Economic Reform: Report on the functioning of Community product and capital markets

(Presented by the Commission)

Table of contents

I.INTRODUCTION

II.EVALUATING OVERALL MARKET PERFORMANCE

A. Market performance: integration continues to be a leading factor for improving market performance

1. Economic integration: capital markets still lag product markets in terms of integration

- Product markets: trade and foreign investments

- Capital markets

2. There is a need to foster innovation and creativity in order to improve economic performance

B. Market performance: the impact of integration on social cohesion and consumers

1. Economic and social cohesion has benefited from greater integration

2. The impact of integration on consumer retail prices: there is still scope for improvement

III. MONITORING HORIZONTAL ISSUES

A. Improving the business environment

1. Entrepreneurship and regulatory simplification

2. Remaining technical barriers to trade

B. Improving the functioning of markets

1. State aids

2. Public procurement

3. Taxation

IV. FOSTERING ECONOMIC REFORM IN THE INTERNAL MARKET FOR SERVICES

A. Opening and integrating services markets

1. Public utilities

2. Financial services

B. Improving the regulatory framework for services activities

1. E-commerce

2. Distribution

V. CONCLUSIONS

Economic Reform: Report on the functioning of Community product and capital markets Statistical

Annexes

Executive Summary

This is the second annual report of the Commission on the functioning of product and capital markets in response to the mandate from the Cardiff European Council. This Council called on the Member States and the Commission to produce annual reports on matters within their sphere of responsibility relating to regulatory reform of product and capital markets. This process lends impetus to economic reform by providing input for the preparation of the Broad Economic Policy Guidelines and serves as the basis for Commission proposals to update target actions included in the Internal Market Strategy. The Cologne and Helsinki European Councils have recently highlighted the importance of economic reform as a key component of our employment strategy and our macro-economic stability policy.

This report is presented at a crucial moment for the European economy. In spite of a broadly favourable global economic environment, Europe faces many challenges as it strives to improve its overall competitiveness. Flexible, integrated, open markets are a precondition for sustainable economic growth and long-lasting job-creation. The current economic upturn provides a window of opportunity to carry out the economic reforms needed to develop dynamic, efficient markets which encourage innovation and entrepreneurship. Reforms must be implemented in a manner which recognises the specific challenges of each national economy.

This report contributes to the process of economic reform in two ways:

First it monitors and assesses product and capital market performances to identify regulatory failure at EU level.

Recent trends in trade, investment and capital market integration are examined.

- Trade continues to be a dynamo for market integration.

- Cross-border direct investment and mergers and acquisitions remain the strongest vectors for structural change in today's Internal Market. Between 1997 and 1998 alone, the value of intra-EU foreign investment doubled. The value of cross-border mergers and acquisitions between EU firms reached a new level in 1998. This trend shows no sign of tapering off.

- Capital market integration is accelerating, even if there remains substantial scope for integration of securities markets. The disappearance of exchange risk has spurred institutional investors in particular to diversify their portfolio composition by increasing the share of securities issued by companies in other Member States. Issuers of securities are seeking to tap the potential for raising capital on an EU-wide basis. Investor's appetite for risk is changing and average European credit ratings are falling sharply. New financial products and markets are emerging in the Union - for example, the total volume of international bond issues in euros is now practically equivalent to the volume of issues in US dollars Taken together, these developments herald the emergence of liquid and modern securities markets, at the service of EU companies. However, this report highlights a number of legal, administrative and structural obstacles which continue to fragment EU securities markets.

There is further evidence of market integration: retail price convergence is continuing albeit more slowly than in the early 1990's. Price dispersion for private consumption between the EU15 countries has fallen from 22,3% in 1990 to an estimated 14,7% in 1998. However, convergence is not always towards lower price levels. Removal of market entry barriers is therefore a necessary, but not a sufficient condition for translating integration into improved market performance. The full play of competition must be sustained by enforcement of stringent anti-trust policies.

The report also documents the way in which integration has helped the poorest parts of the Community catch-up with the rest of the EU. The track-record of the peripheral regions of the EU has disproved the theory that efficiency and social cohesion are contradictory policy objectives.

Second, the report lists policy prescriptions needed to sustain economic reform.

Policy prescriptions to lighten and improve the quality of the Community's regulatory framework and to remove barriers to the efficient functioning of markets are set out. They include:

- the recommendation to Member States to reduce the general economic and regulatory costs of creating new businesses and to review on a systematic basis the existing regulatory framework with a view to improving its quality;

- the proposal to consider the extension of the application of the New Approach to technical harmonisation to new sectors;

- the recommendation to member States to maintain the current overall downward trend in the volume of State Aids and to make additional efforts to avoid sector specific (and especially ad hoc) aids;

- the full and rapid implementation of the Financial Services Action Plan to encourage business and investment activities whilst improving the confidence of consumers and investors, as well as stabilising the financial system;

- in the utility sectors, the adoption and full implementation the Community regulatory framework and the strict enforcement of competition rules;

- the creation of a comprehensive framework for the free movement of Information Society Services and the development of an integrated policy combining government and industry regulation and rules for consumer protection are needed to enhance consumer trust and confidence;

- the elimination of restrictions impairing reform in the distribution sectors.

Implementation of this set of recommendations will contribute to a thriving entrepreneurial economy capable of mastering technological progress for the social and economic enrichment of the continent. The EU and the Member States need to:

1. take advantage of the favourable current economic context to enhance competitiveness by introducing economic reforms compatible with economic and social cohesion and other social objectives;

2. provide the best possible competitive and regulatory environment. Here, public authorities have three important tasks: 1) to guarantee high levels of market competition, so that the necessary structural changes do actually impact on competitiveness and improve consumer welfare; 2) to examine and, whenever necessary, adapt existing regulations to provide a simple yet high quality regulatory environment; and 3) to ensure the active participation of all stakeholders in discussions on efficient ways to further integration;

3. use Internal Market policies and national country-specific microeconomic policies to advance economic reform and competitiveness. The Internal Market can serve as a framework for reversing regulatory deficiencies which stifle competitiveness and growth on an EU-wide basis.

Sustained economic performance is critical for sustained period of job-creation which is the only successful and enduring answer to social exclusion. This report signposts the way towards creating a regulatory climate which is conducive to enterprise-led job-creation. As such, it forms part of the Commission's preparations for the special Lisbon European Council scheduled for March 23 and 24.

I Introduction

This is the second annual report on the functioning of product and capital markets produced by the Commission in response to the conclusions of the Cardiff European Council of June 1998. According to the mandate from the Council, the report presents indicators of effective market integration, including price differentials and the implementation of Internal Market measures, with the purpose of monitoring economic reform efforts at the Community level and setting out policies which aim to make product, service and capital markets more efficient. The Commission report, alongside with the national reports produced by Member States on their areas of competence over product and capital markets, provides input for the preparation of the Broad Economic Policy Guidelines.

In the year that has elapsed since publication of the first report, the European Council has repeatedly underlined the importance of product and capital market reforms and comprehensive economic reform for macroeconomic stability in the Monetary Union. The Employment Pact agreed at the Cologne European Council has emphasised the role of the Cardiff process of economic and structural reform in complementing the Luxembourg process for employment and the macroeconomic dialogue. The Helsinki European Council has noted the success of the Employment Guidelines and stressed the major importance of co-ordinating economic, employment and structural policies to fight unemployment. The Helsinki European Council confirmed that improving market performance is a key element in the process of comprehensive reform. The Presidency conclusions stress the importance of economic reform, and in particular liberalisation and tax reforms, to sustain the favourable economic outlook. To safeguard and promote competitiveness, employment and living standards in a world of free trade and constant technological change, Member States and the Community must redouble their efforts to improve the efficiency of product and capital markets. Moreover, EMU requires flexible markets capable of adjusting to economic shocks without loss of jobs and competitiveness.

The European economy's sound fundamentals and currently favourable economic outlook provide an especially propitious context for economic reform to tackle some of the structural problems which have impaired European competitiveness and employment performances in the past. Low inflation rates, growing investment and income levels and better employment prospects facilitate the introduction of economic reform. The European Union have a window of opportunity to undertake structural reforms that can transform Europe into a fast growing and high employment economy, capable of responding to the challenges of global competition. It is time to build on the macroeconomic stability brought about by EMU to create a dynamic business environment where innovation and creativity thrive and entrepreneurship can translate investment and technological opportunities into more new jobs, whilst preserving the values of our society.

Streamlining and improving the process

Reinforcing co-ordination of economic, employment and structural policies is essential to exploit in full the potential of the Internal Market and the single currency, but the costs of co-ordination should be kept to a minimum. The ECOFIN Council has produced a report to the Helsinki European Council reviewing the instruments currently available and the first year's experience of economic policy co-ordination in stage 3 of EMU, which has important implications for the Cardiff process. It enhances the central role of the Broad Economic Policy Guidelines in Economic Policy co-ordination and emphasises the need to ensure coherence between the different Council formations. From a procedural point of view, the most significant change has been the reduction in the number of reports produced by the Commission. The Cardiff I and II reports produced last year will be replaced by this one single annual report. In addition, the Commission will provide analyses for the peer review exercise on national economic reform plans conducted in the Economic Policy Committee. The special meeting of the European Council in Lisbon will reconsider existing arrangements for economic policy co-ordination.

Adoption by the Internal Market Council of the new strategy for the Internal Market [COM(1999)624] adds a further new dimension to this report. The results of the monitoring process reported below and the conclusions of the appraisal of the functioning of product and capital markets presented here will be the basis for future annual updating of target actions in this new strategy for the Internal Market. For this reason, the report pays special attention to certain issues at the core of the Internal Market such as price convergence or the construction of a Single Market for financial services. This is also in line with the new orientations given by the ECOFIN Council's report to the Helsinki European Council.

Objectives and structure of the report

Following the mandate of the Cardiff European Council, this report's main objective is to present the most significant results of the monitoring and assessment of product and capital market performance carried out by the Commission over the last year. This is essential to identify the most costly obstacles to economic reform in terms of economic efficiency.

The report includes conclusions and recommendations outlining policy measures considered necessary to foster economic reform or helpful to remove obstacles to the efficient functioning of markets. These include new initiatives needed to increase market efficiency or foster economic reform, as well as already announced policy actions, which according to our monitoring and assessment require urgent implementation. Formulating precise policy proposals is beyond the scope of this report. Country-specific economic policy guidelines will be spelled out in the Broad Economic Policy Guidelines on the basis of input provided by the national reports on economic reform submitted by Member States and this report. Conclusions and recommendations presented here will also feed into the review of target actions for the Internal Market strategy.

The structure and layout of the report builds on the main lines of the Cardiff I Report approved by the Commission last year and welcomed by the Council. Modifications have been introduced to take into account suggestions made by the Internal Market Council and conclusions of the ECOFIN Council evaluation of the first Cardiff exercise carried out by the ECOFIN. The scope has been broadened to include certain social dimensions of market performance. Moreover, this year's edition includes a large set of statistical indicators to facilitate work in the next stages of the Cardiff process.

The report consists of three main sections. Section II presents an overall assessment of market performance. It takes into account economic aspects such as market integration, necessary for an efficient resource allocation and growth, as well as other dimensions of market performance, particularly benefits for consumers and economic and social cohesion as defined in the Treaty. Section III reports the main findings from the monitoring of certain key horizontal issues for product and capital market performance and economic reform. In selecting these key issues, the Commission has taken into account the results of last year's Cardiff I and II reports as well as the report of the Internal Market Horizontal Questions Working Group and the synthesis report of the first Cardiff exercise by the Economic Policy Committee. Finally, section IV is dedicated to fostering economic reform in services. Special attention to the services sector is justified by its economic importance in terms of employment and value added, the specific problems raised by structural reforms in this sector and the need to take action at the Community level to open and integrate services markets and improve the regulatory framework for service activities [1].

[1] The report is accompanied by a working document of the Commission services with analytical information on capital market integration, banking, the single market for electricity and price convergence.

II. evaluating overall market performance

Economic integration of product and capital markets is improving the performance of the European economy by increasing market size, reducing costs and fostering competition. Other economic factors and especially, innovation, creativity, economic and financial integration need to play a greater role in the globalised knowledge economy of this new century. The report focuses on these issues for the overall assessment of market performance from an economic perspective.

A. Market performance: integration continues to be a leading factor for improving market performance

1. Economic integration: capital markets still lag product markets in terms of integration

- Product markets: trade and foreign direct investment

The Internal Market programme of trade barrier removal and market liberalisation is continuing to intensify the integration of Member States' markets. Since 1993, growth in intra-EU manufacturing trade has significantly outpaced the growth of GDP. This is all the more remarkable because manufacturing's share of GDP has been shrinking (see Fig 1 & tables 1 & 2). In the area of services, the integration of formerly regulated sectors, the removal of remaining restrictions to trade and other structural changes often due to technological change will surely allow for much more trade interdependence.

Trade remains a vital and permanent means of integrating Community markets, but in today's Internal Market, cross-border investment and mergers and acquisition activity, especially in services, are the most dynamic factors driving integration in today's Internal Market. Between 1997 and 1998 alone, the value of intra-EU foreign investment almost doubled, reflecting a deliberate firm strategy of growth in order to exploit the profitable potential of market opportunities, probably due to a large extent to the new impulse to integration provided by EMU (see table 3).

Cross-border investment is often used to finance mergers and acquisitions (M&As) amongst firms. Intense merger and acquisition activity is a strong indicator of firms seeking growth in order to compete in the enlarged EU market, and recent EU M&A activity has been increasing in intensity (see table 4). The value of cross-border M&As between EU firms in 1998 set a record, and came on top of a rising trend that shows no sign of running out of steam - indications so far suggest that 1999 will smash the 1998 record. In other words, there has been a dramatic increase in the importance of M&As compared to trade as a force for market integration. The sectoral breakdown of this growing cross-border M&A activity is changing: services account for an increasing share of the total number deals (53% in 1998 compared to 42% in 1992).

Finally, it is important to note that extra-EU trade has grown faster than intra-EU trade since 1993. In other words, EU markets are integrating rapidly not just amongst themselves, but also with non-EU markets. This refutes those who saw the Internal Market as an instrument to build "Fortress-Europe". A recent OECD study [2] has confirmed it showing that the EU's level of openness to trade and investment is equal to or higher than the USA's and far higher than Japan's.

[2] OECD, "Trends in market openness", Economics Department working paper n. 221, August 1999.

Transparent and efficient merger control, both at national and Community level, is essential to preserve competition whilst providing legal certainty to the firms. Such control should be based on the strict application of competition rules and be free from domestic industrial policy considerations. In this context, adopting the Take Over bids Directive is now an urgent necessity. The European Company Statute could also facilitate the current process of company expansion. The Commission will continue its vigilance against the emergence of any new sector-specific obstacles to trade in goods and services.

- Capital markets

Indicators show substantial scope for further capital market integration in Europe (see Annex A). For example, European investors hold relatively low percentages of foreign stocks in their portfolios. Furthermore, capital market integration has not yet reached the point where it can smooth consumption and so act as a shock absorber mechanism for the business cycle (see tables 5 & 6).

Nevertheless, things are changing quickly. Removing restrictions to the purchase of stocks and bonds issued in other Member States and the advent of the single currency have all spurred institutional investors to internationally diversify their portfolio composition. Issuers of securities aiming at pan-European markets are benefiting from these new trends: the total volume of international bond issues in euros is now practically equivalent to the volume of issues in US dollars (see table 9), and the volume of derivatives contracts traded has multiplied every quarter since mid-1998 (see table 8). EMU, the elimination of certain regulatory constraints to create a single market for financial services, improvements in settlement mechanisms and, more recently, the implementation of the Financial Services Action Plan are the main drivers of these structural changes.

Investors' behaviour is changing accordingly. A more stable macroeconomic environment, lower interest rates and the single currency seem to have increased the average European investor's appetite for risk. The average credit rating on the European corporate bond market is falling as a consequence of an increase in the number of sub "AAA" rated issuers coming to the market. This seems to indicate that firms' access to finance is already improving. However, these changes also underline the need to increase transparency and review supervision rules as called for by the Commission in the Financial Services Action Plan. This is particularly important for the stability of the system and for individual investors, who have an increasingly important stake in the soundness of capital markets through their participation in pension or investment funds and the bond and stock markets.

In this new and favourable framework for capital market development, all firms especially SMEs should be able to benefit from improved financial conditions. More diverse and adequate sources of finance must be made available to respond to SMEs' specific funding needs. As underlined by the Cardiff European Council, venture capital is an important source of finance for SMEs. Yet the dimension of European venture capital compares unfavourably with the USA [3]. Most European venture capital investment finances SMEs expansion: only a minimal proportion is used as seed capital for start-ups which impede the creation or expansion of new firms with growth potential. In the US, 60% of venture capital comes from pension funds, whereas even in Europe's most developed venture capital market, the UK, the comparable percentage was 30%. Clearly, European institutional investors could play a significantly greater role in venture capital markets.

[3] See Commission Communication [COM(1999)493]: "Risk-Capital: Implementation of the Action Plan. Proposals for moving forward" for further details.

Unnecessary regulatory restrictions for institutional investors should be lifted in order to support the accelerating rate of capital market integration. At the same time, transparency, supervisory and prudential regulations should be adapted to the new market realities along the lines proposed in the Action Plan for Financial Services. This is essential to ensure consumer protection and the stability of the financial system. Initiatives included in the Action Plan for Financial Services and the proposals recently made by the Commission in this area [COM(1999)493] should be implemented as soon as possible to improve access conditions to venture capital, including seed capital, in Europe, especially for SME.

2. There is a need to foster innovation and creativity in order to improve economic performance and competitiveness

A better economic performance must be based on innovation and creativity to maximise growth and employment in the future. Unfortunately, EU industry's share of total RTD spending is low by comparison with the USA and Japan (see table 10). Europe's economic performance is hampered by low RTD investment rates, fragmented RTD policies among Member States. RTD spending, technological output (as reflected in patent applications) and innovation have to be substantially increased to narrow the gap with its world competitors. The Fifth Framework Programme will provide extra funding for EU R&D. The Commission communication "Towards a European Research Area" proposes ways to improve co-ordination and networking to co-ordinate the currently fragmented national systems of RTD and unleash European RTD potential. However, it is down to the private sector to improve technological performance.

Increasing expected returns from investment would give industry an incentive to invest in technology and other forms of intangible capital. Intellectual property rights (IPR) have always helped foster innovation and creativity, so recent modifications to international IPR rules should contribute to that end. Improved standards of protection and better world-wide enforcement of intellectual property rights will further increase firms' incentives for innovation and creativity.

Improving conditions prevailing in markets where IPR are traded is also essential to foster innovation and creativity. Estimating the value of all EU markets for IPR is difficult. International trade in technology accounts for 1 to 2% of GDP in the EU, and much of that trade is between Member States. Good market performance in those markets will be a key factor for competitiveness in the new knowledge-based economy.

Existing and announced efforts to foster RTD and integrate the national systems of innovation should be complemented by Community initiatives to protect intellectual property rights (patents, utility models, copyright, designs and trademarks) to encourage innovation and creativity and facilitate trade in the "single market for technology".

B. Market performance: the impact of integration on social cohesion and consumers

Social acceptability should also form part of any assessment of market performance, together with economic aspects. Efficient market outcomes are only socially satisfactory if they conform with social objectives and values. This report therefore takes into account the promotion of social and economic cohesion and of consumers' interests [4] [5].

[4] Consideration of the environmental impact of market outcomes should also be taken into account. This year, the Commission adopted a communication [COM(1999)263] dealing with the environment and the Internal Market. The Council adopted a resolution on the same subject. Environmental issues will be covered in future reports on the basis of this work. Some environmental aspects of the liberalisation of the electricity market are briefly mentioned in the corresponding annex.

[5] Another important aspect to consider and better understand is the relationship between labour market and product and capital market performance, but this is beyond the scope of this report. The existence of different policy instruments to monitor labour markets and product and capital markets (Luxembourg and Cardiff) must not however obstruct consideration of their inter-relationships.

1. Economic and social cohesion has benefited from greater integration

The Internal Market epitomises how the economic objectives of market liberalisation and integration can be perfectly compatible with social values such as economic and social cohesion in the sense of the Treaty. Economic and social cohesion among European regions has improved considerably in the key period for the creation of the Internal Market. According to the "Sixth Periodic report on the social and economic situation and development of the Regions of the European Union", GDP per head in the 10 regions with the lowest income levels increased from 41 to 50% of the Community average between 1986 and 1996. However, the extent to which there is a direct relationship between these aggregate economic results and the Internal Market is difficult to establish.

Evidence provided in the Communication on "Structural change and Adjustment in European Manufacturing" [COM(1999)465] contradicts some economists' predictions that the Internal Market would increase the gap between core and "peripheral" EU economies. Contrary to those predictions, between 1988 and 1998, the geographic concentration of manufacturing activities across countries has declined (see Fig. 2 & 3). In other words, peripheral and smaller countries have grown faster than larger Member States. Moreover, the Internal Market has permitted the exploitation of economies of scale and increasing productivity. Thus, closer integration in Europe does not seem to have led to a "core-periphery" model at the Member State level.

Growing integration therefore seems to have helped rationalise EU production and accelerate growth comparatively more in the less favoured countries of the Union, diversifying their industrial structures. The process has been underpinned by progressive reduction in the relative disparities across Member States in the availability of technology, capital and labour. Therefore, European economic integration does seem to be contributing effectively to the goal of economic and social cohesion established in the Treaty. This trend needs to be monitored in the future, especially at the regional level, but data availability and difficulties involved in measuring these structural changes may prevent reporting on an annual basis.

Improvements in efficiency have been compatible and should remain compatible with a catching-up process of economic convergence. In the Internal Market strategy, further integration of other Community policies such as economic and social cohesion will be pursued as a strategic objective.

2. The impact of integration on consumer retail prices: there is still scope for improvement

Health and safety, choice, price, quality, accessibility and fair and transparent market relationships are key dimensions of market performance from a consumer perspective. These issues will be progressively incorporated in future editions of this report. This year we have focused on the Internal Market's effect on prices as a major source of benefits to consumers.

According to Eurostat data, price dispersion for private consumption between the EU15 countries has fallen, from 22,3% [6] in 1990 to an estimated 14,7% in 1998. The trend was most noticeable in tradable goods: food, footwear and household equipment. Price dispersion remains high in non-tradable sectors such as construction, but it has been reduced in other non tradable sectors such as recreation, education and culture. The pattern of convergence in public utilities prices reflects developments in the process of liberalisation: in energy sectors, where the pace of liberalisation has varied widely across countries, price dispersion is greater now than in 1990, unlike the telecommunications, where prices have converged quickly thanks to competition and technology (see tables 11 to 13).

[6] These figures indicate the coefficient of variation, which measures dispersion as a percentage of the deviation in prices in all counties with respect to the average price for the EU.

Indirect taxation and fluctuating exchange rates explain a lot of current levels of price dispersion. VAT differences account for approximately 20% of price variation in final consumption (see table 14). Exchange rate fluctuations contributed significantly to widening price dispersion between 1992 and 1995 (especially in 1995), as Member States with already relatively low prices experienced significant currency depreciations. As a result, price convergence seems to stop after 1993. However, EU15 figures for the following three years when exchange rates were more stable show continuing convergence, albeit slower than between 1985 and 1995. Moreover, the six Member States least affected by exchange rate fluctuations in the 1992-95 period display no widening of price dispersion (see table 15).

From the point of view of consumers' welfare, it is important to examine the level to which retail prices are converging. In a competitive environment, integration would lead to convergence toward lower price levels. In less competitive markets, convergence may be towards higher price levels. Although it is difficult to ascertain these trends, there is evidence that in markets where competition is intense, e.g. telecommunications, price convergence is towards lower prices. However, this has not always the case in all sectors (see Annex B. Further information can be found in the "EU Economy: 1999 Review" - SEC(1999)1950)).

Evidence on price convergence should be treated cautiously for different reasons. First, the quality of the data available needs to be improved. Secondly, integration is just one of many factors having an impact on price convergence. Market competition, the catching-up process and factors such as efficiency in the distribution sector also drive the evolution of price dispersion. Therefore, price convergence should be considered a key issue for the process of economic reform and not just as an indicator of economic integration.

Economic integration is not the only driver of price convergence and therefore, comprehensive economic reform is necessary to achieve further price convergence towards lower price levels in today's Internal Market. This will require combining national and Community measures to foster competition, regulatory reform and further integration. Other measures to enhance price transparency within markets to enable consumers and buyers in general to bring about price convergence will be important, especially in newly liberalised sectors. Efficiency improvements in the distribution sector will also play a key role.

III. Monitoring horizontal issues

The flexible markets needed by EMU require the elimination of remaining barriers to integration in product and capital markets. Distortions of competition and obstacles to the functioning of the Internal Market due to state aids, public procurement practices, regulations or tax measures should also be removed. Identifying those remaining obstacles and evaluating their relative impacts are major difficulties of economic reform.

Despite their limitations, summary indicators of economy wide regulation calculated by the OECD can be useful for that purpose, as they should reflect the friendliness of regulations to market mechanisms. Moreover, they permit to carry out cross-country comparisons. The indicators highlight substantial differences across Member States, suggesting the need for country specific solutions (see table 16).

In terms of overall product market regulation, EU countries seem on average, to perform worse than the USA, but better than other OECD countries such as Japan or Norway. State control over the economy (including variables such as government involvement in the operation of private businesses or the size of the public enterprise sector) is, according to the OECD, the main source of regulatory rigidities in the EU. But the EU is not an exception and other OECD economies such as Korea, Switzerland and, especially, Norway score high values for this indicator too. Trade and investment barriers are very low for EU countries. Perhaps the most remarkable results are those provided by the indicator of barriers to entrepreneurial activity, because differences across European countries are quite significant.

For policy purposes, it is necessary to examine at country and Community levels the behaviour of the variables behind those summary indicators. Here below, we report on five of those key issues for the functioning of markets. They have been selected attending to Commission priorities and the conclusions from the first Cardiff exercise and include structural issues with a direct impact on the business environment, as well as, policy-related issues having an impact on market functioning.

A. Improving the business environment

1. Entrepreneurship and regulatory simplification

Creating a new firm is still daunting in many Member States: complex economic and administrative regulation, inadequate financing possibilities, inappropriate bankruptcy and insolvency rules, limited information and advice, and insufficient training, amongst other factors are just some of the difficulties inhibiting the creation and development of small business. The impact is reflected in the overall rate of start-ups, significantly lower than in the US, as well as in the survival rates of new firms over time. This situation calls for urgent economic and regulatory reforms. Substantial differences in company registration procedures across Member States (see Fig. 4 & 5) suggest that much can be done to improve the situation, especially by exchanging examples of best practices such as:

- Establishing one-stop shops for start-ups. These have substantially simplified administrative procedures and the provision of advice and information. Most Member States have either already established or intend to establish such centres (e.g. Spain's "Single Business Window", Portugal's Enterprise Formality Centres or France's "Guichet Unique"). Some Member States (e.g. the UK) also try to monitor progress after the start-up phase.

- Reducing business set-up times. France is making efforts to speed up registration procedures for new companies, whilst Portugal plans to reduce the period needed to start a firm up from 6 months to 20 days;

- Reducing bureaucracy. Finland plans to introduce a single registration form. The Dutch programme "Towards lower administrative costs" has already cut the number of regulations affecting business and established just one collection point for all employee-related data.

Minimum capital requirements to create private limited companies can also be a major barrier to new enterprise creation, particularly for SMEs. In 10 Member States, there is a minimum capital requirement of EUR8.000, but in Germany it is fixed at EUR25.000. Conversely, firms require no minimum capital in the UK or Ireland. Unfortunately, the European tendency seems to be to increase minimum capital requirements (e.g. Greece, Finland). Meanwhile, even if the direct costs of registering a private limited company do not appear prohibitive, the overall costs (i.e. including fees paid to lawyers, accountants, agents or consultants) can be much higher than in the US. Estimates range from EUR3.400 in France, EUR2.200 in Italy to EUR420 in the UK, EUR300 in Spain and EUR250 in Ireland. The US average is EUR500.

The Commission is co-ordinating a series of actions with Member States aiming to achieve a better EU regulatory framework. One way to achieve this objective is to require that proposed legislation meet certain quality standards and, if appropriate, be subject to a business impact analysis. Businesses can review a limited number of legislative proposals by participating in the pilot Business Test Panel scheme.

A second Community initiative, SLIM, aims to simplify and improve the quality of existing legislation. A recent review of SLIM sees it continuing to play a major role in achieving better EU regulations provided some refinements are made to enhance transparency, improve linkages with national exercises, and adopt recommendations faster. The review also underlined the need to adopt a more focused approach to the question of legislative simplification, by enhancing the strategic role of SLIM in the Commission's general programme of better regulation/regulatory reform. As a result, future SLIM exercises should be undertaken in response to broad but well defined (better regulation) objectives established at the Commission level, supported by the Member States.

Finally, the BEST Action Plan drawn up in response to the recommendations of the Business Environment Simplification Task Force (BEST) brings together for the first time the diverse policy fields that impact on entrepreneurship and enterprise under one umbrella. It concentrates on the aspects that are most important to SMEs, e.g. new approach in education, training and the workplace, better access to finance and innovation, and better public administration.Member States should continue their efforts to reduce the general economic and regulatory costs of starting new businesses. Systematic reviews of existing regulatory frameworks should be carried out on a sectoral basis, paying special attention to those sectors subject to specific regulatory regimes. The Commission will review and report on the effectiveness of existing initiatives to simplify the regulatory environment. The SLIM evaluation will be presented early this year.

2. Remaining technical barriers to trade

Last year's report noted that certain technical barriers to trade remain inside the Community. As foreseen in the Treaty, for sound reasons such as public health or safety, Member States may sometimes require that products on their markets fulfil certain technical requirements. However, in certain individual cases different national requirements could obstruct cross-border trade in a way contrary to the Treaty. There are a number of Community instruments to eliminate these technical obstacles to trade and their effectiveness needs to be assessed. In fact, the EU has used three approaches to eliminate technical barriers to trade: application of the mutual recognition principle in non-harmonised areas; detailed technical harmonisation (the old approach); and legislative harmonisation limited to the adoption of the essential requirements with which products put on the market must conform (the New Approach).

The Commission produced last year a Communication [COM(1999)299] and an extensive first report on the application of the Mutual Recognition Principle in the fields of goods and services. These documents provide concrete initiatives to be undertaken both by the Member States and the Commission for a more effective application of mutual recognition [7]. Mutual recognition is to be the subject of close monitoring in future biannual reports. As a complement to that analysis, the impact of the New Approach to harmonisation of technical regulation of products is briefly considered below.

[7] On 28.10.1999, the Council welcomed these commitments and adopted a resolution on mutual recognition.

Trade covered by the New Approach inside the EU has been gradually growing in importance and now represents about 31% of total manufacturing trade. This suggests that the New Approach may have been successful in opening up intra-EU trade. There are twenty New Approach Directives, although two cover over 80% of New Approach trade - one covering electromagnetic compatibility and one covering the safety of machinery. The first Directive is becoming steadily more important in terms of the share of New Approach products which it covers (see Fig. 6 & 7).

Fig. 8 shows the comparative evolution of electromagnetic product exports within the EU against the evolution of total manufacturing exports inside the EU. The evolution is set at 100 in 1991 because the Directive came into force on 1st January 1992; if the Directive has helped to facilitate cross-border trade in products incorporating electromagnetic components, then this could only have arisen subsequently. The first year in which the Directive applied did not seem to have any significant impact on intra-EU trade for such products. However, after 1993, once standards were available and the Directive was effectively enforced, intra-EU exports of products covered by the Directive started growing, faster than intra-EU exports of manufacturing products as a whole.

This does suggest that the Directive is helping to improve cross-border trade in these products. Cyclical factors affecting the sector cannot explain this upturn in intra-EU trade as the investment cycle, a good proxy for internal demand for many of the products covered by the Directive, shows no special change around 1993.

Thus, evidence seems to confirm that the New Approach can be an effective instrument to break down EU cross-border technical trade barriers. However, the effective implementation of this instrument requires the simultaneous co-existence of three different factors: directives, standards and effective enforcement.

The Commission and Member States should consider extending application of the New Approach to new sectors. In cases where it is already applied, the development of standards and effective implementation of directives is essential.

B. Improving the functioning of markets

1. State aids

Overall levels of state aids in Member States are still rather high, risking distortions to competition in the Internal Market. The EU15 spent an annual average of more than EUR95 billion per year on aid between 1995-97 (approximately 1,2% of GDP). The trends are encouraging, but some reasons for concern remain. One encouraging trend is the decline of state aids as a percentage of GDP since 1990, particularly in Member States where state aids represented over 1,5% of GDP in 1990. Nonetheless, for some Member States, the downward trend seems to have halted between the period 1993-1995 and 1995-1997 (see Fig. 9).

However, as the Council concluded last year, the composition of state aids, not just their total volume, need to be examined to clarify their impact on competition in the Internal Market. State aids can usefully be grouped into three categories:

(1) Regional state aids, including aids granted under Article 87(3)a and c which accounted for 0,3% of GDP in 1995-1997 (see Fig. 12). In principle, these aids are granted mainly on equity grounds [8].

[8] In principle, regional state aids should be more important in countries with greater income disparities. However, as fig. 13 shows, there seems to be no direct correlation between the relative importance of regional state aids and regional income disparities.

(2) Horizontal state aids, principally, but not always, intended to foster efficiency in a non-sector specific way by compensating for market failures (i.e. aids to innovation, energy savings, SMEs, environment); these aids represented 0,1% of GDP in 1995-1997 (see Fig. 10).

(3) Sectoral state aids, aimed at traditional industrial sectors (coal, shipbuilding and steel) and designed to support investment, these probably have the most distortionary impact on competition. They represented ca. 0.16% of GDP. If aid to transport services is also included, sectoral aid represented 0,67% of GDP in the period 1995-1997 (see Fig. 11).

Apart from Ireland where there was an increase in aid to the steel and railways sectors, all countries have reduced or at least held constant their sectoral aids (as a percentage of GDP). Some countries (e.g. Denmark) seem to be substituting sectoral by horizontal aids. In Greece, regional aid seems to be replacing sectoral aid. Nevertheless, sectoral state aids still account for a large share of all aids, a share which has been resolutely constant between 1990 and 1997. In other words, although the total overall amount of state aids has been declining, the share of those aids which probably has the worst impact on competition is not changing (see Fig. 14).

Ad hoc state aids may be particularly anti-competitive, so their use is a cause for concern. They are sectoral aids not covered by any authorised scheme or framework and mainly intended to accompany restructuring, often in response to short-term necessities. Although down from 15,3% over 1993-95, overall ad hoc aid still represented some 13% of total Community aid in the 1995-97 period (when there is a substantial increase in ad hoc aid to industry in Spain (see tables 17 & 17a). Ad hoc aid to the financial services sector has been growing steadily since 1993 and increased again by some 11% in 1997. Most of that aid was granted in France, but Ireland, Italy and Portugal also pursued the same course. These results are heavily biased by large cases, but future trends should nevertheless be carefully monitored in view of the key changes currently underway in this sector.

The current overall downward trend in the volume of State Aids should be maintained. Member States should make additional efforts to avoid sector specific and especially ad hoc aids. The Commission will pay special attention to the evolution of such aids.

2. Public Procurement

Public procurement is a key area of the Internal Market, both in terms of its economic importance, and as an instrument of direct economic influence for Member States' administrations. The public sector's purchases of supplies, services and (construction) works are important to the EU economy (estimated at around 14% of GNP or over EUR1.000 billion in 1998, equivalent to more than half of Germany's GDP). It is therefore vital for the functioning of the EU economy that public procurement markets are open to EU-wide competition. This will give taxpayers value for money, improve the quality of the public services they receive and permit the efficient allocation of resources.

Public procurement markets can only be efficient if all the parties involved (purchasers, suppliers and public authorities) have good, relevant market information. The Commission is currently discussing with Member States a preliminary set of nine indicators to measure market trends and the impact of public procurement policy over time in fulfilment of its commitment in the Communication on public procurement [9].

[9] Commission Communication of 11.3.98 [COM(98)143 final] Public Procurement in the European Union.

These indicators provide annual estimates of total public procurement, the amount covered by the public procurement Directives and the amount actually advertised in the Official Journal as well as the number of entities publishing notices, the number of notices published and the amount of cross procurement within the EU. Additional indicators will measure the quality of published notices and compare prices paid by the public sector for the same or similar goods and services across the EU. The value of these indicators as a measure of market openness can be seen from the initial estimates for the period 1993-1998.

More than six times as many awarding authorities in the Member States published tenders in 1998 than in 1993. Whereas there were 30.863 invitations published by contracting bodies in the EU in 1992, by 1998 this figure had risen to 73.688, covering a much wider range of services, supplies and public works.

The total value of these tenders is difficult to estimate. Each tender awarded should result in publication of a contract award notice. As some very large individual contracts can often account for very significant amounts of public procurement, relatively small amounts of missing data could significantly bias results. Bearing this in mind, the maximum estimated total value of invitations to tender published in 1993 was EUR59 bn, compared with EUR137 bn in 1998 (see Fig. 15 & tables 18, 19, 20 & 21).

The number of notices published continues to increase, but publication of contract award notices, as well as the quantity and quality of information they contain, could be substantially improved. This will increase market transparency, including improved statistics to monitor the aggregate development of public procurement. It will also be necessary to ascertain whether increased transparency results in increased effective market competition in public procurement markets. Developing price indicators for public procurement could usefully contribute to that end.

As announced in the Communication on public procurement [10], the Commission will shortly present a set of measures to simplify, clarify and improve the functioning of the public procurement regime. It will also provide indicators to measure market trends and the impact of public procurement policy over time. The existing legal framework needs to be properly implemented and enforced [11].

[10] COM(98)143 final, of 11.03.98, Public Procurement in the European Union.

[11] As of October 1999, none of the eleven directives covering public procurement had been implemented correctly in all of the 15 Member States.

3. Taxation

The Commission has defined and proposed a co-ordinated approach to fight harmful tax competition and the distortion effects it may have on resource allocation and tax systems in different countries. On 1st December 1997 the Council agreed this approach, which includes measures concerning company taxation, the taxation of savings and the problem of withholding taxes on cross-border payments of interest and royalties between associated companies.

In the case of company taxation, the Commission proposed a "Code of conduct" to prevent erosion of the tax base resulting from harmful tax competition (transfer of tax bases to other countries). The prevention of the erosion of the tax base represents the medium term prerequisite to reduce the fiscal burden on our productive system.

In the case of taxation of savings, the Commission has proposed a Directive which aims to reduce economic distortions in the internal market due to the lack of effective taxation of some cross-border interest payments within the Community. The proposal is based on the so-called "co-existence model", which allows each Member State to choose between a withholding tax of 20% or providing information to other Member States on interest payments to non-residents. This proposal has no impact on current tax regimes applicable to residents.

The proposal of a common system of taxation for interest and royalty payments follows the neutrality principle for taxing capital, already used in the past for parent and subsidiary companies. In all those cases, withholding tax at source can mean unnecessary financial costs for companies and even double taxation in some cases.

In the context of the analysis of company taxation and the need to combat harmful tax competition, the Council asked the Commission to present a study on company taxation by mid 2000. This study will analyse differences in effective levels of corporate tax in Member States and identify the main tax provisions that may hamper cross-border economic activity in the single market. On this basis, an assessment should be undertaken of the effects on the location of economic activity and investment. The results of this study should permit, on the one hand, to better identify the influences of the tax basis on the effective levels of company taxation, and, on the other hand, to highlight the taxation measures which could be proposed in order to contribute to the integration of the internal market and hence to the competitiveness of European firms.

Administrative co-operation plays a key role in non-discriminatory and single market oriented tax systems. The main objective to protect national and Community financial interests when they are under growing threat from fraud is behind the Commission's new proposal on mutual assistance for the recovery of taxes, which also proposes that direct taxation be included.

Furthermore, the Commission has undertaken a total review of the function of VAT control and administrative co-operation, which will be presented in the Third Article 14 report (under regulation 218/1992). Such a function is essential for the competitiveness and neutrality - in terms of taxation- of the single market and to protect legitimate trade.

Priority must be given to reinforcing the co-ordination of fiscal policies and administrative co-operation in the tax sphere. This will promote tax systems favourable to employment while preserving tax revenues and ensure the internal market's optimal performance. In this context, business taxation has a central role to play. Member States are asked to attach the greatest importance to the search for co-operative solutions in this field.

IV. Fostering economic reform in the internal market for services

Services account for an increasing share of EU GDP and employ twice as many people as industry and agriculture combined. Over the last decade, the sector's record of growth and job creation in almost all Member States has exceeded overall economic performance, so that the share of services in the total economy has grown throughout the EU. Yet, employment in the services sector in Europe is below US levels. The performance of certain key sectors such as distribution or financial services is crucial to the European economy and this calls for special monitoring of these markets [12]. Continued efforts to integrate and open service markets and improving the regulatory framework for certain service activities are the main priorities for the sector.

[12] Unfortunately, analytical work is limited by the lack of statistical information. Steps should be taken to remedy this problem.

A. Opening and integrating services markets

1. Public utilities

Progress in opening these key services to competition continues to reap significant economic and social dividends. Entry into force by February 19th of Directive 96/92 made 1999 a key year for liberalisation of Member States' electricity markets. Only France and Luxembourg failed to meet the deadline [13]. Moreover, most Member States have opted for those alternatives proposed in the Directive leading to the most transparent and open market structures. Member States have set themselves ambitious market liberalisation targets in terms of market shares and segments open to competition. However, the ultimate objective for Europe's energy markets is not just liberalisation, but construction of a single European energy market, although this poses certain additional problems. The economic benefits of liberalisation are already being felt by business and households in some countries. For instance, in Germany, Portugal, France, Belgium and Spain, electricity prices (without taxes) for households and industry have fallen in anticipation of the opening of the sector to competition (see tables 22a & b and Annex C).

[13] Ireland has a 1 year derogation and Greece has a 2 year derogation.

In telecommunications, business and citizens benefit from a generally liberalised framework since 1 January 1998. The market power of incumbent operators is shrinking in the face of new entrants and growing competition; as a result, consumers are enjoying declining prices (business charges down by up to 25%, residential users' charges down by up to 40% between 1997 and 1999). Interconnection charges and the cost of leased lines are also dropping, although their absolute level is still too high by international standards. Despite progress made, the Fifth Report on Implementation of the Telecommunications Regulatory Package [COM(1999)537] highlights some concerns. Amongst the most important are disparities in the effectiveness of national regulatory authorities, the minimal harmonisation of Community licensing and interconnection regimes, poor competition in the local access market and possible barriers to entry arising from implementation of the regulatory framework for cost accounting and the financing of universal service obligations (see tables 23 a & b).

The results so far of liberalising air transport are positive: entry has taken place satisfactorily and there are now more, larger competitors in the market. The number of carriers has increased from 132 in 1993 to 164 in 1998, the market share of incumbent national carriers has been declining steadily and the number of routes with more than two operators has trebled since 1992 (see tables 24 a & b). Liberalisation has brought benefits to consumers in terms of better services at lower cost. However the trend for fares is not fully satisfactory; promotional fares have become more widespread, but the more competitive market structure has not always significantly reduced the prices of fully flexible fares. The Commission's Communication on the European airline industry [COM(1999)182 final] shows that there are still large differences in fares per Km across Europe and expresses concern about tariffs on certain routes. A special monitoring procedure to follow the evolution of tariffs has been set up by the Commission. The shortage and high cost of airport infrastructure and air space congestion remain the main bottlenecks to further competition and negatively affect the competitiveness of the airline industry as a whole. Small and medium sized airlines cannot improve their market positions faster due to these barriers. Despite regulation 95/93 and Council Directive 96/67/EEC, different regulatory practices across Member States in slot allocation and other areas such as ground handling also hinder the development of fully competitive markets. Finally, it is necessary to complete the single aviation market with a genuine external dimension in order to eliminate the distortion of the internal market caused by "open skies agreements".

Opening up the postal sector has been difficult. Directive 97/67/CE was adopted by the Council laying out tariff principles, defining the framework for the provision of a universal service and establishing transparency of accounts. By the end of October 1999, eight countries, Belgium, Denmark, Greece, Finland, France, Italy, Sweden and the United Kingdom have fully implemented the EU directive. There is partial transposition of the directive in Germany, Austria, the Netherlands, Portugal and Spain. The Commission is currently considering how to respond to this situation (see table 25).

There are certain features common to most of these processes.

- First, eliminating traditional structures for service provision often requires creating new markets not needed in an environment of vertically integrated monopolists. Often, this is a complex matter due to technical reasons (e.g. electricity generation), the need to use common networks to provide services (e.g. electricity and telecommunication networks, air traffic control) or the need to allocate scarce resources (e.g. airports). It requires the development of new market designs to link suppliers and consumers and organise market activities in the most efficient way.

- A second common feature is the existence of certain bottlenecks in the processes (examples include network access agreements in telecommunications, air traffic control or slot allocations at airports). Often, the existence of dominant incumbents controlling strategic assets lies at the heart of these problems.

- Thirdly, ensuring universal service obligation is essential to successfully reaching a socially acceptable market outcome. Sometimes, designing funding arrangements capable of preserving competition and the need to safeguard all stakeholders' interests may be difficult, but socially acceptable solutions should be found.

Member States should adopt and fully implement the Community Regulatory Framework in the four sectors, but particularly in electricity. Strict enforcement of competition rules and if necessary, development of the regulatory framework will ensure effective competition in markets recently opened up to competition. This is essential whenever bottlenecks or the provision of universal service obligations place incumbents in a privileged competitive situation. Specific solutions will be devised to tackle special problems such as the monitoring of air transport tariffs or network access pricing in telecommunications.

2. Financial services

European financial services are changing rapidly and deeply. In banking, a process of convergence and structural consolidation is underway which is still far from complete. Increased competition triggered by technological change, developments in the field of regulation, the process of disintermediation and, more recently, the introduction of the single currency, are affecting the structure of balance sheets and the performance of the entire European banking system. Increased competition for savings in lending and deposits markets have reduced profitability in traditional retail banking activities. However, income from non-interest paying activities has increased considerably. Increased competition from Euro-securities markets may reduce the size of corporate banking activities (see Annex D).

European banking profitability compares poorly with the USA, where regulatory reforms in the second half of the 1990s boosted banking competition and the restructuring of the sector (see table 27). New opportunities to exploit economies of scale and economies of scope have driven European banks to consolidate, not necessarily at the expense of competition. The number of banking sector mergers quadrupled between the mid and late 1990s. During the first half of 1999, about 25% by value of all completed mergers and acquisitions involved financial institutions. The focus has mostly been on domestic consolidation and restructuring. Cross-border consolidation has been predominantly regional, particularly within Scandinavian, Iberian and Benelux countries. Essentially, banks have been seeking to build sizeable national groups able to compete in the European market (see table 28).

Technological change and the relative simplicity of certain products facilitates integration of pan-European retail banking markets, but high fees for cross-border transactions hinder the process. High cross-border transaction costs are mainly due to the underdevelopment of retail payment systems across Europe. Changes at the inter-bank and intra-bank levels are necessary to be able to achieve fully integrated retail payment systems for citizens and business. The concerted strategy involving the ECSB, EU institutions, the Member States and the private sector called for by the Commission in its 1999 Financial Services Action Plan is more urgent than ever to solve this long-standing problem.

The market for insurance services is characterised by slow but progressive integration and a strong move towards concentration. Integration is relatively slow in the life insurance industry because of differing national taxation regimes. Different tax systems also hinder the creation of a single market for pension funds. That is why the Action Plan for Financial Services calls for a better co-ordination of tax arrangements governing supplementary pension provisions. In addition, the Action Plan advocates eliminating unnecessary national restrictions to pension funds' investment activities so as to accelerate European financial market integration.

Increased demand for financial assets other than government bonds is stimulating the markets for corporate assets, and there is scope for further growth in Europe's stock markets. The weight of European stock markets in total world stock market capitalisation was about 25% in 1998, well below the weight of North American exchanges.

Full and rapid implementation of the Financial Services Action Plan is imperative, especially the following points:

- the development of retail payments systems is essential to facilitate the integration of pan-European retail banking markets;

- bank governance and control should be strengthened by establishing common standards of financial reporting throughout the Union;

- the review of national codes or corporate governance foreseen in the Action Plan should also provide new directions on the possible ways forward;

- it is necessary to review existing arrangements in order to provide sound supervisory structures adapted to the new market realities of the different segments of the financial services sector;

- the Commission will put forward a proposal for a Directive on pension funds by mid-2000;

- finally, convergent rules, as proposed in the Action Plan, could facilitate the integration of European stock exchange markets.

B. Improving the regulatory framework for services activities

1. E-commerce

E-commerce has the potential to create EU-wide markets in previously non-traded sectors and for firms previously tied to local markets - if the conditions are right. The provision of high value-added content over the network, with its advantage in terms of speed and quality compared to traditional means of dissemination, can be expected to be a major contributor to the growth of traded on-line services.

The growth rate of e-commerce is highly dependent on competition conditions in the information technology and telecommunication sectors. Although telecom liberalisation has reduced tariffs substantially, line rental charges remain relatively high in some European countries. As regards delivery systems, the level of penetration of ICT in enterprises varies between countries and is particularly low in SMEs. This, combined with low levels of ICT literacy, may ultimately be the limiting factor on the growth of e-commerce in Europe.

The 1997 Communication on e-commerce [COM(97)157 final] set out the objective of a clear, predictable, coherent regulatory framework to allow e-commerce to flourish, whilst safeguarding legitimate public interest objectives, especially those of consumers. The development of consumer confidence in the new medium will be crucial for the growth of e-commerce. Moreover, an adequate and effective intellectual property rights framework is needed to protect and foster creativity.

In November 1998, the Commission adopted a proposed Directive [COM(98)586 final] on certain legal aspects of electronic commerce in the Internal Market, laying out a regulatory framework for e-commerce on which the Council reached agreement on a common position in December 1999. It ensures the free movement of the Information Society services by clarifying the application of key Internal Market principles (the country of origin principle and the principle of mutual recognition). The principles established in the Directive apply to financial services and capital markets, subject to the very limited exemptions for the protection of consumers including investors [14].

[14] The European Parliament has recognised the urgent need for this Directive and gave it strong support in its first reading. A modified proposal was adopted in August 1999 (COM(1999)427 final). The Internal Market Council of 7th December 1999 has reached a political agreement on a common position on this directive.

A coherent legal framework and effective cross-border legal redress need to be complemented with extra-judicial cross-border redress systems based on transparent and recognised codes of conduct (which are relatively more accessible to the consumer). Consumers need to be able to sort out problems with on-line suppliers cheaply and easily. A recognised and trusted web-trader audit system, entailing the granting of "quality seals", backed up by a system of low-cost, effective out-of-court redress would ensure consumer confidence. Such a scheme is not for the Commission to run or even set up, but it could support consumer associations developing such schemes.

Much success has already been achieved in putting in place a comprehensive framework for e-commerce in the Internal Market - directives covering transparency, legal protection of conditional access services and electronic signatures have already been adopted.

Creating a comprehensive framework for the free movement of Information Society Services within the EU requires the effective application of directives that have already been adopted. In addition, the framework urgently needs completing, through the final adoption of the directive on certain legal aspects of electronic commerce and that on electronic money. Moreover, the Council should reach a common position on the IPR and distance selling (including financial services data protection) proposals for directives. An integrated policy combining government and industry regulation and rules for consumer protection are needed to enhance consumer trust and confidence. Market conditions in other sectors having an impact on e-commerce, such as telecommunications, must be monitored. A new strategy to solve the problem of the application of indirect taxation in the field of electronic commerce is required.

2. Distribution

Improving the efficiency of the distribution system is essential for the performance of product markets. A more efficient and competitive distribution sector could lead to lower prices and a wider variety of goods and services for consumers. Currently, the sector is characterised by significant differences in productivity across countries. Enhanced competition and regulatory reforms could improve its performance. Land-use restrictions for large scale outlets and opening hours restrictions are two important sorts of regulations that limit competition in the distribution sector. Recently, progress in achieving greater liberalisation of shop opening hours has been balanced by a more restrictive stance on the expansion of larger retail outlets.

Planning rules (including planning limitations in inner city areas) can have a number of impacts on the retail sector's performance: they reduce the potential gains to consumer welfare of larger outlets and they reduce innovation effects, especially the development of modern retail formats. Countries with tight regulations generally have fewer new store openings (e.g. Italy). There seems to be an increasing tendency to tighten retail planning rules in traditionally more liberal countries. As a result, fewer large stores are opening in countries such as Germany and the UK (see table 30).

Restricting opening hours limits consumer choice, but protects small owner-operated shops which find expanding opening times more difficult (see table 29). Nevertheless, the overall tendency is for more relaxed rules on opening times, as short opening hours are increasingly recognised to reduce consumer welfare and conflict with a more general demand for flexible working hours arrangements. Restrictions on opening hours appear to have softened in Northern Europe especially, particularly in Denmark, Austria, the Netherlands and Germany. Increasingly, regional or local authorities are intervening in deliberations to change regulations governing shop opening hours.

National authorities should eliminate restrictions impairing reform in the distribution sectors. The adoption and implementation of the proposed new Regulation on the application of Article 81(3) to vertical agreements between producers and distributors should have a positive impact on distribution.

V. Conclusions

1. The EU should take advantage of the favourable current economic context to enhance competitiveness by introducing economic reforms compatible with economic and social cohesion and other social objectives

Europe could enter a phase of long-term economic expansion if, by building on the advantages provided by EMU, economic reforms are undertaken to create a more innovative, dynamic and better performing economic environment. Our experience in constructing the Internal Market demonstrates that improvements in efficiency, economic integration and market competition are compatible with the kind of catching-up process of economic convergence social cohesion requires; public utility markets can be effectively opened-up to competition whilst providing affordable services of general interest; the interests of SMEs, consumers and environmental protection can be preserved and often enhanced by the process of reform. In the past, Europe has succeeded in associating growth and economic reforms with an expansion of production, with an increase in prosperity and an improvement in living standards when the capacity and willingness to change really existed. This is essential to gain widespread political support for economic reform.

The challenge ahead for Europe will consist in reconciling the needed economic reforms to improve competitiveness with the maintenance of a high level of employment and the strengthening of social cohesion. Policies will have to be implemented to make these three tasks compatible. The Union and the Member States have an opportunity in the special meeting of the European Council in Lisbon on 23/24 March 2000 to further develop these issues.

2. The EU and Member States should provide the best possible competitive and regulatory environment and bring together stakeholders to discuss and find efficient solutions for furthering integration

Efficient markets require a predictable and transparent legal environment. Yet, markets rely also on unwritten arrangements and practices to minimise transaction costs between suppliers and users. They constitute the real "economic infrastructure" of markets and are essential for markets to be efficient economic instruments. In some cases, creating a single market implies reviewing existing market arrangements to ensure that they are adapted to their new geographic dimensions. This is clearly the case with new settlement and payment systems for financial services or the creation of a single market for energy in Europe. In other cases, notably electronic commerce, entirely new arrangements are needed to create a market ex-novo. In all these cases, regulation is needed, but additional changes are essential to adapt the economic infrastructure of markets to the new Internal Market-created conditions. Those changes can only be introduced by industry or local authorities and private sector initiatives must play the leading role in developing new and more efficient EU-wide market designs. Economic reform must start from the grassroots in society. Nonetheless, public authorities have an important role to play in three areas.

i. First, as previous experience in areas such as telecommunications or technical standardisation proves, the Community has a comparative advantage in acting as a catalyst for change by bringing together stakeholders to discuss and find efficient solutions for furthering integration. The current Florence initiative to develop technical solutions for electricity market integration with minimum public sector interference is an example of best practice in this context.

ii. Second, both national and Community authorities must review current regulatory arrangements wherever evidence exists of an excessive regulatory burden or transaction costs hindering market efficiency. Public authorities must strive to provide a simple yet high quality regulatory environment for consumers, producers and society in general.

iii. Public authorities must ensure high levels of competition so that market forces can lead to efficient market outcomes, translating structural changes into consumer welfare and enhanced competitiveness.

3. The EU and Member States should use Internal Market policies and national country-specific microeconomic policies to foster economic reform and competitiveness

Two main sets of instruments will be needed to carry out the necessary structural reforms in full respect of the subsidiarity principle:

- Member States should find suitable microeconomic-policy solutions to their specific structural and economic problems in product, capital and other markets. Just as the Union has been able to combine cohesion with integration, so should Member States strive to undertake reforms compatible with their own social values or economic characteristics.

- Economic reform requires reinforcement of the Internal Market as the cornerstone for the EU's microeconomic policies. Inclusion of microeconomic policy considerations in the Broad Economic Policy Guidelines should be complemented by an additional impulse to economic integration, as EMU demands.

4. A global environment of market opening will facilitate regulatory reform

The potential benefits of EU economic and regulatory reform will be considerably greater if they take place in a global environment of market opening and regulatory reform, especially in certain service sectors. In certain areas like air transport, e-commerce or financial services, the globalisation of competition calls for regulatory convergence at global scale. Europe could use the leverage it has obtained from opening up significantly to world trade and investment to foster opening in certain currently heavily regulated world markets - for example, in financial services. Moreover, countries seeking accession to the Union will have to keep pace with the process of EU economic reform and adapt their market structures accordingly in order to enable their economies to take full advantage of enlargement.

Economic Reform: Report on the functioning of Community product and capital markets

Presented by the Commission in response to the conclusions of the Cardiff European Council

Statistical Annexes

EVALUATING OVERALL MARKET PERFORMANCE Market performance: integration continues to be a leading factor for improving market performance Economic integration: capital markets still lag product markets in terms of integration Product markets: trade and foreign investments

Figure 1 - Evolution of EU GDP and manufacturing exports

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Source: COMEXT database - Eurostat

Table 1 - Relative importance of trade in manufacturing and services

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Source: COMEXT and CRONOS databases - Eurostat

Table 2 - Evolution of intra-EU services trade relative as a percentage of GDP (1992-1997) - Comparison with manufacturing 1997

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Source: COMEXT and CRONOS databases - Eurostat

Table 3 - Foreign direct investment flows in the EU (millions Euros)

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Source: Eurostat

Table 4 - Merger and acquisitions' activity

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* first nine months

Source: M&A database

Capital markets

Table 5 - Share of domestic portfolios invested in foreign equities

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1 1996 and 1990-96 for Spain

Source: OECD Financial Accounts Statistics

Table 6.a - "Home bias": Correlation of real private consumption growth rates, 1961-1998

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Source: Ameco

Table 6.b - "Home bias": Correlation of real GDP growth rates, 1961-98

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Source: Ameco

Table 7 - Total share issues (Initial public and secondary offerings) (million EUR)

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1 excluding Spain

Source: International Federation of European Stock Exchanges

Table 8 - Stock indices of Pan-European and national futures markets

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1) DJ Euro Stoxx 50 and DJ Stoxx 50

2) including DAX odd lot

Source: Deutsche Börse

Table 9 - International bond issues

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1 Three quarters of 1999

Source: Bank for International Settlements, Quarterly Review, November 1999

There is a need to foster innovation and creativity in order to improve economic performance

Table 10 - EU Technological Performance indicators

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Source : STI, OCED and Eurostat, Community Innovation survey, Statistics in Focus.

Market performance: the impact of integration on social cohesion and consumers

Economic and social cohesion

Figure 2 - Production and trade specialisation: 1988 to 1998 - (share of the largest five sectors)

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Source: WIFO calculations using SBS and COMEXT

Figure 3 - Geographic concentration of production and exports

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Source: WIFO calculations using SBS and COMEXT

The impact of integration on consumer retail prices

Table 11 - Trends of after-tax price dispersion 1985-1998 (standard deviation)

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Source: 1985-1997 Eurostat; 1998 DG Internal Market estimates

Table 12 - Price dispersion in the EU15: Broad categories, 1990-1998 (co-efficient of variation)

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Source: 1990-1997 Eurostat; 1998 DG Internal Market estimates

Table 13 - Price dispersion in the EU15: detailed sectoral split 1990-1998 (co-efficient of variation)

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Source: 1990-1997 Eurostat; 1998 DG Internal Market estimates

Table 14 - Estimated EU15 pre-tax price dispersion, 1990-97 (coefficient of variation)

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Source: Eurostat and DG ECFIN

Table 15 - Price dispersion in 6 countries (Austria, Belgium, Denmark, France, Germany, Netherlands) with relatively stable bilateral exchange rates (coefficient of variation)

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Source: 1990-1997 Eurostat; 1998 DG Internal Market estimates

Monitoring horizontal issues

Table 16 - OECD Summary Indicators of economy-wide regulation in 1998

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Source: OECD - "Cross-Country Regulation Patterns and their Implications for Sectoral Performance: A Progress Report" - ECO/CPE/WP1(99)16) - 1 October 1999.

Improving the business environment Entrepreneurship and regulatory simplification

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Figure 4 - Time needed to register a company

Source: Logotech study ("International comparison of the formal requirements and administrative procedures required for the formation of SMEs - 1997) and Commission

Figure 5 - Total number of procedures necessary to register a company

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Source: Logotech study ("International comparison of the formal requirements and administrative procedures required for the formation of SMEs - 1997) and Commission

Remaining technical barriers to trade

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Figure 6 - Evolution of intra-EU12 manufacturing and NA trade

Source: COMEXT

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Figure 7 - Share of intra-EU12 manufacturing trade covered by the New Approach, Detailed Harmonisation and the Principle of Mutual Recognition

Source: COMEXT

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Figure 8 - Products affected by Directive on Electromagnetic compatibility, evolution of trade (1991=100)

Source: COMEXT

Improving the functioning of markets State aids

Figure 9 - Total State Aids as a percentage of GDP

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Source: European Commission - Directorate General Competition

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Figure 10 - Horizontal State Aids as a percentage of GDP

Source: European Commission - Directorate General Competition

Figure 11 - Sectoral State Aids as a percentage of GDP

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Source: European Commission - Directorate General Competition

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Figure 12 - State Aids granted for regional purposes

Source: European Commission - Directorate General Competition

Figure 13 - Regional income disparities in Member States and the use of regional

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State Aids - 1996

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Source: Eurostat and Directorate General for Competition

Figure 14 - Total EU state aids divided by objective (percentage of total)

Source: European Commission - Directorate General Competition

Table 17 - Ad-hoc State aid in manufacturing, financial services and air transport

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* aid in Germany given via the Treuhandanstalt (THA) or the Bundesanstalt für vereinigungsbedingte Sonderaufgaben (BvS)

Source: European Commission - Directorate General Competition

Table 17a - State aid on an ad-hoc basis and Treuhand aid awarded in the manufacturing, financial services and air transport sectors in the Member States - annual averages 1993-1995 and 1995-1997

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Source: European Commission - Directorate General Competition

Improving the functioning of markets Public Procurement

Figure 15 - EU trends

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Source: European Commission DG Markt

Table 18 - Total Public Procurement (in EUR billion)

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Table 19 - Value of calls for tenders published in the Official Journal (in EUR billion)

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Table 20 - Number of calls for competition published

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Source: European Commission Directorate General for the Internal Market

Table 21 - Number of entities publishing

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Source: European Commission Directorate General for the Internal Market

Fostering economic reform in the Internal Market for Services - Opening and integrating services markets - Public utilities

Table 22.a - Telecommunications Transposition of Harmonisation Directives and Universal Service Obligation

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Source: Fifth Report on the Implementation of the Telecommunications Regulatory Package.

PT: Partial Transposition; ST: Substantial Transposition

1 Recent legislation under examination; 2 Deferment requested; 3 Old Voice Telephony 95/62/EC is substantially transposed

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Table 22.b - Telecommunications: Market structure and Performance

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Table 22.b - Telecommunications: Market structure and Performance (Cont.)

Table 23.a - Directive 96/92/EC: Summary of the regulatory stance of Member States and future market structure

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Source: European Commission DG TREN TPA: Third Party Access; TSO: Transmission System Operators

Table 23.b - Electricity markets: prices by consumer type 1996-1999

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Source: Eurostat

Table 23.b: Electricity markets: prices by consumer type 1996-1999 (Cont.)

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Source: Eurostat

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Table 24.a - Passenger Air Transport: Market Structure

Source: European Commission DG TREN

ASK = Available seats / km

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Table 24.b - Market Performance - Average Fare from main Capital Airports (EUR per km) - July 1997

Source: European Commission DG TREN

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Table 25 - Postal services

Source: European Commission DG MARKT

Financial services

Table 26 - Five-firm concentration in major countries (1998)

D // 39.10

E // 58.32

F // 47.63

I // 58.17

UK // 54.67

EU // 13.05

Japan // 36.37

US // 30.83

Source: City University and London Economics study with data from IBCA database.

Table 27 - EU bank profitability (% of total assets) 1991-1998

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Source: City University and London Economics study with data from IBCA database

Table 28 -- Distribution of banking mergers across the EU by type

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Source: City University and London Economics study with data from Thompson Securities Data.

Improving the regulatory framework for services activities Distribution

Table 29 - Opening-time restrictions

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Source: Instituto de Empresa - "Los Horarios comerciales en la Union Europea" - 1999

Table 30 - Construction of hypermarkets and superstores

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Source: Pellegrini - "Regulation and the Retail Trade" - Mimeo

Table 31 - Structure and productivity of retail distribution within the EU

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(1): Excluding repair of personal and household goods

Source: Eurostat