Commission Recommendation on the Broad Guidelines of the Economic Policies of the Member States and the Community (for the 2003-2005 period)
Date: 2003-04-24
Institutions: European Commission
Subjects: EU Member State, budget policy, economic policy, macroeconomics, public finance

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 24.4.2003
COM(2003) 170 final/2

Corrigendum
Point 2.1., paragraphe 2)
Concerne uniquement les versions FR et EN.

COMMISSION RECOMMENDATION

on the Broad Guidelines of the Economic Policies
of the Member States and the Community
(for the 2003-2005 period)

TABLE OF CONTENTS

I.

1.

2.

General economic policy guidelines ................................ 3

Meeting the Lisbon strategic goal - the economic policy contribution.. 3

Strengthening the EU's economy.............................................................. 4

2.1.

2.2.

2.3.

Growth- and stability-oriented macroeconomic policies ........... 4

Economic reforms to raise Europe's growth potential ............... 6

Strengthening sustainability ..................................................... 11

II.

Country-specific economic policy guidelines..................... 15

0.

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

Euro Area.................................................................................................. 15

Belgium ..................................................................................................... 18

Denmark ................................................................................................... 21

Germany ................................................................................................... 24

Greece........................................................................................................ 29

Spain.......................................................................................................... 33

FRANCE...................................................................................................... 37

IRELAND .................................................................................................... 42

ITALY ......................................................................................................... 44

LUXEMBOURG ........................................................................................... 49

THE NETHERLANDS .................................................................................. 51

AUSTRIA .................................................................................................... 54

PORTUGAL................................................................................................. 57

FINLAND .................................................................................................... 61

SWEDEN ..................................................................................................... 64

UNITED KINGDOM .................................................................................... 67

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I.

1.

GENERAL ECONOMIC POLICY GUIDELINES

MEETING THE LISBON STRATEGIC GOAL - THE ECONOMIC POLICY
CONTRIBUTION

The  EU  is  at  a  crucial  juncture  in  its  history.  Following  the  successful
introduction  of  euro  notes  and  coins,  the  EU  is  now  on  the  eve  of  an  historic
enlargement  which  will  increase  its  size  to  25  Member  States  and  create  an
economic entity with a population of more than 450 million. At the same time, the
world  is  facing  extraordinary  geopolitical  tensions,  casting  their  shadow  on
economic  prospects,  certainly  in  the  short-term  but  possibly  also  in  the  medium-
term.

At  Lisbon,  the  EU  set  itself  a  new  strategic  goal  for  the  current  decade:  ‘to
become  the  most  competitive  and  dynamic  knowledge-based  economy  in  the
world capable of sustainable economic growth with more and better jobs and
greater  social  cohesion’.  Successful  implementation  of  the  Lisbon  strategy
depends upon simultaneous and coherent policy action being taken in a wide range
of areas in the economic, social and environmental domains.

These Broad Economic Policy Guidelines concentrate on the contribution that
economic  policies  can  make  over  the  next  three  years.  In  line  with  the
arrangements on streamlining and the conclusions of the Brussels Spring European
Council, they focus on the key economic policy issues and priorities for the latter
period. They are at the heart of the policy co-ordination endeavour that underpins
economic  governance in the  EU  and  its Member  States. The  guidelines  testify  to
the EU's recognition of the imperative for higher and sustainable growth rates and
this  result.  Sound
its  resolve 
macroeconomic conditions and policies are a prerequisite for a sustainable increase
in economic prosperity. A stronger entrepreneurial spirit and improved investment
in knowledge  and innovation is  key  to  opening  up  new  opportunities  for  growth.
Better  functioning  and  more  competitive  labour,  product  and  capital  markets  are
indispensable  to  achieve  a  more  flexible  economy  and  lift  potential  growth.  Due
regard must however be paid to economic, social, and environmental sustainability
concerns to ensure that efforts will produce the expected results in the longer term.

the  necessary  action 

to  achieve 

take 

to 

implement 

the  Employment  Guidelines  and 

In addition to these Broad Economic Policy  Guidelines  (BEPGs), Member  States
should  fully 
the  associated
Recommendations,  which  are  required  by  the  Treaty  (Article 128 (2))  to  be
consistent with the BEPGs. The Employment Guidelines aim at giving direction to
and ensuring co-ordination of Member States' employment policies, while dealing
with employment issues in a more comprehensive way than the BEPGs. Member
States should also address the common objectives agreed in the framework of the
open method of coordination on pensions and social inclusion.

The general economic policy guidelines are applicable to all Member States and to
the Community. Within the overall strategy, key economic policy challenges may

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differ  across  Member  States  due  to  differences  in  economic  performance,
prospects, structures and institutions. Taking due account of them, part II presents
country-specific economic policy recommendations. Part II also includes a section
on the euro area, addressing its specific challenges.

While the general policies advocated in these guidelines are largely relevant for the
new Member States, the 2004 update of these guidelines will provide the occasion
to take a closer look at their situation and particular policy requirements.

2.

STRENGTHENING THE EU'S ECONOMY

Economic growth has turned out to be significantly weaker than anticipated. GDP
growth  remained  sluggish  in  2002  and  short-term  indicators  suggest  that  it  will
continue  do  so.  Beyond  the  recent  geopolitical  tensions  and  fading  external
demand, weak growth stems from already falling confidence among business and
consumers and the insufficient resilience to shocks. Any short-term growth outlook
is  conditional  on  the  economic  consequences  of  the  military  conflict  in  Iraq  that
started  late  March.  Assuming  abating  geo-political  tensions,  lower  oil  prices  and
increasing confidence, a recovery should be possible in the second half of 2003. It
is likely to be weak because domestic demand is forecast to be under the influence
of  rising  unemployment  and  still  weak  balance  sheets  of  both  financial  and  non-
financial corporations.

Employment  growth  has  been  resilient  until  late  2002,  but  given  that  the  labour
market  situation  reflects  economic  developments  with  a  lag,  unemployment  is
likely to continue rising in 2003. Wage growth for instance has been slow to adapt
to low productivity growth.

Headline inflation has recently hovered just above two percent. Core inflation has
been  decelerating  since  the  second  half  of  2002,  albeit  at  a  slow  rate.  In  this
respect, it appears that rigidities still stand in the way of fast adjustments. Looking
forward,  slowing  labour  costs  should  lead  to  a  deceleration  of  inflation  to  rates
below  two  percent.  In  the  near-term,  there  are  major  uncertainties  linked  to
developments in oil prices against the background of geopolitical tensions.

Against this background, it is important that economic policies inspire confidence
and  thereby  help  to  create  conditions  for  stronger  domestic  demand  and  job
creation  on the short term  as  well  as  for  an  expansion  of  growth  potential  in  the
medium-term.

2.1.

Growth- and stability-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
expansion  and  the  full  realisation  of  current  growth  potential.  They  should
furthermore  aim  at  establishing  the  framework  conditions  that  promote  adequate
levels  of  saving  and  investment,  as  well  as  a  stronger  orientation  of  the  latter
towards knowledge and innovation, to position the economy on a sustained, higher,
non-inflationary,  growth  and  employment  path.  In  planning  for  the  future,  firms

4

and  individuals  must  have  confidence  that  price  stability  will  be  maintained,  and
that  exchange  rates  and  long-term  interest  rates  will  be  reasonably  stable.  The
maintenance of sound macroeconomic conditions depends on the policies pursued
by  central  banks  and  governments,  and  the  wage  developments  resulting  from
settlements concluded by social partners.

Monetary  authorities  should  pursue  price  stability  and,  subject  to  this  being
achieved, support the general economic policies.

Member  States  should  contribute  through  their  budgetary  policies  to
stabilising output around a higher and sustainable growth trend, by allowing
the full and symmetric play of the automatic stabilisers over the cycle and, in line
with  the  Commission  communication  of  27  November  2002,  reinforcing  the  co-
ordination  of  their  budgetary  policies.  Two  conditions  apply.  First,  excessive
deficits should be avoided. Second, budget positions close to balance or in surplus
in  cyclically-adjusted  terms  should  be  achieved.  However,  when  assessing
compliance with the close to balance or in surplus requirement, particular attention
shall  be  paid  to  country-specific  circumstances,  in  particular  to:  (i) ensure  that  a
sufficient safety margin is preserved at all times in order to allow for the full play
of  automatic  stabilisers  without  breaching  the  3%  of  GDP  reference  value,
(ii) ensure  the  long-term  sustainability  of  public  finances,  and  (iii) the  coherence
between  the  evolution  and  quality  of  the  public  finances  in  the  Stability  and
Convergence programmes and the close to balance or in surplus requirement.

In particular, Member States should over the coming three years:

1) Maintain  budgetary  positions  of  close  to  balance  or  in  surplus
throughout  the  economic  cycle,  and  as  long  as  this  has  not  yet
been  achieved,  take  all  the  necessary  measures  to  ensure  an
annual improvement in the cyclically-adjusted budget position of
at least 0.5% of GDP.

2)

Subject to this, and particularly when growth resumes, avoid pro-
cyclical policies that counteract the full and symmetric play of the
automatic  stabilisers  over  the  cycle.  Reinforce  as  from  this  year
the coordination of their budgetary policies.

Wage developments should contribute to stable macroeconomic conditions and to
an employment-friendly policy mix.

Member States should promote the right framework conditions for wage
negotiations by social partners. It is important to:

3)

Ensure  that  nominal  wage  increases  are  consistent  with  price
stability and productivity gains. In particular, wage developments
should  remain  moderate  in  the  context  of  a  possible  cyclical
recovery  in  productivity  or  oil-price-hike-induced  increases  in
inflation  to  allow  for  a  restoration  of  profit  margins  so  as  to
underpin job-creating investment growth.

5

2.2.

Economic reforms to raise Europe's growth potential

Structural  reforms  are  essential  to  increase  the  EU’s  growth  potential.  To  yield
maximum  synergies,  they  are  best  implemented  in  a  comprehensive  and  co-
ordinated way. By introducing more flexibility in the economy, they contribute to
macroeconomic  stability.  Furthermore,  structural  reforms  in  different  areas,  if
implemented  together,  can  produce  substantial  benefits  and  reduce  adjustment
costs.  For  example,  additional  labour  supply  triggered  by  labour  market  reforms
will be taken up more rapidly in the presence of new business opportunities opened
up by product and capital market reforms. Conversely, new business opportunities
created by  product  and  capital  market  reforms  can  only  be  taken  advantage  of  if
appropriately educated and skilled workers can be hired under the right conditions.

i)

Towards full employment: more and better jobs

Human resources remain greatly under-utilised in the EU. This is evidenced by the
comparatively low employment rates in the EU as well as low labour productivity
growth  (the  latter  is  addressed  in  section  2.2.ii).  The  main  reason  why  GDP  per
capita is well below the US level is that fewer people are in employment, and those
that  are  tend  to  work  fewer  hours.  While  this  might  partly  reflect  a  greater
preference for  leisure,  it  is  often  simply  a  question  of  whether  it  pays  to  work.
Many  people  have  been  effectively  encouraged  to  leave  the  labour  market  or  to
remain  inactive,  for  example  through  relatively  generous  or  loosely  enforced
benefit systems, or through incentives to take early retirement. When they do seek
work, they are faced with the prospect of high labour taxes as well as withdrawal of
benefits. Some, particularly the low-skilled or those living in poorer regions, find
themselves  priced  out  of  jobs,  which  points  to  the  need  both  to  improve  the
quality of education and training (as discussed in section ii) and to allow wages to
better  reflect  productivity.  Inflexible  labour  market  regulations,  protecting
established  employees  but  making  it  riskier  for  firms  to  take  on  new  staff,  leave
many  on  the  margins  of  the  labour  market.  They  are  left  with  a  choice  between
intermittent  temporary  jobs  or  long-term  unemployment  and  inactivity.  By
contrast, less regulation and more flexible work organisation – for example, greater
opportunities for part-time work and flexible working hours – properly balanced by
due security in employment relationships, would make it easier both for people to
join the labour force and for firms to take them on. Obstacles and disincentives to
labour  mobility  –  both  geographical  and  occupational  –  also  impede  the  proper
functioning  of  the  labour  market,  leaving  ample  scope  for  an  improved  match
between  job  openings  and  the  human  resources  available  to  fill  them.  In  this
context,  Member  States  should  examine  how  the  effective  integration  of  migrant
workers could ease pressures in the labour market.

Creating  the  conditions for  full  employment,  better  quality  and  productivity
at work and greater cohesion and  inclusive labour  markets  are fundamental
to  the  Lisbon  strategy  and  have  become  the  overarching  objectives  of  the
European Employment Strategy. Making better use of human resources is a top
priority in the Lisbon strategy. It is reflected in the decision of EU Heads of State
and  Government  to  establish  targets  for  overall,  female  and  older  workers’

6

employment rates and to call for an increase of five years in the effective average
age  at  which  people  stop  working  in  the  EU.  Their  achievement  would  mark  an
important step towards the objective of full employment. Higher employment rates
would directly contribute to a higher growth path. They are an element of the well
established  three-pronged  strategy  for  tackling  the  budgetary  implications  of
ageing  populations.  In  this  context,  they  would  also  help  with  the  financing  of
social  security  systems,  thus  allowing  for  further  reductions  in  non-wage  labour
costs in the future. To reach these targets, the root causes of high unemployment
and low labour force participation in the EU must be tackled. Action to improve
incentives in order to make work pay, to facilitate job creation and to improve
the functioning of the labour market is important in this respect.

implement  all 

In  pursuing  reforms  to  increase  employment,  Member  States  should
vigorously 
the
recommendations  addressed  to  them,  which  deal  with  employment
issues  in  a  more  comprehensive  way.  In  order  to  contribute  to  raise
Europe’s  growth  potential  and  to  tackle  the  budgetary  implications  of
ageing populations, Member States should over the coming three years:

the  Employment  Guidelines  and 

4)

5)

6)

7)

8)

Improve  the  combined  incentive  effects  of  taxes  and  benefits,
reduce  high  marginal  effective  tax  rates  in  order  to  eliminate
unemployment and poverty traps, cut the tax burden on low-paid
labour,  improve  the  administration  of  eligibility  criteria  for
benefits whilst preserving an adequate level  of  social  protection,
and  ensure  the  efficiency  of  job  search  assistance  for  benefit
recipients (see also Employment Guideline 8).

Ensure  that  wage  bargaining  systems  allow  wages  to  reflect
productivity,  taking  into  account  productivity  differences  across
skills and local labour market conditions.

Promote  more  adaptable  work  organisation  and  review  labour
market  regulations,  notably 
to  employment
contracts  taking  account  of  the  need  for  both  flexibility  and
security (see also Employment Guideline 3).

those  relating 

Facilitate  labour  mobility,  both  geographical  and  occupational,
especially by promoting the recognition of qualifications and the
transfer  of  social  security  and  pension  rights,  by  eliminating
obstacles  to  mobility  related  to  the  housing  market,  and  by
promoting  lifelong  learning  (see  also  Employment  Guidelines 4
and 10).

Ensure  efficient  active  labour  market  policies  that  are  targeted
towards  individual  needs  with  special  attention  to  people  facing
the greatest difficulties in the labour market, according to rigorous
impact evaluations (see also Employment Guideline 1 and 7).

7

ii) Towards  a  competitive  and  dynamic  knowledge-based  economy  with

better jobs: Increasing productivity and business dynamism

Increasing the EU’s growth potential depends not only on job creation but also on
giving  an  additional  stimulus  to  labour  productivity  and  business  dynamism.
Indeed,  in  a  context  of  a  progressively  declining  labour  force  linked  to  ageing,
further  productivity  increases  are  indispensable  to  maintain  and  increase  future
living  standards.  Increasing  productivity  makes  it  possible  to  raise  real  wages,
gives  scope  for  investing  and  enhances  the  funding  base  for  public  services.  To
boost productivity it is necessary to fully reap the benefits of the internal market, to
invest  in  skills,  knowledge,  innovation  and  organisational  change  and  make
broader  use  of  new  technologies.  At  the  same  time,  much  stronger  business
dynamism  is  needed  to  improve  the  competitive  position  of  European  firms.
Labour  productivity  gains  are  highly  dependent  on  increased  investment  in
physical capital (‘capital deepening’) and in knowledge and innovation. Striving
for quality at work and improving the overall quality of human resources through
investment will contribute to raising human capital and labour productivity levels.
Non-discrimination  in  the  access  to  education  and  training  will  also  enhance
productivity and improve the opportunities to find a job. Job quality is addressed in
detail in the Employment Guidelines.

Both the public and the private sector will have to contribute if the Lisbon goals are
to  be  achieved.  Governments  can  contribute  by  spending  public  money  as
efficiently as possible, by redirecting public expenditure towards growth-enhancing
investment  in  physical  and  human  capital  and  knowledge  subject  to  overall
budgetary  constraints,  and  by  seeking  a  higher  leverage  of  public  support  on
private investment. The lion’s share of the increase in investment will have to come
from the private sector. Policies should therefore aim at improving  the  economic
framework  conditions,  which  will  encourage  businesses  to  innovate,  invest  and
grow. This implies fostering competition in product and capital markets, promoting
entrepreneurship  and  ensuring  a  high  quality  regulatory  environment,  increasing
investor confidence, and rewarding investment in knowledge and innovation. The
Internal Market plays an important role in this respect, including financial market
integration, as recent studies have shown. The Commission will present a new and
streamlined Internal Market Strategy for the 2003-2005 period with new proposals
to  exploit  the  full  potential  of  the  Internal  Market  for  growth,  job  creation  and
competitiveness.

8

In particular, Member States should over the coming three years:

9)

Foster  competition 
in  goods  and  services  markets  by:
(i) increasing  the  transposition  rate  of  Internal  Market  directives
and  eliminating  remaining  barriers  (including  barriers  created
through the fiscal system) to cross-border trade and market entry
in goods and, especially services markets; (ii) further opening up
public procurement; (iii) giving adequate resources to competition
and  regulatory  authorities,  (iv) continuing  efforts  to  reduce  the
overall level of State aid, whilst reorienting aid towards horizontal
objectives  of  common  Community  interest  and  targeting  it  to
identified  market  failures;  and  (v) encouraging  market  entry  and
effective  competition  in  network  industries  while  pursuing  a
greater  connectivity  of  national  markets  and  ensuring  access  for
consumers to services of general economic interest.

9

10) Accelerate the integration of EU capital markets, in particular by
implementing  the  Risk  Capital  Action  Plan  by  2003  and  the
Financial  Services  Action  Plan  by  2005  (2003  for  securities
markets);  ensuring  consistent  enforcement  of  EU  rules  and
removing  barriers 
to  efficient  cross-border  clearing  and
settlement.

11) Generate  a  supportive  environment  for  entrepreneurship  and  for
SMEs to start-up and grow by reducing the administrative burden
on business; by increasing the efficiency of the public sector; by
simplifying  the  corporate  tax  system;  and  by  improving  the
regulatory  environment,  notably  entry  and  exit  mechanisms.
Improve  the  access  to  finance  for  small  and  medium-sized
enterprises.

12) Agree  on  and  implement  measures  to  strengthen  corporate
governance  rules,  at  national  and  at  Community  level.  Further
improve arrangements at national and Community level to deliver
efficient  cross-sector  and  cross-border  financial  supervision  and
financial crisis management.

13)

14)

the  e-Europe  2005  Action  Plan; 

Promote  investment  in  knowledge  and  innovation  and  make
progress  towards  the  3%  of  GDP  objective  of  total  R&D
investment by: (i) developing framework conditions conducive to
R&D and innovation and realising an  affordable, legally-certain,
Community  patent;  (ii) promoting  access  and  use  of  ICT  in  line
with 
the
development  of  the  Union's  satellite  navigation  system  Galileo;
and  (iv) improving  the  quality  and  efficiency  of  education  and
training  systems,  including  lifelong  learning  and  active  labour
market policies, in order to respond adequately to changing skills
requirements,  thereby  maintaining  and  upgrading  the  human
capital base (see also Employment Guideline 4).

(iii) facilitate 

Enhance  the  contribution  of  the  public  sector  to  growth  by:
(i) redirecting, i.e. while respecting overall budgetary constraints,
public  expenditure  towards  growth-enhancing  investment  in
physical  and  human  capital  and  knowledge;  (ii) increasing  the
efficiency  of  public  spending, 
introducing
mechanisms  to  assess  the  relationship  between  public  funds  and
policy  objectives  and 
spending;  and
(iii) establishing an appropriate framework for joint public-private
initiatives.

to  help  control 

inter  alia,  by 

10

2.3.

Strengthening sustainability

Growth will only prove to be sustainable if due attention is being paid to issues of
economic,  social,  and  environmental  sustainability.  Carrying  out 
impact
assessments and cost-benefit analysis of proposed legislation will allow synergies
and  trade-offs  between  economic,  environmental  and  social  objectives  to  be
identified  and  assessed  systematically.  Where  possible,  flexible,  market-based
solutions  that  achieve  environmental  and  social  goals  without  jeopardising
economic performance, should be preferred.

i) Economic sustainability: Ensuring the long-run sustainability of public

finances

Ageing  populations  imply  important  challenges.  Rising  old  age  dependency
ratios  will  put  increasing  pressure  on  public  finances.  Rising  expenditure  on,
notably,  public  pensions and  health  care,  will  have  to  be  shouldered  mainly  by  a
shrinking  share of the  working  age  population. The  need to  ensure  the  long-term
sustainability of public finances has been underlined by the Lisbon, Stockholm and
Barcelona  European  Councils.  To  address 
the  economic  and  budgetary
consequences  of  ageing,  the  Stockholm  European  Council  decided  that  a  three-
pronged  strategy  should  be  followed,  focusing  on  increasing  employment  rates
(see section 2.2. i), on the reduction of public debt, and on reforming pension and
health care systems.

Sustainability concerns should be explicitly taken into account when assessing the
budget  positions  of Member  States  and  greater  weight  must  be  attached  over  the
coming  years  to  government  debt  ratios  in  the  budgetary  surveillance  process.
Reforms of pension systems should be forcefully pursued in line with the broad
common  goals  agreed  by  the  Gothenburg  and  Laeken  Councils.  This  should  be
done with a view to safeguarding the adequacy of pensions, ensuring the financial
sustainability of pension systems and modernising pension systems in response to
changing  needs  of  the  economy,  society  and  individuals.  The  Joint  Report  on
Member  States'  pension  strategies,  welcomed  by  the  Brussels  Spring  European
Council in March 2003, underlines that ensuring long-term financial sustainability
is  not  only  important  in its  own  right  but  is  also  a  necessary  precondition  for  an
adequate  provision  of  pensions  in  the  future.  It  concludes  that  the  momentum
behind the reform process to secure the sustainability of adequate pensions must be
maintained,  including  more  wide-ranging  and  ambitious  efforts.  To  address  the
budgetary  impact  of  ageing  in  a  timely  manner,  full  use  should  be  made  of  the
current  window  of  opportunity  before  the  effects  of  ageing  are  felt  more
forcefully. In this context, the impact of immigration needs to be further examined.

11

In particular, Member States should over the coming three years:

15)

Ensure  a  further  decline  in  government  debt  ratios;  Member
States still having government debt ratios above the 60% of GDP
reference value,  should in the first  instance ensure a  satisfactory
pace  of  government  debt  reduction  towards  that  value;  other
Member States should ensure a further sufficient reduction in the
debt  ratio  to  further  strengthen  public  finances  in  view  of  the
costs of ageing, including higher age-related spending.

16) Design,  introduce  and  effectively  implement  reforms  of  pension
systems. Encourage longer working lives by modifying incentives
embedded in pension and tax-benefit systems that encourage early
withdrawal  from  the  labour  market  and  by  restricting  access  to
early  retirement  schemes.  Make  the  pension  system  cope  better
with  demographic  developments  and  expected  increases  in  life
expectancy.  Increase  funding  and  improve,  where  necessary,
access to supplementary pension schemes and ensure the safety of
such 
between
increasing 
contributions  and  benefits.  Adapt  pension  systems  to  more
flexible  employment  and  career  patterns  as  well  as to  individual
needs,  including  the  portability  of  pension  benefits  (see  also
Emplyment Guidelines 5 and 8).

benefits,  while 

transparency 

ii)

Social  sustainability:  Contributing 
cohesion

to  economic  and  social

The  Lisbon  Strategy  will  only  be  successful  and  be  able  to  attract  continued  and
widespread support for necessary structural reforms if it contributes to improving
opportunities for all. Sound economic policies can make an important contribution
to economic and social cohesion: first, because jobs are the best protection against
poverty and social exclusion, by improving the conditions for stronger job creation,
especially for people with relatively low skill levels and for those living in regions
that  lag  behind;  second,  by  creating  the  conditions  for  enhanced  growth  and
investment  and  thereby  facilitating  regional  catching  up  (while  poorer  Member
States  catch  up  with  the  rest,  differences  in  economic  development  remain,  and
these  will  widen  significantly  after  enlargement);  and  third,  by  contributing  to  a
more  productive  economy  respectful  of  social  conditions  and  equal  treatment,
thereby  also  generating  resources  for  the  necessary  accompanying  social,
educational  and  regional  development  policies  to  facilitate  the  transformation  of
the economy and to reduce poverty and social exclusion. Inclusive labour markets
as a contribution to cohesive societies are addressed in the Employment Guidelines
and in the Social Inclusion Process.

Catching  up  and  employment  creation  depend  on  favourable  conditions  for
private sector activity and investment. Successful implementation of the policies
set out in the various parts of this document will help to create such conditions. In
particular,  measures  to  improve  the  functioning  of  labour  markets  and  allowing
wages  to  properly  reflect  productivity  differences  across  skills  and  local  labour
market  conditions  are  important.  Furthermore,  there  is  a  need  for  targeted  policy

12

actions  aimed  at  ensuring  the  availability  of  basic  infrastructure  of  a  sufficient
quality, and at improving education and life long learning in order to raise the skills
and adaptability of the labour force. In this context, it should be recalled that the
EU  contributes  importantly  to  investment  in  regions  lagging  behind  through  the
cohesion and structural funds as well as the  European  Investment  Bank.  Member
States should provide an efficient level of public investment across a wide range of
education  and  training,  and  undertake  reforms  to  improve  educational  standards
and to encourage sustained investment from enterprises and individuals.

In particular, public authorities should over the coming three years:

17) Whilst ensuring an adequate level of social protection, take steps
to  modernise  social  protection  systems  and  to  fight  poverty  and
exclusion with a view to supporting the broad Lisbon objectives,
notably  on  employment,  in  order  to  achieve  an  inclusive  labour
market and a more cohesive society for all (see also guideline 4).

18)

19)

Improve the functioning of markets so that they are conducive to
private  investment  in  regions  lagging  behind,  particularly  by
taking  steps  to  allow  wages  to  reflect  productivity  taking  into
account  differences  in  skills  and  local  labour  market  conditions
(see also guideline 5).

Ensure that public support, including from EU sources, in regions
lagging  behind  is  strongly  focused  on  investment  in  human  and
knowledge  capital,  as  well  as  adequate  infrastructure,  and  that
investment programmes are designed and administered efficiently
so  as  to  maximise  their  impact  (see  also  guideline 13).  In  this
context,  strengthen  the  operational  co-operation  between  the
Commission and the European Investment Bank.

iii) Environmental sustainability: Promoting efficient natural resource use

To  contribute  to  an  increase  in  the  well-being  of  current  and  future  citizens,
economic growth must not be at the expense of the environment. To promote
an  efficient  use  of  natural  resources,  their  prices  should  reflect  their  costs  to
society,  including  the  external  costs  related  to  the  environmental  damage  caused
during their extraction, use and final disposal. This will encourage adaptation and
innovative solutions by firms.

However, a common feature of many natural resources (for example, clean air and
water)  is  that  there  are  no  clearly  defined  ownership  rights.  In  such  cases,  even
while it  is in the interest  of  society  as a  whole  that  the  resource is  managed  in  a
sustainable way, no one individual has an incentive to do so.

Thus  there  is  a  need  for  government  action  to  successfully  de-couple  economic
growth  from  environmental  degradation.  This  is  likely  to  require  a  mix  of
regulatory and  market-based  instruments.  The  environmental  costs of  economic

13

activity  should  gradually  be  priced  in.  The  use  of  scarce  natural  resources
should  be  paid  for.  The  “polluter  pays  principle”  should  be  systematically
applied.

In particular, Member States should over the coming three years:

20) Reduce  sectoral  subsidies,  tax  exemptions  and  other  incentives
that  have  a  negative  environmental  impact  and  are  harmful  for
sustainable  development.  Ensure,  inter  alia  through  the  use  of
taxes  and  charges,  that  pricing  of  the  extraction,  the  use  and,  if
applicable,  the  discharge  of  natural  resources,  such  as  water,
adequately  reflects  their  scarcity  and  all  resulting  environmental
damage.

21) Reduce  energy  subsidies,  promote  market  instruments,  further
broaden  the  coverage,  and  ensure  appropriate  differentiation  of
energy  taxation  to  deliver  a  more  sustainable  mix  and  level  of
energy  consumption,  and  further  enhance  competition  and
network interconnection in energy markets.

22) Adjust  the  system  of  transport  taxes,  charges  and  subsidies  to
better  reflect  environmental  damage  and  social  costs  due  to
transport, thereby reducing distortions in the demand for transport
services  and  the  choice  of  transport  modes,  and  increase
competition,  e.g.  through  accelerated  regulated  market  opening,
in  transport  modes  such  as  freight  railways  to  make  them  more
competitive.

23) Renew  efforts  to  meet  their  commitments  under  the  Kyoto
protocol, which is particularly important for those Member States
that at present are not on track to meet their commitments. To this
end, implement the EC greenhouse gas emissions trading scheme:
draw  up  national  allocation  plans;  establish  national  allowance
registries; set up systems to adequately monitor, report and verify
emissions  at  installation  level.  Prepare  new  and  immediately
implement  existing  policies  and  measures  for  those  sectors  not
covered  by  allowance  trading  and  set  up  systems  to  report  on
those  policies  and  measures  and  their  prospective  effects  on
emissions.

14

II.

0.

COUNTRY-SPECIFIC ECONOMIC POLICY GUIDELINES

Euro Area

The economic slowdown observed in 2001-2002 exposed the structural weaknesses
of the euro area. Internal dynamics, which still appeared robust in 2000, dissolved
when  recovery  failed to  materialise.  One  reason  is  to  be  found  in  the  euro  area's
low rate of potential growth, which limits the scope for a sustainable high rate of
economic  growth.  Another  conjunctural  reason  is  the  weakness  in  domestic
demand,  which  did  not  provide  a  sufficient  buffer  to  the  impact  of  economic
shocks. This became particularly evident in 2002 when domestic demand was not
sufficiently robust to take over from the initial stimulus from the external side.

Economic growth is expected to gradually recover to potential after the effects of
recent  shocks  fade  away.  At  the  beginning  of  2003,  the  economic  outlook  is
conditioned  on  a  number  of  assumptions  on  whether,  when  and  what  kind  of
downward  risks  materialise.  Geo-political  uncertainty  is  particularly  weighing  on
the  economic  outlook.  Generally,  forecasts  assume  growth  to  remain  still  very
weak in 2003, with a recovery only gathering strength in the second half of 2003
and accelerating in 2004. The challenges facing the euro area are to:

(cid:1)  Cater for a balanced macroeconomic policy mix

(cid:1)  Address unwarranted inflation differences

(cid:1)  Strengthen economic policy co-ordination

Cater for a balanced macroeconomic policy mix

The  policy-mix  in  the  euro  area  needs  to  be  carefully  designed  in  supporting
economic recovery without being detrimental towards long-term sustainability and
stability.  Whilst  preserving  their  stability-orientation,  macroeconomic  policies
should use the leeway available to support a recovery in growth in the short run. In
the  current  juncture,  it  is  important  that  the  policy  mix  underpins  confidence
among consumers and investors. Any policy action needs to be assessed against its
impact on economic confidence. This holds in particular for budgetary policy. This
implies  that  macroeconomic  policies  should  remain  committed  to  medium-term
stability to enhance confidence among  business and  consumers. The  ECB  should
aim at maintaining price stability in the medium term and, without prejudice to the
price stability objective, support the general economic policies in the Community.

As economic activity approaches the rate of potential growth, it will be important
to re-focus macroeconomic policies on medium-term targets. Budgetary policy has
to  ensure  a  fiscal  position  consistent  with  the  need  to  prepare  for  the  impact  of
ageing  populations  on  the  one  hand  and  to  accomplish  a  composition  of  public
expenditure and revenues that fosters economic growth on the other.

15

Address unwarranted inflation differences

The high degree of inflation convergence in the euro area reached in 1997 was not
sustained  and  there  has  been  a  steady  upward  rise  in  inflation  differences  since.
Inflation differences  between  Member  States  can reflect  the  effective  functioning
of  a  monetary  union  where,  because  there  is  no  room  for  manoeuvre  at  country
level  on  exchange  rates  and  monetary  policy,  changes  in  relative  prices  between
countries  become  a  key  adjustment  mechanism.  In  contrast,  inflation  differences
appear unwarranted when they are due to the malfunctioning of product and labour
markets,  or  inappropriate  policies.  In  particular,  price  and  wage  increases  in
response  to  temporary  shocks  should  not  lead  to  entrenched  inflation.  Prices  and
wages  should  display  the  flexibility  required  to  prevent  such  a  development  and
foster stability.

Recent inflation dispersion largely reflects the diversity of national economies and
is  not  a  major  source  of  concern.  Indeed,  inflation  divergence  over  the  2000-02
period  is  essentially  attributable  to  food,  energy  and  some  services.  The  three
sectors  account  for  nearly  three-quarters  of  the  increase  in  inflation  dispersion
relative to 1997. In particular, the increase in energy prices in 2000-2001 and the
effect of animal diseases in 2001 hit some countries more than others. Moreover,
there  are  still  important  differences  in  the  national  price  levels  of  many  tradable
goods  and  services  in  the  euro  area.  Further  progress  in  the  functioning  of  the
Internal  Market  combined  with  the  higher  price  transparency  resulting  from  the
euro  should  lead  to  further  convergence  in  national  price  levels,  entailing  some
temporary inflation divergence. Finally, the asymmetric impact of price shocks on
inflation has probably been compounded in some Member States by the existence
of  schemes  indexing  wages  to  inflation  and  differing  policy  responses  to  energy
price increases.

Strengthen economic policy co-ordination

With  intensified  economic  integration,  the  potential  for  spillover  effects  rises,
which strengthens the case for economic policy co-ordination. The introduction of
the single currency has deepened the externalities of national  policies in  the  euro
area.  The  euro  exchange  rate,  the  euro  area’s  external  balance  and  the  average
inflation  rate  in  the  euro  area  have  become  collective  goods.  It  implies  the  need
both  for  stronger  macroeconomic  and  structural  policy  co-ordination  in  the  euro
area  to  improve  the  euro  area's  resilience  to  shocks,  and  improve  its  growth
potential and performance.

Preserving macroeconomic stability and a policy mix conducive to growth relies on
a coherent formulation of macroeconomic policies. While respecting their mandate
and independence, the relevant policy actors must ensure the compatibility of their
objectives and aim for a common assessment of the underlying economic situation.
Budgetary  authorities  should  safeguard 
the  rules-based
framework for fiscal policy by complying with the agreed rules in a transparent and
foreseeable manner. Member States should be open to peer pressure, benchmarking
and the provision of best practices also in the area of structural policies.

the  credibility  of 

16

To foster harmonious economic developments, it is essential to closely co-ordinate
economic  policies  among  policy  actors  and  to  have  a  continuous  and  fruitful
dialogue  in  the  Council  and  the  Eurogroup  involving  and  the  ECB  and  the
Commission. The involvement  of  the  social  partners  through  the  macroeconomic
dialogue  also  plays  an  important  role.  At  international  level,  the  growing
importance  of  the  Euro  area  also  calls  for  a  strengthening  of  the  relevant  co-
ordination  mechanisms  such  that  it  speaks  with  a  voice  commensurate  with  its
economic and financial weight in the different fora.

Specific recommendations to the euro area

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

In  order  to  cater  for  a  balanced  macroeconomic  policy  mix,  policy  actors  at  the
national and the euro area level are recommended to:

1.

Ensure  a  stance  of  monetary  policy,  budgetary  policy  and  wage  growth
that is compatible with price stability and the need to enhance confidence
among business and consumers in the short run as well as with economic
growth close to potential in the medium term.

In order to address unwarranted inflation  differences  policy  actors  at  the  national
and the euro area level are recommended to:

2.

Strengthen  competition  on  product  and  capital  markets,  improve  the
functioning  of  the  labour  market,  inter  alia  by  tackling  impediments  to
wage flexibility and encourage geographic mobility.

In  order  to  strengthen  policy  co-ordination  policy  actors  at  the  national  and  the
euro area level are recommended to:

3.

4.

Deepen  the  analysis  of  and  discussion  on  economic  developments  and
policy requirements, exchange information on envisaged policy measures
to the largest possible degree, and strengthen the external representation
of the euro area.

Improve  the  efficiency  of  the  existing  co-ordination  procedures  in  the
area of structural reforms that aim at strengthening the euro area's growth
potential and its resilience to shocks.

17

1.

BELGIUM

Robust economic performance was registered in Belgium in recent years. However,
the  general  economic  downturn  had  a  sharp  impact  on  the  economy  of  Belgium,
with  real  GDP  growth  decelerating  progressively  from  3.7%  in  2000  to  0.7%  in
2002. An upturn in activity is foreseen in 2003, strengthening in the forthcoming
years,  potential  output  being  estimated  at  little  below  2.5%.  Belgium  made
considerable  progress  in  budgetary  adjustment  in  the  past  years.  However,  the
current  unfavourable  macroeconomic  context  requires  additional  efforts  to
implement the commitments to budgetary consolidation.

Recently, the path of reduction of the government debt ratio has decelerated due to
lower economic growth and also the negative impact of financial operations. Yet,
in  particular  in  view  of  the  future  budgetary  costs  of  an  ageing  population,  fast
reduction  in  the  government  debt  is  of  central  importance  for  Belgium.
Improvement  in  the  functioning  of  the  labour  market,  a  necessity  in  itself,  could
also  make  a  contribution  of  budgetary  adjustment.  Moreover,  product-market
reforms  are  needed  in  order  to  improve  competitiveness  and  productivity.  The
challenges facing Belgium are to:

(cid:1)  Ensure the continuation of the budgetary adjustment in the forthcoming years,
in  particular  in  view  of  ensuring  the  long-term  sustainability  of  public
finances in the face of population ageing

(cid:1) 

Increase  the  low  participation  and  employment  rates,  especially  for  older
workers and women, and improve incentives to work

(cid:1)  Enhance competition in certain services sectors and continue to increase the
efficiency  of  the  public  administration  and  to  improve  the  business
environment

Ensure the continuation of the budgetary adjustment in  the  forthcoming  years,
in particular in view of ensuring the long-term sustainability of public finances
in the face of population ageing

The challenge of reducing the still high debt ratio (of 105.4% of GDP in 2002) and
to prepare for the budgetary costs of an ageing population, require sustained sound
budgetary  policies  over  the  long  run.  The  strategy  followed  by  Belgium,  in
particular, the policy of maintaining high primary surpluses, is expected to provide
leeway  to  cover  age-related  budgetary  costs.  However,  such  an  effort  has  to  be
sustained  over  the  long  run  and  a  failure  to  maintain  the  primary  surpluses  at  a
sufficiently  high  level  might  mean  that  the  risk  of  unsustainable  public  finances
could not be avoided.

In coming years, budgetary policy will face the challenge of maintaining control of
government  primary  expenditure,  limiting  its  increase  in  real  terms,  while

18

providing  for  the  costs  of  needed  reforms  and  other  budgetary  objectives.  In  this
context, budgetary efforts aimed at reducing the government debt ratio need to be
supported by policies to improve labour force participation and to raise the still low
employment rates.

Increase the low participation and employment rates, especially for older workers
and women, and improve incentives to work

The employment rate, which has been growing steadily over the second half of the
nineties, was still at 59.9%, 4 percentage points below the EU average in 2001, and
far away from the EU employment targets. The employment rate of older workers
(55-64 years) was only 25.1% in 2001, the lowest rate in the European Union and
about 13.5 percentage points below the EU average. It is unlikely that the measures
taken so far will suffice to reach the EU target for 2010. The challenges posed by
an  ageing  population  suggest  a  need  for  measures  aimed  at  mobilising  the  non-
occupied  potential  labour force, thereby  increasing  employment  and  participation
rates.

Notwithstanding recent measures to address the problem of benefit dependency and
to  reduce  the  risk  of  “unemployment  traps”,  there  is  still  a  sizeable  number  of
working age benefit recipients  not  in employment.  The  work  disincentives  of  the
current  unemployment  benefit  schemes    calls  for  their  further  review  in  order  to
tackle  the  still  high  share  of  long-term  unemployment,  which  remains  a  major
structural  problem.  Linguistic  barriers,  high  housing  registration  costs,  and  wage
compression are contributing to the persistence of disparities between geographical
areas and reducing incentives to mobility.

Enhance  competition  in  certain  services  sectors  and  continue  to  increase  the
efficiency of the public administration and to improve the business environment

Competition  remains  limited  in  most  network  industries  and  in  local  services,
leading to high consumer prices for example for local phone calls or electricity. In
network  industries,  difficulties  for  competitors  to  access  the  networks,  physical
bottlenecks, and the historical links with public authorities contribute  to  maintain
the market power of incumbents. In local services, the links between local public
authorities  and  private  partners,  notably  in  inter-municipal  trusts,  still  lack
transparency.  In  spite  of  larger  institutional  powers,  the  competition  authority
remains understaffed and the effective independence of all sectoral regulators is not
yet secured.

In the recent past, measures to reduce the administrative burden for companies and
to  improve  the  efficiency  of  public  administration  are  helping  to  create  a  more
business-friendly environment. In particular, plans have been carried out to reduce
the  costs  and  administrative  procedures  involved  in  creating  a  company  and  the
'Copernicus'  plan  aims  at  modernising  the  federal  administration.  The  impact  of
these plans has still to fully materialise.

19

Country specific recommendations to Belgium

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

In order to ensure the continuation of the budgetary adjustment in the forthcoming
years,  in  particular  in  view  of  ensuring  the  long-term  sustainability  of  public
finances in the face of population ageing, Belgium is recommended to:

1.

2.

3.

Ensure  that  the  government  debt  ratio  is  kept  on  a  sustained  declining
trend  at  a  satisfactory  pace  by  maintaining  high  primary  surpluses
(GL 15);

Limit  the  real  expenditure  increase  in  Entity I  (Federal  government  and
social security) to 1.5% and allocate proceeds stemming from higher than
expected economic growth to improve the budgetary position as a matter
of priority; and

Strengthen  the  existing  strategy  in  order  to  prepare  for  the  budgetary
implications  of  population  ageing:  in  particular  by  reducing  the  debt
level,  better  addressing  the  low  effective  retirement  age,  pursuing  the
reform  of  the  pension  systems,  and  strengthening  efforts  to  finance  the
Ageing Fund (GL 16 and E-REC 2).

Belgium should also vigorously implement all the Employment Recommendations
(E-REC),  which  deal  with  employment  issues  in  a  more  comprehensive  way.  In
order  to  increase  growth  potential,  ensure  the  long-term  sustainability  of  public
finances,  and  address  the  effects  of  ageing  populations,  it  is  especially  important
for Belgium to increase the low participation and employment rates, especially for
older  workers  and  women,  and  improve  incentives  to  work.  Belgium  is  in
particular recommended to:

4.

5.

Take further steps to reinforce measures to postpone retirement from the
labour force, in particular by combining a removal of incentives to early
retirement (GL 16) with enhanced prevention and activation measures for
older workers; and

Continue  progress  in  making  work  pay  by  eliminating  the  major
distortions to work incentives arising from the interaction of the tax and
benefit systems (GL 4 and E-REC 3).

In order to enhance competition in certain services sectors and continue to increase
the  efficiency  of  the  public  administration  and  to  improve  the  business
environment, Belgium is recommended to (in line with GL 9 to 14):

6.

7.

Take  measures  to  enhance  effective  competition  in  network  industries
and in local services (in line with GL 9); and

Improve public administration in the context of  the  ongoing  reform  and
pursue the reduction of administrative burden for companies (GL 11).

20

2.

Denmark

The  Danish  economy  has  for  some  years  now  been  operating  close  to  potential
growth  rates  with  real  growth  rates  averaging  2½%  in  the  last  10  years.  In  this
period the economy benefited from a large reduction in unemployment from over
12% of the labour force to now around 5% - a large part of this reduction can be
viewed  as  being  structural.  As  it  will  not  be  possible  to  replicate  this  fall  in
unemployment in coming years and as demographic changes result in lower growth
in  working  age  population,  potential  growth  rates  are  expected  to  be  reduced  to
around  2%.  The  large  reduction  in  unemployment  in  the  last  decade  also  had  a
positive impact on public finances, where a surplus has been achieved every year
since 1997.

For  the  Danish  economy  to  continue  to  be  in  good  shape,  despite  the  lower
potential growth rates, it is necessary to address some structural issues. In order to
continue to achieve high surpluses on public finances it is necessary to increase the
labour  supply,  both  as  a  mean  to  reducing  expenditures  and  to  increasing  tax
revenues. Furthermore, the price level continues to be among the highest in the EU
–  partly  reflecting  lack  of  competition  in  certain  sectors  and  there  is  room  for
improving efficiency in the public sector. The challenges facing Denmark are to:

(cid:1)  Ensure an adequate labour supply in view of the ageing of the population

(cid:1)  Enhance  competition  in  certain  sectors  and  improve  the  efficiency  of  the

public sector

Ensure an adequate labour supply in view of the ageing of the population

Employment  rates  are  already  high  in  Denmark,  and  well  beyond  the  Lisbon
targets  for  EU  as  a  whole,  including  for  women  and  older  workers.  However,  in
order to prepare for the impact of the ageing population on public finances and to
safeguard the growth potential, it is necessary to increase labour force participation
rates  and  to  reduce  unemployment  rates  further,  and  beyond  what  already
implemented reforms are expected to generate. These  increases  will contribute  to
achieving the government’s targets of surpluses of 1½-2½ % of GDP as a means to
prepare for the impact of ageing on public finances.

Much has already been done in the field of active labour market policies, especially
with  regard  to  the  right  to  and  obligation  of  job  activation.  Measures  have  also
been  taken  within  benefit  systems  and  retirement  schemes.  Furthermore,  a  tax
reform  has  been  announced recently  for  2004-2007  with  the  purpose  of lowering
taxes on earned income, which should also contribute to an increase in the labour
supply. However, further reforms would be needed to ensure a marked increase in
the  already  high  labour  force  participation  and  employment  rates.  Sources  of
potential labour supply increases could include better integration of immigrants in
the labour  market,  a  faster  channelling  of  students  through  the  education  system,
and  efforts  to  improve  labour  market  attachments  for  senior  workers.  Further

21

improvements  in  the  number  of  people  in  the  labour  force  or  in  the  number  of
hours  worked  per  person  could  be  encouraged  via  additional  tax  and  benefit
reforms,  in  particular  by  reducing  the  still  relatively  high  marginal  tax  rates,  or
tightening the conditions for early retirement or a combination of both. Ministry of
Finance’s estimates show that reductions of different kinds of tax rates may have a
marked  impact  on  labour  supply.  However,  considerations  concerning  additional
tax reforms should take into account the framework of sound public finances. With
regard  to  increasing  the  retirement  age,  consideration  could  be  given  to  further
improve incentives to continue to work instead of withdrawing early from the work
force by entering into early retirement. Moreover, in maintaining the high surpluses
on  public  finances  it  is  not  only  necessary  to  increase  the  labour  supply,  strict
expenditure  control  also  has  to  be  continued  in  order  to  prevent  slippage,  which
may jeopardise the targets.

Enhance competition in certain sectors and improve the efficiency of the public
sector

Enhancing competition could contribute to lower the Danish price level, which is
the  highest  in  the  EU,  and  to  improve  productivity,  which  is  around  the  EU
average. Competition is weak in a number of industries, such as the energy sector,
housing,  construction  and  non-tradable  services.  The  full  liberalisation  of  the
energy  market  could  also  contribute  to  better  competition  and  lower  prices
throughout the economy.

The Danish public sector is among the largest in the EU. Substantial efforts have
been made to improve its efficiency and Denmark has a rate of openly advertised
public  procurement  above  the  EU  average.  However,  public  entities  are  still  sole
producers in many areas of public services and it remains to be seen to what extent
recent  reforms  to  extend  consumer  choice  for  public  services  will  increase
competition  from  the  private  sector.  One  example  where  the  efficiency  could  be
increased  is  the  education  sector,  where  the  OECD  PISA  study  shows  relatively
poor results for Denmark, despite high education expenditure.

Country specific recommendations to Denmark

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

Denmark should also vigorously implement all the Employment Recommendations
(E-REC),  which  deal  with  employment  issues  in  a  more  comprehensive  way.  In
order to prepare for the impact of the ageing population on public finances and to
safeguard the growth potential, Denmark is in particular recommended to:

1.

Continue  efforts  to  make  work  pay  by  increasing  incentives  to  join  the
labour  force  and  to  postpone  retirement,  in  particular  by  ensuring  the
implementation of the tax reform and by considering additional steps to

22

tighten eligibility rules and reduce marginal taxes within a framework of
sound public finances (GL 4 and E-RECs 1 and 3); and

2.

Ensure expenditure control at all levels of government so that the multi-
annual targets for real public consumption growth are respected (GL 14).

In order to enhance competition in certain sectors and improve the efficiency of the
public sector, Denmark is recommended to (in line with GL 9 to 14):

3.

4.

Step  up  efforts  to  enforce  competition  in  sectors  where  competition  is
inadequate (GL 9); and

Continue efforts to increase the efficiency of the public sector, inter alia
by improving framework conditions for increased competition, promoting
the  benchmarking  of  public  sector  efficiency,  and  by  increasing  public
tendering (GL 11).

23

3.

Germany

Since  the  boom  caused  by  unification,  Germany  has  experienced  much  lower
growth  rates  since  the  mid-nineties,  both  in  comparison  with  other  European
countries and with its own historical rates. Stagnation, partly linked to the costs and
effects of unification,  has  gradually  become  more  and  more  entrenched.  In  2003,
GDP  growth  is  very  likely  to  remain  below  1%  for  the  third  year  in  a  row.
Germany’s low growth potential of around 1½ % (compared with one of 2¼% for
the  rest  of  the  EU)  is  the  result  of  structural  adjustments  in  the  aftermath  of
reunification, rigidities in the labour market and regulatory burdens that hold back
productivity,  and  also  of  a  very  low  population  growth.  While  low  growth  is  a
problem  in  itself,  it  spills  over  into  the  field  of  public  finances,  where  tax  and
social security revenue shortfalls have led to Germany’s breaching of the Treaty’s
deficit  criterion.  At  the  same  time,  the  approach  chosen  to  correct  the  excessive
deficit  -  increases  in  taxes  and  social  security  contributions  -  exacerbates  the
problem of low growth. However, on 14 March Chancellor Schröder outlined in a
parliamentary  speech  elements  of  a  broad-based  reform  agenda,  which  would
constitute important steps towards solving Germany’s structural problems.

The solution to the difficult state of public finances cannot be found independently
of  addressing  the  root  causes  of  the  low  growth  and  vice  versa.  Far-reaching
reforms  are  the  more  pressing,  because  the  social  security  systems  are  not
sufficiently  equipped  to  dealing  with  the  consequences  of  population  ageing.  To
solve the twin problems of low growth potential and unsustainable public finances
in Germany, it is therefore imperative that four key challenges be addressed. The
first two are mainly remedies to raise the low economic growth potential, while the
latter  two  address  the  sustainability  of  public  finances.  The  challenges  facing
Germany are to:

(cid:1)  Promote job creation and adaptability and mobilise the unutilised employment

potential

(cid:1) 

Increase productivity through improvements in the business environment and
the efficiency of the education system

(cid:1)  Accelerate the consolidation of public finances

(cid:1)  Secure the long-term viability of pension and health-care systems

Promote  job  creation  and  adaptability  and  mobilise  the  unutilised  employment
potential

The  overall  employment  rate  in  Germany  is  close  to  the  EU-target  of  67%  for
2005. The employment rate for women already exceeds the intermediate EU-target
of 57% for 2005, whereas for older workers it remains very low, even below the
level  reached  in  1997.  Germany’s  good  record  in  employing  young  people
contrasts  with  a  severe  lack  of  job  opportunities  for  low-skilled  workers,  elderly

24

triggered  higher 

workers,  and  for  people  living  in  disadvantaged  regions,  notably  the  East.
Considering the large job deficit in the Eastern Länder, there is a risk that regional
disparities on the labour market may widen further. Employing the aforementioned
groups  would  evidently  provide  a  substantial  growth  impulse,  as  well  as
strengthening public finances. Three structural factors appear most important in the
labour  market:  First,  Germany  suffers  from  severe  unemployment  and  inactivity
traps,  in  particular  for  low  wage  earners  where  the  combined  effect  of  taxation,
social  security  contributions  and  benefit  withdrawal  continues  to  create  a  high
marginal  effective  tax  rate  above  the  threshold  of  € 400  per  month.  The  recent
transitions  from
strengthening  of  benefit  sanctions  has 
unemployment  to  inactivity,  but  the  effect  on  incentives  for  active  job  search,
including sectoral and regional mobility is too early to assess. Second, labour costs
of  low-skilled  workers  or  people  in  depressed  regions  risk  exceeding  their
tariff  wages
productivity 
(Flächentarifvertrag),  which  are  nearly  identical for  the  whole  country  in  a  given
sector. Reduced wages for trial periods of new job entrants, or for disadvantaged
regions, are not only impeded by union wage contracts but also by law. Indeed, the
Günstigkeitsprinzip  legally  binds  companies  to  the  minimum  wages  defined  by
sectoral  wage  agreements,  if  the  company  is  a  member  of  the  respective
employers’ association or the agreement has been declared generally applicable by
the government. Where opening clauses exist, they are seldom applied, particularly
so in the West. Third, reintegration of unemployed workers is also made difficult
by  inefficiencies  of  large-scale  active  labour  market  programmes  (ALMPs)  and
insufficient evaluation and targeting of such measures. It is still too early to see the
effects of recent efforts to improve the evaluation of ALMPs.

the  application  of  coordinated 

levels  due 

to 

Increase productivity through improvements in the business environment and the
efficiency of the education system

Low  labour  input  growth  is  accompanied  by  a  parallel  decline  in  productivity
growth  and  business  investment  in  recent  years,  which  may  be  associated  with  a
still  high  regulatory  burden  and  remaining  barriers  to  competition.  Although
progress  has  been  made  in  the  context  of  the  Hartz  reform,  labour  markets  in
particular  remain  heavily  regulated.  Main  elements  in  this  respect  are  the
restrictions on temporary agency work contracts and the uncertainty related to the
application of employment protection legislation by courts. Rules controlling entry
into  crafts  and  liberal  professions  are  under  review.  In  addition,  there  is  the
complexity  of parts  of  the tax  code  and  the  relatively  limited  provision  of  public
services  over  the  Internet.  Finally,  legal  restrictions  unnecessarily  hinder
competition  in  retailing,  energy  network  access  fees  remain  relatively  high  and
subject to  ex-post  control,  and  there is little evidence  of an  opening  up  of  public
procurement.

With the prospect of a diminishing labour force, the level of qualification is all the
more important if Germany is to raise its productivity in order to maintain its living
standards. The  PISA-OECD  study  highlighted  the  relatively  poor  performance  of
German secondary schools. In addition, the very long university study times are a
long-standing  problem.  Reforms  of  the  education  system  also  constitute  an

25

important element for tackling unemployment because the low skilled makes up a
large share of the unemployed.

Accelerate the consolidation of public finances

The  2002  general  government  deficit  was  3.6%  of  GDP,  clearly  exceeding  the
respective  Treaty  criterion.  On  21  January  2003,  the  Ecofin-Council  had  already
decided  that  an  excessive  deficit  existed  in  Germany  and  recommended  to  the
German authorities to implement  measures  amounting  to one  percentage  point  of
GDP  in  2003  and  to  bring  the  excessive  deficit  to  an  end  by  2004  at  the  latest.
Budget  consolidation  would  also  contribute  to  improving  the  general  business
climate  and  hence  increase  Germany’s  growth  potential.  However,  without
additional  structural  reforms  to  raise  Germany’s  low  growth  potential,  a  steady
decline in the  debt  ratio  and compliance  with  the  proclaimed  target  of  a  close  to
balance  budgetary  position  in  2006  seems  unlikely.  Germany  was  asked  by  the
Council, therefore, to implement urgent reforms, not only in the labour market, but
also  in  the  social  security  and  benefit  systems  in  general,  and  to  reduce  the
regulatory burden on the economy.

Secure the long-term viability of pension and health-care systems

Germany’s social security systems are financed  mainly on a pay-as-you-go basis.
As a consequence, pension and health care systems will have difficulties in coping
with the problem of an ageing population. If present rules remain unchanged, social
security  contributions,  already  among  the  highest  in  Europe,  would  have  to  rise
substantially  over  the  next  decades.  This  would  exacerbate  the  burden  caused  by
high  unemployment  and  depress  growth  even  further.  In  the  pension  system,  a
better link between individual payments and acquired  pension  rights is  needed to
avoid that  pension  contributions are perceived largely  as  taxes.  First  steps  by  the
German government towards a privately funded pension system (“Riester-Rente”)
have  been  taken,  but  only  15%  of  the  employees  have  made  use  of  this  new
possibility  so  far,  not  least  because  it  is  accompanied  by  relatively  high  level  of
regulation.

The  health  care  system  has  also  come  under  increasing  strain  in  recent  years,
mainly due to insufficient cost controls and the absence of economic incentives for
cost  savings.  Currently,  a  re-orientation  of  the  health  care  system  is  under
discussion. This would include limiting the insurance coverage to major risks only,
which would allow for substantial cost reductions.

The  concern  about  long-term  sustainability  of  public  finances  is  all  the  more
pressing  as  Germany’s  debt-to-GDP  ratio  remains  above  the  60%  threshold,  and
where a clear downward has trend not yet been established.

26

Country specific recommendations to Germany

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

Germany should also vigorously implement all the Employment Recommendations
(E-REC),  which  deal  with  employment  issues  in  a  more  comprehensive  way.  In
order  to  increase  growth  potential,  ensure  the  long-term  sustainability  of  public
finances, address the effects of ageing populations and reduce regional disparities,
it is especially important for Germany to promote job creation and adaptability and
mobilise 
in  particular
recommended to:

the  unutilised  employment  potential.  Germany 

is 

1.

2.

3.

Reform the tax-benefit system (GL 4 and E-REC 6), notably by assuring
positive  net  income  gains  from  moving  into  a  job  or  a  higher  income
bracket  across  all  income  levels,  and  by  enforcing  the  conditionality  of
benefits upon active job search;

Take measures to ensure that wages reflect better productivity differences
across 
the
Günstigkeitsprinzip,  allowing  temporarily  lower  payments  for  job
starters; and

(GL 5),  notably  by 

skills  and 

reviewing 

regions 

Improve the efficiency of ALMPs, in particular of job search assistance.
Reform  ALMPs  according  to  cost-effectiveness  criteria  and  target  them
better  towards  those  persons  most  prone  to  the  risk  of  long-term
unemployment (GL 8, 13 iv and E-REC 1).

to  increase  productivity 

the  business
In  order 
environment and the efficiency of the education system, Germany is recommended
to (in line with GL 9 to 14):

improvements 

through 

in 

4.

5.

Encourage businesses to invest and grow by creating a more competitive
environment  (GL 9)  and  by  further  reducing  the  regulatory  and
administrative burden (GL 11), inter alia by lowering the effective degree
of employment protection (GL 6); and

Carry  out  further  reforms  contributing 
achievements and the elimination of persistent skill shortages (GL 13).

improved  educational

to 

In  order  to  accelerate  the  consolidation  of  public  finances,  Germany  is
recommended to:

6.

Implement discretionary measures amounting to 1% of GDP in 2003 and
put an end to the present excessive deficit situation by 2004 at the latest
(GL 1); and

27

7.

Lower  the  cyclically-adjusted  deficit  by  at  least  1 percentage  point  of
GDP between the end of 2003 and 2005.

In  order  to  secure  the  long-term  viability  of  pension  and  health-care  systems,
Germany is recommended to:

8.

9.

Promote  the  take-up  of  supplementary  pension  schemes,  strengthen
incentives  for  later  retirement,  and  strengthen  the  link  between  public
pension contributions and pension rights (GL 16); and

Increase the efficiency in the health care sector by introducing economic
incentives for health care providers and recipients, such as cost sharing.

28

4.

Greece

In 2002, the Greek economy continued to expand at a high rate, despite the adverse
international  economic  conditions.  Real  GDP  growth  is  expected  to  remain  well
above the EU average, reaching 3.8% in 2003 (slightly above the potential growth
rate  of  around  3.5%).  However,  economic  activity,  which  has  been  boosted  by
private  and  public  investments,  mainly  through  the  preparation  for  the  Olympic
games and the third Community Support Framework, is very unlikely to exceed or
remain  at  its  potential  level  after  2004.  Moreover,  high  growth  rates  and  rising
energy  prices  may  create excessive  price  pressures.  In  spite  of  the  strong  growth
and  falling  interest  rates,  the  government  debt  ratio  has  not  been  reduced
significantly. In fact, while the debt ratio declined at a slow pace in the 1997-1999,
it  increased  in  2000-2001  mainly  due  to  the  reclassification  of  large  financial
operations previously excluded from budgetary accounts.

The  situation  in  the  labour  market  is  improving  at  a  very  slow  pace.
Notwithstanding the strong job creation, employment growth is not satisfactory and
unemployment, although it fell below 10% of the labour force in 2002, remained at
a high level. The interplay of rigidities in labour and product markets and the late
development  of  knowledge-based  society,  due  in  particular  to  the  low  level  of
investment  in  human  capital  and  in research, are impeding  the increase in  labour
productivity to levels that would accelerate the catching-up process.

Greece  needs  to  further  consolidate  public  finances  in  order  to  reduce  the  high
government  debt  ratio  at  a  satisfactory  pace.  Structural  problems  in  labour  and
product markets must be addressed in order to reduce the high unemployment rate,
improve  productivity  and  enhance  the  efficient  functioning  of  the  economy.  The
challenges facing Greece are to:

(cid:1)  Ensure  the  long-term  sustainability  of  public  finances  in  the  face  of
population ageing, in particular in view of the high government debt ratio

(cid:1) 

Increase the low level of productivity,  which is  associated  with  problems  in
the functioning of the labour and product markets, low investment in human
capital, and the late development of the knowledge-based society

(cid:1)  Reduce the  high  rate  of  structural  unemployment,  and  increase  employment

rates, particularly for women

Ensure the long-term sustainability of public finances in the face of population
ageing in particular in view of the high government debt ratio

Despite  the  budgetary  adjustments  and  the  improvement  in  government  balances
achieved  in  previous  years,  the  debt  ratio  was  not  put  on  a  sustained  declining
trajectory.  In  fact,  the  debt  ratio  increased  in  2000  and  2001,  after  the  revisions
required  by  Eurostat,  and  stood  at  105.3%  of  GDP  in  2002.  The  large  financial
operations  partly  outweighed  the  positive  impact  of  the  primary  surplus  on

29

government debt. The primary surplus is expected to have risen at a slower pace in
2002,  while  the  government  deficit  is  estimated  to  be  equal  to  1.1%  of  GDP
compared to 1.2% in 2001. The high growth rates of output constitute a solid base
for  further  improving  government  balances  and  turning  the  budget  deficit  into  a
surplus.  Limiting  public  consumption  spending  in  order  to  free  resources  for
productive uses and containing high debt ratio are of paramount  importance. The
high  debt  ratio,  if  not  controlled,  may  put  at  risk  the  sustainability  of  public
finances  in  the  longer  run  when  financial  pressures  stemming  from  the  ageing
population are expected to arise. Despite the efforts undertaken in the 2002 pension
reform,  the  still-large  projected  increase  in  public  spending  on  pensions  (from  a
high starting position) suggests that further efforts are required.

Increase the low  level  of  productivity,  which is  associated  with problems in  the
functioning of the labour and product markets, low investment in human capital,
and the late development of the knowledge-based society

The level of labour productivity, while rising strongly in recent years, remains the
second  lowest  in  the  EU.  This  can  be  explained  by  low  levels  of  investment  in
R&D,  the  still  low  -  albeit  growing  -  level  of  ICT  diffusion,  low  levels  of
educational attainment of the population and the resulting lack of skilled workers.
In  addition,  the  large  percentage  of  small  and  micro  domestic  firms,  which  is
partially due to distortions created, for example, by labour market legislation and
by taxation, contributes to low investment in R&D and innovation.

A better business environment  is also  key  to  improving  the  efficiency  of  product
markets.  First,  competition  in  certain  network  industries  is  still  limited.  For
example,  in  the  electricity  and  gas  sectors,  the  vertically  integrated  incumbents
dominate the markets. Second, despite recent measures to simplify  the regulatory
environment and the taxation system, business dynamism continues to be hindered
by complex procedures and a lack of efficiency of public administration. Third, the
transposition rate of internal market directives is the second lowest in the EU.

Reduce  the  high  rate  of  structural  unemployment,  and  increase  employment
rates, particularly for women

Greece’s  overall  employment  rate  is  considerably  below  the  targets  set  by  the
European  Council,  in  particular  for  women.  Unemployment  fell  for  a  third
consecutive  year  in  2002,  but  remains  well  above  the  EU  average,  with  the
unemployment  rate  for  women  more  than  double  the  rate  for  men,  and  youth
unemployment  very  high.  Labour  market  rigidities  still  hamper  the  more  flexible
functioning  of  the  labour  market.  There  have  been  no  changes  in  the  wage
formation system that would allow greater differentiation according to productivity
and  skills.  The  remaining  complexity  of  the  tax  system,  despite  the  recent
improvements, the high social security contributions and the stringent employment
protection legislation are still important obstacles to hiring. Moreover, the limited
impact of reforms aimed to promote flexible forms of employment point to the fact
that  many  employers  have  ready  recourse  to  flexibility  through  the  informal

30

economy.  The  reform  of  the  public  employment  services,  which  is  essential  to
address the high level of long-term unemployment, is still delayed.

Country specific recommendations to Greece

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

In  order  to  ensure  the  long-term  sustainability  of  public  finances  in  the  face  of
population ageing, in particular in view of the high government debt ratio (GL 15),
Greece is recommended to:

1.

2.

3.

4.

Ensure  that  the  government  debt  ratio  is  kept  on  a  sustained  declining
trend  at  a  satisfactory  pace  by  maintaining  high  primary  surpluses
(GL 15)

Ensure  effective  control  of  government  current  primary  spending  by
addressing  resolutely 
inelastic  elements  of
expenditures (GL 14), e.g. the wage bill;

the  problem  of 

the 

Use public resources more effectively with the aim off improving labour
productivity and enhancing working capacity of the unemployed (GL 14);
and

Pursue reforms of the social security system, and in particular the pension
system (GL 16), in order to avoid budgetary  strains  in the future  due to
the problem of the ageing population.

In  order  to  increase  the  low  level  of  productivity,  which  is  associated  with
problems in the functioning of the labour and product markets, low investment in
human capital, and the late development of the knowledge-based society, Greece is
recommended to (in line with GL 4 - 8 and 9 - 14):

5.

6.

7.

Step up efforts to increase the availability  of skilled  human  capital, and
continue to promote business involvement in R&D and innovation, and to
improve ICT diffusion (GL 13 and E-REC 2);

Enhance particularly competition in the energy sectors (GL 9);

Continue to simplify the business and taxation environment and raise the
transposition rate of internal market directives (GL 9 and 11);

31

Greece  should  also  vigorously  implement  all  the  Employment  Recommendations
(E-REC),  which  deal  with  employment  issues  in  a  more  comprehensive  way.  In
order  to  increase  growth  potential,  ensure  the  long-term  sustainability  of  public
finances, and address the effects of ageing populations, it is particularly especially
for  Greece  to  reduce  the  high  rate  of  structural  unemployment,  and  increase
employment rates, particularly for women. Greece is in particular recommended to:

8.

9.

10.

Improve  work  incentives,  particularly  in  tax  and  pension  systems,  in
order to encourage increased employment in the formal sector, including
part-time work (GL 4 and 16 and E-REC 4));

Promote  changes  to  the  wage  bargaining  to  ensure  that  wages  reflect
productivity differentials (GL 5); and

Implement  the  labour  reform  package  to  improve  the  balance  between
flexibility  and security  by  ensuring  effective  implementation  of  reforms
aiming  to  modernise  work  organisation  and  by  reviewing  unduly
restrictive labour market regulations (GL 6 and E-REC 1).

32

5.

Spain

Spain’s  economic  performance  was  remarkably  strong  in  the  second  half  of  the
1990s with growth rates (close to 4% on average) significantly exceeding those of
the euro area, as well as its medium-term potential rate (estimated at around 3%).
Contrary to previous downturns, a positive growth differential has been maintained
during the slowdown that began in 2001. This performance has been underpinned
by unprecedented employment creation, while monetary conditions have also been
particularly accommodating. On the downside, inflation has remained persistently
higher  than  the  average  for  the  euro  area,  above  the  differential  that  could  be
expected  for  a  catching-up  country.  Apparent  productivity  growth  has  declined,
highlighting  structural  problems  such  as  an  insufficient  degree  of  competition  in
some sectors.

To  maintain  its  convergence  towards  higher-income  economies  within  the  EU
(Spain’s  GDP  per  capita  remains  about  15%  lower  than  the  EU  average),  the
Spanish  economy  needs  to  consolidate  the  improved  performance  of  the  labour
market,  reduce  unemployment  disparities  among  regions  and  raise  overall  labour
force participation. In turn, growth would be supported by increasing productivity
through  encouraging  R&D  and  human  capital  formation  and  enhancing
competition.  Achieving  these  objectives  should  underpin  the  fiscal  consolidation
registered  in  recent  years.  Nevertheless,  the  risk  of  future  public  finance
imbalances  as  a  result  of  the  delayed  but  steep  impact  of  ageing  cannot  be
excluded. Therefore, to ensure the long-term sustainability of public finances, the
public  pension  system  needs  major  reform,  including  in  particular  strengthening
the link between contributions and benefits. The challenges facing Spain are to:

(cid:1)  Raise the low employment rates, especially among women, and reduce wide
regional labour market disparities, particularly as regards unemployment

(cid:1) 

Increase  the  low  level  of  productivity,  including  by  strengthening  the
knowledge-based economy in terms of educational attainment and skill levels,
investment in IT, R&D and innovation performance

(cid:1)  Ensure the long-run sustainability of public finances in the face of population

ageing

Raise  the  low  employment  rates,  especially  among  women,  and  reduce  wide
regional labour market disparities, particularly as regards unemployment

Notwithstanding 
recent  years
the  great  efforts  and  progress  made 
(unemployment rate reduced by more than 11 p.p. since 1995), the unemployment
rate  at  around  11.5%  remains  significantly  above  the  EU  average,  while  the
employment  rate  remains  well  below  the  EU  average.  The  reduction  in
unemployment  has  been  greater  for  women  than  for  men,  but  the  female
unemployment rate is still more than double that of  men.  Moreover,  despite  high
employment  creation,  unemployment  is  still  unevenly  distributed  across  regions.

in 

33

takes 

little  account 

Wage  setting 
in  practice  of  substantial  productivity
differentials.  The  labour  market  remains  heavily  segmented  between  employees
with permanent contracts and the large number on fixed-term contracts. In turn, the
share of part-time jobs in employment remains low. Geographical labour mobility,
while to some extent promoted by recent labour market and income tax reforms, is
still limited, partly on account of structural obstacles, notably the poor functioning
of the housing market. Additionally, the public employment services may lack the
organisational resources to administer well-targeted active labour market measures
and an unemployment benefit system based on job-seekers’ individual commitment
to activity.

Increase the low level of productivity, including by strengthening the knowledge-
based economy in terms of educational attainment and skill levels, investment in
IT, R&D and innovation performance.

Productivity in Spain is below the EU average and its growth has been very modest
since the second half of the 1990s. This is in part a result of the strong increases in
employment,  which  have  been  concentrated  in  low  productivity  activities.
Educational levels are relatively low. Low business investment in R&D is another
barrier  to  faster  productivity  growth.  The  low  patenting  rate  and  insufficient
investment in IT and e-commerce are indications of weak innovation. Productivity
growth  is  also  constrained  by  the  insufficient  competition  in  certain  sectors,
notably  in  retail  trade  and  electricity.  While  initiatives  have  recently  been
undertaken  to  increase  competition  in  the  electricity  sector,  the  four  major
vertically  integrated  incumbents  still  have  monopoly  in  their  respective  regional
markets,  and  import  capacities  still  remain  low.  Despite  recent  efforts,  the
relatively  high  degree  of  administrative  burden  on  business  creation  is  an
additional factor restricting competition.

Ensure  the  long-run  sustainability  of  public  finances  in  the  face  of  population
ageing

Although in Spain’s case manifesting themselves later than in other countries, the
long-term budgetary implications of ageing, above all for public pensions, but also
for areas such as health expenditures, are of special concern. Most studies point to
a very steep increase in the dependency ratio between 2020 and 2030, implying a
growing budgetary impact. An early comprehensive review  of the  public  pension
system  is  required  in  order  to  reduce  uncertainty  and  to  allow  phased
implementation  of  reforms.  Despite  some  recent  measures  aiming  at  prolonging
working  life  and  raising  participation  rates,  no  significant  reforms  of  the  public
pension system have yet been undertaken. Key parameters such as the number of
contributory  years,  the  age  of  retirement  and  the  replacement  ratio  remain
unchanged  and  there  is  only  a  weak  relationship  between  contributions  and
benefits.

34

Country specific recommendations to Spain

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

Spain should also vigorously implement all the Employment Recommendations (E-
REC), which deal with employment issues in a more comprehensive way. In order
to  raise  growth  capacity,  ensure  the  long-term  sustainability  of  public  finances,
address  the  effects  of  ageing  populations  and  reduce  regional  disparities,  it  is
especially important for Spain to raise the low employment rates, especially among
women, and reduce wide regional labour market disparities, particularly as regards
unemployment. Spain is in particular recommended to:

1.

2.

3.

4.

Continue  to  encourage  increased  labour  market  participation,  especially
among women, including through higher provision of childcare facilities
and the promotion of greater use of part-time contracts (E-REC 2);

Encourage a reform of wage setting in order to better reflect geographical
differentials in productivity and economic circumstances at the firm level,
as  well  as  phasing-out  indexation  provisions  in  collective  agreements
(GL 5);

Further  reform  of  employment  protection  legislation  so  as  to  reduce
segmentation  of 
types  of
contracts(GL 6 and E-REC 1); and

labour  market  across  different 

the 

Facilitate  the  geographical  mobility  of  workers  by  removing  fiscal  and
other  distortions,  including  by  promoting  the  rental  market  for  housing
and removing rigidities in the availability of land for development (GL 7
and E-REC 3).

35

In  order  to  increase  the  low  level  of  productivity,  including  by  strengthening  the
knowledge-based  economy  in  terms  of  educational  attainment  and  skill  levels,
investment in IT, R&D and innovation performance, Spain is recommended to (in
line with GL 9-14):

5.

6.

Step  up  efforts  to  increase  skilled  human  capital,  investments  in  R&D
and innovation, and ICT diffusion (GL 13); and

Continue  to  take  measures  to  further  enforce  effective  competition  in
certain  sectors,  such  as  electricity  and  retail  distribution  (GL 9)  and
pursue  ongoing  efforts  to  reduce  administrative  burden  on  business
(GL 11).

In  order  to  ensure  the  long-run  sustainability  of  public  finances  in  the  face  of
population ageing, Spain is recommended to:

7.

Implement a major reform of the pension system, beginning to undertake
a review in 2003, so as to strengthen the link between contributions and
benefits and control the long-term increases in pension expenditure linked
to the foreseen demographic changes (GL 16).

36

6.

FRANCE

During the last few years, the French economy grew at a faster pace than its main
European  partners.  This  performance  is  to  be  largely  attributed  to  strong  job
creation  during  a  number  of  years,  but  it  also  reflects  the  impact  of  an
accommodative  budgetary  policy  after  1999.  According  to  recent  Commission
calculations, potential real GDP growth still hovers slightly below 2.5%,  close  to
the average of the EU countries. The slow decrease of underlying inflation in the
last six months suggests that the economy is currently operating slightly below its
potential.  Recent  indicators  suggest  that  real  GDP  growth  is  currently  slowing
down in France as in other euro area countries.

In  the  coming  years,  potential  output  will  start  to  be  negatively  impacted  by  the
developments  in  the  demographic  structure.  However,  there  is  still  much  scope
available  for  supporting  potential  growth  through  structural  reforms  both  on  the
labour  market,  by  means  of  increasing  labour  market  participation  and  reducing
structural  unemployment,  and  on  the  product  market,  by  improving  effective
competition  in  key  network  industries.  Strengthening  the  efforts  towards  fiscal
consolidation  would  create  room  for  diminishing  the  tax  burden  weighing  on
labour cost and investment, thereby contributing to raise potential output. After the
marked deterioration in the cyclically-adjusted budgetary position in 2002, which
led to a deficit above the threshold limit of 3% of GDP, consolidating government
finances  constitutes  a  major  and  urgent  challenge  for  the  French  authorities,  in
particular in view of the impact of the ageing population on public finances. The
challenges facing France are to:

(cid:1)  Reduce rapidly the general government deficit to below 3% of GDP and keep

government finances on a steady consolidation path

(cid:1) 

Increase labour market participation and reduce structural unemployment

(cid:1)  Ensure  the  long-term  sustainability  of  public  finances  in  the  face  of

population ageing

(cid:1)  Ensure  effective  competition  in  the  network  industries  and  accelerate  the
adoption of Internal-Market measures, in order to create a level playing field

Reduce  rapidly  the  general  government  deficit  to  below  3%  of  GDP  and  keep
government finances on a steady consolidation path

The  general  government  deficit  reached  3.1%  of  GDP  in  2002  in  France.  This
represents a large slippage compared to the initial objective set in the Finance law
for  2002  of  a  general  government  deficit  of  1.4%  of  GDP.  According  to
Commission  calculations,  the  deterioration  in the  2002  budgetary  position  results
mainly  from  a  worsening  in  the  cyclically-adjusted  budgetary  position  by  some
1.2 percentage point of GDP, due to the implementation of tax cuts and to overruns
in  expenditures.  These  developments  provide  evidence  on  the  existence  of  an

37

excessive deficit in France, in the sense of the Treaty on European Union and the
Stability  and  Growth  Pact.  The  Commission  therefore  has  decided  to  initiate  an
Excessive Deficit Procedure (EDP) in the case of France.

the  cyclically-adjusted  budgetary  position 

France is currently subject to a recommendation adopted by the Council in January
2003 with a view to giving an early warning in order to prevent the occurrence of
an excessive deficit in 2003. So far, France has not taken measures apt to improve
significantly 
that  year  as
recommended by the Council. As a consequence, in the current context of subdued
growth, the general government deficit will very probably exceed the 3% of GDP
ceiling  in  2003.  In  view  of  these  developments,  and  taking  into  account  that  the
budgetary  burden  arising  from  an  ageing  population  will  start  increasing  rapidly
from  2005  onwards,  budgetary  consolidation  in  France  must  be  given  strong
priority.

in 

Increase labour market participation and reduce structural unemployment

A  key  medium-term  challenge  for  the  French  economy  continues  to  be  the
structural  problems  in  the  labour  market,  as  human  resources,  despite  recent
progress,  are  still  under-utilised.  France  still  has  a  relatively  low  overall
employment  rate  (63.8%  in  2002)  and  a  very  low  employment  rate  for  older
workers (among the lowest in the EU). In the context of an ageing population and
after a reduction in statutory working hours, the challenge is to encourage  labour
force participation). Improvements in participation rates are to be achieved through
further tax and benefit reforms, as well as from reforms to early retirement schemes
and  pensions  systems.  France  also  needs  to  continue  to  reduce  the  high  rate  of
structural unemployment and, the mismatch between supply and demand, which is
posing  recruitment  problems  in  certain  sectors.  Reductions  in  labour  cost,
especially  for  low-wage  earners  should  be  pursued.  Labour  market  regulations
should  be  further  reviewed,    especially  by  simplifying  the  enforcement  of
employment protection..

Ensure the long-term sustainability of public finances in the face of population
ageing

Government  finances  difficulties  caused  by  the  ageing  population  need  to  be
urgently  addressed.  Under  current  conditions,  avoiding  the  rapid  increase  in  the
deficit of the pension system, projected by the EPC to increase by 3.7 percentage
points  of  GDP  between  2000  and  2040,  would  require  substantial  increases  in
social security contributions. Such a development would increase considerably the
burden  on  labour  with  a  strong  negative  impact  on  the  labour  market.  The
government has committed itself to implementing a reform of the pension system,
before the end of the first half of 2003, after consultation with the social partners.
Such reforms will help to ensure the sustainability of public finances in the long-
term.  These  reforms  should  be  designed  in  such  a  way  that  ensures  inter-
generational  fairness  and  an  equitable  treatment  across  different  schemes.  In  the
health  sector, despite  the  recent  adoption  of  structural  measures  designed  to  curb
the  dynamic  of  spending,  expenditures  are  still  projected  to  increase  notably  in

38

2003 and in the years beyond. The government has indicated its intention to decide
on a reform of the health sector in the second semester of 2003.

The  concern  about  long-term  sustainability  of  public  finances  is  all  the  more
pressing as France’s debt-to-GDP ratio is very likely to breach the 60% threshold
in 2003.

Improve the  business environment,  ensure  effective  competition  in  the  network
industries and accelerate the adoption of Internal-Market measures, in order to
create a level playing field

While  measures  aimed  at  increasing  the  degree  of  market  opening  have  been
recently taken or announced, effective competition in the French gas and electricity
markets  remains  weak  and  the  market  shares  of  the  state-owned  incumbents  are
still  very  high,  especially  when  compared  with  those  of  their  counterparts  in  the
other large Member States.

Business  creation  and  growth  are  still  hindered  by  the  existence  of  different  and
complex  social  and  fiscal  procedures.  Although  France  has  expressed  its
commitment  to  increase  the  rate  of  transposition  of  internal  market  directives,  it
continues to have the worst record amongst EU Member States in transposing and
implementing these directives.

Country specific recommendations to France

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in part  I  of  the  Broad  Economic  Policy
Guidelines.

In order to reduce rapidly the general government deficit to below 3% of GDP and
keep government finances on a steady consolidation path, France is recommended
to:

1.

2.

Ensure that the situation of a general government deficit above the 3% of
GDP  threshold  is  corrected  by  2004  at  the  latest,  namely  through  the
adoption  of  measures  leading  to  a  significant  improvement  in  the
cyclically-adjusted deficit already in 2003 (GL 1); and

As  from  2004,  lower  the  cyclically-adjusted  deficit  by  at  least  0.5
percentage  point  a  year  (GL 1).  In  particular,  use  any  revenue  made
available  by  stronger-than-expected  growth  to  accelerate  the  adjustment
path to a close to balance budgetary position, while the implementation of
tax  cuts  should  be  conditional  upon  the  attainment  of  the  cyclically-
adjusted deficit targets.

France  should  also  vigorously  implement  all  the  Employment  Recommendations
(E-REC),  which  deal  with  employment  issues  in  a  more  comprehensive  way.  In
order  to  increase  potential  growth,  ensure  the  long-term  sustainability  of  public
finances, and address the effects of ageing, it is especially important for France to

39

increase labour market participation and reduce structural unemployment. France is
in particular recommended to:

40

3.

that 

the  new  unemployment 

is  fully
Ensure 
implemented, including appropriate requirements and effective incentives
to search for a job (GL 4 and E-REC 1); and

insurance  system 

In  order  to  ensure  the  long-term  sustainability  of  public  finances  in  the  face  of
population ageing, France is recommended to:

4.

5.

Undertake  with  urgency  a  comprehensive  reform  of  the  pension  system
(GL 16),  with  the  aim  of  ensuring  its  financial  sustainability  and
increasing the effective retirement age, while adapting pension systems to
more  flexible  employment  and  career  patterns  as  well  as  to  individual
needs; and

Monitor  closely  the  efficiency  of  the  measures  undertaken  to  curb  the
dynamics  of  spending  in  the  health  sector  so  as  to  reduce  it  to  a
sustainable  level,  and,  if  necessary,  introduce  new  measures  to  achieve
this objective (GL 14).

In order to ensure effective competition in the network industries and accelerate the
adoption  of  Internal-Market  measures,  in  order  to  create  a  level  playing  field
France is recommended to:

6.

7.

8.

Ensure  effective  competition  in  energy  markets,  namely  in  gas  and
electricity sectors (GL 9);

Sustain the efforts to  reduce  and  simplify  business  regulations  (GL 11);
and

Raise the transposition rate of Internal Market directives and bring down
the number of infringement proceedings (GL 9).

41

7.

IRELAND

Irish economic growth averaged a spectacular 10% over the period 1995-2000. The
concomitant impressive rise in employment (5½% on average) was made possible
by  significant  increases  in  labour  force  participation,  a  dramatic  drop  in
unemployment  and  a reversal  of  the traditional  net  emigration  pattern  from  1996
onwards.  As  these  sources  of  labour  supply  were  exceptional,  the  economy
increasingly  suffered  from  supply  constraints  (both  regarding  labour  and
infrastructure)  in  the  late  nineties.  As  a  result,  and  in  line  with  the  worldwide
downturn,  the  pace  of  expansion  slowed  markedly  from  2001  onwards.  Looking
forward,  Ireland  should  benefit  strongly  from  the  expected  global  recovery  on
account  of  its  high  degree  of  openness.  However,  the  era  of  double-digit  growth
has ended and Irish potential GDP growth in the medium term is unlikely to exceed
5%, around double that in the EU as a whole in view of a continuation, for the time
being, of higher labour force growth and stronger productivity gains.

Creating stable macro-economic conditions would facilitate the adjustment to this
slower pace of expansion and help preserve the successes achieved during the past
boom.  Further,  to  ensure  that  economic  potential  is  being  exploited  to  the  full,
structural measures should be taken to strengthen the supply-side of the economy,
which  would  also  help  to  contain  inflationary  pressures.  The  challenge  facing
Ireland is to:

(cid:1)  Achieve  a  smooth  transition  from  double-digit  economic  growth  in  the  late
1990s  to  lower,  sustainable  growth  in  the  years  ahead  by  ensuring  stable
macroeconomic  conditions  and  by  strengthening  the  supply-side  of  the
economy

Achieve a smooth transition from double-digit economic growth in the late 1990s
to 
the  years  ahead  by  ensuring  stable
macroeconomic conditions and by strengthening the supply-side of the economy

lower,  sustainable  growth 

in 

Thanks to rapid growth in the previous decade, both the public finance position and
the  labour  market  situation  improved  considerably.  The  general  government
balance  was  in  surplus  from  1997  to  2001,  while  the  debt  ratio  is  currently  the
second  lowest  in  the  EU.  Looking  forward,  the  implementation  of  the  public
investment  programme  and  of  social  and  health  spending  initiatives  will  have  to
reflect  the  moderation  of  economic  and,  thus,  revenue  growth  and  the  need  to
improve value for money in public services delivery, (building on recent measures
to  improve  expenditure  management  and  control).  Strong  employment  growth
brought  the  unemployment  rate  down  to  below  4%  in  2001  (from  above  15%  in
1993),  but  the  increasingly  tight  labour  market  led  to  high  rates  of  inflation  and
wage  growth.  Maintaining  full  employment,  the  aim  of  the  recently  negotiated
social  partnership  agreement,  requires  a  prudent  and  flexible  approach  in  wage
negotiations and measures to strengthen the supply-side of the economy.

42

Reform in three broad areas appears most promising in order to boost the supply-
side. First, the supply constraints experienced on the infrastructure front are being
addressed in the framework of the National Development Plan 2000-2006, but the
roll-out of the Plan has been slower than planned given rising construction and land
acquisition costs, as well as planning delays. Second, in spite of the high proportion
of ICT value-added in the economy, R&D spending is low in Ireland (at 1.2% of
GDP in 1999). Ireland’s  productivity  would  benefit from  measures to raise  R&D
spending. Third, while some progress has been made, there remains an insufficient
degree  of  competition  in  some  sectors  of  the  Irish  economy,  in  particular  the
network industries and several other service sectors (such as professional services,
retail distribution and insurance).

Country specific recommendations to Ireland

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

Ireland  should  also  vigorously  implement  all  the  Employment  Recommendations
(E-REC), which deal with employment issues in a more comprehensive way.

In order to achieve a smooth transition from double-digit economic growth in the
late  1990s  to  lower,  sustainable  growth  in  the  years  ahead  by  ensuring  stable
macroeconomic  conditions  and  by  strengthening  the  supply-side  of  the  economy,
Ireland is recommended to:

1.

2.

3.

4.

Enhance  the  efficiency  of  public  expenditure  and  improve  revenue  and
expenditure  planning  in  a  stability-oriented  medium-term  framework
(GL 14);

Encourage  the  social  partners  to  adhere  to  a  prudent  and  flexible  wage
norm to allow for adaptation to productivity and skill differentials and at
the same time safeguard competitiveness (GL 3 and 5);

Prioritise  the  roll-out  of  the  infrastructural  elements  of  the  National
Development  Plan,  while  preserving  budgetary  stability,  and  pursue
policy measures to raise the level of R&D (GL 13); and

Increase  competition  in  the  network  industries  and  in  certain  sectors  of
the  economy,  such  as  retail  distribution  (including  the  liquor  trade),
insurance and the professions (GL 9).

43

8.

ITALY

Italy’s economic growth has generally lagged behind that of the EU since the early
1990s.  While  the  growth  differential  has  narrowed  during  the  last  cyclical
slowdown, inter alia because of a less restrictive policy mix, the  rate  of  potential
output  growth  is  still  estimated  to  be  below  the  euro  area  average.  Despite  this
relatively  weak  growth,  consumer  price  inflation  has  typically  been  higher  than
elsewhere  in  the  euro  area,  signalling  structural  weaknesses.  Persistently  weak
potential output growth, together with a slackening of the fiscal adjustment effort
since 2000, has hampered the  structural  consolidation  of  public  finances.  In  turn,
the  very  high  public  debt,  via  its  impact  on  national  saving  and  capital
accumulation, has hindered growth. Ongoing wage moderation and some important
reform steps starting  in  1998  have  significantly  improved  the  performance  of the
labour  market,  pushing  the  rate  of  unemployment  below  9%  at  the  end  of  2002.
However, the rising contribution of labour to  economic  growth  has  been  coupled
with  a  marked  slowdown  in  total  factor  productivity  partially  attributed  to  the
increased  participation  of  low-skilled  labour,  especially  in  the  service  sector.  In
spite  of  significant  improvements  in  the  past  years,  participation  rates  are  still
among the lowest in the EU.

Taken as a whole, Italy’s main problem remains low growth potential. Key factors
holding  back  potential  growth  include  the  still  unresolved  condition  of  public
finances,  the  persisting  regional  gap,  especially  in  terms  of  the  large  share  of
inactive or unemployed working-age population in the South, as well as drags on
total  factor  productivity  such  as  the  low  levels  of  education  and  of  R&D
investment. The challenges facing Italy are to:

(cid:1)  Rapidly consolidate public finances

(cid:1)  Ensure  the  long-term  sustainability  of  public  finances  in  the  face  of

population ageing

(cid:1)  Raise the low employment rate, especially among women and older workers,

and reduce the wide North-South economic disparities

(cid:1)  Strengthen the knowledge-based economy in terms of educational attainment

and skill levels, investment in IT, R&D and innovation performance

(cid:1)  Continue to improve the business environment and to enhance competition in

the energy and services sectors

Rapidly consolidate public finances

In  the  run-up  to  the  creation  of  EMU  and  immediately  thereafter,  Italy’s  fiscal
accounts improved remarkably. However, in more recent years fiscal consolidation
has slowed down, inter alia due to markedly lower-than-expected growth, and to a
series  of  tax  reductions.  Keeping  primary  expenditures  in  check  has  proved

44

problematic.  In  late  2002  and  early  2003,  the  authorities  adopted  tighter  controls
and more transparent spending procedures, which should lead to improvements in
future  years.  Ongoing  decentralisation  will  require  additional  measures  to  clarify
and enforce fiscal responsibility at all levels of government, while maintaining an
adequate level of interregional transfers. The last few years have seen recourse to
substantial sales of publicly-owned real assets and an array of tax amnesties. These
transitory measures, while staving off the risk of breaching the 3% of GDP deficit
threshold, have replaced more fundamental action. The medium-term objective of
cyclically-adjusted budget  balance is,  however,  critical  to placing  public  finances
on a sustainable footing, given moreover that the debt ratio remains above 100% of
GDP  and  the  fiscal  implications  of  a  severely  ageing  population  are  looming.
Accelerating fiscal consolidation and reducing debt, and thus the present high debt
servicing costs, will also create margins for improving the quality of expenditure.

Ensure the long-term sustainability of public finances in the face of population
ageing

During  the  1990s  Italy  took  major  steps  to  reform  the  pension  system  to  avert
unsustainable  expenditure 
trends.  However,  given  adverse  demographic
projections,  ageing–related  expenditure  for  healthcare  and  pensions  is  still
projected  to  rise  in  the  next  decade.  Although  designed  to  take  into  account  the
effects  of  changes  in  life  expectancy  and  in  the  long-term  growth  rate  of  the
economy, the new system might still be subject to significant financial imbalances
in the event of adverse demographic and economic events. On the basis of current
policies, the risk of unsustainable public finances in the light of ageing population
therefore  cannot  be  excluded.  In  this  context,  the  high  debt  ratio  creates  tight
constraints on fiscal policy, as primary surpluses in the order of 5% of GDP will
need to be maintained over a long period. Announced changes in the social security
system, while promoting privately-funded pension schemes, do not address critical
issues  in  the  public  pension  system,  such  as  the  long  transition  to  a  new
contributions-based system. Moreover, the planned reductions in contributions for
newly hired workers could affect the long-term balance of the pensions system, if
not matched by corresponding reductions in workers’ entitlements.

Raise the low employment rate, especially among women and older workers, and
reduce the wide North-South economic disparities

Despite improvements in recent years, there remains an important gap between the
employment  rates  in  Italy  and  the  EU  average,  especially  for  women  and  older
workers. National targets have been set in these areas. Overall, the large share of
unutilised human resources chiefly reflects the persisting large regional gap, with
the  North  recording  high  participation  rates  and  almost  full  employment  on  one
side and the South characterised by low participation and high unemployment  on
the  other. This  relative  gap  has  been  persistent,  even  while  absolute  performance
has improved in both North and South. This may hide a large share of undeclared
work. The regional pattern of employment and unemployment is very similar to the
regional  productivity  differences,  suggesting  that  the  existing  wage-bargaining
system  may  be  insufficiently  flexible  in  taking  into  account  such  regional

45

differences. In addition, lower productivity in the South is also likely to reflect the
lower endowment of infrastructure. A further major weakness of the labour market
is the imbalance between flexibility and security. There has been growing recourse
to more flexible contracts, which enjoy a relatively low degree of protection vis-à-
vis the still strict protection of permanent jobs in medium and large firms. This has
entrenched a dual labour market structure, with insecurity at one end amplified by a
very limited system of unemployment benefits and social assistance, and relatively
underdeveloped  active  labour  market  policies.  Further  initiatives,  which  aim  at
increasing flexibility at the margin, inter alia by introducing new labour contracts
and by liberalising employment services, were introduced by the government at the
beginning of 2003. Finally, the implementation of long standing plans such as the
lifelong learning strategy or the reform of the Public Service is lagging behind.

Strengthen  the  knowledge-based  economy  in  terms  of  educational  attainment
and skill levels, investment in IT, R&D and innovation performance

in 

the  knowledge-based  economy 

Despite  some  progress 
Italy  remains
underdeveloped.  While  recently  measures  have  been  adopted  to  improve  the
situation, educational levels remain relatively low, as is the availability of skilled
human  resources.  Italy  also  ranks  low  in  the  area  of  Internet  and  e-commerce
access and use. Business innovation is weak: business R&D expenditures relative
to GDP (0.5% in 2000) and patent applications relative to population reach barely
half the EU average. The relatively large reliance of the Italian economy on small
and medium size enterprises is a contributory factor, as these companies often lack
the critical mass to carry out such activities.

Continue to improve the business environment and to enhance competition in the
energy and services sectors

While  measures  have  been  taken  to  reduce  red  tape  and  to  improve  the  business
environment,  administrative  procedures  for  businesses  remain  rather  costly  and
time  consuming.  This  contributes  to  making  the  Italian  business  sector  relatively
less dynamic than that of other Member States, as  measured  by  indicators  on  net
business creation.

Effective  liberalisation  of  energy  sector  is  proceeding  only  slowly.  Incumbents
retain a dominant position in the market although it is declining  in  the  electricity
sector.  Moreover,  third  parties’  access  to  the  networks,  while  legally  free,  still
remains  difficult.  This  contributes  to  electricity  and  gas  prices  remaining  among
the highest in the EU. Competition in some service sectors is also being introduced
relatively  slowly,  notably  in  the  area  of  professional  services  and  local  public
services. Finally, the rate of transposition of Internal Market directives deteriorated
in  2002  and  the  number  of  infringements  proceedings  open  before  the  European
Court of Justice is the second worst in the EU.

46

Country specific recommendations to Italy

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

In order to rapidly consolidate public finances, Italy is recommended to:

1.

2.

3.

Until  a  medium-term  budget  position  close  to  balance  or  in  surplus  is
achieved, ensure a reduction in the cyclically-adjusted deficit of  at  least
0.5% of GDP per year (GL 1), replacing one-off measures by measures of
a more permanent character;

Strengthen  policy  co-ordination  between  all  levels  of  government,  by
ensuring  adequate  and  transparent  enforcement  mechanisms  for  fiscal
discipline,  while  providing  for  clear  sources  of  financing  regional
spending; and

Finance any further reduction in the tax burden through structural cuts in
primary expenditure.

In  order  to  ensure  the  long-term  sustainability  of  public  finances  in  the  face  of
population ageing, Italy is recommended to:

4.

5.

Accelerate the reduction in the debt ratio so as to ensure that the debt is
sufficiently diminishing towards the 60% of GDP threshold (GL 15); and

Adopt further measures to address the critical issues in the public pension
system  (GL 16),  in  particular  the  long  transition  period  to  the  new
contributions-based  system  and  the  remaining  vulnerability  of  the  new
system  to  adverse  demographic  and  economic  events,  and  promote
supplementary privately funded pension schemes.

Italy should also vigorously implement all the Employment Recommendations (E-
REC), which deal with employment issues in a more comprehensive way. In order
to  increase  the  growth  capacity,  ensure  the  long-term  sustainability  of  public
finances, address the effects of ageing populations and reduce regional disparities,
it  is  especially  important  for  Italy  to  raise  the  low  employment  rate,  especially
among  women  and  older  workers,  and  reduce  the  wide  North-South  economic
disparities. Italy is in particular recommended to:

6.

7.

Further encourage increased labour force participation, especially among
women,  including  by  adequate  provision  of  child-care  facilities;  and
among  older  workers,  stepping  up  and  reinforcing  measures  targeted  at
postponing retirement from the labour force (GL 4 and 16 and E-RECs 3
and 4);

Further  reform  employment-protection  legislation  (GL 6),  in  order  to
facilitate job creation and adaptability and to reduce the segmentation of
the labour market across type of contracts and firm size; and, at the same

47

time,  increase  the  resources  and  improve  the  efficiency  of 
the
unemployment benefit and social assistance system (GL 4 and E-RECs 1
and 6); and

8.

Encourage  social  partners  to  move  towards  more  decentralised  wage
to  better  reflect  different
setting  mechanisms 
productivity conditions and individual skill levels (GL 5).

that  allow  wages 

In  order  to  strengthen  the  knowledge-based  economy  in  terms  of  educational
attainment  and  skill  levels,  investment  in  IT,  R&D  and  innovation  performance,
Italy is recommended to:

9.

Pursue efforts undertaken to raise the overall education and skill base of
the population, to further increase investment in R&D and innovation and
to promote higher ICT take up, in particular through measures targeted at
small and medium enterprises (GL 13).

In  order  to  continue  to  improve  the  business  environment  and  to  enhance
competition in the energy and service sectors, Italy is recommended to (in line with
GL 9 to 14):

10.

11.

Improve the business environment by reducing the administrative burden
on businesses (GL 11); and

Increase effective competition in the service sector, ensure the continued
opening  up  of  the  energy  markets,  and  improve  the  implementation  of
Internal Market directives (GL 9).

48

9.

LUXEMBOURG

During  the  1990s  Luxembourg  enjoyed  very  high  rates  of  real  GDP  growth.
However,  in  2001  the  open  economy  of  Luxembourg  experienced  a  very  sharp
slowdown,  to  a  large  extent  due  to  the  external  environment.  The  economic
downturn is also expected to lead to a worsening of public finances with a certain
lag. The budget surplus of 6.1% of GDP in 2001 is estimated to have decreased to
2.6% of GDP in 2002 and deficits are forecast for 2003 and 2004. That  said, the
situation of government finances in Luxembourg remains relatively favourable, in
view of the low level of debt and the existence of budgetary reserves.

Faced with the prospect of a lower rate of economic growth than experienced for
most  of  the  1990s,  Luxembourg  should  attempt  to  raise  its  productive  potential,
while  ensuring  stability-oriented  macro-economic  policies  as  the  basis  for
sustainable growth. In order to promote growth and maintain sound public finances
it is necessary to increase labour supply, both as a means to reduce expenditure and
to  increase  tax  revenues.  To  boost  its  productive  potential,  Luxembourg  should
primarily  address  two  key  challenges  in  the  area  of  labour  market  and  product
market reform. The challenges facing Luxembourg are to:

(cid:1) 

(cid:1) 

Increase  the  low  national  participation  and  employment  rates,  especially  for
older workers

Improve the business environment and encourage entrepreneurship in order to
achieve a more balanced economic structure

Increase  the  low  national  participation  and  employment  rates,  especially  for
older workers

Labour  force  participation  in  Luxembourg  is  below  the  EU  average;  the
participation rates of older workers are particularly  low.  Employment  growth  has
been  possible  thanks  to  cross-border  workers  and  increased  participation  of
national  prime-age  women,  while  virtually  no  progress  has  been  achieved
regarding  the  employment  rate  of  older  workers,  despite  some  measures
undertaken  with  the  aim  of  increasing  incentives  to  remain  in  the  workforce.
Mobilising  part  of  the  unutilised  national  employment  potential  is  of  great
importance  to  enhance  labour  supply  and  thus  provide  an  impetus  to  growth.
Moreover, postponing withdrawal from the labour market would decrease benefit
dependency,  thereby  reducing  public  expenditure  on  benefits  and  pensions.
Incentives to remain in the labour force could be improved by  further  reforms  of
early retirement and pre-retirement schemes. Also the effects of the latest revisions
in the disability pension scheme should be closely monitored.

49

Improve the business environment  and  encourage  entrepreneurship in  order to
achieve a more balanced economic structure.

Regulation in the Luxembourg economy is still fairly high, notably for prices, and
the  reform  aiming  at  modernising  the  competition  framework  has  not  yet  been
implemented.  Whilst  the  high  openness  of  Luxembourg  brings  competition  from
abroad,  reforms  to  adapt  domestic  competition  policy  and  their  follow-up  are
necessary to maintain the benefits of competitive economic conditions.

Over  the  last  decade,  Luxembourg's  economy  has  developed  a  high  degree  of
specialisation  in  financial  services.  This  situation  has  been  so  far  beneficial  to
employment and growth but also makes Luxembourg more vulnerable to possible
future sector-specific shocks. A more balanced economic structure based on small
and medium sized enterprises has the potential to decrease this dependency and to
raise the national labour force participation and employment rates.

Country specific recommendations to Luxembourg

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

should 

also  vigorously 

Luxembourg 
the  Employment
Recommendations  (E-REC),  which  deal  with  employment  issues  in  a  more
comprehensive way. In order to increase growth potential, it is especially important
for Luxembourg to increase the low national  participation  and employment  rates,
especially for older workers. Luxembourg is in particular recommended to:

implement 

all 

1.

Review  incentives  for  early  and  pre-retirement  and  ensure  appropriate
eligibility rules in the disability pension scheme (GL 16 and E-REC 2).

In  order  to  improve  the  business  environment  and  encourage  entrepreneurship  to
achieve a more balanced economic structure, Luxembourg is recommended to:

2.

3.

Fully  implement  the  reforms  of  competition  law  and  to  ensure  that
competition  and  regulatory  authorities  have  sufficient  independence,
resources and power to fulfil their tasks (GL 9); and

Take  measures  to  encourage  and  facilitate  the  creation  of  SMEs  and  to
help those to access venture capital (GL 11).

50

10.

THE NETHERLANDS

From  the  mid-1990s  to  2000,  the  Netherlands  enjoyed  rates  of  real  GDP  growth
clearly  exceeding  the  EU  average,  while  the  harmonised  unemployment  rate
declined  substantially  to the  second  lowest level in the  EU.  From  2001  onwards,
the  economy  experienced  a  marked  economic  slowdown,  which  also  led  to  a
significant worsening of public finances, and, with some delay,  a  deterioration  in
the labour market. Expectations are that an economic recovery would be relatively
muted, while government finances are projected to deteriorate further in the wake
of  the  unfavourable  macro-economic  situation.  In  2003,  real  GDP  growth  is
expected to remain below 1%, after a growth rate of only 0.3% in 2002. Potential
economic growth is estimated to have slowed down to around 2 %, compared to 2
¼%  in  the  rest  of  the  EU.  The  weakened  growth  potential  reflects  a  number  of
factors,  including  a  high  incidence  of  people  relying  on  social  security  benefits,
demographic trends, and a low level of competition in some sectors that hold back
labour supply and productivity, and losses in external competitiveness, which may
be partly attributed to sharp wage increases and insufficient business investment in
R&D and innovation over the past years.

Faced with the prospect of a lower rate of economic growth than experienced for
most of the 1990s, the Netherlands should attempt to raise its productive potential,
while  ensuring  stability-oriented  macro-economic  policies  as  the  basis  for
sustainable  growth.  To  this  end,  the  Netherlands  has  to  address  three  key
challenges. The first key challenge addresses the  sustainability  of  public  finances
while  the  next  two  relate  to  reforms  of  labour  and  product  markets  intended  to
mobilise  under-utilised  resources  and  increase  competition  and  productivity  as
means to enhance economic growth. The challenges facing the Netherlands are to:

(cid:1)  Pursue  budgetary  adjustment  in  the  coming  years  in  the  face  of  weaker

potential growth, and the budgetary costs of ageing

(cid:1)  Draw currently inactive people into the labour market

(cid:1)  Tackle the relatively slow productivity growth, stemming, inter alia, from the
low  level  of  competition  in  some  sectors,  and  insufficient  business
investment, particularly in R&D.

Pursue budgetary adjustment in the coming years in the face of weaker potential
growth and the budgetary costs of ageing

The situation of public finance in the Netherlands has deteriorated recently from a
relatively  favourable  starting  position,  largely  due  to  the  sharp  economic
slowdown. In 2002, the nominal and cyclically-adjusted general government deficit
is estimated to have been around 1% of GDP. However, at present it is difficult to
assess fiscal policy in the coming years as no new government has yet been formed
following the Parliamentary elections of 22 January 2003. However, in the absence
of  policy  changes,  the  government  balance  is  expected  to  deteriorate  further  in

51

coming  years.  Thus,  budgetary  adjustment  would  be  needed  to  achieve  and
maintain  a  budgetary  position  close  to  balance  or  in  surplus.  In  particular,  it  is
important  that  government  expenditure  is  brought  in  line  with  the  revenue  basis,
reflecting the expected slowdown of the potential rate of real GDP growth.

Draw currently inactive people into the labour market

Despite a favourable labour  market  situation, inactivity  in the  Netherlands is still
relatively  high.  Of  particular  concern  is  the  high  number  of  people  currently  on
disability  benefits,  and  the  unemployment  traps  in  the  social  benefit  schemes,
which continue to create disincentives for people to take up work. The substantial
size  of  the  untapped  reserve  of  labour  is  illustrated  by  the  number  of  benefit
claimants, e.g. 7% of the labour force receives unemployment and social benefits
and 11% receive disability benefits. Further improvement of employment rates will
also  depend  on  continued  growth  of  female  employment,  and  on  a  stronger
activation  of  older  persons  and  minorities.  Mobilising  the  unutilised  potential  of
labour  supply  is  of  primary  importance  in  order  to  increase  employment  and
provide a substantial stimulus for growth.

Tackle the relatively slow productivity growth, stemming, inter alia, from the low
level  of  competition  in  some  sectors,  and  insufficient  business  investment,
particularly in R&D

Productivity growth has been relatively  slow  in  the  Netherlands  since  1999,  with
levels falling further below the EU average in 2002. This may be partly attributed
to  rapid  employment  growth  and  labour  hoarding.  Low  productivity  growth  can
also be due, however, to the low level of competition in some sectors as well as the
low and declining specialisation of the Netherlands in high- and medium high-tech
manufacturing sectors. For example in construction, the Parliamentary Committee
found evidence of illegal price agreements in 2002. In network industries, reform
fatigue,  partly  stemming  from  perceptions  that  liberalisation  has  failed  to  benefit
consumers,  has  slowed  down  progress  in  tackling  the  still  insufficient  degree  of
competition. The weakness of the regulatory regimes in liberalised sectors explains
in part why the benefits of reform have not yet materialised fully. Low investment
in R&D acts as a drag on productivity growth in the Netherlands. In the second half
of the 1990s, business investment in R&D was 10% below EU average and even
more  below  that  of  neighbouring  countries  such  as  Belgium  and  Germany.  A
particular problem is the low level of science and technology graduates aged 20-29,
who provide the principal source of the future stock of researchers.

Country specific recommendations to the Netherlands

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

52

In order to pursue budgetary adjustment in the coming years in the face of weaker
potential  growth,  and  the  budgetary  costs  of  ageing,  the  Netherlands  is
recommended to:

1.

Continue  to  contain  government  expenditure  within  clearly  defined
ceilings  set  in  real  terms,  consistent  with  a  budgetary  position  close  to
balance or in surplus (GL 1 and 14).

implement  all 

The  Netherlands  should  also  vigorously 
the  Employment
Recommendations  (E-REC),  which  deal  with  employment  issues  in  a  more
comprehensive  way.  In  order  to  increase  growth  potential,  ensure  the  long-term
sustainability  of  public  finances,  address  the  effects  of  ageing  populations  and
promote  inclusion  in  the  labour  market,  it  is  especially  important  for  the
Netherlands  to  draw  currently  inactive  people  into  the  labour  market.  The
Netherlands is in particular recommended to:

2.

Push forward with reforms of benefit systems in order to make work pay
(GL 4 and E-REC 3). Concentrate, in particular, on benefit eligibility and
conditionality.  Legislate  and  implement  the  planned  reform  of  the
disability scheme, thereby paying attention to both the inflow and to the
activation of those who already receive benefits.

In  order  to  tackle  the  relatively  slow  productivity  growth,  stemming,  inter  alia,
from  the  low  level  of  competition  in  some  sectors,  and  insufficient  business
investment, particularly in R&D, the Netherlands is recommended to (in line with
GL 9 to 14):

3.

4.

Improve the regulatory framework as well as its implementation (GL 11),
especially in sectors where competition has been found to be inadequate,
such as construction and professional services; and

Promote  a  more  technology  oriented  education  and  strengthen  science-
industry  links  with  the  aim  of  increasing  business  investment  in  R&D
(GL 13).

53

11.

AUSTRIA

Since the 1970s, real GDP growth in Austria has on average been slightly higher
than  in  the  EU.  Potential  output  growth,  however,  is  estimated  to  have  been
declining since 1990 from above to below the EU-average. While in 1990 potential
output growth in Austria was estimated at 3.1% (compared with an EU average of
2.8%), it fell to 1.9% in 2002 (2.2% on average in the EU) and is projected to drop
further.  Population-ageing  and  barely  rising  labour  force  participation  rates,
combined with below average total factor productivity growth, play a major role in
these  subdued  prospects. The  same  factors  also  weigh  on  public  finances,  with  a
twofold impact: first, low potential growth is tantamount to foregoing revenues and
second, population ageing exerts upward pressure on spending. As expenditure cuts
did  not  break  underlying  spending  pressures,  the  tax  burden  remained  high  in
particular since 1995 and peaked in 2001, implying the danger of setting in motion
the  vicious  circle  of  a  high  tax  burden  and  slow  growth.  In  order  to  ease  the
constraints  on  public  finances  and  resume  above-average  gains  in  incomes  and
living  standards,  Austria  should  seek  to  strengthen  incentives  to  hire,  work  and
invest.  This  in  turn  requires  achieving  and  maintaining  a  budgetary  balance  at
lower ratios of taxes and expenditure to GDP.

A  main  factor  holding  back  Austria’s  growth  potential  are  the  negative
consequences  on  labour  supply  induced  by  generous  social  transfers  and  ample
provisions  of  public  services,  which,  combined  with  the  budgetary  effects  of
population ageing, resulted in a persistent upward pressure on public expenditure.
This, in turn, gives rise to a high tax burden, in particular on labour, while at the
same time discouraging labour force participation as well as on labour demand. In
addition,  a  feeble  innovative  capacity,  in  particular  poor  diffusion  of  technology,
thus resulting in a weak technology base, remains one of the fundamental problems
of the Austrian economy. Therefore, public spending could usefully be redirected
towards these growth-enhancing items. Moreover, a lack of competition in product
markets  appears  to  be  an  additional  obstacle  to  more  dynamic  growth.  The
challenges for Austria are to:

(cid:1)  Ensure the sustainability of public finances in the face of population ageing

(cid:1)  Continue to improve the weak technology base, and encourage business R&D

and innovation

(cid:1)  Strengthen the development of effective competition in some sectors

Ensure the sustainability of public finances in the face of population ageing

Austria’s pension system is financed nearly exclusively on a pay-as-you-go basis,
although recent measures aim at strengthening privately funded systems. Despite a
reform in 2000 and fairly moderate benefit increases in recent years, the long-term
sustainability  of  the  pension  system  is  not  ensured  in  view  of  the  projected
population ageing. The adverse demographic  dynamics  is  exacerbated  by  the  -  at

54

58  years  –  low  actual  average  effective  retirement  age  and  the  very  low
employment rates for older workers, despite the fact  that the  overall  employment
rate  already  exceeds  the  EU  target  for  2005.  Moreover,  as  pension  benefits  are
currently calculated on basis of only 15 – in the future 18 – working years with the
highest earnings, there is a weak link between contributions and benefits, and the
current level on  pension  spending  as  a  share  of  GDP is  one  of the highest  in the
EU.  If  the  present  system  were  to  remain  unchanged  or  to  be  modified  only
marginally,  the  already  high  tax  burden  would  need  to  increase  further,  with
negative  consequences  for  labour  supply  and  demand  and,  thus,  for  growth
potential.  In  December  2002,  an  expert  group,  the  Pension  Reform  Commission,
presented a comprehensive report, which elaborated on various options for reform.
Also  the  health  care  system,  despite  recent  measures  to  contain  spending,  will
come under increasing financial strain.

The  concern  about  long-term  sustainability  of  public  finances  is  all  the  more
pressing  as  Austria’s  debt-to-GDP  ratio  remains  above  the  60%  threshold,  and
where a clear downward has trend not yet been established.

Continue  to  improve  the  weak  technology  base,  and  encourage  business  R&D
and innovation

Weak  effective  competition  in  some  sectors  has  put  too  little  pressure  on  the
business sector to innovate and to invest in research and development. The level of
R&D expenditures as a percentage of GDP is slowly increasing but remains below
the EU average and the share of business R&D progressively declined from around
50% to about 40% since 1992. In addition, IT expenditures remain below the EU
average  and  the  level  of  venture  capital  investment  is  amongst  the  lowest  in  the
EU.  Besides  a  low  degree  of  competition,  the  relatively  heavy  reliance  of  the
Austrian economy on small and medium sized enterprises contributes to explaining
these low levels of R&D and innovation, as these companies often lack the critical
mass to carry out such activities. To improve this weak technology base, Austria is
developing programs to offer financial and fiscal incentives to innovate and to co-
ordinate  SMEs  efforts.  The  growing  number  of  patents  and  the  good  level  of
tertiary graduates in science and technology are positive developments  that could
be used as levelling tools.

Strengthen the development of effective competition in some sectors

Until  the  late  1990's,  the  relatively  low  degree  of  openness  of  the  Austrian
economy, the long tradition of relying on social consensus and regulations, and the
need to involve social partners and Länder to achieve reforms act as constraints on
the  competition  framework.  This  has  led  to  high  concentration  in  certain  sectors
such  as  newsmagazines,  food  retailing,  drugstores,  health  insurance,  furniture
retailing, or network industries. The reform of the Austrian law on competition and
the  establishment  of  an  independent  federal  competition  authority  are  recent
developments that could create a more competitive environment. However, the new
competition  authority  needs  to  establish  itself  and  start  its  investigations.  This
situation is made difficult by understaffing. In addition, sector regulators, such as

55

in the telecommunications sector, sometimes lack the power to effectively enforce
their  decisions,  leading  to  long  proceedings  in  Courts  before  a  decision  is  made
effective.

Country specific recommendations to Austria

Meeting the challenges outlined above requires broad structural reforms as they are
laid  down  in  the  general  policy  recommendations  (GL)  in  part  I  of  the  Broad
Economic Policy Guidelines.

Austria should  also  vigorously  implement  all  the  Employment  Recommendations
(E-REC), which deal with employment issues in a more comprehensive way.

In  order  to  ensure  the  sustainability  of  public  finances  in  the  face  of  population
ageing, Austria is recommended to:

1.

2.

Implement  measures  leading  to  structural  expenditure  savings,  also  at
lower  levels  of  government,  so  as  to  lower  the  high  tax  burden,  while
securing a cyclically-adjusted budgetary position close to balance (GL 1);
and

Reform  the  public  pension  system  to  ensure  the  sustainability  of  public
finances (GL 16); in particular link the  level of  pension  benefits to  life-
long contributions; increase the low average effective retirement age and
ensure in this context that incentives to work are enhanced (GL 4 and E-
RECs 2 and 3), with a view to raising the labour market participation of
women and older workers;

In order to continue to improve the technology base and encourage business R&D
and innovation, Austria is recommended to:

3.

Take measures to encourage business research and innovation, especially
for SMEs, (GL 13).

In  order  to  strengthen  the  development  of  effective  competition  in  some  sectors,
Austria is recommended to (in line with GL 9 to 14):

4.

Increase the resources of the competition authority and to take measures
to  enhance  effective  enforcement  of 
in
telecommunications (GL 9).

regulators’  decisions 

56

12.

PORTUGAL

In  the  1995-2000  period,  economic  growth  averaged  4%,  driven  by  strong
domestic demand. Since 2001, economic activity has been decelerating  under  the
influence of cyclical weakness in Europe. This development has been accentuated
by  the  ongoing  correction  of  the  macroeconomic  imbalances  that  emerged  in  the
second half of the 1990s, notably a significant external deficit, and unsatisfactory
progress in fiscal consolidation, leading to a major budgetary slippage in 2001. The
measures  taken  in  2002,  notably  the  adoption  of  a  rectifying  budget,  represent  a
first  step  towards  narrowing  the  above-mentioned  imbalance.  In  2003,  weak
international  developments  and further  adjustment  in  households’  demand  should
contribute to economic growth remaining below 1% for a second consecutive year,
well  below  potential  growth  which  is  estimated  at  around  2¾%  -  3%  (about  ½
percentage  point  above  the  EU  average).  This  positive  growth  differential  is
somewhat  misleading,  because  it  largely  reflects  a  strong  rise  in  the  growth  of
factor  inputs,  accompanied  by  only  small  gains  in  total  factor  productivity.  Low
productivity growth in Portugal is mainly a structural problem, associated with the
low efficiency of the education system, insufficient competition, low spending on
R&D, and weak ICT diffusion. In combination with relatively high nominal wage
growth, Portugal’s competitiveness has therefore gradually been eroded.

The  budgetary  consolidation  strategy  defined  in  the  latest  update  of  the  stability
programme  rests  to  a  large  extent  on  the  successful  implementation  of
comprehensive  structural  reforms.  Given  the  intention  to  lower  over  the
medium-term  the  total  revenue-to-GDP  ratio,  reflecting  the  planned  reduction  in
corporate  taxes  in  order  to  strengthen  the  international  competitiveness  of  the
Portuguese  economy,  this  leaves  only  one  road  open  to  ensure  budgetary
consolidation  on  a  sustainable  basis.  This  is  the  restraint  of  current  primary
expenditure  growth,  which  in  turn  requires  the  implementation  of  structural
reforms.  Another  major  aim  of  the  envisaged  reforms  is  to  enhance  the  growth
potential  of  the  economy,  through  policies  to  secure  a  sustained  improvement  in
total factor productivity. The challenges facing Portugal are to:

(cid:1)  Accelerate  the  consolidation  of  public  finances  and  address  the  strong

dynamics of government expenditure

(cid:1) 

Increase  overall competitiveness  which  is  at  risk  from  the  low  efficiency  of
the  education  system,  low  R&D  spending,  a  low  degree  of  competition  in
certain sectors, and high nominal wage growth

(cid:1)  Ensure  the  long-term  sustainability  of  public  finances  in  the  face  of

population ageing

57

Accelerate the consolidation of public finances and address the strong dynamics
of government expenditure

In  the  period  that  led  to  the  budgetary  slippage  of  2001,  the  rate  of  growth  of
current  primary  expenditure  was  consistently  above  that  of  nominal  GDP.1  For
most  of  the  second  half  of  the  1990s,  this  was  compatible  with  the  pursuit  of
budgetary  consolidation  as  buoyant  domestic  demand  boosted  tax  revenues.
However,  this  pattern  of  budgetary  consolidation  came  to  an  end  with  the
deterioration  in  cyclical  conditions  in  2001,  and  the  disappearance  of  the
dampening  effect  on  interest  expenditures  caused  by  the  convergence  of  interest
rates  to  the  lower  levels  prevailing  abroad.  Budgetary  consolidation  resumed  in
2002,  although  due  to  the  usual  lags  associated  with  the  implementation  of
structural adjustments, it had to rely greatly on the adoption of one-off measures. In
the  short-term,  the  adoption  of  non-recurrent  measures  is  necessary  to  regain  the
lost  momentum  in  budgetary  consolidation  and  to  reinforce  policy  credibility,
thereby buying time for the government's expenditure-releasing structural measures
to take hold.

In  order  to  accelerate  the  consolidation  of  public  finances and  address  the  strong
dynamics of government expenditure, a determined and timely implementation of
the  structural  reform  measures  announced  in  the  January  2003  update  of  the
stability  programme  is  required.  Reforms  in  key  areas,  notably  in  public
administration, education, healthcare, and social security, are likely to have a direct
impact  on  budgetary  consolidation.  Other  reforms  (for  instance  in  the  labour
market) are likely to have an indirect impact on budgetary consolidation, either by
fostering  a  more  efficient  use  of  resources,  or  by  broadening  the  tax  bases  as  a
result of successful supply-side policies.

Increase overall competitiveness, which is at risk from the low efficiency of the
education  system,  low  R&D  spending,  a  low  degree  of  competition  in  certain
sectors, and high nominal wage growth

The  weak  productivity  performance  and  high  nominal  wage  growth  have  both
contributed  to  the  deterioration  observed  in  Portugal’s  external  competitiveness.
First, labour productivity in Portugal is the lowest in the EU and is growing slowly.
The main reason for this is the low average level of education attainment also for
the  younger  age  groups.  The  insufficient  levels  of  investment  in  R&D  and
innovation by the business sector and the weak ICT diffusion also deprive Portugal
of  an  important  source  of  productivity  gains.  The  low  leverage  effect  of  R&D
public  financing  over  private  investment  in  R&D  and  innovation  is  a  sign  of
inefficiencies  in  the  national  research  and  innovation  system.  Insufficient
competition in network industries is  another  key  restraint.  Second,  nominal  wage
growth has increased by around 6% a year during the last 10 years (double that of
the EU 15), even if a certain wage moderation has been noticed in recent years.

1

In  the  1995-2001  period,  current  primary  expenditure  increased  by  9%  per  year,
while  nominal  GDP  grew  by  7.2%  per  year;  consequently,  the  current  primary
expenditure-to-GDP ratio rose from 33.4% in 1995 to 36.7% in 2001.

58

                                                
Although  Portugal  has  increased  spending  on  education  substantially  in  recent
years, the share of early school-leavers without upper-secondary education and not
in training is by far the highest in the EU.2 A breakdown of education expenditure
by  main  categories  shows  that  a  relatively  high  fraction  goes  into  the  wage  bill
compared  with  other  developed  countries,  suggesting  an  inefficient  use  of
resources. Despite recent progress, the level of vocational training is significantly
below  the  EU  average.  It  has  proved  difficult  to  involve  small  enterprises  in  the
national programmes designed to upgrade the skills of their staff.

Ensure the long-term sustainability of public finances in the face of population
ageing

The  challenges  posed  to  the  long-term  sustainability  of  public  finances  reinforce
the need of securing a fast pace of debt reduction prior to the budgetary impact of
population  ageing  taking  hold.  For  this,  it  is  crucial  to  successfully  complete  the
process of budgetary consolidation, reaching a budget position of close-to-balance
or  in  surplus  by  2006  as  envisaged  in  the  January  2003  update  of  the  stability
programme  of  Portugal  and  sustaining  it  thereafter.  This  is  a  necessary,  but  not
sufficient,  step  to  ensure  the  sustainability  of  public  finances.  It  must  be
supplemented by the determined implementation of a number of structural reforms
in order to curb the growth of age-related expenditures, and to raise to the overall
growth potential of the economy.

Country specific recommendations to Portugal

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

Portugal should also vigorously implement all the Employment Recommendations
(E-REC), which deal with employment issues in a more comprehensive way.

In  order  to  accelerate  the  consolidation  of  public  finances and  address  the  strong
dynamics of government expenditure, Portugal is recommended to:

1.

2.

3.

2

Secure that the government deficit is further reduced in 2003 as planned,
and  that  the  cyclically-adjusted  deficit  is  thereafter  lowered  by  at  least
0.5% of GDP a year in  order  to reach  a  budget  position  that is close to
balance (GL 1);

Ensure  that  the  deficit  reduction  is  obtained  mainly  through  the
expenditure side by firmly executing budgetary plans for all sub-sectors
of the general government (GL 14); and

Undertake  structural  reforms  in  areas  with  a  more  direct  impact  on
budgetary  consolidation,  notably  in  public  administration,  education,
healthcare, and social security.

45.5% in 2002 for both genders, and 52.9% for males.

59

                                                
In  order  to  increase  overall  competitiveness,  which  is  at  risk  from  the  low
efficiency  of  the  education  system,  low  R&D  spending,  a  low  degree  of
competition  in  certain  sectors,  and  high  nominal  wage  growth,  Portugal  is
recommended to (in line with GL 9-14):

4.

5.

6.

7.

Promote  the  stronger  involvement  of  the  business  sector  in  R&D
spending and innovation (GL 13), together with higher ICT take-up;

Improve the efficiency of spending in education with a view to, inter alia,
raising  the  qualification of  human  resources  (GL 13  and  E-REC 1),  and
reducing  substantially 
the  number  of  early  school-leavers  with
insufficient levels of schooling or training;

Enhance  effective  competition  in  liberalised  utilities,  especially  in  the
energy sector, and create a better competitive environment by increasing
the transposition rate of internal market directives (GL 9); and

Encourage the social partners to secure wage moderation, while allowing
wage  increases  to  take  into  account  productivity  and  skill  differentials,
with a view to improving competitiveness (GL 3 and 5).

In  order  to  ensure  the  long-term  sustainability  of  public  finances  in  the  face  of
population ageing, Portugal is recommended to:

8.

9.

Increase  the  efficiency  of  the  healthcare  system  by  introducing  a  wide
range  of  measures  that  strengthen  market  mechanisms  and  rationalise
demand (GL 14); and

Adopt  further  reforms  to  the  pension  system  for  workers  in  the  general
government  sector  to  secure  its  long-term  sustainability  and  in  order  to
progressively align it with the pension regime for private sector workers
(GL 16).

60

13.

FINLAND

Sustained efforts during the 1990`s towards producing and using information and
communication technology has transformed Finland into one of the leading – if not
the most – knowledge-based economies  in  the  world. This  contributed,  alongside
market liberalisation, to real GDP expanding during the second half of the 1990`s
at an annual rate of nearly 5%, i.e. well above potential (of around 3%). The slump
in  external  demand,  and  particularly  in  the  telecom  sector,  since  2000  caused
output  growth  to  fall  below  its  potential.  With  domestic  demand  holding  up,
activity  could  move  close  to  potential  by  2004,  in  line  with  improving  external
conditions.

The  current  overall  unemployment  rate  of  just  above  9%  of  the  labour  force  in
2001-02  appears  to  be  mainly  structural.  The  employment  rate  for  older  workers
has risen rapidly since the 1994 trough, but is still over 20 percentage points lower
than that for all employees. These two factors together with fairly lengthy periods
spent  in  education  and  the  ageing  population  are  becoming  obstacles  to  reaching
the  government’s  target  of  raising  the  overall  employment  rate  to  close  to  70%.
The price level in Finland exceeds that of the EU average by almost one-fifth, in
spite  of  recent  moderation  in  headline  inflation,  suggesting  deficiencies  in
competition, in particular in sheltered service sectors. Furthermore, the financing of
welfare services requires a fairly high level of taxation, which may be difficult to
maintain in view of erosion in tax bases, and enhanced tax competition. The need
for  keeping  a  heavy  tax  burden  could  be  eased  by  the  absence  of  expenditure
overruns observed in central government spending. The challenges facing Finland
are to:

(cid:1)  Reduce  the  high  level  of  structural  unemployment  and  increase  the

employment rate of older workers

(cid:1)  Enhance  competition  in  certain  sectors  and  improve  the  efficiency  of  the

public sector

Reduce the high level of structural unemployment and increase the employment
rate of older workers

Finland exceeds the overall and female employment targets for 2005 for the EU as
a whole, as well as the Lisbon target for the female employment rate for 2010, but
the government’s goal of an employment rate of close to 70% is not yet reached.
This will become very difficult to achieve, due to demographic constraints. Thus,
an increase in the employment rate and in the labour supply will require that older
workers remain longer in the labour market. The overall unemployment rate fell by
7½ percentage points from its peak of 1994 to 9.1% in 2002 (but was unchanged
from  2001  reflecting  sluggish  economic  activity).  Most  estimates  indicate  a
NAIRU  of  about  8-9%,  thus  suggesting  that  the  registered  unemployment  rate  is
mainly structural. The government  has recently  introduced  several  measures  both
to improve the employability of the unemployed and to boost labour supply among

61

older  workers.  Measures  have  been  initiated,  inter  alia,  to  reduce  the  high  tax
burden  on  labour,  to  target  active  labour  market  programmes,  to  tighten  the
eligibility rules for early retirement, and to abolish the 60% ceiling for the accrual
of the pension rights. These steps are welcome, but not sufficient, and some of the
steps taken work in the opposite direction, notably more generous unemployment
benefits and allowing access to the unemployment pension scheme to continue up
to  2008.  Moreover,  the  phasing-in  period  for  certain  measures  of  the  pension
reform  appears  somewhat  protracted,  delaying  the  positive  impact  of  the  reforms
on containing the pension expenditure.

Enhance competition in certain sectors and improve the efficiency of the public
sector

Enhancing competition could help to lower the Finnish price level, which is one of
the  highest  in  the  EU,  and  to  improve  productivity,  which  is  around  the  EU
average. This high price level can only be partly explained by high indirect taxes,
the  remoteness  of  the  country  and  low  population  density.  Investigations  by  the
national Competition Authority point to lack of competition in some sectors, e.g. in
network industries. The relatively feeble overall level of labour productivity for a
country advanced in the transition towards a knowledge-based economy could also
be due to the large public sector and the  limited competition for  the  provision  of
public services. Government reports show that there are potential efficiency gains
in the public sector, which could have large positive effect on the sustainability of
public finances.

Strong economic activity during the second half of the  1990`s  generated  sizeable
revenues,  in  particular  from  corporate  and  capital  income,  although  they  have
recently returned to normal. While this provided some leeway for additional public
spending,  slippage  over  government  spending  targets  on  the  one  hand,  and  over-
reliance on the exceptionally high tax intake on the other hand, are becoming a risk
to the current healthy financial position of central and local government finances.
A more efficient use of current resources and containment of government spending
would provide some leeway for responding to pressures for maintaining the level
of financing of the current services.

Country specific recommendations to Finland

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

62

Finland should also vigorously implement all the Employment Recommendations
(E-REC),  which  deal  with  employment  issues  in  a  more  comprehensive  way.  In
order to increase growth potential, it is especially important for Finland to reduce
the  high  level  of  structural  unemployment  and  increase  the  employment  rate  of
older workers, Finland is in particular recommended to:

1.

2.

Improve incentives in tax and benefit systems further to make work pay,
in  particular  by  addressing  their  combined  effects  on  older  workers,
continue  to  reform  the  eligibility  criteria,  improve  the  administration  of
benefit systems and target the tax measures on low-paid labour (GL 4 and
E-REC 2); and

Seek possibilities to ensure that wage bargaining systems allow wages to
better reflect productivity differences across skills in order to improve the
job prospects of low-skilled unemployed (GL 5)

In order to enhance competition in certain sectors and improve the efficiency of the
public sector, Finland is recommended to (in line with GL 9-14):

3.

4.

5.

Step  up  efforts  to  enforce  competition  in  network  industries  and  non-
tradable services (GL 9);

Make further efforts to increase the efficiency of the public sector, inter
alia  by  improving  the  framework  conditions  for  increased  competition,
promoting the benchmarking of public sector efficiency and by increasing
public tendering (GL 11); and

Improve  mechanisms  to  help control  spending  and  ensuring  compliance
with rules on expenditure (GL 14).

63

14.

SWEDEN

Sweden has experienced relatively high economic growth in recent years and has
shown  some  resilience  to  the  weak  level  of  global  activity.  In  particular,
unemployment  has  remained  low  and  public  finances  sound.  The  sound  fiscal
position  has  permitted  Sweden  to  ease  its  fiscal  stance  in  order  to  counter  the
downturn. The  overall  Swedish fiscal  strategy  of  sustaining  high  surpluses  in  the
longer term, underpinned by a budgetary framework of ensuring tight expenditure
control,  is  expected  to  result  in  the  continuation  of  a  fiscal  position  ‘close  to
balance or in surplus’ in the coming  years.  Inflationary  pressures are  expected  to
continue  to  be  in  line  with  the  inflation  target  range  of  2%  (cid:2)1 percentage  point
guiding monetary policy, underpinned by the gradual closing of the output gap.

The Swedish welfare state is the most comprehensive in the Union, with both the
overall  tax  burden3  and  public  expenditure  exceeding  50%  of  GDP.  This  reflects
social priorities, which generally enjoy widespread support. In order to  safeguard
the achievement of placing the public finances on a sustainable path, it is important
to ensure an efficient use of public resources, not least as an ageing population will
put a further upward pressure on expenditures. Furthermore, measures to enhance
competition  are  necessary  to  address  the  high  price  levels  and  low  labour
productivity.  In  addition,  and  while  Sweden  ranks  high  in  terms  of  employment
rates, increasing labour force participation and fostering employment still remains
a key challenge in order to sustain the financing of the welfare state in the longer
term. The challenges facing Sweden are to:

(cid:1)  Ensure an adequate labour supply in view of the ageing of the population

(cid:1)  Enhance  competition  in  certain  sectors  and  improve  the  efficiency  of  the

public sector

Ensure an adequate labour supply in view of the ageing of the population.

Employment  rates  are  already  very  high  in  Sweden,  and  well  beyond  the  Lisbon
targets  for  EU  as  a  whole,  including  for  women  and  older  workers,  and  the
government has set a target to increase the employment ratio further. In view of the
ageing population, there will be a need to increase labour supply, in particular by
exploiting potential sources of labour among immigrants, the young and the long-
term sick. Additional efforts appear necessary to improve further the incentives to
work,  notably  as  Sweden  still  has  the  highest  overall  tax  burden  in  the  EU  and
international  perspective.  The
relatively  generous  benefit  schemes 
comprehensive  Swedish  welfare  state  involves  a  long-term  challenge  for  the
Swedish  economy.  Its  financing  implies  a  continued  high  overall  tax  burden  and

in  an 

3

Payments from public insurance schemes are taxed in Sweden. This ‘institutional
aspect’ in Sweden results in a higher tax burden as measured by the Commission
services.

64

                                                
therefore  also  a  substantial  tax  wedge  with  adverse  effects  on  the  incentive
structure.  To  this  end,  reducing  the  most  distortionary  elements  of  the  tax  and
benefit  systems  would  be  beneficial  for  growth  and  employment.  Reducing  the
number  of  persons  receiving  various  benefits  is  also  important  with  regard  to
public  finances.  The  problematic  situation  with  extensive  recourse  to  sick-leave
and  early  retirement  deserves  particular  attention,  not  least  as  the  associated
budgetary  costs are high. The  government  has  set  targets  to  halve  the  number  of
persons receiving social assistance by 2004 and to halve the number of days of sick
leave  by  2008.  However,  these  targets  might  not  be  met  on  the  basis  of  current
policies.

Enhance competition in certain sectors and improve the efficiency of the public
sector

Enhancing competition could contribute to lower the Swedish price level, which is
one of the highest in the EU, and to improve productivity, which is below the EU
average. The high price level can only be partly explained by high indirect taxes,
the  remoteness  of  the  country  and  low  population  density.  Competitive
shortcomings  are  found  in  the  private  sector,  as  evidenced  by  the  fact  that  the
Swedish price level remains more than 20% above the EU average. A study from
the Swedish Competition Authority concludes that around half of this difference is
explained  by  insufficient  competition.  In  particular,  price  levels  are  markedly
higher in retailing, housing, construction and non-tradable services.

Sweden has one of the largest public sectors in the EU, which could be one reason
for  the  low  labour  productivity.  Public  operators  are  starting  to  concede  market
shares  in  the  area  of  public  services  provision,  but  private  operators  still  only
represent a small share of employment in welfare services. Increased efficiency in
the provision of public services is important in order to ensure that the population
gets value for money.

Country specific recommendations to Sweden

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

Sweden should also vigorously implement all the Employment Recommendations
(E-REC),  which  deal  with  employment  issues  in  a  more  comprehensive  way.  In
order to increase growth potential and ensure the long-term sustainability of public
finances, it is especially important for Sweden to ensure an adequate labour supply
in view of the ageing of the population, Sweden is in particular recommended to:

1.

Pursue  further  the  reforms  of  tax  and  benefit  systems  to  improve  work
incentives,  in  particular  for  those  groups  with  high  marginal  effective
taxes  (GL 4  and  E-REC 3),  and  complete  the  tax  reform  on  labour
income while maintaining sound public finances.

65

In order to enhance competition in certain sectors and improve the efficiency of the
public sector, Sweden is recommended to (in line with GL 9-14):

2.

3.

Step  up  efforts  to  enforce  competition  in  sectors  where  competition  is
inadequate (GL 9); and

Make further efforts to increase the efficiency of the public sector, inter
alia  by  improving  framework  conditions  for  increased  competition,
promoting  the  benchmarking  of  public  sector  efficiency,  and  by
increasing public tendering (GL 11).

66

15.

UNITED KINGDOM

The  UK  economy  has  enjoyed  almost  a  decade  of  sustained  output  growth.
Inflation is among the lowest in the EU and unemployment is at a 27-year low. The
underlying  outlook  is  broadly  positive,  but  there  are  appreciable  downside  risks.
Among these is the possibility of an abrupt slowdown in the growth of household
consumption from recent high levels, as households begin to adjust to lower gross
wealth  as  a  result  of  the  recent  equity  market  slump.  So  far,  the  sector  has  been
cushioned by continued rises in housing wealth, although the most recent indicators
point  to  a  slowdown  in  house  price  inflation.  The  public  finances  moved  into
deficit of 1.3% of GDP in 2002 and a deficit is expected to persist in both 2003 and
2004  –  partly  for  cyclical  reasons  associated  with  low  financial  company  profits
and  planned  rises  in  current  and  capital  expenditure  relative  to  GDP,  the  latter
aimed  at  rectifying  historical  under-investment  in  public  infrastructure.  The  UK
has  made  further  progress  on  the  labour  market  in  recent  years,  with  further
reforms  of  tax  and  benefit  systems  and  the  development  of  a  range  of  targeted
active  measures.  Labour  market  performance  remains  among  the  best  in  the  EU
with unemployment at around 5%. In particular, despite the relatively tight labour
market, wage pressures are subdued and are expected to remain that way. All in all,
HICP inflation is projected to average under 2% in 2003 and 2004.

The  relatively  low level  of  productivity,  resulting  inter  alia  from  low  basic  skills
among some categories of worker, remains a key challenge. Labour productivity is
below the EU average although the gap has been declining since 1995. At the same
time, expenditures on R&D as a percentage of GDP are just below the EU average.
A  second  key  challenge  is  to  address  the  high  numbers  of  working-age  people
claiming  sickness  and  disability  benefits,  which  may  be  an  obstacle  to  a  further
increase  in  labour  supply.  The  third  key  challenge  is  to  improve  the  quality  and
efficiency  of  UK  public  services.  The  challenges  facing  the  United  Kingdom  are
to:

(cid:1) 

Improve the relatively low level of productivity

(cid:1)  Address  the  high  numbers  of  working-age  people  claiming  sickness  and

disability benefits and sustain labour supply in the longer term

(cid:1) 

Improve the quality and efficiency of public services

Improve the relatively low level of productivity

The UK’s level of productivity is historically weak compared to the  EU average.
Although the productivity gap with the EU has been declining in recent years, UK
labour productivity was still below the EU average in 2002. The UK’s productivity
growth  may  have  been  slowed  by  low-skilled  people  entering  employment  in
recent years. However, other structural factors are important for raising the UK’s
productivity  performance  such  as  competition,  entrepreneurship,  science  and
innovation, skills and investment. The UK government has taken many measures in

67

recent  years  to  increase  productivity,  but  it  will  take  time  for  the  full  effects  of
these measures to feed through into the productivity statistics, and further measures
may  be  needed.  The  recently  strengthened  competition  policy  will  need  to  be
applied  rigorously,  in  particular,  to  the  professions  and  pharmacies,  where  the
Office of Fair Trading has found that regulations inhibit the level of competition,
and  postal  services,  where  the  incumbent  has  had  a  monopoly  until  recently.
Measures to promote R&D and skills should also contribute to higher productivity.

Address  the  high  numbers  of  working-age  people  claiming  sickness  and
disability benefits and sustain labour supply in the longer term

The UK exceeds all of the employment targets set by the European Council, with
an  overall  employment  rate  of  71.6%  in  2002  and  rates  of  65.3%  and  53.5%  for
women and older workers. Unemployment was 5.2% in 2002. The UK  has  made
further progress on the labour market in recent years,  with  further  reforms  of tax
and  benefit systems  and  the  development  of  a  range  of  targeted  active  measures.
However,  high  employment  rates  are  accompanied  by  relatively  low  levels  of
productivity,  in  part  due  to  both  insufficient  levels  of  basic  skills  and  a  lack  of
access to training among some categories of worker. The number of working-age
people claiming sickness and disability benefits remains high at just over 3 million,
of  which  2.7  million  claim  income-replacement  benefits,  which  may  limit  the
scope  for  further  increases  in  labour  supply.  Although  overall  unemployment
remains  well  below  the  EU  average,  there  are  significant  disparities  in  terms  of
access to the labour market with concentrations of inactivity and unemployment in
certain localities and among disadvantaged social groups.

Improve the quality and efficiency of public services

Rising demand and higher expectations of service quality have put pressure on the
delivery of public services. In addition, public services have suffered from under-
investment  in  the  past.  These  developments  have  manifested  themselves  in
problems  such  as  waiting  lists,  deteriorating  infrastructure  and  staff  shortages  in
some  areas.  Therefore,  the  UK  government  has  budgeted  for  a  large  increase  in
expenditure  on  public  services.  Under-investment  in  the  public  infrastructure  is
being addressed, with public sector net investment expected to more than double in
real terms from 2000-01 to around 1.4% of GDP by 2002-03, rising further to 2.0%
of GDP by 2005-06. Moreover, education spending is planned to grow by 5.9% per
year  in  real  terms  until  2005-06  and  healthcare  spending  is  planned  to  grow  by
7.4%  per  year  in  real  terms  over  the  same  period.  The  UK  government  has
recognised  the  need  to  accompany  the  increases  in  expenditure  with  reforms
designed  to  ensure  that  these  resources  are  used  and  allocated  efficiently  and
effectively,  that  consumers  receive  higher  quality  public  services  and  that  both
consumers and taxpayers receive best value for money.

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Country specific recommendations to United Kingdom

Meeting the challenges outlined above requires broad structural reforms as they are
laid down in the general guidelines (GL) in  part  I  of  the  Broad  Economic  Policy
Guidelines.

In order to improve the relatively low level of productivity, the United Kingdom
is recommended to (in line with GL 9 to 14):

1.

2.

3.

Continue  to  improve  competition  in  sectors  like  the  professions,  postal
services and pharmacies (GL 9);

Monitor closely existing measures to promote R&D (GL 13); and

Review  and  strengthen,  where  appropriate,  policies  aimed  at  improving
basic skills in the work force (GL 13).

The  United  Kingdom  should  also  vigorously  implement  all  the  Employment
Recommendations  (and  E-REC),  which  deal  with  employment  issues  in  a  more
comprehensive  way.  In  order  to  increase  growth  potential  and  to  promote  labour
market inclusion, it is especially important for the United Kingdom to address the
high numbers of working-age people claiming sickness and disability benefits and
sustain  labour  supply  in  the  longer  term.  The  United  Kingdom  is  in  particular
recommended to:

4.

Ensure  that  all  those  who  are  able  to  work  have  the  opportunities  and
incentives  to  do  so,  in  particular  by  reforming  sickness  and  disability
benefit schemes (GL 4 and E-REC 3).

In  order  to  improve  the  quality  and  efficiency  of  public  services,  the  United
Kingdom is recommended to:

5.

Ensure that the public services associated with the announced increases in
public  expenditure  (including  investment  in  the  transport  infrastructure)
are  delivered  efficiently  and  with  a  view  to  ensuring  cost-effectiveness
(GL 11 and 14).

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