COMMISSION OF THE EUROPEAN COMMUNITIES
Brussels, 24.4.2003
COM(2003) 170 final/2
Corrigendum
Point 2.1., paragraphe 2)Concerne uniquement les versions FR et EN.
COMMISSION RECOMMENDATION
on the Broad Guidelines of the Economic Policies
of the Member States and the Community
(for the 2003-2005 period)
2TABLE OF CONTENTS
I. General economic policy guidelines ................................ 3
1. Meeting the Lisbon strategic goal - the economic policy contribution.. 3
2. Strengthening the EU's economy.............................................................. 4
2.1. Growth- and stability-oriented macroeconomic policies ........... 4
2.2. Economic reforms to raise Europe's growth potential ............... 62.3. Strengthening su stainabi lity..................................................... 11
II.
Country-specific economic policy guidelines ..................... 15
0. Euro Area.................................................................................................. 15
1. Belgium ..................................................................................................... 18
2. Denmark ................................................................................................... 21
3. Germany ................................................................................................... 24
4. Greece........................................................................................................ 29
5. Spain.......................................................................................................... 336. F
RANCE ...................................................................................................... 37
7. I RELAND .................................................................................................... 42
8. I TALY ......................................................................................................... 44
9. L UXEMBOURG ........................................................................................... 49
10. T HE NETHERLANDS .................................................................................. 51
11. A USTRIA .................................................................................................... 54
12. P ORTUGAL ................................................................................................. 57
13. F INLAND .................................................................................................... 61
14. S WEDEN ..................................................................................................... 64
15. U NITED KINGDOM .................................................................................... 67
3I. G ENERAL ECONOMIC POLICY GUIDELINES
1. M EETING THE LISBON STRATEGIC GOAL - THE ECONOMIC POLICY
CONTRIBUTION
The EU is at a crucial juncture in its history.  Following the successful
introduction of euro notes and coins, the EU is now on the eve of an historicenlargement which will increase its size to 25 Member States and create an
economic entity with a population of more than 450 million. At the same time, the
world is facing extraordinary geopolitical tensions, casting their shadow on
economic prospects, certainly in the short-term but possibly also in the medium-
term.
At Lisbon, the EU set itself a new strategic goal for the current decade: ‘to
become the most competitive and dyna mic knowledge-based economy in the
world capable of sustainable economic growth with more and better jobs and
greater social cohesion’ . Successful implementation of the Lisbon strategy
depends upon simultaneous and coherent policy action being taken in a wide range
of areas in the economic, social and environmental domains.
These Broad Economic Policy Guidelines concentrate on the contribution that
economic policies can make over the next three years . In line with the
arrangements on streamlining and the conclusions of the Brussels Spring European
Council, they focus on the key economic policy issues and priorities for the latter
period.  They are  at the heart of the  policy co-ordination endeavour that underpins
economic governance in the EU and its Member States. The guidelines testify tothe EU's recognition of the imperative fo r higher and sustainable growth rates and
its resolve to take the necessary action to achieve this result. Sound
macroeconomic conditions and policies are a prerequisite for a sustainable increase
in economic prosperity. A stronger entrepreneurial spirit and improved investment
in knowledge and innovation is key to opening up new opportunities for growth.Better functioning and more competitive labour, product and capital markets are
indispensable to achieve a more flexible economy and lift potential growth. Due
regard must however be paid to economic, social, and environmental sustainability
concerns to ensure that efforts will produce the expected results in the longer term.
In addition to these Broad Economic Policy Guidelines (BEPGs), Member States
should fully implement the Employment Guidelines and the associated
Recommendations, which are required by the Treaty (Article 128 (2)) to be
consistent with the BEPGs. The Employment  Guidelines aim at giving direction to
and ensuring co-ordination of Member States' employment policies, while dealing
with employment issues in a more comprehensive way than the BEPGs. MemberStates should also address the common objectives agreed in the framework of the
open method of coordination on pensions and social inclusion.
The general economic policy guidelines are applicable to all Member States and to
the Community. Within the overall strategy, key economic policy challenges may
4differ across Member States due to differences in economic performance,
prospects, structures and institutions. Taking due account of them, part II presents
country-specific economic policy recommendations. Part II also includes a section
on the euro area, addressing its specific challenges.
While the general policies advocated in these guidelines are largely relevant for the
new Member States, the 2004 update of these guidelines will provide the occasion
to take a closer look at their situation and particular policy requirements.
2. S TRENGTHENING THE EU' S ECONOMY
Economic growth has turned out to be si gnificantly weaker than anticipated. GDP
growth remained sluggish in 2002 and short-term indicators suggest that it will
continue do so. Beyond the recent geopolitical tensions and fading external
demand, weak growth stems from already falling confidence among business and
consumers and the insufficient resilience to shocks. Any short-term growth outlookis conditional on the economic consequences of the military conflict in Iraq that
started late March. Assuming abating geo-political tensions, lower oil prices and
increasing confidence, a recovery should be possible in the second half of 2003. It
is likely to be weak because domestic demand is forecast to be under the influence
of rising unemployment and still weak balance sheets of both financial and non-financial corporations.
Employment growth has been resilient until late 2002, but given that the labour
market situation reflects economic developments with a lag, unemployment is
likely to continue rising in 2003. Wage grow th for instance has been slow to adapt
to low productivity growth.
Headline inflation has recently hovered just  above two percent. Core inflation has
been decelerating since the second half of 2002, albeit at a slow rate. In this
respect, it appears that rigidities still stand in the way of fast adjustments. Looking
forward, slowing labour costs should lead to a deceleration of inflation to rates
below two percent. In the near-term, there are major uncertainties linked todevelopments in oil prices against the background of geopolitical tensions.
Against this background, it is important that economic policies inspire confidence
and thereby help to create conditions for stronger domestic demand and job
creation on the short term as well as for an expansion of growth potential in the
medium-term.
2.1. Growth- and stability-orie nted macroeconomic policies
Macroeconomic policies play a key role in sustaining growth and employment
and in preserving price stability . They should aim at supporting a well-balanced
expansion and the full realisation of current growth potential. They should
furthermore aim at establishing the framework conditions that promote adequate
levels of saving and investment, as well as a stronger orientation of the latter
towards knowledge and innovation, to position the economy on a sustained, higher,
non-inflationary, growth and employment path. In planning for the future, firms
5and individuals must have confidence that price stability will be maintained, and
that exchange rates and long-term interest rates will be reasonably stable. The
maintenance of sound macroeconomic conditions depends on the policies pursued
by central banks and governments, and the wage developments resulting from
settlements concluded by social partners.
Monetary authorities should pursue price stability  and, subject to this being
achieved, support the general economic policies.
Member States should contribute through their budgetary policies to
stabilising output around a higher and sustainable growth trend , by allowing
the full and symmetric play of the automatic stabilisers over the cycle and, in line
with the Commission communication of 27  November 2002, reinforcing the co-
ordination of their budgetary policies. Two conditions apply. First, excessivedeficits should be avoided. Second, budget positions close to balance or in surplus
in cyclically-adjusted terms should be achieved. However, when assessing
compliance with the close to balance or in surplus requirement, particular attention
shall be paid to country-specific circumstances, in particular to: (i) ensure that a
sufficient safety margin is preserved at all times in order to allow for the full playof automatic stabilisers without breaching the 3% of GDP reference value,
(ii) ensure the long-term sustainability of public finances, and (iii) the coherence
between the evolution and quality of the public finances in the Stability and
Convergence programmes and the close to balance or in surplus requirement.
In particular, Member States should over the coming three years:
1) Maintain budgetary positions of close to balance or in surplus
throughout the economic cycle, and as long as this has not yet
been achieved, take all the necessary measures to ensure an
annual improvement in the cyclically-adjusted budget position of
at least 0.5% of GDP.
2) Subject to this, and particularly when growth resumes, avoid pro-
cyclical policies that counteract the full and symmetric play of the
automatic stabilisers over the cycle. Reinforce as from this year
the coordination of their budgetary policies.
Wage developments should contribute to stable macroeconomic conditions and to
an employment-friendly policy mix.
Member States should promote the right framework conditions for wage
negotiations by social partners. It is important to:
3) Ensure that nominal wage increases are consistent with price
stability and productivity gains. In particular, wage developments
should remain moderate in the context of a possible cyclical
recovery in productivity or oil-price-hike-induced increases in
inflation to allow for a restoration of profit margins so as to
underpin job-creating investment growth.
62.2. Economic reforms to raise Europe's growth potential
Structural reforms are essential to increase the EU’s growth potential. To yield
maximum synergies, they are best implemented in a comprehensive and co-
ordinated way. By introducing more flexibility in the economy, they contribute to
macroeconomic stability. Furthermore, structural reforms in different areas, if
implemented together, can produce substantial benefits and reduce adjustment
costs. For example, additional labour supply triggered by labour market reforms
will be taken up more rapidly in the presence of new business opportunities openedup by product and capital market reforms. Conversely, new business opportunities
created by product and capital market reforms can only be taken advantage of if
appropriately educated and skilled workers can be hired under the right conditions.
i) Towards full employme nt: more and better jobs
Human resources remain greatly under-utilised in the EU. This is evidenced by the
comparatively low employment rates in the EU as well as low labour productivitygrowth (the latter is addressed in section 2.2.ii). The main reason why GDP per
capita is well below the US level is that fewer people are in employment, and those
that are tend to work fewer hours. While this might partly reflect a greater
preference for leisure, it is often simply a question of whether it pays to work .
Many people have been effectively encouraged to leave the labour market or toremain inactive, for example through relatively generous or loosely enforced
benefit systems, or through incentives to take early retirement. When they do seek
work, they are faced with the prospect of high labour taxes as well as withdrawal of
benefits. Some, particularly the low-skilled or those living in poorer regions, find
themselves priced out of jobs , which points to the need both to improve the
quality of education and training (as discussed in section ii) and to allow wages to
better reflect productivity. Inflexible labour market regulations, protecting
established employees but making it riskier for firms to take on new staff, leave
many on the margins of the labour market. They are left with a choice between
intermittent temporary jobs or long-term unemployment and inactivity. Bycontrast, less regulation and more flexible work organisation – for example, greater
opportunities for part-time work and flexible working hours – properly balanced by
due security in employment relationships, would make it easier both for people to
join the labour force and for firms to take them on. Obstacles and disincentives to
labour mobility – both geographical and occupational – also impede the proper
functioning of the labour market, leaving ample scope for an improved match
between job openings and the human resources available to fill them. In thiscontext, Member States should examine how the effective integration of migrant
workers could ease pressures in the labour market.
Creating the conditions for full empl oyment, better quality and productivity
at work and greater cohesion and inclusive labour markets are fundamental
to the Lisbon strategy and have become the overarching objectives of the
European Employment Strategy . Making better use of human resources is a top
priority in the Lisbon strategy. It is reflected in the decision of EU Heads of State
and Government to establish targets for overall, female and older workers’
7employment rates and to call for an increase of five years in the effective average
age at which people stop working in the EU. Their achievement would mark an
important step towards the objective of full employment. Higher employment rates
would directly contribute to a higher grow th path. They are an element of the well
established three-pronged strategy for tackling the budgetary implications of
ageing populations. In this context, they would also help with the financing of
social security systems, thus allowing for further reductions in non-wage labourcosts in the future.
 To reach these targets, the root causes of high unemployment
and low labour force participation in the EU must be tackled. Action to improve
incentives  in order to make work pay,  to facilitate job creation and to improve
the functioning of the labour mark et is important in this respect.
In pursuing reforms to increase employment, Member States should
vigorously implement all the Employment Guidelines and the
recommendations addressed to them, which deal with employment
issues in a more comprehensive way. In order to contribute to raise
Europe’s growth potential and to tackle the budgetary implications of
ageing populations, Member States should over the coming three years:
4) Improve the combined incentive effects of taxes and benefits,
reduce high marginal effective tax rates in order to eliminate
unemployment and poverty traps, cut the tax burden on low-paid
labour, improve the administration of eligibility criteria for
benefits whilst preserving an adequate level of social protection,
and ensure the efficiency of job search assistance for benefit
recipients (see also Employment Guideline 8).
5) Ensure that wage bargaining systems allow wages to reflect
productivity, taking into account productivity differences across
skills and local labour market conditions.
6) Promote more adaptable work organisation and review labour
market regulations, notably those relating to employment
contracts taking account of the need for both flexibility and
security (see also Employment Guideline 3).
7) Facilitate labour mobility, both geographical and occupational,
especially by promoting the recognition of qualifications and the
transfer of social security and pension rights, by eliminating
obstacles to mobility related to the housing market, and by
promoting lifelong learning (see also Employment Guidelines 4
and 10).
8) Ensure efficient active labour market policies that are targeted
towards individual needs with special attention to people facing
the greatest difficulties in the labour market, according to rigorous
impact evaluations (see also Employment Guideline 1 and 7).
8ii) Towards a competitive and dynamic  knowledge-based economy with
better jobs: Increasing produc tivity and business dynamism
Increasing the EU’s growth potential depends not only on job creation but also on
giving an additional stimulus to labour productivity and business dynamism.
Indeed, in a context of a progressively declining labour force linked to ageing,
further productivity increases are indispensable to maintain and increase future
living standards. Increasing productivity makes it possible to raise real wages,
gives scope for investing and enhances the funding base for public services. To
boost productivity it is necessary to fully reap the benefits of the internal market, toinvest in skills, knowledge, innovation and organisational change and make
broader use of new technologies. At the same time, much stronger business
dynamism is needed to improve the competitive position of European firms.
Labour productivity gains are highly dependent on increased investment in
physical capital  (‘capital deepening’) and in knowledge and innovation . Striving
for quality at work and improving the overall quality of human resources through
investment will contribute to raising human capital and labour productivity levels.
Non-discrimination in the access to education and training will also enhance
productivity and improve the opportunities to find a job. Job quality is addressed in
detail in the Employment Guidelines.
Both the public and the private sector will have to contribute if the Lisbon goals are
to be achieved. Governments can contribute by spending public money as
efficiently as possible, by redirecting public expenditure towards growth-enhancing
investment in physical and human capital and knowledge subject to overall
budgetary constraints, and by seeking a higher leverage of public support onprivate investment. The lion’s share of the increase in investment will have to come
from the private sector. Policies should therefore aim at improving the economic
framework conditions , which will encourage businesses to innovate, invest and
grow. This implies fostering competition in product and capital markets, promoting
entrepreneurship and ensuring a high quality regulatory environment, increasinginvestor confidence, and rewarding investment in knowledge and innovation. The
Internal Market plays an important role in this respect, including financial market
integration, as recent studies have shown. The Commission will present a new and
streamlined Internal Market Strategy for the 2003-2005 period with new proposals
to exploit the full potential of the Internal Market for growth, job creation and
competitiveness.
9In particular, Member States should over the coming three years:
9) Foster competition in goods and services markets by:
(i) increasing the transposition rate of Internal Market directives
and eliminating remaining barriers (including barriers created
through the fiscal system) to cross-border trade and market entry
in goods and, especially services markets; (ii) further opening up
public procurement; (iii) giving adequate resources to competition
and regulatory authorities, (iv) continuing efforts to reduce the
overall level of State aid, whilst reorienting aid towards horizontal
objectives of common Community interest and targeting it to
identified market failures; and (v) encouraging market entry and
effective competition in network industries while pursuing a
greater connectivity of national markets and ensuring access for
consumers to services of general economic interest.
1010) Accelerate the integration of EU capital markets, in particular by
implementing the Risk Capital Action Plan by 2003 and the
Financial Services Action Plan by 2005 (2003 for securities
markets); ensuring consistent enforcement of EU rules and
removing barriers to efficient cross-border clearing and
settlement.
11) Generate a supportive environment for entrepreneurship and for
SMEs to start-up and grow by reducing the administrative burden
on business; by increasing the efficiency of the public sector; by
simplifying the corporate tax system; and by improving the
regulatory environment, notably entry and exit mechanisms.
Improve the access to finance for small and medium-sized
enterprises.
12) Agree on and implement measures to strengthen corporate
governance rules, at national and at Community level. Further
improve arrangements at national and Community level to deliver
efficient cross-sector and cross-border financial supervision and
financial crisis management.
13) Promote investment in knowledge and innovation and make
progress towards the 3% of GDP objective of total R&D
investment by: (i) developing framework conditions conducive to
R&D and innovation and realising an affordable, legally-certain,
Community patent; (ii) promoting access and use of ICT in line
with the e-Europe 2005 Action Plan; (iii) facilitate the
development of the Union's satellite navigation system Galileo;
and (iv) improving the quality and efficiency of education and
training systems, including lifelong learning and active labour
market policies, in order to respond adequately to changing skills
requirements, thereby maintaining and upgrading the human
capital base (see also Employment Guideline 4).
14) Enhance the contribution of the public sector to growth by:
(i) redirecting, i.e. while respecting overall budgetary constraints,
public expenditure towards growth-enhancing investment in
physical and human capital and knowledge; (ii) increasing the
efficiency of public spending, inter alia, by introducing
mechanisms to assess the relationship between public funds and
policy objectives and to help control spending; and
(iii) establishing an appropriate framework for joint public-private
initiatives.
112.3. Strengthening sustainability
Growth will only prove to be sustainable if due attention is being paid to issues of
economic, social, and environmental sustainability. Carrying out impact
assessments and cost-benefit analysis of proposed legislation will allow synergies
and trade-offs between economic, environmental and social objectives to be
identified and assessed systematically. Where possible, flexible, market-based
solutions that achieve environmental and social goals without jeopardising
economic performance, should be preferred.
i) Economic sustainability: Ensuring th e long-run sustainability of public
finances
Ageing populations imply important challenges . Rising old age dependency
ratios will put increasing pressure on public finances. Rising expenditure on,
notably, public pensions and health care, will have to be shouldered mainly by a
shrinking share of the working age population. The need to ensure the long-term
sustainability of public finances has been underlined by the Lisbon, Stockholm andBarcelona European Councils. To address the economic and budgetary
consequences of ageing, the Stockholm European Council decided that a three-
pronged strategy  should be followed, focusing on increasing employment rates
(see section 2.2. i), on the reduction of public debt, and on reforming pension and
health care systems.
Sustainability concerns should be explicitly taken into account when assessing the
budget positions of Member States and great er weight must be attached over the
coming years to government debt  ratios in the budgetary surveillance process.
Reforms of pension systems  should be forcefully pursued in line with the broad
common goals agreed by the Gothenburg and Laeken Councils. This should bedone with a view to safeguarding the adequacy of pensions, ensuring the financial
sustainability of pension systems and modernising pension systems in response to
changing needs of the economy, society and individuals. The Joint Report on
Member States' pension strategies, welc omed by the Brussels Spring European
Council in March 2003, underlines that ensuring long-term financial sustainabilityis not only important in its own right but is also a necessary precondition for an
adequate provision of pensions in the future. It concludes that the momentum
behind the reform process to secure the sustainability of adequate pensions must be
maintained, including more wide-ranging and ambitious efforts. To address the
budgetary impact of ageing in a timely manner, full use should be made of the
current window of opportunity  before the effects of ageing are felt more
forcefully. In this context, the impact of  immigration needs to be further examined.
12In particular, Member States should over the coming three years:
15) Ensure a further decline in government debt ratios; Member
States still having government debt ratios above the 60% of GDP
reference value, should in the first instance ensure a satisfactory
pace of government debt reduction towards that value; other
Member States should ensure a further sufficient reduction in the
debt ratio to further strengthen public finances in view of the
costs of ageing, including higher age-related spending.
16) Design, introduce and effectively implement reforms of pension
systems. Encourage longer working lives by modifying incentives
embedded in pension and tax-benefit systems that encourage early
withdrawal from the labour market and by restricting access to
early retirement schemes. Make the pension system cope better
with demographic developments and expected increases in life
expectancy. Increase funding and improve, where necessary,
access to supplementary pension schemes and ensure the safety of
such benefits, while increasing transparency between
contributions and benefits. Adapt pension systems to more
flexible employment and career patterns as well as to individual
needs, including the portability of pension benefits (see also
Emplyment Guidelines 5 and 8).
ii) Social sustainability: Contributing to economic and social
cohesion
The Lisbon Strategy will only be successful and be able to attract continued and
widespread support for necessary structural reforms if it contributes to improving
opportunities for all. Sound economic policies can make an important contribution
to economic and social cohesion: first, because jobs are the best protection against
poverty and social exclusion, by improving the conditions for stronger job creation,
especially for people with relatively low skill levels and for those living in regionsthat lag behind; second, by creating the conditions for enhanced growth and
investment and thereby facilitating regional catching up (while poorer Member
States catch up with the rest, differences in economic development remain, and
these will widen significantly after enlargement); and third, by contributing to a
more productive economy respectful of social conditions and equal treatment,
thereby also generating resources for the necessary accompanying social,
educational and regional development policies to facilitate the transformation ofthe economy and to reduce poverty and social exclusion. Inclusive labour markets
as a contribution to cohesive societies are addressed in the Employment Guidelines
and in the Social Inclusion Process.
Catching up and employment creation depend on favourable conditions for
private sector activity and investment. Successful implementation of the policies
set out in the various parts of this document will help to create such conditions. In
particular, measures to improve the functioning of labour markets and allowing
wages to properly reflect productivity differences across skills and local labour
market conditions are important. Furthermore, there is a need for targeted policy
13actions aimed at ensuring the availability of basic infrastructure of a sufficient
quality, and at improving education and life long learning in order to raise the skills
and adaptability of the labour force. In this context, it should be recalled that the
EU contributes importantly to investment in regions lagging behind through the
cohesion and structural funds as well as the European Investment Bank. Member
States should provide an efficient level of public investment across a wide range of
education and training, and undertake reforms to improve educational standardsand to encourage sustained investment from enterprises and individuals.
In particular, public authorities should over the coming three years:
17) Whilst ensuring an adequate level of social protection, take steps
to modernise social protection systems and to fight poverty and
exclusion with a view to supporting the broad Lisbon objectives,
notably on employment, in order to achieve an inclusive labour
market and a more cohesive society for all (see also guideline 4).
18) Improve the functioning of markets so that they are conducive to
private investment in regions lagging behind, particularly by
taking steps to allow wages to reflect productivity taking into
account differences in skills and local labour market conditions
(see also guideline 5).
19) Ensure that public support, including from EU sources, in regions
lagging behind is strongly focused on investment in human and
knowledge capital, as well as adequate infrastructure, and that
investment programmes are designed and administered efficiently
so as to maximise their impact (see also guideline 13). In this
context, strengthen the operational co-operation between the
Commission and the Europe an Investment Bank.
iii) Environmental sustainability: Promo ting efficient natural resource use
To contribute to an increase in the well-being of current and future citizens,
economic growth must not be at the expense of the environment . To promote
an efficient use of natural resources, their prices should reflect their costs to
society, including the external costs re lated to the environmental damage caused
during their extraction, use and final disposal. This will encourage adaptation and
innovative solutions by firms.
However, a common feature of many natural resources (for example, clean air and
water) is that there are no clearly defined ownership rights. In such cases, evenwhile it is in the interest of society as a whole that the resource is managed in a
sustainable way, no one individual has an incentive to do so.
Thus there is a need for government action to successfully de-couple economic
growth from environmental degradation. This is likely to require a mix of
regulatory and market-based instruments. The environmental costs of economic
14activity should gradually be priced in. The use of scarce natural resources
should be paid for. The “polluter pays principle” should be systematically
applied .
In particular, Member States should over the coming three years:
20) Reduce sectoral subsidies, tax exemptions and other incentives
that have a negative environmental impact and are harmful for
sustainable development. Ensure, inter alia through the use of
taxes and charges, that pricing of the extraction, the use and, if
applicable, the discharge of natural resources, such as water,
adequately reflects their scarcity and all resulting environmental
damage.
21) Reduce energy subsidies, promote market instruments, further
broaden the coverage, and ensure appropriate differentiation of
energy taxation to deliver a more sustainable mix and level of
energy consumption, and further enhance competition and
network interconnection in energy markets.
22) Adjust the system of transport taxes, charges and subsidies to
better reflect environmental damage and social costs due to
transport, thereby reducing distortions in the demand for transport
services and the choice of transport modes, and increase
competition, e.g. through accelerated regulated market opening,
in transport modes such as freight railways to make them more
competitive.
23) Renew efforts to meet their commitments under the Kyoto
protocol, which is particularly important for those Member States
that at present are not on track to meet their commitments. To this
end, implement the EC greenhouse gas emissions trading scheme:
draw up national allocation plans; establish national allowance
registries; set up systems to adequately monitor, report and verify
emissions at installation level. Prepare new and immediately
implement existing policies and measures for those sectors not
covered by allowance trading and set up systems to report on
those policies and measures and their prospective effects on
emissions.
15II. C OUNTRY -SPECIFIC ECONOMIC POLICY GUIDELINES
0. Euro Area
The economic slowdown observed in 2001-2002 exposed the structural weaknesses
of the euro area. Internal dynamics, which still appeared robust in 2000, dissolvedwhen recovery failed to materialise. One reason is to be found in the euro area's
low rate of potential growth, which limits the scope for a sustainable high rate of
economic growth. Another conjunctural reason is the weakness in domestic
demand, which did not provide a sufficient buffer to the impact of economic
shocks. This became particularly evident in 2002 when domestic demand was notsufficiently robust to take over from the initial stimulus from the external side.
Economic growth is expected to gradually recover to potential after the effects of
recent shocks fade away. At the beginning of 2003, the economic outlook is
conditioned on a number of assumptions on whether, when and what kind of
downward risks materialise. Geo-political uncertainty is particularly weighing onthe economic outlook. Generally, forecasts assume growth to remain still very
weak in 2003, with a recovery only gathering strength in the second half of 2003
and accelerating in 2004. The challenges facing the euro area are to:
/g183 Cater for a balanced macroeconomic policy mix
/g183 Address unwarranted inflation differences
/g183 Strengthen economic policy co-ordination
Cater for a balanced macroeconomic policy mix
The policy-mix in the euro area needs to be carefully designed in supporting
economic recovery without being detrimen tal towards long-term sustainability and
stability. Whilst preserving their stability-orientation, macroeconomic policies
should use the leeway available to support a recovery in growth in the short run. In
the current juncture, it is important that the policy mix underpins confidence
among consumers and investors. Any policy action needs to be assessed against itsimpact on economic confidence. This holds in particular for budgetary policy. This
implies that macroeconomic policies should remain committed to medium-term
stability to enhance confidence among business and consumers. The ECB should
aim at maintaining price stability in the medium term and, without prejudice to the
price stability objective, support the general economic policies in the Community.
As economic activity approaches the rate of potential growth, it will be important
to re-focus macroeconomic policies on medium-term targets. Budgetary policy hasto ensure a fiscal position consistent with the need to prepare for the impact of
ageing populations on the one hand and to accomplish a composition of public
expenditure and revenues that fosters economic growth on the other.
16Address unwarranted inflation differences
The high degree of inflation convergence in the euro area reached in 1997 was not
sustained and there has been a steady upward rise in inflation differences since.
Inflation differences between Member States can reflect the effective functioning
of a monetary union where, because there is no room for manoeuvre at countrylevel on exchange rates and monetary policy, changes in relative prices between
countries become a key adjustment mechanism. In contrast, inflation differences
appear unwarranted when they are due to the malfunctioning of product and labour
markets, or inappropriate policies. In particular, price and wage increases in
response to temporary shocks should not lead to entrenched inflation. Prices andwages should display the flexibility required to prevent such a development and
foster stability.
Recent inflation dispersion largely reflects the diversity of national economies and
is not a major source of concern. Indeed, inflation divergence over the 2000-02
period is essentially attributable to food, energy and some services. The three
sectors account for nearly three-quarters of the increase in inflation dispersion
relative to 1997. In particular, the increase in energy prices in 2000-2001 and theeffect of animal diseases in 2001 hit some countries more than others. Moreover,
there are still important differences in the national price levels of many tradable
goods and services in the euro area. Further progress in the functioning of the
Internal Market combined with the high er price transparency resulting from the
euro should lead to further convergence in national price levels, entailing sometemporary inflation divergence. Finally, the asymmetric impact of price shocks on
inflation has probably been compounded in some Member States by the existence
of schemes indexing wages to inflation and differing policy responses to energy
price increases.
Strengthen economic policy co-ordination
With intensified economic integration, the potential for spillover effects rises,
which strengthens the case for economic policy co-ordination. The introduction of
the single currency has deepened the externalities of national policies in the euro
area. The euro exchange rate, the euro area’s external balance and the average
inflation rate in the euro area have become collective goods. It implies the needboth for stronger macroeconomic and structural policy co-ordination in the euro
area to improve the euro area's resilience to shocks, and improve its growth
potential and performance.
Preserving macroeconomic stability and a policy mix conducive to growth relies on
a coherent formulation of macroeconomic policies. While respecting their mandateand independence, the relevant policy actors must ensure the compatibility of their
objectives and aim for a common assessment of the underlying economic situation.
Budgetary authorities should safeguard the credibility of the rules-based
framework for fiscal policy by complying with the agreed rules in a transparent and
foreseeable manner. Member States should be open to peer pressure, benchmarking
and the provision of best practices also in the area of structural policies.
17To foster harmonious economic developments, it is essential to closely co-ordinate
economic policies among policy actors and to have a continuous and fruitful
dialogue in the Council and the Eurogroup involving and the ECB and the
Commission. The involvement of the social partners through the macroeconomic
dialogue also plays an important role. At international level, the growingimportance of the Euro area also calls for a strengthening of the relevant co-
ordination mechanisms such that it speaks with a voice commensurate with its
economic and financial weight in the different fora.
Specific recommendations to the euro area
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
In order to cater for a balanced macroeconomic policy mix, policy actors at the
national and the euro area level are recommended to:
1. Ensure a stance of monetary policy, budgetary policy and wage growth
that is compatible with price stability and the need to enhance confidence
among business and consumers in the short run as well as with economicgrowth close to potential in the medium term.
In order to address unwarranted inflation differences policy actors at the national
and the euro area level are recommended to:
2. Strengthen competition on product and capital markets, improve the
functioning of the labour market, inter alia by tackling impediments towage flexibility and encourage geographic mobility.
In order to strengthen policy co-ordina tion policy actors at the national and the
euro area level are recommended to:
3. Deepen the analysis of and discussion on economic developments and
policy requirements, exchange information on envisaged policy measuresto the largest possible degree, and strengthen the external representation
of the euro area.
4. Improve the efficiency of the existing co-ordination procedures in the
area of structural reforms that aim at strengthening the euro area's growth
potential and its resilience to shocks.
181. B ELGIUM
Robust economic performance was registered in Belgium in recent years. However,
the general economic downturn had a sharp impact on the economy of Belgium,
with real GDP growth decelerating pr ogressively from 3.7% in 2000 to 0.7% in
2002. An upturn in activity is foreseen in  2003, strengthening in the forthcoming
years, potential output being estimated at little below 2.5%. Belgium madeconsiderable progress in budgetary adjustment in the past years. However, the
current unfavourable macroeconomic context requires additional efforts to
implement the commitments to budgetary consolidation.
Recently, the path of reduction of the government debt ratio has decelerated due to
lower economic growth and also the negative impact of financial operations. Yet,in particular in view of the future b udgetary costs of an ageing population, fast
reduction in the government debt is of central importance for Belgium.
Improvement in the functioning of the labour market, a necessity in itself, could
also make a contribution of budgetar y adjustment. Moreover, product-market
reforms are needed in order to improve competitiveness and productivity. The
challenges facing Belgium are to:
/g183 Ensure the continuation of the budgetary adjustment in the forthcoming years,
in particular in view of ensuring the long-term sustainability of public
finances in the face of population ageing
/g183 Increase the low participation and employment rates, especially for older
workers and women, and improve incentives to work
/g183 Enhance competition in certain services sectors and continue to increase the
efficiency of the public administration and to improve the business
environment
Ensure the continuation of the budgetary adjustment in the forthcoming years,
in particular in view of ensuring the long-term sustainability of public finances
in the face of population ageing
The challenge of reducing the still high debt ratio (of 105.4% of GDP in 2002) and
to prepare for the budgetary costs of an ageing population, require sustained sound
budgetary policies over the long run. The strategy followed by Belgium, inparticular, the policy of maintaining high primary surpluses, is expected to provide
leeway to cover age-related budgetary costs. However, such an effort has to be
sustained over the long run and a failure to maintain the primary surpluses at a
sufficiently high level might mean that the risk of unsustainable public finances
could not be avoided.
In coming years, budgetary policy will face the challenge of maintaining control of
government primary expenditure, limiting its increase in real terms, while
19providing for the costs of needed reforms and other budgetary objectives. In this
context, budgetary efforts aimed at reducing the government debt ratio need to be
supported by policies to improve labour force participation and to raise the still low
employment rates.
Increase the low participation and employment rates, especially for older workers
and women, and improve incentives to work
The employment rate, which has been growing steadily over the second half of the
nineties, was still at 59.9%, 4 percentage points below the EU average in 2001, and
far away from the EU employment targets.  The employment rate of older workers
(55-64 years) was only 25.1% in 2001, the lowest rate in the European Union andabout 13.5 percentage points below the EU average. It is unlikely that the measures
taken so far will suffice to reach the EU target for 2010. The challenges posed by
an ageing population suggest a need for measures aimed at mobilising the non-
occupied potential labour force, thereby increasing employment and participation
rates.
Notwithstanding recent measures to address the problem of benefit dependency and
to reduce the risk of “unemployment traps”, there is still a sizeable number ofworking age benefit recipients not in employment. The work disincentives of the
current unemployment benefit schemes  calls for their further review in order to
tackle the still high share of long-term unemployment, which remains a major
structural problem. Linguistic barriers, high housing registration costs, and wage
compression are contributing to the persistence of disparities between geographicalareas and reducing incentives to mobility.
Enhance competition in certain services sectors and continue to increase the
efficiency of the public administration and to improve the business environment
Competition remains limited in most network industries and in local services,
leading to high consumer prices for example for local phone calls or electricity. Innetwork industries, difficulties for comp etitors to access the networks, physical
bottlenecks, and the historical links with public authorities contribute to maintain
the market power of incumbents. In local services, the links between local public
authorities and private partners, notably in inter-municipal trusts, still lack
transparency. In spite of larger institutional powers, the competition authorityremains understaffed and the effective independence of all sectoral regulators is not
yet secured.
In the recent past, measures to reduce the administrative burden for companies and
to improve the efficiency of public administration are helping to create a more
business-friendly environment. In particular, plans have been carried out to reducethe costs and administrative procedures involved in creating a company and the
'Copernicus' plan aims at modernising the federal administration. The impact of
these plans has still to fully materialise.
20Country specific recommendations to Belgium
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
In order to ensure the continuation of the budgetary adjustment in the forthcoming
years, in particular in view of ensuring the long-term sustainability of public
finances in the face of population ageing, Belgium is recommended to:
1. Ensure that the government debt ratio is kept on a sustained declining
trend at a satisfactory pace by maintaining high primary surpluses
(GL 15);
2. Limit the real expenditure increase in Entity I (Federal government and
social security) to 1.5% and allocate proceeds stemming from higher than
expected economic growth to improve the budgetary position as a matter
of priority; and
3. Strengthen the existing strategy in order to prepare for the budgetary
implications of population ageing: in particular by reducing the debt
level, better addressing the low effective retirement age, pursuing thereform of the pension systems, and strengthening efforts to finance the
Ageing Fund (GL 16 and E-REC 2).
Belgium should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way. In
order to increase growth potential, ensure the long-term sustainability of publicfinances, and address the effects of agei ng populations, it is especially important
for Belgium to increase the low participa tion and employment rates, especially for
older workers and women, and improve incentives to work. Belgium is in
particular recommended to:
4. Take further steps to reinforce measures to postpone retirement from the
labour force, in particular by combining a removal of incentives to early
retirement (GL 16) with enhanced prevention and activation measures for
older workers; and
5. Continue progress in making work pay by eliminating the major
distortions to work incentives arising from the interaction of the tax andbenefit systems (GL 4 and E-REC 3).
In order to enhance competition in certain services sectors and continue to increase
the efficiency of the public administration and to improve the business
environment, Belgium is recommended to (in line with GL 9 to 14):
6. Take measures to enhance effective competition in network industries
and in local services (in line with GL 9); and
7. Improve public administration in the context of the ongoing reform and
pursue the reduction of administrative burden for companies (GL 11).
212. Denmark
The Danish economy has for some years now been operating close to potential
growth rates with real growth rates averaging 2½% in the last 10 years. In this
period the economy benefited from a large reduction in unemployment from over
12% of the labour force to now around 5% - a large part of this reduction can be
viewed as being structural. As it will not be possible to replicate this fall inunemployment in coming years and as demographic changes result in lower growth
in working age population, potential growth rates are expected to be reduced to
around 2%. The large reduction in unemployment in the last decade also had a
positive impact on public finances, where a surplus has been achieved every year
since 1997.
For the Danish economy to continue to be in good shape, despite the lower
potential growth rates, it is necessary to address some structural issues. In order to
continue to achieve high surpluses on public finances it is necessary to increase the
labour supply, both as a mean to reducing expenditures and to increasing tax
revenues. Furthermore, the price level continues to be among the highest in the EU
– partly reflecting lack of competition in certain sectors and there is room for
improving efficiency in the public sector. The challenges facing Denmark are to:
/g183 Ensure an adequate labour supply in view of the ageing of the population
/g183 Enhance competition in certain sectors and improve the efficiency of the
public sector
Ensure an adequate labour supply in  view of the ageing of the population
Employment rates are already high in Denmark, and well beyond the Lisbon
targets for EU as a whole, including for women and older workers. However, in
order to prepare for the impact of the ageing population on public finances and tosafeguard the growth potential, it is necessary to increase labour force participation
rates and to reduce unemployment rates further, and beyond what already
implemented reforms are expected to generate. These increases will contribute to
achieving the government’s targets of surpluses of 1½-2½ % of GDP as a means to
prepare for the impact of ageing on public finances.
Much has already been done in the field of active labour market policies, especially
with regard to the right to and obligation of job activation. Measures have also
been taken within benefit systems and retirement schemes. Furthermore, a tax
reform has been announced recently for 2004-2007 with the purpose of lowering
taxes on earned income, which should also contribute to an increase in the laboursupply. However, further reforms would be needed to ensure a marked increase in
the already high labour force participation and employment rates. Sources of
potential labour supply increases could include better integration of immigrants in
the labour market, a faster channelling of students through the education system,
and efforts to improve labour market attachments for senior workers. Further
22improvements in the number of people in the labour force or in the number of
hours worked per person could be encouraged via additional tax and benefit
reforms, in particular by reducing the still relatively high marginal tax rates, or
tightening the conditions for early retirement or a combination of both. Ministry of
Finance’s estimates show that reductions of different kinds of tax rates may have amarked impact on labour supply. However,  considerations concerning additional
tax reforms should take into account the framework of sound public finances. With
regard to increasing the retirement age, consideration could be given to further
improve incentives to continue to work instead of withdrawing early from the work
force by entering into early retirement. Mo reover, in maintaining the high surpluses
on public finances it is not only necessary to increase the labour supply, strict
expenditure control also has to be continued in order to prevent slippage, which
may jeopardise the targets.
Enhance competition in certain sectors an d improve the efficiency of the public
sector
Enhancing competition could contribute to lower the Danish price level, which is
the highest in the EU, and to improve productivity, which is around the EUaverage. Competition is weak in a number of industries, such as the energy sector,
housing, construction and non-tradable services. The full liberalisation of the
energy market could also contribute to better competition and lower prices
throughout the economy.
The Danish public sector is among the largest in the EU. Substantial efforts have
been made to improve its efficiency and Denmark has a rate of openly advertised
public procurement above the EU average. However, public entities are still sole
producers in many areas of public services and it remains to be seen to what extent
recent reforms to extend consumer choice for public services will increase
competition from the private sector. One example where the efficiency could beincreased is the education sector, where the OECD PISA study shows relatively
poor results for Denmark, despite high education expenditure.
Country specific recommendations to Denmark
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic PolicyGuidelines.
Denmark should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way. In
order to prepare for the impact of the ageing population on public finances and to
safeguard the growth potential, Denmark is in particular recommended to:
1. Continue efforts to make work pay by increasing incentives to join the
labour force and to postpone retirement, in particular by ensuring the
implementation of the tax reform and by considering additional steps to
23tighten eligibility rules and reduce marginal taxes within a framework of
sound public finances (GL 4 and E-RECs  1 and 3); and
2. Ensure expenditure control at all levels of government so that the multi-
annual targets for real public consumption growth are respected (GL 14).
In order to enhance competition in certain sectors and improve the efficiency of the
public sector, Denmark is recommended to (in line with GL 9 to 14):
3. Step up efforts to enforce competition in sectors where competition is
inadequate (GL 9); and
4. Continue efforts to increase the efficiency of the public sector, inter alia
by improving framework conditions for increased competition, promotingthe benchmarking of public sector efficiency, and by increasing public
tendering (GL 11).
243. Germany
Since the boom caused by unification, Germany has experienced much lower
growth rates since the mid-nineties, both in comparison with other European
countries and with its own historical rates. Stagnation, partly linked to the costs and
effects of unification, has gradually become more and more entrenched. In 2003,
GDP growth is very likely to remain below 1% for the third year in a row.Germany’s low growth potential of around 1½ % (compared with one of 2¼% for
the rest of the EU) is the result of structural adjustments in the aftermath of
reunification, rigidities in the labour market and regulatory burdens that hold back
productivity, and also of a very low population growth. While low growth is a
problem in itself, it spills over into the field of public finances, where tax andsocial security revenue shortfalls have led to Germany’s breaching of the Treaty’s
deficit criterion. At the same time, the approach chosen to correct the excessive
deficit - increases in taxes and social security contributions - exacerbates the
problem of low growth. However, on 14 March Chancellor Schröder outlined in a
parliamentary speech elements of a broad-based reform agenda, which would
constitute important steps towards solving Germany’s structural problems.
The solution to the difficult state of public finances cannot be found independently
of addressing the root causes of the low growth and vice versa. Far-reaching
reforms are the more pressing, because the social security systems are not
sufficiently equipped to dealing with the consequences of population ageing. To
solve the twin problems of low growth potential and unsustainable public finances
in Germany, it is therefore imperative that four key challenges be addressed. Thefirst two are mainly remedies to raise th e low economic growth potential, while the
latter two address the sustainability of public finances. The challenges facing
Germany are to:
/g183 Promote job creation and adaptability and mobilise the unutilised employment
potential
/g183 Increase productivity through improvements in the business environment and
the efficiency of the education system
/g183 Accelerate the consolidation of public finances
/g183 Secure the long-term viability of pension and health-care systems
Promote job creation and adaptability and mobilise the unutilised employment
potential
The overall employment rate in Germany is close to the EU-target of 67% for
2005. The employment rate for women already exceeds the intermediate EU-target
of 57% for 2005, whereas for older workers it remains very low, even below thelevel reached in 1997. Germany’s good record in employing young people
contrasts with a severe lack of job opportunities for low-skilled workers, elderly
25workers, and for people living in disadvantaged regions, notably the East.
Considering the large job deficit in the Eastern Länder, there is a risk that regional
disparities on the labour market may widen further. Employing the aforementioned
groups would evidently provide a substantial growth impulse, as well as
strengthening public finances. Three structural factors appear most important in thelabour market: First, Germany suffers from severe unemployment and inactivity
traps, in particular for low wage earners where the combined effect of taxation,
social security contributions and benefit withdrawal continues to create a high
marginal effective tax rate above the threshold of € 400 per month. The recent
strengthening of benefit sanctions has triggered higher transitions fromunemployment to inactivity, but the effect on incentives for active job search,
including sectoral and regional mobility is too early to assess. Second, labour costs
of low-skilled workers or people in depressed regions risk exceeding their
productivity levels due to the application of coordinated tariff wages
(Flächentarifvertrag), which are nearly identical for the whole country in a given
sector. Reduced wages for trial periods of new job entrants, or for disadvantaged
regions, are not only impeded by union wage contracts but also by law. Indeed, theGünstigkeitsprinzip legally binds companies to the minimum wages defined by
sectoral wage agreements, if the company is a member of the respective
employers’ association or the agreement has been declared generally applicable by
the government. Where opening clauses exist, they are seldom applied, particularly
so in the West. Third, reintegration of unemployed workers is also made difficultby inefficiencies of large-scale active labour market programmes (ALMPs) and
insufficient evaluation and targeting of such measures. It is still too early to see the
effects of recent efforts to improve the evaluation of ALMPs.
Increase productivity through improvements  in the business environment and the
efficiency of the education system
Low labour input growth is accompanied by a parallel decline in productivity
growth and business investment in recent years, which may be associated with a
still high regulatory burden and remaining barriers to competition. Although
progress has been made in the context of the Hartz reform, labour markets in
particular remain heavily regulated. Main elements in this respect are therestrictions on temporary agency work contracts and the uncertainty related to the
application of employment protection legislation by courts. Rules controlling entry
into crafts and liberal professions are under review. In addition, there is the
complexity of parts of the tax code and the relatively limited provision of public
services over the Internet. Finally, legal restrictions unnecessarily hindercompetition in retailing, energy network access fees remain relatively high and
subject to ex-post control, and there is little evidence of an opening up of public
procurement.
With the prospect of a diminishing labour force, the level of qualification is all the
more important if Germany is to raise its productivity in order to maintain its living
standards. The PISA-OECD study highlighted the relatively poor performance of
German secondary schools. In addition, the very long university study times are along-standing problem. Reforms of the education system also constitute an
26important element for tackling unemploym ent because the low skilled makes up a
large share of the unemployed.
Accelerate the consolidation of public finances
The 2002 general government deficit was 3.6% of GDP, clearly exceeding the
respective Treaty criterion. On 21 January 2003, the Ecofin-Council had alreadydecided that an excessive deficit existed in Germany and recommended to the
German authorities to implement measures amounting to one percentage point of
GDP in 2003 and to bring the excessive deficit to an end by 2004 at the latest.
Budget consolidation would also contribute to improving the general business
climate and hence increase Germany’s growth potential. However, withoutadditional structural reforms to raise Germany’s low growth potential, a steady
decline in the debt ratio and compliance with the proclaimed target of a close to
balance budgetary position in 2006 seems unlikely. Germany was asked by the
Council, therefore, to implement urgent reforms, not only in the labour market, but
also in the social security and benefit systems in general, and to reduce the
regulatory burden on the economy.
Secure the long-term viability of pension and health-care systems
Germany’s social security systems are financed  mainly on a pay-as-you-go basis.
As a consequence, pension and health care systems will have difficulties in coping
with the problem of an ageing population. If present rules remain unchanged, social
security contributions, already among the highest in Europe, would have to rise
substantially over the next decades. This would exacerbate the burden caused byhigh unemployment and depress growth even further. In the pension system, a
better link between individual payments and acquired pension rights is needed to
avoid that pension contributions are perceived largely as taxes. First steps by the
German government towards a privately funded pension system (“Riester-Rente”)
have been taken, but only 15% of the employees have made use of this newpossibility so far, not least because it is accompanied by relatively high level of
regulation.
The health care system has also come under increasing strain in recent years,
mainly due to insufficient cost controls and the absence of economic incentives for
cost savings. Currently, a re-orientation of the health care system is underdiscussion. This would include limiting the insurance coverage to major risks only,
which would allow for substantial cost reductions.
The concern about long-term sustainability of public finances is all the more
pressing as Germany’s debt-to-GDP ratio remains above the 60% threshold, and
where a clear downward has trend not yet been established.
27Country specific recommendations to Germany
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
Germany should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way. In
order to increase growth potential, ensure the long-term sustainability of public
finances, address the effects of ageing populations and reduce regional disparities,
it is especially important for Germany to promote job creation and adaptability and
mobilise the unutilised employment potential. Germany is in particularrecommended to:
1
. Reform the tax-benefit system (GL 4 and E-REC 6), notably by assuring
positive net income gains from moving into a job or a higher income
bracket across all income levels, and by enforcing the conditionality of
benefits upon active job search;
2. Take measures to ensure that wages reflect better productivity differences
across skills and regions (GL 5), notably by reviewing the
Günstigkeitsprinzip, allowing temporarily lower payments for jobstarters; and
3. Improve the efficiency of ALMPs, in particular of job search assistance.
Reform ALMPs according to cost-eff ectiveness criteria and target them
better towards those persons most prone to the risk of long-term
unemployment (GL 8, 13 iv and E-REC 1).
In order to increase productivity through improvements in the business
environment and the efficiency of the education system, Germany is recommended
to (in line with GL 9 to 14):
4. Encourage businesses to invest and grow by creating a more competitive
environment (GL 9) and by further reducing the regulatory andadministrative burden (GL 11), inter alia by lowering the effective degree
of employment protection (GL 6); and
5. Carry out further reforms contributing to improved educational
achievements and the elimination of persistent skill shortages (GL 13).
In order to accelerate the consolidation of public finances, Germany is
recommended to:
6. Implement discretionary measures amounting to 1% of GDP in 2003 and
put an end to the present excessive deficit situation by 2004 at the latest
(GL 1); and
287. Lower the cyclically-adjusted deficit by at least 1 percentage point of
GDP between the end of 2003 and 2005.
In order to secure the long-term viability of pension and health-care systems,
Germany is recommended to:
8. Promote the take-up of supplementary pension schemes, strengthen
incentives for later retirement, and strengthen the link between public
pension contributions and pension rights (GL 16); and
9. Increase the efficiency in the health care sector by introducing economic
incentives for health care providers and recipients, such as cost sharing.
294. Greece
In 2002, the Greek economy continued to expand at a high rate, despite the adverse
international economic conditions. Real GDP growth is expected to remain well
above the EU average, reaching 3.8% in 2003 (slightly above the potential growth
rate of around 3.5%). However, economic activity, which has been boosted by
private and public investments, mainly through the preparation for the Olympicgames and the third Community Support Fram ework, is very unlikely to exceed or
remain at its potential level after 2004. Moreover, high growth rates and rising
energy prices may create excessive price pressures. In spite of the strong growth
and falling interest rates, the government debt ratio has not been reduced
significantly. In fact, while the debt ratio declined at a slow pace in the 1997-1999,it increased in 2000-2001 mainly due to the reclassification of large financial
operations previously excluded from budgetary accounts.
The situation in the labour market is improving at a very slow pace.
Notwithstanding the strong job creation, employment growth is not satisfactory and
unemployment, although it fell below 10% of the labour force in 2002, remained at
a high level. The interplay of rigidities in labour and product markets and the late
development of knowledge-based society, due in particular to the low level ofinvestment in human capital and in research, are impeding the increase in labour
productivity to levels that would accelerate the catching-up process.
Greece needs to further consolidate public finances in order to reduce the high
government debt ratio at a satisfactory pace. Structural problems in labour and
product markets must be addressed in order to reduce the high unemployment rate,improve productivity and enhance the efficient functioning of the economy. The
challenges facing Greece are to:
/g183 Ensure the long-term sustainability of public finances in the face of
population ageing, in particular in view of the high government debt ratio
/g183 Increase the low level of productivity, which is associated with problems in
the functioning of the labour and product markets, low investment in human
capital, and the late development of the knowledge-based society
/g183 Reduce the high rate of structural unemployment, and increase employment
rates, particularly for women
Ensure the long-term sustainability of public finances in the face of population
ageing in particular in view of  the high government debt ratio
Despite the budgetary adjustments and the improvement in government balances
achieved in previous years, the debt ratio was not put on a sustained decliningtrajectory. In fact, the debt ratio increased in 2000 and 2001, after the revisions
required by Eurostat, and stood at 105.3% of GDP in 2002. The large financial
operations partly outweighed the positive impact of the primary surplus on
30government debt. The primary surplus is expected to have risen at a slower pace in
2002, while the government deficit is estimated to be equal to 1.1% of GDP
compared to 1.2% in 2001. The high growth rates of output constitute a solid base
for further improving government balances and turning the budget deficit into a
surplus. Limiting public consumption spending in order to free resources forproductive uses and containing high debt ratio are of paramount importance. The
high debt ratio, if not controlled, may put at risk the sustainability of public
finances in the longer run when financial pressures stemming from the ageing
population are expected to arise. Despite the efforts undertaken in the 2002 pension
reform, the still-large projected increase in public spending on pensions (from ahigh starting position) suggests that further efforts are required.
Increase the low level of productivity, which is associated with problems in the
functioning of the labour and product markets, low investment in human capital,
and the late development of the knowledge-based society
The level of labour productivity, while rising strongly in recent years, remains the
second lowest in the EU. This can be explained by low levels of investment in
R&D, the still low - albeit growing - level of ICT diffusion, low levels ofeducational attainment of the population and the resulting lack of skilled workers.
In addition, the large percentage of small and micro domestic firms, which is
partially due to distortions created, for example, by labour market legislation and
by taxation, contributes to low investment in R&D and innovation.
A better business environment is also key to improving the efficiency of product
markets. First, competition in certain network industries is still limited. For
example, in the electricity and gas sector s, the vertically integrated incumbents
dominate the markets. Second, despite recent measures to simplify the regulatory
environment and the taxation system, business dynamism continues to be hindered
by complex procedures and a lack of efficiency of public administration. Third, thetransposition rate of internal market directives is the second lowest in the EU.
Reduce the high rate of structural unemployment, and increase employment
rates, particularly for women
Greece’s overall employment rate is considerably below the targets set by the
European Council, in particular for women. Unemployment fell for a thirdconsecutive year in 2002, but remains well above the EU average, with the
unemployment rate for women more than double the rate for men, and youth
unemployment very high. Labour market rigidities still hamper the more flexible
functioning of the labour market. There have been no changes in the wage
formation system that would allow greater differentiation according to productivityand skills. The remaining complexity of the tax system, despite the recent
improvements, the high social security contributions and the stringent employment
protection legislation are still important obstacles to hiring. Moreover, the limited
impact of reforms aimed to promote flexible forms of employment point to the fact
that many employers have ready recourse to flexibility through the informal
31economy. The reform of the public employment services, which is essential to
address the high level of long-term unemployment, is still delayed.
Country specific recommendations to Greece
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic PolicyGuidelines.
In order to ensure the long-term sustainability of public finances in the face of
population ageing, in particular in view of the high government debt ratio (GL 15),
Greece is recommended to:
1. Ensure that the government debt ratio is kept on a sustained declining
trend at a satisfactory pace by maintaining high primary surpluses
(GL 15)
2. Ensure effective control of government current primary spending by
addressing resolutely the problem of the inelastic elements of
expenditures (GL 14), e.g. the wage bill;
3. Use public resources more effectively with the aim off improving labour
productivity and enhancing working capacity of the unemployed (GL 14);and
4. Pursue reforms of the social security system, and in particular the pension
system (GL 16), in order to avoid budgetary strains in the future due to
the problem of the ageing population.
In order to increase the low level of productivity, which is associated with
problems in the functioning of the labour and product markets, low investment in
human capital, and the late development of the knowledge-based society, Greece is
recommended to (in line with GL 4 - 8 and 9 - 14):
5. Step up efforts to increase the availability of skilled human capital, and
continue to promote business involvement in R&D and innovation, and toimprove ICT diffusion (GL 13 and E-REC 2);
6. Enhance particularly competition in the energy sectors (GL 9);
7. Continue to simplify the business and taxation environment and raise the
transposition rate of internal market directives (GL 9 and 11);
32Greece should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way. In
order to increase growth potential, ensure the long-term sustainability of public
finances, and address the effects of ageing populations, it is particularly especially
for Greece to reduce the high rate of structural unemployment, and increaseemployment rates, particularly for women. Greece is in particular recommended to:
8. Improve work incentives, particularly in tax and pension systems, in
order to encourage increased employment in the formal sector, including
part-time work (GL 4 and 16 and E-REC 4));
9. Promote changes to the wage bargaining to ensure that wages reflect
productivity differentials (GL 5); and
10. Implement the labour reform package to improve the balance between
flexibility and security by ensuring effective implementation of reforms
aiming to modernise work organisation and by reviewing unduly
restrictive labour market regulations (GL 6 and E-REC 1).
335. Spain
Spain’s economic performance was remarkably strong in the second half of the
1990s with growth rates (close to 4% on average) significantly exceeding those of
the euro area, as well as its medium-term potential rate (estimated at around 3%).
Contrary to previous downturns, a positive growth differential has been maintained
during the slowdown that began in 2001. This performance has been underpinnedby unprecedented employment creation, while monetary conditions have also been
particularly accommodating. On the downside, inflation has remained persistently
higher than the average for the euro area, above the differential that could be
expected for a catching-up country. Apparent productivity growth has declined,
highlighting structural problems such as an insufficient degree of competition insome sectors.
To maintain its convergence towards higher-income economies within the EU
(Spain’s GDP per capita remains about 15% lower than the EU average), the
Spanish economy needs to consolidate the improved performance of the labour
market, reduce unemployment disparities among regions and raise overall labour
force participation. In turn, growth would be supported by increasing productivity
through encouraging R&D and human capital formation and enhancingcompetition. Achieving these objectives should underpin the fiscal consolidation
registered in recent years. Nevertheless, the risk of future public finance
imbalances as a result of the delayed but steep impact of ageing cannot be
excluded. Therefore, to ensure the long-term sustainability of public finances, the
public pension system needs major reform, including in particular strengtheningthe link between contributions and benefits. The challenges facing Spain are to:
/g183 Raise the low employment rates, especially among women, and reduce wide
regional labour market disparities, particularly as regards unemployment
/g183 Increase the low level of productivity, including by strengthening the
knowledge-based economy in terms of educational attainment and skill levels,
investment in IT, R&D a nd innovation performance
/g183 Ensure the long-run sustainability of public finances in the face of population
ageing
Raise the low employment rates, especially among women, and reduce wide
regional labour market disparities, particularly as regards unemployment
Notwithstanding the great efforts and progress made in recent years
(unemployment rate reduced by more than 11 p.p. since 1995), the unemployment
rate at around 11.5% remains significantly above the EU average, while theemployment rate remains well below the EU average. The reduction in
unemployment has been greater for women than for men, but the female
unemployment rate is still more than double that of men. Moreover, despite high
employment creation, unemployment is still unevenly distributed across regions.
34Wage setting takes little account in practice of substantial productivity
differentials. The labour market remains heavily segmented between employees
with permanent contracts and the large number on fixed-term contracts. In turn, the
share of part-time jobs in employment remains low. Geographical labour mobility,
while to some extent promoted by recent labour market and income tax reforms, isstill limited, partly on account of structural obstacles, notably the poor functioning
of the housing market. Additionally, the public employment services may lack the
organisational resources to administer well-targeted active labour market measures
and an unemployment benefit system based on job-seekers’ individual commitment
to activity.
Increase the low level of productivity, including by strengthening the knowledge-
based economy in terms of educational attainment and skill levels, investment in
IT, R&D and innovation performance.
Productivity in Spain is below the EU average and its growth has been very modest
since the second half of the 1990s. This is in part a result of the strong increases in
employment, which have been concentrated in low productivity activities.
Educational levels are relatively low. Low business investment in R&D is anotherbarrier to faster productivity growth. The low patenting rate and insufficient
investment in IT and e-commerce are indications of weak innovation. Productivity
growth is also constrained by the insufficient competition in certain sectors,
notably in retail trade and electricity. While initiatives have recently been
undertaken to increase competition in the electricity sector, the four majorvertically integrated incumbents still have monopoly in their respective regional
markets, and import capacities still remain low. Despite recent efforts, the
relatively high degree of administrative burden on business creation is an
additional factor restricting competition.
Ensure the long-run sustainability of public finances in the face of population
ageing
Although in Spain’s case manifesting themse lves later than in other countries, the
long-term budgetary implications of ageing, above all for public pensions, but also
for areas such as health expenditures, are of special concern. Most studies point to
a very steep increase in the dependency ratio between 2020 and 2030, implying agrowing budgetary impact. An early compre hensive review of the public pension
system is required in order to reduce uncertainty and to allow phased
implementation of reforms. Despite some recent measures aiming at prolonging
working life and raising participation rates, no significant reforms of the public
pension system have yet been undertaken. Key parameters such as the number ofcontributory years, the age of retirement and the replacement ratio remain
unchanged and there is only a weak relationship between contributions and
benefits.
35Country specific recommendations to Spain
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
Spain should also vigorously implement all the Employment Recommendations (E-
REC), which deal with employment issues in a more comprehensive way. In order
to raise growth capacity, ensure the long-term sustainability of public finances,
address the effects of ageing populations and reduce regional disparities, it is
especially important for Spain to raise the low employment rates, especially among
women, and reduce wide regional labour market disparities, particularly as regardsunemployment. Spain is in particular recommended to:
1. Continue to encourage increased labour market participation, especially
among women, including through higher provision of childcare facilities
and the promotion of greater use of part-time contracts (E-REC 2);
2. Encourage a reform of wage setting in order to better reflect geographical
differentials in productivity and economic circumstances at the firm level,
as well as phasing-out indexation provisions in collective agreements(GL 5);
3. Further reform of employment protection legislation so as to reduce
segmentation of the labour market across different types of
contracts(GL 6 and E-REC 1); and
4. Facilitate the geographical mobility of workers by removing fiscal and
other distortions, including by promoting the rental market for housing
and removing rigidities in the availability of land for development (GL 7
and E-REC 3).
36In order to increase the low level of productivity, including by strengthening the
knowledge-based economy in terms of educational attainment and skill levels,
investment in IT, R&D and innovation perf ormance, Spain is recommended to (in
line with GL 9-14):
5. Step up efforts to increase skilled human capital, investments in R&D
and innovation, and ICT diffusion (GL 13); and
6. Continue to take measures to further enforce effective competition in
certain sectors, such as electricity and retail distribution (GL 9) and
pursue ongoing efforts to reduce administrative burden on business
(GL 11).
In order to ensure the long-run sustainability of public finances in the face of
population ageing, Spain is recommended to:
7. Implement a major reform of the pension system, beginning to undertake
a review in 2003, so as to strengthen the link between contributions and
benefits and control the long-term increases in pension expenditure linked
to the foreseen demographic changes (GL 16).
376. F RANCE
During the last few years, the French economy grew at a faster pace than its main
European partners. This performance is to be largely attributed to strong job
creation during a number of years, but it also reflects the impact of an
accommodative budgetary policy after 1999. According to recent Commission
calculations, potential real GDP growth still hovers slightly below 2.5%, close tothe average of the EU countries. The slow decrease of underlying inflation in the
last six months suggests that the economy is currently operating slightly below its
potential. Recent indicators suggest that real GDP growth is currently slowing
down in France as in other euro area countries.
In the coming years, potential output will start to be negatively impacted by the
developments in the demographic structure. However, there is still much scope
available for supporting potential growth through structural reforms both on the
labour market, by means of increasing labour market participation and reducing
structural unemployment, and on the product market, by improving effective
competition in key network industries. Strengthening the efforts towards fiscal
consolidation would create room for diminishing the tax burden weighing on
labour cost and investment, thereby contributing to raise potential output. After themarked deterioration in the cyclically-adjusted budgetary position in 2002, which
led to a deficit above the threshold limit of 3% of GDP, consolidating government
finances constitutes a major and urgent challenge for the French authorities, in
particular in view of the impact of the ageing population on public finances. The
challenges facing France are to:
/g183 Reduce rapidly the general government deficit to below 3% of GDP and keep
government finances on a steady consolidation path
/g183 Increase labour market participation and reduce structural unemployment
/g183 Ensure the long-term sustainability of public finances in the face of
population ageing
/g183 Ensure effective competition in the network industries and accelerate the
adoption of Internal-Market measures, in order to create a level playing field
Reduce rapidly the general government deficit to below 3% of GDP and keep
government finances on a steady consolidation path
The general government deficit reached 3.1% of GDP in 2002 in France. This
represents a large slippage compared to the initial objective set in the Finance law
for 2002 of a general government deficit of 1.4% of GDP. According to
Commission calculations, the deterioration in the 2002 budgetary position results
mainly from a worsening in the cyclically-adjusted budgetary position by some1.2 percentage point of GDP, due to the implementation of tax cuts and to overruns
in expenditures. These developments provide evidence on the existence of an
38excessive deficit in France, in the sense of the Treaty on European Union and the
Stability and Growth Pact. The Commission therefore has decided to initiate an
Excessive Deficit Procedure (EDP) in the case of France.
France is currently subject to a recommendation adopted by the Council in January
2003 with a view to giving an early warning in order to prevent the occurrence ofan excessive deficit in 2003. So far, France has not taken measures apt to improve
significantly the cyclically-adjusted budgetary position in that year as
recommended by the Council. As a consequence, in the current context of subdued
growth, the general government deficit will very probably exceed the 3% of GDP
ceiling in 2003. In view of these developments, and taking into account that thebudgetary burden arising from an ageing population will start increasing rapidly
from 2005 onwards, budgetary consolidation in France must be given strong
priority.
Increase labour market participation and reduce structural unemployment
A key medium-term challenge for the French economy continues to be the
structural problems in the labour market, as human resources, despite recent
progress, are still under-utilised. France still has a relatively low overallemployment rate (63.8% in 2002) and a very low employment rate for older
workers (among the lowest in the EU). In the context of an ageing population and
after a reduction in statutory working hours, the challenge is to encourage labour
force participation). Improvements in participation rates are to be achieved through
further tax and benefit reforms, as well as from reforms to early retirement schemesand pensions systems. France also needs to continue to reduce the high rate of
structural unemployment and, the mismatch between supply and demand, which is
posing recruitment problems in certain sectors. Reductions in labour cost,
especially for low-wage earners should be pursued. Labour market regulations
should be further reviewed,  especially by simplifying the enforcement ofemployment protection..
Ensure the long-term sustainability of public finances in the face of population
ageing
Government finances difficulties caused by the ageing population need to be
urgently addressed. Under current conditions, avoiding the rapid increase in thedeficit of the pension system, projected by the EPC to increase by 3.7 percentage
points of GDP between 2000 and 2040, would require substantial increases in
social security contributions. Such a development would increase considerably the
burden on labour with a strong negative impact on the labour market. The
government has committed itself to implementing a reform of the pension system,before the end of the first half of 2003, after consultation with the social partners.
Such reforms will help to ensure the sustainability of public finances in the long-
term. These reforms should be designed in such a way that ensures inter-
generational fairness and an equitable treatment across different schemes. In the
health sector, despite the recent adoption of structural measures designed to curb
the dynamic of spending, expenditures are still projected to increase notably in
392003 and in the years beyond. The government has indicated its intention to decide
on a reform of the health sector in the second semester of 2003.
The concern about long-term sustainability of public finances is all the more
pressing as France’s debt-to-GDP ratio is very likely to breach the 60% threshold
in 2003.
Improve the business environment, ensure effective competition in the network
industries and accelerate the adoption of Internal-Market measures, in order to
create a level playing field
While measures aimed at increasing the degree of market opening have been
recently taken or announced, effective competition in the French gas and electricitymarkets remains weak and the market shares of the state-owned incumbents are
still very high, especially when compared with those of their counterparts in the
other large Member States.
Business creation and growth are still hindered by the existence of different and
complex social and fiscal procedures. Although France has expressed its
commitment to increase the rate of transposition of internal market directives, it
continues to have the worst record amongst EU Member States in transposing andimplementing these directives.
Country specific recommendations to France
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
In order to reduce rapidly the general government deficit to below 3% of GDP and
keep government finances on a steady consolidation path, France is recommended
to:
1. Ensure that the situation of a general government deficit above the 3% of
GDP threshold is corrected by 2004 at the latest, namely through theadoption of measures leading to a significant improvement in the
cyclically-adjusted deficit already in 2003 (GL 1); and
2. As from 2004, lower the cyclically-adjusted deficit by at least 0.5
percentage point a year (GL 1). In particular, use any revenue made
available by stronger-than-expected growth to accelerate the adjustmentpath to a close to balance budgetary position, while the implementation of
tax cuts should be conditional upon the attainment of the cyclically-
adjusted deficit targets.
France should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way. Inorder to increase potential growth, ensure the long-term sustainability of public
finances, and address the effects of ageing, it is especially important for France to
40increase labour market participation and reduce structural unemployment. France is
in particular recommended to:
413. Ensure that the new unemployment insurance system is fully
implemented, including appropriate requirements and effective incentives
to search for a job (GL 4 and E-REC 1); and
In order to ensure the long-term sustainability of public finances in the face of
population ageing, France is recommended to:
4. Undertake with urgency a comprehensive reform of the pension system
(GL 16), with the aim of ensuring its financial sustainability and
increasing the effective retirement age, while adapting pension systems to
more flexible employment and career patterns as well as to individual
needs; and
5. Monitor closely the efficiency of the measures undertaken to curb the
dynamics of spending in the health sector so as to reduce it to a
sustainable level, and, if necessary, introduce new measures to achieve
this objective (GL 14).
In order to ensure effective competition in the network industries and accelerate the
adoption of Internal-Market measures, in order to create a level playing field
France is recommended to:
6. Ensure effective competition in energy markets, namely in gas and
electricity sectors (GL 9);
7. Sustain the efforts to reduce and simplify business regulations (GL 11);
and
8. Raise the transposition rate of Internal Market directives and bring down
the number of infringement proceedings (GL 9).
427. I RELAND
Irish economic growth averaged a spectacular 10% over the period 1995-2000. The
concomitant impressive rise in employment (5½% on average) was made possible
by significant increases in labour force participation, a dramatic drop in
unemployment and a reversal of the traditional net emigration pattern from 1996
onwards. As these sources of labour supply were exceptional, the economyincreasingly suffered from supply constraints (both regarding labour and
infrastructure) in the late nineties. As a result, and in line with the worldwide
downturn, the pace of expansion slowed  markedly from 2001 onwards. Looking
forward, Ireland should benefit strongly from the expected global recovery on
account of its high degree of openness. However, the era of double-digit growthhas ended and Irish potential GDP growth in the medium term is unlikely to exceed
5%, around double that in the EU as a whol e in view of a continuation, for the time
being, of higher labour force growth and stronger productivity gains.
Creating stable macro-economic conditions would facilitate the adjustment to this
slower pace of expansion and help preserve the successes achieved during the past
boom. Further, to ensure that economic potential is being exploited to the full,
structural measures should be taken to strengthen the supply-side of the economy,which would also help to contain inflationary pressures. The challenge facing
Ireland is to:
/g183 Achieve a smooth transition from double-digit economic growth in the late
1990s to lower, sustainable growth in the years ahead by ensuring stable
macroeconomic conditions and by strengthening the supply-side of the
economy
Achieve a smooth transition from double- digit economic growth in the late 1990s
to lower, sustainable growth in the years ahead by ensuring stable
macroeconomic conditions and by streng thening the supply-side of the economy
Thanks to rapid growth in the previous decade, both the public finance position and
the labour market situation improved considerably. The general governmentbalance was in surplus from 1997 to 2001, while the debt ratio is currently the
second lowest in the EU. Looking forw ard, the implementation of the public
investment programme and of social and health spending initiatives will have to
reflect the moderation of economic and, thus, revenue growth and the need to
improve value for money in public services delivery, (building on recent measuresto improve expenditure management and control). Strong employment growth
brought the unemployment rate down to below 4% in 2001 (from above 15% in
1993), but the increasingly tight labour market led to high rates of inflation and
wage growth. Maintaining full employment, the aim of the recently negotiated
social partnership agreement, requires a prudent and flexible approach in wagenegotiations and measures to strengthen the supply-side of the economy.
43Reform in three broad areas appears most promising in order to boost the supply-
side. First, the supply constraints experienced on the infrastructure front are being
addressed in the framework of the National Development Plan 2000-2006, but the
roll-out of the Plan has been slower than planned given rising construction and land
acquisition costs, as well as planning delays. Second, in spite of the high proportionof ICT value-added in the economy, R&D spending is low in Ireland (at 1.2% of
GDP in 1999). Ireland’s productivity would benefit from measures to raise R&D
spending. Third, while some progress has been made, there remains an insufficient
degree of competition in some sectors of the Irish economy, in particular the
network industries and several other service sectors (such as professional services,retail distribution and insurance).
Country specific recommendations to Ireland
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
Ireland should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way.
In order to achieve a smooth transition from double-digit economic growth in the
late 1990s to lower, sustainable growth in the years ahead by ensuring stable
macroeconomic conditions and by strengthening the supply-side of the economy,
Ireland is recommended to:
1. Enhance the efficiency of public expenditure and improve revenue and
expenditure planning in a stability-oriented medium-term framework
(GL 14);
2. Encourage the social partners to adhere to a prudent and flexible wage
norm to allow for adaptation to productivity and skill differentials and at
the same time safeguard competitiveness (GL 3 and 5);
3. Prioritise the roll-out of the infrastructural elements of the National
Development Plan, while preserving budgetary stability, and pursue
policy measures to raise the level of R&D (GL 13); and
4. Increase competition in the network industries and in certain sectors of
the economy, such as retail distribution (including the liquor trade),insurance and the professions (GL 9).
448. I TALY
Italy’s economic growth has generally lagged behind that of the EU since the early
1990s. While the growth differential has narrowed during the last cyclical
slowdown, inter alia because of a less restrictive policy mix, the rate of potential
output growth is still estimated to be below the euro area average. Despite this
relatively weak growth, consumer price inflation has typically been higher thanelsewhere in the euro area, signalling structural weaknesses. Persistently weak
potential output growth, together with a slackening of the fiscal adjustment effort
since 2000, has hampered the structural consolidation of public finances. In turn,
the very high public debt, via its impact on national saving and capital
accumulation, has hindered growth. Ongoing wage moderation and some importantreform steps starting in 1998 have significantly improved the performance of the
labour market, pushing the rate of unemployment below 9% at the end of 2002.
However, the rising contribution of labour to economic growth has been coupled
with a marked slowdown in total factor productivity partially attributed to the
increased participation of low-skilled labour, especially in the service sector. In
spite of significant improvements in the past years, participation rates are still
among the lowest in the EU.
Taken as a whole, Italy’s main problem remains low growth potential. Key factors
holding back potential growth include the still unresolved condition of public
finances, the persisting regional gap, especially in terms of the large share of
inactive or unemployed working-age population in the South, as well as drags on
total factor productivity such as the low levels of education and of R&Dinvestment. The challenges facing Italy are to:
/g183 Rapidly consolidate public finances
/g183 Ensure the long-term sustainability of public finances in the face of
population ageing
/g183 Raise the low employment rate, especially among women and older workers,
and reduce the wide North-South economic disparities
/g183 Strengthen the knowledge-based economy in terms of educational attainment
and skill levels, investment in IT, R&D and innovation performance
/g183 Continue to improve the business environment and to enhance competition in
the energy and services sectors
Rapidly consolidat e public finances
In the run-up to the creation of EMU and immediately thereafter, Italy’s fiscal
accounts improved remarkably. However, in more recent years fiscal consolidation
has slowed down, inter alia due to marked ly lower-than-expected growth, and to a
series of tax reductions. Keeping primary expenditures in check has proved
45problematic. In late 2002 and early 2003, the authorities adopted tighter controls
and more transparent spending procedures, which should lead to improvements in
future years. Ongoing decentralisation will require additional measures to clarify
and enforce fiscal responsibility at all levels of government, while maintaining an
adequate level of interregional transfers. The last few years have seen recourse tosubstantial sales of publicly-owned real assets and an array of tax amnesties. These
transitory measures, while staving off the risk of breaching the 3% of GDP deficit
threshold, have replaced more fundamental action. The medium-term objective of
cyclically-adjusted budget balance is, however, critical to placing public finances
on a sustainable footing, given moreover that the debt ratio remains above 100% ofGDP and the fiscal implications of a severely ageing population are looming.
Accelerating fiscal consolidation and reducing debt, and thus the present high debt
servicing costs, will also create margins for improving the quality of expenditure.
Ensure the long-term sustainability of public finances in the face of population
ageing
During the 1990s Italy took major steps to reform the pension system to avert
unsustainable expenditure trends. However, given adverse demographicprojections, ageing–related expenditure for healthcare and pensions is still
projected to rise in the next decade. Although designed to take into account the
effects of changes in life expectancy and in the long-term growth rate of the
economy, the new system might still be subject to significant financial imbalances
in the event of adverse demographic and economic events. On the basis of currentpolicies, the risk of unsustainable public finances in the light of ageing population
therefore cannot be excluded. In this context, the high debt ratio creates tight
constraints on fiscal policy, as primary surpluses in the order of 5% of GDP will
need to be maintained over a long period. Announced changes in the social security
system, while promoting privately-funded pension schemes, do not address criticalissues in the public pension system, such as the long transition to a new
contributions-based system. Moreover, the planned reductions in contributions for
newly hired workers could affect the long -term balance of the pensions system, if
not matched by corresponding reductions in workers’ entitlements.
Raise the low employment rate, especially among women and older workers, and
reduce the wide North-South economic disparities
Despite improvements in recent years, there remains an important gap between the
employment rates in Italy and the EU average, especially for women and older
workers. National targets have been set in these areas. Overall, the large share of
unutilised human resources chiefly reflects the persisting large regional gap, withthe North recording high participation rates and almost full employment on one
side and the South characterised by low participation and high unemployment on
the other. This relative gap has been persistent, even while absolute performance
has improved in both North and South. This may hide a large share of undeclared
work. The regional pattern of employment and unemployment is very similar to the
regional productivity differences, suggesting that the existing wage-bargaining
system may be insufficiently flexible in taking into account such regional
46differences. In addition, lower productivity in the South is also likely to reflect the
lower endowment of infrastructure. A further major weakness of the labour market
is the imbalance between flexibility and security. There has been growing recourse
to more flexible contracts, which enjoy a relatively low degree of protection vis-à-
vis the still strict protection of permanent jobs in medium and large firms. This hasentrenched a dual labour market structure, with insecurity at one end amplified by a
very limited system of unemployment benefits and social assistance, and relatively
underdeveloped active labour market policies. Further initiatives, which aim at
increasing flexibility at the margin, inter alia by introducing new labour contracts
and by liberalising employment services, were introduced by the government at thebeginning of 2003. Finally, the implementation of long standing plans such as the
lifelong learning strategy or the reform of the Public Service is lagging behind.
Strengthen the knowledge-based economy in terms of educational attainment
and skill levels, investment in IT, R&D and innovation performance
Despite some progress the knowledge-based economy in Italy remains
underdeveloped. While recently measures have been adopted to improve the
situation, educational levels remain relatively low, as is the availability of skilledhuman resources. Italy also ranks low in the area of Internet and e-commerce
access and use. Business innovation is weak: business R&D expenditures relative
to GDP (0.5% in 2000) and patent applications relative to population reach barely
half the EU average. The relatively large reliance of the Italian economy on small
and medium size enterprises is a contributory factor, as these companies often lackthe critical mass to carry out such activities.
Continue to improve the business environment and to enhance competition in the
energy and services sectors
While measures have been taken to reduce red tape and to improve the business
environment, administrative procedures for businesses remain rather costly andtime consuming. This contributes to making the Italian business sector relatively
less dynamic than that of other Member States, as measured by indicators on net
business creation.
Effective liberalisation of energy sector is proceeding only slowly. Incumbents
retain a dominant position in the market al though it is declining in the electricity
sector. Moreover, third parties’ access to the networks, while legally free, still
remains difficult. This contributes to electricity and gas prices remaining among
the highest in the EU. Competition in some service sectors is also being introduced
relatively slowly, notably in the area of professional services and local public
services. Finally, the rate of transposition of Internal Market directives deterioratedin 2002 and the number of infringements proceedings open before the European
Court of Justice is the second worst in the EU.
47Country specific recommendations to Italy
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
In order to rapidly consolidate public finances, Italy is recommended to:
1. Until a medium-term budget position close to balance or in surplus is
achieved, ensure a reduction in the cyclically-adjusted deficit of at least
0.5% of GDP per year (GL 1), replacin g one-off measures by measures of
a more permanent character;
2. Strengthen policy co-ordination between all levels of government, by
ensuring adequate and transparent enforcement mechanisms for fiscal
discipline, while providing for clear sources of financing regional
spending; and
3. Finance any further reduction in the tax burden through structural cuts in
primary expenditure.
In order to ensure the long-term sustainability of public finances in the face of
population ageing, Italy is recommended to:
4. Accelerate the reduction in the debt ratio so as to ensure that the debt is
sufficiently diminishing towards the 60% of GDP threshold (GL 15); and
5. Adopt further measures to address the critical issues in the public pension
system (GL 16), in particular the long transition period to the new
contributions-based system and the remaining vulnerability of the new
system to adverse demographic and economic events, and promotesupplementary privately funded pension schemes.
Italy should also vigorously implement all the Employment Recommendations (E-
REC), which deal with employment issues in a more comprehensive way. In order
to increase the growth capacity, ensure the long-term sustainability of public
finances, address the effects of ageing populations and reduce regional disparities,it is especially important for Italy to raise the low employment rate, especially
among women and older workers, and reduce the wide North-South economic
disparities. Italy is in particular recommended to:
6. Further encourage increased labour force participation, especially among
women, including by adequate provision of child-care facilities; and
among older workers, stepping up and reinforcing measures targeted atpostponing retirement from the labour force (GL 4 and 16 and E-RECs 3
and 4);
7. Further reform employment-protection legislation (GL 6), in order to
facilitate job creation and adaptability and to reduce the segmentation of
the labour market across type of contracts and firm size; and, at the same
48time, increase the resources and improve the efficiency of the
unemployment benefit and social assistance system (GL 4 and E-RECs 1
and 6); and
8. Encourage social partners to move towards more decentralised wage
setting mechanisms that allow wages to better reflect differentproductivity conditions and individual skill levels (GL 5).
In order to strengthen the knowledge-based economy in terms of educational
attainment and skill levels, investment in IT, R&D and innovation performance,
Italy is recommended to:
9. Pursue efforts undertaken to raise the overall education and skill base of
the population, to further increase in vestment in R&D and innovation and
to promote higher ICT take up, in particular through measures targeted at
small and medium enterprises (GL 13)
.
In order to continue to improve the business environment and to enhance
competition in the energy and service sectors, Italy is recommended to (in line with
GL 9 to 14):
10. Improve the business environment by reducing the administrative burden
on businesses (GL 11); and
11. Increase effective competition in the service sector, ensure the continued
opening up of the energy markets, and improve the implementation of
Internal Market directives (GL 9).
499. L UXEMBOURG
During the 1990s Luxembourg enjoyed very high rates of real GDP growth.
However, in 2001 the open economy of Luxembourg experienced a very sharp
slowdown, to a large extent due to th e external environment. The economic
downturn is also expected to lead to a worsening of public finances with a certain
lag. The budget surplus of 6.1% of GDP in 2001 is estimated to have decreased to2.6% of GDP in 2002 and deficits are forecast for 2003 and 2004. That said, the
situation of government finances in Luxembourg remains relatively favourable, in
view of the low level of debt and the existence of budgetary reserves.
Faced with the prospect of a lower rate of economic growth than experienced for
most of the 1990s, Luxembourg should attempt to raise its productive potential,while ensuring stability-oriented macro-economic policies as the basis for
sustainable growth. In order to promote growth and maintain sound public finances
it is necessary to increase labour supply, both as a means to reduce expenditure and
to increase tax revenues. To boost its productive potential, Luxembourg should
primarily address two key challenges in the area of labour market and product
market reform. The challenges facing Luxembourg are to:
/g183 Increase the low national participation and employment rates, especially for
older workers
/g183 Improve the business environment and encourage entrepreneurship in order to
achieve a more balanced economic structure
Increase the low national participation and employment rates, especially for
older workers
Labour force participation in Luxembourg is below the EU average; the
participation rates of older workers are particularly low. Employment growth hasbeen possible thanks to cross-border workers and increased participation of
national prime-age women, while virtually no progress has been achieved
regarding the employment rate of older workers, despite some measures
undertaken with the aim of increasing incentives to remain in the workforce.
Mobilising part of the unutilised national employment potential is of greatimportance to enhance labour supply and thus provide an impetus to growth.
Moreover, postponing withdrawal from th e labour market would decrease benefit
dependency, thereby reducing public expenditure on benefits and pensions.
Incentives to remain in the labour force could be improved by further reforms of
early retirement and pre-retirement schemes. Also the effects of the latest revisionsin the disability pension scheme should be closely monitored.
50Improve the business environment and en courage entrepreneurship in order to
achieve a more balanced economic structure.
Regulation in the Luxembourg economy is still fairly high, notably for prices, and
the reform aiming at modernising the competition framework has not yet been
implemented. Whilst the high openness of Luxembourg brings competition fromabroad, reforms to adapt domestic competition policy and their follow-up are
necessary to maintain the benefits of competitive economic conditions.
Over the last decade, Luxembourg's economy has developed a high degree of
specialisation in financial services. This situation has been so far beneficial to
employment and growth but also makes Luxembourg more vulnerable to possiblefuture sector-specific shocks. A more balanced economic structure based on small
and medium sized enterprises has the potential to decrease this dependency and to
raise the national labour force participation and employment rates.
Country specific recommendations to Luxembourg
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
Luxembourg should also vigorously implement all the Employment
Recommendations (E-REC), which deal with employment issues in a more
comprehensive way. In order to increase growth potential, it is especially important
for Luxembourg to increase the low national participation and employment rates,
especially for older workers. Luxembourg is in particular recommended to:
1. Review incentives for early and pre-retirement and ensure appropriate
eligibility rules in the disability pension scheme (GL 16 and E-REC 2).
In order to improve the business environment and encourage entrepreneurship to
achieve a more balanced economic structure, Luxembourg is recommended to:
2. Fully implement the reforms of competition law and to ensure that
competition and regulatory authorities have sufficient independence,
resources and power to fulfil their tasks (GL 9); and
3. Take measures to encourage and facilitate the creation of SMEs and to
help those to access venture capital (GL 11).
5110. T HE NETHERLANDS
From the mid-1990s to 2000, the Netherlands enjoyed rates of real GDP growth
clearly exceeding the EU average, while the harmonised unemployment rate
declined substantially to the second lo west level in the EU. From 2001 onwards,
the economy experienced a marked economic slowdown, which also led to a
significant worsening of public finances, and, with some delay, a deterioration inthe labour market. Expectations are that an economic recovery would be relatively
muted, while government finances are projected to deteriorate further in the wake
of the unfavourable macro-economic situation. In 2003, real GDP growth is
expected to remain below 1%, after a growth rate of only 0.3% in 2002. Potential
economic growth is estimated to have sl owed down to around 2 %, compared to 2
¼% in the rest of the EU. The weakened growth potential reflects a number of
factors, including a high incidence of people relying on social security benefits,
demographic trends, and a low level of competition in some sectors that hold back
labour supply and productivity, and losses in external competitiveness, which may
be partly attributed to sharp wage increases and insufficient business investment in
R&D and innovation over the past years.
Faced with the prospect of a lower rate of economic growth than experienced for
most of the 1990s, the Netherlands should attempt to raise its productive potential,
while ensuring stability-oriented macro-economic policies as the basis for
sustainable growth. To this end, the Netherlands has to address three key
challenges. The first key challenge addresses the sustainability of public finances
while the next two relate to reforms of labour and product markets intended tomobilise under-utilised resources and increase competition and productivity as
means to enhance economic growth. The challenges facing the Netherlands are to:
/g183 Pursue budgetary adjustment in the coming years in the face of weaker
potential growth, and the budgetary costs of ageing
/g183 Draw currently inactive people into the labour market
/g183 Tackle the relatively slow productivity growth, stemming, inter alia, from the
low level of competition in some sectors, and insufficient business
investment, particularly in R&D.
Pursue budgetary adjustment in the comin g years in the face of weaker potential
growth and the budgetary costs of ageing
The situation of public finance in the Netherlands has deteriorated recently from a
relatively favourable starting position, largely due to the sharp economic
slowdown. In 2002, the nominal and cyclically-adjusted general government deficitis estimated to have been around 1% of GDP. However, at present it is difficult to
assess fiscal policy in the coming years as no new government has yet been formed
following the Parliamentary elections of 22 January 2003. However, in the absence
of policy changes, the government balance is expected to deteriorate further in
52coming years. Thus, budgetary adjustment would be needed to achieve and
maintain a budgetary position close to balance or in surplus. In particular, it is
important that government expenditure is brought in line with the revenue basis,
reflecting the expected slowdown of th e potential rate of real GDP growth.
Draw currently inactive people into the labour market
Despite a favourable labour market situation, inactivity in the Netherlands is still
relatively high. Of particular concern is the high number of people currently on
disability benefits, and the unemployment traps in the social benefit schemes,
which continue to create disincentives for people to take up work. The substantial
size of the untapped reserve of labour is illustrated by the number of benefitclaimants, e.g. 7% of the labour force receives unemployment and social benefits
and 11% receive disability benefits. Further improvement of employment rates will
also depend on continued growth of female employment, and on a stronger
activation of older persons and minorities. Mobilising the unutilised potential of
labour supply is of primary importance in order to increase employment and
provide a substantial stimulus for growth.
Tackle the relatively slow productivity growth, stemming, inter alia, from the low
level of competition in some sectors, and insufficient business investment,
particularly in R&D
Productivity growth has been relatively slow in the Netherlands since 1999, with
levels falling further below the EU average in 2002. This may be partly attributed
to rapid employment growth and labour hoarding. Low productivity growth canalso be due, however, to the low level of competition in some sectors as well as the
low and declining specialisation of the Netherlands in high- and medium high-tech
manufacturing sectors. For example in construction, the Parliamentary Committee
found evidence of illegal price agreements in 2002. In network industries, reform
fatigue, partly stemming from perceptions that liberalisation has failed to benefitconsumers, has slowed down progress in tackling the still insufficient degree of
competition. The weakness of the regulatory regimes in liberalised sectors explains
in part why the benefits of reform have not yet materialised fully. Low investment
in R&D acts as a drag on productivity growth in the Netherlands. In the second half
of the 1990s, business investment in R&D was 10% below EU average and evenmore below that of neighbouring countries such as Belgium and Germany. A
particular problem is the low level of science and technology graduates aged 20-29,
who provide the principal source of the future stock of researchers.
Country specific recommendations to the Netherlands
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
53In order to pursue budgetary adjustment in the coming years in the face of weaker
potential growth, and the budgetary costs of ageing, the Netherlands is
recommended to:
1. Continue to contain government expenditure within clearly defined
ceilings set in real terms, consistent with a budgetary position close tobalance or in surplus (GL 1 and 14).
The Netherlands should also vigorously implement all the Employment
Recommendations (E-REC), which deal with employment issues in a more
comprehensive way. In order to increase growth potential, ensure the long-term
sustainability of public finances, address the effects of ageing populations andpromote inclusion in the labour market, it is especially important for the
Netherlands to draw currently inactive people into the labour market. The
Netherlands is in particular recommended to:
2. Push forward with reforms of benefit systems in order to make work pay
(GL 4 and E-REC 3). Concentrate, in particular, on benefit eligibility and
conditionality. Legislate and implement the planned reform of the
disability scheme, thereby paying attention to both the inflow and to theactivation of those who already receive benefits.
In order to tackle the relatively slow productivity growth, stemming, inter alia,
from the low level of competition in some sectors, and insufficient business
investment, particularly in R&D, the Netherlands is recommended to (in line with
GL 9 to 14):
3. Improve the regulatory framework as well as its implementation (GL 11),
especially in sectors where competition has been found to be inadequate,
such as construction and professional services; and
4. Promote a more technology oriented education and strengthen science-
industry links with the aim of increasing business investment in R&D(GL 13).
5411. A USTRIA
Since the 1970s, real GDP growth in Austria has on average been slightly higher
than in the EU. Potential output growth, however, is estimated to have been
declining since 1990 from above to below the EU-average. While in 1990 potential
output growth in Austria was estimated at 3.1% (compared with an EU average of
2.8%), it fell to 1.9% in 2002 (2.2% on average in the EU) and is projected to dropfurther. Population-ageing and barely rising labour force participation rates,
combined with below average total factor productivity growth, play a major role in
these subdued prospects. The same factors also weigh on public finances, with a
twofold impact: first, low potential growth is tantamount to foregoing revenues and
second, population ageing exerts upward pressure on spending. As expenditure cutsdid not break underlying spending pressures, the tax burden remained high in
particular since 1995 and peaked in 2001, implying the danger of setting in motion
the vicious circle of a high tax burden and slow growth. In order to ease the
constraints on public finances and resume above-average gains in incomes and
living standards, Austria should seek to strengthen incentives to hire, work and
invest. This in turn requires achieving and maintaining a budgetary balance at
lower ratios of taxes and expenditure to GDP.
A main factor holding back Austria’s growth potential are the negative
consequences on labour supply induced by generous social transfers and ample
provisions of public services, which, combined with the budgetary effects of
population ageing, resulted in a persistent upward pressure on public expenditure.
This, in turn, gives rise to a high tax burden, in particular on labour, while at thesame time discouraging labour force participation as well as on labour demand. In
addition, a feeble innovative capacity, in particular poor diffusion of technology,
thus resulting in a weak technology base, remains one of the fundamental problems
of the Austrian economy. Therefore, public spending could usefully be redirected
towards these growth-enhancing items. Moreover, a lack of competition in productmarkets appears to be an additional obstacle to more dynamic growth. The
challenges for Austria are to:
/g183 Ensure the sustainability of public finances in the face of population ageing
/g183 Continue to improve the weak technology base, and encourage business R&D
and innovation
/g183 Strengthen the development of effective competition in some sectors
Ensure the sustainability of public finances in the face of population ageing
Austria’s pension system is financed nearly exclusively on a pay-as-you-go basis,
although recent measures aim at strengthen ing privately funded systems. Despite a
reform in 2000 and fairly moderate benefit increases in recent years, the long-term
sustainability of the pension system is not ensured in view of the projected
population ageing. The adverse demographic dynamics is exacerbated by the - at
5558 years – low actual average effective retirement age and the very low
employment rates for older workers, despite the fact that the overall employment
rate already exceeds the EU target for 2005. Moreover, as pension benefits are
currently calculated on basis of only 15 – in the future 18 – working years with the
highest earnings, there is a weak link between contributions and benefits, and thecurrent level on pension spending as a share of GDP is one of the highest in the
EU. If the present system were to remain unchanged or to be modified only
marginally, the already high tax burden would need to increase further, with
negative consequences for labour supply and demand and, thus, for growth
potential. In December 2002, an expert group, the Pension Reform Commission,presented a comprehensive report, which elaborated on various options for reform.
Also the health care system, despite recent measures to contain spending, will
come under increasing financial strain.
The concern about long-term sustainability of public finances is all the more
pressing as Austria’s debt-to-GDP ratio remains above the 60% threshold, and
where a clear downward has trend not yet been established.
Continue to improve the weak technology base, and encourage business R&D
and innovation
Weak effective competition in some sectors has put too little pressure on the
business sector to innovate and to invest in research and development. The level of
R&D expenditures as a percentage of GDP is slowly increasing but remains below
the EU average and the share of business R&D progressively declined from around50% to about 40% since 1992. In addition, IT expenditures remain below the EU
average and the level of venture capital investment is amongst the lowest in the
EU. Besides a low degree of competition, the relatively heavy reliance of the
Austrian economy on small and medium sized enterprises contributes to explaining
these low levels of R&D and innovation, as these companies often lack the criticalmass to carry out such activities. To improve this weak technology base, Austria is
developing programs to offer financial and fiscal incentives to innovate and to co-
ordinate SMEs efforts. The growing number of patents and the good level of
tertiary graduates in science and technology are positive developments that could
be used as levelling tools.
Strengthen the development of effective competition in some sectors
Until the late 1990's, the relatively low degree of openness of the Austrian
economy, the long tradition of relying on social consensus and regulations, and the
need to involve social partners and Länder to achieve reforms act as constraints on
the competition framework. This has led to high concentration in certain sectorssuch as newsmagazines, food retailing, drugstores, health insurance, furniture
retailing, or network industries. The reform of the Austrian law on competition and
the establishment of an independent federal competition authority are recent
developments that could create a more competitive environment. However, the new
competition authority needs to establish itself and start its investigations. This
situation is made difficult by understaffing. In addition, sector regulators, such as
56in the telecommunications sector, sometimes lack the power to effectively enforce
their decisions, leading to long proceedings in Courts before a decision is made
effective.
Country specific recommendations to Austria
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general policy recommendations (GL) in part I of the Broad
Economic Policy Guidelines.
Austria should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way.
In order to ensure the sustainability of public finances in the face of population
ageing, Austria is recommended to:
1. Implement measures leading to structural expenditure savings, also at
lower levels of government, so as to lower the high tax burden, while
securing a cyclically-adjusted budgetary position close to balance (GL 1);
and
2. Reform the public pension system to ensure the sustainability of public
finances (GL 16); in particular link the level of pension benefits to life-long contributions; increase the low average effective retirement age and
ensure in this context that incentives to work are enhanced (GL 4 and E-
RECs 2 and 3), with a view to raising the labour market participation of
women and older workers;
In order to continue to improve the technology base and encourage business R&D
and innovation, Austria is recommended to:
3
. Take measures to encourage business research and innovation, especially
for SMEs, (GL 13).
In order to strengthen the development of effective competition in some sectors,
Austria is recommended to (in line with GL 9 to 14):
4. Increase the resources of the competition authority and to take measures
to enhance effective enforcement of regulators’ decisions in
telecommunications (GL 9).
5712. P ORTUGAL
In the 1995-2000 period, economic growth averaged 4%, driven by strong
domestic demand. Since 2001, economic activity has been decelerating under the
influence of cyclical weakness in Europe. This development has been accentuated
by the ongoing correction of the macroeconomic imbalances that emerged in the
second half of the 1990s, notably a significant external deficit, and unsatisfactoryprogress in fiscal consolidation, leading to a major budgetary slippage in 2001. The
measures taken in 2002, notably the adoption of a rectifying budget, represent a
first step towards narrowing the above-mentioned imbalance. In 2003, weak
international developments and further adjustment in households’ demand should
contribute to economic growth remaining below 1% for a second consecutive year,well below potential growth which is estimated at around 2¾% - 3% (about ½
percentage point above the EU average). This positive growth differential is
somewhat misleading, because it largely reflects a strong rise in the growth of
factor inputs, accompanied by only small gains in total factor productivity. Low
productivity growth in Portugal is mainly a structural problem, associated with the
low efficiency of the education system, insufficient competition, low spending on
R&D, and weak ICT diffusion. In combination with relatively high nominal wagegrowth, Portugal’s competitiveness has therefore gradually been eroded.
The budgetary consolidation strategy defined in the latest update of the stability
programme rests to a large extent on the successful implementation of
comprehensive structural reforms. Given the intention to lower over the
medium-term the total revenue-to-GDP ratio, reflecting the planned reduction incorporate taxes in order to strengthen the international competitiveness of the
Portuguese economy, this leaves only one road open to ensure budgetary
consolidation on a sustainable basis. This is the restraint of current primary
expenditure growth, which in turn requires the implementation of structural
reforms. Another major aim of the envisaged reforms is to enhance the growthpotential of the economy, through policies to secure a sustained improvement in
total factor productivity. The challenges facing Portugal are to:
/g183 Accelerate the consolidation of public finances and address the strong
dynamics of government expenditure
/g183 Increase overall competitiveness which is at risk from the low efficiency of
the education system, low R&D spending, a low degree of competition in
certain sectors, and high nominal wage growth
/g183 Ensure the long-term sustainability of public finances in the face of
population ageing
58Accelerate the consolidation of public finances and address the strong dynamics
of government expenditure
In the period that led to the budgetary slippage of 2001, the rate of growth of
current primary expenditure was consistently above that of nominal GDP.1 For
most of the second half of the 1990s, this was compatible with the pursuit ofbudgetary consolidation as buoyant domestic demand boosted tax revenues.
However, this pattern of budgetary consolidation came to an end with the
deterioration in cyclical conditions in 2001, and the disappearance of the
dampening effect on interest expenditures caused by the convergence of interest
rates to the lower levels prevailing abroad. Budgetary consolidation resumed in2002, although due to the usual lags associated with the implementation of
structural adjustments, it had to rely greatly on the adoption of one-off measures. In
the short-term, the adoption of non-recurrent measures is necessary to regain the
lost momentum in budgetary consolidation and to reinforce policy credibility,
thereby buying time for the government's expenditure-releasing structural measures
to take hold.
In order to accelerate the consolidation of public finances and address the strong
dynamics of government expenditure, a determined and timely implementation of
the structural reform measures announced in the January 2003 update of the
stability programme is required. Reforms in key areas, notably in public
administration, education, healthcare, and social security, are likely to have a direct
impact on budgetary consolidation. Other reforms (for instance in the labourmarket) are likely to have an indirect impact on budgetary consolidation, either by
fostering a more efficient use of resources, or by broadening the tax bases as a
result of successful supply-side policies.
Increase overall competitiveness, which is at risk from the low efficiency of the
education system, low R&D spending, a low degree of competition in certainsectors, and high nominal wage growth
The weak productivity performance and high nominal wage growth have both
contributed to the deterioration observed in Portugal’s external competitiveness.
First, labour productivity in Portugal is the lowest in the EU and is growing slowly.
The main reason for this is the low average level of education attainment also forthe younger age groups. The insufficient levels of investment in R&D and
innovation by the business sector and the weak ICT diffusion also deprive Portugal
of an important source of productivity gains. The low leverage effect of R&D
public financing over private investment  in R&D and innovation is a sign of
inefficiencies in the national research and innovation system. Insufficientcompetition in network industries is another key restraint. Second, nominal wage
growth has increased by around 6% a year during the last 10 years (double that of
the EU 15), even if a certain wage moderation has been noticed in recent years.
                                                
1In the 1995-2001 period, current primary expenditure increased by 9% per year,
while nominal GDP grew by 7.2% per year; consequently, the current primaryexpenditure-to-GDP ratio rose from 33.4% in 1995 to 36.7% in 2001.
59Although Portugal has increased spending on education substantially in recent
years, the share of early school-leavers without upper-secondary education and not
in training is by far the highest in the EU.2 A breakdown of education expenditure
by main categories shows that a relatively high fraction goes into the wage bill
compared with other developed countries, suggesting an inefficient use ofresources. Despite recent progress, the level of vocational training is significantly
below the EU average. It has proved difficult to involve small enterprises in the
national programmes designed to upgrade the skills of their staff.
Ensure the long-term sustainability of public finances in the face of population
ageing
The challenges posed to the long-term sustainability of public finances reinforce
the need of securing a fast pace of debt reduction prior to the budgetary impact of
population ageing taking hold. For this, it is crucial to successfully complete the
process of budgetary consolidation, reaching a budget position of close-to-balance
or in surplus by 2006 as envisaged in the January 2003 update of the stability
programme of Portugal and sustaining it thereafter. This is a necessary, but not
sufficient, step to ensure the sustainability of public finances. It must besupplemented by the determined implementation of a number of structural reforms
in order to curb the growth of age-related expenditures, and to raise to the overall
growth potential of the economy.
Country specific recommendations to Portugal
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
Portugal should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way.
In order to accelerate the consolidation of public finances and address the strong
dynamics of government expenditure, Portugal is recommended to:
1. Secure that the government deficit is further reduced in 2003 as planned,
and that the cyclically-adjusted deficit is thereafter lowered by at least
0.5% of GDP a year in order to reach a budget position that is close to
balance (GL 1);
2. Ensure that the deficit reduction is obtained mainly through the
expenditure side by firmly executing budgetary plans for all sub-sectors
of the general government (GL 14); and
3. Undertake structural reforms in areas with a more direct impact on
budgetary consolidation, notably in public administration, education,healthcare, and social security.
                                                
245.5% in 2002 for both genders, and 52.9% for males.
60In order to increase overall competitiveness, which is at risk from the low
efficiency of the education system, low R&D spending, a low degree of
competition in certain sectors, and high nominal wage growth, Portugal is
recommended to (in line with GL 9-14):
4. Promote the stronger involvement of the business sector in R&D
spending and innovation (GL 13), together with higher ICT take-up;
5. Improve the efficiency of spending in education with a view to, inter alia ,
raising the qualification of human resources (GL 13 and E-REC 1), and
reducing substantially the number of early school-leavers with
insufficient levels of schooling or training;
6. Enhance effective competition in liberalised utilities, especially in the
energy sector, and create a better competitive environment by increasing
the transposition rate of internal market directives (GL 9); and
7. Encourage the social partners to secure wage moderation, while allowing
wage increases to take into account productivity and skill differentials,
with a view to improving competitiveness (GL 3 and 5).
In order to ensure the long-term sustainability of public finances in the face of
population ageing, Portugal is recommended to:
8. Increase the efficiency of the healthcare system by introducing a wide
range of measures that strengthen market mechanisms and rationalise
demand (GL 14); and
9. Adopt further reforms to the pension system for workers in the general
government sector to secure its long-term sustainability and in order to
progressively align it with the pension regime for private sector workers
(GL 16).
6113. F INLAND
Sustained efforts during the 1990`s towards producing and using information and
communication technology has transformed Finland into one of the leading – if not
the most – knowledge-based economies in the world. This contributed, alongside
market liberalisation, to real GDP expanding during the second half of the 1990`s
at an annual rate of nearly 5%, i.e. well above potential (of around 3%). The slumpin external demand, and particularly in the telecom sector, since 2000 caused
output growth to fall below its potential. With domestic demand holding up,
activity could move close to potential by 2004, in line with improving external
conditions.
The current overall unemployment rate of just above 9% of the labour force in
2001-02 appears to be mainly structural. The employment rate for older workers
has risen rapidly since the 1994 trough, but is still over 20 percentage points lower
than that for all employees. These two factors together with fairly lengthy periods
spent in education and the ageing population are becoming obstacles to reaching
the government’s target of raising the overall employment rate to close to 70%.
The price level in Finland exceeds that of the EU average by almost one-fifth, in
spite of recent moderation in headline inflation, suggesting deficiencies incompetition, in particular in sheltered service sectors. Furthermore, the financing of
welfare services requires a fairly high level of taxation, which may be difficult to
maintain in view of erosion in tax bases, and enhanced tax competition. The need
for keeping a heavy tax burden could be eased by the absence of expenditure
overruns observed in central government spending. The challenges facing Finlandare to:
/g183 Reduce the high level of structural unemployment and increase the
employment rate of older workers
/g183 Enhance competition in certain sectors and improve the efficiency of the
public sector
Reduce the high level of structural une mployment and increase the employment
rate of older workers
Finland exceeds the overall and female employment targets for 2005 for the EU as
a whole, as well as the Lisbon target for the female employment rate for 2010, but
the government’s goal of an employment rate of close to 70% is not yet reached.
This will become very difficult to achieve, due to demographic constraints. Thus,
an increase in the employment rate and in the labour supply will require that olderworkers remain longer in the labour market. The overall unemployment rate fell by
7½ percentage points from its peak of 1994 to 9.1% in 2002 (but was unchanged
from 2001 reflecting sluggish economic activity). Most estimates indicate a
NAIRU of about 8-9%, thus suggesting th at the registered unemployment rate is
mainly structural. The government has recently introduced several measures bothto improve the employability of the unemployed and to boost labour supply among
62older workers. Measures have been initiated, inter alia, to reduce the high tax
burden on labour, to target active labour market programmes, to tighten the
eligibility rules for early retirement, and to abolish the 60% ceiling for the accrual
of the pension rights. These steps are welcome, but not sufficient, and some of the
steps taken work in the opposite direction, notably more generous unemploymentbenefits and allowing access to the unemployment pension scheme to continue up
to 2008. Moreover, the phasing-in period for certain measures of the pension
reform appears somewhat protracted, delaying the positive impact of the reforms
on containing the pension expenditure.
Enhance competition in certain sectors an d improve the efficiency of the public
sector
Enhancing competition could help to lower the Finnish price level, which is one of
the highest in the EU, and to improve productivity, which is around the EU
average. This high price level can only be partly explained by high indirect taxes,
the remoteness of the country and low population density. Investigations by the
national Competition Authority point to lack of competition in some sectors, e.g. in
network industries. The relatively feeble overall level of labour productivity for acountry advanced in the transition towards a knowledge-based economy could also
be due to the large public sector and the limited competition for the provision of
public services. Government reports show that there are potential efficiency gains
in the public sector, which could have large positive effect on the sustainability of
public finances.
Strong economic activity during the second half of the 1990`s generated sizeable
revenues, in particular from corporate and capital income, although they have
recently returned to normal. While this provided some leeway for additional public
spending, slippage over government spending targets on the one hand, and over-
reliance on the exceptionally high tax intake on the other hand, are becoming a riskto the current healthy financial position of central and local government finances.
A more efficient use of current resources and containment of government spending
would provide some leeway for responding to pressures for maintaining the level
of financing of the current services.
Country specific recommendations to Finland
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
63Finland should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way. In
order to increase growth potential, it is especially important for Finland to reduce
the high level of structural unemployment and increase the employment rate of
older workers, Finland is in particular recommended to:
1. Improve incentives in tax and benefit systems further to make work pay,
in particular by addressing their combined effects on older workers,
continue to reform the eligibility criteria, improve the administration of
benefit systems and target the tax measures on low-paid labour (GL 4 and
E-REC 2); and
2. Seek possibilities to ensure that wage bargaining systems allow wages to
better reflect productivity differences across skills in order to improve the
job prospects of low-skilled unemployed (GL 5)
In order to enhance competition in certain sectors and improve the efficiency of the
public sector, Finland is recommended to (in line with GL 9-14):
3. Step up efforts to enforce competition in network industries and non-
tradable services (GL 9);
4. Make further efforts to increase the efficiency of the public sector, inter
alia by improving the framework conditions for increased competition,
promoting the benchmarking of public sector efficiency and by increasing
public tendering (GL 11); and
5. Improve mechanisms to help control spending and ensuring compliance
with rules on expenditure (GL 14).
6414. S WEDEN
Sweden has experienced relatively high economic growth in recent years and has
shown some resilience to the weak level of global activity. In particular,
unemployment has remained low and public finances sound. The sound fiscal
position has permitted Sweden to ease its fiscal stance in order to counter the
downturn. The overall Swedish fiscal strategy of sustaining high surpluses in thelonger term, underpinned by a budgetary framework of ensuring tight expenditure
control, is expected to result in the continuation of a fiscal position ‘close to
balance or in surplus’ in the coming years. Inflationary pressures are expected to
continue to be in line with the inflation target range of 2% /g1771 percentage point
guiding monetary policy, underpinned by the gradual closing of the output gap.
The Swedish welfare state is the most comprehensive in the Union, with both the
overall tax burden
3 and public expenditure exceeding 50% of GDP. This reflects
social priorities, which generally enjoy widespread support. In order to safeguard
the achievement of placing the public finances on a sustainable path, it is important
to ensure an efficient use of public resources, not least as an ageing population willput a further upward pressure on expenditures. Furthermore, measures to enhance
competition are necessary to address the high price levels and low labour
productivity. In addition, and while Sweden ranks high in terms of employment
rates, increasing labour force participation and fostering employment still remains
a key challenge in order to sustain the financing of the welfare state in the longerterm. The challenges facing Sweden are to:
/g183 Ensure an adequate labour supply in view of the ageing of the population
/g183 Enhance competition in certain sectors and improve the efficiency of the
public sector
Ensure an adequate labour supply in view of the ageing of the population.
Employment rates are already very high in Sweden, and well beyond the Lisbon
targets for EU as a whole, including for women and older workers, and thegovernment has set a target to increase the employment ratio further. In view of the
ageing population, there will be a need to increase labour supply, in particular by
exploiting potential sources of labour among immigrants, the young and the long-
term sick. Additional efforts appear necessary to improve further the incentives to
work, notably as Sweden still has the highest overall tax burden in the EU andrelatively generous benefit schemes in an international perspective. The
comprehensive Swedish welfare state involves a long-term challenge for the
Swedish economy. Its financing implies a continued high overall tax burden and
                                                
3Payments from public insurance schemes are taxed in Sweden. This ‘institutional
aspect’ in Sweden results in a higher tax burden as measured by the Commissionservices.
65therefore also a substantial tax wedge with adverse effects on the incentive
structure. To this end, reducing the most distortionary elements of the tax and
benefit systems would be beneficial for growth and employment. Reducing the
number of persons receiving various benefits is also important with regard to
public finances. The problematic situation with extensive recourse to sick-leaveand early retirement deserves particular attention, not least as the associated
budgetary costs are high. The government has set targets to halve the number of
persons receiving social assistance by 2004 and to halve the number of days of sick
leave by 2008. However, these targets might not be met on the basis of current
policies.
Enhance competition in certain sectors an d improve the efficiency of the public
sector
Enhancing competition could contribute to lower the Swedish price level, which is
one of the highest in the EU, and to improve productivity, which is below the EU
average. The high price level can only be partly explained by high indirect taxes,
the remoteness of the country and low population density. Competitive
shortcomings are found in the private sector, as evidenced by the fact that theSwedish price level remains more than 20% above the EU average. A study from
the Swedish Competition Authority concludes that around half of this difference is
explained by insufficient competition. In particular, price levels are markedly
higher in retailing, housing, construction and non-tradable services.
Sweden has one of the largest public sectors in the EU, which could be one reason
for the low labour productivity. Public operators are starting to concede market
shares in the area of public services provision, but private operators still only
represent a small share of employment in welfare services. Increased efficiency in
the provision of public services is important in order to ensure that the population
gets value for money.
Country specific recommendations to Sweden
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
Sweden should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way. In
order to increase growth potential and ensure the long-term sustainability of public
finances, it is especially important for Sweden to ensure an adequate labour supply
in view of the ageing of the population, Sweden is in particular recommended to:
1. Pursue further the reforms of tax and benefit systems to improve work
incentives, in particular for those groups with high marginal effective
taxes (GL 4 and E-REC 3), and complete the tax reform on labour
income while maintaining sound public finances.
66In order to enhance competition in certain sectors and improve the efficiency of the
public sector, Sweden is recommended to (in line with GL 9-14):
2. Step up efforts to enforce competition in sectors where competition is
inadequate (GL 9); and
3. Make further efforts to increase the efficiency of the public sector, inter
alia by improving framework conditions for increased competition,
promoting the benchmarking of public sector efficiency, and by
increasing public tendering (GL 11).
6715. U NITED KINGDOM
The UK economy has enjoyed almost a decade of sustained output growth.
Inflation is among the lowest in the EU a nd unemployment is at a 27-year low. The
underlying outlook is broadly positive, but there are appreciable downside risks.
Among these is the possibility of an abru pt slowdown in the growth of household
consumption from recent high levels, as households begin to adjust to lower grosswealth as a result of the recent equity market slump. So far, the sector has been
cushioned by continued rises in housing wealth, although the most recent indicators
point to a slowdown in house price inflation. The public finances moved into
deficit of 1.3% of GDP in 2002 and a deficit is expected to persist in both 2003 and
2004 – partly for cyclical reasons associated with low financial company profitsand planned rises in current and capital expenditure relative to GDP, the latter
aimed at rectifying historical under-inve stment in public infrastructure. The UK
has made further progress on the labour market in recent years, with further
reforms of tax and benefit systems and the development of a range of targeted
active measures. Labour market performance remains among the best in the EU
with unemployment at around 5%. In particular, despite the relatively tight labour
market, wage pressures are subdued and are expected to remain that way. All in all,HICP inflation is projected to average under 2% in 2003 and 2004.
The relatively low level of productivity, resulting inter alia from low basic skills
among some categories of worker, remains a key challenge. Labour productivity is
below the EU average although the gap has been declining since 1995. At the same
time, expenditures on R&D as a percentage of GDP are just below the EU average.A second key challenge is to address the high numbers of working-age people
claiming sickness and disability benefits, which may be an obstacle to a further
increase in labour supply. The third key challenge is to improve the quality and
efficiency of UK public services. The challenges facing the United Kingdom are
to:
/g183 Improve the relatively low level of productivity
/g183 Address the high numbers of working-age people claiming sickness and
disability benefits and sustain labour supply in the longer term
/g183 Improve the quality and efficiency of public services
Improve the relatively low level of productivity
The UK’s level of productivity is historically weak compared to the EU average.
Although the productivity gap with the EU ha s been declining in recent years, UK
labour productivity was still below the EU average in 2002. The UK’s productivitygrowth may have been slowed by low-skilled people entering employment in
recent years. However, other structural factors are important for raising the UK’s
productivity performance such as competition, entrepreneurship, science and
innovation, skills and investment. The UK government has taken many measures in
68recent years to increase productivity, but it will take time for the full effects of
these measures to feed through into the productivity statistics, and further measures
may be needed. The recently strengthened competition policy will need to be
applied rigorously, in particular, to the professions and pharmacies, where the
Office of Fair Trading has found that regulations inhibit the level of competition,and postal services, where the incumbent has had a monopoly until recently.
Measures to promote R&D and skills should also contribute to higher productivity.
Address the high numbers of workin g-age people claiming sickness and
disability benefits and sustain labour supply in the longer term
The UK exceeds all of the employment ta rgets set by the European Council, with
an overall employment rate of 71.6% in 2002 and rates of 65.3% and 53.5% for
women and older workers. Unemployment was 5.2% in 2002. The UK has made
further progress on the labour market in recent years, with further reforms of tax
and benefit systems and the development of a range of targeted active measures.
However, high employment rates are accompanied by relatively low levels of
productivity, in part due to both insufficient levels of basic skills and a lack of
access to training among some categories of worker. The number of working-agepeople claiming sickness and disability benefits remains high at just over 3 million,
of which 2.7 million claim income-replacement benefits, which may limit the
scope for further increases in labour supply. Although overall unemployment
remains well below the EU average, there are significant disparities in terms of
access to the labour market with concentrations of inactivity and unemployment incertain localities and among disadvantaged social groups.
Improve the quality and efficiency of public services
Rising demand and higher expectations of service quality have put pressure on the
delivery of public services. In addition, public services have suffered from under-
investment in the past. These developments have manifested themselves inproblems such as waiting lists, deteriorating infrastructure and staff shortages in
some areas. Therefore, the UK government has budgeted for a large increase in
expenditure on public services. Under-investment in the public infrastructure is
being addressed, with public sector net investment expected to more than double in
real terms from 2000-01 to around 1.4% of GDP by 2002-03, rising further to 2.0%of GDP by 2005-06. Moreover, education spending is planned to grow by 5.9% per
year in real terms until 2005-06 and healthcare spending is planned to grow by
7.4% per year in real terms over the same period. The UK government has
recognised the need to accompany the increases in expenditure with reforms
designed to ensure that these resources are used and allocated efficiently andeffectively, that consumers receive higher quality public services and that both
consumers and taxpayers receive best value for money.
69Country specific recommendations to United Kingdom
Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part I of the Broad Economic Policy
Guidelines.
In order to improve the relatively low level of productivity, the United Kingdom
is recommended to (in line with GL 9 to 14):
1. Continue to improve competition in sectors like the professions, postal
services and pharmacies (GL 9);
2. Monitor closely existing measures to promote R&D (GL 13); and
3. Review and strengthen, where appropriate, policies aimed at improving
basic skills in the work force (GL 13).
The United Kingdom should also vigorously implement all the Employment
Recommendations (and E-REC), which deal with employment issues in a more
comprehensive way. In order to increase growth potential and to promote labour
market inclusion, it is especially important for the United Kingdom to address the
high numbers of working-age people claimi ng sickness and disability benefits and
sustain labour supply in the longer term . The United Kingdom is in particular
recommended to:
4. Ensure that all those who are able to work have the opportunities and
incentives to do so, in particular by reforming sickness and disability
benefit schemes (GL 4 and E-REC 3).
In order to improve the quality and efficiency of public services, the United
Kingdom is recommended to:
5. Ensure that the public services associated with the announced increases in
public expenditure (including investment in the transport infrastructure)
are delivered efficiently and with a view to ensuring cost-effectiveness
(GL 11 and 14).