varying capacity of wage levels in the different countries to respond to changing conditions.

2.2.3. In the long term, the economic and political future of the European Union with a single market and a single currency will only run smoothly if current differences in living standards not only do not widen further, but even narrow down over time. This is true for both employment figures and income levels in the individual countries. If there is no long-term convergence on both these fronts - or if there is further divergence - demands for transfers, or migratory movements from the countries left behind, appear unavoidable.

2.2.4. Wherever wage increases at sectoral level are geared towards sectoral productivity, real wages rise retrospectively to match advances in productivity (although the wage share remains constant), and unit labour costs grow in line with the tolerated inflation rate. Generally, however, growth is not a continuous process; expansion is slowed down or accelerated by negative or positive disturbances on the supply and demand side. Wage policy must respond in an appropriately flexible way. Gearing wage policy towards productivity avoids the risk of conflicts with the central bank, which put a brake on investment momentum. Successful companies thus have a better chance to expand.

2.2.5. Wage policy structure is not the only competitive factor in play here. Other measures directly related the labour market are also involved. These range from the upskilling of the labour force to institutional labour-market arrangements such as protection against dismissal, maternity protection, paid leave for new parents, help for seriously disabled persons, sick pay, etc. There is no doubt that all measures to enhance human resources help promote speedy structural change in any economy. This is reflected in higher productivity and higher wages. In a single labour market the competitive position of a person or a group of persons with similar skills are primarily related to: a) whether they have adequate skills in relation to market demand, b) if the wages and salaries etc. they request are competitive and c) if they are prepared to move.

2.2.6. In Europe, the diverse nature of such arrangements would appear to pose a considerable risk for monetary union, since countries with well-developed regulatory or social security systems would find themselves at a constant competitive disadvantage. However, at least the launch of European monetary union poses no problem in this regard, since such differences were already taken into account in conversion rates with zero-impact on competition. Even later on, more stringent safeguards, leading inevitably to lower wage increases in real terms, will not damage economic development if wages continue to be set in line with productivity.

2.2.7. Non-wage issues specific to the labour market also include arrangements for working time and overall operating time. This is not so much a question of how long an individual must work - since this factor is already included in unit labour costs - but relates more particularly to the flexibility of working time. More flexible working time means that, while hourly rates of pay remain the same, working time is better adapted to operational needs. This helps save not only on wage costs, but on capital costs too, for example by extending the overall period worked. In this way, it is possible to secure competitive advantages. In future, more flexible working time could become a key factor of competition in Europe.

2.2.8. Investments in infrastructure should be treated in a similar way to investments in human resources. If a country decides to step up infrastructure investments, and provides the resources required, it can also reap the benefits later in the form of enhanced productivity and higher growth.

2.2.9. Dealing with external costs is more difficult. Normally, the external costs of production must be met by the companies which generate them. In this connection, once European monetary union is launched, it could prove difficult for individual countries to continue to forge ahead in environmental protection, since any competitive advantage which may be lost as result can no longer be recouped via exchange rate adjustments. Countries seeking higher environmental standards, for example, will either succeed in implementing them in a way that has zero-impact on growth, or environmental standards will be uniformly raised across the EU.

3. Policy requirements

3.1. Monetary policy in European monetary union

3.1.1. European economic policy has long focused on monetary convergence. Given the impossibility of achieving such convergence without the harmonization of European monetary policy, this has for some time now meant a far-reaching reassignment of economic policy responsibilities in countries seeking to participate in the third stage. In the 1980s, the stability target was, in practice, set by Germany, as a country with low price inflation and the largest domestic economy in Europe. Since the Deutschmark had also joined the US dollar as a global reserve currency, harmonization broadly meant adapting to German monetary policy which was not necessarily channelled towards European interests and was also very much focused on price stability. Otherwise, with exchange rates demonstrating the required constancy, the other countries would have risked becoming less competitive.

3.1.2. In countries where markedly higher inflation than Germany's generated a considerable need for convergence, the job losses and internal tensions involved meant that harmonization repeatedly fuelled market expectations that the currencies concerned would have to be devalued. The adjustment strategy made it possible to anticipate single currency conditions by giving uniform direction to monetary policy across Europe.

3.1.3. What strategy will the European Central Bank (ECB) now pursue? The Maastricht Treaty stipulates that the ECB's 'primary` objective is the maintenance of price stability, thereby rejecting - at least in the Maastricht Treaty - the position of the US Federal Reserve, where the targets of price stability and growth enjoy equal status. Nonetheless, it would be desirable for the ECB - in line with Article 105 of the Maastricht Treaty - to gear its monetary policy not only to price stability, but also to the objectives of economic growth and lower unemployment.

3.1.4. The advantage of limiting the target to price stability would be to create clarity as to who is accountable for meeting that target. However, the Keynesian view would be that, by targeting price stability as the primary objective, Europe would be at risk of acquiring a central bank which, although its remit was price stability, would also exert a critical influence on European growth and employment. This could lead to responsibility for growth and employment being shunted onto financial policy as monetary policy, taking no further account of these targets, became prematurely concerned with holding down prices during periods of economic expansion, while possibly giving an inadequate response during economic down-turns by being slow to switch to expansion. Transitional problems would be a further factor to be reckoned with.

3.1.5. Those on the receiving end of monetary policy signals must have an incentive to respond and, indeed, the capacity to react at all. () This depends primarily on institutional objectives, as demonstrated by the example of the relationship between the central bank and the two sides of industry. There would be an incentive to give a correlative response to signals if (i) the central bank worked towards price stability, (ii) the trade unions sought to optimize their members' real income and (iii) companies strove to maximize profits. In this light, it appears useful to set an intermediate target, such as the inflation rate, which gives clear, credible signals to active market players. On the basis both of a wage policy geared towards productivity and stable prices, the ECB can and should pursue a low-interest policy which promotes investment demand.

3.2. Financial policy in European monetary union

3.2.1. The financial policy discussion on meeting the Maastricht Treaty criteria throws up the basic question of what role national financial policy can and should play in a monetary union. The first point to be cleared up is how far financial policy can help stabilize economic activity. Consideration should also be given to whether, given the loss of monetary policy instruments to stabilize asymmetrical disturbances, this role should pass to financial policy. There are, however, some reservations about such an approach.

3.2.2. As well as fundamental scepticism, rooted in neo-classical theory, about the ability of counter-cyclical financial policy to achieve stability (), there is widespread concern that individual countries would incur excessive debt, to the detriment of all the countries involved. () For this reason, the benchmark values for fiscal deficits were incorporated into the Maastricht Treaty as a guide for national financial policy. Moreover, the treaty contains a 'no bailing-out` clause under which individual countries have to meet their own debts.

3.2.3. For the EU as a whole, the imposition of deficit limits threatens to generate a counter-productive policy mix. Cuts in public investments in capital goods and human resources prove particularly damaging. Overall, a number of factors indicate that the most marked consolidation effect would be achieved by a combination of expansive monetary policy - ensuring propitious growth conditions - and a policy of using additional growth-led tax revenue for the express purpose of consolidation rather than for additional expenditure.

3.2.4. In future, financial policy is unlikely to be the policy area to assume the full burden of adjustment in the wake of disturbances which affect different individual countries in different ways. This task will fall, certainly in part, to wage policy. It is therefore all the more important to remodel tax and duty systems to promote employment, including above all a reduction in non-wage labour costs, financed by a rise in indirect taxes, especially VAT and energy taxes.

3.3. Wage policy in European monetary union

3.3.1. In order to ensure stability following the launch of European monetary union, wage policy must be anchored on two fronts. On the one hand, there has to be the monetary anchor, defining the scope for price rises. Only the European Central Bank, which is responsible for monetary policy, can determine this anchor. By specifying a 'tolerated` inflation rate, the ECB sets out the framework within which European wage policy as a whole may operate without the imposition of monetary restrictions.

3.3.2. As well as an inflation target, wage policy needs a further, realistic anchor to fulfil its remit. This second anchor is the only way to give wage policy the direction it needs to prevent conflict with monetary policy and at the same time promote growth, employment and real convergence, irrespective of the level at which such policy is set and the degree of centralization involved.

3.3.3. The best possible scenario would be for each country's wage levels to be set in line with that country's potential sectoral productivity.

3.3.3.1. Such an approach would allow countries like Portugal, which are catching up with the rest of Europe, and have high productivity growth as a result, scope for relatively high wage increases, giving workers there the chance to have their real income brought into line with other European countries.

3.3.3.2. An approach of this kind would also prevent the emergence of inflationary risks since, ideally, the price effect of wage rises would not overshoot the inflation target.

3.3.3.3. However, there will have to be exceptions to this rule. Unless they base their strategy solely on redistribution of work through shorter working hours, very high-unemployment countries such as Spain and Finland would need to achieve above-average economic growth for their unemployment rates to 'converge`. If these countries are unable to boost their growth, nominal wages will have to lag behind increases in domestic productivity for some time in order to improve the international competitiveness of the countries concerned. This increase in international competitiveness should, however, be accepted by the other countries.

3.3.4. The institutional mechanism for setting wage levels should, therefore, be directed at productivity. The crucial factor is whether those involved in setting wage levels are receptive to central bank signals and gear their decisions to productivity. Several strategies may be drawn on here. In some European countries, the central bank sends out signals to the two sides of industry whose centralized remit covers the economy as a whole. The tripartite council system used, for example, in the Netherlands could be expanded along these lines.

3.3.5. In theory, it would also be possible for smaller European countries to be guided by wage settlements in individual sectors in major neighbouring countries. To do this, however, it is absolutely essential to improve information on wage settlements and the content of framework agreements on employment conditions in neighbouring European countries. Here, the European Commission could and should take action. Leaving the development of wage policy bodies to a haphazard search process may create externalities as the result of practices which run counter to stability. In this case, far-reaching regional differences - i.e. the opposite of convergence - would follow, together, probably, with the call for transfers to overcome these imbalances. If the demand for transfers were met, the regional imbalances would remain and the payments required would place those countries pursuing a stability-led wage-setting process under permanent strain.

3.3.6. As things stand, the more acute risk is not that stability requirements will be exceeded, but that they will not be fully brought to bear. From a European viewpoint, competition to reduce wages is not a viable strategy since it is detrimental to neighbouring European countries. Some countries' exports would undoubtedly rise, but largely at the expense of European trading partners. This would hardly be conducive to European growth, and a convergence process would not get under way. Even espousal of neo-classical ideas of the production process, with wide-ranging substitution options, would produce a sobering result. Real wage reductions imply a cut both in consumption - since real income has to drop as labour productivity decreases - and in investments, since the use of capital becomes too expensive in relation to labour.

3.3.7. Observations concerning a wage policy for the whole of Europe contain an essential message for economic development. Economic progress is indivisibly linked with competition, but not competition of all kinds. Higher growth across Europe and catching-up by poorer countries is only possible if competition is also entrepreneurial in scope. In the private sector, this means focusing on giving companies a competitive edge through the application of new technologies, more efficient links between factors of production or the development of new products. In the public sector, a region's competitiveness may depend on improved infrastructure, enhanced human resources and a more efficient education and taxation system. This kind of competition produces growth through economic creativity.

3.3.8. There are, on the other hand, competition strategies which seek to create jobs by cutting wages, curbing social benefits or reducing taxes. Such an approach may augur well only for an individual country, a firm or in microeconomic terms, but the resulting competitive advantages are driven not by innovation, but by a 'devaluation` of what has already been achieved. In macroeconomic terms, such an approach opens up no additional economic opportunities, but is at most a zero-sum game, the loser being the one left behind in competitive cost-cutting. From a European perspective, competition to cut wages and moves to curb social benefits are unacceptable since they involve inroads into prosperity. Since social security levels always have to be geared to the economic performance of each individual country, European policy cannot, of course, guarantee that these levels will be uniformly high. European policy should, however, also work to counteract calls within one country for social security cutbacks on the grounds that levels are lower in a neighbouring country. This does not affect reforms of the social security system which rely more on proactive input than on a passive, reactive approach.

3.4. European structural policy

3.4.1. However, the EU, and particularly the Member States, must also work to bring locational conditions into line in the various different European regions, not least via an active structural policy. This includes in particular investments in infrastructure (transport, telecommunications), human resources (education and training), research and technology, promotion of the environment and targeted assistance for private investors (business development). These investments strengthen less well-developed areas and thus help bring down productivity differentials. It would be too much to expect wage policy to compensate for regional structural differences.

3.4.2. The most effective instrument of EU structural policy is the Community's Structural Funds; for 1994-1999, these amount to ECU 141 billion, one third of the total budget; this is only 1,97 % of 1997 European GDP. The Commission has put forward reform proposals for the Structural Funds in order to meet structural policy's growing remit, primarily the result of future EC enlargement. These funds help break down the productivity backwardness of less developed regions and reduce unemployment there. They are thus a useful adjunct to coordinated monetary, financial and wage policy in Europe. Moreover, Cohesion Fund resources are available for Member States whose GDP is less than 90 % of the EU average.

3.4.3. Primary responsibility for improving regional structural differences, however, lies with the Member States, particularly since some of these differences are less between countries than within one and the same country (Germany, Italy, France, United Kingdom).

4. Conclusion

With a coordinated wage, monetary and financial policy, EMU may be expected to boost growth and employment, largely as a result of lower transaction costs, lower nominal interest rates and stiffer competition. Sectoral wage policy in the various Member States should in each case be geared towards average productivity growth and the ECB's target inflation rate. Higher wage settlements which diverge from this are to be rejected, as is any competitive race between the individual Member States to cut wages. This would also pave the way for inflation-free economic growth, thereby allowing the ECB to use its monetary policy to help bring down unemployment in Europe. Financial policy would then also be able to curb public deficits via automatic rises in government revenue, without triggering restrictive effects.

Brussels, 9 September 1998.

The President of the Economic and Social Committee

Tom JENKINS

() Cf. Hall, Franzese (1996): Mixed signals: central bank independence, coordinated wage-bargaining and European monetary union, 15.7., unpublished manuscript.

() A coordinated financial policy would be less likely to provoke such scepticism.

() cf. Baumgartner et al (1997): Auswirkungen der Wirtschafts- und Währungsunion (Impact of economic and monetary union), WIFO paper (Austrian institute for economic research).