Communication from the Commission on the implementation of the 2003-05 broad economic policy guidelines (presented in accordance with Article 99 (3) of the EC Treaty) {SEC(2004) 44}
Date: 2004-01-21
Institutions: European Commission
Subjects: EU Member State, application of EU law, economic policy

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 21.1.2004
COM(2004) 20 final

COMMUNICATION FROM THE COMMISSION

ON THE IMPLEMENTATION OF THE 2003-05 BROAD ECONOMIC POLICY
GUIDELINES

(presented in accordance with Article 99 (3) of the EC Treaty)

{SEC(2004) 44}

EN

  EN

PART I

General Assessment1)

1) Commission Communication

2

 
TABLE OF CONTENTS

EXECUTIVE SUMMARY ...................................................................................................... 4

1.

2.

2.1

2.2

2.3

3.

4.

4.1

4.2

4.3

4.4

4.5

4.6

4.7

4.8

4.9

4.10

4.11

4.12

4.13

4.14

4.15

Introduction .............................................................................................................. 10

Strenghthening the EU's Economy ......................................................................... 12

Growth- and stability-oriented macroeconomic policies ........................................... 12

Economic reforms to raise Europe’s growth potential ............................................... 22

Strengthening sustainability ....................................................................................... 50

Euro area specific challenges................................................................................... 62

Implementation by the Member States: a preliminary assessment..................... 69

Belgium ...................................................................................................................... 70

Denmark ..................................................................................................................... 70

Germany ..................................................................................................................... 71

Greece......................................................................................................................... 71

Spain........................................................................................................................... 72

France ......................................................................................................................... 73

Ireland......................................................................................................................... 73

Italy............................................................................................................................. 74

Luxembourg ............................................................................................................... 74

Netherlands................................................................................................................. 75

Austria ........................................................................................................................ 75

Portugal ...................................................................................................................... 75

Finland........................................................................................................................ 76

Sweden ....................................................................................................................... 76

United Kingdom ......................................................................................................... 77

3

 
EXECUTIVE SUMMARY

The BEPGs outline
the medium-term
economic policy
strategy…

… on how to reach
the Lisbon goal.

This  Communication  presents  a  first  assessment  of  the  follow-up
given  to  the  general  guidelines  in  the  2003-05 Broad  Economic
Policy Guidelines (BEPGs). An assessment on the implementation of
the country-specific recommendations is given in the accompanying
working  document  of  the  Commission  services.  Together,  they
constitute the first Implementation Report (IR) following the move to
multi-annual guidelines in 2003. The 2003-05 BEPGs laid down the
EU’s  medium-term  economic  policy  strategy  with  particular
attention to the contribution economic policies can make to reach the
Lisbon strategic goal. The three key elements of this strategy are:

(cid:1) 
(cid:1) 
(cid:1) 

growth- and stability-oriented macroeconomic policies;

economic reforms to raise Europe’s growth potential; and

strengthening sustainability.

Implementation
assessment will be
stepped up gradually.

Stagnation in the
first half of 2003.

Implementation  Report 

is  presented  as  part  of 

Following the move to a better streamlined policy coordination cycle,
the
this 
“Implementation Package” together with the draft Joint Employment
Report  and  the  Implementation  Report  on  the  Internal  Market
Strategy. Furthermore, as a consequence of the clearer medium-term
focus  of  the  policy  strategy,  this  first  Implementation  Report  can
only  provide  a  preliminary  assessment.  It  concentrates  on  policy
measures  taken  and/or  envisaged  in  2003  in  response  to  the
2003-05 BEPGs. Specific attention is given to the three priority areas
highlighted  by  the  Council.  The  implementation  assessment  will  be
stepped up the closer we get to the full review of the BEPGs planned
for 2006.

The economic background to this IR is that of a stagnation in the first
half of 2003. Despite a clear improvement in economic activity in the
third  quarter,  growth  over  the  year  as  a  whole  is  expected  to  have
been a modest 0.8 per cent in the EU (and a mere 0.4 per cent in the
euro area). The protracted period of low growth has started to take its
toll  on  the  labour  market.  Employment  growth  came  to  a  halt  and
unemployment  rose  to  8.1 per  cent  in  the  Union.  Headline  inflation
has been slow to come down, partly due to price increases for oil and
fresh food, and rises in indirect taxes. A lack of response of wages to
the cyclical slowdown in labour productivity also implied continued
pressures on nominal unit labour costs.

4

 
Macroeconomic
policies supported
growth.

Budgets  continued  to
deteriorate…

…but five Member
States managed to
maintain budget
positions close to
balance or in surplus
in 2003…

…and a further three
markedly improved
their CAB…

…while the excessive
deficit situation
seems likely to persist
for three others.

On  the  basis  of  this  first  implementation  assessment,  the  following
key messages emerge.

Macroeconomic  policy  was  accommodative  in  2003.  Both  the  ECB
and the national central banks in Denmark, Sweden, and the United
Kingdom lowered further their key interest rates, thereby supporting
domestic  demand.  Despite  the  appreciation  of  the  euro,  overall
monetary  conditions  remained  accommodative.  The  free  play  of
automatic  stabilisers  helped  to  stabilise  the  economy.  The  EU’s
cyclically-adjusted  primary  balance  remained  broadly  unchanged,
indicating an overall neutral fiscal stance in 2003.

The economic slowdown continued to weigh on public finances and
progress  seems  mixed  as  regards  reaching  or  maintaining  a  sound
budgetary  position.  The  average  nominal  budget  deficit  worsened
further  in  2003  to  2.7 per  cent  of  GDP.  However,  differences  are
sizeable  across  Member  States.  Belgium,  Denmark,  Spain,  Austria,
Finland  and  Sweden  had  a  cyclically-adjusted  budgetary  position
close to balance or in surplus in 2002. With the exception of Austria,
the other five Member States maintained such a budgetary position in
2003. Nominal deficits deteriorated sharply in several other Member
States,  with  two  countries  (Germany  and  France)  expected  to  have
deficits exceeding the 3 per  cent of  GDP  limit  by  a  wide  margin  in
2003.  While  the  economic  slowdown  is  the  main  factor  behind  the
recent  deterioration  in  the  public  finances,  part  of  the  slippage  in
2003 also stems from discretionary measures in some Member States
(notably Greece, Austria, and the United Kingdom).

In 2003, only Ireland, the Netherlands and Portugal showed a marked
improvement (of more than 0.5 per cent of GDP) of their cyclically-
adjusted budget balance (CAB). In the case of Portugal, this is due to
substantial  one-off  measures,  which  also  resulted  in  keeping  the
nominal deficit just below the 3 per cent limit in 2003. However, the
deficit  is  expected  to  deteriorate  in  2004  in  the  absence  of  further
measures,  thereby  going  above  the  ceiling  again.  The  other  two
countries with an excessive deficit, Germany and France, made little,
if any, progress. Notwithstanding the consolidation measures taken in
Germany  of  about  1 per  cent  of  GDP,  the  lower-than-expected-
growth  makes  them  inadequate  to  bring  the  excessive  deficit
situation to an end in 2004. France has not taken effective action to
redress  the  budgetary  imbalances  to  bring  the  excessive  deficit
situation to an end this year.

Wages put pressure
on profitability.

Nominal wages continued to grow by about 3 per cent in 2003 in the
EU (2 ¾ per cent in the euro area), despite the continued slowdown
in  economic  activity.  This  has  put  further  pressure  on  profitability

5

 
Labour market
reforms have been
stepped up in some
areas, but appear
insufficient to reach
the Lisbon targets.

Disappointing labour
productivity
growth…

and  job-creating  investment.  However,  seen  in  a  medium-term
perspective,  wage  trends  appear  still  broadly  compatible  with  price
stability.

The  labour  market  performed  quite  well  in  the  beginning  of  this
economic downturn, reaping the  benefits of earlier  reforms  but also
reflecting labour hoarding. The effect of the slowdown started to be
felt more strongly in 2003 with employment growth stagnating and a
continued rise in unemployment. The increase in the pace  of  labour
market  reforms  in  2003  appears  encouraging,  but  it  needs  to
accelerate  further.  In  particular,  efforts  have  been  made  by  most
Member States to make work pay, even if reforms remain focused on
the  tax  side.  Some  Member  States  have  taken  action  to  address
incentive effects in the benefit systems (Denmark, Germany, France,
the Netherlands, and the United Kingdom), which contribute most to
the  risk  of  unemployment-  and  inactivity  traps.  Several  Member
States  have  taken  further  measures  to  make  the  work  organisation
more  adaptable  (notably  Denmark,  Spain,  France,  Italy, 
the
Netherlands  and  Sweden)  and  most  Member  States  aim  to  foster
occupational  mobility  through  lifelong  learning  initiatives.  Active
labour market policies have also become better in responding to the
individual  needs  of  the  unemployed.  However  and  despite  some
improvements  noted  or  planned  in  Denmark,  Ireland,  and  the
Netherlands,  progress  appears  limited  as  regards  improving  the
efficiency of ALMPs: e.g. evaluations are not systematically carried
out  or  reported.  Progress  also  appears  limited  in  promoting  wage
differentiation  or  addressing  the  regulatory  burden  in  the  labour
market. Despite the progress noted with some types of labour market
reforms,  the  Lisbon-  and  Stockholm  employment  rate  targets  risk
being  missed,  unless  further  and  comprehensive  reforms  are
undertaken without delay.

Labour productivity growth continued to disappoint and the gap with
the  USA  widened.  Lower labour productivity per hour  worked now
represents  40 per  cent  of  the  difference  in  GDP  per  capita  between
the EU and the USA. The gradual deterioration in labour productivity
growth  since  the  mid-1990s  can  be  explained  in  equal  parts  by  the
slowdown  in  investment  and  in  total  factor  productivity  (which
generally  include  effects  from  more  efficient  resource  utilisation,
technological progress and the  natural  catching-up  process  of  lesser
developed EU countries). ICT and their adoption are a key driver of
productivity  growth  and  the  differentials  between  the  EU  and  US
productivity  trends  are  strongly  influenced  by  differences  in  the
extent to which ICTs have penetrated the respective economies. This
illustrates 
integration,  business
to  stimulate  market 
dynamism, and investment, particularly in knowledge.

the  need 

6

 
...partly due to slow
progress on the
Internal Market.

Better progress on
competition policies
and the liberalisation
of network industries.

Measures taken to
improve the business
environment…

…while investment
in knowledge and
innovation is still
insufficient.

Economic  reforms  are  essential  to  enhance  the  EU’s  growth
potential, which is necessary to achieve the ‘Lisbon targets’. Progress
in implementing the guidelines aimed at increasing productivity and
business  dynamism  seems  mixed.  The  functioning  of  the  Internal
Market  is  still  hampered  by  the  absence  of  proper  regulation  in  the
areas  covered  by  proposals  pending  before  the  Council  and  the
European  Parliament 
(including  directives  on  professional
qualifications  and  on  intellectual  property  rights).  The  average
transposition  rate  by  Member  States  also  deteriorated  somewhat
in 2003.

in 

improving 

Progress  has  been  better 
the  effectiveness  of
competition  policies,  where  e.g.  Belgium,  Austria,  and  the  United
Kingdom  have  acted  to  ensure  the  effective  independence  and
capabilities  of  their  competition  authorities.  Market  opening  in
network industries also continues to progress both at EU level (with
e.g.  the  directive  laying  down  common  rules  for  the  electricity  and
gas market and an agreement on the trans-European networks) and at
national  level,  even  if  the  market  share  of  the  incumbent  often
remains very high after liberalisation.

The  business  environment  continues  to  be  hampered  by  some
weaknesses,  such  as  relatively  high  administrative  burdens  and  the
difficulties to find financing (notably venture  capital).  Nevertheless,
several  countries  (e.g.  Belgium,  Germany,  Greece,  Spain,  France,
Luxembourg, and Austria) took measures to facilitate business start-
ups in 2003.

The transition to the knowledge based economy is progressing, albeit
slowly,  and  differences  between  Member  States  remain  important.
The  Commission  put  forward  an  Action  Plan  aimed  at  promoting
R&D investments (to 3 per  cent of GDP by  2010) where  two-thirds
are to be financed by the private sector. So far, evolutions remain far
from satisfactory with declining R&D spending (as a share of GDP)
in  e.g.  Ireland,  the  Netherlands,  and  the  United  Kingdom.  It  is  also
worrying  that  Member  States  failed  so  far  to  substantially  raise
investment  in  human  resources,  which  was  also  addressed  in  a
Communication  from  the  Commission  in  November  2003.  On  the
positive side, several Member States are trying to improve the quality
and efficiency of their education systems, where e.g. Spain adopted a
law on quality in education and Sweden introduced a new system of
vocational training.

Good progress in
implementing the
RCAP and the FSAP,

As  regards  capital  markets,  the  Risk  Capital  Action  Plan  is  almost
completely implemented. The Financial Services Action Plan is well
on  the  way  to  full  implementation  and  transposition  of  the  adopted

7

 
but a final effort is
needed.

Long-term
sustainability of
public finances is not
yet secured in about
half of the Member
States.

legislative  measures  into  national  law  has  begun.  However,  a  final
effort  is  required  to  meet  the  2005  deadline.  Integration  of  clearing
and settlement arrangements has become a clear priority for action at
both  the  EU  and  the  Member  State  level  in  2003.  Following
corporate  scandals  in  recent  years,  several  Member  States  have
strengthened  corporate  governance  arrangements  at  the  national
level, while the Commission has adopted an Action Plan on company
law  and  corporate  governance  in  May  2003.  Financial  supervision
arrangements are  being  streamlined,  both  at  Member  State- and  EU
level.

Long-term  sustainability  of  public  finances,  particularly  in  view  of
the ageing population, is not yet secured in about half of the Member
States, notably Belgium, Germany, Greece, Spain, France, Italy, and
Portugal. While significant progress has been made through pension
reform  measures  in  some  Member  States  in  2003,  in  particular  in
France  and  Austria,  less  progress  was  made  in  bringing  the  public
debt down. Public debt remained above 60 per cent of GDP in 2003
in six Member States, including in Belgium, Greece, and Italy where
it continued to exceed 100 per cent of GDP.

Limited progress on
social sustainability,
despite some
measures taken.

The  progress  in  improving  social  sustainability  is  hampered  by  the
deteriorating  labour  market  situation,  since  jobs  play  an  important
role  in  lifting  people  out  of  poverty  and  social  exclusion.  Some
measures  have  been  undertaken  to  tackle  regional  differences  in
unemployment,  and  above  all,  to  enhance 
the  efficiency  of
investments financed by the Structural Funds.

Environmental
sustainability
remains a major
challenge

Some  progress  has  been  made  towards  improving  environmental
sustainability  in  2003.  At  the  EU  level,  the  Council  extended  the
coverage  of  Community  legislation  in  energy  taxation  (on  e.g.
minimum taxation levels). Several Member States (e.g. Belgium, the
Netherlands, and Sweden) took further measures to promote the use
of  renewable  energy.  Other  Member  States  (notably  Germany  and
Austria) took measures in the area of transport pricing. In the United
Kingdom, congestion charges were introduced in London, causing a
marked  change  in  behaviour.  In  contrast,  and  despite  the  good
progress  made  at  the  end  of  the  1990s,  no  progress  was  noted  as
regards reduction of greenhouse gas emissions.

Mixed progress so far
in the euro area,
where more action is
needed on the
budgetary side…

Progress in response to the guidelines for the euro area is mixed. The
macroeconomic  policy  mix  appeared  broadly  compatible  with  price
stability  and  continued  to  be  supportive  to  growth.  However,  the
implementation of the budgetary guidelines is worrisome. Only three
Member States maintained budgetary positions close to balance or in
surplus  in  2003  (namely  Belgium,  Spain  and  Finland),  and  three
others  recorded  an  improvement  in  the  cyclically-adjusted  budget

8

 
… and as regards the
euro area’s external
representation.

balance of at least 0.5 per cent of GDP (Ireland, the Netherlands and
Portugal).  Half  of  the  euro  area  Member  States  made  insufficient
progress  towards  sound  public  finances  in  2003.  Finally,  progress
appears very limited in  improving the external representation  of the
euro area in international fora.

Despite important
progress noted in
some areas, the
overall pace of
reform has not been
stepped up.

Recognising that this is only the first  year in  a multi-annual setting,
the overall picture that emerges from this review is mixed. The pace
of  reform  (incl.  both  measures  taken  and/or  envisaged)  appears  to
have  improved  somewhat  as  regards  the  labour  market,  policies
affecting  competition, the business  environment and  the use of  new
technologies,  education,  and  pensions.  Progress  is  more  limited  in
market  integration,  investment  in  knowledge  and  research,  social-
in
and  environmental  sustainability.  The 
budgetary positions in several Member States and the lack of resolve
to  address  the  (excessive  deficit)  situation  is  a  source  of  great
concern. Taken together, it does not appear as if the overall pace of
reforms has been stepped up as requested by the Council. There is a
clear  risk  that  with  the  current  reform  pace,  full  implementation  of
the BEPGs can not be secured by 2006, thereby putting the fulfilment
of the Lisbon targets by 2010 at risk. The slowdown and the need to
consolidate  public  finances  cannot  be  an  excuse  for  postponing
necessary  reforms  further.  Indeed,  both  fiscal  consolidation  and
structural  reforms  can  be  growth  supportive  even  in  the  short  run
through  positive  effects  on  confidence.  Their  longer-term  positive
impact on growth is undisputed.

rapid  deterioration 

9

 
1.

INTRODUCTION

This Communication aims to assess the action taken or envisaged in response
to the EU’s medium-term economic policy strategy as laid down in the 2003-
05 Broad  Economic  Policy  Guidelines  (BEPGs)1.  The  BEPGs  provide  the
overarching  instrument  for  economic  policy  co-ordination  in  the  European
Union. Following  streamlining  of the  Union’s policy  co-ordination  processes,
the BEPGs focus on key economic policy issues and the measures to be taken
over the medium term to effectively address them. Other processes (such as the
Internal  Market  Strategy  and  the  European  Employment  Strategy)  deal  with
their issues in greater detail. This Implementation Report is presented as a part
of an “Implementation Package” with the draft Joint Employment Report  and
the  Implementation  Report  on  the  Internal  Market  Strategy.  Together  they
support the Commission’s 2004 Spring Report. It has taken due account of the
recent report of the European Employment Taskforce.

The EU’s medium-term economic policy strategy is concentrated around:

•

•

•

growth- and stability-oriented macroeconomic policies;

economic reforms to raise Europe’s growth potential; and

strengthening sustainability.

The BEPGs concentrate on the contribution that economic policies can make in
the medium term to the fulfilment of the strategic goal set in Lisbon in 2000:
“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”.  An  environmental  dimension  was  added  to  the
Lisbon Agenda in 2001.

The  Implementation  Report  provides  a  key  input  for  the  multilateral
surveillance of the economic policies of the Member  States and the Union  as
envisaged by the Treaty Article 99 (3). This Implementation Report is the first
one following the move to multi-annual guidelines. Recognising that Member
States  now  have  three  years  to  address  the  general  guidelines  and  country-
specific  recommendations  in  the  BEPGs,  an  incremental  approach  will  be
followed  where  the  implementation  assessment  becomes  gradually  more
thorough the closer we get to the full review of the BEPGs planned for 2006.
This implies that the implementation assessment of this first intermediate year
is  less  detailed  and  conclusive,  and  concentrates  on  policy  intentions  to  a
greater extent than future assessments.

1 

See Council recommendation of 26 June 2003 on the BEPGs (2003/555/EC), published in the
Offical Journal No. L 195/1 of 1 August 2003.

10

 
                                                
Box 1: Follow-up given to the Council’s three main priorities

In  a  cover  note  to  the  2003-05 Broad  Economic  Policy  Guidelines  (BEPGs)  the  Ecofin  Council  highlighted
three main priorities for policy action in the coming year:
1. 
2. 
3. 

promoting growth;
increasing flexibility in our labour markets; and
ensuring sustainability of our public finances.

The  Council  also  stated  that  the  pace  of  reform  must  be  stepped  up  and  that  a  timely  and  effective
implementation of the BEPGs is of crucial importance for confidence and growth. Moreover, it indicated that it
had a vital role to play, together  with the Eurogroup, to jointly  monitor and encourage  implementation  by  all
policy actors.

Thereafter,  the  Italian  Presidency  indicated  that  the  Council  will  start  holding  regular  implementation
discussions throughout the year. A working breakfast was devoted to the follow-up given to the 2003-05 BEPGs
so far, notably with regard to the sustainability of public finances on 4 Nov. 2003. Adopting conclusions on this
report will be the next opportunity for the Council to return to implementation discussions.

It  is  not  easy  to  briefly  summarise  the  actual  follow-up  given  to  the  three  priority  areas  highlighted  by  the
Council, given their very broad nature. For instance, all general guidelines under “growth- and stability-oriented
macroeconomic policies” and “economic reforms to raise Europe’s growth potential” are more or less directly
aimed at improving Europe’s growth- performance and potential. The presentation below should therefore not
be seen as replacing the more in-depth assessment carried out in the full report.

As regards “giving priority to growth in Europe” and the need to find an appropriate balance of macroeconomic
policies,  this  Implementation  Report  concludes  that  such  policies  have  been  accommodative  to  growth.  The
monetary  policy  stance  was  loosened  as  the  ECB  cut  interest  rates  by  75 basis  points  in  total  in  2003.  The
budgetary stance remained neutral given the broadly unchanged cyclically-adjusted budget deficit, although the
play of automatic stabilisers helped to stabilise the economy.

In addition to sound macroeconomic policies, the Council highlighted the need to step up investments in human
and  physical  capital  and  to  complete  the  Internal  Market.  Progress  appears  mixed.  Total  investments  are
expected to have declined in 2003 (by 0.4 per cent in EU15 and 1 per cent in the euro area), albeit at a lower
rate  than  in  2002,  and  in  line  with  the  adverse  cyclical  conditions.  Investment  in  knowledge  and  innovation
continues to lag behind that of the USA. Moreover, progress in creating a better functioning Internal Market has
slowed  down.  However,  the  European  initiative  for  growth,  which  was  launched  in  October  2003,  aims  to
encourage certain trans-European network infrastructure and R&D projects where funding can be provided from
the EU budget. The contribution from the Community for trans-frontiers infrastructure investments is limited to
20 per cent of the project’s cost. These projects will also benefit from an enhanced co-ordination in respect of
planning, environmental impact assessment and financing.

As  regards  “increasing  flexibility  in  our  labour  markets”,  it  appears  as  if  the  pace  of  labour  market  reforms
slightly improved in 2003, but needs to be stepped up further if the Lisbon targets are to be met. Efforts have
been made in several Member States to make work pay, even if reforms remain focused on the tax side. Several
Member States  have also taken further  measures to  make  the  work  organisation  more  adaptable  and  to  foster
occupational  mobility.  Active  labour  market  policies  (ALMPs)  have  also  become  better  in  responding  to  the
individual needs of the unemployed. In contrast, few measures have been proposed to address incentive effects
in benefit schemes, promote wage differentiation, enhance the efficiency of ALMPs in line with evaluations, or
address the regulatory burden (e.g. the employment protection legislation).

As regards “ensuring sustainability of our public finances” progress seems to be mixed. Since 2000, the public
debt  level  is  increasing  in  both  the  EU  and  in  the  euro  area,  and  remains  well  above  the  reference  value  of
60 per cent of GDP for the latter. Important pension reforms, on the other hand, were adopted in some Member
States in 2003, notably in France and Austria. Several Member States have also tried to improve the interaction
between  the  pension  system  and  the  labour  market  performance,  but  the  employment  rate  of  older  workers
amounted to only 40 per cent in 2002, with sizeable differences across Member States.

11

 
This  Communication  (Part I  of  the  Implementation  Report)  is  complemented
by  a  working  document  of  the  Commission  services  that  provides  a  first
assessment  of  the  implementation  of  the  recommendations  given  to  Member
States  to  address  their  individual  challenges  on  a  country-by-country  basis
(Part II). As for the general guidelines, the implementation assessment will be
stepped up gradually in the coming years.

2.

STRENGTHENING THE EU’S ECONOMY

2.1 

Growth- and stability-oriented macroeconomic policies

2.1.1

 Economic background: lowest economic growth since 1993

Economic  growth  has  turned  out  to  be  markedly  weaker  than  anticipated.
Following a poor performance at the end of 2002, the EU economy stagnated
in the first half of 2003. Even if activity clearly improved in the third quarter,
the average growth rate is expected to have been a modest 0.8 per cent in 2003
(0.4 per cent in the euro area), see Graph 1. This is the lowest growth rate since
1993.  There  are  several  factors  behind 
the  disappointing  economic
performance  and  the  delay  in  the  expected  recovery.  Firstly,  confidence  was
generally  undermined  by  the  geopolitical  tensions  linked  to  the  Iraq  war.
Secondly,  uncertainties  related  to  future  labour  and  pension  income  and  the
adverse  wealth  effects  of  the  prolonged  stock  market  decline  dampened
consumers  confidence  in  the  euro  area.  Thirdly,  weak  profitability  in  the
corporate sector following e.g. the on-going balance sheet adjustment  and  the
increased  costs  for  external  funding  is  likely  to  have  reduced  or  postponed
substantial.  Market
investments.  Finally, 
segmentation and inflexibility caused e.g. real unit labour costs and consumer
price  inflation  to  adjust  only  sluggishly  to  weak  economic  growth  and
deteriorating labour market conditions.

structural 

rigidities 

remain 

The  protracted  period  of  sluggish  growth  has  started  to  take  its  toll  on  the
performance of the labour market. In 2003, some 200.000 jobs are expected to
have been lost in net terms in the euro area (thereby recording the first decline
since 1994). The unemployment rate is forecasted to have increased to 8.1 per
cent in the EU (8.9 per cent in the euro area).

Inflation,  estimated  at  2 per  cent  in  the  EU  in  2003  (2.1 per  cent  in  the  euro
area),  has  been  relatively  slow  to  come  down  despite  weak  growth.  This  is
partly due to temporary factors such as the pass-through of oil price increases,
weather-induced food prices hikes and rises in indirect taxes. But core inflation
has  also  been  sticky,  because  of  upward  pressures  on  unit  labour  costs  from
steady  nominal  wage  growth  in  combination  with  a  cyclically  induced
slowdown  in  productivity  growth,  and  a  slow  pass-through  of  the  euro
appreciation into consumer prices.

12

 
Graph 1: Economic developments in the EU

%

Real GDP growth

Contribution to real GDP growth

%

5

4

3

2

1

0
95Q01

Year/year
Quarter/quarter

2

1.5

1

0.5

0

-0.5

-1

Domestic demand (incl.
stock)
Net exports

Real GDP growth

97Q01

99Q01

01Q01

03Q01

98Q01

99Q01

00Q01

01Q01

02Q01

03Q01

%

Unemployment rate and employment 
growth
Employment growth (rhs)

yoy % ch.

Unemployment rate (lhs)

12

11

10

9

8

7
1995

1997

1999

2001

2003

Source : Commission services.

3

2

1

0

-1

%

4

3.5

3

2.5

2

1.5

1

0.5

0
1995

Headline, core inflation and energy
Annual percentage changes; monthly data

HICP (lhs)

Core HICP (lhs)

Energy (rhs)

1997

1999

2001

2003

20

15

10

5

0

-5

-10

Macroeconomic policy conditions remained accommodative

Macroeconomic  policies  have  been  accommodative  in  view  of  the  weak
growth conditions.

The ECB cut interest rates two times in 2003, by a cumulative 75 basis points
to 2 per cent for the minimum bid rate, in connection with decelerating cyclical
conditions,  see  Graph 2.  Its  supportive  effect  on  growth,  and  above  all  on
domestic  demand,  was  partly  counteracted  by  the  recent  strengthening  of  the
euro that hampered net export somewhat. Overall, the monetary policy stance
continued  to  be  accommodative.  Even  though  inflation  has  remained  above
2 per cent and monetary aggregates have grown strongly, inflation expectations
remained low and stable.

Outside the euro area, central banks lowered policy rates in several steps in the
first half of the  year. The  Bank  of England  cut  the  repo  rate, the main policy
rate, twice by 0.25 percentage points to 3.5 per cent by mid-July. Subsequently,
amid  signs  of  strengthening  economic  activity  and  strong  credit  growth,  it

13

 
raised  the  repo  rate  in  November  by  0.25 percentage  points.  In  Sweden,  the
Riksbank  cut  the  policy  rate  three  times  in  the  period  between  January  and
early July, by 1.0 percentage point in total. The repo rate has subsequently been
kept unchanged and currently stands at 2.75 per cent, its lowest level ever.

Graph 2: Short-term and long-term interest rates

%

Short-term interest rates

SE

DK

UK

Euro area

%

Long-term interest rates

SE

DK

UK

Euro area

7

6

5

4

7

6

5

4

3

2
Jan99

Jan00

Jan01

Jan02

Jan03

3
Jan99

Jan00

Jan01

Jan02

Jan03

Source : Commission services.

The overall fiscal policy stance remained neutral in the EU, where the primary
cyclically-adjusted  budget  balance  was  broadly  unchanged,  see  Graph 3.
Nominal  budgetary  positions  deteriorated,  as  automatic  stabilisers  acted  to
cushion  the  effects  of  the  protracted  slowdown.  The  lack  of  a  budgetary
consolidation in some Member States during the previous  up-turn  has limited
the current room of manoeuvre. This has put the overall EU fiscal framework
under pressure, see also Section 2.1.2 below.

Graph 3: Fiscal stance and cyclical conditions
 in EU Member States 2003

e
c
n
a
t
s

l

a
c
s
F

i

)

B
P
A
C
n

i

s
e
g
n
a
h
C

(

2

1

0

-1

-2

Pro-cyclical fiscal 
tigthening

PT

NL

ES

DE

EUR-12

IT

EU-15

UK

Counter-cyclical fiscal 
easing

BE

FR

AT

FI

DK

SE

Counter-cyclical 
fiscal tigthening

IE

EL

Pro-cyclical fiscal 
easing

-3

-2

-1

0

1

2

Cyclical conditions 
(Output gap)

Source : Commission services.

Wage  growth  remained  unchanged  at  around  3 per  cent  in  EU-15  in  2003
(2 ¾ per cent in  the euro  area). The  continued rise in nominal  wages coupled
with a slight decline in inflation has allowed real wage growth to edge higher,

14

 
 
 
 
 
thereby  benefiting  households’  purchasing  power.  Against  a  background  of  a
cyclical  reduction  in  labour  productivity  growth,  unit  labour  cost  growth
remained  above  2 per  cent  last  year.  Wage  trends  still  appear  broadly  in  line
with  price  stability,  provided  that  the  expected  cyclical  recovery  in  labour
productivity is not translated into higher wage growth.

2.1.2 

Budgetary developments: fiscal policy framework under pressure

Further deterioration in budgetary positions

The impact of the economic slowdown on EU public finances became clearly
visible after 2000. Both automatic stabilisers and discretionary policies exerted
pressures  on  the  budget  balances,  and  the  nominal  surplus  of  1.0 per  cent  of
GDP  in  20002  for  EU-15  turned  into  a  deficit  of  1.9 per  cent  in  2002.  The
average nominal budget position worsened  further  in  2003 to -2.7 per cent  of
GDP  in  the  EU,  with  sizeable  differences  across  Member  States.  Despite  the
general worsening, four Member States managed to maintain a nominal budget
position in balance or in surplus during the whole period 2000-2003 (BE, DK,
FI and SE). A substantial deterioration can be noted for several other Member
States,  where  two  countries  (DE  and  FR)  are  expected  to  have  deficits
exceeding the 3 per cent of GDP reference value by a large margin in 2003.

For the EU as a whole, the economic slowdown is the main factor responsible
for the deterioration in public finances in recent years, through the working of
the  automatic  stabilisers.  An  important  part  of  the  deterioration  stems  from
discretionary  deficit-increasing  measures.  The  cyclically-adjusted  budget
deficit  rose  from  -1.2 per  cent  of  GDP  in  2000  to  -2.2 per  cent  in  2003.  At
Member State level, the development has been quite diverse (see also Graph 4).
Of all the Member States that had a cyclically-adjusted budget deficit in 2000,
the  situation  worsened  in  the  case  of  Germany,  Greece,  France,  and  the
Netherlands, while it improved in Belgium, Spain, Italy, Austria, and Portugal.

2 

The  EU-15  net  lending  figure  included  one-off  proceeds  for  telephone  licences  (UMTS)  of
1.2 per cent of GDP in 2000.

15

 
                                                
Graph 4: Cyclically-adjusted budget balance

PT

BE
ES

AT

IT

EL
EUR12

NL
EU15

DE

FR

DK

SE

FI

UK

LU
IE

)
3
0
0
2
-
0
0
0
2

e
g
n
a
h
c
(

B
A
C

3

2

1

0

-1

-2

-3

-4

-6

-4

-2

0

2

4

6

CAB (level 2000)

Source : Commission services.

Against this background, the 2003-05 BEPGs recommended Member States to:

1. 

2. 

reach  or  maintain  budgetary  positions  of  close  to  balance  or  in  surplus
throughout the economic cycle*; to correct excessive deficits in line with
the Stability and Growth Pact;
subject  to  (1),  avoid  pro-cyclical  policies,  in  particular  in  economic
upturns.

* Euro area Member States were recommended to improve their cyclically-adjusted
balance by at least 0.5 per cent of GDP annually in case the medium-term objective
had not yet been achieved.

Implementation of the guideline on fiscal policies is worrisome

According  to  the  Commission’s  economic  forecasts  (autumn  2003)  five
Member  States  maintained  a  budget  position  of  close  to  balance  or  in
surplus  in  2003  (in  cyclically-adjusted  terms),  namely  Belgium,  Denmark
Spain, Finland and Sweden (see Table 1). These Member States seem likely to
maintain  sound  positions  over  the  coming  years.  In  the  case  of  Austria  and
according to the recent Stability programme, the budgetary situation weakened
in  2003  to  a  degree  that  it  no  longer  complies  with  this  guideline.  On  the
assumption  of  unchanged  polices,  the  autumn  forecasts  imply  that  two  more
Member States (IE and AT) could achieve a sound position by 2005. However
as  regards  Austria,  it  now  appears  unlikely  that  the  forthcoming  tax  cuts
(amounting  to  1  per  cent  of  GDP)  will  be  accompanied  by  corresponding
expenditure  restraint;  thereby  causing  the  cyclically-adjusted  balance  to
deteriorate considerably in 2005.

Member  States  that  had  not  reached  the  above  mentioned  objective  are
recommended to improve their cyclically-adjusted budget balance (and the
adjustment should amount to at least 0.5 per cent of GDP per year for euro area
countries  with  deficits  below  the  3 per  cent  of  GDP  ceiling  whereas  bigger
improvements are expected from those with a deficit in excess of that limit, see

16

 
 
 
also Section 3). In 2003, only Ireland, the Netherlands, and Portugal showed a
more  marked  improvement  (of  more  than  0.5 per  cent  of  GDP)  of  their
cyclically-adjusted budget balance.  In 2004,  an improvement  is also expected
in  Germany  and  France,  while  the  cyclically-adjusted  budgetary  deficits  in
Greece,  Italy,  Luxembourg,  and  Portugal  could  sharply  deteriorate  in  2004
and/or 2005 (but it should be noted that the forecasts for 2005 are based on a
no-policy change scenario for all Member States).

Table 1 : Evaluation of changes in nominal and cyclically-adjusted balances 

Nominal balance 

Cyclically-adjusted balance (CAB)1 

Change in CAB1 

2003 

2004 

2003 

2004 

2005* 

2004 

BE 
DE 
EL 
ES 
FR 
IE** 
IT 
LU 
NL 
AT 
PT 
FI 
Euro area 
DK 
SE 
UK** 
EU-15 

0.2 

-4.2 
-1.7 

0.0 

-4.2 

-0.8 

-2.6 

-0.6 

-2.6 

-1.1 

-2.9 

2.4 

-2.8 
0.9 

0.2 

-2.8 

-2.7 

-0.4 

-3.9 
-2.4 

0.1 

-3.8 

-1.1 

-2.8 

-2.1 

-2.7 

-0.7 

-3.3 

1.7 

-2.7 
1.2 

0.5 

-2.7 

-2.6 

0.8 

-3.5 
-2.2 

0.1 

-3.9 

-1.0 

-2.1 

-0.5 

-1.3 

-0.7 

-2.0 

2.8 

-2.3 
1.0 

0.4 

-2.4 

-2.2 

0.1 

-3.3 
-3.1 

0.3 

-3.3 

-0.6 

-2.3 

-1.3 

-0.7 

-0.3 

-2.1 

2.1 

-2.1 
1.4 

0.9 

-2.3 

-2.0 

-0.2 

-3.0 
-3.2 

0.3 

-3.2 

-0.2 

-3.2 

-1.7 

-0.6 

-0.1 

-2.6 

2.0 

-2.1 
1.9 

1.5 

-2.1 

-1.9 

-0.7 

0.2 
-0.9 

0.2 

0.6 

0.4 

-0.2 

-0.9 

0.6 

0.4 

-0.1 

-0.7 

0.2 
0.4 

0.5 

0.1 

0.2 

2005* 

-0.3 

0.3 
0.0 

0.1 

0.1 

0.4 

-0.9 

-0.3 

0.1 

0.2 

-0.5 

-0.1 

0.0 
0.5 

0.6 

0.2 

0.1 

1 On the basis of the PF method, except in the case of Germany, Spain, Luxembourg, and Austria were the HP filter method has been used.  
* The forecast for 2005 is based on an ‘unchanged policy’ assumption for all Member States. 
**  The  autumn  forecast  was  prepared  before  Ireland  presented  its  2004  budget  and  before  the  United  Kingdom  presented  its  2003  Pre-
Budget Report. 
Note : Differences are due to rounding.  
Source  : Autumn 2003 Commission forecasts. 

In  2002,  the  Council  identified  an  excessive  deficit  in  Portugal,  followed  by
Germany  and  France  in  2003.  Both  Germany  and  Portugal  have  made
considerable  efforts in response to the  recommendation to bring this situation
to  an  end.  According  to  the  forecasts  and  following  substantial  one-off
measures, the nominal deficit in Portugal is expected to stay below 3 per cent
of  GDP  in  2003,  but  risks  exceeding  the  limit  again  in  2004.  In  the  German
case, measures amounting to about 1 per cent of GDP have been taken in 2003,
thereby  fulfilling  that  part  of  the  Council  recommendation  of  January  2003.
However, given the adverse cyclical conditions, the measures taken now appear
inadequate in order  to  bring the  excessive  deficit situation to  an  end  in  2004.
France does not appear to have taken effective action to redress the budgetary

17

 
 
 
 
imbalances,  and  given  the  current  economic  outlook,  the  excessive  deficit
situation  is  likely  to  persist  with  a  continuation  of  a  deficit  well  above  3 per
cent of GDP in 2004.

In  view  of  the  developments  outlined  above,  the  Commission  adopted
recommendations  to  Germany  and  France  in  accordance  with  Treaty  Articles
104 (8)  and  104 (9)  that  no  effective  action  has  been  taken  (FR)  or  was
inadequate (DE), and that both Member States should take measures to remedy
the  excessive  deficit  situation.  However,  in  light  of  the  weak  economy,  the
Commission recommended to allow both Member States one additional year to
bring down the deficit below 3 per cent of GDP, i.e. by 2005. On 25 November
2003,  the  Council  rejected  the  Commission’s  recommendations  and  found  an
agreement  outside  the  Treaty,  de  facto  suspending  its  application  for  these
articles.  The  Council  took  note  of  the  commitments  made  by  Germany  and
France to reduce their deficits to below 3 per cent of GDP by 2005.

Graph 5  examines  the  fiscal  stance  (approximated  by  the  changes  in  the
cyclically-adjusted primary balance (CAPB)) in relation to cyclical conditions
which is approximated by the size of the output gap. The overall fiscal stance
for the EU is expected to be broadly neutral in 2003. However, the aggregate
fiscal  stance  results  from  quite  diverse  fiscal  stances  across  Member  States,
despite fairly similar cyclical developments. Some Member States are expected
to  run  somewhat  pro-cyclical  policies,  reflecting  consolidation  efforts  needed
to  abide  by  Guideline  no.  1  on  sound  budgetary  positions  (e.g.  NL  and  PT),
which  takes  precedence  over  the  Guideline  on  avoiding  pro-cyclical  policies.
The  pro-cyclical  fiscal  stance  in  Greece,  however,  can  not  be  explained  by  a
need to consolidate public finances.

Graph 5: Fiscal stance and cyclical conditions in the EU 
in 2003

Pro-cyclical 
fiscal tigthening

PT

NL

BE

ES*

Counter-cyclical 
fiscal tigthening

IE

DE

IT

2003

FR

Counter-cyclical 
fiscal easing

AT
UK

FI

DK

SE

2002

2001

EL

2000

Pro-cyclical 
fiscal easing

e
c
n
a
t
s

l

a
c
s
F

i

)

B
P
A
C
n

i

s
e
g
n
a
h
c
(

2

1

1

0

-1

-1

-2

-3

-2

-1

0
Cyclical conditions
(Output gap)

1

2

3

Source : Commission services.

18

 
 
 
 
 
Box 2: Follow-up to country specific recommendations related to public finances

Country  Specific  Recommendations
(as an extension of general Guidelines
no. 1, 14-15)

Significant Measures in 2003

Adopted                                                                               Proposed

taken  insufficient 

to  ensure  recommended

Fiscal  measures 
correction in 2003-2004

Measures  of  about  1%  of  GDP  taken  in  2003  but  inadequate  to
eliminate excessive deficit by 2004

GUIDELINE 1: Reach or maintain budgetary positions of close to balance or in surplus throughout the economic cycle*; correct excessive deficits in line with the
Stability and Growth Pact (*Euro area Member States were recommended to improve their cyclically-adjusted balance by at least 0.5 per cent of GDP annually in
case the medium-term objective had not yet been achieved)
DE:  ensure  a  rigorous  budget  execution,
including measures for 2003 of 1% of GDP;
eliminate  excessive  deficit  by  2004;  lower
the cyclically-adjusted deficit by at least 1pp
of GDP between end-2003 and 2005
FR: reduce the cyclically-adjusted deficit by
more  than  planned  in  2003  and  by  0.5%  of
GDP  or  more  in  2004  to  ensure  that  the
nominal deficit is brought down to below 3%
in 2004 at the latest
IT:  reduce  the  cyclically-adjusted  deficit  by
at least 0.5% of GDP per year until a close to
balance  or  in  surplus  position  is  achieved;
replace one-off measures by more permanent
measures
NL:  continue 
to  contain  government
expenditure  within  clearly  defined  ceilings
set in real terms, consistent with a budgetary
position close to balance or in surplus
AT:  achieve  structural  expenditure  savings,
also at lower levels of government, to lower
the  high 
tax  burden,  while  securing  a
cyclically-adjusted  budgetary  position  close
to balance
PT:  ensure  the  planned  further  reduction  in
the  deficit  for  2003;  thereafter  lower  the
cyclically  adjusted  deficit  by  at  least  0,5  %
of  GDP  a  year  to  reach  a  close  to  balance
position

Reform  of  public  pensions  system  and  of  pension  system  for
federal  employees;  income  tax  relief  taking  effect  in  2004  but
offset  by  indirect  tax  increase;  reduction  in  number  of  federal
employees  and,  at  Länder  level,  of  school  teachers;  but  costly
(third) economic stimulus package (with main impact in 2005)

Fiscal measures for 2004 insufficient to ensure planned correction;
budgetary impact of one-offs in 2004 expected to be slightly lower
than in 2003

Major  income  tax  cuts  envisaged  for  2005;
reform of health care system planned for 2005 at
the earliest

No  reduction  in  the  nominal  deficit  ratio  in  2003  due  to  adverse
cyclical conditions; further disimprovement expected for 2004

Multi-annual real expenditure ceilings aimed at achieving close to
balance position included in the 2004 budget

19

 
Box 2: Follow-up to country specific recommendations related to public finances (continued)

Country Specific Recommendations (as
an  extension  of  general  Guidelines  no.
1, 14-15)

Significant Measures in 2003

Adopted                                                                               Proposed

GUIDELINE 14: Enhance the contribution of the public sector to growth

DK: ensure expenditure control at all levels of
government
EL:  ensure  control  of  government  current
primary  spending;  use  public  resources  more
effectively

FR:  curb  the  dynamics  of  spending  in  the
health sector

medium-term 

IE:  enhance  public  expenditure  efficiency;
improve 
and
expenditure planning
PO: 
through
obtain 
expenditure  side;  increase  health-care  system
efficiency

reduction 

revenue 

deficit 

Some  measures 
deceleration of health expenditure

taken  but 

insufficient 

to  ensure 

lasting

Comprehensive  reform  of  health 
insurance
system  to  curb  durably  health  expenditure
growth

Extension  of  multi-annual  budgeting;  reform  of  health  care
system; new capital appraisal procedures

Expenditure outcome for 2003 expected to be broadly as planned;
ambitious reform of health care system proceeding rapidly

Vast programme of structural reforms

improve 

FI: 
compliance with expenditure rules

spending 

control; 

ensure

Introduction of improved multi-annual spending limits

Basic  service  programme  between  central
government  and  municipalities 
improve
balance  and  predictability  of  municipalities’
responsibilities, obligations and financing

to 

UK:  ensure  efficient  and  cost-effective
delivery of public services

Efficiency  review  of  expenditure;  web-based  reporting  against
new PSA targets;  new  ‘Green  Book’  on appraisal  and  evaluation
guidelines

GUIDELINE 15: Ensure a further decline in government debt ratios

BE:  ensure  a  sustained  declining  trend  of  the
debt 
ratio  by  maintaining  high  primary
surpluses
EL:  ensure  a  sustained  declining  trend  of  the
ratio  by  maintaining  high  primary
debt 
surpluses
FR: 
government gross debt to GDP ratio in 2003
IT: ensure that the debt ratio is diminishing at
a  satisfactory  pace  towards  the  60%  of  GDP
threshold

the  general

increase 

limit 

the 

in 

Measures taken (incl. transfer of Belgacom’s pensions fund)

Privatisation proceeds ± 2 per cent of GDP

Resumption of privatisations

Privatisation  of  1  per  cent  of  GDP  per  year  on
average

20

 
2.1.3 Wage  developments:  wage  growth  too  high  to  be  conducive  to

employment creation

Wage growth declined less than the drop in productivity growth…

Wages  have  responded  only  modestly  to  the  worsened  economic  situation,
partly reflecting a greater resilience initially shown in the labour market in the
current  slowdown.  Nominal  wage  growth  has  fallen  gradually  from  3½ per
cent  in  2000  to  around  3 per  cent  in  2003  in  the  EU,  while  it  remained
relatively  stable  around  2¾ per  cent  in  the  euro  area  during  the  same  period.
Unit labour costs increased, in contrast, as labour productivity growth declined
sharply  early  in  the  slowdown  reflecting  labour  hoarding  in  several  Member
States.

Against this background, the 2003-05 BEPGs recommended to:

3. 

ensure that nominal wage increases are consistent with price stability and
productivity gains; and foster the macroeconomic dialogue.

...but  wages  appear  broadly  compatible  with  price  stability  in  the  medium-
term

Overall, the 2003 nominal wage increases of around 3 per cent in the EU and
2¾ per  cent  in  the  euro  area  are  broadly  in  line  with  medium-term  price
stability.  However,  the  cyclical  slowdown  in  labour  productivity  growth  has
kept the rise in nominal unit labour costs above 2 per cent for the third year in a
row. This still relatively high pace has contributed to the very gradual retreat in
inflation. In addition, small advances in productivity have just been sufficient
to keep real unit labour costs in check, see Table 2 below.

Wage  increases  appear  relatively  high,  given  the  weak  demand  for  labour.  A
number of institutional features contribute to explain a certain lack of nominal-
and real wage flexibility (such as union power, co-ordination/centralisation of
bargaining, bargaining coverage, the use of wage rules in collective bargaining,
and  not  least  various  insider-outsider  mechanisms).  No  major  changes  have
been observed as regards the framework of wage formation in general in 2003,
or the linking of wages to prices by means of indexation more specifically.

At a country level, nominal wage increases were comparatively high in Greece,
Spain,  Ireland,  the  Netherlands,  and  the  United  Kingdom3,  i.e.  all  countries
with relatively tight labour markets and/or high inflation. Real unit labour costs
rose particularly in Ireland, Luxembourg, and the Netherlands.

3 

The increase in nominal compensation per employee in the United Kingdom in 2003 is partly
explained  by  a  raise  in  the  employers’  National  Insurance  Contribution  (NIC),  which
contributed to the apparent wage increase by around 1.5 percentage points.

21

 
                                                
Table 2 : Wage developments in 2003 

Nominal 
compensation 
per employee 

Real wages1 

Labour 
Productivity 

NULC2 

RULC3 

BE 

DE 

EL 

ES 

FR 

IE 

IT 

LU 

NL 

AT 

PT 

FI 

Euro area 

DK 

SE 

UK 

EU-15 

2.2 

1.9 

6.5 

4.1 

2.7 

5.1 

3.0 

2.7 

4.1 

2.5 

2.7 

3.1 

2.7 

3.7 

3.7 

4.3 

3.1 

 0.8 

 0.7 

 2.4 

 0.1 

 1.0 

 3.5 

 0.0 

 0.8 

 1.3 

 1.2 

-0.6 

 2.0 

 0.6 

 1.4 

 1.6 

 1.9 

 0.9 

 1.0 

 1.6 

 3.0 

 0.6 

 0.3 

 0.7 

-0.5 

-0.5 

  0.2 

  0.8 

  0.2 

  1.7 

  0.6 

  1.5 

  1.6 

  1.4 

  0.8 

1 Nominal compensation adjusted by the GDP deflator. 
2 Nominal unit labour costs. 
3 Real unit labour costs. 

Source : Commission services. 

1.1 

0.3 

3.4 

3.5 

2.4 

4.3 

3.5 

3.2 

3.9 

1.7 

2.5 

1.4 

2.1 

2.2 

2.1 

2.9 

2.3 

-0.3 

-0.9 

-0.7 

-0.6 

  0.7 

  2.8 

  0.5 

  1.3 

  1.1 

  0.4 

 -0.9 

   0.3 

  -0.1 

   0.0 

   0.1 

   0.5 

   0.1 

The macroeconomic dialogue fosters a common understanding among policy actors

Over  the  last  few  years,  the  Macroeconomic  Dialogue  has  developed  into  a
useful forum at EU level for the regular exchange of views between all policy
actors, including the social partners. It fosters a common understanding of the
economic situation and can thereby help to prevent tensions that could lead to
an unbalanced macroeconomic policy mix.

2.2 

Economic reforms to raise Europe’s growth potential

The  EU  needs  higher  and  sustainable  economic  growth  for  the  rest  of  this
decade  to  achieve  the  Lisbon  objectives.  Structural  reforms  are  necessary  to
increase  Europe’s  growth  potential.  They  are  best  implemented  in  a
comprehensive  and  coordinated  way.  The  2003-05 BEPGs  therefore  focused
on the need to both improve the functioning of the labour market, the quality of
human resources, and to increase productivity and business dynamism.

22

 
 
 
2.2.1

The  Lisbon  employment  targets  are  in  serious  jeopardy  of  being
missed

Progress towards the Lisbon and Stockholm employment targets is too slow

After  several  years  of  strong  job  creation,  the  impact  of  the  economic
slowdown  on  employment  has  started  to  be  felt  more  strongly.  Following  a
deceleration in 2002, job creation in the EU came to a standstill in 2003, and
employment  contracted  slightly  in  the  euro  area.  As  firms  accelerated  labour
cutbacks, unemployment started increasing more rapidly. From 7.3 per cent in
early  2001,  the  (seasonally  adjusted)  unemployment  rate  increased  to  8.0 per
cent  in  October  2003.  Differences  across  Member  States  are  sizeable.
Unemployment  remains  below  5 per  cent  in  Luxembourg,  the  Netherlands,
Austria,  and  Ireland,  while  it  is  above  9 per  cent  in  Spain,  Germany,  and
France.

The total employment rate stood at 64.3 per cent in the EU in 2002 (varying
from  55.5 per  cent  in  IT  to  75.9 per  cent  in  DK).  Graph 6  illustrates  the
different  starting  points  in  1999  and  developments  across  Member  States.
Following  a  certain  catching-up  during  the  past  three  years,  the  difference
between the highest and the lowest national employment rate was reduced from
23.3 to 20.4 percentage points.

Graph 6: Total employment rate

ES

IT

2
0
0
2
-
9
9
9
1

e
g
n
a
h
c

e
t
a
r

t
n
e
m
y
o
p
m
E

l

5

4

3

2

1

0

-1

FR

IE

EL

LU

EU15

BE

NL

SE

AT

UK

FI

PT

DE

DK

50

52

54

56

58

60

62

64

66

68

70

72

74

76

78

80

Employment rate 1999

Source : Commission services (structural indicator no. I.1.1).

The  employment  rate  for  older  workers  was  only  40.1 per  cent  in  2002,
leaving  the  greatest  distance  to  cover  towards  the  target  for  2010  (of  50 per
cent  for  the  average  EU  employment  rate).  The  differences  across  Member
States are particularly large - only 26.7 per cent of those aged 55 to 64 work in
Belgium, while it is 68.0 per cent in Sweden (see Graph 7). Moreover, progress
in recent years is slowest in some of the Member States with the lowest starting
levels.  It is important that the errors of  the past must not  be repeated,  i.e.  the

23

 
 
 
 
recourse  to  early  retirement  as  a  seemingly  convenient  solution  for  corporate
restructuring has to be avoided.

Graph 7: Older workers employment rate

2
0
0
2
-
9
9
9
1

e
g
n
a
h
c

e
t
a
r

t
n
e
m
y
o
p
m
E

l

10
9
8
7
6
5
4
3
2
1
0

FI

FR

NL

ES

BE

LU
IT

AT

EU-15

DE

EL

IE

UK

DK

SE

PT

20

25

30

35

40

45

50

55

60

65

70

Employment rate 1999

Source : Commission services (structural indicator no. I.1.4).

Women benefited particularly from employment growth in the recent past. The
female  employment  rate  reached  55.6 per  cent  in  2002  (see  Graph 8).
Although cohort effects will continue to push the female employment rate up,
since the propensity to work is higher  among  younger  generations of women,
specific  barriers  to  female  labour  market  participation  (such  as  the  lack  of
childcare  and  opportunities  for  part-time  employment)  remain  a  major
impediment in some Member States.

Graph 8: Female employment rate

IT

EL

NL

AT

FI

SE

IE

LU

EU-15

FR

DE

PT

UK

BE

DK

2
0
0
2
-
9
9
9
1
e
g
n
a
h
c

e
t
a
r

t
n
e
m
y
o
p
m
E

l

5

4

3

2

1

0

30

35

40

45

50

55

60

65

70

75

80

Employment rate 1999

Source : Commission services (structural indicator no. I.1.2).

24

 
 
 
 
 
 
 
Kok report calls for wide-ranging reforms

Given  the  lack  of  employment  growth  in  2003  and  a  modest  acceleration
forecast  for  2004  and  2005,  the  EU  is  likely  to  miss  the  intermediate
employment rate target of 67 per cent by the end of 2005, and does not appear
on course to meet 2010 targets. The risk of missing the Lisbon- and Stockholm
employment  targets  should  not  be  attributed  to  the  cyclical  slowdown.  The
problems are of a structural nature and to come anywhere close to meeting the
employment targets, the swift implementation of comprehensive labour market
reforms is urgently needed.

This  was  also  highlighted  in  the  recent  report  of  the  European  Employment
Taskforce  (EETF),  which  was  chaired  by  former  Dutch  Prime  Minister  Mr.
Wim Kok, and released in November 2003. It makes an important contribution
to  the  debate  on  how  the  EU  can  renew  making  progress  towards  the  Lisbon
employment  targets.  The  policy  recommendations  are  broad  ranging,  and
underline the need for a consistent set of policy measures. The report outlined
the  following  four  key  requirements  to  boost  employment  and  productivity  –
increasing adaptability of workers and enterprises, attaching more people to the
labour  market,  investing  more  and  more  effectively  in  human  capital,  and
ensuring  effective  implementation  of  reforms  through  better  governance.
Overall, the policy recommendations are in line with the 2003-05 BEPGs. For
example, the EETF report underlines the need for employees and employers to
be  able  choose  from  a  variety  of  contractual  employment  relations,  and  that
business  regulation  needs  to  be  simplified.  It  acknowledges  the  contribution
that  temporary  work  agencies  can  play  in  increasing  the  adaptability  of  the
labor market, while providing employees with a well-defined  framework. The
EETF  calls  for  a  reconsideration  of  the  concept  of  security  for  employees  by
simultaneously considering the contractual framework and adequate protection
in the case of job loss through more dynamic forms of social protection “job-
to-job insurance” and active measures. In addition, the EETF calls for renewed
impetus  in  tax/benefit  reform,  and  agrees  that  in-work  benefits  can  be  a
powerful  tool  for  alleviating  unemployment  traps,  but  that  they  need  to  be
designed carefully in order to avoid poverty traps or excessive overall costs. It
supports  further  reform  of  means-tested  benefits  and  the  individualisation  of
income  taxation  in  order  to  remove  inherent  disincentives.  Finally,  the  EETF
recognises  the  importance  for  wage  differentiation  to  reflect  productivity  and
the sectoral and regional labour market situation.

25

 
Against this background, the 2003-05 BEPGs recommended Member States to:

4. 

5. 

6. 

7. 

8. 

improve the combined incentive  effects  of  taxes  and  benefits  and  reduce
high marginal effective tax rates;

ensure  that  wage  bargaining  systems  allow  wages  to  reflect  productivity
differences;

review  labour  market  regulation  and  promote  more  adaptable  and
innovative work organisation;

facilitate labour mobility;

ensure efficient active labour market policies.

Overall, the pace of labour market reforms has become more encouraging,
but it needs to accelerate further

In general, the pace of reforms on the labour market has slightly improved in
2003.  Significant  reforms  have  been  adopted  in  several  Member  States,  see
Box 3.  However,  their  impact  is  still  to  be  seen  as  reforms  are  still  in  the
process of being adopted and/or implemented in several Member States.

Tax/benefit reforms contribute to improving incentives, but so far they remain
piecemeal and too much focused on the tax side

Improving  incentives  to  work  remains  a  serious  challenge  in  most  Member
States.  Indeed,  all  Member  States  but  three  (ES,  IE  and  PT)  received
recommendations to address disincentives to work generated by the combined
effect of taxes and benefits.

In  general,  measures  implemented  and  announced  in  2003  continue  to  be
concentrated on the tax side, introducing or increasing work-related tax credits
(BE, FR,  IE and NL) and  reducing the marginal  tax  rates at  the  lower end  of
the  wage  scale  (in  particular  in  DE,  FR  and  IT).  Others  Member  States,  like
Belgium,  Austria,  Denmark,  and  Finland,  envisage  further  steps  in  this
direction in the coming years. However, although the focus of measures on the
tax side may be understandable from a political perspective, it is problematic as
public  finances  are  under  pressure  in  several  Member  States,  further  limiting
the room for manoeuvre.

Few  steps  have  been  taken  (or  announced)  to  reform  benefit  systems,  which
contribute  most  to  the  risk  of  unemployment-  and  inactivity  traps.  Eligibility
criteria,  duration  of  benefits,  enforcement  of  job-search  and  availability-to-
work requirements have changed only little. Nevertheless, Germany envisages
important  steps  in  this  direction  and  is  going  to  implement  a  reform  of  the
unemployment  benefit  scheme  in  the  coming  months.  A  review  of  the

26

 
unemployment  insurance  has  been  undertaken  in  the  Netherlands  in  2003,
markedly  tightening  eligibility  requirements.  Some  measures  have  also  been
undertaken in Denmark. Although Member States are increasingly developing
activation  measures  related  to  the  granting  of  welfare  benefits,  much  more
needs  to  be  done  in  terms  of  closer  interactions  between  passive  and  active
labour market programmes.

Childcare provision has improved only slightly, even though it is recognised as
a priority in most Member States. More efforts by Member States are needed to
ensure  adequate  and  affordable  childcare  for  children  in  line  with  the
Barcelona targets of childcare coverage.

Few concrete measures to foster wage differentiation can be noted so far

Unemployment differentials remain important across regions and skills levels.
Seven  Member  States  (DE,  GR,  ES,  IE,  IT,  PT,  FI)  received  a  specific
recommendation 
to  allow  for  stronger  wage  differentiation,  reflecting
productivity  ratios  and  local  labour  market  conditions.  Although  discussions
have  started  in  some  Member  States,  few  concrete  measures  towards  wage
differentiation can be noted so far.

In  2003,  concrete  initiatives  remained  at  early  stages  of  discussion  or  were
piecemeal. Wage differentiation in public sector collective agreements is being
discussed in the UK. In Germany, public employers have been trying to reduce
time  reductions  without
personnel  costs,  e.g.  by  negotiating  working 
compensating  payments  for  overstaffed  services  or  by  cutting  additional
benefits  for  employees  and  officials.  A  relaxation  of  the  “favourability
principle”  is  under  discussion  in  Germany  and  France,  where  lower-level
agreements  can  only  be  more  favourable  than  sectoral  agreements.  This
notwithstanding,  an  informal  trend  towards  more  flexibility  at  the  firm  level
continues  while  respecting  the  role  of  social  partners  according  to  national
practices.

In most Member States, work organisation is becoming more adaptable, but
there are only few recent initiatives to address employment protection
legislation

A  move  towards  full  employment  will  require  rapid  net  employment  growth
and high labour turnover. This needs to be supported by a flexible regulatory
framework  and  work  organisation.  Excessively  rigid 
labour  market
regulations  discourage  hiring  and  slow  down  adjustment.  Country-specific
recommendations were issued to Germany, Greece, Spain, and Italy to this end.
Flexibility  has  been  improved  in  most  Member  States,  through  e.g.  enhanced
rights  to  flexible  working  to  improve  reconciliation  of  work  and  family  life.
Security has also been strengthened, particularly the health and safety aspects
in  work  organisation.  However,  not  enough  has  been  done  to  tackle
employment  protection  legislation  (EPL),  or  to  render  non  standard  contracts
more attractive to employees.

27

 
Further  steps envisaged.
Some steps envisaged to reduce MTR

Implementation of unemployment benefit reform

Box 3: Follow up to country specific recommendations related to labour markets

Country specific recommendation (as an extension of general Guidelines no. 4-
8)

Significant Reform Measures in 2003
Adopted                                                                               Proposed

Some decline of MTR at lower wages.

Work-related tax credits increased, reduced MTR at lower wages.

Reduced MTR at lower wages from Mini/Midi jobs & Mainz model.

Work-related tax credits reduce MTR at lower wages
Some measures to tighten eligibility.

GUIDELINE 4: Improve the combined incentive effects of taxes and benefits and reduce high marginal effective tax rates
BE:  reduce distortions to work incentives in tax-benefit systems
DK:    improve  labour  supply  incentives,  in  particular  tax  reform  and  eligibility
rules.
DE:    continue  tax-benefit  reforms  to  work  incentives,  enforce  job-search
conditionality.
EL:  improve formal work incentives, including part-time,  through reduced non-
wage costs and pension rights transferability.
FR:    implement  new  unemployment  insurance  system,  including  effective  job-
search incentives.
IT:    increase  labour  force  participation  of  women  and  older  workers;  increase
resources and efficiency of unemployment benefit and social insurance system.
NL:  continue benefit reforms, particularly eligibility and conditionality & reform
disability system.
AT:    improve  pension  contributions-benefits  link  and  improve  older  worker
participation.
FI:    improve  tax-benefit  incentives  and  eligibility  criteria,  particularly  for  older
workers.
UK:    improve  work  incentives, particularly  by  reforming  sickness  and  disability
benefits.
GUIDELINE 5: Ensure that wage bargaining systems allow wages to reflect productivity, taking into account productivity differences across skills and local labour market conditions
DE:    reform  wages  to  reflect  productivity  differences  through  reviewing
Günstigkeitsprinzip.
EL:  reform wage bargaining to reflect productivity differences.
ES:    reform  wage  setting  to  reflect  productivity  differences  and  phase-out
indexation provisions in collective agreements.
IE:  Social Partners to allow wages to  adapt to productivity and skills differences.
IT:  encourage more decentralised wage setting to better reflect productivity and
skills.
PT:  encourage  wage  moderation  to  allow  increases  to  take  into  account
productivity and skills.
FI: reform wage bargaining to reflect productivity differences.

Agreement on orientations for lower-level bargaining & increases to
reflect productivity.

Tighter eligibility requirements for UI; in-work tax credits increased.

Min pay reduced in East German construction sector.

In-work tax credits extended.

Further steps to reduce MTR envisaged.

Further steps to reduce MTR envisaged.

Favourability principle under consideration.

Proposed  ‘social  pact’  on  pay  moderation  and
collective agreements.

28

 
Box 3: Follow up to country specific recommendations related to labour markets (continued)

Country specific recommendation (as an extension of general Guidelines no. 4-
8)

Significant Reform Measures in 2003
Adopted                                                                               Proposed

Reduced EPL for small firms; some flexibility introduced into social
criteria used in lay-offs.

GUIDELINE 6: While respecting the role of social partners according to national practices, review labour market regulations notably by relaxing overly restrictive employment protection legislation (EPL) and
addressing those relating to employment contracts, and promote more adaptable and innovative work organisation.
DE:    further  reduce  regulatory  and  administrative  burden,  i.a.  by  lowering
effective degree of employment protection.
EL:  improve flexibility & security balance; modernise work organisation; review
labour market regulations.
ES:    further  reform  EPL  to  reduce  labour  market  segmentation  across  types  of
contract.
IT:   further  reform  EPL  and  reduce  labour market  segmentation  across different
contract types and firm size
GUIDELINE  7:  Facilitate  labour  mobility,  both  geographical  (within  as  well  as  across  countries)  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.
ES:  continue to facilitate geographical mobility, i.a. remove fiscal distortions and
improve rental market conditions and availability of land for development.
GUIDELINE 8: Ensure efficient active labour market policies with special attention to people facing the greatest difficulties in the labour market, according to rigorous impact evaluations.
DE: continue to improve efficiency of ALMPs, in particular jobsearch assistance.
Improve cost-effectiveness and targeting.

Rental  market  &  benefit  reforms  to  encourage  take-up  of  jobs
requiring relocation; agricultural regional mobility promoted.

Hartz  III  to  reduce  ratio  of unemployed  :  case  worker
from 410:1 to 75:1

Measure to ease housing search & residence change.
New co-ordination methods among PES.

Unemployment and social assistance merged under PES.

29

 
The  promotion  of  adaptable  work  organisation  has  mostly  been  taken  up  in
social  dialogues  at  the  national  level.  In  2003,  agreements  were  reached  on
flexibility  of  working  time  (DK,  NL,  and  SE)  and  modernisation  of  public
sector  work  organisation  (ES).  Legislative  reviews  are  planned  in  France,
Ireland,  the  Netherlands,  and  Portugal.  The  UK  has  introduced  principles  to
improve the quality of future  regulations. France has introduced legislation to
make the 35-hour week more flexible. Several Member States (e.g. IE and NL)
are also looking at how to adapt to future changes in working practices, such as
how  best  to  take  advantage  of  e  working  opportunities.  Many  countries  (e.g.
IE,  NL, and UK) have taken measures  to improve  reconciliation of work  and
family life through increased rights to parental- and/or care leave.

Employment  contracts  and  EPL  were  only  addressed  in  a  few  countries  in
2003.  The  new  labour  code  in  Portugal  includes  an  increase  in  fixed-term
contract  duration,  working  hours  flexibility,  devices  to  control  unjustified
absenteeism and encouragement of  occupational mobility.  Portugal and  Spain
have  continued  efforts  to  reduce  their  high  share  of  fixed-term  contracts.  In
Italy, a decree on labour market reform has just entered into force. It includes
new forms of ‘flexible’ contracts, but the EPL was not addressed. In Germany,
a  relaxation  in  the  social  criteria  have  been  put  forward  determining  which
employees are laid off first in redundancies, including also a relaxation of the
EPL for small firms.

Some Member States are encouraging geographical mobility, and a majority
is addressing occupational mobility

Regional  disparities,  often  with  simultaneous  unemployment  and  skills
shortages,  continue  to  point  to  the  need  to  foster  geographical  and
occupational  mobility.  A 
to
recommendation 
geographical mobility was addressed to Spain.

to  eliminate  barriers 

Some Member States have taken measures to encourage geographical mobility.
The  dissemination  of  information  on  vacancies  is  improving  through  the
cooperation  of  Member  States  and  the  use  of  information  technology.  Some
Member States  have  introduced  changes in the  tax/benefit system  in  2003,  in
order  to  improve  incentives  to  mobility  (DE,  EL,  ES,  FR,  and  SE).  Belgium
and Spain have started addressing rigidities in the housing market.

Most Member States continued to take initiatives to promote lifelong learning
to foster occupational mobility. Some Member States have recently adopted, or
are planning to adopt, measures to facilitate the recognition of informal skills.
Denmark has  introduced new training measures to address foreseen shortages
of  skilled  labour.  Belgium  has  stepped  up  efforts  to  overcome  linguistic
barriers.

30

 
Individualised approaches are spreading, but the redesign of ALMPs in the
light of evaluations remains exceptional

Active labour market policies (ALMPs) are an important instrument to open
a path back to employment and to prevent long-term unemployment. However,
they need to focus on “the right measure to the right person at the right time”.
Germany  received  a  specific  recommendation  to  increase  the  efficiency  of
ALMPs.  While  individualised  approaches  are  becoming  more  widespread,
evaluations are not systematically carried out, nor used to critically assess and
redesign programmes.

Despite  growing  awareness  of  shortcomings  in  their  efficiency  following
rigorous  assessments,  only  a few Member  States adapted  ALMPs  in  2003,  or
announced  plans  for  doing  so.  For  instance  in  Denmark,  the  former  high
activation  target  was  abandoned  in  order  to  focus  more  strongly  on  job
placement  activities,  and  it  is  planned  to  streamline  the  tools  available  to  the
employment  service.  Sweden  has  looked  at  simplifying  the  structure  of
programmes.  In  Ireland,  there  has  been  a  shift  from  employment  schemes
towards  measures  focusing  on  employability,  while  in  the  Netherlands
“reintegration agencies” are paid depending on the integration results achieved.

More  progress  is  made  concerning  the  targeting  of  measures  towards  those
hardest  to  place.  The  early  identification  of  jobseekers’  needs  and,  where
required, a tailor-made offer of an active programme are being implemented or
on the agenda in a majority of Member States. In this context, the role of job
placement  activities 
is  being  strengthened.  Unemployed  with  good
employment prospects are increasingly channelled to self-service  facilities.  In
Germany, the government proposed a simplification of benefit administration.
It  will  free  additional  resources  for  placement  activities.  It  is  also  likely  to
enhance efficiency e.g. by removing incentives for municipalities to provide an
active  measure  with  the  main  goal  of  re-qualifying  a  participant  for
unemployment  benefits.  Most  Member  States  are  planning  to  enhance  the
cooperation of different actors involved in job-placement, training, and benefit
administration, in some cases by bringing the different providers together in a
“one stop shop”.

2.2.2

Economic reforms not reflected in productivity growth figures

The economic reform effort recommended by the 2003-05 BEPGs is aimed at
increasing the long-term growth potential of the EU economy. This should be
seen  within  the  context  of  a  divergence  in  EU  employment  and  productivity
growth patterns in recent years. Compared with the first half of the 1990s, the
period 1996-2002 witnessed a significant increase in the contribution of labour
to GDP growth in the EU, but this has been partly offset by a reduction in the
contribution from labour productivity. By comparison, the USA has been able
to  combine  a  strong  employment  performance  with  accelerating  labour

31

 
productivity  growth,  resulting  in  GDP  growth  that  was  more  than  a  full
percentage point higher than in the EU over the period 1996-2003.

The labour productivity gap has widened between the EU and the USA...

The growth rate of labour productivity per person employed in the EU slowed
down  from  1.9 per  cent  in  the  first  half  of  the  1990s  to  1.3 per  cent  in  the
second  half.  Since  then,  annual  labour  productivity  growth  has  fluctuated
between  0.5 per  cent  and  1 per  cent,  reflecting  initially  a  greater  resilience  in
the  labour  market  to  the  economic  slowdown  with  continued  (albeit  modest)
employment growth. The experience in the EU was quite different from that in
the  US,  where  labour  productivity  growth  rates  have  recovered  to  levels  of
2 per cent or more. As a consequence, the productivity gap with the USA has
widened, with EU productivity per hour worked being 12 per cent below that in
the  US.  This  productivity  gap  is  now  responsible  for  40 per  cent  of  the
difference  in  GDP  per  capita  between  the  EU  and  the  USA  (where  the
European GDP per capita amounted to 72 per cent of the level in the USA in
2003), see Graph 9.

Graph 9: GDP per capita 2003 (US=100)

160

120

80

40

0

LU US

IE DK AT NL BE UK

FI

IT

Source : Commission services (structural indicator no. a1).

DE SE FR EU
15

ES EL

PT

…but the EU average hides significant differences between Member States

Differences  are  wide  in  hourly  productivity  levels  and  growth  rates  between
Member  States  (see  Graph 10).  Starting  from  a  good  position,  hourly  labour
productivity continued to increase  relatively  rapidly  in  Denmark,  Ireland, and
France. In France this may be associated with the introduction of the 35-hour
working week as labour productivity  growth  per person  employed  was  below
the EU average. Productivity levels in Greece and the UK continued to catch-
up with the EU average. In Spain and Portugal, on the other hand, productivity
fell even further behind. Drops in relative productivity levels were observed as
well in Italy and the Benelux countries.

32

 
Graph 10: Evolution of the hourly productivity
 (2000-2002)

6

5

4

3

2

1

0

l

a
e
r
e
g
a
r
e
v
a

l

a
u
n
n
a

2
0
0
2
-
0
0
0
2

y
t
i
v
i
t
c
u
d
o
r
p

y
l
r
u
o
h
f
o
e
t
a
r
h
t
w
o
r
g

%

-1

50

EL

IE

UK

DK

US

FR

EU-15

FI

PT

JP

ES

SE

AT

DE

IT

NL

70

90

110

BE

LU

130

150

Level of hourly productivity in 2002 (PPS, EU15=100)

Source : Commission services.

The deterioration in EU labour productivity growth may be explained in
equal parts by slow-downs in investment and technological progress…

The productivity challenge is clear, with the EU’s long-established superiority
in terms of labour productivity growth having disappeared since the mid 1990s.
Half  of  the  decline  in  labour  productivity  growth  since  the  first  half  of  the
1990s  can  be  attributed  to  a  reduction  in  the  contribution  from  capital
deepening,  while  the  other  half  emanates  from  a  deterioration  in  total  factor
productivity.  Whilst  investment  in  ICT  was  contributing  positively,  its
contribution to labour productivity growth was only half of that in the United
States. The main reason for this was a lesser use and slower diffusion of these
technologies  in  certain  services  sectors,  including  in  particular  the  financial
services  and  distribution  sectors.  This  illustrates  the  need  to  raise  business
dynamism  and  investment,  particularly  in  ICT.  That  can  only  be  achieved
through  a  reform  strategy  aimed  at  improving  the  regulatory  environment,
promoting market integration and efficiency, stimulating the diffusion of ICT,
and boosting investments in human capital and R&D.

33

 
 
 
 
 
 
 
 
 
 
Table 3 : Spending on gross fixed capital formation, education and R&D in the EU
 (as a percentage of GDP)

Average
1991-1995

1996

1997

1998

1999

2000

2001

2002

2003

20.5

19.6

19.4

19.9

20.2

20.6

20.2

19.4

19.1

17.6

17.1

17.2

17.6

17.9

18.3

17.9

17.2

16.7

2.9

2.5

2.2

2.3

2.3

2.3

2.3

2.2

2.4

Total
investment

Private
investment

Public
investment

Education

R&D

0.7

5.2

0.7

5.0

0.7

5.0

0.7

5.0

0.7

4.9

0.7

5.1

Sources:  For  investments:  AMECO  DG  ECFIN  database;  for  public  spending  on  education:  Eurostat  but  2001  is
according to the COFOG classification; and for public spending on R&D: OECD.

…and recent developments in business investment and spending on IT,
R&D, and education are not very promising.

Due to business cycle effects, business investment as a percentage of GDP in
the  EU  declined  from  18.3 per  cent  in  2000  to  17.2 per  cent  in  2002,  see
Table 3. This produced a reduction in total gross fixed capital formation (from
20.6 per cent in 2000 to 19.1 per cent in 2003) in spite of the fact that public
investment has been quite stable (at 2.2-2.4 per cent of GDP) over recent years.
Expenditure  ratios  on  IT,  R&D,  and  education  showed  little  movement.
According  to  the  Commission’s  economic  forecast  (autumn  2003),  business
investment  should  recover  in  2004  and  2005,  provided  that  the  economic
framework conditions that encourage businesses to invest and grow have been
put in place. Recent efforts to ease the regulatory burden on business should be
helpful in that respect. Spending on IT should benefit as well from regulatory
reform.  A  cross-country  analysis  of  investment  rates4  reveals  that  countries
with low levels of regulation have in general been more successful in adopting
new technologies in the form of ICT investment.

Despite  its  many  successes,  the  Internal  Market  is  still  not  functioning  as  it
should.  After  years  of  steady  progress  throughout  the  1990s,  some  key
indicators  of  Internal  Market  integration  are  now  pointing  in  the  wrong
direction. Growth in trade amongst the EU Member States has almost stalled,
growing  by  less  than  3 per  cent  annually  over  the  past  three  years,  and  the

4 

European Commission (2003), “Drivers of productivity growth: an economy-wide and sectoral
perspective”, Chapter 2 in the EU Economy 2003 Review.

34

 
                                                
dispersion of price levels between Member States in 2001 did not differ from
that observed in 1998 or 1999.

Against this background, the 2003-05 BEPGs recommended Member States to:

9. 

10. 

11. 

12. 

13. 

foster competition in goods and services markets;

accelerate  the  integration  of  EU  capital  markets  and  ensure  consistent
enforcement  of  EU  rules  and  removing  barriers  to  efficient  cross  border
clearing and settlement;

generate a supportive environment for entrepreneurship and  for  SMEs  to
start-up and grow;

agree on and implement measures to strengthen corporate governance and
further improve arrangements at national and Community level to deliver
efficient cross-sector and cross-border cooperation in financial supervision
and financial crisis management;

take  active  steps to  promote  investment  in  knowledge,  new  technologies
and  innovation  and  make  progress  towards  the  3 per  cent  of  GDP
objective of total R&D investment;

14. 

enhance the contribution of the public sector to growth.

Mixed progress in fostering competition in goods and services markets…

A  regulatory  environment  that  is  conducive  to  investment  is  essential  to
make  the  EU  economy  more  competitive  and  dynamic.  Creating  a  well-
functioning  Internal  Market  with  an  effective  competition  policy  is  essential.
Since the launch of the Lisbon Strategy more than 25 legislative measures have
been  adopted  to  extend  the  reforms  in  these  areas  (including  the  tax  package
aimed  at  curbing  harmful  tax  competition),  but  a  number  of proposals
(including  directives  on  professional  qualifications  and  intellectual  property
rights)  remain  pending  before  the  Council  and  the  European  Parliament.  The
Commission issued new proposals for directives to eliminate further obstacles
to  the  Internal  Market  found  in  the  tax  regimes  applicable  to  associated
companies  located  in  different  Member  States;  to  further  simplify  and
streamline  VAT;  and  to  update  guidelines  and  financing  rules  for  trans-
European networks. It has  adopted a proposal for the establishment of a legal
framework  for  providing  cross  border  services  between  Member  States.

35

 
Significant Reform Measures in 2003
Adopted                                                                               Proposed

Box 4: Follow up to country specific recommendations related to product markets

Country Specific Recommendations (as an extension of general Guideline no. 9)

GUIDELINE 9: Foster competition in goods and services markets.
BE:  Enhance effective competition in network industries and in local services.

DK:  Enforce competition in sectors where it is inadequate.

DE:  Create a more competitive environment.

EL:  Enhance competition in the energy sectors.

ES:  Enforce effective competition in retailing and monitor developments on the electricity market.

FR:  Ensure competition in energy markets.

         Raise the transposition rate of Internal Market directives and reduce number of infringements.
IE:  Increase competition in network industries and certain other sectors.

IT:  Increase effective competition in the service sector, widen the opening of the energy markets,
        and improve the implementation of Internal Market directives.
LU:  Fully implement the reforms of the competition law and ensure that competition and regulatory
         authorities have sufficient independence, resources and power.
NL:  Improve the regulatory framework as well as its implementation.
AT:  Increase resources of the competition authority and enforce decisions of the telecom regulator.
PT:  Enhance effective competition in liberalised utilities and increase the transposition rate of
         Internal Market directives.

FI:  Enforce competition in network industries and non-tradable services.

Improvements in the role of regulatory authorities.
Further opening up to competition of network industries.
Electricity market fully liberalised.
Changes to legal framework for payment services and drinking cans.
Project to identify regulatory barriers to competition started.
Proposals to reform competition law.
Proposal to relax the law on unfair competition.
Introduction of a wholesale electricity market.
Removal of administrative barriers to entry into electricity market.
As of January 2003, customers are free to choose electricity supplier.
Legal basis to put in place a forward electricity market adopted.
Transposition of the Gas directive.
Opening up of energy market in line with EU directives.
Emergency plan to speed up transposition.
Reform of motor vehicle insurance partially complete.

Gas sector fully liberalised.

New legislation on public procurement.

Increased power will be given to the Dutch Competition Authority.
Resources of the competition authority marginally increased.
Approval of a plan to restructure the gas sector.
Elimination  of  long  term  purchase  agreements  between  electricity
generators and the electricity transmission company.
Increase in transposition rate Internal Market directives.
Number portability in mobile telephony.
Amendment of Electricity Act to make it easier to change suppliers.

SE:  Enforce competition in sectors where it is inadequate.

UK:  Improve competition in sectors like the professions, postal services and pharmacies.

Application of zoning and building legislation under investigation.
Project to increase cross-border competition in construction sector.
Rules  of  some  professional  bodies  amended  to  remove  unnecessary
restrictions of competition.

36

Proposals should become law in 2004.

The  completion  of  the  Spanish-Portuguese  electricity  market
is planned for 2004.
Legal separation management gas pipeline network in 2004.
In  electricity,  the  operation  of  the  transmission  grid  will  be
legally separated from power generation in 2004.
Competition  Authority  review  of  retail  sector  and  rules  of
professional bodies.
Proposals to reform professional services in Parliament.
Law reforming the electricity sector in Parliament
Law  to  abolish  present  legislation  on  fixed  and  regulated
prices and install an independent competition authority.

Further increases planned.
The  completion  of  the  Spanish-Portuguese  electricity  market
is planned for 2004.
Opening up of the retail market for electricity by 2004.

Reform of the Competition Restrictions Act.
Establishment of Competition Institute.
Proposals  on  reform  of  energy  network  pricing  and  on
enhancing competition in financial services reviewed.
New law on price information.
Proposals to raise competition in services and construction.
Slight relaxation of restrictions on pharmacies.

 
…particularly due to a lack of implementation of measures agreed

The  average  rate  of  transposition  by  Member  States  of  Internal  Market
directives  deteriorated  from  97.9 per  cent  in  2002  to  97.7 per  cent  in
November 2003, putting the target of 98.5 per cent (which is already overdue)
further  out  of  reach.  Only  five  Member  States,  Denmark,  Spain,  Ireland,
Finland, and the United Kingdom actually met the agreed target, while in five
other Member States - Belgium, Germany, Greece, France, and Luxembourg -
the transposition  rate even dropped  below 97 per  cent. Moreover, the number
of infringement cases related to the non-conformity or incorrect application of
Internal Market  law declined  only  slightly.  France  and  Italy  have  particularly
bad  records  in  this  respect.  Finally,  the  amount  of  cross  border  public
procurement remains very low, even if the share of call for tenders published in
the Official Journal has been rising. Germany continued to lag behind the other
Member States. Nevertheless, public procurement legislation appears to have a
positive effect on cross border transactions.5

Measures  have  been  taken  to  improve  the  effectiveness  of  competition
policies. At the Community level, the most notable step has been the adoption
by the Council of the new regulation on implementing the anti-trust rules. This
regulation  will  streamline  the  procedures,  improve  the  co-ordination  between
competition authorities and enhance the Commission’s powers of investigation.
Some Member States (incl. BE, AT, and the UK) have taken action to enhance
the  effective  independence  and  capabilities  of  their  competition  or  regulatory
authorities. The level of sectoral and ad-hoc state aid in the EU appears to have
stabilised at around 0.7 per cent of GDP.

Market opening in the network industries continues to progress, but does not
necessarily  guarantee  effective  competition.  Even  in  liberalised  markets,  the
market share of the incumbent often remains very high. In fixed telephony, for
example,  its  market  share  was  81 per  cent  for  local  calls  and  70 per  cent  for
long  distance  and  62 per  cent  for  international  calls  in  2002.  In  this  latter
market  segment,  the  market  shares  of  incumbents  were  relatively  high  in
Greece,  Luxembourg,  and  Portugal.  Nevertheless,  prices  of  long  distance  and
international calls continued to decline slowly. The new regulatory framework
for electronic communications, in force at the EU level since July 2003, aims at
enhancing competition and improving legal certainty.

5 

European Commission services working paper, Internal Market DG (forthcoming): A report on
the functioning  of  public  procurement  markets  in  the  EU:  benefits  from  the  application  of  EU
directives  and  challenges  for  the  future.  Almost  half  of  firms  seeking  a  public  procurement
contracts  did  so  across  borders,  most  of  them  via  subsidiaries  located  in  the  Member  State
publishing the call for tender. Moreover, the probability, that a bid  was  successful  was  similar
for domestic firms and foreign subsidiaries (30 per cent and 35 per cent respectively).

37

 
                                                
Contrary  to  telecommunications  prices,  electricity  and  gas  prices  show  no
clear downward trend. Electricity prices have experienced a general increase in
2003  due  to  low  rainfall  reducing  hydro-electric  output  and  extreme  weather
conditions.  However,  even  in  these  circumstances,  prices  are  still  no  higher
than  pre-liberalisation  levels  in  nominal  terms  and  much  lower  in  real  terms.
Nevertheless, in Belgium, Greece, France, and Ireland, the market share of the
largest  electricity  generator  was  still  at  90 per  cent  or  above  in  2001.
Meanwhile,  gas  prices  are,  on  average,  some  10 per  cent  lower  than  January
2001.  The  Council  adopted  a  number  of  pieces  of  legislation  in  2003  that
should  contribute  to  the  completion  of  market  opening  in  these  sectors.  The
Barcelona  European  Council  fixed  in  March  2002  the  target  of  reaching  by
2005  10 per  cent  electricity  interconnection  capacity  for  each  member  state
compared to the domestic installed production capacity. The progress towards
this target has been very slow, as there have been only minor capacity additions
in the recent years.

There  was  progress  at  Community  level  in  liberalising  rail  transport.  The
Transport  Council  reached  an  agreement  in  March  on  the  "2nd  railways
package",  opening  the  international  freight  market  by  January  2006,  and  the
cabotage  market  by  January  2008.  A  further  opening  of  the  international
passenger  market  is  still  being  debated  between  the  Parliament  and  the
Council.

The RCAP is almost, but not completely implemented as the deadline approached…

As  the  2003  deadline  for  implementation  of  the  Risk  Capital  Action  Plan
(RCAP) approached, considerable progress can be reported. Most of the RCAP
measures  have  been  completed.  Member  States  have  also  taken  steps  in
providing  an  environment  –  in  terms  of  administrative/legal,  regulatory,  and
fiscal  aspects  –  which  is  more  conducive  to  developing  the  risk  capital
industry.

Several  Member  States  have  undertaken  reforms  which  facilitate  institutional
investment  in  risk  capital. They include:  (i) the  creation of  a  new  category  of
closed-end collective investment undertakings dedicated to investment in non-
quoted  SMEs  (BE  and  LU);  (ii) some  facilitating  of  the  setting  up  or
functioning  of  venture  capital  companies  (ES  and  PT);  (iii) the  easing  of
quantitative constraints on  pension funds and insurance  company  investments
(DK  and  PT).  Some  further  types  of  distortions  have  been  removed  (e.g.
minimum  funding  requirements  in  the  UK),  while  others  may  still  impede
institutional  investment  in  risk  capital  (e.g.  liquidity  requirements  in  BE,  EL
and AT).

Insolvency  and  bankruptcy  rules  are  being  adjusted  in  some  of  the  Member
States (e.g. BE, FI, and the UK), with a view to minimise the disincentives to
entrepreneurial  risk  taking,  but  with  a  varying  outcome  regarding  the
remaining level of disincentives.  In other Member States, however, it appears

38

 
difficult to actually finalise reforms underway (e.g. DK, IT, and the NL). Most
of  the  Member  States  are  making  further  improvements  in  their  fiscal
frameworks for risk capital investment, whether by reducing corporate tax rates
(e.g. BE and DE), by reducing VAT compliance costs for SMEs (e.g. the UK),
or by introducing tax relief for venture capital investment (e.g. DE, ES, FR, IT,
PT, SE, and the UK). However, further progress seems necessary, most notably
in reducing the often substantial differences in national fiscal frameworks that
are faced by pan-EU operators.

…and good progress is made so far with the FSAP…

The end of the legislative phase of the Financial Services Action Plan (FSAP)
is  in  sight.    36  of  the  42  original  measures  are  now  finalised.  Progress
continues to be made on the few remaining proposals. An agreement has been
struck  between  Council  and  Parliament  on  the  text  of  a  new  take-overs
directive. Following Council agreement on the investment services directive, it
now remains to forge consensus with the European Parliament on a handful of
substantive issues. On the transparency directive, political settlement has been
reached in the Council. The EP is working on the basis of the Council text so
as  to  ensure  final  adoption  in  the  first  half  of  2004.  3  FSAP  measures  must
await the reformation of the EP before the legislative process can be brought to
a  conclusion.  Amongst  these  is  the  proposal  for  a  new  directive  on  capital
adequacy. This is linked to the finalisation of Basel II Accord, now scheduled
for mid-2004.

Alongside conclusion of the FSAP agenda, the Commission will launch work
on  initiatives  foreseen  in  the  Communication  on  company  law  and  corporate
governance  (including  a  proposal  for  the  modernisation  of  EU  legislation  on
statutory  audit).  Elsewhere,  the  Commission  will  take  forward  work  on
important prudential legislation relating to reinsurance and insurance solvency.

A key adjunct to the FSAP has been the creation of structured arrangements for
national regulatory and supervisory authorities to participate in the formulation
and  consistent  implementation  of  EU  financial  legislation  ("Lamfalussy"
approach).  This  approach  has  been  successfully  road-tested  in  the  securities
sector.  The Commission has recently proposed  to  extend  this  approach  to  the
banking, insurance  and  UCITS  fields. The increased transparency and  greater
collective  dimension  in  performance  of  supervision  is  the  key  to  more
consistent and effective enforcement of financial regulation in an enlarged EU
financial marketplace.

As  the  legislative  phase  of  the  FSAP  draws  to  a  close,  the  Commission  has
launched  a  comprehensive  assessment  of  the  state  of  integration  of  EU
financial  markets.  This  is  not  a  prelude  to  a  comprehensive  new  legislative
programme.  It is an attempt to identify successes and failures  of  the  evolving
EU legislative framework and to draw lessons from the FSAP experience. As a
first  step,  four  expert  groups  in  the  fields  of  banking,  insurance,  asset

39

 
management, and securities will assess the extent to which the EU  legislative
framework  enables  financial  institutions  to  organise  their  business  on  a  pan-
European  basis.  The  output  from  these  groups  will  be  submitted  to  public
scrutiny and high-level public debate before being consolidated in late 2004.

Elsewhere, a sub-group of the newly created Financial Services Committee has
been  tasked  with  establishing  a  shared  assessment  of  Member  States  of
remaining  priorities  for  financial  integration.  They  will  report  to  European
Finance Ministers in mid-2004.

…while the cross-border clearing and settlement is still to become more
integrated

The Commission is also anxious to take forward the policy debate on the value
of / need for collective EU-level action in the areas of clearing and settlement
–  but  also  for  cash  transfers  and  payment  systems  (the  Commission  has
recently launched a Consultation Communication  on  cross-boarders payments
with  an  end-January  2004  deadline).  Integration  of  clearing  and  settlement
arrangements has become a clear priority for action at both the EU and national
levels. Following up on the second report of the Giovannini Group of financial
market  experts  from  April  2003,  the  Commission  will  shortly  come  forward
with  a  Communication  formulating  a  strategy  for  removing  barriers  to  an
integrated EU clearing and settlement system.

the  EU  clearing  and  settlement
in 
Restructuring  and  consolidation 
infrastructure has also continued in 2003 at the national level (DE, EL, and IT).
The  process  of  consolidation  and  restructuring  within  EU  stock  exchanges
accelerated.  An  integrated  Nordic-Baltic  market  for  trading,  clearing  and
settlement  of  securities  was  created  by  the  merger  of  the  Stockholm  and
Helsinki  stock  exchanges,  with  the  merged  entity  maintaining  a  strategic  co-
operation  with  the  Copenhagen,  Oslo  and  Iceland  stock  exchanges  within
NOREX. Italy’s MTS continued to expand internationally, providing a widely
accepted  infrastructure  for  bond  trading.  In  2003,  Euronext  (comprising  the
Belgian,  French,  Netherlands  and  Portuguese  stock  exchanges  together  with
the  UK-based  Liffe  derivatives  market)  expanded  further  via  an  agreement
with the Warsaw stock exchange.

In spite of recent improvements, the business environment in the EU
continues to be hampered by some weaknesses

Businesses’ perceptions of the administrative burden in 2003 remained quite
negative  in  many  Member  States  and  particularly  so  in  Belgium,  Germany,
France and the Netherlands.6 Also, the percentage of 18-64 year-olds involved

6 

European Commission (2003): survey reported in the Enterprise Policy Scoreboard 2003, ENSR
(European Network for SME Research).

40

 
                                                
in entrepreneurial activity remains below that in the United States. According
to  this  measure,  entrepreneurial  activity  is  particularly  weak  in  Belgium  and
France.  The  rate  of  enterprise  creation  is  relatively  low  in  Belgium,  Finland,
and Sweden (see Graph 11).

Graph 11: Gross birth rate of enterprises in 
% of enterprise population (2000)1

LU

DK

ES

NL

UK

IT

PT

FI

BE

SE

0

5

10

15

%

1 Number of real enterprise births divided by the 
population of active enterprises.
Source : Commission services.

Differences  in  entrepreneurship  between  countries  may  be  explained  by
many factors. An often-mentioned factor is ease of access to finance. The most
commonly used indicators of access to finance – equity finance, venture capital
and  initial  public  offerings  –  tend  to  be  strongly  influenced  by  the  business
cycle. Venture capital, in particular, has suffered greatly from the slowdown in
economic  growth.  In  spite  of  the  different  measures  taken  to  encourage
investment  in  risk  capital  (see  Section  on  the  RCAP),  early-stage  venture
capital investment levels in 2002 were only half or less of their 2000 levels in
many  Member  States.  Greece,  Finland,  and  Sweden  were  exceptions.
Moreover,  investment  shifted  from  the  seed  segment  to  more  mature
investments.

41

 
Box 5: Follow up to country specific recommendations related to product markets and knowledge based economy
Country  Specific  Recommendations  (as  an  extension  of  general
Guidelines no. 11, 13 and 14)
GUIDELINE 11: Generate a supportive environment for entrepreneurship and for SMEs to start-up and grow.
BE: 
administrative burden for companies.

  Improve  public  administration  and  pursue  the  reduction  of

Significant Reform Measures in 2003
Adopted                                                                               Proposed

DE:  Reduce the regulatory and administrative burden.

EL:    Simplify  the  business  and  taxation  environment  and  raise  the
transposition rate of Internal
         Market directives
ES:  Reduce the administrative burden on business.
FR:  Reduce and simplify business regulations.

IT:  Reduce the administrative burden on business.
LU:    Encourage  the  creation  of  SMEs  and  help  those  to  access  venture
capital.

Further  streamlining  and  acceleration  of  administrative
procedures,  including  decrease  of  the  time  and  costs  of
administrative obligations for companies and simplification of
procedures to start a new company.
Proposal to bring forward third stage of tax reform.

80 new ‘One-Stop-Shops’ over the coming two years.

Reform of bankruptcy law.

Simplification and centralisation of information on companies.
Provision of loan guarantees to SMEs.
Extension  of  electronic  interactive  applications  in  the  field  of  VAT
returns and social security obligations.
Government initiative to reduce bureaucracy and over-regulation.
Various measures to encourage enterprise creation.
Measures to reduce bureaucratic and legal obstacles to start-ups.
Simplification of tax system and particularly tax audit procedures.

initiative 

law  has  been  adopted 

Simplified legal framework for SMEs. 11 new ‘One-Stop-Shops.
(reduction  of
Economic 
administrative  burden,  reduction  of  time  and  costs  required  for
company start-up, improved access to capital).
Simplified administrative procedures for company start-ups..
Streamlining of data required to start up a business.
Public-private joint venture to better SMEs’ access to venture capital.
Actions in schools to promote entrepreneurship.

42

 
Box 5: Follow up to country specific recommendations related to product markets and knowledge based economy (continued)
Country Specific Recommendations (as an extension of general Guidelines no. 11,
13 and 14)
GUIDELINE 13: Take active steps to promote investment in knowledge, new technologies and innovation and make progress towards the 3% of GDP objective of total R&D investment.
DE:  Reform education and training system.

Significant Reform Measures in 2003
Adopted                                                                               Proposed

EL:  Increase the availability of skilled human capital, promote business involvement
in R&D and
         innovation, and improve ICT diffusion.
ES:    Increase  skilled  human  capital,  investments  in  R&D  and  innovation,  and  ICT
diffusion.
IE:  Prioritise roll-out of infrastructure and raise the level of R&D.

IT:  Raise the education and skill base of the population; increase investment in R&D
and innovation;
        promote ICT take up, in particular through measures targeted at SMEs.

NL:  Promote technology oriented education and strengthen science-industry links.

AT:  Encourage business research and innovation, especially for SMEs.

PT:    Promote  stronger  involvement  of  the  business  sector  in  R&D,  innovation  and
ICT.
Improve the efficiency of spending in education.

UK:  Monitor closely existing measures to promote R&D.
          Review  and  strengthen  policies  aimed  at  improving  basic  skills  in  the  work
force.
GUIDELINE 14: Enhance the contribution of the public sector to growth.
DK:  Increase the efficiency of the public sector.

FI:  Increase the efficiency of the public sector.

Introduction of training vouchers.
Tests for on-the-job trainers no longer obligatory.
Development of IT in schooling and vocational training.
Initiatives supporting the establishment of spin-off firms.
Educational reform programme.
Promotion  of  human  capital  development  and  support  programmes
for SMEs focused on R&D and technological investments

Reform of primary and secondary education system.
Creation of new fund for technological innovation projects.
Actions to encourage a more intensive use of ICT among companies
and households and schools.
Innovation Council has been created to stimulate innovations by the
private sector.

Tax allowance for innovation expenditures.
Strategic R&D partnership projects with Central and Eastern Europe.
Revision of legal framework for venture and risk capital investments.
Tax deduction for investment in R&D
Financial compensation for hiring technologically educated staff.
Actions to promote the use of ICT in academia and the public sector.
Educational reform programme.

Boost  supply  of  all-day  schools  and  develop  education
standards.

Plan to promote the development of the information society.
Plan to stimulate business R&D expenditures.
Government  spending  on  R&D  and  innovation  to  be
increased. New tax credit to promote business R&D.

Measures  to  increase  the  intake  into  science  and  technology
courses,  bringing  focus to  scientific  research,  and  improving
co-operation between research organisations and business.
Plan to streamline public support for R&D and innovation.

A number of new training measures announced.

Government Action Plan to increase the efficiency of public sector.
Opening up of market for elderly care.
Basic education reform
Launch  of  Productivity  Action  Programme 
administration.

to  reform  public

Reform of National Procurement Act.
Set-up of advisory service point for public procurement.
Introduction of vouchers for social and health care services.

SE:  Increase the efficiency of the public sector.

Municipal benchmarking database publicly available.

43

 
the  European  Charter  for  Small  Enterprises 

However,  many  other  business  framework  conditions  have  shown  a  gradual
improvement (time and costs of setting up a company, internet penetration, e-
government,  corporate  tax  system,  etc.),  and  progress  towards  meeting  the
recommendations  of 
is
encouraging. Several Member States have taken or implemented new measures
aimed at reducing red tape and easing business start-ups (notably BE, DE, EL,
ES, FR, LU,  and AT).  In addition, governments are increasingly turning their
attention  to  shaping  tomorrow's  entrepreneurs  and  have  stepped  up  efforts  to
develop  entrepreneurial  skills  in  education.  Member  States  with  programmes
that  support  the  teaching  of  entrepreneurial  skills  in  primary  schools  now
include Ireland, Luxembourg, Finland, Sweden, and the UK.

Investment in knowledge and innovation is lagging, even if…

There  remains  a  substantial  gap  between  the  EU  and  the  USA  in  terms  of
innovative  capacity  as  measured  by  the  availability  of  venture  capital,  R&D
intensity,  the  number  of  patent  applications  and  IT  expenditures  (see
Graph 12).  Nevertheless,  the  formation  of  the  European  Research  Area  will
create an internal market for research which should contribute to achieving the
Lisbon Strategy Goals. Moreover, Member States have unanimously endorsed
the Barcelona target of increasing investment in R&D to approach 3 per cent of
GDP  by  2010,  and  a  vast  majority  of  them  have  defined  national  targets.    In
April 2003, the Commission put forward an Action Plan aimed at achieving the
Barcelona  target,  taking  into  account  that  two  thirds  of  the  additional
investment is supposed to be financed by the private sector; this in light of the
fact that the bulk of the R&D gap, and most of its increase in recent  years, is
due to  lower funding by  the private  sector.  In Sweden and  Finland,  however,
R&D  expenditures  as  a  percentage  of  GDP  are  above  that  in  the  USA  and
rising rapidly. Greece, Ireland, the Netherlands, and the UK, on the other hand,
have witnessed  a  decline in R&D spending  as  a percentage of GDP  in  recent
years. Even more worrying  is the observation  that companies  in certain high-
technology  and  research-intensive  sectors  such  as  pharmaceuticals  or
biotechnology are conducting a growing share of their research outside Europe,
especially in the US, in order to take advantage of more favourable regulatory
or other framework conditions. Still pending decisions on intellectual property
rights, including a legally secure and affordable Community patent are just an
example of what appears to be missing.

All  Member  States  have  decided  to  take  an  active  part  in  applying  the  open
method of coordination in support of the Barcelona targets. Various measures
have  been  taken  to  stimulate  R&D  and  innovation.  For  example,  Belgium,
Portugal,  and  the  UK  have  extended  tax  credits  for  R&D  and  innovation
expenditures and Ireland has introduced them in the budget for 2004; Belgium,
Germany, Ireland, and Italy have opened up new sources of funding for R&D
and  innovation;  Ireland  and  the  Netherlands  have  taken  measures  to  improve
the cooperation between research and business; Greece is supporting university

44

 
spin-offs; and Denmark and the Netherlands are making an  effort to  raise  the
number of university graduates in science and technology.

Graph 12: The EU/US gap in knowledge-based economy is 
large and persistent

Venture capital - early stage - relative to gdp

Venture capital - expansion and replacement - relative
to gdp*

High tech Patents EPO (per million inh)

Total R&D expenditure (GERD, % gdp)*

IT expenditure (% gdp)

Percentage of GERD financed by industry

Patents EPO (per million inh)

2000
2001

-100% -80% -60% -40% -20%

0%

Current EU-US gap

* 2002 data.
Source : Commission services (incl. structural indicators on Research and Innovation).

…the development and use of key technologies in Europe is progressing

The  fact  that  there  are  large  differences  between  the  research  efforts  of  EU
Member  States  may  not  be  a  problem  as  such,  as  long  as  the  results  of  the
R&D  efforts  are  spread  widely  and  knowledge  is  transferred  into  innovation
across  Europe.  Knowledge  diffusion  is  as  important  an  element  of  the  EU
innovative  capacity  as  is  investment  in  research  and  development.  Studies
indicate  that  only  15 per  cent  of  knowledge  is  gathered  outside  the  region  of
origin and only 9 per cent outside the country of origin in North America and
Western  Europe.  In  its  Action  Plan  “Investing  in  research”  the  Commission
supported public-private partnerships and introduced the  concept  of European
Technology Platforms, which are aimed at furthering the development and use
of  key  technologies  in  Europe  through  improved  science-industry  links.  In
addition,  the  Commission  intends  to  propose  a  directive  permitting  entry  and
stay  of  third  country  researchers,  which  should  help  facilitate  researcher
mobility.

Deployment  of  the  Galileo  satellite  navigation  system  is  now  planned  for
2006-2007 with a start of operations in 2008. The Galileo joint undertaking has
started operation in  June  2003  and  international commercial interest  has fully
consolidated it as a global project. Moreover, the eEurope Action Plan has been
instrumental  in  raising  Internet  access  and  use.  The  percentage  of  EU
households  with  internet  access  at  home  rose  to  50 per  cent  in  2003.  In

45

 
addition,  84 per  cent  of  enterprises  with  more  than  9 employees  had  internet
access  in  2003,  which  was  a  five  percentage  point  increase  over  the  previous
year.    In  comparison  with  the  year  before,  the  broadband  internet  access  rate
per 100 EU inhabitants in October 2003 almost doubled to 5.2 per cent, but this
was still less than the level reached by the US (8.1 per cent) in July 2003. The
highest  broadband access rates in the EU  can  be  found  in  Denmark  (11.2 per
cent),  Belgium  (11.1 per  cent),  the  Netherlands  (10.1 per  cent)  and  Sweden
(9.0 per cent).

Corporate governance strengthened at national and at community level…

A  series  of  high-profile  corporate  scandals  in  both  the  United  States  and
Europe undermined investor confidence in the integrity of financial markets. It
focused  the  attention  of  policymakers  on  the  need  to  reinforce  existing
corporate  governance  arrangements.  The  Commission  presented 
two
Communications  on  company  law  and  corporate  governance  in  May  2003.
These Communications provide an Action Plan, comprising a balanced mix of
legislative  and  non-legislative  initiatives  and  combining  harmonisation  of  a
few essential rules with closer co-ordination between national codes.

Several  Member  States  have  proceeded  with  strengthening  corporate
governance  arrangements  at  the  national  level  also,  either  by  establishing  a
voluntary self-regulatory corporate governance code (e.g. AT and the UK), by
introducing in company laws measures to improve corporate  governance (e.g.
EL, IE, IT, and NL), or by strengthening auditors’ independence (e.g. FR).

…and financial supervision strengthened

for  cross-border  supervision,  notably 

In  September  2003,  the  Ecofin  Council  reviewed  the  implementation  on
financial  supervision  and  on  financial  crisis  management.  The  Council
concluded  that  further  progress  has  been  made  in  improving  the  institutional
through  enhanced
arrangements 
procedures  for  information  exchange.  A  further  review  will  be  carried  out  in
September  2004.  Meanwhile,  the  extension  of  the  Lamfalussy  arrangements
should further encourage cross-border co-operation in financial supervision and
crisis management, as well as facilitating convergence in supervisory practices
between the Member States.

At  the  national  level,  several  Member  States  carried  on  the  restructuring  of
supervisory structures in 2003. In France, supervisory authorities for securities
have  finally  been  regrouped,  insurance  and  banking  authorities  have  been
streamlined,  and  the  law  on  financial  safety  has  been  modernised.  In  other
Member States, reforms of the national regulatory and supervisory authorities
included various measures. They include the establishment of new supervisory
boards  for  the  integrated  institutions  (BE),  the  transfer  of  capital  market
regulatory  authority  from  the  exchanges  and  the  Ministry  of  Economy  and
Finance  to  the  supervisory  authority:  Hellenic  Capital  Market  Commission

46

 
(EL),  legislation affording the Government emergency  powers  to  regulate  the
financial  sector  in  exceptional  circumstances  (FI),  regulatory  measures  to
strengthen  financial  supervision  of  the  insurance  industry  (PT),  consolidating
financial regulation into a uniform cross-sector law for financial services (DK),
and  adjusting  the  legislation  to  the  new  functional  approach  of  supervision
(NL).

Member States are making an effort to improve the quality and efficiency of
their education and training systems

There are clear signs of efforts to improve quality and efficiency in education
and  training  in  several  countries  (e.g.  BE,  DK,  ES,  IT,  PT,  FI  and  SE).  In
Spain, for example, a basic law on the quality of education has been adopted,
while  in  Sweden  a  new  vocational  training  system  has  been  put  into  place.
While some Member States are concentrating on in-company lifelong learning,
others are more focused on improving basic skills and second chance schemes
for  adult  education.  Nevertheless,  the  lack  of  quality  and  attractiveness  of
vocational  training  remains  a  serious  cause  for  concern.  Moreover,  there  is  a
risk of a serious shortage of teachers and a need for an increase in the supply of
scientists,  technicians,  engineers  and  business  graduates.  Finally,  the  level  of
private funding of higher education is only a small fraction of the level attained
in  the  US.  To  address  these  problems,  the  Commission  proposes  a  series  of
measures  that  are  described  in  its  November  2003  Communication  entitled
“Education  and  training  2010,  the  success  of  the  Lisbon  strategy  hinges  on
urgent reforms”.

Initiatives have been taken to enhance the contribution of the public sector to
growth

the  economic  slowdown,  public 

The European initiative for growth, which was launched in October 2003 and
endorsed by  the European Council  in December,  aims to  mobilise  public  and
private  funds  to  finance  certain  infrastructure  and  R&D  projects  that  have  a
truly  European  scale.  The  Council  reached  a  political  agreement  that  up  to
20 per cent of the trans-frontier infrastructure projects’ costs could come from
the  EU  budget.  Despite 
investment
expenditures  have  been  stable  around  2.3 per  cent  of  GDP.  However,
differences  are  noticeable  across  Member  States,  where  the  investment  ratios
vary  from  around  1½  per  cent  of  GDP  (in  BE,  DK,  DE,  AT  and  the  UK)  to
3 per cent or more (in EL, ES, FR, IE, LU, NL, PT, and SE). In general, public
expenditures on education as a share of GDP declined slightly in recent years,
in  part  due  to  demographic  factors,  while  public  spending  on  R&D  has  been
stable around 0.7 per cent of GDP. Member States have taken various measures
to  encourage  the  development  of  public-private  partnerships,  the  adoption  of
new  technologies  in  government  and  competition  in  public  procurement,
particularly  through  an  increased  use  of  ICT  tools.  In  addition,  statutory
corporate tax rates have been sharply reduced in many Member States over the
past  couple  of  years,    accompanied  by  measures  that  broadened  the  tax  base

47

 
leading  to  less  dispersion in the  tax burden on  corporations between  Member
States.

Graph 13: Public investments in EU Member States in 
2003

P
D
G

f

o
%

6

5

4

3

2

1

0

  BE    DE   EL     ES    FR    IE     IT     LU    NL    AT    PT    FI   EU-
12

  DK    SE    UK  EU-
15

Source : Commission services.

investment 

is  expected 

Another way of strengthening the contribution of the public sector to growth is
towards  growth-enhancing  cost-effective
through  redirecting  spending 
investments  in  physical  and  human  capital.  As  a  share  of  total  public
expenditure,  public 
increase  modestly  by
0.3 percentage points in the EU in 2003. More marked increases can be noted
for  Spain,  Italy7  and  the  UK,  while  the  share  is  expected  to  decline  by
0.6 percentage points or more in Ireland8 and Finland. The expected increase in
the share of the EU’s public spending on investments is a positive step towards
improving its growth capacity and securing “value for tax payers’ money”. Not
least, since interest payments are expected to increase in some Member States
as  a  consequence  of  the  deterioration  of  budgetary  positions  (in  e.g.  DE  and
FR) thereby crowding out other expenditures.

to 

Social  transfers  will  continue  to  represent  by  far  the  largest  share  of  public
expenditure in the EU (see Table 4). However, levels and developments differ
across  Member  States  (where  they  are  likely  to  increase  by  more  than
1 percentage point in BE, NL, PT and SE, while they will decline in the UK by
almost as much).

7 

8 

The increase in public investments in Italy is  mostly  an  accounting  effect,  resulting  from  the
marked decrease in sales of public-owned real assets compared to the previous year.
Despite the recent reduction, Irish public investment still corresponded to around 4 per cent of
GDP in 2003, thereby remaining one of the highest investment ratios in the EU.

48

 
 
 
 
                                                
Table 4 : Composition of public expenditure in 2003 (as a percentage of total public expenditure) 

Purchases of 
goods and 
services1 

Compensation 
of employees 

Subsidies 

Interest 

Investment2 

Others 

Social 
transfers 
other than 
in kind 
32.7 
32.8 
40.7 
36.2 
30.7 
34.7 
25.5 
35.9 
34.8 
26.3 
37.3 
29.5 
35.4 
31.2 
31.9 
35.7 

20.8 
16.2 
23.3 
8.5 
19.0 
20.1 
20.5 
16.8 
20.3 
30.2 
17.7 
13.1 
17.5 
20.1 
30.0 
20.5 

BE 
DK 
DE 
EL 
ES 
FR 
IE 
IT 
LU 
NL 
AT 
PT 
FI 
SE 
UK 
Euro 
area 
EU-15 
21.9 
1 Government consumption expenditure net of compensation of employees. 
2 Gross fixed capital formation, concerns physical capital. 

23.2 
32.5 
16.2 
26.0 
25.5 
26.0 
25.9 
22.5 
18.8 
22.6 
18.9 
32.4 
28.5 
27.9 
19.1 
22.0 

22.0 

34.9 

3.1 
3.9 
2.9 
0.3 
2.8 
2.4 
2.3 
2.1 
3.8 
3.0 
6.0 
3.2 
2.9 
2.6 
1.6 
2.7 

2.5 

11.0 
6.2 
6.5 
13.3 
6.3 
6.0 
4.3 
11.0 
0.3 
6.2 
6.9 
6.2 
4.4 
4.5 
4.8 
7.4 

6.9 

3.0 
3.0 
3.2 
8.6 
8.8 
5.8 
11.8 
5.5 
10.7 
7.1 
2.4 
7.2 
5.5 
5.5 
3.5 
5.3 

4.9 

6.2 
5.4 
7.2 
7.0 
7.0 
5.0 
9.7 
6.3 
11.4 
4.5 
10.8 
8.4 
5.7 
8.2 
9.0 
6.4 

6.9 

Total 
spending 
as a share 
of GDP 
51.2 
55.5 
49.1 
46.3 
39.8 
54.7 
34.8 
48.5 
48.0 
48.5 
51.4 
47.1 
50.9 
59.0 
42.8 
49.0 

48.4 

Source : Commission services. 

Although  additional  steps  have  been  taken,  enforcement  of  budgetary  rules
and procedures could be enhanced at the national level

In  2003  Member  States  continued  to  apply  national  budgetary  rules  and
procedures in order to improve efficiency and control. However, as shown by
the  Commission  Report  "Public  Finances  in  EMU  -  2003"  there  are  large
variations  in  the  kind  of  fiscal  rules  adopted  and  implemented  across  EU
Member  States.  All  countries  have  targets  for  the  upcoming  and  subsequent
years  in  so-called  multi-annual  budget  plans.  Some  Member  States  target  the
budget  balance,  while  others  set  expenditure  limits.  Nevertheless,  the
deterioration  of  budgetary  positions  in  respect  to  targets  indicates  that  the
enforcement  of  the  rules  in  many  cases  is  weak.  The  mechanism  to  control
public  spending  at  sub-national  level  also  remains  a  key  issue  for  some
Member States.

A  number  of  Member  States  have  recently  improved  the  budgetary  process
somewhat. In Spain the General Law on Budgetary Stability, which came into

49

 
 
 
 
 
force in 2003, requires that all the general government sub-sectors should show
a  surplus  or  balanced  budget  in  nominal  terms  every  year.  In  Portugal  the
Budgetary  Stability  Law,  which  is  effective  from  2003,  sets  more  stringent,
although  temporary  limits  to  net  borrowing  across  all  levels  of  general
government. Austria adopted this year a budget law which implies a cut in the
ministries’  budgetary  envelops  by  5 per  cent  across-the  board  compared  with
the  budget  2002.  Also,  Finland  has  reformed  its  spending  limits.  A  multi-
annual  budget  plan  covering  the  election  period  has  been  introduced.  The
spending  limits  cover  ¾ of  the  central  government’s  budget  expenditure,
including  supplementary  budgets.  Budgetary  items  sensitive  to  the  business
cycle  and  interest  payments  on  the  general  government  debt  are,  however,
excluded.

Full assessment of efficiency in public sector not yet possible

The composition of public expenditure does not change much from one year to
another.  In  particular,  it  takes  time  for  public  consumption  to  adapt  to  new
legislation, changes in the demographic structure of the population, or changes
in  welfare  functions.  For  this  reason,  it  is  difficult  to  assess  progress  in  the
composition  of  public  spending.  In  addition,  the  lack  of  timely  and
comprehensive  data  hampers  a  thorough  assessment  of  the  quality  of  public
expenditure.  Moreover,  the  impact  of  public  expenditure  on  economic  and
social  goals  is  difficult  to  assess.  Expenditure  efficiency  relates  to  the  links
between  inputs  (mainly  money,  but  not  solely)  and  output.  A  proper
assessment would require better information, notably on measures of the input
(policies  and  expenditure)  and  output  (objectives  met),  and  a  detailed
microeconomic assessment of specific policies.

National  fiscal  rules  can  also  contribute  to  enhance  the  quality  of  public
spending and to the compliance with the EU fiscal framework. Again, a proper
evaluation requires a longer observations period. Nevertheless, in many cases it
would be  useful to strengthen the  enforcement mechanisms: experiences  with
fiscal  policy  rules  in  different  countries  indicate  that,  without  an  effective
enforcement and sanction system, rules often turn out to be ineffective in term
of ex-post outcome.

2.3

Strengthening sustainability

2.3.1

Economic  sustainability:  ensuring  the  long-run  sustainability  of
public finances

Since 2000, the average public debt ratio in the EU has not declined

The  sustainability  of  public  finances  in  view  of  the  ageing  population  is  far
from secured in about half of the Member States (notably BE, DE, EL, ES, FR,

50

 
IT, and PT)9. As a whole, the average government debt to GDP ratio in the EU
has not declined between 2000 and 2003 and thus remains at 64.1 per cent of
GDP  (70.4 per  cent  of  GDP  in  the  euro  area).  However,  the  situation  differs
substantially across Member States (see Graph 14). The debt ratio declined in
most  Member  States  during  the  period  2000-2003,  in  particular  in  Belgium,
Greece,  and  Spain,  while  it  rose  in  Germany,  France,  and  Portugal.  Despite
recent  improvements,  the  debt  ratios  continue  to  be  above  60 per  cent  in  six
Member States (BE, DE, EL, FR, IT and AT), where it is very high or above
100 per cent of GDP in Belgium, Greece, and Italy.

Graph 14: Debt ratio

2000

2003

120

100

80

60

40

20

0

  BE     DK     DE  

  EL  

  ES     FR  

  IE  

  IT  

  LU  

  NL  

  AT  

  PT  

  FI  

  SE     UK   EU-
12

EU-
15

Source : Commission services (structural indicator no. g).

Both the size and age structure of the EU’s  population will  undergo  dramatic
changes  over  the  coming  decades.  Its  working-age  population  is  projected  to
decline very significantly, from 243 million in 2000 to 203 million in 2050, a
drop of 40 million persons or 18 per cent. At the same time, the population of
older persons above 65 years will increase by 40 million persons to 103 million
in 2050, an increase of over 60 per cent.

The  demographic  developments  have  a  significant  impact  on  two  important
elements.  First,  most  Member  States  project  the  long-term  rate  of  economic
growth to be lower than 2 per cent, also due to the contraction of the number of
active  people.  Second,  there  will  be  a  pressure  for  higher  public  expenditure
due to ageing population over the next 15 to 20 years.

Against this background, the 2003-05 BEPGs recommended Member States to:

9 

This  is  based  on  the  sustainability  assessment  of  the  2003  updated  programmes,  except  for
Germany  and  Spain  where  the  assessments  should  be  considered  as  provisional  since  they  are
still ongoing.

51

 
                                                
15. 

16. 

ensure a further decline in government debt ratios;

design, introduce and effectively implement reforms of pension systems.

A stronger commitment to reduce debt ratios needed in several Member
States

The Commission’s economic forecast (autumn 2003) show that the debt ratio
declined in most Member States in 2003. Six Member States, namely Belgium,
Germany, Greece, France,  Italy and Austria, are expected to have a debt ratio
above  60 per  cent  of  GDP  in  2003  and  2004.  The  debt  ratio  is  expected  to
continue to decline in Belgium, Greece, and Austria, to stabilise in Italy, while
it continues to increase in Germany and France in the coming two years.

There would appear to be a need for stronger commitment to reduce debt ratios
in  several  Member  States,  not  least  those  with  very  high  government  debt
ratios. The current trends do not show a satisfactory rate of reduction that could
bring debt ratios below the 60 per cent of GDP reference value before the full
impact  of  ageing  takes  place  in  15  to  20  years.  In  addition,  the  unfavourable
development  noted  in  some  Member  States  where  debt  ratios  are  raising  in
recent years is a source of concern.

The pace of pension reform has accelerated in the EU and important pension
reform measures have been adopted in some Member States

Eight  Member  States  received  country  specific  recommendations  concerning
the reform of  their pension systems (BE, DE,  EL,  ES,  FR,  IT,  AT,  and  PT).
Significant  progress  has  been  made  in  several  Member  States.  France  and
Austria  adopted  major  reforms  in  2003  that  are  an  important  step  towards
securing more sustainable pension systems. Germany and Portugal introduced
some changes aiming at improving the financial balance of their public pension
schemes  and  facilitating  the  development  of  supplementary  private  pension
schemes.  Greece put in place the operational reorganisation of social  security
funds  enacted  in  2002.  In  Germany  the  public  debate  has  continued  on  the
basis  of  a  report  of  the  ‘Commission  for  Sustainability  in  Financing  the
German Social Insurance System’, and the Italian government tabled a reform
proposal.

Some  progress  towards  tackling  the  budgetary  consequences  of  ageing
populations on public pension schemes

France enacted a gradual increase in the number of contribution years entitling
to  a  full  pension  and  modified  the  indexation  mechanism  from  wages  to
consumer prices to tackle budgetary consequences.  Moreover, private  sector
employees  will  have  to  pay  higher  social  contributions,  compensated  by  a
symmetric  decrease  in  unemployment  contributions.  Austria  has  enacted  the
gradual extension of the  reference period for calculating  pension  benefits  and

52

 
will  also  gradually  lower  the  yearly  accumulation  rate  for  pension  rights.
Portugal  extended  the  contribution  period,  increased  the  basic  pension
calculation  period,  and  linked  the  benefits  growth  to  the  rate  of  growth  of
wages  net  of  contributions.  According  to  the  Italian  government’s  proposal,
eligibility conditions are to be tightened and the minimum retirement age is to
be increased.

Both  France  and  Germany  have  initiated  reforms  that  address  demographic
risks.  France  has  implemented  a  rule  linking  the  contribution  period  required
for entitlement to a full pension to the increase in life expectancy. In Germany ,
the gradual raising of the retirement age and the link between benefits and the
system dependency ratio through an indexation rule have been proposed.

Reforms  address  interaction  of  pension  systems  with  labour  market
performance

More transparency and better incentives to take  up  work  have  been  sought  in
several Member States to improve the interaction between the pension system
and  labour  market  performance  in  several  respects.  As  part  of  efforts  to
strengthen  the  link  between  contributions  and  entitlements,  the  Austrian
government  intends  to  harmonise  all  pension  insurance  systems  and  establish
an  integrated  uniform  pension  system:  it  is  also  considering  establishing
individual  retirement  accounts.  In  Italy,  the  government  plans  to  reduce  the
contribution  rate  to  the  public  pension  scheme  for  newly  hired  employees.
Greece proceeds with moves towards a uniform social security system with the
single  managing  body,  where  uniform  terms,  conditions  of  entitlement  and
method of pension calculation for all wage-earners is going to be introduced.

Raising  the  employment  rates  of  older  workers  will  require  removing
incentives to withdraw early from the labour market and providing  incentives
to  prolong  working  lives.  In  Austria,  early  retirement  schemes  will  be
gradually  abolished.  Both  French  and  Austrian  reforms  have  strengthened
financial  incentives  for  the  employees  to  remain  active  after  having  obtained
the right to retire. In France, incentives have been offered to the employers to
hire elderly workers as well as to discourage employers from dismissing them
or obliging them to retire. The French reform made it easier to receive both a
pension  and  a  supplementary  income  from  employment.  An  increase  in  the
statutory retirement age has been proposed in Germany,  while  the  Italian  and
Portuguese governments have proposed methods to calculate seniority pensions
which penalise early retirees.

But more analysis required on long-term impact of the reforms

The  long-term  impact  of  reforms,  including  the  financial  impact,  depends
notably on the length of the transition periods, which are necessary in order to
ensure a smooth adjustment process and in view of the legitimate expectations
of people planning for their own retirement. The downside of this is that, as in

53

 
the case of the Austrian and French reforms, a long time will be needed before
they  produce  a  full  positive  impact  on  public  finances  and  labour  market
performance. Lower benefits from public pension schemes imply a rebalancing
between  different  pillars  of  the  pension  system.  A  key  consideration  in  this
context is whether an appropriate fiscal and regulatory regime has been put in
place  to  develop  supplementary  retirement  schemes  through  occupational
pension  schemes  and/or  third  pillar  schemes  so  that  citizens  have  alternative
means  to  save  for  retirement  income.  Italy,  Germany,  and  Austria  have
proposed  to  establish  or  further  develop  private,  fully  funded  schemes.  The
proposed changes deserve a more thorough analysis.

2.3.2

Social sustainability: Contributing to economic and social cohesion

The lack of up-to-date data continues to hamper the assessment of progress in
improving social sustainability. The weakened labour market situation lately is
a  source  of  concern  as  regards  social  sustainability,  since  jobs  play  an
important role in lifting people out of poverty and social exclusion. While the
long-term  unemployment  rate  continued  to  decline  in  2002  (to  3.0 per  cent
down from 3.5 per cent in 2000), more recent developments are likely to have
been less promising as e.g. the overall unemployment rate started to increase.
For  instance,  the  share  of  jobless  households  has  not  declined  in  2002
(unchanged at 12.2 per cent).

Graph 15: Long-term unemployment

LU

DK

AT

NL

PT

UK

SE

FI

IE

DE

EU-15

FR

BE

EL

IT

ES

e
t
a
r

l

t
n
e
m
y
o
p
m
e
n
u
m
r
e
t
-
g
n
o
L

2
0
0
2
-
9
9
9
1
e
g
n
a
h
c

1

0

-1

-2

-3

0

1

2

3

4

5

6

7

8

Long-term unemployment rate 1999

Source : Commission services (structural indicator no. IV.6.1).

54

 
 
 
 
 
Box 6: Follow up to country specific recommendations related to pension systems

Country specific recommendation
(as an extension of general GL no 16)
BE:  reinforce  measures  to  postpone
retirement from the labour force.
DE:  promote  supplementary  pension
schemes,  strengthen 
for
later retirement.
EL:  pursue  reforms  of 
the  social
security  system,  and  in  particular  the
pension system.

incentives 

link 

strengthen 

ES: 
between
contributions  and  benefits  and  control
the  long-term  increases  in  pension
expenditure.
FR:  undertake  comprehensive  reform
of the pension system

IT:  address  long  transition  period  to
the  new  contributions-based  system
and  promote  supplementary  privately
funded pension schemes.

AT:  reform  public  pension  system;
increase 
effective
retirement age and ensure incentives to
work are enhanced.

average 

low 

Adopted

Proposed

Measures

Contribution  rate  increased  from  19.1%  to  19.5%.  Raised
monthly income ceiling for the contributions payments.

Increase  statutory  retirement  age.  Indexation  formula  linking
benefits to the system dependency ratio. Establish fully-funded,
individual accounts.

Incorporation of the uniform social security funds. Creation of
occupational funds. A uniform method of pension calculation.
Single framework of rules for pension entitlement for all wage
earners.

Gradual increase in the number of contribution years entitling
to  a  full  pension.  Financial  incentives  to  remain  active  until
and after the statutory retirement age. Public pensions indexed
in  line  with  consumer  prices,  instead  of  wages.  Increase  in
social contributions in the private sector

Gradual abolition of early retirement. Strengthened incentives
to  stay  in  employment.  Extended  reference  period  for
calculating the pension benefits. Lower accumulation rate for
pension rights

Incentives  to  raise  retirement  age  through  seniority  pension
calculated on the basis of notional defined contributions, rather
than earnings-based system. Tightened eligibility conditions and
incentives to remain in employment. Support for private, fully-
funded  schemes  through  harmonising  legislation  on  collective
and  individual  pension  funds,  to  eliminate  distortions  and
increase competition amongst them.
Harmonisation  of  the  pension  systems  and  establishment  of  an
integrated system

PT:  adopt  further  reforms 
the
pension  system  for  workers  in  the
general government.

to 

Extended reference period for calculating the pension benefits.
Extended  contribution  period.  Benefits  indexed  to  the  net
wage.

Financial  disincentive  for  early  retirement.  Measures  to  reduce
the pension system generosity.

55

 
Against this background, the 2003-05 BEPGs recommended Member States to:

17. 

18. 

19. 

take steps to modernise social protection systems and to fight poverty and
exclusion with a view to supporting the broad Lisbon objectives;

improve the functioning of markets so that they are conducive to private
investment  in  regions  lagging  behind,  particularly  by  allowing  wages  to
reflect productivity differences;

ensure  that  public  support  in  regions  lagging  behind  is  focused  on
investment  in  human  and  knowledge  capital,  as  well  as  adequate
infrastructure,  and 
investment  programmes  are  designed  and
administered efficiently.

that 

Increased efforts needed in modernising the social protection system

Efforts concentrate more on the tax side than on benefit reforms. In 2003, only
Denmark, Germany, France, the Netherlands, and the United Kingdom appear
to have taken further steps to reform benefit systems (see also the follow-up to
Guideline 4).  Several  Member  States  introduced  measures  to  facilitate  the
access  to  the  labour  market  of  those  at  a  disadvantage.  Promoting  their
employment  opportunities  is  key  to  social  inclusion.  Thus,  recruitment
incentives  targeting  disabled  persons  are  being  introduced  in  Belgium  and
increased  in  Austria,  while  Denmark  targets  newly  qualified  disabled.  New
financial  incentives  to  encourage  people  with  disabilities  to  seek  and  take  up
work and to make work attractive are also implemented in Ireland and the UK.
Newly introduced  employment  subsidies target the long-term  unemployed  (in
the  NL,  FR  and  the  eastern  Länder  in  DE),  the  disabled  (FR  and  the  eastern
Länder) or the unskilled youth (the eastern Länder).

With no major initiative to enhance wage differentiation, regional
differences in unemployment remain wide

in  poorer  regions,  with  a 

In spite of significant employment growth in the second  half  of  the 1990s,  in
particular  in  lagging  regions,  regional  differences  in  both  employment  and
unemployment  rates  remain  substantial.  High  unemployment  is  generally
concentrated 
low  GDP  per  capita.  While
unemployment rates were below 3 per cent in 27 regions in 2002 mostly in the
Netherlands and the UK, they exceeded 20 per cent in ten regions in the south
of  Spain  and  Italy  and  the  French  overseas  territories.  Regional  differences
remain  wide  within  some  Member  States,  e.g.  in  Italy  where  the  difference
between  the  highest  unemployment  rate  (in  Calabria)  and  the  lowest  (in
Trentino-Alto Adige) exceeds 21 percentage points.

Such differences in unemployment point to the need for additional policy steps,
in  particular  with  a  view  to  enhancing  human  capital  investments  in
In  2003,  no  major
disadvantaged  regions  and  wage  differentiation. 

56

 
comprehensive initiative has been taken in the Member States most concerned
to  allow  wages  to  reflect  differences  in  skills  and  in  local  labour  market
conditions  (see  also  the  follow  up  to  Guideline 5  on  wage  differentiation).
Nevertheless, wage differentiation  under  the  form  of  performance-related  pay
is  gaining  ground.  Elements  of  flexibility  based  on  company/sector  situation
are either possible in e.g. Spain (in the interconfederal agreement for 2003) or
due  for  discussion  in  Germany  and  France  where  a  relaxation  of  the
“favourability principle”  (by  which  lower  level  agreements  can  only  be  more
favourable than sectoral ones) is being considered.

Measures taken to ensure efficiency of investments made

The  lack  of  timely  and  sufficiently  disaggregated  data  hampers  a  thorough
assessment of the types of investments that are the focus of public support. In
three  cohesion  countries  (ES,  IE,  and  PT)  data  on  national  public  structural
support  in  lagging  regions  are  available  from  the  ex-post  and  mid-term
additionality  assessments  for  1994/1999  and  2000/2002.  There  is  some
evidence  of  an  increased  emphasis  on  human  resources,  in  particular  on
qualifications  related  to  RTD,  where  their  shares  in  national  public  spending
have  increased  in  2000/2002.  The  importance  of  infrastructure  has  declined
somewhat, but still represents a major share of structural public spending.

The  Commission  has  recently  taken  steps  to  increase  the  efficiency  of
investment  programmes  supported  by  the  EU.  The  management  of  the
2000-2006  structural  funds  programmes  will  be  simplified  and  made  more
flexible.  As  a result of  the  mid-term  evaluation  which  is  due  to  take  place  in
2004,  the  Commission  and  the  Member  States  will  decide  to  reallocate
resources from ineffective measures to more effective measures, with a view to
increasing  their  contribution  to  Lisbon  objectives,  notably  investment  into
knowledge  and  innovation.  The  achievement  of  the  targets  on  effectiveness,
management,  and  financial  implementation,  which  are  set  out  in  each
programme,  will  also  be  assessed  before  31 March  2004.  The  results  will  be
decisive  for the  allocation of the  performance reserve  (that was introduced  in
2000). Cooperation with the EIB has also been enhanced, notably to strike an
adequate balance between loans and grants co-financing. The Bank has stepped
up its advisory work on the appraisal of the technical and economic soundness
of a number of ERDF, Cohesion fund and Ispa projects. From 2000, a hundred
projects have been reviewed.

2.3.3

Environmental  sustainability:  promoting  efficient  management  of
natural resources

Maintaining a high level of environmental quality is not only an end in itself
but may have wider benefits

Reforms  such  as  removing  subsidies  and  introducing  taxes  and  charges  that
internalise  external  costs  of  pollution  not  only  yield  environmental  benefits,

57

 
they also enhance the effects of structural reforms in other areas by helping to
“get  prices  right”.  This  is  particularly  so  if  revenue  from  environmentally-
motivated  reforms  is  used  to  reduce  other,  distortionary  taxes.  Alternatively,
although revenue raising is not the primary purpose of these measures, they can
contribute towards fiscal consolidation, or the provision of other public goods.

Against this background, the 2003-05 BEPGs recommended Member States to:

20. 

21. 

22. 

23. 

reduce sectoral subsidies, tax exemptions and other incentives that have a
for  sustainable
negative  environmental 
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;

impact  and  are  harmful 

reduce  subsidies 
to  non-renewable  energy  and  promote  market
instruments,  further  broaden  the  coverage,  and  ensure  appropriate
differentiation of energy taxation;

adjust the system of transport taxes, charges and subsidies to better reflect
environmental  damage  and  social  costs  due  to  transport,  and  increase
competition in transport modes;

renew  efforts  to  meet  commitments  under  the  Kyoto  protocol  and
implement  the  EC  greenhouse  gas  emissions  trading  scheme  and  set  up
systems  to  report  on  those  policies  and  measures  and  their  prospective
effects on emissions. Take measures to reach the targets set by subsequent
European  Councils,  notably  on  energy  efficiency,  renewable  energy  and
bio fuels.

Progress towards environmental sustainability in 2003 was disappointing

than 

rather 

to  securing  medium-  and 

Given the economic slowdown, more attention was paid to boosting growth in
the  short-term 
longer-term
sustainability.  However,  some  events  served  as  reminders  of  the  need  for
action  in  this  area.  Whether  or  not  it  can  be  attributed  to  human-induced
climate change, the  long hot summer of 2003  stretched  electricity  supplies  to
capacity.  This,  together  with  (unrelated)  power  cuts  in  some  Member  States,
stresses the importance of removing distortions in energy prices  and ensuring
that  all  actors  –  generators,  suppliers  and  consumers  –  face  appropriate
incentives.

The  Council  adopted  a  number  of  pieces  of  legislation  in  2003  that  should
contribute to this: directives concerning common rules for the electricity and
gas  markets  aimed  at  making  these  markets  competitive,  secure,  and
environmentally sustainable, and a regulation setting fair rules for cross-border
electricity exchanges. The latter  has been  complemented by  a  decision of EU
electricity regulators to make no additional charges for cross-border electricity

58

 
transactions  in  the  internal  market.  The  Council  also  adopted  the  directive
restructuring the Community framework for taxing energy products. Although
this  will  have  little effect  on  energy  prices in the short  run,  the  directive  will
have  a  more  substantial  impact  over  time,  in  particular  in  the  new  Member
States.  It  extends  the  Community  framework  to  include  the  use  of  coal  and
natural  gas  as  heating  fuels,  so  that  the  Community  is  moving  towards  a
framework that could enable appropriate differentiation of energy taxation.

At  Member  State  level,  there  have  been  a  number  of  changes  relating  to
support  for  different  energy  sources.  2003  has  been  the  year  for  the
implementation of the directive on electricity from renewable energy sources.
Results  in  terms  of  generation  of  green  electricity  are  far  from  impressive
except  for  wind  energy  mainly  in  three  Member  States:  Germany,  Spain  and
Denmark (23 GW were installed in Europe at the end of 2002). Although it is
premature to make a detailed analysis, it is already  clear that  the  Community
target of 22 per cent electricity share from renewable energies in 2010 will not
be achieved unless Member States take additional action. The Commission will
report to the Council and to the European Parliament in May 2004 assessing to
what  extent  Member  States  have  made  progress  towards  their  national
indicative  targets  and  consistency  with  the  22 per  cent  Community  target  of
the  European  gross  electricity
renewable  electricity  contribution 
consumption in 2010.

to 

Belgium  (Wallonia)  and  Sweden  introduced  “green  certificates”,  requiring
electricity  suppliers  to  source  a  minimum  percentage  of  their  output  from
renewable  energy  sources.  Sweden  also  continued  its  policy  of  switching
taxation  from  labour  to  pollution.  The  Netherlands  now  uses  its  tax  on
electricity  from  renewable  sources  to  fund  differentiated  feed-in  tariffs  for
these energies. While Germany reduced the overall level of state aid to the coal
industry, operating aid was increased.

Congestion charges in London led to marked changes in behaviour

In the area of transport pricing, Austria plans to introduce a kilometre-based
charge  for  commercial  vehicles  from  2004;  delays  in  the  start  of  a  similar
scheme  in  Germany  highlight  the  importance  of  ensuring  that  transport
charging schemes will work in practice and do not entail excessive transaction
costs.  In  the  United  Kingdom,  London  launched  a  congestion  charge  in
February  2003.  This  scheme  has  been  highly  successful  in  terms  of  its
objective  of  reducing  traffic  congestion,  without  giving  rise  to  significant
negative  side-effects,  while  it  has  yielded  significantly  less  revenue  than
expected.  Other  cities,  such  as  Rome,  Bristol  or  Edinburgh,  have  been
experimenting  with  road  pricing  in  order  to  reduce  car  traffic  in  city  centres.
Some of these schemes are still at a preliminary stage; however, the automated
control system in place in Rome since 2001 has already restricted access to the
historic  city  centre.  One  may  tentatively  conclude  that  changes  in  urban
transport  prices  can  lead  to  greater  changes  in  behaviour  than  is  generally

59

 
believed,  which has  as a  consequence that one should  not necessarily  look  to
transport charging schemes as major revenue sources.

There  was  progress  at  Community  level  in  liberalising  rail  transport.  The
Transport  Council  reached  an  agreement  in  March  on  the  "2nd  railways
package",  opening  the  international  freight  market  by  January  2006,  and  the
cabotage  market  by  January  2008.  A  further  opening  of  the  international
passenger  market  is  still  being  debated  between  the  Parliament  and  the
Council.  At  Member  State  level,  the  existing  legislation  (the  first  rail
legislative  “package”  introducing  competition  to  the  market  for  international
freight  services)  has  been 
ineffectively,
discouraging private investment in the sector.

implemented  slowly  and/or 

Graph 16: Distance to target indicators for the Kyoto 
Protocal and burden sharing targets of the EU MSs

EU-15

2.1

-28.8

-6.8

-5.5

-5.2

LU

DE

SE

UK

FR

FI

NL

EL

BE

IT

DK

AT

PT

ES

IE

0.4

4.7

7.4

9.8

10.5

10.7

11.4

16.8

21.6

23.8

23.9

-40

-30

-20

20
0
Percent points below (-) or above (+) linear target path

-10

10

30

Note: The Danish distance-to-target indicator is +2.6 points if Danish greenhouse  gas 
emissions are adjusted for electricity trade in 1990.
Explanatory note: The distance-to-target indicator is a measure of how close the current 
emissions are to a – hypothetical – linear path of emissions reductions (or allowed 
increases) from 1990 to the Kyoto target of 2008-12 (for total greenhouse gas 
emissions) assuming that only domestic measures will be used. 
Source : EEA, 2003.

Greenhouse gas emissions are rising – not falling in the EU

As  regards  climate  change,  the  European  Environment  Agency  reported  that
EU greenhouse gas emissions rose in 2001 for the second  year in succession,
moving the Union away from its target under  the Kyoto Protocol,  despite  the

60

 
slowdown in economic growth. Indeed, only five Member States (DE, FR, LU,
SE and the UK) are currently on track or close to their specific targets, while
ten  Member  States  are  well  above  their  target  paths  (ES,  IE,  AT  and  PT  are
15 percentage points or more off track), see Graph 16.

All  Member  States  are  preparing  to  implement  the  EU  emissions  trading
scheme,  which  became  law  in  October.  However,  projections  by  Member
States  show  that  even  with  this  and  other  existing  and  planned  policies  and
measures, most will not reach their targets unless they aim higher. This points
to  the  need  for  additional  action  on  their  part,  for  example  by  setting  more
ambitious objectives for the sectors covered by the emissions trading scheme in
their  forthcoming  national  allocation  plans,  or  by  introducing  cost-effective
measures  to  tackle  emissions  in  sectors  outside  the  scheme.  Several  Member
States  have  already  decided  or  declared  their  intention  to  use  the  flexible
mechanism  of  the  Kyoto  protocol  in  addition  to  domestic  and  European
policies  and  measure  to  achieve  their  targets.  Still  only  a  few  have  explicitly
foreseen the budgetary resources to be used to this end.

As regards compliance with legal reporting requirements and the evaluation of
actual  and  projected  progress,  some  Member  States  were  several  months  late
with  the  submission  of  inventory  data,  others  did  not  deliver  all  the  data
required  or  the  required  level  of  detail  (by  gas  and  by  sector)  for  their
inventories  as  well  as  for  their  projections  (in  particular  Germany,  Greece,
Italy,  Luxembourg,  the  Netherlands,  Portugal  and  Spain).  Additional  efforts
will be required by all Member States to improve the situation.

61

 
3.

EURO AREA SPECIFIC CHALLENGES.

In 2003 the euro area recorded subdued growth for the third year in a row.

For  a  third  consecutive  year,  economic  performance  disappointed.  Average
GDP  growth  declined  gradually  to  a  mere  0.4 per  cent  in  2003,  the  rate  of
unemployment increased by about half a percentage point to 8.9 per cent, while
public  finances  deteriorated  further.  At  the  same  time,  inflation  came  down
only sluggishly, fluctuating around 2 per cent in the course of 2003. However,
survey  indicators  paint  an  increasingly  optimistic  picture  and  the  recovery  is
likely to gain pace in 2004.

Against  this  background,  the  2003-05  BEPGs  recommended  policy  actors  at
national level to:

24. 

25. 

26. 

27. 

28. 

Contribute to a policy-mix that is compatible with price stability;

maintain budgetary positions of close to balance or in surplus throughout
the economic cycle in cyclically-adjusted terms, and if needed, take all the
necessary  measures  to  ensure  an  annual  improvement  of  at  least  0.5 per
cent of GDP. Countries with excessive deficits need to correct them;

analyse the causes of inflation differences to identify instances when they
are undesirable;

deepen  the  analysis  of  economic  developments  and  policy  requirements,
focus more on implementation, and strengthen the external representation
of the euro area;

improve the efficiency of the existing co-ordination procedures in the area
of structural reforms.

Policy mix appears supportive to growth

Macroeconomic  policy  was  accommodative  in  2003.  The  ECB  cut  interest
rates two times in 2003, by a cumulative 75 basis points to a level of 2 per cent
for  the  minimum  bid  rate.  When  assessed  against  the  so-called  Taylor  rule10,
short-term interest rates have been accommodative to economic activity during
the  slowdown.  The  fiscal  policy  in  the  euro  area  was  broadly  neutral  as  the
cyclically-adjusted primary balance remained unchanged.  However, it can not
be excluded that the public debate on the sustainability of public finances and
an  apparent  reduced  resolve  to  abide  by  the  SGP  has  weighed  on  consumer

10 

According to the so-called Taylor rule, the appropriate short-term interest rate is conditional on
two variables, the actual rate of inflation and the size of the output gap. Any deviation of both
variables  from  their  target  value  should  lead  to  adjustments  of  the  short-term  interest  rate
according to the weights of both variables in the Taylor rule.

62

 
                                                
confidence. The strong co-movement of the households’ savings ratio with the
budget deficit would  appear to be  a clear indication of that,  and rising  public
consumption in the euro area went alongside weaker private spending. During
2003,  the  euro  exchange  rate  appreciated  by  8 per  cent  in  nominal  effective
terms. This contributed to some losses in market shares of euro-area exporters
on  the  world  market,  while  the  positive  disinflationary  impulse  has  not  yet
visibly fed through to consumer price inflation.

e
c
n
a

t
s

l

a
c
s
F

i

e
c
n
a
t
s

l

a
c
s
F

i

Graph 17: Policy-mix in the euro area

Fiscal  tightening / 
Monetary loosening

Fiscal/Monetary tightening

1999

2003

2002

2001

2000

Fiscal/Monetary 
loosening

Fiscal loosening / Monetary 
tightening

-1.5

-1.0

-0.5

0.0
Monetary stance
(Change in real short-term interest rates)

0.5

1.0

1.5

Source : Commission services.

Graph 18: Policy-mix in euro area Member States
 in 2003

Fiscal tigthening
Monetary easing

IE

ES

BE

PT

DE

IT

FR

EUR-12

EL

AT

FI

Fiscal tigthening
Monetary tightening

NL

Fiscal easing
Monetary easing

Fiscal easing
Monetary tightening

)

B
P
A
C
n

i

e
g
n
a
h
C

(

1.0

0.5

0.0

-0.5

-1.0

)

B
P
A
C
n

i

s
e
g
n
a
h
C

(

3

2

1

0

-1

-2

-3

-2.0

-1.5

-0.5

-1.0

0.0
Monetary stance 
(Changes in real short-term interest rates)

1.0

0.5

1.5

2.0

Source : Commission services.

63

 
 
 
 
 
 
 
 
 
Implementation of the guideline on fiscal policies is worrisome

In recent years the fiscal position in the euro area has deteriorated. The annual
nominal  budget  deficit  has  increased  by  3 percentage  points  of  GDP  since
200011  to  a  deficit  of  –2.8 per  cent  of  GDP  in  2003.  The  working  of  the
automatic  stabilisers  explains  most  of  this  development.  Another  part  of  the
slippage  results  from  discretionary  deficit-increasing  measures.  Overall,  the
cyclically-adjusted budget balance worsened by 0.4 percentage points between
2000 and 2003.

According to the Commission’s economic forecast (autumn 2003) three of the
four euro area Member States that had a cyclically-adjusted budget position of
close to balance or in surplus in 2002, namely Belgium, Spain, and Finland,
managed to maintain those in 2003 and will continue to do so in 2004. In view
of the national budgets  and on  the  assumption  of  unchanged  polices  in  2005,
Ireland  and  Austria  could  achieve  a  sound  position  by  2005.  However  as
regards  Austria,  it  now  appears  unlikely  that  the  forthcoming  tax  cuts
(amounting  to  1  per  cent  of  GDP)  will  be  accompanied  by  corresponding
expenditure  restraints,  thereby  causing  the  cyclically-adjusted  balance  to
deteriorate considerably in 2005.

Among  those  euro  area  Member  States  that  had  not  reached  the  above
mentioned objective, only Ireland, the Netherlands, and Portugal  are expected
to  have  improved  their  cyclically-adjusted  budget  balance  by  at  least
0.5 per  cent  of  GDP  in  2003.  In  2004,  France  and  the  Netherlands  would,
according  to  the  forecast,  be  able  to  comply  with  this  Guideline.  Although  a
certain improvement in the cyclically-adjusted deficit is expected for Germany,
it  would,  just  as  the  remaining  Member  States  (EL,  IT,    LU,  and  PT),  not
achieve  the  required  improvement  in  2004.  However,  on  the  basis  of  the  no-
policy-change  assumption,  the  cyclically-adjusted  budgetary  positions  in
Greece, Italy,  Luxembourg and Portugal would seem to sharply deteriorate in
2004 and/or 2005. This clearly indicates the need for further policy measures in
2004.

11 

The euro area net lending figure included one-off proceeds for telephone licences (UMTS) of
1.1 per cent of GDP in 2000.

64

 
                                                
e
c
n
a

t
s

l

a
c
s
F

i

)

B
P
A
C
n

i

s
e
g
n
a
h
C

(

Graph 19: Euro area fiscal stance and cyclical 
conditions, 1999-2003

2

1

0

-1

-2

Pro-cyclical fiscal 
tigthening

PT

NL

Counter-cyclical 
fiscal easing

-3

-2

Counter-cyclical 
fiscal tigthening

EL

Pro-cyclical fiscal 
easing

1

2

EUR-12

IE

ES

BE

DE

IT

EU-15

UK

AT

FI

FR

DK

SE

0

-1
Cyclical conditions 
(Output gap)

Source : Commission services.

The  three  countries  in  an  excessive  deficit  situation  are  having  difficulties
correcting  it.  Both  Germany  and  Portugal  have  made  considerable  efforts  in
response to the recommendation to bring this situation to an end. According to
the forecasts and following substantial one-off measures, the nominal deficit in
Portugal  is  expected  to  stay  below  3 per  cent  of  GDP  in  2003,  but  risks
exceeding the limit again in 2004. In the German case, measures amounting to
about 1 per cent of GDP have been taken in 2003, thereby fulfilling that part of
the  Council  recommendation  of  January  2003.  However,  given  the  adverse
cyclical conditions the measures taken appear inadequate in order to bring the
excessive  deficit  situation  to  an  end  in  2004.  France  does  not  appear  to  have
taken  effective  action  to  redress  the  budgetary  imbalances,  and  given  the
current  economic  outlook,  the  excessive  deficit  situation  is  likely  to  persist
with a continuation of a deficit well above 3 per cent of GDP in 2004.

In  view  of  the  developments  outlined  above,  the  Commission  adopted
recommendations  to  Germany  and  France  in  accordance  with  Treaty  Articles
104 (8)  and  104 (9)  that  no  effective  action  has  been  taken  (FR)  or  was
inadequate (DE), and that both Member States should take measures to remedy
the  excessive  deficit  situation.  However,  in  light  of  the  weak  economy,  the
Commission recommended to allow both Member States one additional year to
bring down the deficit below 3 per cent of GDP, i.e. by 2005. On 25 November
2003,  the  Council  rejected  the  Commission’s  recommendations  and  found  an
agreement  outside  the  Treaty,  de  facto  suspending  its  application  for  these
articles.  The  Council  took  note  of  the  commitments  made  by  Germany  and
France to reduce their deficits to below 3 per cent of GDP by 2005.

Inflation differences remain wide

Over the first three quarters of 2003, inflation differences in the euro area, as
measured by the difference between the Member State with the highest and the

65

 
 
 
 
 
one  with  the  lowest  HICP  inflation  rates  or  by  the  unweighted  standard
deviation, have narrowed slightly compared to the situation last year, but they
remain wider compared to the first year of EMU.

At  the  euro  area  level,  the  extent  of  inflation  dispersion  observed  since  the
introduction of the euro does not appear to be significantly higher than that of
other  monetary  unions.  It is roughly  comparable  to  that  of  cities  in  the  USA,
while  it  is  somewhat  above  that  of  regions  in  the  USA  or  that  within  some
Member  States.  From  a  historical  perspective,  the  inflation  dispersion  in  the
euro area seems low. The sui generis (or special) character of the euro area and
the relatively short experience with it, however, call for a degree of caution in
interpreting results from such comparisons.

Graph 20: Inflation differences and dispersion, euro area

yoy  %  ch.

HICP differences

HICP
Maximum
Minimum

7

6

5

4

3

2

1

0

-1

-2

96

97

98

99

00

01

02

03

Source : Commission services.

3.5

3

2.5

2

1.5

1

0.5

0

HICP inflation dispersion
(percentage points)

Standard deviation (unweighted)

Range between highest / lowest (rhs)

9

8

7

6

5

4

3

2

1

0

96

97

99

00

02

03

At the national level, it should be noted that  since the  start of Stage Three of
EMU,  some  countries  have  registered  persistent  differentials  relative  to  the
euro area average, particularly in the main sectors that make up core inflation
(HICP  excluding  energy  and  unprocessed  food).  On  the  one  hand,  inflation
differences  can  be  considered  a  normal  adjustment  mechanism  in  a  monetary
union.  Given  that,  by  definition,  the  nominal  exchange  rate  instrument  is  no
longer  available  for  national  purposes,  required  national  adjustments  in  a
monetary union fall on relative price and wage movements. On the other hand,
the persistence of inflation differentials could indicate that structural rigidities
are impeding a smooth adjustment, requiring policy action at the national level
to  prevent  an  unwarranted  deterioration  in  competitiveness.  The  fact  that  the
single  monetary  policy  is  geared  to  safeguarding  price  stability  for  the  euro
area  as  a  whole,  and  hence  cannot  address  country  specific  inflation
differentials, underscores the importance of continuing with structural reforms.
They  raise  growth  potential,  safeguard  long-term  competitiveness  at  the
national  level,  and  will  also  increase  the  flexibility  of  national  economies
thereby  easing  the  adjustment  process  to  common  or  country  specific  shocks
and reducing the scope for protracted inflation differentials. However, it should
be recognised that in the short-term, differences in the speed and magnitude of
implementation  of  structural  reforms  may  temporarily  accentuate  inflation
dispersion among Member States.

66

 
The external representation of the euro area needs to be strengthened

Economic  policy  co-ordination  has  proven  increasingly  beneficial  in  e.g.  the
spring  2003  when  the  increased  economic  uncertainty  related  to  the  Iraq
conflict demanded  for a  coherent policy  approach.  In  contrast  to  the  oil  price
hike  in  2000,  Member  States  abstained  from  isolated  national  measures  and
agreed  on  a  common  line  in  international  fora.  Also  the  discussions  on  the
impact of the sizeable euro appreciation witnessed in 2003 took place in a more
orderly  form  than  when  the  euro  depreciated,  which  has  supported  the
credibility of EMU’s policy framework.

Although  the  start  of  EMU  constituted  a  major  change  for  the  international
monetary system, this has, however, yet to result in a complementary upgrade
of the international role of the euro area. The need to strengthen the external
representation  of  the  euro  area  in  the  relevant  international  institutions  and
fora was fully recognised by the Convention, in order to ensure that the area’s
political importance becomes commensurate to its economic weight. While the
issue  was  discussed  in  several  working  groups,  no  clear  conclusion  has  been
reached  and  the  text  of  the  draft  Constitution  basically  leaves  the  matter
unchanged.  Apart  from  the  debate  in  the  Convention,  no  actual  and  tangible
improvements  can  be  reported  in  respect  of  the  euro  area’s  representation  on
the international scene. Nevertheless, the preparations of euro area positions in
e.g.  the  IMF  has  improved  somewhat,  at  least  as  regards  issues  where  a
consensus can be reached and ‘common understandings’ adopted.

The  Lisbon  Strategy  has  reinforced  the  awareness  of  and  interest  in
structural reforms

The Lisbon Strategy, which is at the centre of the structural reform process, has
increased  the  awareness  of,  and  interest  in,  medium  term  policies  that
simultaneously  promote  potential  growth;  full  employment;  improvements  in
the European social model; and a sustainable development. That has called for
a ‘streamlining’ of the policy co-ordination processes, with a view to increase
the coherence and complementarity between the various processes. The Broad
Economic  Policy  Guidelines  were  thus  adopted  as  a  part  of  a  “Guidelines
Package”  together  with  the  Employment  Guidelines  and  the  Internal  Market
Strategy for the first time in 2003. A  greater emphasis has also been  given to
the  follow-up  in  terms  of  implementation,  when  the  Council  adopted
conclusions on the 2003 Implementation Report for the first time, stating inter
alia that  it was  a  useful  tool  to  monitor  progress  and  give  guidance  for  areas
where  further  progress  is  particularly  needed.  The  Italian  Presidency  has
indicated that the Council will start holding regular implementation discussions
throughout the year. A first working breakfast in November 2003 was devoted
to the follow-up given to the 2003-05 BEPGs so far, notably with regard to the
sustainability  of  public  finances.  While  it  appears  too  early  for  any  firm
conclusions  on  the  efficiency  of  the  existing  co-ordination  processes,  the

67

 
streamlining ought to have improved the consistency between the different sets
of guidelines and should limit the reporting burden for Member States.

Looking  ahead,  the  Lisbon  Strategy  will  be  subject  to  a  mid-term  review  in
2005 with an eye to making it a more effective tool for achieving the objectives
set out at the Lisbon and Gothenburg European Councils. In addition, decisions
on  the  financial  perspectives  post-2006  will  be  taken  on  the  basis  of  policy
priorities  and  objectives  identified  within  the  context  of  the  Lisbon  strategy.
The  Open  Method  of  Co-ordination  (OMC),  which  was  conceived  with  the
launch  of  the  Lisbon  strategy,  is  increasingly  being  used  to  co-ordinate
Member States’ and Community policies in a number of areas, including R&D,
education and social protection policies.

68

 
4.

IMPLEMENTATION  BY  THE  MEMBER  STATES:  A  PRELIMINARY
ASSESSMENT.

In  the  accompanying  working  document  of  the  Commission  Services  more
detailed  information  can  be  found  on  how  economic  policies  in  the  Member
States  so  far  have  responded  to  the  identified  challenges  and  the  country-
specific  recommendations  in  the  2003-05 BEPGs.  As  this  Communication
provides  a  first,  intermediate,  look  at  the  progress  made  and  Member  States
have  two  more  years  to  complete  their  follow  up  on  the  challenge  and
recommendations, a full assessment can only be made in two years time i.e. in
the Implementation Report 2006. Nevertheless, a preliminary assessment of the
degree of implementation at this moment can give a useful overview of which
Member  States  have  taken  steps  in  the  right  direction  towards  adequately
addressing the policy challenges.  In  a  number of  cases reforms  undertaken or
envisaged allow already a more in-depth assessment.

Since the number and the nature of challenges differ among Member States, a
comparison  of  the  follow-up  between  Member  States  is  difficult.  Some
challenges are more demanding and often more difficult to fulfil than others. In
the following summary of the progress made in the individual Member States,
the  indication  ‘fully  addressed’  is  used  when  policy  actions  in  response  to  a
challenge  going  in  the  right  direction  have  been  adopted  or  proposed.  The
indication ‘largely addressed’ is used when actions have been taken but do not
yet cover the whole challenge and all specific recommendations. The indication
‘partially  addressed’  is  used  when  policy  actions  have  been  adopted  or
proposed  only  relating 
the
to  a  small  part  of 
recommendations. When no follow-up has yet been given to the challenge and
recommendations, the indication ‘not yet started’ is used.

the  challenge  and 

It  must  be  stressed  that  from  the  assessments  on  how  well  Member  States
responded to these recommendations, it cannot be inferred how Member States
compare  in  terms  of  absolute  performance  and  improvements  therein.  From
this follows that a Member State can be performing relatively well compared to
other  Member  States,  but  nevertheless  has  not  implemented  or  planned
measures 
the  country-specific
the  policy  challenges  and 
recommendations. An indication of the absolute performance (both in terms of
progress and in terms of level) of Member States on the basis of the shortlist of
structural indicators can be found in the Commission’s Spring Report 2004, see
Annex 1 therein.

tackle 

to 

On the basis of  the  detailed  information of the individual countries it appears
that all Member States have started to address their challenges. While Belgium,
Denmark,  Germany,  Ireland,  the  Netherlands,  Austria,  Portugal,  Finland  and
the  UK  seem  to  be  addressing,  overall,  the  identified  challenges  in  a

69

 
satisfactory  way,  there  seems,  however,  to  be  scope  for  improvement  in  the
other Member States.

4.1

Belgium

Overall, Belgium seems to be addressing the three identified policy challenges.
The  challenge  and  the  recommendations  regarding  public  finance  in  the
2003-05  BEPGs  appear  largely  addressed.  The  high  debt  ratio  continues  to
decline  steadily  and  primary  surpluses,  although  decreasing,  remain  sizeable.
Measures  have  been  taken  to  limit  the  growth  of  real  expenditure  but  the
increase  is  still  higher  than  recommended.  Preparations  for  the  budgetary
implications of ageing continued in 2003, notably via stimulating employment,
but more needs to be done to ensure long term sustainability.

Also the challenge and the recommendations on the labour market seem to be
largely addressed. Some action has been taken to address the low employment
rate  among  older  workers.  Progress  is  made  on  reducing  distortions  to  work
incentives in tax-benefit systems with a strong focus on the tax-side.

the  challenge  and 

Finally, 
recommendations  on  competition,  public
administration  and  the  business  environment  appear  partially  addressed.
Improvements were made in the regulatory framework in telecommunications,
postal  services  and  railways,  and  energy  markets  have  been  opened  to
competition  in  Flanders.  However,  no  progress  has  been  registered  in
stimulating  competition  in  local  services  and  the  reform  of  the  public
administration has been suspended.

4.2

Denmark

Overall, Denmark seems to be addressing the two identified policy challenges.
The  challenge  and  recommendations  regarding  long  term  fiscal  sustainability
appear fully addressed. The tax reform, aimed at increasing labour supply, will
be implemented in 2004. Regarding labour market reform some measures have
been adopted to tighten eligibility rules. Achieving the targets for the growth of
public  consumption  will  require  discipline  in  adhering  to  the  budget
agreements across all government levels, including the tax freeze.

The challenge and recommendations on enhancing competition and improving
efficiency  in  the  public  sector  seem  largely  addressed.  Some  measures  have
been  taken  in  2003  to  increase  competition  and  the  regulatory  barriers  to
competition  are  being  identified,  but  weak  competition  persists  in  many
sectors.  Reforms  in  welfare  services  have  increased  competition  and  the
government  has  presented  plans  to  make  further  use  of  benchmarking  and
reduce administrative burdens.

70

 
4.3

Germany

in  parliament, 

the  measures  adopted 

Overall, Germany seems to be addressing the four identified policy challenges.
Based  on 
the  challenge  and
recommendations  regarding  the  labour  market  appear  largely  addressed.
Measures  have  been  implemented  and  proposed  to  reform  the  tax-benefit
system including a reduced eligibility of unemployment benefits and promotion
of low-wage jobs. Some progress has been made in a more flexible system of
wage  formation  but  the  authorities  should  go  further  to  promote  wage
flexibility across skills and regions. Efforts to enhance the efficiency of active
labour market policies have started, but there remains room for improvement.

Also  the  challenge  and  recommendations  on  increasing  productivity  and  the
efficiency  of  the  education  system  appear  largely  addressed.  An  initiative  to
improve  the  business  environment,  through  the  reduction  of  red  tape  and
overregulation was launched. In addition, the competition law will be brought
in  line  with  EU-rules  and  the  law  on  unfair  competition  will  be  relaxed.
Measures  also  have  been  proposed  to  improve  primary  and  secondary
education, but success hinges upon effective follow-up by the Länder.

The challenge and recommendations on public finances in the 2003-05 BEPGs
seem  only  partially  addressed.  Despite  the  implementation  of  compensatory
measures  amounting  to  about  1  per  cent  of  GDP,  the  government  deficit  is
expected  to  have  exceeded  4 per  cent  of  GDP  in  2003.  Following  the
confirmation of the German authorities that the 2004 deficit will exceed the 3
per  cent  ceiling,  the  Commission  made  recommendations  to  decide  that
inadequate action has been taken and to allow, in light of the weak economy, to
bring  the  government  deficit  below  3  per  cent  of  GDP  in  2005,  which  were
rejected by the Council. The  Council took  note  of  the  commitments  made  by
Germany on 25 November 2003 to reduce the cyclically-adjusted deficit by 0.6
per  cent  in  2004  and  at  least  0.5  per  cent  of  GDP  in  2005  to  ensure  that  the
general government deficit is brought below 3 per cent of GDP in 2005.

Finally, the challenge and recommendations on long term sustainability appear
being  largely  addressed.  Measures  have  been  proposed  to  address  the  ageing
challenge notably the introduction of a sustainability factor in order to contain
the  increase  in  pension  payments.  Changes  in  the  supervision  of  private
pension schemes and adjustments to increases in pensions need however to be
complemented with a structural reform of the pension system.

4.4

Greece

Overall,  Greece  does  not  yet  seem  to  be  addressing  sufficiently  all  three
identified  policy  challenges.  The  challenge  and  recommendations  regarding
public  finance  in  the  2003-05  BEPGs  appear  partially  addressed.  As  primary
surpluses  are  decreasing,  the  reduction  of  the  high  debt  ratio  as  requested
depends  to  a  great  extent  on  the  success  of  the  announced  privatisation

71

 
programme.  So  far  no  sufficient  measures  have  been  implemented  to
effectively  control  government  spending  and  no  follow-up  has  been  made  or
planned to continue reforms in the social security system.

The  challenge  and  recommendations  on  increasing  productivity  seem  largely
addressed.  The  government  has  launched  several  initiatives  to  accelerate  the
transition  towards  the  knowledge-based  economy,  to  improve  the  business
environment and to simplify  the  tax system.  In the area  of  competition  in the
energy  sectors,  steps  were  taken  in  the  right  direction  but  still  need  to  be
strengthened in order to ensure effective competition.

Finally,  the  challenge  and  the  recommendations  on  the  labour  market  appear
partially  addressed.  Some  measures  to  improve  work  incentives  have  been
implemented, in particular for women and low wage workers, but no progress
is made in reducing non-wage costs as requested. No action has yet been taken
to changing the wage bargaining process.

4.5

Spain

Overall,  Spain  does  not  yet  seem  to  be  addressing  sufficiently  all  three
identified policy challenges. The challenge and recommendations regarding the
labour  market  appear  being  partially  addressed.  Measures  have  been
implemented  to  increase  female  participation  through  tax  incentives  and  a
higher  provision  of  care  facilities.  In  addition,  some  progress  has  so  far  been
made in the removal of fiscal distortions hampering the geographical mobility
of  workers.  Nevertheless,  no  changes  were  made  to  the  wage  bargaining
system including the use of indexation clauses whereas the requested reform of
employment protection legislation to reduce the labour market segmentation is
still pending.

The  challenge  and  recommendations  on  raising  the  low  level  of  productivity
seem  largely  addressed.  Several  initiatives  have  been  launched  to  strengthen
the  knowledge-based  economy.  Progress  was  also  made  in  improving  the
business environment by tax incentives and a reduction of red tape. As regards
competition,  some  progress  has  been  made  in  the  electricity  market  while
effective competition in retail distribution has not been addressed.

Finally,  the  challenge  and  recommendation  on  the  long  term  sustainability  of
public  finances  seem  partially  addressed.  Some  measures  have  been
implemented so as to tackle the budgetary impact of ageing, namely actions to
increase  the  employment  rate  while  continuing  to  reduce  public  debt.  In
addition the Pension Reserve fund is planned to be further increased to 1.6 per
cent  of  GDP.  However,  no  measures  strengthening  the  link  between
contributory  effort  and  pension  benefits  have  been  adopted,  which  appears
indispensable to ensure the long term sustainability.

72

 
4.6 

France

Overall,  France  does  not  yet  seem  to  be  addressing  sufficiently  the  four
identified  policy  challenges.  The  challenge  and  recommendations  regarding
public  finance  in  the  2003-05  BEPGs  seem  only  partially  addressed.
Insufficient measures were taken to respect the recommendation issued by the
Council  in  June  in  the  context  of  the  Excessive  Deficit  Procedure.  Therefore
the Commission made recommendations to decide that no effective action has
been taken and to allow, in light of the weak economy, to bring the government
deficit below 3 per cent of GDP in 2005, which were rejected by the Council.
The Council  took note of the commitments made by France on 25 November
2003 to reduce the cyclically-adjusted deficit by 0.8 per cent of GDP in 2004,
and by 0.6 per cent of GDP or a larger amount in 2005 so as to ensure that the
general government deficit is brought below 3 per cent of GDP in 2005.

By contrast, the challenge and recommendations on the long term sustainability
of  public  finances  appear  largely  addressed.  A  comprehensive  reform  of  the
pension system has been adopted increasing the contribution period entitling to
a full pension and strengthening the financial incentives to remain active. The
reform represents a major improvement of long run fiscal sustainability. Some
measures  have  been  introduced  to  control  health  spending,  but  a  more
comprehensive reform of the health insurance system is to be implemented in
2004.

The  challenge  and  recommendations  on  the  labour  market  appear  partially
addressed.  In  particular,  specific  measures  were 
to  encourage
participation of older workers and to make work pay.

taken 

Finally, the challenge  and recommendations on the business environment  and
competition seem partially addressed. Measures have been taken to reduce and
simplify business regulations. Competition in energy markets has improved but
the  market  is  still  dominated  by  incumbents.  While  the  transposition  rate  of
internal  market  directives  (one  of  the  lowest  in  the  EU)  has  increased,  the
number of infringement increased too.

4.7 

Ireland

Ireland  seems  to  be  addressing  the  single  identified  policy  challenge.  The
challenge and recommendations regarding the management of the transition to
lower, sustainable growth appear largely addressed. Efforts are being made to
enhance  the  efficiency  of  public  expenditure,  notably  by  extending  multi-
annual  budgeting  and  reorganising  the  health  sector.  Various  measures  are
taken to improve capital spending and to increase the level of R&D. As regards
competition,  measures  for  several  sectors  are  under  review  including  full
liberalisation of gas and electricity markets.

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4.8 

Italy

Overall, Italy does not yet seem to be addressing sufficiently all five identified
policy  challenges.  The  challenge  and  recommendations  regarding  public
finance  in  the  2003-05  BEPGs  appear  partially  addressed.  Little  progress  has
been  made  in  achieving  lasting  budgetary  consolidation  and  the  Italian
government  has  continued  to  rely  on  one-off  measures.  Primary  expenditures
continue  to  show  a  strong  downward  rigidity  constraining  the  room  for
implementation of the tax reform.

The challenge  and recommendations  regarding the  long  term  sustainability  of
public  finance  seem  only  partially  addressed.  An  acceleration  of  the  planned
reduction  of  the  high  debt  ratio  would  be  warranted  in  the  light  of  ageing.
Proposals  to  reduce  pension  expenditures  as  of  2008  were  presented  to
parliament.

Also  the  challenge  and  recommendations  regarding  the  labour  market  seem
partially addressed. Reform measures have been taken but important elements
of  labour  market  reform  are  either  still  pending  in  parliament  (employment
protection legislation) or were not tackled (wage differentiation).

The challenge and recommendations regarding the knowledge-based economy
are  being  fully  addressed.  In  particular,  the  primary  and  secondary  education
level  system  has  been  reformed  and  several  measures  have  been  taken  to
stimulate R&D and innovation.

The  challenge  and  recommendations  regarding  the  business  environment  and
competition  seem  largely  addressed.  Administrative  burdens  on  start  ups  and
red  tape  affecting  businesses  have  become  less  onerous.  However,  the
liberalisation of the service and energy sector proceeds at a slow pace and the
rate of transposition of internal market directives has further decreased.

4.9 

Luxembourg

Overall,  Luxembourg  does  not  yet  seem  to  be  addressing  sufficiently  both
identified policy challenges. The challenge and recommendations on the labour
market  seem  partially  addressed.  No  action  has  so  far  been  taken  to  reduce
incentives  for  early  retirement.  Some  progress  has  been  made  to  reduce  the
inflow in disability pension schemes by tightening eligibility.

Also the challenge and recommendations concerning the business environment
and  entrepreneurship  seem  partially  addressed.  Little  progress  has  been  made
regarding  the  reform  of  the  competition  law  but  some  measures  have  been
taken to encourage entrepreneurship.

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4.10 

Netherlands

Overall,  the  Netherlands  seem  to  be  addressing  the  three  identified  policy
challenges. The challenge and recommendation regarding public finance in the
2003-05  BEPGs  appear  fully  addressed.  The  new  government  continued  to
limit  expenditure  growth  under  multi-annual  ceilings  defined  in  real  terms.
Additional  efforts  may  be  required  to  ensure  that  expenditure  plans  remain
consistent with a budgetary position of close to balance or in surplus.

The  challenge  and  recommendation  on  the  labour  market  seem  largely
addressed. Whereas the envisaged reform to reduce the flow into the disability
scheme seems adequate, additional efforts are needed to activate people that are
already  in  this  scheme.  Progress  has  been  made  in  reforming  other  benefit
systems with the aim of enhancing incentives to work.

Finally, the challenge and recommendations on productivity growth seem fully
addressed.  The  government  plans  to  make  improvements  in  the  regulatory
framework  for  competition  by  increasing  the  powers  of  the  competition
authority. Also  progress  is  made  in  promoting  a  stronger  technology  oriented
education and in improving the co-operation between research institutions and
business.

4.11 

Austria

Overall, Austria seems to be addressing the three identified policy challenges.
The  challenge  and  recommendations  regarding  public  finance  in  the  2003-05
BEPGs  appear  largely  addressed.  Action  to  achieve  structural  expenditure
savings  has  been  taken  but  was  partly  offset  by  increases  in  discretionary
expenditure.  Most  notable  in  Austria  is  the  comprehensive  overhaul  of  the
pension  system  which  leads  to  significant  savings  in  the  long  run  and  should
raise the participation rate of older workers.

The challenge and recommendation regarding the weak technology base appear
largely  addressed.  Several  measures  have  been  implemented  to  increase  and
rationalise R&D and innovation support.

Finally,  the  challenges  and  recommendation  regarding  competition  appear
partially  addressed.  Although  steps  have  been  made  to  enhance  effective
competition in the  retail  sector, no measures  have  been  made  to  address  high
concentration in some other sectors. The resources of the competition authority
remain  inadequate  and  the  power  of  the  telecom  regulator  continues  to  be
insufficient.

4.12 

Portugal

Overall, Portugal seems to be addressing the three identified policy challenges.
The  challenge  and  recommendations  regarding  public  finance  in  the  2003-05

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BEPGs seem largely addressed. Although the general government deficit rose
in  2003 but  stayed just  below 3 per cent  due to the  effect  of  sizeable  one-off
measures, progress was made in curbing expenditure growth notably through a
strong  deceleration  of  public  consumption  outlays.  Portugal  has  continued  to
implement  reforms  in  several  areas  such  as  health-care  and  education  with  a
direct impact on budgetary consolidation as requested.

The  challenge  and  recommendations  on  productivity  and  business  dynamism
seem largely addressed. Measures have been taken to stimulate innovation and
R&D,  to  improve  the  quality  of  education  and  to  reduce  the  number  of  early
school  leavers.  Steps  in  the  right  direction  have  been  taken  to  enhance
competition in the gas sector, but in the electricity sector effective competition
is  not  yet  secured.  Finally,  the  transposition  rate  of  internal  market  directives
improved in 2003 but stays below the set target of 98.5 per cent. A quasi-wage
freeze  in  the  government  sector  has  contributed  strongly  to  overall  wage
moderation,  possibly  bringing 
in  price-
competitiveness registered in recent years.

the  deterioration 

to  a  halt 

Finally, the challenge and recommendations on long term sustainability appear
fully addressed. A comprehensive reform of the health-sector is proceeding at a
rapid pace but  it is  yet  too early to  assess  its  impact.  Reforms  of  the  pension
system  for  workers  in  the  general  government  sector  have  so  far  only  partly
been implemented, but the government plans to introduce additional measures.

4.13 

Finland

Overall,  Finland  seems  to  be  addressing  the  two  identified  policy  challenges.
The  challenge  and  recommendations  regarding  the  labour  market  seem
partially  addressed.  Tax  reductions  implemented  and  intended  will  lead  to  a
reduction  of  the  tax  wedge  for  a  low  wage  earner  by  1  percentage  point.
Reform of eligibility criteria to improve work incentives are however lacking.
There is little progress in allowing wages to reflect productivity differences.

The  challenge  and  recommendations  on  competition  and  public  sector
efficiency appear largely addressed. Some steps toward improved competition
in  network  industries  and  non-tradable  services  have  been  launched.  Further
efforts have been made to improve the efficiency of the public sector. The new
government  has  introduced  multi-annual  spending  limits  for  the  period  2003-
2007  in  order  to  improve  spending  control,  in  line  with  the  request  in  the
recommendation.

4.14 

Sweden

Overall,  Sweden  does  not  yet  seem  to  be  addressing  sufficiently  the  two
identified  policy  challenges.  The  challenge  and  recommendations  regarding
labour supply appear partially addressed. On the one hand, measures have been
undertaken  to  retain  older  workers  and  to  promote  the  participation  of

76

 
immigrants  and  young  in  the  labour  force.  On  the  other  hand,  some  planned
measures  could  have  a  negative  impact  on  labour  supply.  Furthermore,  there
are no detailed plans as to when the last step of the income tax reform will be
implemented.

The  challenge  and  recommendations  on  competition  and  public  sector
efficiency  appear  partially  addressed.  Efforts  have  been  made  to  improve
competition in some sectors, such as construction and food retail, but no further
measures  have  been  taken  to  open  up  the  rental  housing  market.  Steps  have
been taken to increase the efficiency of the public sector by increasing the use
of  benchmarking,  but  no  major  initiatives  have  been  taken  to  improve
framework conditions for increased competition for public services.

4.15 

United Kingdom

Overall, the United Kingdom seems to be addressing the three identified policy
challenges.  The  challenge  and  recommendations  regarding  productivity  seem
fully addressed. The competition authority is progressing in further improving
competition  in  specific  sectors  such  as  professional  bodies,  although  the
government is taking a cautious line on the deregulation of pharmacies and the
liberalisation of postal services. Furthermore a long term strategy has been set
out to improve the basic  skills  in the work  force containing  clear  quantitative
targets.

The  challenge  and  recommendation  on  the  labour  market  also  seem  fully
addressed.  Pilot  projects  have  been  launched  to  address  the  issue  of  high
sickness  and  disability  benefits  (Pathways  to  Work)  and  financial  incentives
(Working Tax Credit) have been improved.  A growing number of workers is
being targeted by the above policies.

Finally, the challenge and recommendation on quality and efficiency of public
services  appear  fully  addressed.  Reforms  have  been  made  to  ensure  that
increased  public  spending  is  allocated  efficiently  and  effectively.  The
authorities  plan  to  make  an  Efficiency  Review  and  further  improvements  are
made in the use of Public Service Agreements, which are considered central in
the strategy for public sector reform and improved delivery.

77