Council Recommendation of 21 June 2002 on the broad guidelines of the economic policies of the Member States and the Community
Date: 2002-06-21
Institutions: Council of the European Union
Subjects: EU Member State, action programme, economic analysis, economic planning, economic policy, recommendation

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II

(Acts whose publication is not obligatory)

COUNCIL

COUNCIL RECOMMENDATION

of 21 June 2002

on the broad guidelines of the economic policies of the Member States and the Community

(2002/549/EC)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community, and in particular to Article 99(2)
thereof,

Having regard to the recommendation from the Commission,

Having regard to the discussion by the European Council on 21 June 2002 in Seville,

Whereas a Resolution on the recommendation from the Commission was adopted by the European
Parliament,

HEREBY RECOMMENDS:

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TABLE OF CONTENTS

I. General economic policy guidelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2. Main priorities and policy requirements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.1. Economic recovery is taking off . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.2. Key challenges ahead . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3. Policy recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.1. Ensure growth- and stability-oriented macroeconomic policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.2. Improve the quality and sustainability of public finances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.3. Invigorate labour markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.4. Re-ignite structural reform in product markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.5. Promote the efficiency and integration of the EU financial services market . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.6. Encourage entrepreneurship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.7. Foster the knowledge-based economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.8. Enhance environmental sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

II. Country-specific economic policy guidelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1. Belgium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2. Denmark . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3. Germany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4. Greece . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5. Spain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6. France . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7. Ireland. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8. Italy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9. Luxembourg . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10. Netherlands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11. Austria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

12. Portugal

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13. Finland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

14. Sweden . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15. United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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4

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9

11

12

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19

20

20

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24

27

29

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33

35

38

39

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42

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I. GENERAL ECONOMIC POLICY GUIDELINES

1.

INTRODUCTION

The EU has a well-defined economic policy strategy that is oriented towards the pursuit of growth-
and stability-oriented macroeconomic policies, capable of adequately responding to changing
economic circumstances in the short run, and towards improving the long-term capacity for sustain-
able, job-creating and non-inflationary growth. The 2002 Broad Economic Policy Guidelines (BEPGs)
adapt and update this strategy in the light of the political orientations of the Barcelona European
Council
(15 and 16 March 2002), also taking into account the development of the sustainable
development strategy. They have been drawn up against the background of the examination of the
implementation of the 2001 BEPGs and the assessment of the economic situation and outlook as
presented in the Commission's Spring 2002 Economic Forecasts.

Section 2 sketches the economic background to these guidelines and identifies the key economic
policy challenges. Section 3 then describes the general policy recommendations that are applicable to
all Member States and the Community. Within the overall strategy, policy priorities differ somewhat
across Member States due to differences in economic performance, prospects, structures and institu-
tions. Taking due account of them, Part II presents the country-specific economic policy guidelines.

In line with continued efforts to draw lessons from experience for strengthened coordination, and in
line with the Barcelona European Council's urge to streamline relevant processes and to focus on
action for implementation rather than on the annual elaboration of guidelines, the format and
frequency of the BEPGs may change as from 2003. Against this background, the 2002 BEPGs opt for
continuity with the previous year's edition.

2. MAIN PRIORITIES AND POLICY REQUIREMENTS

2.1. Economic recovery is taking off

The EU economy was in 2001 marked by a sharp and unexpected slowdown in economic activity.
Macroeconomic policies were put to the test and employment growth decelerated.

However, there are now increasing signs that the economy has stabilised and is already picking up.
The response of economic policy, sound fundamentals, an improvement in confidence, and in external
demand, allied with the unwinding of the impact of a series of adverse economic shocks, have
provided the platform for this recovery. The smooth introduction of the euro in 1999 and the notes
and coins in 2002 brings a welcome note of stability and confidence. Notwithstanding persisting
downside risks and uncertainty, expectations are that the EU economy would gather strength to reach
a growth rate close to or above potential in the second half of 2002 and into 2003, i.e. at the time
when the recommendations in these guidelines are to be implemented.

As labour market developments reflect the economic situation with a lag, employment and unemploy-
ment trends are unlikely to improve visibly before 2003. It is expected that inflationary pressures
remain contained over the medium term and that, in the course of 2002, HICP inflation will stabilise
at levels around 2 %.

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2.2. Key challenges ahead

The main challenge for economic policy in the EU is to improve the well-being of its current and
future citizens. To this end, policies should be geared at achieving a balanced and sustainable
expansion of economic activity. The Lisbon European Council has reflected this main challenge in the
overarching objective of making Europe the most competitive and dynamic knowledge-based
economy by the year 2010, capable of sustainable growth with more and better jobs and greater social
cohesion.

Sound fundamentals, appropriate economic policies, and the absence of major economic imbalances
put the economy in a good starting position. Progress in structural reforms to date has contributed to
the improved economic performance and job creation over recent years. The challenge is now to build
upon these achievements and to further strengthen the basis for future growth. The imminent
enlargement makes it all the more urgent for the EU to be sufficiently dynamic and flexible.

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Despite the progress already made, the rate of potential growth has to be increased in order to give the
economy leeway for a full-blown recovery before capacity constraints result in upward price pressures.
Moreover, in the long run, when labour supply will get tighter as the effect of ageing populations sets
in at full force, the potential growth rate would tend to decline in the absence of measures to
accelerate productivity and enhance labour force participation and employment.

The pace of economic reform needs to be stepped up to attain a stronger economic performance and
to meet the challenges set by the Lisbon agenda so as to regain the conditions for full employment.
(i) safeguarding and further strengthening the
Action would have to concentrate on four areas:
macro-economic framework; (ii) promoting more and better jobs, raising labour force participation
and addressing persistent unemployment; (iii) strengthening conditions for high productivity growth;
and (iv) promoting sustainable development in the interest of current and future generations.

(i) Safeguarding and further strengthening the macroeconomic framework

Safeguarding and further strengthening the macroeconomic framework facilitates an appropriate policy
stance in all economic circumstances, thereby providing an environment in which sustainable and
stable macroeconomic growth is ensured, economic cycles are smoothed and internal dynamism and
resilience are reinforced. Such an environment underpins medium-term growth, a culture of entrepre-
neurship and innovation and increases prosperity, as the economy can benefit fully from progress with
economic reforms.

The recent economic downturn has underlined the importance of a clear policy framework and a quick
transition to the medium-term budgetary positions agreed in the context of the Stability and Growth
Pact (SGP).

A strong macroeconomic policy framework

The primary objective of monetary policy in the euro area is to maintain price stability. Without
prejudice to this objective, it supports the general economic policies in the Community. By main-
taining price stability, monetary policy plays an important role both in stabilising output around its
trend rate and in creating an environment conducive to strengthening the economy's supply side and
potential growth. The commitment to price stability has fostered a culture of stability, reducing
uncertainty and creating favourable conditions for wage moderation, thereby providing a necessary
basis for an investment-friendly environment. The very stable inflation expectations of below 2 % bear
witness to this.

A sound budgetary policy is the second pillar of the macroeconomic framework in the EU. As a
general principle, it is important that budgetary policies be guided by the need to avoid pro-cyclical
stances, which can exacerbate swings in economic activity, lead to unsustainable structural balances
and undermine the price-stability orientation of the single monetary policy. Given the risks and
uncertainties of fiscal fine-tuning, notably in regard to timing, efficiency and its irreversibility, the
norm for budgetary policies should be to allow for the symmetric play of automatic stabilisers over the
economic cycle, subject to the respect of the 3 % of GDP excessive deficit limit. Besides providing
leeway for the free and symmetric play of automatic stabilisers, medium-term budgetary positions that
are close to balance or in surplus allow for a steady decline in government debt and interest payments
relative to GDP, thereby enhancing the sustainability of public finances and the capacity to deal with
budgetary challenges, inter alia, those stemming from ageing populations. Moreover, Member States
that would wish to make use of discretionary policy should create the necessary room for manoeuvre.
The basic policy philosophy is anchored in the Stability and Growth Pact, which facilitate the task of
monetary policy to maintain price stability and thereby fosters conditions conducive to economic
growth and continued employment creation.

Close coordination of economic policies among policy actors and continuous and fruitful dialogue
between the Council, the Eurogroup, and the ECB, involving the Commission and respecting all aspects
of the independence of the ESCB are essential in fostering harmonious economic developments. The
involvement of the social partners through the macroeconomic dialogue also plays an important role.

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The growing interdependence of the euro-area economies calls for a regular review of the methods and
procedures for coordinating economic policies, for reinforcing implementation, and enhancing trans-
parency.

Completing the transition to sound public finances

The completion of the transition phase to accomplishing medium term budgetary positions close to
balance or in surplus is a necessary condition to realise the full benefits of EMU and of the budgetary
policy coordination arrangements covered by the SGP. Until then, and given the need not to breach
the 3 % reference value, a trade-off may exist in adverse economic conditions between, on the one
hand, budgetary consolidation to attain the medium-term positions and, on the other hand, stabilisa-
tion of output fluctuations through the full play of automatic stabilisers. Therefore, efforts need to be
stepped up to achieve budgetary positions close to balance or in surplus as soon as possible in all
Member States and at the latest by 2004. Beyond providing scope for the free play of automatic
stabilisers, budgetary policies should be guided by the need to improve the quality and the sustain-
ability of public finances. The window of opportunity before the effects of ageing come to be felt more
forcefully should be used to achieve sound public finance positions.

(ii) Promoting more and better jobs, raising the employment rate and addressing persistent

unemployment

Analysing EU employment growth in a medium-term perspective, the performance has been strong.
Besides favourable macroeconomic conditions, the vigorous job creation witnessed since 1997 also
inter alia, in the context of the
reflects the labour market reforms undertaken by Member States,
European Employment Strategy and the Broad Economic Policy Guidelines. These include measures to
lower the cost of
labour and/or to improve the adaptability of the workforce, sustained wage
moderation, improved real wage flexibility and reforms of tax, and to a lesser extent, benefit systems.
Labour markets have also tended to become more flexible, as indicated by the large contribution of the
development of part-time and temporary employment to overall

job creation.

Despite the improved performance in the second half of the 1990s, human resources are still
underutilised in the European Union and structural problems remain. Unemployment, and in particular
long-term unemployment, is still high in a number of Member States and it should be prevented that
the expected cyclical increase in unemployment in 2002 causes an increase also in structural unem-
ployment. Unemployment is often concentrated in the more deprived regions and among the more
vulnerable groups of workers. Nevertheless, in a number of Member States, situations arise, where high
unemployment coincides with labour shortages and labour market conditions often vary considerably
across regions, indicating a mismatch between labour supply and demand, due partly to obstacles to
geographical and occupational mobility, as well as a lack of required skills and of differentiation in
wage developments.

Moreover, labour force participation rates, especially for women and older workers, are unsatisfactorily
low and significant efforts are needed to raise employment rates to the Lisbon and Stockholm targets
so as to prepare also for the consequences of ageing populations. Realising the Lisbon targets implies
an increase of about 15 million jobs in the EU between 2002 and 2010. To prepare for the impact of
ageing, the Barcelona European Council has called for an increase of the effective average retirement
age in the EU by about five years by 2010.

Forceful continuation of the policy action addressed at reducing unemployment and a comprehensive
strategy for increasing participation rates is therefore necessary, as endorsed by the Barcelona European
Council. This includes the reform of tax and benefit systems and other action to modernise labour
markets, to strengthen incentives for people to take up work, to enable people to participate in the
labour market, to improve information about job opportunities, to accompany the return of long-term
unemployed through active labour market policies, to promote entrepreneurship and to enhance
conditions under which enterprises can gainfully employ more labour. Promoting human capital
formation in order to provide higher skills, adaptable over the worker's whole life cycle, thereby
contributing to better quality in work, can in this context act as a catalyst. Additional indicators for
quality in work are being developed in the context of the Structural Indicators.

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(iii) Strengthening conditions for high productivity growth

Maintenance of high standards of living in the longer run, as the share of the working age population
starts to decline as the result of ageing, will increasingly depend upon productivity increases. Labour
productivity growth in the Union is relatively low and has actually slowed by half a percentage point
on average between the first and second half of the 1990s, essentially as a result of richer job growth
on the back of structural reforms, and has significantly been affected by stronger labour market
inclusion of low skilled and other workers with less than average productive potential. The recent low
growth of labour productivity, if maintained, does not allow for sustainable GDP growth rates of 3 %
that are deemed necessary to comply with the Lisbon agenda.

Private sector investment and innovation are likely to benefit from a more competitive and entrepre-
neurial environment, in turn raising productivity per worker and hence living standards. There is
substantial scope for improving the investment environment through structural reforms in product,
capital and labour markets. Equally important are an adequate regulatory environment, efficient public
services and network industries and investment in training and education as well as the adaptability of
the work force.

Despite encouraging progress so far, large segments of European product markets are still insufficiently
integrated to make the Union an attractive location for investment. Further reforms are needed to
integrate energy and communication networks across Europe. To facilitate the cross-border provision
of services, especially in the distribution sector, and to raise the mobility of both skilled and unskilled
workers, increased coordination of national and Community policies is required. In financial services
and capital markets, EMU has already created new opportunities for efficiency gains. Nevertheless, both
national authorities as well as private market participants should take their responsibility to accomplish
further financial integration, while there is still a long and unfinished agenda to be completed that is
set out in various parts of these guidelines. The promotion of competition within the internal market
finds its logical complement in increased competition at world level. The European Union should
therefore continue to adopt a common external policy that favours open world trade and press for
adherence to WTO rules by all

its members.

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(iv) Promoting sustainable development in the interest of current and future generations

Taking account of the needs of current and future generations, including environmental sustainability
and social and regional cohesion, will ensure that policy measures that aim to boost prosperity will
contribute fully to increasing the well-being of citizens. Economic policies can make a significant
contribution towards this goal, but its achievement would typically require substantial policy actions in
a number of areas, which would tend to go beyond economic policy considerations only.

For instance, economic policies can make a major contribution to enhancing environmental sustain-
ability by making sure that the external effects of economic activities on the environment are priced in.
Also, economic policies can create conditions for resource and energy efficiency, thereby promoting
innovation and job creation. Likewise, economic policies can make an important contribution to the
adequate preparation for the challenges posed by ageing societies notably where labour market
participation and its financial consequences are concerned. The aim is to ensure the positive interaction
of economic and social policies with a view to supporting a long-term sustainable working life while
making optimal use of the human resource potential and ensuring greater social cohesion.

Finally, economic policies can contribute to social and economic cohesion in various ways. A good
economic performance underpins job creation and jobs are the best protection against poverty and
social exclusion. A modern and active welfare state that encourages people to work would also be
important in this respect. A growth- and stability-oriented macroeconomic framework as well as
efficient product, capital and labour markets are important determinants of both national and regional
catching-up. Economic policies can be improved in some policy areas by better taking account of
specific local conditions. Facilitating labour market adjustment by encouraging the wage formation
process to reflect differences in local conditions, notably in productivity and skill
levels, and by
reducing disincentives to geographic labour mobility is an important step and should be further
pursued. Furthermore, raising the effectiveness of public spending with regional
incidence by
improving public systems for allocation and delivery should also be given further consideration.

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3.

POLICY RECOMMENDATIONS

3.1. Ensure growth- and stability-oriented 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 economic expansion and the full realisation of current growth
potential and it should contribute to the establishment of the framework conditions that promote adequate levels
of saving and investment
to position the economy on a sustained, higher, non-inflationary, growth and
employment path.

Member States should achieve and preserve a sound budgetary position as agreed in the context of the Stability
and Growth Pact. All Member States need to ensure that,
in compliance with the SGP, cyclically-adjusted
budgetary positions move towards, or remain close to balance or in surplus in the coming years.

General government balance (1):

Spring forecast compared to Stability and Convergence Programmes

Spring 2002

Stability and Convergence Programmes
(submitted between October 2001 and January 2002)

(% of GDP)

2000

2001

2002

2003

2000

2001

2002

2003

2004

B

D

EL

E

F

IRL

I

L

NL

A

P

FIN

euro area

DK

S

UK

0,1

– 1,3

– 0,8

– 0,4

– 1,3

4,5

– 1,7

5,8

1,5

– 1,9

– 1,9

7,0

– 0,8

2,5

3,7

1,8

0,0

– 2,7

– 0,4

0,0

– 1,5

1,7

– 1,4

5,0

0,2

0,1

– 2,7

4,9

– 1,3

2,9

4,8

0,9

EU-15

– 0,2

– 0,7

– 0,2

– 2,8

0,3

– 0,2

– 2,0

0,4

– 1,3

2,0

0,0

– 0,1

– 2,6

3,3

–1,5

2,1

1,7

– 0,2

– 1,1

0,2

– 2,1

0,5

0,0

– 1,8

0,2

– 1,3

2,5

– 0,4

0,3

– 2,5

2,7

– 1,2

2,4

1,9

– 0,5

– 0,9

0,1

– 1,3

– 1,1

– 0,3

– 1,4

4,5

– 1,5

6,2

1,5

– 1,1

– 1,5

6,9

– 0,6

2,5

4,1

2,0

– 0,1

0,0

– 2,5

0,1

0,0

– 1,4

1,4

– 1,1

4,1

0,7

0,0

– 2,2

4,8

– 0,9

1,9

4,6

– 0,2

– 0,7

0,0

– 2,5

0,8

0,0

– 1,8

0,7

– 0,5

2,8

0,4

0,0

– 1,8

2,6

– 0,9

1,9

2,1

– 1,1

– 1,0

0,5

– 1,5

1,0

0,0

– 1,5

– 0,5

0,0

3,1

0,2

0,0

– 1,0

2,1

– 0,5

2,1

2,2

– 1,3

– 0,7

0,6

– 1,0

1,2

0,1

– 0,5

– 0,6

0,0

3,4

0,5

0,2

0,0

2,6

– 0,2

2,1

2,3

– 1,1

– 0,3

(1) Government balances in 2000, 2001 and 2002 exclude one-off proceeds from the sale of UMTS licences.

The UMTS amounts as a % of GDP would be, according to the Spring 2002 forecasts,
In 2000: D: 2,5 %, E: 0,1 %, I: 1,2 %, NL: 0,7 %, A: 0,4 %, P: 0,3 %, euro area: 1,1 %, UK: 2,4 % and EU-15: 1,2 %.
In 2001: B: 0,2 %, EL: 0,5 %, E: 0,0 %, F: 0,1 %, euro area: 0 %, DK: 0,2 % and EU-15: 0 %.
In 2002: E: 0,0 %, F: 0,1 %, IRL: 0,2 %, euro area: 0 % and EU-15: 0 %.
In the German stability programme the target for 2004 was set at – 1 % of GDP, but at the February Ecofin Council the German Government committed
itself to a budget close to balance by 2004.
For France figures take into account the adjustments made by the French authorities to the 2001 Stability Programme in a letter sent to the Commission
on 22 January 2002.

Regarding the euro area, the primary objective of the ECB's monetary policy is to maintain price stability.
Without prejudice to this objective,

it supports the general economic policies in the Community.

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In general, the euro-area Member States should:

(i) orient and implement their budgetary policies so as to achieve or maintain budgetary positions of
close to balance or in surplus over the economic cycle; if budgetary positions of close to balance
or in surplus are not yet achieved, take all the necessary action, in the context of the implementa-
tion of the budgets for 2002 and the preparation of budgets for 2003, to ensure that such
medium-term objectives are respected by 2004 at the latest;

(ii) ensure that tax reforms are financed appropriately in order to safeguard the commitment to
sound public finances; avoid pro-cyclical fiscal policies thus contributing to an appropriate
macroeconomic policy mix at the national and euro-area level; allow automatic stabilisers to
operate in full as the recovery gets underway; ensure a rigorous execution of their budgets so as to
prevent slippage from the stability programme targets; and

(iii) further strengthen public finances with a view to secure their long-term sustainability by making

use of the window of opportunity prior to the demographic changes taking hold.

Regarding the non-euro-area Member States, monetary policy in Denmark is guided by the fixed-exchange
rate policy toward the euro in the framework of ERM2, which is seen as instrumental to achieve price stability. In
Sweden and the United Kingdom monetary policies aim at price stability through targeting inflation. Their
successful achievement will help create the conditions for exchange rate stability.

In general, non-euro-area Member States shall also maintain sound budgetary positions in accordance with the
Stability and Growth Pact. In general, they should:

(i) orient and implement their budgetary policies so as to maintain budgetary positions of close to

balance or in surplus over the economic cycle;

(ii) ensure that tax reforms are financed appropriately in order to safeguard the commitment to
sound public finances; avoid pro-cyclical fiscal policies thus contributing to an appropriate
macroeconomic policy mix at the national level; allow automatic stabilisers to operate in full as
the recovery gets underway; ensure a rigorous execution of their budgets so as to prevent slippage
from the convergence programme targets; and

(iii) further strengthen public finances with a view to secure their long-term sustainability by making

use of the window of opportunity prior to the demographic changes taking hold.

Wage developments in Member States should reflect different economic and employment situations. Govern-
ments should promote the right framework conditions for wage negotiations by social partners. For wage
developments to contribute to an employment-friendly policy-mix, social partners should continue to pursue a
responsible course and conclude wage agreements in Member States in line with the general principles set out in
the Broad Economic Policy Guidelines. It is necessary that:

(i) the increase in nominal wages be consistent with price stability;

(ii) the increase in real wages not exceed growth of labour productivity taking into account the need
to strengthen, where necessary, and subsequently maintain, the profitability of capacity-enhancing
and employment-creating investment; and

(iii) national labour institutions and collective bargaining systems, respecting the autonomy of social
partners, take into account the relationship between sectoral and local wage developments and
labour market conditions,
inter alia,
productivity and skills differentials. This will also assist in guaranteeing the EU's competitiveness
and improving employment across skills and geographical areas.

thereby allowing an evolution of wages according to,

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3.2. Improve the quality and sustainability of public finances

To maximise the contribution of public finances to growth and employment and the achievement of the objectives
agreed in Lisbon and Stockholm, all Member States must achieve and sustain sound budgetary positions. This is
especially important in countries that have yet to achieve budget positions that are ‘close to balance or in surplus’
as required by the Stability and Growth Pact. An appropriate balance and sequencing have to be drawn between
running down public debt, cutting taxes and continuing to finance public investment in key areas. Countries with
a high level of public debt and/or that have not yet reached the medium-term budgetary target of the Pact should
give priority to budgetary consolidation. this will help countries prepare for the additional budgetary costs of
ageing populations. The assessment of the sustainability of public finances on the basis of updated stability and
convergence programmes confirms that, if no far-reaching reform is undertaken, there is a substantial risk of
budgetary imbalances emerging in the future due to ageing populations in many Member States.

To this end Member States should:

(i) pursue efforts to make tax and benefit systems more employment friendly,

including, where
appropriate, a reduction of the overall tax burden, targeted reforms of the tax and benefit systems,
especially with respect
to low-wage labour, within continued fiscal consolidation, and by
improving the efficiency of tax systems (see also section 3.3);

(ii) promote the quality of public expenditure by redirecting funds towards physical and human

capital accumulation and research and development;

(iii) enhance the efficiency of public spending by institutional and structural reforms; in particular
introduce or enhance the mechanisms that help assess and control spending, including budgetary
procedures;

(iv) improve the long-term sustainability of public finances by pursuing the comprehensive three-
pronged strategy, of raising employment rates, reducing public debt and adapting pension
systems, agreed by the Stockholm European Council. This involves a suitable combination of
measures, to be determined by the Member States, to run down public debt at a fast pace,
modernise labour markets to raise employment rates (especially amongst women and older
workers), reform pension and healthcare systems for the elderly with a view of placing them on a
sound financial footing. In that framework, public pension reserve funds could also contribute to
improving the sustainability of public finances, provided they receive substantial contributions.
Member States should strengthen their capacity to evaluate the long-term sustainability of public
finances and factor these analyses into medium-term budgetary planning processes. This will help
reinforce examination in the context of multilateral surveillance as asked by the Barcelona
European Council;

(v) reform pension policies towards the broad common goals agreed by the Gothenburg and Laeken
Councils so as to secure the long-term financial sustainability, to safeguard the adequacy of
pensions and meet changing societal needs; develop a comprehensive strategy that takes due
the balance between these broad objectives and challenges faced by individual
account of
countries; in particular introduce measures that aim at increasing the effective retirement age;
greater reliance to funding should also be considered; and

(vi) pursue tax co-ordination further so as to avoid harmful tax competition and implement effectively
the Council agreement of November 2000 on the tax package with a view to meeting the
December 2002 deadline for agreement.

Just like the Member States, the Community should apply strict budgetary discipline. This must be
applied to all categories of the financial perspective, while respecting the inter-institutional agreement
on budget discipline and the improvement of
the budget procedure; a flexible allocation of
Community resources should be exploited in order to enhance the economic impact of the EU budget.

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3.3. Invigorate labour markets

Despite the impact of the cyclical slowdown, the labour market situation continued to improve in 2001, even
though the very positive developments of the preceding year could not be repeated. The average unemployment
rate of 7,6 % was 0,5 percentage points below the 2000 average (see chart on unemployment rate). Progress
towards the employment goals set by the Lisbon and Stockholm European Councils continued in 2001, although
it was more moderate than the year before. The overall employment rate now stands at 64 %, the employment
rate of women at 55 % and that for older workers (aged 55 to 64) at 38 % (see charts on overall, female and
older workers employment rates).

Progress achieved over previous years with structural reforms of labour markets, also in the context of the
European Employment Strategy, has become visible in more employment intensive growth. Sustained wage
moderation has allowed employment to increase significantly and unemployment to fall without resulting in a
boost to inflation; a greater use of temporary and part-time contracts has contributed to making labour markets
more flexible and inclusive; tax reductions targeted to the low end of the wage distribution have improved
incentives to take up a job; and Member States have started to move away from passive towards active labour
market measures. Unfortunately, the pace of labour market reforms seems to have slowed down in 2001; it needs
to be increased in order to achieve the Lisbon objectives.

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Important challenges remain that need to be addressed through further reforms. In line with the discussion in
Section 2.2(ii), the challenges include:

— promoting more and better jobs,

— increasing participation rates further, especially for women and older workers,

in order to meet

the

Lisbon-Stockholm targets for employment and to prepare for the consequences of ageing populations,

— reducing high unemployment rates,

— reducing the mismatch between demand for and supply of labour across regions and occupation,

— promoting social

inclusion.

These challenges should also be seen in conjunction with other challenges directly relevant for the labour market,
such as wage formation, entrepreneurship and education and training, taken up in sections 3.1, 3.6 and 3.7,
respectively. On 18 February 2002, the Council adopted detailed guidelines for employment policies for the year
2002, consistent with the priorities in the 2001 Broad Economic Policy Guidelines, as well as Member State
specific recommendations therein. In pursuing labour market reforms, Member States should vigorously implement
the Employment Guidelines and the recommendations addressed to them.

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Member States should,

in particular, take the following measures:

(i) adapt tax and benefit systems to make work pay and encourage the search for jobs. Reduce high
marginal effective tax rates, in particular for low wage earners, and reduce unemployment traps.
Address incentive effects of benefit schemes, such as conditionality of benefits, eligibility, duration,
the replacement rate, as well as availability of in-work benefits and the use of tax credits, in order
to make the systems more employment friendly; in addition, review administrative systems and
management rigour. Reduce incentives for early retirement. Step up efforts to increase opportuni-
ties for older workers to remain in the labour market, in order to increase by about five years the
effective average retirement age in the EU by 2010, thereby increasing their labour market
participation;

(ii) strengthen active labour market policies, by improving their efficiency both regarding the use of
resources and their effectiveness in terms of increasing regular employment, including through
modernising employment services. This implies, inter alia, better targeting them to those groups
most prone to the risk of long-term unemployment, on those measures that have proven most
effective and meeting the demands of the labour market. In this context an active and preventive
policy to set measures providing incentives for the re-incorporation in the labour market to
groups and individuals at risk or with a disadvantage is also needed;

(iii) bring down obstacles to mobility within and between Member States. Along the lines of the
Action Plan Skills and Mobility, foster the recognition of qualifications, facilitate the transferability
of social security and pension rights, improve information and transparency on job opportunities
and ensure that tax and benefit systems, as well as housing markets, do not inhibit mobility;

(iv) safeguarding the employability of workers through training and reskilling and facilitate occupa-
tional mobility by improving lifelong learning, in dialogue with the social partners, thereby also
contributing to better job quality and higher productivity;

(v) promote,

in dialogue with the social partners, more flexible work organisation and review
employment contract
related costs, with the aim of
promoting more jobs and striking a proper balance between flexibility and security. Ensure that
any reductions in overall working time do not lead to increases in unit labour costs, and that the
future labour supply needs are taken fully into account; and

regulations and, where appropriate,

(vi) remove existing barriers to female labour force participation and strive, in line with national
patterns of provision, to provide childcare by 2010 to at least 90 % of children between three
years old and the mandatory school age and at least 33 % of children under three years of age).
Address the underlying factors that lead to a gender pay gap and encourage family oriented
policies in order to combine work and having a family.

3.4. Re-ignite structural reform in product markets

Progress in implementing the economic reform agenda of the Lisbon strategy has been mixed. Progress has been
made in transposing Internal Market directives into national legislation, in opening up public procurement, in
reinforcing the powers of the competition authorities, and in reducing State aid. The liberalisation of the
telecommunication and electricity markets has started to result in price reductions. Similarly, positive effects are
expected from the increased access to rail freight networks. However, prospects for further price declines are likely
to be affected by physical bottlenecks, inadequate regulatory structures, slow market opening, and the high market
shares of incumbents in these sectors. This illustrates that to create a fully integrated and efficient Internal
Market, further reforms on product (goods and services) markets are needed, particularly in areas where progress
has been too slow. In spite of the fact that EU goods markets are becoming increasingly integrated, differences in
standards and regulations continue to hinder cross-border activities. Moreover, the creation of an internal market
for services has advanced only slowly. In light of the above, Member States should:

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(i) fully implement the Internal Market:

— step up efforts to increase the transposition rate of Internal Market directives to 98,5 %,
in 2003 of directives whose
achieve full transposition by the Spring European Council
implementation is more than two years overdue, and ensure the correct implementation of
Internal Market legislation,

— pursue more vigorously the elimination of remaining technical barriers to trade by speeding
up the development of new product standards and improving the application of the mutual
recognition principle by national administrations,

— create an effectively functioning Internal Market in services by the removal of barriers to

cross-border trade and market entry, and

— further open up and render more transparent public procurement markets,

inter alia, by
bringing it online by 2003 and by adopting the public procurement legislative package as
early as possible in 2002.

(ii) ensure effective competition, thereby delivering real benefits to consumers:

— ensure effective independence, adequate capacity and effectiveness of the competition and
regulatory authorities, promote cooperation between competition and regulatory authorities,
and enhance the coherence of the application of competition rules by the Commission and the
national competition authorities, and

— secure less and better State aid in relation to GDP, redirecting aid toward horizontal objectives
of common interest and targeting it to identified market failures. Increase the transparency of
State aid policies and assess their effectiveness.

(iii) accelerate reforms in the network industries, while underlining the importance for citizens, and

for territorial and social cohesion, of access to services of general economic interest:

— encourage market entry and improve consumer choice in liberalised markets, in particular by

fully implementing the new communications regulatory package by July 2003,

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— in electricity and gas, ensure freedom of choice of supplier as of 2004 for all non-household
consumers (amounting to at least 60 % of the total market) and establish a national regulatory
function. In electricity, reach an agreement in 2002 for a transparent and non-discriminatory
tariff system for crossborder transactions. The level of electricity interconnections between
Member States should be equivalent to at least 10 % of their installed production capacity by
2005. Financing requirements should be mainly met by enterprises involved,

— ensure efficient use of existing infrastructure and provide incentives to build new infrastructure
where necessary by taking decisions by the end of 2002 on the revision of the guidelines and
accompanying financial rules on trans-European energy and transport networks, and

— in transport, take decisions by the end of 2002 on proposals concerning airport slot alloca-
tion, port services and public services contracts; actively consider the Community accession to
Eurocontrol and create a ‘single sky’ by 2004; open the trans-European rail freight network up
to competition by 15 March 2003 and pursue work on the second railway package.

3.5. Promote the efficiency and integration of the EU financial services market

Reforms should seek above all to hasten the integration of financial markets, and to reap the full benefits of an
efficient channelling of saving, by reducing the costs of accessing capital to encourage investment in the EU. At
the centre of these efforts is the Financial Services Action Plan, which is to be implemented by 2005, with every
effort made by all parties concerned to achieve an integrated securities market by the end of 2003. In this context
there is also a need to enhance the efficiency of cross-border clearing and settlement arrangements at the European
level.

The Risk Capital Action Plan (RCAP) should be implemented by 2003. It contains a set of measures (many in
common with the FSAP) in respect of private equity (venture capital and buy out) that promote market
integration, enact structural reform in areas such as regulation, taxation and bankruptcy law and foster a culture
of enterprise.

Integration will enhance financial stability within the EU so long as institutional arrangements for the
cooperation and coordination in the field of prudential supervision are adequate. In response to ongoing
consolidation within and across financial sectors, several Member States have reformed or are in the process of
reforming their supervisory arrangements. The choice of arrangements varies among Member States, which is
likely to increase the need for clear procedures for cross-border cooperation between different national supervisors.

The need for better corporate governance has been underlined by recent events affecting financial markets. The
EU, following the Barcelona European Council mandate, has broadened the remit of already existing working
groups and intends to take additional measures to improve the present institutional framework in this field.

In order to accelerate progress in financial

integration, there will be a need to:

(i) step up efforts by all relevant parties, the Council, the European Parliament, the Commission, and
the Member States, to ensure full
implementation of the FSAP by 2005, and by 2003 for
securities markets legislation; therefore, as highlighted by the European Council in Barcelona, the
Council and the European Parliament need in particular to adopt as early as possible in 2002 the
proposed Directives on Collateral, Market Abuse, Insurance Intermediaries, Distance Marketing of
Financial Services, Financial conglomerates, Prospectuses and Pension Funds, and the International
Accounting Standards Regulation. Furthermore the Council agreed at Oviedo that individual
measures should meet the objectives of integration and efficiency; the Member States should
ensure, as soon as possible, the implementation of legislation already adopted by the Council;

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(ii) intensify efforts to implement the RCAP by 2003 reforming bankruptcy procedures to provide a
better balance between entrepreneurial activity and investor protection, and developing a fiscal
framework more conducive to investment and entrepreneurship;

(iii) further improve arrangements at national, Community and international level to deliver efficient
cross-border/cross-sector cooperation, coordination and exchange of information for prudential
purposes; and

(iv) strongly encourage the removal of barriers to efficient cross-border clearing and settlement and

monitor its progress.

3.6. Encourage entrepreneurship

Increased and more productive business investment is necessary to improve the productivity and raise the level of
potential growth of the European economy. The creation of a competitive business environment supported by
adequate public infrastructure and a modern and efficient public administration is key to stimulating business
creation and expansion. This has been recognised by all Member States, as illustrated by the variety of measures
taken to reduce the regulatory burden on business, to stimulate business creation, and to ease access to finance for
SMEs. The European Charter for Small Enterprises endorsed at the Feira European Council (June 2000) should
also contribute to supporting small businesses. Nevertheless, differences in business conditions between Member
States, in particular in the area of taxation, remain important. This offers a wide scope for learning from best
practice examples. Member States should:

(i) create a business-friendly environment:

— improve and simplify the corporate tax system and the regulatory environment. Reduce
barriers to entrepreneurship to the barest minimum, including through a reduction of the
typical time and cost required for setting up a new company and reducing administrative
burdens;

— increase the efficiency of public services, inter alia, via increased use of public tendering and
benchmarking; increased participation of the private sector and competition between public
service operators, while ensuring that various service providers compete on a level playing
field; and by making government services available online, and

— reduce barriers to cross-border economic activity associated with, among other things, differ-
ences between Member States in accounting standards, rules on corporate governance, busi-
ness taxation and VAT;

(ii) translate into action the commitments made under the European Charter for Small Enterprises;

(iii) encourage risk-taking through improving access to finance especially for SMEs in their early
stages. Particularly important for SMEs is the supply of capital coupled with managerial skills (see
also Section 3.5).

3.7. Foster the knowledge-based economy

In spite of recent progress,
the European Union continues to lag behind the United States in both the
development and diffusion of new technologies. Moreover, there are important differences between Member States,
both in terms of R&D expenditures as a percentage of GDP and the number of patent applications per head of
the population. Increased and improved investments in human capital, R&D and ICT, by the private sector in
particular, are required in order to strengthen European competitiveness. The Union's recently approved Galileo
satellite radio-navigation project is notable in this context. Businesses, social partners and citizens need to be
encouraged to seize the opportunities offered by the knowledge-based economy. Education and training systems
need to become better adapted to the needs of those typically disadvantaged in the labour market. This implies
that Member States should:

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(i) stimulate R&D and innovation:

— develop framework conditions conducive to raise overall spending in the Union on R&D with
the aim of approaching 3 % of GDP by 2010 and increase efficiency of R&D. Two-thirds of
this investment should come from the private sector. This implies improving the incentives for
firms to invest in R&D through an integrated strategy aimed at raising the level of competition
on product markets, providing better access to risk capital, better protecting intellectual
property rights (including the creation of an affordable Community patent) while ensuring
more rapid diffusion of new technologies, and using efficiently fiscal and other financial
incentives,

— improve ties between universities and business leading to knowledge transfer and a better
commercialisation of R&D results. Establish clear and consistent priorities for public research,

— enhance collaboration on research and innovation across Europe, and

— adopt the sixth Research Framework Programme.

(ii) promote access and use of ICT:

— ensure effective competition in local telecommunication networks (the ‘local loop’) in order to

speed up the development of the European broadband network, and

— stimulate, inter alia, through the definition of a new e-Europe 2005 Action Plan, internet use
across all strata of society (i.e. in households, schools, enterprises and public administrations)
and, in particular, raise the ratio of internet-connected PCs to pupils to one for every 15
pupils.

(iii) strengthen education and training efforts:

— both private and public, in order to increase the supply of trained researchers, to increase the
number of highly qualified ICT personnel, and to improve the general level of educational
attainment of the population and ensure that all citizens have access to basic skills,

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— enhance the capabilities of education and training systems to respond adequately to changes in
skill requirements, and in particular to meet the needs of groups typically disadvantaged in the
labour market such as women, older workers or early school

leavers, and

— introduce instruments to ensure the transparency of diplomas and qualifications.

3.8. Enhance environmental sustainability

Protection of environmental resources such as clean air, water and soil, maintaining biodiversity and reducing
environmental threats to public health require an active environmental policy in order to ensure a responsible use
of scarce natural resources and development which is economically, environmentally and socially sustainable in the
long run. Commitments undertaken at international level, notably in the area of climate change, also call for
policy action.

The Stockholm European Council has asked to integrate the promotion of sustainable development into the Broad
Economic Policy Guidelines. As further emphasised by the Gothenburg European Council, sustainable develop-
ment is a concept that goes beyond a purely economic assessment and strives for improvements in the quality of
life by promoting coherent policy actions based on an overarching assessment of the economic, social and
environmental dimension. In doing so, it takes a long-term view, looking at the welfare of both present and
future generations. Proper and comprehensive analysis of the social, economic and environmental costs and
benefits of policy measures is therefore needed in each policy area.

Concrete priority actions have been identified for the different policy areas. This section focuses on the integration
of environmental aspects into economic policy, in particular the use of market-based instruments, as a means of
promoting sustainable development.

Government action is often delayed by concerns about possible short-term consequences of policies to protect the
environment on economic growth, employment and on the competitiveness of individual firms, sectors and
Member States. Clear and stable objectives for sustainable development could present economic opportunities
through a potential for technological innovation and investment, generating growth and employment. In this
context Member States should make increased use of economic instruments. These instruments provide flexibility
to industry to reduce pollution in a cost-effective way, and encourage technological innovation. Furthermore, they
are often the most efficient means to curb negative external effects since they lead to the internalisation of external
costs in prices. They are therefore a way to implement more consistently and cost-effectively the polluter-pays
principle. In this respect, better information of the citizens and firms involved and a proper evaluation of
instruments are important.

Member States should set clear targets and timetables for their policies, such as those approved by the European
Council in Gothenburg in this context, and apply them consistently so that business and consumers can adjust
smoothly. Continued action is needed every year to bring about a gradual decoupling of economic growth from
resource use, in particular between growth in transport and energy consumption and GDP growth. Coordinated
and gradual but steady and credible changes in the level and structure of tax rates until external costs are fully
reflected in prices would minimise structural adjustment problems and support adaptation and innovative
solutions by firms. This approach would also minimise cost inefficient exemptions for those firms or sectors that
are most affected. Such exemptions often reduce the environmental effectiveness of the measure, distort the tax
structure and are difficult to remove at a later date. Establishing a framework for or coordinating the use of
economic instruments at Community level could help avoid such distortions and underpin the Internal Market.

Accordingly,

(i) Member States as well as the Community should in their respective areas of competence aim at
providing impact analyses considering the social and environmental consequences of the policy
measures;

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(ii) in order to increase effectiveness of market-based instruments, competition should be increased

by deregulating and connecting markets and by lowering entry and exit barriers;

(iii) Member States should introduce and strengthen policies based on economic instruments like
insurance/liability schemes, voluntary commitments and
taxation, user and polluter charges,
tradable emission rights. A key sector for such a policy is the transport sector with its different
modes, which still lacks an adequate consistent and integrated system of user charges and taxes
in order to appropriately integrate externalities and mirror resource use;

(iv) in order to fulfil the requirements of the Kyoto protocol in a cost-effective way, Member States
should prepare for the introduction of emissions trading at EU level by ensuring, inter alia, that
they have in place sufficiently robust procedures for monitoring, reporting and verification of
emissions. Those Member States which have already established emissions trading schemes for
greenhouse gases, or which are considering doing so, should ensure that their schemes are
compatible with the Community scheme currently under discussion in the Council. Member
States should consider how to allocate emission allowances. More generally, Member States
should prepare appropriate measures and policies to deliver their Kyoto obligations, in particular
aiming at more efficient management of energy and transport demand;

(v) Member States should encourage the disclosure of environmental information in the annual
accounts of companies in line with the Commission Recommendation of 30 May 2001;

(vi) Member States should, where consistent with the objectives of sustainable development, reduce
sectoral subsidies and tax exemptions and other measures, which have a negative environmental
impact;

(vii) Member States should, in parallel with the agreement on the opening of the energy markets,
reach an agreement by December 2002 on an appropriate framework for energy taxation at the
European level; and

(viii) in order for the European Union ‘to show substantial progress in enhancing energy efficiency by
2010’, as requested by the Barcelona European Council, Member States should continue to
implement measures targeted on energy use,

including transport.

II. COUNTRY-SPECIFIC ECONOMIC POLICY GUIDELINES

1.

BELGIUM

The Belgian economic activity experienced a sharp deceleration in 2001, real GDP growth reaching 1 %,
after an exceptional year 2000 when the economy expanded by 4 %; the slowdown in world trade and the
resulting deterioration in business confidence were the main reasons for this development. Economic
activity is currently expected to recover gradually in the first quarters of 2002 and more firmly in the
second half of the year, both export and import volumes resuming dynamism; however, real GDP growth,
on average, is not expected to exceed the result of the preceding year. In 2003, the economy should expand
by slightly below 3 %, as a result of more buoyant international trade and more robust domestic demand.
Inflation, as measured by the HICP, is expected decelerate to clearly below 2 % in 2002, from 2,5 % in
2001, and remain contained in 2003. Employment is projected to rise in 2003, although at a more modest
rate compared to recent past; unemployment is expected to increase somewhat in 2002 but should resume
a falling trend in 2003. Wage developments would remain moderate in the context of the new framework
wage agreement to be concluded, by the end of 2002, for the period 2003-2004.

Although declining, the Government debt ratio to GDP is still at a very high level in Belgium and requires
further budgetary adjustment, in particular in view of ensuring the sustainability of public finance in a
context of ageing populations. Pension reform, already underway, must be pursued further, in particular as
far as regulations leading to early retirement and complementary pension are concerned, in order to face
this challenge. The low employment rate, the high regional differences in unemployment,
insufficient
competition in specific service sectors, the administrative burden on business and insufficient efficiency in
the public administration represent other areas requiring attention.

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B u d g e t a r y p o l i c y

In spite of the sharp slowdown in economic activity in 2001, the general Government accounts were in
balance (or in a surplus of 0,2 % of GDP including the UMTS licences receipts); instrumental in maintaining
a general Government balance was a high primary surplus, at 6,6 % of GDP, reached through retrenchment
in primary expenditure and buoyant tax revenues; specific factors, such as real estate sales, contributed by
about 0,3 % of GDP to this result. The 2001 update of the stability programme targets a general
Government balance in 2002, and a surplus of 0,5 % of GDP in 2003. Maintaining high primary surpluses
of the order of 6 % of GDP per year remains an essential element of the budgetary adjustment strategy,
given the still very high level of the Government debt and in view of the challenges in the long term
induced by the ageing population. A limit on real expenditure growth of Entity I (Federal Government and
social security) to 1,5 % per year is considered appropriate to achieve this objective. The decline in the
Government debt ratio was modest in 2001, a development due mainly to low nominal GDP growth and
to ad hoc factors; the Government debt ratio is projected to fall to marginally below 100 % of GDP at the
end of 2003. In view of the above, and considering that Belgium is a member of the euro area, budgetary
policy should aim:

(i) in 2002, to not allow a deterioration in the Government balance compared to 2001, notably through

containment of Government current expenditure;

(ii) to resume budgetary consolidation in 2003 and achieve a 0,5 % of GDP general Government surplus
by adhering to the 1,5 % limit on real expenditure growth for Entity I and by strict budgetary
surveillance of all parts of Government; and

(iii) to strengthen the existing strategy in order to prepare for the budgetary implications of population
ageing; in particular by further reducing the debt level and by pursuing further the reform of the
pension system, by better addressing the low average effective retirement age and quantifying more
clearly the budgetary resources to be allocated annually to the Ageing Fund.

L a b o u r m a r k e t s

The Belgian labour market was affected by weaker economic growth in 2001. The rapid decline in the
unemployment rate recorded over the previous two years gradually came to a halt and it is now projected
to increase somewhat in 2002. Although the overall employment rate grew steadily over the second half of
the nineties, rising from 56,3 % in 1996 to about 61 % at the end of 2000, it is still below the EU average,
mainly because of relatively lower rates for young (29 % for those aged 15 to 24), older persons (only 24 %
for those aged 55 to 64), and women (51,5 %). Within the framework of the ‘active welfare State’ approach,
the gradual shift from passive policies to preventive and more active measures continued in 2001.
Notwithstanding measures already implemented, benefit dependency is still relatively high for some
segments of the labour market and other measures could be taken to remove the remaining ‘unemployment
traps’ and ‘activate’ the still sizeable number of working age benefit recipients, especially older workers, not
in employment. Regional differences remain noticeable. The employment rate in the Flanders (about 64 %
in 2000) was still eight to nine percentage points higher than in Wallonia and the Brussels region. This
reflects inadequate labour mobility and insufficient wage flexibility. Linguistic barriers, high housing costs
(due to remaining heavy registration taxes), increasing traffic congestion, an inadequate public transporta-
tion network, are the main obstacles to mobility. As an additional dimension, better use of existing
legislation which allows employees to participate in the financial results of their enterprises could contri-
bute to wage differentiation. In view of the above, while vigorously implementing all the employment
recommendations adopted by the Council in February 2002, the main priorities for Belgium should be to:

(i) consolidate recent reforms of the tax and benefit systems to make work pay,

in particular, by
removing the remaining disincentives for older people to continue to work or re-enter the labour
market;

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(ii) take measures to increase labour mobility, inter alia, by encouraging social partners to allow existing
wage-setting mechanisms to better reflect local labour market conditions and skills, while preserving
wage moderation;

(iii) promote a proper balance between flexibility and security, and monitor closely the impact on labour
in particular the new time-credit

supply of recent initiatives to increase working-time flexibility,
system; and

(iv) intensify efforts to increase the employment rate for women by removing disincentives to their entry

or re-entry to the labour market.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

The openness of the Belgian economy stimulates competition on the goods markets, leading to high labour
productivity and consumer price levels in line with the EU average. The transposition rate of Internal
Market directives met the March 2002 target of 98,5 %. Despite a lack of effective competition on the local
loop, the liberalisation process is progressing well in the telecommunications sector, and broadband access
is diffusing fast, thanks to cheap access costs. However, the links between local public authorities and
private partners still lack transparency, and liberalisation is less advanced in some service sectors such as
energy. In particular, the delay in establishing the independent transmission system operator for electricity
and the lack of regulatory approval of transmission tariffs has impeded market entry. As a result,
competition remains limited in these sectors, leading to high prices. Whilst, on average, R&D and ICT
expenditures are around EU standards, they remain concentrated in a few sectors and companies. Important
reforms to reduce red tape and increase the efficiency of public services have been launched and have
started to deliver results. However, the levels of administrative burden and State aid to railways remain
high. In view of the above, the main priorities for Belgium should be to:

(i) increase competition in electricity and gas by officially designating an independent transport system
operator with no significant involvement from incumbents (ownership unbundling), and by taking
measures to encourage new retail suppliers by ensuring fair access to networks;

(ii) increase the transparency of the links between the public and private sectors at the local and provincial
level, especially the role of municipalities and their associations in different sectors such as energy, in
order to avoid distortions of competition and conflicts of interest; and

(iii) take further measures to reduce the administrative burden for businesses, including the time and cost

required for registering a new company, and to develop e-government.

2.

DENMARK

In 2001, economic growth decelerated to 0,9 %, primarily due to a marked slowdown in investment
growth and a deterioration of external demand growth. Output expansion is forecast to rise to some 1(cid:1) %
this year and accelerate to around 2½ % in 2003, mainly driven by domestic demand. In 2002, the factors
sustaining growth should be private consumption, which is expected to rise in line with real take-home
pay, and investment, which should recuperate with the expectations of a more favourable outlook. Danish
exports are assumed to grow fairly in line with external demand, and with imports developing in line with
final demand, the growth contribution of net exports is expected to be negative again this year. In 2003,
domestic demand should strengthen further whereas net exports are assumed to give a fairly neutral
contribution to growth. Inflation (HICP), which rose by 2,3 % in 2001, is forecast to remain around this
level also in the current year, as rises in the prices of clothing should compensate for the effects of
somewhat lower oil prices and the ‘tax freeze’ introduced by the new government, before falling slightly in
2003. The labour market will remain tight. Employment is expected to rise marginally in the current year
and by close to ½ % in 2003. Despite the slowdown in the economy, registered unemployment has
remained at a very low level and a small decline in the unemployment rate is expected in 2003 as growth
takes off.

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The Danish economy, which currently operates at a level close to its potential, needs to enhance its
production potential by focusing on the following key challenges: easing labour supply constraints, which
would also help holding back the sustained high pay rises. Competition in a number of important business
sectors remains inadequate and, taking the size of the public sector into account, efficiency in this sector
needs to be further improved. Furthermore, achieving effective restraint of government consumption
remains essential, and this is even more compelling after the introduction of the ‘tax freeze’ so that the
general Government finances can continue to run high surpluses also in the medium-term.

B u d g e t a r y p o l i c y

In 2001, the general Government surplus was 2,8 % of GDP, excluding the UMTS revenues of 0,2
percentage points. The budget surplus is expected to decline to 2,1 % of GDP in the current year and
thereafter to rise to 2,4 % of GDP in 2003. The decline in the surplus in 2002 is primarily due to the fact
that a proposed change of the Special Pension Savings Scheme has been incorporated for the forecast years,
thus for technical reasons lowering the surplus by some ½ percentage points of GDP (1). The latest update
of the Danish convergence programme maintained the strategy of slowly declining ratios of primary
expenditure and taxes to GDP. As often in the past, the real increase in government consumption in 2001
exceeded the target set by the previous Government. A novel element is that the new Government, which
took office in November 2001, has committed itself not to raise any direct or indirect tax rates. In addition,
a ceiling on the nominal property value tax has been imposed. No expiry date has been set for this ‘tax
freeze’. Long-term projections in the updated programme suggest that general Government finances have to
run annual surpluses of 1½ to 2½ % of GDP up to the year 2010 in order to cope with the financial impact
of the ageing population. In view of the above, budgetary policy should aim to:

(i) ensure that the Government's target of restraining real growth in Government consumption to 1 % a
year on average is reached, implying that the increase in 2003 preferably should not exceed the
authorities' forecast of 0,7 % in order to offset the rise of 1,3 % included in the budget for 2002; and

(ii) secure implementation of the tax freeze by all levels of government, possibly by binding commitments
from the part of counties and municipalities in the agreements related to the budget for 2003.

L a b o u r m a r k e t s

The Danish employment performance is the best among EU countries, with employment rates in 2001 of
76 % overall, 72 % for women and 56 % for older workers. The unemployment rate continued to fall
slightly in 2001, reaching 4,3 %, and the labour market situation remained tight. No new reform efforts
were undertaken in 2001. However, the previous reforms continue to reduce inflows to the early retirement
and disability pension schemes and marginal tax rate reductions are due to take place in 2002 in
accordance with the 1999 Whitsun package. The new Government has recently announced a tax-freeze.
Despite previous reforms, there has been a clear trend towards negotiating shorter working hours and
withdrawal from the labour market is relatively high. The share of working-age people in benefit schemes
(including unemployment benefits) and active labour market programmes is 21 %, which in part contri-
butes to persistent labour supply constraints. A further expansion in labour supply, which is necessary in
light of the ageing of the population, could be encouraged via tax and benefit reforms, to make the
underlying tax-benefit structure more favourable for employment. In view of the above, while vigorously
implementing all the Employment Recommendations adopted by the Council in February 2002, the main
priority for Denmark should be to:

(1) The new Government has proposed that the Special Pension Savings Scheme (SP) should be transformed from a
redistributive tax scheme to a compulsory, individual pension scheme effective as of 2001. The proposal has the
majority needed in the Parliament. The change will lower the level of the general government surplus by approxi-
mately ½ percentage points of GDP from 2002 onwards because these savings, following the change, will be
considered as private rather than public savings in the national accounts. This is in line with the deficit and debt
reporting of 28 February 2002.

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(i) make work pay by continuing the changes of transfer systems and by reducing further the fiscal

pressure on labour, especially on low and medium wage earners.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

The Danish economy is less open (as measured by total trade-to-GDP ratio) than most other small Member
States and has a relatively high price level, which is partly due to a lack of competition in a number of
sectors. Ad hoc and sectoral State aid is low and the record in transposing Internal Market directives is
excellent. Progress has been made in liberalising telecommunication and electricity markets as well as in
opening up public procurement. There has been less success in opening up gas markets to competition. ICT
penetration is high and R&D expenditures are above the EU average. However,
in the field of R&D,
Denmark performs less well than the other Nordic Member States, in part owing to lower business R&D
spending and a poorer commercialisation record. In addition, according to an OECD survey, Denmark
combines a high level of public education expenditure with relatively low education results. In view of the
above, the main priorities for Denmark should be to:

(i) step up efforts to enforce competition in those sectors where competition has been found to be

inadequate;

(ii) enhance competition in public service provision at the local level via increased participation of the

private sector and competition between public service operators; and

(iii) complete full market opening of electricity and gas markets and ensure fair network access.

3.

GERMANY

In 2001, German GDP increased by 0,6 %. Regarding private consumption, the income tax reductions
implemented in January of the year limited the decline in the growth rate triggered by the hike in fuel
prices, and the worsening of the international environment with its negative impact on unemployment,
which started to rise slightly during the year. By contrast, investment fell strongly in an environment of low
growth expectations. A further drag on the economy was the substantial depletion of inventories. As a
result domestic demand remained flat in 2001. Growth therefore came essentially from net exports. For
2002, leading indicators point to a recovery by the middle of the year. Driving force should be a pick up in
investment, while consumption is likely to remain sluggish as a result of rising unemployment. Despite the
expected strong upswing, however, annual average GDP growth in 2002 will remain below 1 % due to the
strong negative statistical overhang at the beginning of the year. On the back of higher than assumed oil
and food prices the average rise in consumer prices in 2001 reached 2,4 %. The expected reversal of these
price effects should lower price pressures and keep CPI inflation below 2 %, at one of the lowest levels in
the euro area. Employment started to decline in 2001 and will, in spite of the expected acceleration of
economic activity, on average be lower in 2002. As a consequence, unemployment should be slightly
higher in 2002 on average than in 2001.

As a result of the tax reform and the economic downswing, the government deficit in Germany rose to
2,7 % of GDP in 2001. A key challenge is, therefore, to accelerate the consolidation of public finances and
to ensure a strict implementation of the stability programme, in particular with a view to keeping the 2002
Government deficit below the Treaty's 3 % of GDP reference value. While the present cyclical downturn as
such is mainly externally induced, the growth potential of the German economy is held back by lagged
effects from re-unification, including the crisis in the construction sector, and by slow progress in structural
reform. Highest priority should be to increase and make full use of growth potential. Implemented against a
growth- and stability oriented macroeconomic background, reforms should aim at reducing the persistently

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high unemployment rate and regional unemployment disparities and at improving efficiency of active
labour market policies. This should be supported by policies to increase the employment rate, notably by
reforming the benefit schemes in order to make work pay and by tackling the disincentives to labour
market participation, especially of women. With the German tax and pension reforms, progress in this
respect has been made recently. While the recent pension reform is an important step in the right direction,
further reforms may be needed in the future. Improvements in the overall business environment, particu-
larly by further product, capital and labour market reform, should also contribute to strengthening
Germany's economic growth potential.

B u d g e t a r y p o l i c y

According to the most recent estimate by the Federal Statistical Office, the 2001 general Government deficit
reached 2,7 % of GDP. This deterioration compared to the outcome for 2000 (–1,3 % of GDP excluding
UMTS proceeds) and to the projections of the October 2000 update of the German Stability Programme (a
projected 2001 deficit of 1½ % of GDP) is mainly due to the stronger than anticipated growth slowdown
and some statistical revisions. Expenditure overruns, however, were registered in the overall health care
sector and also in some Länder budgets. In the current year, low GDP growth and the rise in some benefits
should imply that the deficit will not decline compared to last year, in spite of the hike in some taxes.

In the Ecofin Council meeting of 12 February 2002, the German Government committed itself to respect
the 3 % of GDP reference value for the general Government deficit in 2002 and confirmed its commitment
to reach a close to balance budgetary position in 2004. This was reaffirmed by the agreement reached
between Bund and Länder in the special session of the Financial Planning Council (Finanzplanungsrat) on 21
March 2002. In view of the above, and considering that Germany is a member of the euro area, budgetary
policy should aim to:

(i) ensure that the 3 % of GDP reference value for the general government deficit will not be breached.
Use any potential growth dividend to reduce the 2002 deficit below the 2½ % of GDP targeted in the
last updated Stability Programme;

(ii) aim at a sufficient decline of the 2003 deficit to ensure that a close to balance position in 2004 can be
achieved. To this end, continue expenditure restraint and ensure that any budgetary room for
manoeuvre be used to reduce the deficit;

(iii) implement the necessary reform of the health care system in order to reduce expenditure pressures
and to contribute to improving the quality and sustainability of public finances by improving the
quality and economic efficiency of medical care; and

(iv) adopt in the current parliamentary term the agreed changes to the Haushaltsgrundsätzegesetz and enable
an effective control of the agreements reached in the special session of the Finanzplanungsrat of 21
March 2002.

L a b o u r m a r k e t s

The German labour market suffered from the economic downturn in 2001, when employment growth
came to a halt and unemployment started to rise again. The overall employment rate is, at 65 % in 2000,
above the average of the European Union. Youth unemployment is relatively low. However, unemploy-
ment, half of which is long-term unemployment, remains high, at 7,9 % slightly above the EU average.
flexibilisation of wage
Regional unemployment rates continue to vary sharply. Despite of a recent
bargaining, wage differentiation and mobility are not sufficient to contribute adequately to a marked
reduction of the regional differential. Positive steps, such as the Job-AQTIV-Act and the so-called ‘Mainz
Model’ for subsidising low wage jobs, have been taken through new legislation aimed at rationalising active
labour market policies (ALMPs), but the efficiency of large-scale active programmes in high-unemployment
regions must continue to be improved. Moreover, the labour market activity of low skilled workers is very
low and their unemployment risk is 60 percent higher than that of the average worker. Further increases of
the employment rate will critically depend on overcoming still strong disincentives and barriers with
respect to labour market activity of low skilled workers, older workers and women. In view of the above,
while vigorously implementing all the employment recommendations adopted by the Council in February
2002, the main priorities for Germany should be to:

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(i) intensify efforts to make work pay via tax and benefit reform, in particular for women and older
workers. Candidates for benefit reform are: benefit eligibility, conditionality, duration and replacement
rates as well as benefit withdrawal when taking up work. Social security contributions should be
reduced, in particular at the low end of the wage scale, while complying with the need for sound
public finances;

(ii) improve the efficiency of ALMPs, in particular where they are used on a large scale, and further
develop job-search assistance while improving its efficiency. Improve the targeting of ALMPs towards
those groups most prone to the risk of long-term unemployment, as well as to meet the demands of
the labour market;

(iii) promote labour institutions and collective bargaining systems, respecting the autonomy of social
partners, that take into account the relationship between wage developments and labour market
conditions, thereby allowing an evolution of wages according to productivity developments and skills
differentials, in order to improve employment across skills and geographical areas, while preserving
stability- and employment-oriented wage developments;

(iv) promote more flexible work organisation and review employment contract regulations with the aim of

promoting more jobs and striking a proper balance between flexibility and security; and

(v) remove barriers to female labour market participation,

inter alia by promoting the availability of

childcare facilities.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

The German economy is relatively open for a large-sized economy (as measured by the total trade-to-GDP
ratio) and consumer price levels are close to the EU average. State aid is declining gradually. Time and cost
requirements for the start-up of a private limited company are around the EU average and only minimal for
sole traders. Germany has a strong position in the knowledge-based economy as measured by business
expenditures on R&D, patent applications, and the share of the labour force with at least upper secondary
education. Progress on Internal-Market related issues (transposition of Internal Market directives, opening
up of public procurement) has been limited. Partly due to national measures serving environmental
objectives, price levels for electricity (households) and gas remain well above the EU average and former
regional monopolists still enjoy a strong position in supply activities. Finally, the educational achievements
of 15-year-olds and the share of high school students that go on to university are below the EU average.
Two thirds of the age group concerned start a qualified dual vocational training programme, which has a
positive effect on youth employment and keeps unemployment in this age group on a relatively low level
compared to other Member States. In view of the above, the main priorities for Germany should be to:

(i) ensure effective competition on electricity and gas markets leading to a reduction of the levels of and
regional differences in the fees charged for the use of energy distribution networks; establish a
regulatory function for energy with a view to ensuring effective control of the tariff-setting conditions;

(ii) make the necessary efforts to improve students' educational achievements in general and especially to

raise the share of school

leavers that go on to university; and

(iii) raise the transposition rate of Internal Market legislation with the aim of achieving the target of 98,5 %
of Internal Market directives, and raise the value of public tenders published in the Official Journal.

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4.

GREECE

In 2001, following the deterioration in the global economy, economic activity decelerated somewhat but
was supported by domestic factors. Considerably lower interest rates, following euro-area membership as
from 2001, and increasing inflows of financial resources from the EU Structural Funds, combined with the
preparation for the Olympic Games of 2004, sustained investment. At the same time, a sharp increase in
consumer credit and recovery in real disposable income, boosted consumer spending. Nonetheless, external
trade had a negative effect on real GDP growth, reflecting both the high import content of domestic
demand and limited improvement in competitiveness. Such a pattern of growth is expected to persist in
2002, while an improvement is forecast for 2003 as a result of resuming external demand. The situation in
the labour market improved at a slow pace in the latest years, employment rising at relatively low rates in
the whole economy despite strong job creation in the services and the construction sector. Inflation
pressures in early 2001, resulting from second round effects of the oil prices hike in 2000, started to ease
in the second half of 2001. The private sector's wage negotiations have been concluded. The agreement
includes a nominal

increase of 5,4 % and 3,9 % for the years 2002 and 2003 respectively.

Despite progress made in recent years, medium-term challenges require further improvement in the
functioning of the Greek economy. Fiscal imbalances were corrected in recent years, but the government
debt ratio remains at a very high level and requires further robust budgetary adjustment, particularly taking
account of the serious risk that budgetary imbalances might emerge in the future due to ageing popula-
tions. The current real GDP growth phase provides an opportunity to accelerate structural reform aimed at
increasing the still low level of productivity, at improving the efficiency of the labour and product markets
and at creating a better environment for business. Finally, tackling the high rate of structural unemploy-
ment and increasing employment rates remains a key challenge.

B u d g e t a r y p o l i c y

In 2001, the general Government account achieved a deficit of 0,4 % of GDP and a balance when including
non-budgeted UMTS receipt. The 2001 update of the Stability Programme projects the Government surplus
at 0,8 % of GDP in 2002 and 1 % of GDP in 2003; these budgetary projections are based on high real GDP
growth for the period reaching around 4 % per year. The budgetary strategy continues to be centred on the
achievement of high Government primary surpluses which, nonetheless, are expected to decline over the
period; in fact, the improvement in the Government balances fully results from a steady decrease in interest
payments while, in contrast, little retrenchment in current primary expenditure is expected. The Govern-
ment debt ratio is forecast to decline from 99,6 % of GDP in 2001 to 94,4 % of GDP in 2003, a reduction
limited by autonomous factors, namely large financial operations. In view of the above and considering that
Greece is a member of the euro area, budgetary policy should aim to:

(i) ensure that the budgetary stance in 2002 and 2003 does not contribute to inflationary pressures, also
taking into account the outcome of the forthcoming 2002 national wage agreement in the private
sector;

(ii) comply with the guideline already issued in the 2000 BEPG asking for the application of clearly

defined and binding norms for current expenditure increase in real terms;

(iii) ensure that the Government debt to GDP ratio declines in line with the projected reduction in the
Government deficit as well as with the increase in nominal GDP and limit the use of financial
operations influencing negatively the level of the Government debt; and

(iv) accelerate the reform of the social security systems and in particular proceed to the reform of the
pension system from 2002 in order to avoid serious budgetary imbalances which might emerge in
future years from the ageing populations.

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L a b o u r m a r k e t s

The economic upturn in recent years in Greece has been accompanied by employment growth (although at
rates below the euro-area average). While this employment creation was initially outstripped by increases in
labour supply, in the last one or two years job growth has led to a slight fall in the unemployment rate,
notably in 2000. Nevertheless, the Greek labour market is still characterised by a low employment rate
(55,7 % in 2000) and a high level of structural unemployment. Moreover, the labour market is highly
segmented with high rates of youth and female unemployment, and a high share of long-term unemploy-
ment. Labour market policy measures in 2001 focused on the implementation of the December 2000
package of labour market reforms, and the on-going reforms in the Public Employment Service and the
educational and vocational training system. Despite recent measures, the labour market still displays a
number of problems including: heavy labour market regulation;
insufficient wage differentiation; and
distortions to incentives to work in the formal sector embedded in pension entitlements and in the tax
system. The latter include a strong degree of progressivity of personal income taxes and a high burden on
dependent employees compared with the self-employed, even though the average tax burden is low.
Moreover, the educational and vocational training system should be further strengthened to better meet the
requirements of the labour market. In view of the above, while vigorously implementing all the Employ-
ment Recommendations adopted by the Council in February 2002, the main priorities for Greece should be
to:

(i) urgently pursue reform of pensions entitlements in order to encourage older workers to take up and

remain in work;

(ii) continue to improve educational and vocational training systems in order to enhance the skills of the

labour force and meet the needs of the labour market;

(iii) continue progress in eliminating the major distortions to work incentives arising from the interplay of

social security contributions and labour market rigidities;

(iv) promote changes to the wage formation system in order to ensure that wages better take into account
labour market conditions. In particular, the opt-outs

differences in productivity levels and local
included in the territorial employment pacts should be made a practical possibility; and

(v) fully implement

labour market reform packages, and monitor their impact on labour market
performance in order to ensure that positive effects are maximised. In particular, further build upon
these efforts by loosening restrictive employment protection legislation, with a view to ensuring a
proper balance between flexibility and security, and by speeding up the restructuring of the Public
Employment Service.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

in the EU. The Internal Market

Partly due to its geographical location the Greek economy is less open than any other Member State (as
measured by the total trade-to-GDP ratio). The effective enforcement of competition policy rules is thus
very important to guarantee high levels of competition in domestic product markets and stimulate
productivity gains. Indeed, the level of labour productivity, while rising strongly in recent years, remains the
second lowest
the
transposition rate remains below the March 2002 target of 98,5 %. While efforts are underway to improve
the business environment and enhance the performance of the public administration, the costs to set up a
new company remain high and the system of company taxation is quite complex and possibly constrains
firms' incentives to grow. Also because liberalisation has happened only recently, the market position of
incumbents in network industries remains strong. The low levels of average educational attainment of the
population remain a concern, and are among the factors responsible for the overall still low, albeit growing,
level of ICT diffusion in Greece (broadband penetration is the lowest in the EU) and the very weak R&D and
innovation performance. In view of the above, the main priorities for Greece should be to:

transposition deficit was more than halved but

(i) step up efforts to increase the availability of skilled human capital, promote business involvement in

R&D and innovation and continue to improve ICT diffusion;

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(ii) continue to streamline administrative rules and procedures, to increase the efficiency of the public
administration and make the system of company taxation neutral as to the form of business
organisation;

(iii) enhance effective competition in liberalised network industries,

in particular for the provision of

electricity and sea transport services; and

(iv) sustain the progress made in raising the transposition rate of Internal Market legislation with the aim

of achieving the target of 98,5 % of Internal Market directives.

5.

SPAIN

After having grown by around 4 % in 1999 and 2000, output growth weakened significantly in 2001 due
to a more moderate domestic demand, in particular a fall sharp of investment in equipment, and a gradual
slowdown of exports during the year. In 2002, heavily influenced by the slowdown registered in the second
half of the previous year, GDP growth is expected to decelerate further on average but with a recovery
improvement in
gaining strength through the year. This recovery should stem from both a gradual
domestic demand components and renewed dynamism of exports. In 2003, along with better international
prospects and underpinned by a recovery of domestic expenditure, GDP should grow in line with estimated
potential. Based on this macroeconomic scenario, employment growth should slow down in 2002 and
recover strength next year implying a decreasing unemployment rate to around 12 % in 2003. Inflation is
expected to fall to around 2,5 % on average in 2002 compared to 3,6 % in the previous year. This easing of
inflationary pressures would be supported by the national wage agreement signed last year to preserve wage
moderation and by moderate import prices. In 2003, inflation could further decelerate to close to 2,0 % on
average. Although Spain made progress in implementing the recommendations of the 2001 BEPGs and
In particular the
prospects for the Spanish economy are positive, some problems remain unsolved.
long-term sustainability of public finances need to be addressed through a comprehensive reform of the
pension system since the April 2001 agreement between the government and the social partners did not
represent a significant step to tackle the underlying imbalances.

Secondly, the unemployment rate, although more than 10 percentage points below its 1994 peak and
decreasing, remains high in comparison to other EU countries, along with wide disparities among regions
and low employment rates especially for women. Finally, in spite of the easing of inflationary pressures,
underlying inflation continues to post relatively high growth rates while apparent labour productivity
growth remains sluggish. This performance may be indicative of an insufficient degree of competition in
some sectors and a lag in the development of the knowledge-based economy.

B u d g e t a r y p o l i c y

Despite weakening growth the fiscal consolidation process continued in 2001, when the general govern-
ment sector was for the first time in the last 25 years in balance down from a 0,3 % deficit recorded in
2000. According to the 2002-2005 updated Stability Programme, the general government sector is
expected to maintain a balanced budget in 2003 and reach a small surplus of 0,2 % of GDP in 2005. The
fiscal strategy outlined in the update remains unchanged compared to the previous programmes. It is based
on a restraint of primary current expenditure, supported by decreasing interest payments, which allows for
an increase in capital expenditure. In turn, the programme envisages a new reform of personal income tax
fiscal consolidation. The programme
to take effect from 2003, consistent with the maintenance of
incorporates the new financial system for territorial governments, which has involved the decentralisation
of tax and spending powers. In parallel with the start of this new system, the Law of Budgetary Stability,
aiming at ensuring the commitment of all general government sub-sectors to the respect of the close-to-
balance objective, was approved. This will contribute to enhance the sustainability of public finances in
Spain.

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The 2002-2005 updated Stability Programme does not provide detailed information on measures to deal
with ageing population and the announced intention of pursuing the reform of the pension system lacks a
detailed calendar. This may be of concern, given Spain's particularly adverse demographic projections,
according to Eurostat. In the recent past, the main measures adopted to deal with ageing were, first, the
Social Security Fund created in 2000 to finance future liabilities, assets of which were planned to reach 1 %
(In early April the Spanish authorities
of GDP in 2004 according to the latest stability programme.
announced that this target would be reached in 2002). Additionally, some incentives to raise the effective
retirement age have been introduced. All in all, and considering that Spain is a member of the euro area,
budgetary policy in Spain should aim to:

(i) ensure restraint of primary current expenditure as planned, so as to maintain the balanced budget

position in accordance with the updated stability programme;

(ii) ensure that the reform of personal income tax to be legislated in 2002 enhances incentives to work

and save, and does not put at risk medium-term stability objectives; and

(iii) review the public pension system in a comprehensive way so as to promote its long-term viability.
Give priority to the introduction of incentives to raise the effective retirement age and the use of the
surpluses registered in the social security sub-sector to further increase the pension reserve fund.

L a b o u r m a r k e t s

A marked improvement in labour market performance over the past few years means Spain is catching up
rapidly with other EU Member States in terms of employment rates. The overall employment rate rose from
52,3 % in 1999 to 54,7 % in 2000. The female employment rate rose by three percentage points to 40,3 %.
Unemployment has continued to fall, to 13,0 %, and female unemployment remains double the rate for
males. Regional unemployment disparities remain severe, with unemployment rates on the mainland
ranging from 6,3 % to 22,3 % (Q4 2001). Key structural problems include the failure of labour costs to
adjust to productivity and local labour market conditions, and low labour mobility, partly owing to housing
market rigidities and the operation of certain regional benefit schemes. The reforms of March 2001 appear
to go some way towards addressing rigidities in the area of employment contracts. There remains further
scope for increasing overall investment in training and for measures to ensure the efficiency of active labour
market policies. Further efforts to encourage increased labour market participation will be needed in order
to sustain the impressive performance of recent years. In view of the above, while vigorously implementing
all the employment recommendations adopted by the Council in February 2002, the main priorities for
Spain should be to:

(i) take further steps towards the reform of wage formation so that wages take better account of regional

differences and evolve according to productivity developments and skills differentials;

(ii) diminish obstacles to labour mobility,

inter alia, through improvements to the functioning of the
housing market and reform of regional benefit schemes and encourage conditions conducive to
employment creation in regions lagging behind;

(iii) ensure that active labour market measures are efficient and tailored to the needs of those most prone
to the risk of long-term unemployment or those with lower participation rates (in particular women)
and to the demands of the labour market;

(iv) take further steps to encourage increased labour force participation, especially among women, and
adopt targets for the adequate provision of facilities for care of children and other dependants; and

(v) ensure a proper balance between flexibility and security by means of monitoring closely the impact of
the recent employment contract reforms and taking further steps, if necessary, with a view to early
progress in terms of a reduced share of fixed-term contracts and greater use of the part-time contract.

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L 182/31

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

The openness of the Spanish economy has continually increased in recent years. The record in transposing
Internal Market legislation is among the best in the EU. However, the slowdown of productivity growth is
perceived as a problem for the Spanish catching-up economy. The implementation of the ambitious
liberalisation plan launched by the Government in June 2000 continued in 2001, but the market share of
incumbents in fixed telecommunication and gas remain high and the wholesale market for electricity is still
provided by a reduced number of private operators. In addition, some non-tradable sectors such as
hypermarkets, still have sector-specific regulations with restrictive effects on competition. Initiatives to
increase ICT users and to foster R&D were adopted by the Government and the results are expected soon.
The low public and business expenditure on R&D, together with relatively few patent applications, remain
major weaknesses relative to other Member States. Public expenditure on education is below the EU average
and educational attainment is low. Finally, the regulatory framework for SMEs remains relatively complex,
which can contribute to the long time and high cost involved in creating a new company. In view of the
above, the main priorities for Spain should be to:

(i) continue policies aimed at guaranteeing a level playing field for operators in the telecommunications
and energy sectors, at reducing the market share of the incumbents in order to enhance effective
competition in those sectors, and at encouraging market entry in the wholesale market for electricity;

(ii) continue to take measures to enforce effective competition in retail distribution;

(iii) step up efforts to increase skilled human capital, business involvement in R&D and innovation, and

ICT diffusion; and

(iv) pursue the strategy to reduce the administrative burden for businesses, including the time and cost

required for registering a new company.

6.

FRANCE

After three years of robust growth, resulting in strong employment creation, economic activity slowed
markedly from the beginning of 2001, reflecting the impact of the deterioration in the global economy.
The sharp deceleration in exports entailed adjustment in stocks and investment projects were postponed.
Conversely, private consumption, which benefited from a robust growth in disposable income and a
resilient labour market, remained dynamic, allowing the economy to avoid a more severe slowdown.
Prospects for 2002 and 2003 are more favourable; as the economy is not burdened by any important
imbalance,
improving confidence and accelerating external demand should lead to a rebound in GDP
growth in the course of 2002. The slight deterioration in the situation in the labour market observed since
May 2001 should come to an end in the course of 2002 and the unemployment rate is expected to recover
a downward path. This should not alter significantly the behaviour of wages, which are projected to grow
moderately. Finally, inflation should remain clearly below 2 % in the next two years, at one of the lowest
level in the euro area. When compared to other countries of the euro area, the French economy showed a
relatively strong resilience to the recent shock on external demand. This can be partly attributed to the
strength of the labour market and to lower inflation, together with positive effects of formerly planned tax
cuts. However, some further progress remains to be made. On the labour market, increasing labour market
participation and reducing the high rate of structural unemployment remains a key challenge. Moreover,
health and pension reform should be tackled, with a view to ensuring the sustainability of public finances.
Efforts should be made to secure the control of public expenditure, in particular in the health sector.
Finally, in order to enhance the medium-term performance of the economy, structural reforms, including
liberalisation of network industries, should be accelerated.

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B u d g e t a r y p o l i c y

In 2001, the general Government deficit is estimated to have increased to 1,5 % of GDP (1,4 % including
UMTS revenues), as against 1,3 % in 2000. The non-achievement of the deficit target fixed in the 2001
Finance Law, 1 % of GDP, is to be attributed partly to cyclical conditions, which reduced tax revenues, and
partly to higher-than-planned increase in nominal expenditures. Under the macroeconomic assumptions of
the 2001 updated stability programme, taking into account the implementation of tax cuts and the planned
increase in real expenditures, the general government deficit should reach 1,9 % of GDP in 2002 before
decreasing only slightly in 2003. The new Government has just launched a public finance audit. Pursuing
the consolidation effort along the lines of the 2001 updated stability programme is a necessary step in view
of medium term challenges for the general Government finances stemming from ageing of population.
Reducing the overall level of taxation is also important to enhance the growth potential without endan-
gering the fiscal consolidation. In view of the above, and considering that France is a member of the euro
area, budgetary policy should aim to:

(i) ensure that the 3 % of GDP reference value for the general Government deficit will not be breached in
2002; to this end, the Government shall closely monitor budgetary developments and ensure that any
future tax cuts are deficit-neutral;

(ii) aim at a sufficient decline of the 2003 deficit to ensure that a close to balance position in 2004 can be

achieved; and

(iii) conduct without delay a comprehensive policy of structural reforms designed for enhancing the
in
growth potential and reducing in the medium term the general
particular, define without delay a comprehensive reform of the pension system, allowing to secure its
sustainability in the context of ageing populations.

level of public expenditure;

L a b o u r m a r k e t s

After a number of impressive years, in line with a slowdown in economic activity, employment growth
slowed and the trend of gradual decline in the unemployment rate was halted. Despite the good
performance of previous years, the employment rate in France remains relatively low (62,0 % in 2000), and
that of older workers very low. The unemployment rate is still high, with high rates of youth unemploy-
ment, despite large-scale public youth job creation schemes. Policy measures in 2001 included: the
continued implementation of the 35-hour working week legislation, notably to the transition period for
small- and medium-sized firms (SMEs); the introduction of a new support scheme to help the unemployed
with job search (the PARE); the continued phased introduction of the earned income tax credit; and finally
the adoption of a new law on social modernisation which strengthened employment protection legislation.
Moreover, publicly subsidised job creation schemes have represented a substantial share of net job creation
in recent years. However, despite recent measures, there still remain problems of disincentives emerging
from the tax and benefit system, particularly for low-paid and older workers. The transition to a shorter
working week could also prove more problematic in SMEs despite measures to allow a more relaxed
implementation in these firms. In addition, the protracted phased implementation of the shorter working
week has led to the existence of several wage minima, some of which have been rising quickly due to the
interaction of the indexation mechanism for hourly minima with automatic increases in hourly wages.
Finally, it is unclear what impact the further recent strengthening of employment protection legislation will
have on labour market dynamics. In view of the above, while vigorously implementing all the Employment
Recommendations adopted by the Council in February 2002, the main priorities for France should be to:

(i) consolidate recent reforms of the tax and benefit system to improve the incentives to take up and stay
in work, and to encourage job-search. Firstly, incentives for older workers to remain in jobs should be
strengthened, in particular by reducing the opportunities for early retirement, and by reforming the
overall pension system. Secondly, focus should be paid to low-paid workers, disincentives to part-time
work, and minimum income guarantee schemes;

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(ii) closely monitor the implementation of the 35-hour working week, and take measures necessary to
address any adverse medium-term effects on wage costs and labour supply, while encouraging the full
exploitation of opportunities for more flexible work organisation; and

(iii) reform employment protection legislation with a view to striking a proper balance between greater
flexibility and security to facilitate access to employment. Avoid any negative effects on labour market
dynamics of the recent changes to employment regulations.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

The French economy is open to international competition and is well integrated into European markets.
Labour productivity is relatively high and the price level has fallen towards the European average. Progress
has been made in transposing Internal Market directives in the last two years and ad hoc State aid has been
reduced markedly. However, the gas and electricity markets are being liberalised at a slow pace and France's
record in transposing the Internal Market directives is still considerably below the March 2002 target of
98,5 %. Moreover, despite some improvements, the administrative burden on business remains among the
highest in the EU. Finally, although measures have been taken to encourage the development of a
knowledge-based society, France still lags behind most other Member States especially in the use of the
Internet. In view of the above, the main priorities for France should be to:

(i) speed up the liberalisation of the gas and electricity sectors by implementing the current Gas Directive
without delay, by opening up markets for non-household consumers to competition and encouraging
market entry in order to foster effective competition;

(ii) raise the transposition rate of Internal Market directives with the aim of achieving the target of 98,5 %

of Internal Market directives;

(iii) continue ongoing efforts made to reduce the administrative burden on business, especially by lowering

the time required for registering a new private limited company; and

(iv) take measures to further facilitate access to the internet among households, small businesses and

schools.

7.

IRELAND

After average growth of 9,9 % in the period 1996-2000, the Irish economy experienced a sharp slowdown
in the course of 2001. The weakening of activity was due to the interplay of capacity constraints,
foot-and-mouth disease precautions and the downturns of the international economy in general and the
ICT sector in particular, to which Ireland is more heavily exposed than other EU countries. Confidence
indicators and the purchasing managers'
index suggest that a rebound from a late-2001 trough is
underway, with a strong recovery expected from about mid-2002. By 2003, the economy should have
reverted to a growth rate that is sustainable in the medium term, of about 5 % to 6 %. While the labour
market proved to be remarkably resilient in 2001, a further increase in unemployment seems inevitable in
2002, to some 4½ %. Nonetheless, the labour market is expected to remain quite tight. As a result, some
drift above the wage provisions in the national agreement is to be expected and domestically-generated
inflationary pressures are unlikely to abate. Due to various indirect tax rate increases, average inflation in
2002 will probably be higher than the 4,0 % recorded for 2001, although the general trend from the first
quarter of 2002 should be downwards.

Social partnership has been a cornerstone of Irish economic policy since 1987. The current three-year
agreement, which expires end-2002, provided for increases in after-tax income of 25 % or more, to be
reached through a combination of nominal wage increases and direct tax relief. A key challenge is to adapt
the current wage setting process and the tax and spending commitments in national agreements to the new
environment characterised by conditions approaching full employment and more limited budgetary
resources. Growth in discretionary (voted) spending has been in double-digits in recent years, which is not

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11.7.2002

sustainable in the context of slower medium-term economic growth although the current low expenditure
ratio in Ireland should be noted. Developing the necessary policies to guide public spending in line with
resources in the medium term and improving expenditure control (while addressing key infrastructure and
other priorities for sustained economic growth) should be seen as another key challenge. While Ireland has
taken measures to increase competition in some markets,
there remains an insufficient degree of
competition in some sectors. For example, in the areas of professional services, retail distribution and
network industries, there is scope for strengthening competition.

B u d g e t a r y p o l i c y

In 2001, a large tax shortfall led to a general Government surplus of 1,7 percent of GDP, some 2½
percentage points below target. This is the lowest surplus since 1997. The stability programme 2002-2004
targets a small surplus for 2002 and envisages a return to a (small) deficit for 2003-2004. However, in the
event that the large contingency provisions against unforeseen developments incorporated in the 2003-
2004 targets are not used, a small surplus would be recorded in each year and the close-to-balance
requirement of the Stability and Growth Pact would be broadly respected. Regarding debt developments,
the stability programme projects a near-stabilisation of the debt ratio at the low level of 34 % of GDP. In
view of the above, and considering that Ireland is a member of the euro area, budgetary policy should aim
to:

(i) ensure that the budgetary stance for 2002 is broadly neutral;

(ii) ensure continued compliance with the close-to-balance requirement of the Stability and Growth Pact

after 2002; and

(iii) improve expenditure control through setting norms and ensure in the 2003 budget and beyond that
expenditure priorities and resource generation are targeted at a sustainable budgetary and economic
outcome.

L a b o u r m a r k e t s

Employment growth held up well during 2001, despite the economic slowdown, with employment gains
moderating but still averaging some 3 % for the year. The overall employment rate exceeds the EU average
and female employment growth continues to outpace that for males but there still remains scope for
further increases in the female employment rate. Unemployment rose slightly during the second half of
2001 but the rate still remained close to 4 % at year end. While this rate is likely to rise somewhat in 2002,
conditions approaching full employment are expected to continue. The available evidence indicates that
earnings growth remains fairly high, exceeding the 7½ % pay increase for 2001 provided under the national
agreement. The challenges of a tight labour market remain in relation to mobilising labour and future wage
setting processes. In view of the above, while vigorously implementing all the Employment Recommenda-
tions adopted by the Council

in February 2002, the main priorities for Ireland should be to:

(i) promote the setting of wages in line with productivity developments and skills differentials and

consistent with the maintenance of competitiveness and price stability; and

(ii) continue to focus measures on increasing the participation of women in the labour market.

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P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

Ireland is highly exposed to international competition and labour productivity is well above the EU average.
Ireland's price level was 5 % above the EU average in 2000 and has been rising relative to the EU average in
recent years. The liberalisation of the network industries is continuing, although State-owned incumbents
still have high market shares in these sectors. Whilst regulations affect the level of competition in certain
service sectors such as the professions and retail distribution the overall regulatory burden on business is
low. In March 2002 the rate of transposition of Internal Market directives (97,9 %) remained below the
target of 98,5 %. Sectoral and ad hoc State aid is low although total State aid (as a % of GDP) is at the top
end of the range in the EU. Ireland's ICT production (as a % of total production) is the highest in the EU,
partly due to the presence of a large number of foreign-owned high-tech firms. However, R&D expenditure
is below the EU average, particularly public R&D, which is being addressed by recent measures. In view of
the above, the main priorities for Ireland should be to:

(i) implement measures to increase effective competition in the local telecommunications, electricity, gas
and transport sectors in particular to address high market shares of State-owned or private incum-
bents;

(ii) address Government regulation, which may impair competition in certain market sectors such as the

professions and retail distribution; and

(iii) raise the transposition rate of Internal Market legislation with the aim of achieving the target of 98,5 %

of Internal Market directives.

8.

ITALY

In 2001 real GDP growth slowed to 1,8 %, prompted by a declining external contribution and, subse-
quently, by weakening domestic demand. After passing the trough in November, economic activity is
expected to pick up gradually at the beginning of 2002 on account of the improving global outlook and
recovering confidence. The upturn is likely to become steeper around mid year. Investment expenditure, in
particular, is forecast to accelerate in view of a temporary tax incentive scheme due to expire at the end of
the year. Owing to the low starting point inherited from 2001, real GDP growth will remain well below
2 % in 2002 and is expected to rise to around 2(cid:1) % in 2003. Employment growth is likely to weaken in
2002, on account of the lag with respect to output. The performance of the labour market is forecast to
improve again in 2003, with the rate of unemployment likely to fall below 9 %. With no significant
pressure from import prices and wages and a still negative output gap up until the end of the year, inflation
is expected to ease in 2002. However, due to the rising inflationary pressure in the first four months of
2002, resulting from temporary effects, annual average inflation is set to stay above 2 %. In 2003, inflation
is expected to ease somewhat on the year as a whole, but it is likely to stay at 2 % on account of rising
demand pressure ensuing from the economic recovery.

In the coming years fiscal policy aims at simultaneously achieving a significant reduction in the tax burden
while respecting the medium-term objective of a budget in balance or in surplus. Hence, improving the
control and quality of government expenditure remains of paramount importance. Although narrowing
somewhat in 2001, the wide unemployment gap between the North and the South continues to be the
overriding regional and labour market issue. Linked to that are the restrictive employment protection
legislation and the underdeveloped unemployment safety net. To support the goal of rising the underlying
speed limit of the economy to around 3 % per year, economic policy needs to address the low employment
rates as well as to accelerate the thus-far slow transition to the knowledge-based society in terms of
educational attainments, skilled human resources and R&D performance. In the same policy context, it is
necessary to improve the business environment and to enhance competition in the product markets.

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B u d g e t a r y p o l i c y

The general Government deficit to GDP ratio in the year 2000, previously estimated at 1,5 % of GDP (0,3 %
of GDP including receipts from the sale of UMTS licences), was revised to 1,7 % of GDP (0,5 % including
UMTS receipts). Mostly as a consequence of this revision, the general government turnout in 2001 was a
deficit of 1,4 % of GDP, against a government projection of 1,1 % of GDP. The 2001 public accounts
benefited from one-off operations amounting to some 0,6 % of GDP (sales of public real estate assets of
0,4 % of GDP, largely through a securitisation process, and 0,2 % of GDP from the securitisation of future
net proceeds from the state lottery). Primary current expenditure was broadly stable at 37,5 % of GDP, after
decreasing by 0,3 points of GDP between 1999 and 2000. The cyclically adjusted deficit, according to
Commission calculations, improved slightly compared to 2000 but the underlying budgetary position does
not improve if the one-off operations are netted out in both years. The debt ratio decreased by 1,2
percentage points of GDP to 109,4 %, a marked slowdown in the process of continued reduction.
Market-related difficulties in meeting the privatisation objectives and lower-than-expected growth mainly
contributed to this slowdown.

The November 2001 update of the stability programme targets a sizeable reduction in the deficit ratio to
0,5 % of GDP in 2002 and a balanced budget in 2003, while the debt ratio is to fall below 100 per cent of
GDP by 2004. The Italian authorities face the challenge of securing additional and lasting reductions in the
primary expenditure to GDP ratio, improving the quality of expenditure, reducing the tax burden while
achieving and maintaining the close-to-balance budgetary objective required by the Stability and Growth
Pact. In view of the above, and considering that Italy is a member of the euro area, budgetary policy should
aim to:

(i) ensure in 2002 and 2003 the respect of a steady path of deficit reduction, in order to achieve the
objective of a close to balance budget in 2003, by securing primary surpluses at the high levels
projected in the updated stability programme, notably thanks to improved control of expenditures;

(ii) ensure that the timing and the scope of the reform of taxation, outlined in the enabling act presented
to Parliament and aimed at reducing the tax burden, simplifying taxation and narrowing the tax
wedge, are consistent with the achievement and maintenance of a budgetary position close to balance
or in surplus; and

(iii) ensure that the changes to the social security system, for which the government has requested
delegated powers from Parliament, address the critical aspects of the present pension system; and
implement the measures aimed at promoting supplementary privately-funded pension schemes, clari-
fying the possible related budgetary costs.

L a b o u r m a r k e t s

The Italian labour market situation continued to improve in 2001, with the unemployment rate falling
from 10,4 % to a still high 9,5 % and female labour force participation increasing. On average, employment
grew by almost 2,1 per cent to an estimated 54,6 % and the overall participation rate rose to 60,4 % (from
59,9 % in 2000). Besides wage moderation, the higher employment intensity of growth over the recent
years is also due to the increased labour market flexibility ‘at the margin’, allowing greater use of new and
more flexible contracts (part-time, temporary jobs, fixed-term contracts, new apprenticeship). The measures
designed to lower labour costs for permanent employees continued to have a significant impact on
employment growth during 2001. However, the Italian labour market is still characterised by many
weaknesses, notably a persistent low employment rate, especially for women (about 40 %) and older
workers (only 28 % for the 55 to 64 year old). Wide regional disparities in labour market performances are

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still a major source of inefficiency. The unemployment rate in the south is at 19,3 %, compared to 7,4 % in
the centre and only 3,8 % in the north. A more decentralised wage-bargaining system should be agreed by
the Social partners in order to allow for greater wage differentiation. As a result of stricter protection of
workers in permanent jobs in medium and large firms and the still relatively low degree of protection of
non-employed and ‘atypical workers’, the labour market continues to be characterised by a marked dualism.
The unemployment benefit system remains limited in scope and uneven, with different schemes and
disparities in benefit conditions (level, duration and eligibility criteria). Although the tax wedge on labour
costs has been reduced over the latest years, especially that on low-paid workers, it remains relatively high.
In view of the above, while vigorously implementing all the Employment Recommendations adopted by the
Council

in February 2002, the main priorities for Italy should be to:

(i) encourage Social Partners to allow wage-setting mechanisms to better take into account productivity

and local

labour market conditions, while preserving wage moderation;

(ii) ensure the full implementation of the recent labour market reform package in order to increase labour
market flexibility, to limit market dualism, to promote greater workplace adaptability, to extend the
coverage and effectiveness of the unemployment benefit system and to strengthen active labour
market policies;

(iii) take steps to further encourage increased labour force participation, especially among women,
including setting targets to ensure adequate provision of facilities for care of children and other
dependants; and among older workers, stepping up and reinforcing incentives to postpone retirement
from the labour force; and

(iv) continue efforts to reduce the tax burden on labour, especially on low-paid earners, with a view to
preserving equity goals and increasing work incentives, within the framework of continued fiscal
consolidation.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

The Italian economy is relatively less open (as measured by the total trade-to-GDP ratio) than other EU
economies of similar size. Labour productivity is above the EU average, but has slightly decreased recently
in relative terms. The transposition rate of Internal Market directives while in line with the EU average
remains below the March 2002 target of 98,5 % and the number of infringement cases for violation of
Internal Market rules is among the highest in the EU. Efforts to improve the business environment have
started to bear fruit, but administrative procedures remain relatively complex, and competition in the
service sector is taking hold rather slowly. Recent measures should contribute to increasing competition in
the energy sector, where incumbents retain a very strong market position and prices remain among the
highest in the EU; which may be explained in part by a fuel mix strongly based on oil products. Italy's
transition to the knowledge-based society may be constrained by the relatively low average levels of
educational achievement of the population and the weak R&D and innovation base of the economy.
Internet penetration in households and in schools is below the EU average, even if the former is rapidly
catching up. The development of e-commerce is relatively slow. In view of the above, the main priorities
for Italy should be:

(i) continue to strengthen the overall education and skill base of the population, further increase private

sector involvement in R&D and innovation and promote higher ICT take up;

(ii) increase effective competition in the service sectors, particularly professional services, and implement
all reforms to extend market opening and further enhance competition in the energy sector in order to
allow the pass-on of the benefits of liberalisation to final users,
including households and small
businesses;

(iii) sustain the efforts undertaken to reduce the administrative burden for businesses, including the time

and cost required for registering a new company; and

(iv) continue to raise the transposition rate of Internal Market legislation with the aim of achieving the
target of 98,5 % of Internal Market directives, and bring down the number of infringement procedures.

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9.

LUXEMBOURG

Real GDP growth decelerated in the course of 2001 but still reached 3,5 % on yearly average according to
first national account statistics. Domestic demand remained robust: private consumption benefited from the
tax cuts operated at the beginning of the year, Government consumption continued to increase at a rather
fast pace and investment proved dynamic. Exports still increased by more than 2,5 % over the year, while
imports rose at least as fast,
imports of goods remaining dynamic in line with domestic demand.
Employment continued to increase by more than 5 %, hardly less than in 2000, though decelerating in the
course of the year, while unemployment began to rise at the end of the year. Wages accelerated further in
2001, rising by about 5½ % after 4,6 % in 2000. On the contrary, prices decelerated in 2001, the rise in
the HICP reaching 2,4 % as against 3,8 % in 2000. However, underlying inflation kept accelerating,
reaching 3,3 % in the second half of 2001.

Increasing the low national participation and employment rates, especially for older workers remains a key
challenge. Moreover, developments in wages and labour costs require attention and need to be maintained
in line with the rest of the euro area in the coming years. To this end, the wage formation process calls for
adjustment. Finally, efforts should be undertaken to accelerate implementation of the reform of competition
legislation and empowering the competition authority to apply EC law.

B u d g e t a r y p o l i c y

In 2001, the general Government surplus declined to below 4 % of GDP partly as a result of decelerating
activity and of the tax cuts implemented in the framework of the 1 January 2001 tax reform; but the main
factor of decline was a large increase in Government expenditure reaching 1,7 % of GDP. Further decline in
the surplus is expected in 2002, due to cyclical factors and to a second phase of the tax reform; in addition,
Government expenditure will continue to increase at a very fast pace, public investment, particularly in
infrastructures, is expected to reach 4,6 % of GDP in 2002, the highest percentage in the whole EU. In
2003, recovery in activity is expected to result in a renewed although moderate increase in the Government
surplus. However, current Government expenditures will continue to expand significantly. In view of the
above and considering that Luxembourg is a member of the euro area, budgetary policy should aim to:

(i) contain current Government expenditure in 2003 in order to ensure that the increase will not exceed
that of total budget expenditure and to this aim endeavour to overcome rigidities in specific kinds of
current expenditure.

L a b o u r m a r k e t s

The overall performance of the Luxembourg labour market was good in 2001. The unemployment rate
remained very low and employment growth continued to be strong, largely thanks to the availability of
cross-border workers. Nevertheless, the national employment rates remain low and the labour market has
been tightening, as revealed by strong nominal wage increases. This underlines the need to better exploit
the country's own labour potential, as indicated by low national employment rates for older workers (27 %)
and women (50 %). In 2001, the Government made some effort to restrict access to the disability pension
scheme and to increase incentives to work longer through an increase of the accrual rate of old-age pension
rights for additional years worked beyond the age of 55. In addition, female labour force participation and
flexibility in work were encouraged by allowing voluntary access to part-time work by full-time workers.
Despite these reforms, incentives to remain in labour force could be improved by further reforms of early
retirement, pre-retirement and disability pension schemes. In view of the above, while vigorously imple-
menting all the Employment Recommendations adopted by the Council
in February 2002, the main
priority for Luxembourg should be to:

(i) intensify efforts to increase the national employment rate: especially for older workers by reducing
incentives for early retirement, and by increasing incentives in pre-retirement and disability pension
schemes to remain in employment; and for women by removing obstacles to their entry or re-entry to
the labour market (by,

increasing the availability of child care facilities).

inter alia,

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P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

The high degree of openness of the Luxembourg economy stimulates competition on the product markets,
which results in very high productivity and prices below the EU average. Network industries are progres-
sively being liberalised and ICT diffusion is progressing well. However, some elements of the competition
framework, such as obsolete legislation on prices, have the potential to restrict competition on product
markets. Moreover, the lack of empowerment of the competition authority makes it difficult to ensure
effective enforcement of EC competition rules. In March 2002 the rate of transposition of Internal Market
directives (97,7 %) remained below the target of 98,5 %. In view of the above, the main priorities for
Luxembourg should be to:

(i) implement the announced reform of competition legislation, including the abolition of fixed and
monitored prices, the empowering of the competition authority to apply EC competition law, and the
reform of public procurement legislation;

(ii) take measures to reduce the administrative burden for businesses, including the time and cost required

for registering a new company, and to develop e-government; and

(iii) raise the transposition rate of Internal Market legislation with the aim of achieving the target of 98,5 %

of Internal Market directives.

10. NETHERLANDS

Real GDP growth decelerated at the beginning of 2001, reaching only 1,1 % in average for the year as
against 3,5 % in 2000. Exports as well as imports decreased substantially following the decline in
international trade; domestic demand was also subdued, private investment decreasing from the second half
of 2000 and consumption reacting abnormally to the large increase in households' disposable income,
which was boosted by fast rising wages and the effects of the tax reform at the beginning of the year. Real
GDP growth is expected to pick up again in the course of 2002, as private consumption should accelerate
and exports should follow the recovery in international trade: the expansion could reach around 1½ % in
2002 and some 2(cid:1) % in 2003. Employment kept increasing fast in 2001, though decelerating in the
second part of the year. As a result of sizeable labour hoarding, the productivity of labour declined and
unemployment remained stable until the end of 2001. The increase in employment should decelerate
significantly in 2002 and recover only modestly in 2003, leading in both years to a substantial rise in
unemployment, the level of which should, however, remain much lower than in neighbouring countries.
Moreover,
labour markets are likely to remain quite tight. The current upward pressure on wages is
therefore unlikely to disappear overnight. Inflation, which had accelerated significantly in the course of
2000 to about 3 % at the end of the year, partly as an effect of rising oil prices, jumped to 5 % in 2001,
due to a rise in indirect taxation which was part of the tax reform and also to still rapidly rising wages;
price increases are expected to decelerate only progressively in the coming years.

Increasing further labour market participation by drawing currently inactive people into the labour market
remains a key challenge. Moreover, due to substantial acceleration in wages in the latest years, part of the
very significant gains of competitiveness achieved during nearly 15 years have been lost. This might reduce
the benefits for the Netherlands economy from the world recovery and dampen future growth prospects. A
second key challenge is therefore to ensure, as soon as possible, a renewal of wage moderation and to
tackle relatively slow labour productivity growth, in order to maintain the competitiveness of the economy.

B u d g e t a r y p o l i c y

The general Government surplus declined from 1,5 % of GDP in 2000 to 0,2 % of GDP in 2001 (excluding
UMTS receipts), mainly as a result of a significant reduction in budgetary revenues. The wide-ranging tax
reform, which came into effect on 1 January 2001, induced a decline in Government receipts from the
income tax and from the social security contributions, only partly compensated by the increase in indirect
taxes (specifically the rise in the standard VAT rate from 17,5 % to 19 %). This effect was aggravated, at the
end of the year, by the impact on tax revenues of the cyclical deceleration in the economy. Moreover, the
EMU-balance deteriorated 0,3 of a percentage point because of a one-time expenditure due to the

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acquisition of the stake of DSM in EBN. This acquisition is to be seen as part of the process to liberalise the
Netherlands gas market. Although some spending was reallocated in the Spring of 2001 towards priorities
in the areas of healthcare, education and security, the expenditure ceilings were respected thanks to
lower-than-expected interest payments and social security outlays. In the absence of any discretionary
measure, letting the automatic stabilisers fully play, the Government accounts are currently expected to be
broadly in balance in 2002 and to post a moderate deficit in 2003 which might reach 0,4 % of GDP,
according to the Spring Commission forecasts. In view of the above and considering that the Netherlands is
a member of the euro area, budgetary policy should aim to:

(i) ensure that the budgetary stance in 2002 does not contribute to inflationary pressures, should they

persist notably as a result of excessive wage increases; and

(ii) avoid a deterioration in the government balance in 2003 and, to this end, contain current Government

expenditure within clearly defined ceilings set in real terms.

L a b o u r m a r k e t s

The Netherlands labour market continues to perform very well, with the lowest unemployment rate in the
European Union and employment rates already above the Lisbon targets for the EU as a whole. Despite the
cyclical slowdown and still robust employment growth in 2001, labour market tightness continued to be a
major driving force behind strong wage increases. Further improvement of employment rates will depend
on continued growth of female participation and a stronger activation of older persons and minorities.
Moreover, there exists a substantial untapped reserve of labour among benefit claimants, e.g. 7 % of the
labour force receives unemployment and social benefits and 11 % receive disability benefits (although some
of those with partial disabilities are working). Some new measures were introduced, and some existing ones
refined, in order to strengthen work incentives for benefit recipients, older workers and low wage earners.
However, the discussion on a reform of the disability scheme has not yet led to tangible results; and the
cumulative effect of benefits, including local subsidies, continues to create inactivity traps. In view of the
above, while vigorously implementing all the Employment Recommendations adopted by the Council in
February 2002, the main priority for the Netherlands should be to:

(i) make work pay via reforms of benefit eligibility, conditionality and rules for cumulation of benefits.
Carry through and implement a reform of the disability scheme, thereby, in view of the size of the
stock of recipients, paying attention to both the inflow and to the activation of those who already
receive benefits.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

The Netherlands economy is very open (as measured by the total trade-to-GDP ratio). This assures a high
level of competition and relatively low price levels in sectors producing tradable goods and services. Market
liberalisation has contributed to relatively low prices for telephone calls and electricity use. The transposi-
tion rate of Internal Market directives met the March 2002 target of 98,5 %. Measures have been taken to
encourage ICT use and reduce the shortage of ICT experts. However, labour productivity growth has been
relatively slow as a result of, among other things, the rapid employment growth in services, the low level of
competition in some more sheltered services sectors (e.g. notaries, childcare, taxis and broadband Internet),
and insufficient business investment, particularly in R&D. In spite of efforts made to stimulate research and
innovation, business expenditures on R&D as a percentage of GDP remain below the EU average, which
may be associated with the lack of a science- and technology-oriented labour force. The typical time and
costs required for setting up a private limited company are above the EU average. In view of the above, the
main priorities for the Netherlands should be to:

(i) create the conditions for a further increase in business investment in R&D by taking measures to raise
the number of science and technology graduates entering into the labour force and by promoting a
more technology-oriented education;

(ii) address market regulations which may impair competition in service sectors,

including notaries,

childcare, taxis and broadband internet; and

(iii) take further measures to develop e-government and to reduce the administrative burden on business,

including the time and cost required for registering a new company.

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11. AUSTRIA

Output growth decelerated in 2001 to about 1 %, following buoyant economic activity during the period
1998-2000. Weak demand, worsening business confidence and excess capacities lead to a fall in equipment
investment, at the same time as construction investment plunged. Domestic demand was furthermore
curbed by budgetary consolidation. Although exports fell into step with the slowdown of economic activity
of main trading partners, the growth contribution of net exports remained clearly positive due to a strong
deceleration in import growth. In 2002, domestic demand is expected to pick up somewhat, thereby
offsetting a further decline in export growth. As a result, GDP growth on average should remain more or
less steady. In 2003 the projected improvement in both external trade and domestic demand should bring
output expansion close to potential, i.e. to some 2½ %. Oil price developments and increases in excise
duties drove up prices until May 2001. Higher housing costs also added to price pressures. In 2002, by
contrast, the expected easing of import prices should dominate consumer price developments. In 2003, the
increase in the HICP is expected to remain at the 2002 level. The expansion in total employment came to a
halt in 2001. Employment is projected to decline slightly in 2002 but job growth should resume in 2003.
Unemployment started to rise in 2001 and is expected to continue its rise in 2002 to some 4,0 % of the
labour force before reversing in 2003.

Although the budgetary situation improved considerably in 2001, efforts to improve the sustainability in a
longer-term perspective given the expected strong expenditure pressure stemming from the ageing of the
population are necessary. In particular, a low effective retirement age and high benefit levels continue to
exert significant upward pressure on public pension outlays. Although pension scheme reforms and
moderate benefit rises in recent years have partially addressed these issues, much remains to be done to put
the pension system on a sustainable footing. Output growth in Austria has been strongly based on factor
expansion while total factor productivity growth remains rather moderate. Moreover, a weak technology
base stands in the way of an expeditious transition to a knowledge-based economy. Although different
initiatives have been undertaken in this regard, such as an increase in R&D expenditure or the reinforce-
ment of links between business and universities, it remains to be seen whether these measures are sufficient
to help Austria to catch up with other more advanced EU countries in terms of a knowledge based
economy.

B u d g e t a r y p o l i c y

Budgetary consolidation in 2001 was impressive. General Government finances improved from a deficit of
1,9 % of GDP (1,5 % including UMTS proceeds) in the year before to a balanced position. As this was
achieved against output growth much below trend the improvement in the cyclically adjusted position was
even stronger. Expenditure growth was kept at bay thanks to the ongoing effects of the reform of the
pension system and public administration. The favourable outcome in 2001 is, however, mainly due to a
strong increase in tax revenue. As a consequence, the tax burden climbed to a record high. The stability
programme update projects a balanced budget also for the years 2002 and 2003. To attain the targets of
the programme, structural savings measures will be needed at the level of the Länder, which committed
themselves to considerable surpluses in the framework of a national stability pact. Despite recent structural
reforms, the sustainability of the pension system is not secured in view of the sharp rise in the age-depend-
ency ratio in coming decades. In view of the above, and considering that Austria is a member of the euro
area, budgetary policy should aim to:

(i) implement measures leading to structural expenditure savings, especially at lower levels of Govern-
ment, so as to meet the target of a balanced budget in 2002 and 2003 set in the updated stability
programme of December 2001;

(ii) ensure that the planned reduction in the high tax burden enhances incentives to work and invest and
does not conflict with the target of maintaining budgetary balance; this requires additional savings
efforts at all

levels of government; and

(iii) review the public pension system to ensure the sustainability of public finances, addressing in
particular the low average effective retirement age through the reduction of incentives for early
retirement.

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L a b o u r m a r k e t s

The overall performance of the Austrian labour market remained very satisfactory in 2001. Although the
economic slowdown has started to be felt and unemployment has started to increase, the unemployment
rate is, at 3,6 %, still among the lowest in the European Union. Skills gaps, which have occurred in the ICT
sector, manufacturing and services, are likely to be attenuated by the current slowdown. While the total
employment rate is, at 68 % in 2000, above average, the employment rate of older workers appears to be
stagnating at a very low level of 29 %. This is problematic in view of the high burden stemming from
population ageing. Following the pension reform of 2000, the reduced inflow into retirement experienced
in 2001 looks encouraging, but it is still too early to see the full impact on the effective average retirement
age. In 2001, a number of active measures that proved successful in the past have been strengthened or
refined. However, disincentives to work after the minimum age for early retirement remain, and the
lengthening of benefit duration for older workers is likely to produce adverse effects, thus weakening the
impact of the early retirement reform to which it is an accompanying measure. In view of the above, while
vigorously implementing all the Employment Recommendations adopted by the Council in February 2002,
the main priority for Austria should be to:

(i) speed up reform of tax and benefit systems to remove disincentives for older workers to remain active

in the labour market.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

Despite Austria's lower exposure to international competition than for other small Member States, labour
productivity and price levels are in line with the EU average. Important measures are being taken to rapidly
liberalise network industries and to appoint sectoral regulators. Further improvements in the regulatory
framework would foster competition and increase pressure for companies to innovate. In March 2002 the
rate of transposition of Internal Market directives (98,1 %) remained below the target of 98,5 %. Austria's
lag in business R&D and in high tech patents also contributes to its relatively weak technology base which
risks delaying the transition to the knowledge-based economy. The typical time and costs requirements for
setting up a private limited company are relatively high. In view of the above, the main priorities for
Austria should be to:

(i) continue to implement measures aimed at promoting and diffusing ICT and R&D in businesses, in

order to increase business expenditure on R&D as a percentage of GDP;

(ii) improve Austria's integration within the Internal Market by accelerating the transposition of Internal
Market directives with the aim of achieving the target of 98,5 % of Internal Market directives and by
levels of public
ensuring a full application of Community rules on public procurement by all
authorities;

(iii) improve the regulatory framework by increasing the effective powers of the telecommunications

regulator; and

(iv) further implement measures to reduce the administrative burden on business, including the time and

cost required for registering a new private limited company.

12.

PORTUGAL

Economic growth decelerated to about 1(cid:1) % in 2001, as a sharp slowdown in domestic demand was only
partly offset by an improvement in net exports. This ends an extended period of growth driven by domestic
demand. The efforts of private sector agents to redress their balance sheets, following the sharp rise in
indebtedness levels in recent years, are expected to limit domestic demand growth also in 2002-2003,
estimated to average about 1¼ %. With foreign demand expected to be weak in the first half of 2002
output growth will also remain subdued but should pick up in step with the recovery of global demand in
the latter part of the year. In view of the negative statistical overhang in the beginning of 2002, annual GDP
growth is expected to reach only around 1½ % in 2002, before reviving to a growth rate of some 2¼ % in
2003. After an upsurge in inflation in 2000 and through 2001, due partly to temporary factors,

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inflationary pressures have subsided since the second quarter of 2001. Inflation measured by the HICP is
projected to pursue its deceleration in the near term, attaining a value of around 2½ % on an annual
average in 2003. The unwinding of the tight labour market situation coupled with the projected low wage
increases in the public sector are expected to have a moderating impact on wage developments and,
subsequently, price inflation. Employment growth is forecast to slow down significantly during the
2002-2003 period, after expanding by 1,6 % in 2001, while unemployment should rise somewhat, with
the unemployment rate averaging about 5 % in 2003.

A new Government was sworn in on 6 April 2002. The consolidation of public finances will be a major
policy challenge for this government during its term. Fiscal consolidation faltered in 2001, due also to
significant revenue shortfalls. However, viewed over the longer period it is the strong dynamics of
government expenditure, which appears to be at the root of the sluggish budgetary consolidation process.
The reversal of the rapid upward trend in general government outlays is, therefore, a priority matter on the
road to sounder public finances. The Portuguese economy has lost competitiveness in recent years, as
evidenced also by a large trade deficit. A number of factors have contributed to this, in particular low
growth of labour productivity coupled with high wage settlements. The unsatisfactory level and growth of
labour productivity is associated, inter alia, with a low level of educational attainment of the workforce
which continues to be one of the most significant structural problems. The pursuit of higher levels of
productivity is also constrained by insufficient competition in product markets. Portugal is one of the EU
countries most exposed to the budgetary consequences of population ageing. A number of recent reforms
have addressed this issue. Although these reforms will improve the financial balance of the pension system
in the longer term, further action seems to be required to ensure sustainability of public finances. Moreover,
the strong dynamics of health-care expenditure suggests that the ongoing reform process to improve the
control and efficiency of expenditure in the health care sector needs to be pursued with resolve.

B u d g e t a r y p o l i c y

Fiscal consolidation halted in 2001, with the government deficit increasing to an estimated 2(cid:1) % of GDP
(2¼ % in 2000 excluding UMTS proceeds), which compares with an initial target of 1,1 %. This is much
higher than expected in December 2001, when the authorities submitted their stability programme update.
Slower economic growth than expected is an important factor behind the considerably worse than targeted
budgetary outcome in 2001. However, other factors are also behind this, notably an underestimation of the
revenue losses implied by the reform of direct taxes implemented in 2001 and lower-than-projected
efficiency gains in tax collection and administration. Moreover, despite a restrictive package adopted in
June, current primary expenditure exceeded the target.

Finally, the strong upward revision between December 2001 and April 2002 was caused by much
higher-than-estimated deficits at the level of local governments and a statistical reclassification of certain
capital transactions between the Government and public enterprises. The December 2001 update of the
stability programme maintains the objective of balancing general Government accounts by 2004. In the
Ecofin Council meeting of 12 February 2002, the Portuguese Government committed itself to respect the
3 % of GDP reference value for the general Government deficit in the current year and confirmed its
commitment to reach a balanced position in 2004. In view of the strong deterioration of the deficit in
2001 this requires a considerable more ambitious fiscal consolidation policy in the period 2002-2004. In
the light of the much worse than expected budgetary outcome in 2001, and of the poor execution of the
initial budget for 2002, the new Government adopted on 15 May 2002 a rectifying budget including
corrective measures to the tune of 0,6 % of GDP. In view of the above, and considering that Portugal is a
member of the euro area, budgetary policy should aim to:

(i) ensure that the 3 % of GDP reference value for the general Government deficit will not be breached in
2002, to this end implement strictly the rectifying budget, which aims at a deficit of 2,8 % of GDP and
use all opportunities to achieve a better than targeted budgetary outcome; and strengthen budgetary
surveillance at all

levels of government;

(ii) achieve a close to balance budgetary position by 2004; this will require discretionary measures in

addition to those included in the 2001 updated stability programme;

(iii) implement the measures announced in the rectifying budget for 2002 to rein in expenditure with
determination with a view to reducing the expenditure dynamics of general Government; and

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(iv) continue the process of pension reform by implementing measures in addition to those contemplated
by the 2001 reform to ensure sustainability of the pension system in the medium and longer term;
introduce effective measures to curb the unsustainable pace of health care expenditure, particularly for
the consumption of pharmaceuticals.

L a b o u r m a r k e t s

The labour market situation remained favourable in Portugal
in 2001, despite the marked decline in
economic activity. The unemployment rate continued to be one of the lowest in the Union at just above
4 %. Employment grew by 1,5 % and the employment rates are all (whether overall, female or that of older
worker) well above the EU-averages. Wage levels and labour costs remain among the lowest in the Union,
but the tight labour market situation in some sectors and strong wage increases in the public sector have
triggered nominal wage growth of over 6 % in 2000-2001. Together with the modest increase in labour
productivity, real unit labour costs have increased by some 1,3 % in 2000-2001, well above the basically
unchanged level noted for the EU as a whole. In addition, the level of labour productivity is low in Portugal,
partly explained by the very low levels of educational attainment (also for the younger age groups). On
average, the share of the population that has attended at least upper secondary education was only 21 % in
1999 (compared to 59 % on average in the EU).

Although, Portugal has increased spending on education substantially in recent years, the continued high
incidence of early dropouts and a need to streamline and simplify the very many measures suggest a
relatively inefficient use of resources. The share of workers with temporary contracts has almost doubled in
the last five years, partly as a result of the stricter employment protection legislation for workers with
regular contracts. In view of the above, while vigorously implementing all the Employment Recommenda-
tions adopted by the Council

in February 2002, the main priorities for Portugal should be to:

(i) improve education and training systems in the framework of a better articulated lifelong learning
strategy in order to raise the employability and adaptability of the labour force and increase labour
productivity;

(ii) promote wage developments that are consistent with the maintenance of competitiveness and price

stability so that real wages do not grow above labour productivity; and

(iii) modernise the labour market institutions,

inter alia, by adapting employment contract regulations

taking into account the need for a proper balance between flexibility and security.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

Partly because of its geographical position, the Portuguese economy is relatively less open (as measured by
the total trade-to-GDP ratio) than other Member States of comparable size. Labour productivity is the
lowest in the EU and is growing only slowly. Among the determinants of the low productivity and overall
competitiveness of the economy are the low level of educational attainment of the workforce and the very
weak involvement of the business sector in R&D and innovation. Several measures have been taken to
promote ICT diffusion, increase R&D activity and reduce the administrative burden on businesses. Liberali-
sation of network industries has made progress but there is still scope for enhancing competition, as
incumbents have retained strong market positions and prices remain relatively high. Portugal's record in
transposing Internal Market directives is below the March 2002 target of 98,5 %. Competition in overall
product markets would greatly benefit from the implementation of the announced reinforcement of the
institutional setting for the enforcement of competition policy and the control of sector-specific and ad hoc
State aid, which remains the second highest in the EU and is only decreasing at a slow pace. In view of the
above the main priorities for Portugal should be:

(i) continue to strengthen the overall education and skill base of the population and further promote the
stronger involvement of businesses in R&D and innovation, together with higher ICT take up;

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(ii) enhance effective competition in liberalised utilities and especially in the energy sector, in order to

reduce the prices for users;

(iii) monitor the cost-effectiveness of sector-specific State aid schemes with a view to their possible

reduction; and

(iv) continue progress in raising the transposition rate of Internal Market legislation with the aim of

achieving the target of 98,5 % of Internal Market directives.

13.

FINLAND

Due to a sharp decline in export growth accompanied by heavy de-stocking the Finnish economy
experienced a sharp slowdown in 2001, with GDP growth being estimated at 0,7 % after 5,6 % the year
before. A gradual recovery of the external contribution to growth is expected to revive economic activity in
2002-2003. Furthermore, private consumption should gain strength owing to continued income tax cuts,
moderating inflation and continued favourable monetary conditions. However, against the background of a
low rate of capacity utilisation in manufacturing and an estimated decrease in demand for additional
housing and business premises, investment is anticipated to be weak. Inflation (HICP) eased somewhat to
2,7 % in 2001 as the impact of higher prices for fuel and food faded towards the end of the year. However,
prices of services rose fairly strongly and this factor is also expected to put a floor under price inflation in
2002-2003. Employment continued to increase in 2001, though at a steeply declining pace. In 2002,
employment is expected to decrease in the light of continued subdued growth in the export-oriented
manufacturing sector and only limited employment expansion in the service sector. Consequently, unem-
ployment is anticipated to edge up in 2002, with a reversal expected only in 2003.

At 9,1 % of the labour force the unemployment rate remained in 2001 clearly above the average of the
euro area. Most of the unemployment appears to be of a structural nature. Although efforts have been
made to better target and tailor ALMPs and to help the inclusion of the most hard-to-place unemployed in
the labour market, while benefit eligibility criteria were tightened, other measures such as the increase in
unemployment benefits run contrary to the aim of increasing incentives to work. Finland is one of the
Member States most exposed to the effects of an ageing population. The government is committed to
pension reform with a view to making public finances sustainable in the long term. A number of the
reform steps go in the right direction but for several of the measures the envisaged period of implementa-
tion appears unduly long. Finland remains one of the countries with the highest price levels in the EU. This
is due in part due to insufficient competition in certain sectors calling for stepped up efforts in this area.

B u d g e t a r y p o l i c y

Central Government finances are estimated to weaken from a surplus of 1,9 % of GDP in 2001 to 1 % in
2002. The Government's aim of achieving a structural surplus in central Government finances of 1½ to 2 %
of GDP over the medium term appears now very difficult to achieve, the more so as, in order to boost
employment creation, the Government might decide to reduce further income tax rates. Against the
background of the Government's aim of preparing for the forthcoming age-related expenditure pressures
tax cuts need to be accompanied by expenditure restraint. Central government spending in recent years has
repeatedly overshot the medium-term spending guidelines. In addition to a weakening of central govern-
ment finances, the financial balance of local governments has stayed persistently in deficit since 1997,
except for 2000 when company taxes were particularly buoyant. Budgetary discipline at general govern-
ment level could be enhanced by a recently adopted legislation requiring local governments to aim for
medium-term budgetary balance from 2002 onwards. However, in the absence of an enforcement mecha-
nism in the legislation it is uncertain whether this regulation will achieve the envisaged results. In view of
the above, and considering that Finland is a member of the euro area, budgetary policy should aim to:

(i) avoid a significant deviation from the medium-term spending guidelines of keeping government
expenditure in real terms at the level of 1999; to this end adhere tightly to the budget's expenditure
target for 2002 and adopt the necessary expenditure reducing measures in the budget for 2003;

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(ii) improving the budgetary discipline at local government level by establishing an enhanced surveillance
mechanism to the recently adopted regulation requiring local governments to aim for budgetary
balance in their finances in the medium term; and

(iii) continue with determination the ongoing process of pension reform, in particular adopt and imple-
ment at an early stage the envisaged changes in the pension formula by taking into account the
increased life expectancy and extending the period of calculation for pensionable earnings to the
whole work career.

L a b o u r m a r k e t s

The performance of the Finnish labour market in 2001 was mixed. While employment continued to grow
and unemployment to decline, real unit labour costs increased and labour productivity fell due to a sharp
slowdown in the economic growth. As a result, employment growth is expected to cease in 2002. The
unemployment rate remains at a high level, 9,1 % in 2001, and is expected to rise in 2002. Unemployment
is predominantly structural in nature, with large regional differences. The Government's responses to labour
market problems focused strongly on the reduction of overall taxes on labour between 1997 and 2002.
However, these reductions have been essentially proportional, thus doing little to redress the relative
position of low-wage earners, in particular, with respect to high marginal effective tax rates. In 2001, the
Government introduced measures to improve the effectiveness of active labour market programmes
(ALMPs), to prevent exclusion of the hard-to-place unemployed from the labour market and to reform
pension systems with the aim of increasing flexibility regarding the retirement age and increasing incentives
to remain longer in the labour force. However, the number of working-age people in various benefit
schemes and ALMPs remains high and the late implementation of the latter reforms weakens their effect on
the baby-boom generation and risks delaying the achievement of the Government's objective of raising the
effective retirement age. In addition, the already-decided measures to increase the level of unemployment
benefits in 2002 run contrary to the aim of increasing incentives to work and undermine the effects of tax
reductions and ALMPs. In view of the above, while vigorously implementing all the Employment Recom-
in February 2002, the main priorities for Finland should be to:
mendations adopted by the Council

(i) make work pay in order to reduce the high level of structural unemployment. Reforms should cover
benefit schemes, including early retirement arrangements, with a view to lowering the relatively high
marginal effective tax rates for low wage earners in particular. Also, the eligibility criteria and job
protection legislation should be reviewed; and

(ii) continue to increase the efficiency of active labour market programmes and to refocus them to the

needs of those most prone to the risk of long-term unemployment.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

Due to its peripheral location in the European Union, the Finnish economy is potentially less exposed to
international competition than most other Member States. Consumer price levels are among the highest in
the European Union, which is partly due to the relatively high degree of market concentration in some
sectors, such as the media and retail distribution. The Finnish transposition rate of Internal Market
directives is among the highest in the EU and telecommunication and electricity markets have been fully
liberalised. Although the resources and powers of the competition authorities have been increased, Finland
is one of the few Member States, which has not taken measures to empower the national competition
authority to apply EC competition law directly. Moreover, while improvements have been made recently,
the value of public procurement that is publicly advertised is below the European average and private sector
participation in the provision of public services is low, especially at the local level. Measures have been
taken to promote entrepreneurship but the time required to register a private company remains among the
longest in the EU. Finally, Finland is one of the best performers in the European Union in the field of the
transition to the knowledge-based economy. In view of the above, the main priorities for Finland should be
to:

(i) enhance competition in public service provision at the local level via increased participation of the

private sector and competition between public service operators;

(ii) facilitate business creation by reducing further the time required for registering a new company; and

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(iii) give the Finnish Competition Authority powers to apply Articles 81 and 82 of the EC Treaty.

14.

SWEDEN

Sweden experienced a sharp slowdown in 2001 and real GDP growth decelerated to 1,2 % from 3,6 % in
2000, heavily influenced by the global slowdown and in particular of the slump in the ICT sector. However,
the expected gradual acceleration of the world economy in 2002 and 2003 should result in stronger
external demand. The relatively favourable fundamentals in Sweden should also aid a recovery in domestic
demand in 2002 and 2003. Overall, real GDP is expected to grow by around 1,7 % in 2002 and by some
2,8 % in 2003. HICP inflation increased substantially in 2001 and averaged 2,7 %, partly due to temporary
factors. However, the indications are that inflationary pressures should diminish from the second quarter of
2002 and remain close to 2 % into 2003. Employment growth has been robust in recent years and was 2 %
still in 2001, which has contributed to a substantial fall in the unemployment rate, to 5,2 % in 2001.
However, some lagged effects of the slowdown of economic activity in 2001 are expected and a slight
increase in unemployment is expected in 2002. This should be reversed as the economy gains momentum
in 2003.

Enhancing the growth potential of the economy remains a key challenge, as productivity per person has
fallen in recent years compared with the EU-15 average. Policies aimed at strengthening entrepreneurship
and growth of firms as well as efforts to improve incentives to work should be given high priority. While
Sweden ranks high in terms of employment rates, increasing labour force participation and foster employ-
ment nevertheless remains a key challenge in the medium term in order to cope with an ageing population.
A further expansion in labour supply could be encouraged via continued reforms to make the underlying
tax-benefit structure more favourable to employment. Moreover,
labour market
programmes need to be monitored. Measures to enhance competition in some sectors and to increase the
efficiency of the public sector are key challenges in order to address the high price levels and the weak
labour productivity performance.

the effectiveness of

B u d g e t a r y p o l i c y

In 2001, the general Government surplus rose markedly, by 1 percentage point, to 4,8 % of GDP.
According to the 2002 Spring Fiscal Policy Bill, continued large surpluses of 1,8 % of GDP in both 2002
and 2003 are expected. Swedish medium-term budgetary policy is threefold and consists of (i) nominal
ceilings on central Government expenditure set annually for three years ahead, (ii) a medium-term balanced
budget constraint for local governments and (iii) a 2 % of GDP surplus target for general Government
finances on average over the business-cycle. The margin created by achieving higher surpluses than targeted
has been used partly for tax relief and partly for debt reduction. Gross debt fell below 60 % of GDP in 2000
and is expected to continue to fall and reach 48,3 % of GDP in 2004, according to the 2002 Spring Fiscal
Policy Bill. This debt reduction, together with the reformed pension system, form an important part of
Sweden's strategy for coping with the ageing of the population. In view of the above, budgetary policy
should aim to:

(i) continue with the strategy of lowering taxes for low and medium wage earners in 2002 and at the

same time ensure adherence to the central Government expenditure ceiling; and

(ii) achieve in 2003 a general government surplus in accordance with the Government's medium-term
surplus target of 2 % of GDP over the cycle for the Government finances while maintaining tight
expenditure control.

L a b o u r m a r k e t s

The Swedish labour market continued to improve in 2001, despite the substantial slow down in economic
growth. Unemployment declined to around 5 % of the labour force, while employment grew by almost
2 %, boosting further the already high employment rates. In particular, the employment rate of older
workers (55 to 64 years old) at almost 65 % in 2000 is markedly higher than in other Member States. The
remaining ‘labour reserve’ for a further increase of labour supply in the medium term is thus limited. In
fact, relatively high nominal wage increases in 2001 (compared to the modest performance of labour
productivity), in e.g. the construction and services sectors, suggest a certain shortage and mismatch of
labour already now. This is partly alleviated by the strong emphasis put on training in Sweden, where
almost 5 % of the labour force either participates in various active labour market programmes (ALMPs) or

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the special, temporary education programme, which both contribute to an improved adaptability of the
work force. However, recent evaluations of some types of ALMPs indicate a relatively mixed outcome (in
terms of the net gains in employment), underlining the importance of further improving their efficiency.
Despite recent measures, the tax burden on labour and, in particular, on low wage earners remains one of
the highest in the Union. Relatively generous benefit levels contribute to high net replacement rates, but
comparatively strict eligibility criteria (in combination with the active employment policy) limit the risk of
long-term unemployment
the
Employment Recommendations adopted by the Council in February 2002, the main priorities for Sweden
should be to:

the above, while vigorously implementing all

In view of

in Sweden.

(i) pursue further the reforms of tax and benefit systems to promote work incentives; and

(ii) further improve the efficiency of active labour market programmes (ALMPs) and continue to target
them at those most prone to the risk of long-term unemployment, as well as to meet the demands of
the labour market.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

Sweden's openness (as measured by total trade-to-GDP ratio) is higher than the other Nordic economies
and notably increased in the 1990s, but price levels remain high and labour productivity is below the EU
average. The record in transposing Internal Market directives is excellent, State aid is among the lowest in
the EU, and reforms of network industries are well advanced. However, competition in public services
provision is still insufficient at the local level. Competition is also insufficient in some sectors such as the
retail market for pharmaceutical products, a state-owned monopoly, and food trade. Sweden has the highest
total R&D expenditure in the EU although it is highly concentrated in a few knowledge-intensive sectors.
The uptake of ICT by the population is proceeding at a high pace and the share of the ICT industry in total
production is large compared to other Member States. In view of the above, the main priorities for Sweden
should be to:

(i) enhance competition in public service provision at the local

level; and

(ii) step up efforts to enforce competition in those sectors where competition has been found to be

inadequate, such as the retail market for pharmaceutical products and food.

15. UNITED KINGDOM

United Kingdom economic activity held up well in 2001 as a whole. Depressed net exports associated with
the weaker global economy were offset by exceptionally strong growth in household expenditure. GDP rose
by 2,2 % in the year as a whole. Growth in 2002 is expected to be a little lower, at around 2 %, as a result
of the global slowdown. However, within 2002, growth is expected to recover as growth of the world
economy rises and the economy continues to be supported by growth in domestic demand, in part as a
result of monetary loosening in 2001 and planned rises in Government current and capital expenditure.
Growth in 2003 is expected to be a little above trend as United Kingdom export markets grow respectably.
Inflation is projected to remain subdued in 2002 and 2003 as output remains close to potential. In
particular, increased wage pressures are not expected to emerge despite unemployment remaining low at no
more than 5,5 %. HICP inflation is projected to average under 2 % in 2002 and 2003.

The relatively low level of productivity remains a key challenge. Productivity per person employed is below
the EU average although the gap has been declining since 1995. As far as the labour market is concerned, a
key challenge is the high concentration of unemployment and inactivity in certain communities. Although
unemployment has fallen in all regions and countries of the United Kingdom there remain local areas with
high rates of worklessness. The third key challenge is to improve the quality of United Kingdom public
services, notably in the transport sector.

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B u d g e t a r y p o l i c y

The Government surplus was 0,9 % of GDP in 2001. The projections in the convergence programme show
the Government finances moving into small deficit of 0,2 % of GDP in financial year 2001-2002 which
rises to a deficit of 1,1 % of GDP in 2002-2003 and persists around that level in the remaining years of the
programme, to 2006-2007. A deficit of around 1 % of GDP now emerges, one year earlier than in the
previous update,
largely as the result of temporary economic factors (e.g. a lower level of GDP than
previously projected, and lower financial company profits). This 1 % of GDP deficit persists in the
projections, both unadjusted and cyclically adjusted, as a result of a very cautious trend growth assumption
of 2,25 % per annum and as a result of addressing the low level of government investment, as suggested in
the 2001 BEPGs. Gross debt relative to GDP was 39 % in 2001. In the convergence programme it is
projected to fall to 36,3 % by 2006-2007. With a low and falling debt to GDP ratio, the United Kingdom is
in a good position to meet the consequences of ageing populations and the public finances are sustainable
on current policies. In view of these developments, including cautious growth forecasts, and noting the
requirements of ‘close to balance or in surplus in the medium term’ contained in the Stability and Growth
Pact, budgetary policy should:

(i) allow public investment, net of depreciation, to rise from 2001-2002, as projected in the convergence

programme, and as suggested in the 2001 BEPGs; and

(ii) be alive to any deterioration in the public finances that would take them away from the terms of the

Stability and Growth Pact and,

if necessary, take remedial action.

L a b o u r m a r k e t s

The United Kingdom labour market remains among the best-performing in the EU. In 2000, the United
Kingdom hit all of the Lisbon/Stockholm employment targets, with an overall employment rate of 71,5 %,
a female employment rate of 64,8 % and an employment rate for older workers of 50,8 %. Unemployment
has risen slightly in recent months (to 5,1 % s.a. in December 2001) but remains close to its lowest level in
over two decades, as does long-term unemployment, which continues to fall as a share of the total. The
range of active measures aimed at tackling long-term unemployment and inactivity has been refined, while
recent reforms of benefit administration will
introduce a more work-focused approach for those on
sickness and disability benefits who are able to work. However, the number of working-age people claiming
out-of-work sickness and disability benefits continued to rise to almost 2,6 million in May 2001, an
increase of 2,6 % over the previous year. More than 2 million of these have been claimants for a year or
more. Although unemployment has fallen in all regions and countries of the United Kingdom, there remain
local areas with high rates of worklessness. Relative regional unemployment disparities continued to rise,
although differences within regions remain wider than differences between them. Local concentrations of
unemployment and inactivity in several areas throughout the nation remain a concern. In view of the
above, while vigorously implementing all the Employment Recommendations adopted by the Council in
February 2002, the main priorities for the United Kingdom should be to:

(i) reinforce active measures targeted at those communities and individuals most prone to the risk of

concentrated or long-term unemployment and inactivity; and

(ii) reform sickness and disability benefit schemes to provide people who are able to work with the

opportunities and incentives to do so.

P r o d u c t m a r k e t s , e n t r e p r e n e u r s h i p a n d t h e k n o w l e d g e - b a s e d e c o n o m y

is favourable to entrepreneurship with low levels of
The United Kingdom's economic environment
regulation and relatively low corporate tax rates. State aid is among the lowest in the EU and liberalisation
of the network industries is well advanced. However the United Kingdom's level of productivity remains
relatively low which is partly due to factors such as weak competition in some sectors (e.g. retail banking,
postal services and the professions), skills shortages and under-investment in the economy including public
services such as the railways. The United Kingdom Government has announced a substantial increase in

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investment in the transport sector through its 10-year plan for transport. Following the independent
Wanless Review on long-term healthcare funding, the Government has also announced significant extra
investment in the National Health Service. This will see total United Kingdom health spending rise from
7,7 % of GDP this year to around 9,4 % of GDP in 2007-2008. The United Kingdom's transposition rate of
Internal Market directives was, at 98,7 % in March 2002, above the target of 98,5 %. As regards the
knowledge-based economy, IT expenditure (as a percentage of GDP) and the level of internet access are
both above the EU average, although the take-up of broadband internet in the United Kingdom is relatively
low. In view of the above, the main priorities for the United Kingdom should be to:

(i) continue to improve competition, building on existing policy measures,

in sectors such as retail

banking, postal services and the professions; and

(ii) deliver the announced infrastructure investment in the railways, establish a new railway infrastructure

company and improve the regulation of the railway sector.

Done at Seville, 21 June 2002.

For the Council

The President

R. DE RATO Y FIGAREDO