Commission Recommendation on the 2004 update of the Broad Guidelines of the Economic Policies of the Member States and the Community (for the 2003-2005 period) (presented in accordance with Article 99(2) of the EC Treaty)
Date: 2004-04-07
Institutions: European Commission
Subjects: EU Member State, economic policy

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 7.4.2004 
COM(2004) 238 final 

COMMISSION RECOMMENDATION 

on the 2004 update of the Broad Guidelines of the Economic Policies  
of the Member States and the Community 
(for the 2003-2005 period) 

(presented in accordance with Article 99(2) of the EC Treaty) 

EN 

   EN 

 
 
 
  
TABLE OF CONTENTS 

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

The existing strategy remains valid ..........................................................................................3 

Improved economic background...............................................................................................4 

Integrating the ten new Member States into the 2003-05 BEPGs ............................................5 

Growth and stability-oriented macroeconomic policies ...........................................................6 

Economic reforms to raise Europe’s growth potential..............................................................7 

Strengthening sustainability....................................................................................................10 

Country-specific economic policy guidelines ......................................................................12 

Belgium...................................................................................................................................12 

Denmark..................................................................................................................................12 

Germany..................................................................................................................................12 

Greece .....................................................................................................................................13 

Spain .......................................................................................................................................14 

France......................................................................................................................................14 

Ireland .....................................................................................................................................15 

Italy .........................................................................................................................................15 

Luxembourg............................................................................................................................16 

The Netherlands ......................................................................................................................16 

Austria.....................................................................................................................................17 

Portugal...................................................................................................................................17 

Finland ....................................................................................................................................17 

Sweden....................................................................................................................................18 

United Kingdom......................................................................................................................18 

Cyprus.....................................................................................................................................19 

Czech Republic .......................................................................................................................22 

Estonia ....................................................................................................................................27 

Hungary ..................................................................................................................................31 

Latvia ......................................................................................................................................36 

Lithuania .................................................................................................................................41 

Malta .......................................................................................................................................46 

Poland .....................................................................................................................................50 

Slovakia ..................................................................................................................................56 

Slovenia ..................................................................................................................................60 

I. 

1. 

2. 

3. 

3.1 

3.2 

3.3 

II. 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

12. 

13. 

14. 

15. 

16. 

17. 

18. 

19. 

20. 

21. 

22. 

23. 

24. 

25. 

2 

 
 
  
 
I. 

1. 

GENERAL ECONOMIC POLICY GUIDELINES 

The existing strategy remains valid  

The Council adopted a recommendation on 26 June 2003 on the broad guidelines 
of  the  economic  policies  of  the  Member  States  and  the  Community  for  the 
2003-2005 period1. These Broad Economic Policy Guidelines (BEPGs) constitute 
the  EU’s  medium-term  economic  policy  strategy.  The  BEPGs  focus  on  the 
contribution  that  economic  policies  can  make  to  the  fulfilment  of  the  strategic 
Lisbon goal. They are concentrated around: 

•  growth- and stability-oriented macroeconomic policies; 

•  economic reforms to raise Europe’s growth potential; and 

•  strengthening sustainability. 

Against the background of the results of a first assessment of the follow-up given 
to  the  2003-05  BEPGs  as  presented  in  the  Implementation  Report2  and  the 
guidance  from  the  Spring  2004  European  Council,  this  recommendation  updates 
and  completes  the  existing  strategy.  No  major  policy  adjustments  are  deemed 
necessary that would warrant a change in the general guidelines. The focus in this 
update  is  on  the  integration  of  the  ten  new  Member  States  into  the  existing 
economic policy coordination framework.  

Part I of this update concentrates on relevant considerations in applying the general 
guidelines  in  the  2003-2005  BEPGs  to  the  new  Member  States.  The  existing 
general  guidelines  all  remain  valid  and  are  unchanged.  They  are  applicable  to  all 
Member  States  and  to  the  Community.  With  a  view  of  completing  the  existing 
strategy,  Part II  presents  country-specific  recommendations  for  the  ten  new 
Member States. It also contains updates of the country-notes for Germany, Greece, 
France,  Italy,  the  Netherlands,  Portugal  and  the  United  Kingdom  to  allow  for 
policy adjustments in the area of budgetary policies. 

1 

2 

Council  recommendation  of  26  June  2003  on  the  broad  guidelines  of  economic 
policies  of  the  Member  States  and  the  Community  (for  the  2003-05  period), 
2003/555/EC, published in the Official Journal No. L 195/1 of 1 August 2003. 
Commission  Communication  ‘First  Report  on  the  Implementation  of  the  2003-
2005  Broad  Economic  Policy  Guidelines’  COM(2004)20  final,  adopted  on 
21 January 2004. 

3 

 
 
 
                                                 
2. 

IMPROVED ECONOMIC BACKGROUND  

The  economic  recovery  is  finally  taking  hold  in  the  EU  supported  by  a  general 
improvement  in  the  international  environment.  GDP  growth  has  gradually 
strengthened since the adoption of the BEPGs in the summer of 2003, with exports 
having  been  the  main  driver  in  the  beginning  of  the  recovery,  despite  a 
strengthening  of  the  euro.  Conditions  are  also  in  place  for  an  improvement  in 
domestic  demand:  confidence  among  businesses  and  consumers  has  picked  up, 
interest rates are at historically low levels, and equity prices have been recovering. 
Against  this  background,  the  Spring  Economic  Forecast  2004  foresees  a  further 
recovery and growth is expected to reach potential towards the end of 2004. It is 
necessary  to  consolidate  these  first  signs  of  growth.  The  European  Council 
endorsed  in  December  2003  the  initiative  to  launch  targeted  action  in  order  to 
facilitate sustainable growth.  

Inflation  is  expected  to  fall  below  2 per  cent  during  2004  and  to  further  ease  in 
2005.  While  increases  in  administered  prices  and  indirect  taxes  will  have  an 
upward impact on prices in 2004, the unwinding of the temporary effects from past 
increases in some food prices have an opposite effect. Similarly, the appreciation of 
the euro will hold back price increases. For example, this has largely absorbed the 
rise  in  the  dollar  price  of  oil.  Furthermore,  wage  moderation  is  expected  to 
continue in the medium-term and with the cyclical recovery in labour productivity, 
growth in nominal unit labour costs can fall back markedly thereby contributing to 
price stability. 

The  labour  market  situation  tends  to  reflect  economic  developments  with  a  lag. 
Following  a  stand-still  in  2003,  employment  is  expected  to  benefit  from  the 
turnaround and pickup of overall economic activity, which took place in the second 
half of last year. However, given the gradual nature of the recovery, employment is 
expected to increase modestly this year and to rise more strongly next year.  

Overall, economic developments are in line with the prevailing expectations when 
adopting  the  medium-term  economic  policy  strategy:  the  economy  is  recovering, 
albeit  at  a  moderate  pace,  and  the  outlook  for  2004-05  does  not  point  to  any 
macroeconomic  imbalances  requiring  a  policy  change.  At  the  same  time,  the 
forecast  illustrates  the  still  slow  adjustment  capacity  of  the  EU  economy  and  the 
low level of potential growth. It is therefore essential that the improving economic 
conditions  should  be  fully  seized  upon  to  make  decisive  progress  in  closing  the 
“delivery gap” in terms of discrepancy between envisaged and eventually adopted 
structural  reform  measures.  The  current  pick-up  in  economic  activity  could  be 
further  underpinned  by  sound  macroeconomic  policies  and  by  determined 
implementation  of  all  the  growth-enhancing  economic  reforms  outlined  in  the 
2003-05 BEPGs.  

4 

 
 
 
3. 

INTEGRATING  THE  TEN  NEW  MEMBER  STATES  INTO  THE 
2003-05 BEPGS  

The accession of Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, 
Malta, Poland, Slovakia and Slovenia on 1 May 2004 will be a major event in the 
Union’s history. 

Enlargement will contribute to new economic dynamism with mutually reinforcing 
effects. The new Member States’ growth potential is estimated at around 4 per cent 
per year, reflecting inter alia their solid progress in recent years with structural and 
institutional reforms. The Internal Market will be expanded to 455 million citizens. 
Notwithstanding recent progress, it must be recognised that their starting position is 
different and that the acceding countries will initially only account for 5 per cent of 
the Union’s GDP. With income levels of less than  half of those of the EU-15 on 
average (see Graph 1), the main challenges for the acceding countries are to secure 
real  convergence  in  the  long-run,  whilst  at  the  same  time  achieving  nominal 
convergence in the short to medium-term. 

Graph 1: GDP per capita 2003 (EU-15=100) 

90

80

70

60

50

40

30

20

10

0

CY

SI

MT

CZ

HU

SK

AC10

PL

EE

LT

LV

Source: Commission services (Eurostat, Structural indicators). 

The  structural  challenges  faced  by  the  new  Member  States  do  not  differ 
fundamentally  from  those  of  the  present  ones,  even  if  some  challenges  are  more 
demanding.3  The  existing  economic  policy  strategy  would  thus  appear  to  be 

3 

European  Economy,  occasional  paper  no.  4  ‘Key  structural  challenges  in  the 
acceding  countries:  the  integration  of  acceding  countries  into  the  Community’s 
economic  policy  co-ordination  processes’  by  Economic  Policy  Committee,  July 
2003. 

5 

 
 
 
 
                                                 
broadly appropriate. The scale of the challenges faced by these countries makes it 
crucial  to  find  an  appropriate  balance  between  different  policy  requirements.  For 
instance,  in  view  of  the  still  incomplete  structural  shift  to  a  modern  service-
oriented  market  economy,  most  acceding  countries  need  to  pursue  policies 
favouring  real  convergence.  The  EU  will  contribute 
to  real 
convergence  by  investment  in  the  regions  lagging  behind  through  the  cohesion- 
and structural funds as well as the European Investment Bank. However, national 
budgets must also cater for the important financing requirements linked to the need 
to upgrade the physical and human capital base, and fiscal authorities will have to 
cope  with  expenditure  pressures  stemming  from  the  completion  of  transition 
reforms, while ensuring fiscal rectitude. At the same time and in view of an initial 
average budget deficit of some 6 per cent of GDP, it will be essential to ensure the 
necessary consolidation of public finances to underpin macroeconomic stability.  

importantly 

The subsequent sections review the existing economic policy strategy and highlight 
those general guidelines or policy areas, where the specific circumstances of most 
acceding countries are such that a longer adjustment period could be warranted. It 
must be stressed that differences are sizeable across the acceding countries. Taking 
due  account  of  differences  in  their  economic  performances,  prospects,  structures 
and  institutions,  Part II  of  this  update  presents  country-specific  recommendations 
to the individual acceding countries.  

3.1 

Growth and stability-oriented macroeconomic policies 

Sound  macroeconomic  policies  play  a  crucial  role  in  sustaining  growth  and 
employment and in preserving price stability. The new Member States should, just 
as the existing ones, aim at achieving well-balanced growth that fully realises the 
growth potential. In addition, as regards most acceding countries, macroeconomic 
policies must also be able to support the remaining structural shift towards a more 
services oriented economy.  

The new Member States will need to seek a strong synergy between the necessary 
structural  reforms  and  macroeconomic  policies  that  underpin  stability.  Exchange 
rate  regimes  constitute  an  important  part  of  the  overall  economic-  and  monetary 
policy framework and should be oriented towards achieving real- and sustainable 
nominal  convergence.  Participation  in  ERM  II,  at  some  stage  after  accession, 
should help those endeavours. A credible monetary policy will allow for a further 
decline in long-term interest rates that is conducive to both the much needed high 
level of investment and fiscal consolidation. 

As  regards  the  need  to  ‘reach  or  maintain  sound  budgetary  positions’,  an 
appropriate  time  path  must  be  found  between  the  speed  of  the  necessary  budget 
consolidation and an appropriate fiscal stance supporting the transition. Budgetary 
surveillance as regards the new Member States will start with the examination of 
their  Convergence  Programmes.  Particular  attention  will  be  paid  to  country-
specific  circumstances,  in  particular  to:  initial  budgetary  positions,  ongoing 
structural  shifts  in  the  economies  and  the  possible  risks  resulting  from  current 

6 

 
 
 
account  imbalances  and  strong  credit  growth.  It  could  be  appropriate,  from  an 
economic  point  of  view,  to  allow  for  a  multi-annual  adjustment  period  in  some 
cases when correcting a deficit of more than 3 per cent. This would allow the new 
Member States to consolidate their public  finances  in a sustainable way, while at 
the same time completing the restructuring of the economy. In general, efficiency 
of public spending can be considerably enhanced, inter alia through a redirection 
of  public  spending  towards  growth-enhancing,  cost-effective  investments  in 
physical  and  human  capital  and  in  research  and  innovation.  In  addition,  a 
broadening of tax bases on labour and improving tax collection so as to ensure the 
appropriate revenues could facilitate a reduction of labour tax rates (including high 
social security contribution rates).  

Table 1: Macroeconomic indicators for the new and the current 
Member States in 2003 

AC10 

EU15 

GDP growth (real, % p.a.) 

Inflation (% p.a.) 

Current account (% of GDP) 

Unemployment (%) 

3.6 

2.1 

-3.7 

 14.3 

Government balance (% of GDP) 
AC10= the ten acceding countries. 
Source: Commission services (incl. Eurostat, structural indicators). 

-5.7 

0.8 

2.0 

0.2 

8.0 

-2.6 

The current account deficit amounted to some 3¾ per cent of GDP on average in 
2003  in  the  new  Member  States,  reflecting  the  catching-up  process  and  sizeable 
domestic  savings-investment  gaps.  A  major  macroeconomic  policy  challenge  for 
some of the acceding countries therefore consists of keeping relatively high current 
account deficits within the range where sound external financing can be secured. In 
this  respect,  fiscal  restraint  and  the  need  to  avoid  pro-cyclical  policies  will  be 
essential  to  reduce  current  account  deficits,  as  its  financing  could  become  more 
difficult once the privatisation process is fully completed.  

A  stable  macroeconomic  environment  requires  nominal  wage  increases  that  are 
consistent with both price stability and productivity gains. It will also be important 
for  wage  formation  in  the  acceding  countries  to  support  the  restructuring  of  the 
economy  by  allowing  wages  to  better  reflect  differences  in  local  labour  market 
conditions  across  firms,  sectors,  regions  and  occupations.  Beyond  this,  real  wage 
developments need to support external competitiveness in the new Member States 
in light of the need to attract foreign direct investment.  

3.2 

Economic reforms to raise Europe’s growth potential 

Catching-up  in  income  levels  is  a  long-term  process.  It  will  be  crucial  to  narrow 
both  the  gap  in  employment  rates  and  productivity  levels  between  the  acceding 
countries and the EU-15. The existing guidelines aiming at ‘more and better jobs’ 

7 

 
 
 
 
 
 
 
and at ‘increasing productivity and business dynamism’ are best implemented in a 
comprehensive and coordinated way.  

The  contribution  that  employment  policies  can  make  is  reflected  in  the  existing 
guidelines that concentrate on ‘making work pay’ and on pricing people back into 
jobs,  particularly  the  low-skilled  or  those  living  in  poorer  regions.  The  labour 
market situation is considerably worse in the acceding countries, with employment 
rates either static or on a downward path, high unemployment rates (they also tend 
to  be  of  a  long-term  nature  and  concentrated  amongst  young  people),  large 
numbers  of  inactive  persons  and  sizeable  informal  sectors.  It  will  therefore  be 
essential that policy efforts concentrate on a small number of priority areas that are 
likely to have the largest impact on labour market performances: ensuring that real 
wage developments reflect productivity growth; improving the financial incentives 
to  work  by  reforming  tax/benefit  systems;  improving  human  capital  formation, 
inter  alia  through  the  provisions  of  lifelong  learning  facilities;  and  undertaking 
appropriate  reforms  of  labour  market  regulations.  Employment  policies  need  to 
support  the  ongoing  process  of  large  structural  shifts  in  the  sectoral  and  regional 
composition of employment.  

Graph 2: Employment and productivity levels in the EU Member States  
and acceding countries (2002) 

d
e
y
o
p
m
e

l

n
o
s
r
e
p

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

r
u
o
b
a
L

)
2
0
0
2
(

0
0
1
=
5
1
-

U
E

140

130

120

110

100

90

80

70

60

50

40

30

IT

LU

IE

BE

FR

EU 15

FI

ES

MT

EL

AT

UK

CY

DE

NL

SE

DK

HU
SK
AC-10

PL

SI

CZ

PT

LV
LT

EE

Lisbon target

50

55

60

65
Employment rate as %  of working age population

70

75

80

Source: Commission services (Eurostat, structural indicators). 

It  will  be  essential  to  raise  both  employment  rates  and  to  improve  productivity 
growth  simultaneously  for  the  new  Member  States  (see  Graph  2).  The  ongoing 
restructuring  of  their  economies  is  instrumental  in  improving  the  generally  low 

8 

 
 
 
 
 
 
 
 
 
 
 
 
productivity  level.  The  transition  from  a  specialisation  in  low-value  added  and/or 
low labour cost activities towards higher value-added activities should take account 
of current comparative advantages. Increased economic integration into the Internal 
Market  and  accompanying  measures  to  promote  competition  in  the  economy 
should  speed  up  the  restructuring  process  in  the  new  Member  States.  Increased 
competition requires more rapid progress with privatisation, cutbacks in the use of 
administered  prices,  a  reduction  in  the  regulatory  burden  on  business  and  greater 
support  for  entrepreneurship.  In  this  context,  the  capacity  of  central  and  local 
authorities to enforce legislation needs to be strengthened, in particular as regards 
the legal rules on market entry and exit of companies. 

Table 2: Economic indicators for the new and the current 
Member States in 2003 

AC10 

EU15 

GDP per capita 1 
Productivity per person employed 2 
Employment rate (in 2002) 3  

48.7 

53.6 

55.9 

100 

100 

64.3 

17.9 

Business investments (% of GDP)4 
Total FDI inflows (% of GDP) 5 
R&D expenditure (% of GDP)6 
1  in  PPS,  level,  EU15=100.  2  GDP  in  PPS  per  person  employed,  level,  EU15=100.. 
3  Total  employment  rate  -  Employed  persons  aged  15-64  as  a  share  of  the  total 
population of the same age group, 2002. 4 Gross fixed capital investments by the private 
sector, 2002. 5 2002. 6 Gross domestic expenditure on R&D, 2001. 

17.2 

0.83 

1.98 

4.4 

5.0 

Source: Commission services (incl. Eurostat, structural indicators). 

Productivity  growth  will  be  further  enhanced  by  the  transition  of  new  Member 
States  to  a  knowledge-based  economy,  which  is  at  the  centre  of  the  EU  Lisbon 
strategy.  Also,  the  European  Initiative  for  Growth  underlines  the  importance  of 
investments  in  networks  and  in  research  as  crucial  steps  to  boost  growth,  better 
integrate  an  enlarged  Europe  and  improve  productivity  and  competitiveness.  For 
the new Member States, R&D diffusion and technology transfers are as important 
as R&D investment as a tool for accelerating the transition towards higher value-
added activities. Sustaining a high level of foreign direct investment is essential in 
this  endeavour,  as  is  an  increased  responsiveness  of  the  education  and  training 
systems to the changing needs of the labour market4. Reforms of the education and 
training  systems  would  also  help  to  encourage  the  move  to  more  innovative, 
knowledge-intensive  activities,  as  would 
in  environmental 
technologies. 

investments 

An  important  role  in  allocating  and  channelling  savings  towards  productive 
investments  and  establishing 
is  played  by  smoothly 
functioning,  developed  capital  markets.  While  the  capital  markets  have  grown  in 

investor  confidence 

4 

Joint interim report of the Council and the Commission ‘Education and Training 
2010’, adopted on 26 February 2004. 

9 

 
 
 
 
 
 
 
                                                 
the acceding countries since the early 1990s (both in terms of size and value), they 
generally  remain  underdeveloped  relative  to  most  of  the  current  Member  States 
(except  for  Cyprus  and  Malta).  Rapid  integration  into  the  single  market  for 
financial services by a quick transposition and implementation of all the acquis in 
this area, will be all the more important to support the development of a sound and 
well-capitalised  financial  sector  and  for  maintaining  a  level  playing  field  for 
financial institutions in an enlarged EU. In addition, the capital markets in most of 
the  new  Member  States  are  characterised  by  a  high  level  of  bank  intermediation 
(typically  making  up  more  than  80 per  cent  of  total  financial  assets  in  Central 
Europe  and  the  Baltic  States)  and  extensive  foreign  bank  ownership  (except  for 
Cyprus and Slovenia), while several are also experiencing a rapid development of 
other financial intermediaries such as pension funds (e.g. Poland). In this context, it 
will be particularly important for the new Member States to further strengthen their 
financial  supervisory  arrangements  and  improve  cross-border  cooperation  in 
financial supervision and financial crisis management. 

3.3 

Strengthening sustainability 

The BEPGs put considerable emphasis on ensuring that growth is sustainable in the 
EU,  by  integrating  economic,  social,  and  environmental  sustainability  into  the 
economic policy strategy.  

An ageing population will imply similar challenges for economic sustainability in 
the new Member States as in the EU-15. While their starting positions are better in 
general (with lower debt levels in most cases), the demographic outlook is likely to 
have greater economic (and social) implications.  

Table 3: Sustainability indicators for the new and the current 
Member States 

AC10 

EU15 

Government debt (2003, % of GDP)  

Employment rate of older workers1 

Long-term unemployment rate1  

Greenhouse gas emissions2 

42.2 

30.4 

8.1 

69 

64.0 

40.1 

3.0 

98 

Energy intensity3 
1 Figures for 2002. 2Figures for 2001, 1990 base year =100. 3 Energy consumption 
in 2001 divided by GDP at constant prices, kilogram of oil equivalent per 1000 
Euro. 

709 

194 

Source: Commission services (incl. Eurostat, structural indicators). 

Overall,  sound  economic  policies  make  an  important  contribution  to  social 
sustainability  as  jobs  play  a  vital  role  in  lifting  people  out  of  poverty  and  social 
exclusion.  In  the  new  Member  States,  additional  emphasis  must  be  put  on 
modernising social protection systems and improving the skills of the work force, 
with  a  view  to  increasing  participation  rates  and  improving  mobility.  The  low 
employment rates of both young and older workers require special attention in this 

10 

 
 
 
 
 
respect. Pronounced regional disparities need to be addressed, notably by ensuring 
efficient investments and an appropriate wage differentiation (reflecting differences 
in  productivity).  In  addition,  the  business  environment  has  to  be  improved, 
particularly  by  capacity  building  measures  in  public  administration.  This  should 
also enhance the efficiency in the use of EU Structural and Cohesion funds. 

The substantial investments in energy and transport infrastructure that are needed 
in  most  of  the  new  Member  States  aim  at  reducing  the  environmental  impacts  of 
energy  and  transport  use  and  improving  energy  efficiency.  Such  investments  will 
be  crucial  as  their  energy  intensities  exceed  those  of  current  Member  States  by  a 
factor of almost 4, see Table 3, in spite of improvements of as much as 6% per year 
over  the  last  decade.  In  particular,  it  will  be  essential  to  take  full  account  of  the 
costs  of  environmental  damage  in  investment  decisions,  including  by  reducing 
energy  subsidies  and  introducing  appropriate  taxes  and  charges,  for  example  for 
energy consumption and/or transport use.  

11 

 
 
 
II. 

COUNTRY-SPECIFIC ECONOMIC POLICY GUIDELINES 

Part  II  contains  updates  of  the  country-notes  for  Germany,  Greece,  France,  Italy, 
the Netherlands, Portugal and the United Kingdom. It also presents country-notes 
for the ten new Member States. 

The  Council  adopted  the  broad  guidelines  of  the  economic  policies  for  the 
2003-05 period  for  the  current  Member  States  on  26 June 2003.  The  country-
specific  recommendations  therein  generally  remain  valid,  although  some  of  them 
need  to  be  updated  to  allow  for  necessary  policy  adjustments  in  the  area  of 
budgetary policies.  

It is important to note that, even when measures have been taken that partly or even 
fully  address  a  particular  recommendation,  that  recommendation  is  not  updated 
until a full assessment of their impact can be carried out. The pace and nature of 
progress in the implementation of the various guidelines is reviewed in the annual 
Implementation Report. 

1. 

Belgium 

No update. 

2. 

Denmark 

No update. 

3. 

Germany 

One of the challenges facing Germany is to “reduce rapidly the general government 
deficit  to  below 3 per  cent of  GDP  and  keep  government  finances  on  a  steady 
consolidation  path”.  In  order  to  achieve  this,  Germany  was  recommended  in  the 
2003 version of the Broad Economic Policy Guidelines to: 

•  ensure  a  rigorous  budget  execution  and  implement  the  announced  or 
compensatory  measures  for  2003  amounting  to  1 per  cent  of  GDP  and  put  an 
latest 
end 
(recommendation 6); and 

the  present  excessive  deficit  situation  by  2004  at 

the 

to 

•  lower  the  cyclically-adjusted  deficit  by  at  least  one  percentage  point  of  GDP 

between the end of 2003 and 2005 (recommendation 7). 

These  two  recommendations  were  similar  to  those  addressed  by  the  Council  to 
Germany on 21 January 2003 in accordance with Articles 104(7) of the Treaty. On 
18 November 2003, the Commission adopted two recommendations on the basis of 
Article  104(8)  and  104(9)  respectively  for  the  Council  to  decide  (1)  that  action 
taken by Germany was inadequate to bring the excessive deficit to an end and (2) 
to  give  notice  to  Germany  to  take  the  necessary  measures  to  bring  the  general 

12 

 
 
 
the  Council  did  not  adopt 

government  deficit  below  3 per  cent of  GDP  in  2005  at  the  latest.  On 
two  Commission 
25 November 2003, 
recommendations but adopted instead a set of conclusions endorsing, inter alia, the 
commitments made by Germany to reduce the cyclically-adjusted deficit by 0.6 per 
cent of GDP in 2004, and by 0.5 per cent of GDP or a larger amount in 2005 so as 
to ensure that the general government deficit would be brought below 3 per cent of 
GDP  in 2005.  In  its  Opinion  on  the  2003 update  of  the  stability  programme  of 
Germany5, the Council reaffirmed these conclusions. 

the 

In the light of these developments and bearing in mind that budgetary plans for the 
years beyond 2005 are to an important extent formed within the period covered by 
the  BEPGs 
stability  programmes), 
recommendations 6 and 7 are replaced by the following:  

the  multi-annual 

(inter  alia 

in 

“6. 

7. 

7bis 

achieve  an  annual  reduction  in  the  cyclically-adjusted  deficit  of  0.6 per 
cent  of  GDP  in 2004  and  of  at  least  0.5 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 (GL 1); 

should  the  recovery  in  economic  activity  be  stronger  than  currently 
expected, allocate any higher-than-expected revenues to deficit reduction 
and accelerate the reduction in the cyclically-adjusted deficit; 

ensure that the budgetary consolidation continues in the years after 2005, 
namely  through  a  steady  reduction  in  the  cyclically-adjusted  budgetary 
deficit  by  at  least  0.5 percentage  points  of  GDP  per  year  or  more  if 
necessary  to  achieve  the  medium  term  position  of  government  finances 
close to balance or in surplus and bring back the debt ratio to a declining 
path (GL 1).” 

4. 

Greece 

One  of  the  challenges  facing  Greece  is  to  “ensure  the  long-term  sustainability  of 
public finances in the face of population ageing, in particular in view of the high 
government  debt  ratio”.  In  order  to  achieve  this,  Greece  was  inter  alia 
recommended in the 2003 version of the Broad Economic Policy Guidelines to: 

•  ensure effective control of government current primary spending by addressing 
resolutely the problem of the inelastic elements of expenditures, e.g. the wage 
bill (recommendation 2). 

According  to  the  fiscal  data  for  2003,  as  communicated  by  the  Greek  authorities 
but not yet validated by Eurostat, the general government deficit would have stayed 
only  just  below  the  3 per  cent  of  GDP  reference  value.  This  represents  a 
considerable widening of the deficit compared to 2002 in spite of a positive output 

5 

OJ C68, 18.3.2004. 

13 

 
 
 
                                                 
gap,  reflecting  the  pro-cyclical,  expansionary  nature  of  Greek  fiscal  policies.  For 
2004,  there  is  a  distinct  risk  that  the  reference  value  for  the  deficit  may  be 
breached.  Greece  is  moving  further  away  from  a  budgetary  position  of  close  to 
balance or in surplus.  

In the light of these developments, recommendation 2 is replaced by the following: 

“2. 

take appropriate measures to avoid the occurrence of an excessive deficit; 
move  towards  achieving  a  medium-term  close  to  balance  or  in  surplus 
position  by  ensuring  an  improvement  in  the  cyclically-adjusted  budget 
balance  of  at  least  0.5 per  cent of  GDP  per  year,  specifically  through 
effective control of government current primary spending (GL 1).” 

5. 

Spain 

No update. 

6. 

France 

One of the challenges facing France is to “reduce rapidly the general government 
deficit  to  below 3 per  cent of  GDP  and  keep  government  finances  on  a  steady 
consolidation path”. In order to achieve this, France was recommended in the 2003 
version of the Broad Economic Policy Guidelines to: 

•  achieve  a  significantly  larger  improvement  in  the  cyclically-adjusted  deficit 

in 2003 than that currently planned (recommendation 1); 

•  implement  measures  ensuring  that  the  cyclically-adjusted  deficit  is  reduced 
in 2004 by 0.5 per cent of GDP, or by a larger amount, so as to ensure that the 
cumulative  improvement  in  2003-2004  is  enough  to  bring  the  nominal  deficit 
below 3 per cent in 2004 at the latest (recommendation 2); and 

•  limit  the  increase  in  the  general  government  gross  debt  to  GDP  ratio  in 2003 

(recommendation 3). 

These  three  recommendations  were  similar  to  those  addressed  by  the  Council  to 
France on 3 June 2003 in accordance with Article 104(7) of the Treaty. On 8 and 
21 October 2003  respectively,  the  Commission  adopted  two  recommendations  on 
the  basis  of  Article  104(8)  and  104(9)  respectively  for  the  Council  to  decide  (1) 
that  no  effective  action  had  been  taken  by  France  in  response  to  the 
recommendation  of  3 June  and  (2)  to  give  notice  to  France  to  take  the  necessary 
measures to bring the government deficit below 3 per cent of GDP in 2005 at the 
latest.  On  25 November 2003,  the  Council  did  not  adopt  the  two  Commission 
recommendations but adopted instead a set of conclusions endorsing, inter alia, the 
commitments  made  by  France  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 would be brought below 3 per cent of 

14 

 
 
 
GDP  in 2005.  In  its  Opinion  on  the  2003 update  of  the  stability  programme  of 
France6, the Council reaffirmed and further clarified these conclusions. 

In the light of these developments and bearing in mind that budgetary plans for the 
years beyond 2005 are to an important extent formed within the period covered by 
the BEPGs (inter alia in the multi-annual stability programmes), recommendations 
1, 2 and 3 are replaced by the following: 

“1. 

2. 

3. 

achieve  an  annual  reduction  in  the  cyclically-adjusted  deficit  of  0.8 per 
cent  of  GDP  in 2004  and  of  at  least  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 (GL 1); 

should  the  recovery  in  economic  activity  be  stronger  than  currently 
expected, allocate any higher-than-expected revenues to deficit reduction 
and accelerate the reduction in the cyclically-adjusted deficit through the 
implementation  of  additional  measures.  In  addition,  any  budgetary 
margin  stemming  from  a  slower  than  planned  increase  in  expenditures 
should be allocated to deficit reduction; 

ensure that the budgetary consolidation continues in the years after 2005, 
namely  through  a  steady  reduction  in  the  cyclically-adjusted  budgetary 
deficit  by  at  least  0.5 percentage  points  of  GDP  per  year  or  more  if 
necessary  to  achieve  the  medium  term  position  of  government  finances 
close to balance or in surplus and bring back the debt ratio to a declining 
path (GL 1).” 

7. 

Ireland 

No update. 

8. 

Italy 

One  of  the  challenges  facing  Italy  is  to  “rapidly  consolidate  public  finances”.  In 
order to achieve this, Italy was inter alia recommended in the 2003 version of the 
Broad Economic Policy Guidelines to: 

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

The fiscal data for 2003 show that the general government deficit was 2.4 per cent 
of GDP, almost unchanged compared to 2002 (2.3 per cent). In a context of weak 
economic growth, the authorities have continued to rely on temporary measures to 

6 

OJ C43, 19.2.2004. 

15 

 
 
 
                                                 
restrain  the  deficit.  Such  measures  are  estimated  to  have  improved  the  budgetary 
outturn by slightly more than 2 percentage points of GDP (around 1.5 percentage 
points in 2002). Markedly lower interest expenditure compared to the previous year 
also helped stave off a larger increase in the deficit. In 2004, with reliance of one-
off  measures  to  be  reduced  by  half,  there  is  a  distinct  risk  that  the  3 per  cent  of 
GDP  reference  value  for  the  deficit  may  be  exceeded.  With  the  output  gap 
practically  unchanged,  the  development  in  the  cyclically-adjusted  balance  is  also 
unfavourable.  The  adjustment  towards  a  position  close  to  balance  in  cyclically-
adjusted terms is further set back. 

In light of these developments, recommendation 1 is replaced by the following: 

“1. 

take appropriate measures to avoid the occurrence of an excessive deficit; 
move  towards  achieving  a  medium-term  close  to  balance  or  in  surplus 
position  by  ensuring  an  improvement  in  the  cyclically-adjusted  budget 
balance  of  at  least  0.5 per  cent  of  GDP  per  year,  replacing  one-off 
measures by measures of a more permanent character (GL 1).” 

9. 

Luxembourg 

No update. 

10. 

The Netherlands 

One of the challenges facing the Netherlands is to “pursue budgetary adjustment in 
the coming years in the face of weaker potential growth, and the budgetary costs of 
ageing”.  In  order  to  achieve  this,  the  Netherlands  was  recommended  in  the  2003 
version of the Broad Economic Policy Guidelines to: 

•  continue to contain government expenditure within clearly defined ceilings set 
in real terms, consistent with a budgetary position close to balance or in surplus 
(recommendation 1). 

The  fiscal  data  for  2003  show  that  the  general  government  deficit  increased  to 
3.2 per cent of GDP. This deterioration is linked to the sharp economic downturn, 
which led to a stronger-than-expected increase in the deficit, despite a substantial 
package  of  fiscal  savings.  For  2004,  there  is  a  risk  that  the  3 per  cent  of  GDP 
reference  value  for  the  deficit  might  be  exceeded  as  well.  However,  taking  into 
account the widening of the output gap, the development of the cyclically-adjusted 
balance  is  more  favourable.  In  cyclically-adjusted  terms  an  adjustment  towards  a 
position close to balance is underway.  

In the light of these developments, recommendation 1 is replaced by the following: 

“1. 

stand  ready  to  take  the  necessary  measures  in  response  to  the  possible 
existence of an excessive deficit, while continuing to contain government 
expenditure  within  clearly  defined  ceilings  set  in  real  terms,  consistent 
with  a  medium-term  budgetary  position  close  to  balance  or  in  surplus 
(GL 1 and 14).” 

16 

 
 
 
11. 

Austria 

No update. 

12. 

Portugal 

One of the challenges facing Portugal is to “accelerate the consolidation of public 
finances and address the strong dynamics of government expenditure”. In order to 
achieve this, Portugal was inter alia recommended in the 2003 version of the Broad 
Economic Policy Guidelines to: 

•  ensure that the government deficit is further reduced in 2003 as planned and that 
the  cyclically-adjusted  deficit  is  thereafter  lowered  by  at  least  0.5 per  cent  of 
GDP  a  year  in  order  to  reach  a  budget  position  that  is  close  to  balance 
(recommendation 1). 

The fiscal data for 2003 show a general government deficit of 2.8 per cent of GDP, 
thereby  in  compliance  with  the  Council  Recommendation  of  5 November  2002 
addressed  to  Portugal  under  Article  104(7)  of  the  Treaty,  which  called  for  a 
government  deficit  below  the  3 per  cent  of  GDP  reference  value  by  2003  at  the 
latest.  The  large  negative  output  gap  associated  with  the  economic  recession  of 
2003 hindered considerably the process of budgetary consolidation, because of the 
massive shortfall in tax revenue that developed during 2003 (excluding the one-off 
measure  on  the  sale  of  tax  and  social  contributions  arrears).  Although  the 
government  has  been  broadly  successful  in  securing  the  planned  restraint  of 
expenditure  (i.e.  growth  in  current  primary  expenditure  continued  to  decelerate 
from  8.9 per  cent  in  2001  to  7.8 per  cent  in  2002  and  4.1 per  cent  in  2003),  the 
shortfall in tax revenue induced by the recession led the government to rely, to a 
significant  degree,  on  one-off  measures  for  a  second  consecutive  year  (1.5  and 
2.1 per cent of GDP in 2002 and 2003 respectively). For 2004, there is a distinct 
risk that the reference value for the deficit may again be exceeded in view of slow 
growth and the only partial replacement planned so far of the significant amount of 
one-off measures adopted in 2003.  

In light of these developments, recommendation 1 is replaced by the following: 

“1. 

take appropriate measures to avoid that the deficit breaches the 3 per cent 
of  GDP  reference  value  again;  move  towards  achieving  a  medium-term 
close to balance or in surplus position by ensuring an improvement in the 
cyclically-adjusted  budget  balance  of  at  least  0.5 per  cent  of  GDP  per 
year,  replacing  one-off  measures  by  measures  of  a  more  permanent 
character (GL 1).” 

13. 

Finland 

No update. 

17 

 
 
 
14. 

Sweden 

No update. 

15. 

United Kingdom 

The  fiscal  data  for 2003  show  that  the  general  government  deficit  was  3.2 per 
cent of GDP, above the 3 per cent of GDP reference value. The budgetary position 
deteriorated  more  than  planned  in 2003  due  principally  to  weaker-than-expected 
direct tax receipts. In the medium term, both the headline and cyclically-adjusted 
deficits are projected to decline to just below 2 per cent of GDP, in the context of 
continuing  increases  in  planned  expenditure  aimed  at  addressing  past  under-
investment  by  the  public  sector  and  under-provision  of  public  services.  The 
projected deficit path does not, however, allow a sufficient safety margin to prevent 
a  breach  of  the  3 per  cent of  GDP  reference  value  with  normal  macroeconomic 
fluctuations.  Furthermore,  there  are  risks  to  the  budgetary  projections  stemming 
from the assumed autonomous rise in the revenue ratio.  

In  the  light  of  these  developments,  the  United  Kingdom  faces  an  additional 
challenge  compared  to  the  2003  version  of  the  Broad  Economic  Policy 
Guidelines, namely to: 

Strengthen  the  budgetary  position  so  as  to  avoid  emerging  budgetary 
imbalances  

In  order  to  strengthen  the  budgetary  position  so  as  to  avoid  emerging  budgetary 
imbalances, the United Kingdom is recommended to: 

“6. 

stand  ready  to  take  the  necessary  measures  so  as  to  endeavour  to  avoid 
the  occurrence  of  an  excessive  deficit;  improve  the  cyclically-adjusted 
position  to  consolidate  the  public  finances,  consistent  with  a  budgetary 
position of close to balance or in surplus in the medium term (GL 1).” 

18 

 
 
 
16. 

Cyprus 

The small economy, with tourism as a mainstay, has shown some resilience in the 
face  of  a  difficult  international  environment.  At  first,  steady  and  high  real  GDP 
growth averaging 4.2 per cent for 1997-2001 was driven both by domestic demand 
and  continued  high  growth  in  tourist  arrivals.  However,  after  11  September  2001 
the  economy  was  hit  by  the  slump  in  tourism  linked  to  international  terrorist 
threats,  war  in  Afghanistan  and  Iraq,  and  SARS,  with  the  decline  continuing  in 
2003. Growth therefore more than halved but still reached 2 per cent in 2002 and 
2003,  supported  by  moderate  domestic  demand.  This  is  however  below  potential 
growth. 

The  relatively  good  growth  performance  was  supported  by  a  market  economy 
dominated by the private sector and with, inter alia, a highly developed financial 
and  legal  system,  generally  prudent  economic  policies,  and  a  flexible  labour 
market.  The  latter  has  been  operating  close  to  full  employment  and  with  high 
participation  rates;  with  unemployment  rates  fluctuating  between  3-5 per  cent, 
Cyprus effectively does not have an unemployment problem. At the same time, the 
crisis  in  (mass-)  tourism  in  Cyprus  has  underlined  the  increasing  economic 
dependence on this sector, while traditional sources of export earnings, particularly 
within the manufacturing sector, show a structural decline. Therefore, Cyprus may 
have  an  interest  in  increasing  its  diversification  towards  higher  value  added 
activities. To this end, Cyprus may accelerate the transition toward a knowledge-
based economy and continue to simplify the business environment. 

A  fiscal  consolidation  plan  was  introduced  in  1999  and  revised  and  extended  in 
following years. However, fiscal performance in 2002 and 2003 slipped again and 
consolidation  was  effectively  abandoned  as  deficits  increased  to  4.6 per  cent  and 
6.3 per cent of GDP respectively. The expansionary fiscal stance contributed to an 
increase in domestic demand and a current account deficit projected at 4.4 per cent 
of GDP for 2003. The government intends to tackle anew the fiscal deficit for this 
and  following  years,  thus  working  towards  a  more  favourable  policy  mix  and 
supporting a narrowing of the current account deficit. 

Policies  in  Cyprus  should  aim  at  achieving  a  high  degree  of  sustainable 
convergence, in particular as regards the consolidation of public finances. Both the 
further consolidation of public finances and management of the increasing tourism 
dependence need to be supported by policies which assist in perpetuating the strong 
growth performance into the  medium  and long term. This requires in particular  a 
strengthening of the growth and employment base and Cyprus should continue its 
further  transition  to  a  knowledge-based  economy.  It  must  be  noted  that  the 
challenges  outlined  below  are  subject  to  unusual  uncertainty  as,  in  the  event  of 
reunification, the island’s economic situation would fundamentally change. Against 
this background, Cyprus faces two major challenges:  

•  Ensure a reduction of the general government deficit on a sustainable basis,  

19 

 
 
 
•  Increase  the  diversification  of  the  economy  towards  higher  value  added 

activities.  

Ensure  a  reduction  of  the  general  government  deficit  on  a  sustainable 
basis 

Fiscal  consolidation  went  increasingly  off  target  in  2002  and  2003.  The  original 
fiscal  consolidation  plan,  introduced  in  1999,  was  revised  in  2001  and  again  in 
2002.  It  aimed  at  reducing  the  deficit  to  2.0 per  cent  of  GDP  by  2002  while 
reaching  fiscal  balance  by  2005.  However,  lower  growth  in  2002  brought  the 
budget  shortfall  to  4.6 per  cent  of  GDP,  instead  of  a  previously  planned  2.6 per 
cent.  For  2003  further  slippage  occurred,  linked  to  continued  modest  growth  and 
tax  avoidance  with  marked  revenue  shortfalls,  while  spending  increased  through 
higher  defence  outlays  and  expansionary  measures  introduced  to  offset  subdued 
external demand. This effectively rendered the consolidation program defunct, and 
the  government  deficit  for  2003  reached  6.3 per  cent  of  GDP.  The  expansionary 
fiscal  stance  contributed  to  an  increase  of  domestic  demand  and  to  a  continued 
relatively  high  current  account  deficit  projected  at  4.4 per  cent  of  GDP  for  2003. 
The government intends to tackle anew the  fiscal  deficit, thus working towards  a 
more  favourable  policy  mix  and  supporting  a  narrowing  of  the  current  account 
deficit.  To  put  fiscal  consolidation  on  track  again  significant  corrective  measures 
are  required.  The  quality  of  public  finances  should 
to  a 
comprehensive  fiscal  reform,  to  be  finished  by  end-2004.  These  reforms  will 
support further deficit reductions and assist in keeping the current account deficit in 
sustainable territory if private net saving should become less favourable again. 

improve  due 

Increase  the  diversification  of  the  economy  towards  higher  value  added 
activities 

While  tourism  accounts  for  around  15-20 per  cent  of  GDP  and  employment,  the 
economy  has  shown  some  resilience  in  the  face  of  a  difficult  international 
environment. However, in a longer term perspective, Cyprus may have an interest 
to  up-grade  tourism  activities  and  to  develop  other  value  added  activities.  In  this 
respect, the Cypriot government has initiated a number of reforms to facilitate the 
transition  towards  a  knowledge  based  economy.  Nevertheless  the  low  level  of 
R&D  expenditure,  particularly  by  the  business  sector,  and  the  lack  of  IT  related 
skills  may  still  be  handicaps.  Finally,  both  e-commerce  and  the  percentage  of 
households with internet access are quite limited. 

A  better  business  environment  is  also  key  to  improving  the  efficiency  of  product 
markets.  First,  the  Cypriot  economy  is  dominated  by  small  family  enterprises 
whose expansion may be partly hindered by access to finance. Second, competition 
in  the  network  industries  is  still  limited.  For  example,  the  unbundling  of  the 
transmission system operator is still lacking in the electricity market. In November 
2003,  the  regulator  for  the  telecommunications  and  postal  services  sectors  issued 
two decrees advancing but not completing the unbundling of the local loop in these 
sectors. Finally, barriers to market access remain in air transport and the acquis in 
the maritime sector still has to be fully implemented.  

20 

 
 
 
Country specific recommendations to Cyprus 

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

In  order  to  ensure  a  reduction  of  the  general  government  deficit  on  a  sustainable 
basis, Cyprus is recommended to:  

1. 

reduce the general government deficit in a credible and sustainable way 
within a multi-annual framework in line with the decisions to be taken by 
the  Council  in  the  context  of  the  forthcoming  budgetary  surveillance 
exercise (GL 1). 

In order to increase the diversification of the economy towards higher value added 
activities, Cyprus is recommended to:  

2. 

step up efforts to increase the adequacy of skilled human capital, promote 
R&D  and  innovation,  in  particular  in  the  business  sector,  and  improve 
conditions to facilitate ICT diffusion (GL 9, 13). 

3. 

continue to simplify the business and taxation environment (GL 11). 

21 

 
 
 
17. 

Czech Republic 

After  the  economic  slowdown  of  1997-1998,  the  Czech  Republic’s  annual  real 
GDP  growth  averaged  about  3 per  cent,  with  the  exception  of  2002  when  the 
country  was  hit  by  serious  floods  and  GDP  growth  reached  only  2 per  cent.  The 
HICP inflation reached very low levels (1.4 per cent in 2002 and -0.1 per cent in 
2003)  and  the  monetary  authorities  were  undershooting  the  inflation  target.  The 
growth performance has been underpinned by restructuring efforts, but output has 
not  yet  fully  reached  its  estimated  potential.  The  main  restructuring  process  took 
place  in  the  banking  sector.  The  restructuring  of  the  banking  sector  was 
accompanied  by  substantial  fiscal  costs  as  the  state  took  over  bad  assets  in  the 
banks’  balance  sheets.  Moreover,  fiscal  policy  has  been  until  recently  somewhat 
relaxed, causing the general government deficit to surge. The expansionary fiscal 
stance contributed to a domestic demand boom and an increasingly consumption-
driven widening of the current account deficit to more than 6 per cent of GDP. 

Policies in the Czech Republic should aim at achieving a high degree of sustainable 
convergence,  in  particular  as  regards  the  consolidation  of  public  finances.  The 
economy has been characterised by relatively low growth in comparison with the 
other  new  Member  States.  Therefore,  the  further  consolidation  of  public  finances 
needs  to  be  supported  by  policies  which  assist  in  accelerating  the  growth 
performance into the medium and long term. This requires, in particular, an effort 
to tackle the remaining structural shortcomings, notably in the labour market and in 
the  business  environment,  and  to  speed  up  the  transition  towards  a  knowledge-
based  economy.  Against  this  background,  the  Czech  Republic  faces  four  major 
challenges:  

•  Urgently  ensure  a  further  reduction  of  the  general  government  deficit  on  a 

sustainable basis and the long-term sustainability of public finances, 

•  Continue to address the structural problems in the labour market,  

•  Improve conditions for an accelerated productivity growth, 

•  Promote entrepreneurship and SMEs.  

Urgently ensure a further reduction of the general government deficit on 
a sustainable basis and the long-term sustainability of public finances 

The  general  government  deficit  increased  from  6.4 per  cent  of  GDP  in  2002  to 
12.9 per cent of GDP in 20037, thereby giving impetus for further worsening of the 
current  account  deficit.  In  2003,  the  government  has  introduced  a  fiscal 
consolidation programme which aims to reduce the general government deficit to 
4 per  cent  of  GDP  in  2006.  The  fiscal  consolidation  will  support  further  deficit 

7 

This deficit is partly due to one single imputed state guarantee, which is about 6.3 
per cent of GDP. 

22 

 
 
 
                                                 
reductions  and  assist  in  bringing  the  current  account  deficit  in  more  sustainable 
territory if private net saving should become less favourable.  

However, improvement in the quality of public finances will largely depend on the 
implementation of the fiscal reform. A very important feature of the fiscal reform is 
the  modification  of  the  institutional  framework,  with  the  introduction  of  the 
medium-term  expenditure  frameworks  and  performance-oriented  budgets.  In 
particular,  the  expenditure  frameworks  should  diminish  the  central  government’s 
incentives to provide state guarantees, which remain a source of substantial fiscal 
risk.  In  addition,  given  the  ongoing  decentralisation  of  public  administration,  the 
lack  of  budgetary  rules  at  regional  and  local  levels  represents  a  risk  to  a  sound 
fiscal position in the future. As a positive development, it is worth mentioning that 
in  its  reform  plans  the  government  does  not  foresee  a  lowering  of  the  share  of 
public investment expenditures as a percentage of GDP in the coming years. 

As  far  as  the  long-term  sustainability  of  public  finances  is  concerned,  extra-
budgetary  spending  and  rapidly  increasing  social  security  and  health  care 
expenditures  are  reasons  for  major  concern.  Although  the  current  level  of 
government  debt  in  the  country  is  not  high,  developments  regarding  the  items 
above contributed to a rapid increase in recent years (from 25.2 per cent of GDP in 
2001 to 37.6 per cent of GDP in 2003). 

Continue to address the structural problems in the labour market 

Between 1990 and 2002 the Czech labour market experienced substantial structural 
changes.  The  share  of  people  employed  in  the  primary  sector  fell  from  12.4 per 
cent to 4.8 per cent of the labour force, from 45.1 per cent to 39.6 per cent in the 
secondary  sector  and  increased  from  42.5 per  cent  to  55.6 per  cent  in  the  tertiary 
sector. The unemployment rate was 7.3 per cent at the end of 2002, and has since 
risen up to 8.1 per cent in the fourth quarter of 2003. In addition to the restructuring 
process, unemployment is likely to be affected by public finance reform, according 
to  which  2 per  cent  of  public  sector  jobs  are  to  be  lost  annually  over  the  period 
2004-2006.  The  impact  of  trade  unions  on  wage  formation  is  low.  The  wage 
negotiation  process  is  decentralised  with  wage  setting  mostly  at  the  enterprise 
level.  Bargaining  coordination  across  firms  and  sectors  is  weak.  Despite  the  fact 
that the employment rate is high (65.5 per cent in 2002) and the unemployment rate 
is around the EU average, the Czech labour market displays a number of structural 
shortcomings.  First,  regional  disparities  in  unemployment  are  very high.  The rate 
of unemployment in structurally weak regions is more than four times higher than 
in  Prague  and  in  some  regions  it  exceeds  25 per  cent.  Second,  the  share  of  long-
term unemployed (more than one year) is very high as it reached 40.3 per cent by 
the end of 2003. In addition, the average period of registration at the labour offices 
is becoming longer. Third, the rate of youth unemployment (people under 25 years 
old) is very high. The average share of youth unemployed was almost 23 per cent 
with substantial regional disparities. 

On  the  labour  supply  side,  long-term  unemployment  and  low  occupational 
flexibility  stem  from  the  disincentives  embedded  in  the  tax  and  benefit  system, 

23 

 
 
 
from  the  underdeveloped  system  of  life-long  learning  programmes,  and  from 
shortcomings of the education and training systems. As regards the latter, they do 
not sufficiently provide skills that are adapted to the needs of the labour market, in 
particular  to  the  demands  of  the  knowledge-based  economy.  The  structural 
shortcomings  in  the  Czech  labour  market  also  mirror  low  geographical  mobility, 
which  results  from  two  principal  shortcomings:  First,  the  regulation  of  housing 
prices weakens incentives for supply of housing in regions where jobs are created. 
And second, the weak transport infrastructure increases the costs of commuting and 
creates obstacles for investment and setting up of new enterprises in the structurally 
weak regions.  

On the labour demand side, the high rate of health and social security contributions 
might  have  negative  effects.  The  total  rate  of  health  and  social  security 
contributions has reached 47.5 per cent of gross wage of which about ¼ is paid by 
employees and about ¾ by employers. 

Improve conditions for an accelerated productivity growth 

Productivity growth in the Czech Republic has been comparatively low. Over the 
period  1996-2002,  labour  productivity  grew  by  2.1 per  cent  annually,  the  lowest 
rate among the new members. Moreover, the level of productivity is still very low 
in  comparison  with  the  EU  (around  55 per  cent  of  the  EU  15  average  in  2003). 
Factors  contributing  to  this  situation  could  be  the  limited  flexibility  of  the 
education system, the low effectiveness of R&D and innovation, and the low use of 
ICT. The limited flexibility of the education and training system in responding to 
the  changing  skills  requirements  manifests  itself  through  the  qualification 
mismatches  in  the  labour  market.  Educational  attainment  (the  percentage  of  the 
population aged 20-24 with at least upper secondary education) is very high (92 per 
cent), but the share of tertiary graduates is one of the lowest in the EU. Despite a 
relatively high level of expenditure on R&D in comparison with the new members, 
the  resulting  innovation  activity,  as  measured  by  the  number  of  patents,  is  very 
low,  pointing  to  low  effectiveness  of  R&D.  There  seems  to  be  only  limited 
cooperation  between  the  research  institutions  (e.g.  universities  and  the  Czech 
Academy  of  Sciences)  and  the  private  sector.  Recognising  these  problems,  the 
government has adopted the National R&D Policy for 2004-2008 to promote R&D 
but results will largely depend on its full implementation.  

Promote entrepreneurship and SMEs 

Despite the progress in establishing a well-functioning competition framework and 
continuous developments in the legal environment there seem to remain significant 
barriers  to  entrepreneurship  in  the  Czech  Republic.  This  is  reflected  inter  alia  in 
the low share of GDP accounted for by SMEs (less than 40 per cent). The gross-
birth  rate  of  enterprises  as  a  percentage  of  all  enterprises  is  relatively  low  in 
comparison with other new members. 

Factors  contributing  to  this  situation  appear  to  be  the  weaknesses  in  the  business 
environment  which  have  a  disproportionately  heavier  impact  on  SMEs,  e.  g. 

24 

 
 
 
regarding  regulations  and  legal  enforcement,  excessive  administrative  burden  on 
companies and limited access to finances. The administrative process of setting up 
a  new  company  is  very  lengthy  and  complicated.  The  ineffective  and  often  non-
transparent  operation  of  the  Commercial  Register  is  frequently  criticised  by 
entrepreneurs. Also the bankruptcy legislation does not allow for effective market 
exit or restructuring of troubled companies. Several legislative proposals to tackle 
some of these problems are currently being prepared but the progress has proven to 
be slow. Notwithstanding improvements in the qualification of judges, the quality 
and  timeliness  of  legal  enforcement  remain  fundamental  weaknesses.  In  addition, 
new businesses find it excessively difficult to find external sources of financing. 

Country specific recommendations to the Czech Republic 

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

In order to urgently ensure a further reduction of the general government deficit on 
a  sustainable  basis  and  the  long-term  sustainability  of  public  finances,  the  Czech 
Republic is recommended to:  

1. 

2. 

reduce the general government deficit in a credible and sustainable 
way within a multi-annual framework in line with the decisions to 
be  taken  by  the  Council  in  the  context  of  the  forthcoming 
budgetary surveillance exercise (GL 1). 

reform the health care and pension systems to ensure their financial 
sustainability, in particular to counter the expected increase in the 
old-age  dependency  ratio  and  take  measures  to  reduce  fiscal  risk 
stemming  from  the  rising  stock  of  contingent  liabilities;  and  to 
ensure  that  incentives  to  work  are  enhanced  and  the  high  social 
security contribution rates are lowered (GL 4, 14 and 16). 

In  order  to  continue  to  address  the  structural  problems  in  the  labour  market,  the 
Czech Republic is recommended to:  

3. 

strengthen  labour  supply  by  reforming  tax  benefit  systems  to 
eliminate  disincentives  to  work  and  enhance  occupational  and 
regional mobility by reducing skill mismatches, whilst ensuring the 
efficiency  of  retraining  measures  and  other  active  labour  market 
policies, deregulating the housing market, and improving transport 
infrastructure (GL 4, 7, 8 and 13).  

In  order  to  improve  conditions  for  an  accelerated  productivity  growth,  the  Czech 
Republic is recommended to: 

25 

 
 
 
4. 

5. 

improve  the  efficiency  and  quality  of  the  education  and  training 
system and its responsiveness to changing skills requirements (GL 
13). 

improve the efficiency of R&D and innovation activities, foster the 
transfer  of  knowledge  through  FDI  and  support  the  diffusion  of 
knowledge (GL 13). 

In  order  to  promote  entrepreneurship  and  SMEs,  the  Czech  Republic  is 
recommended to: 

6. 

the  business  climate  by, 

improve 
the 
administrative  burdens, 
framework and increasing access to finance (GL 11 and 12). 

in  particular,  removing 
legal 

improving  and  enforcing 

26 

 
 
 
18. 

Estonia 

Against the background of weak external demand, macroeconomic performance in 
Estonia remained solid in 2003, but the current account deficit widened to 13.7 per 
cent  of  GDP.  GDP  growth  of  4.8 per  cent  was  underpinned  both  by  buoyant 
investment and private consumption growth. The latter was driven by strong credit 
expansion, higher wages and modest employment growth. Against the backdrop of 
a protracted investment sluggishness in the euro area, capital spending in Estonia 
grew briskly at over 11 per cent, due to strong FDI inflows and low interest rates. 
Inflation,  which  had  accelerated  to  almost  7 per  cent  in  mid-2001,  receded  to 
1.3 per  cent  in  2003.  The  general  government  surplus  widened  to  1.8 per  cent  of 
GDP in 2002 and further to 2.6 per cent in 2003, on account of strong activity and 
improved tax collection, and despite additional spending approved by parliament. 
Some local governments continued to exert a drag on public finances.  

Policies  in  Estonia  should  aim  at  achieving  a  high  degree  of  sustainable 
convergence, and a narrowing of the current account deficit. Fiscal policy can have 
a  significant  impact  on  the  current  account,  while  structural  policies,  particularly 
those that aim at improving productivity and increasing competition, can raise the 
economy's  growth  potential,  and  in  turn  further  improve  the  saving-investment 
balance and the current account. Additionally, the labour market, and specifically 
the  high  unemployment  rate,  remains  an  important  challenge  for  the  authorities 
following  the  restructuring  of  the  economy  after  independence.  Against  this 
background, Estonia faces four major challenges: 

•  Address  the  sizeable  current  account  deficit,  to  which  an  appropriate  fiscal 

policy should contribute, 

•  Address the structural problems in the labour market, 

•  Improve conditions for increasing productivity, 

•  Develop effective competition in network industries. 

Address  the  sizeable  current  account  deficit,  to  which  an  appropriate 
fiscal policy should contribute 

A  mismatch  between  domestic  and  foreign  demand  was  manifested  in  a  robust 
demand  for  imports  (8.1 per  cent  increase),  and  a  relatively  sluggish  export 
performance  (5.1 per  cent  increase),  and  consequently  in  a  deterioration  in  the 
current account deficit to 13.7 per cent of GDP in 2003. A number of large one-off 
items,  concerning  mainly  the  import  of investment  goods,  and  a negative  income 
balance accounted for a large part of the deficit, while the capital account remained 
in surplus, thanks to strong FDI inflows. The low level of public debt (around 5 per 
cent of GDP) and the positive credit rating of the country help to allay immediate 
stability concerns about the financing of the current account deficit. In addition, the 
central government has accumulated a “stability reserve” amounting to 9 per cent 

27 

 
 
 
of GDP, which has been financed from budget surpluses and privatisation revenues 
since 1997.  

Structural  policies  enhancing  the  external  competitiveness  of  Estonian  goods  and 
services, primarily through a rapid improvement of the country’s infrastructure as 
well  as  investment  in  human  capital,  with  a  particular  focus  on  the  country’s 
disadvantaged  regions,  are  therefore  essential  to  decisively  reduce  this  major 
macroeconomic imbalance of the Estonian economy in the medium-term. 

The  continuation  of  prudent  fiscal  policies  plays  a  key  role  in  addressing  the 
current  account  deficit.  While  the  general  government  surplus  increased  from 
1.8 per  cent  of  GDP  in  2002  to  2.6 per  cent  of  GDP  in  2003,  some  local 
governments continued to exert a drag on public finances with budget slippages in 
both 2002 and 2003. Despite the fiscal surpluses of recent years and the low public 
debt,  plans  for  additional  expenditures  and  tax  cuts  along  with  commitments 
related to EU accession will make for higher budgetary pressure in the near future. 
This  may  lower  national  savings  further  and  thus  have  a  negative  impact  on  the 
overall  policy  mix,  particularly  against  the  background  of  a  very  high  current 
account  deficit.  On  the  whole,  the  Estonian  general  government  balance  should 
remain  in  balance  or  in  surplus  over  the  next  few  years,  even  with  some  fiscal 
easing.  Moreover,  an  easing  of  fiscal  policy  over  the  first  few  years  of  EU 
membership is likely to coincide with an economic upswing. A pro-cyclical effect 
of  the  envisaged  fiscal  policy  stance  may  not  be  ruled  out.  Thus,  the 
implementation  of  the  medium-term  fiscal  policy  program  in  Estonia  requires  a 
prudent and flexible approach.  

Address the structural problems in the labour market  

Conditions  in  the  labour  market  in  Estonia  have  deteriorated  gradually  following 
the  country's  independence.  The  restructuring  of  the  economy,  and  the  resulting 
skill mismatch, appear to be the main factors behind the rise in unemployment to 
14½ per  cent  by  mid-2000  (based  on  the  ILO  definition).  The  employment  rate 
which had declined from 65 per cent in 1997 to 60.6 per cent in 2000, edged up to 
61.1 per  cent  in  2002  for  the  first  time  since  the  country’s  independence 
contributing  to  a  turnaround  in  the  labour  market,  resulting  in  a  fall  in  the 
unemployment rate to 10.3 per cent in 2002. However, this improvement was the 
result of modest employment gains, and a significant decline in the economically 
active population; employment increased by some 2 per cent over 1997-2002 while 
the economically active population declined by almost 2.5 per cent. 

The rising unemployment over 1997-2002 was associated with a steady increase in 
the  proportion  of  long-term  unemployed,  and  of  discouraged  workers,  and 
consequently an increase in the structural unemployment rate. However, the share 
of  those  without  a  job  for  more  than  a  year  declined  to  41 per  cent  of  the 
unemployed in 2002, or almost to the same level as in 1997, after having increased 
considerably  to  60 per  cent  during  this  period.  Even  so,  the  number  of  long-term 
unemployed  remains  particularly  high,  suggesting  that  a  large  number  of  the 
unemployed do  not  possess  the  skills  required  to  reintegrate  successfully  into the 

28 

 
 
 
labour market. Regional disparities continue to persist and unemployment remains 
considerably  higher  in  the  Northeast  (at  around  19 per  cent  of  the  labour  force) 
than compared with the South (8½–9 per cent).  

Improve conditions for increasing productivity  

In Estonia, the level of productivity is still very low compared to the EU average 
(42 per  cent  of  the  EU 15  level  in  2002).  While  labour  productivity  growth 
remained strong (7 per cent per annum) over the period 1997-2000, it has slowed 
down since 2000. Two main factors could constitute a handicap for future increases 
in productivity growth: the lack of qualifications in the workforce and the low level 
of  R&D  and  innovation.  These  two  factors  also  explain  that  FDI  are  mainly 
concentrated in areas that do not require important R&D and qualifications.  

The  lack  of  qualifications  in  the  workforce  results  from  inefficiencies  in  the 
education system, as public expenditures on education are relatively high (6.7 per 
cent of GDP in 2000). Particularly worrying is the fact that the education system is 
not sufficiently close to the needs of the labour market, creating a mismatch.  

A  well-designed  R&D  policy  can  also  have  an  important  role  in  increasing 
productivity  growth.  Currently  Estonia  has  a  relatively  low  level  of  R&D 
expenditures,  below  that  of  other  European  countries  (0.8 per  cent  of  GDP  in 
2001),  and  the  lowest  rate  of  business  R&D  among  the  new  members.  This  is 
partly  due  to  the  weak  links  between  the  academic  sector  and  the  business 
community.  In  this  area,  a  new  strategy  has  been  approved  which  foresees  a 
significant increase in total R&D expenditures over the period 2002-2006. 

Develop effective competition in network industries 

While the liberalisation of network industries has started in Estonia, competition is 
still  very  limited  in  the  electricity  market.  The  country  has  negotiated  a  long 
transition period for the liberalisation of this sector, in light of its dependence on 
oil  shale  as  a  source  of  electricity  generation.  The  restructuring  of  the  oil-shale 
sector has started, but the progress made in the planned liberalisation of the market 
is  limited.  The  electricity  market  is  dominated  by  a  State-owned,  vertically 
integrated company with operations in supply, generation, monopoly transmission 
and distribution. The declared current market opening of 10 per cent, is below most 
of  the  other  new  member  states’  degree  of  market  opening.  One  of  the  most 
important  obstacles  to  liberalisation  of  the  electricity  market  is  the  imposition  of 
strict  import  licence  rules  by  the  authorities.  Ensuring  the  independence  of  the 
energy regulator is also important given the State’s ownership of the incumbent in 
the electricity market.  

The  problems  are  less  acute  in  gas  and  telecommunication.  The  gas  market  is 
privatised  and  open,  with  a  single  supplier  operating  on  the  market.  The 
telecommunication  market  has  been  also  liberalised.  However,  some  problems 
might arise because the owner of the network also operates as a distributor. 

29 

 
 
 
Country specific recommendations for Estonia 

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

In  order  to  address  the  sizeable  current  account  deficit,  to  which  an  appropriate 
fiscal policy should contribute, Estonia is recommended to: 

1. 

implement  a  fiscal  policy  that  is  in  line  with  the  decisions  to  be 
taken  by  the  Council  in  the  context  of  the  forthcoming  budgetary 
surveillance  exercise  (GL  1),  and  which  is  consistent  with  the 
objective of avoiding pro-cyclical policies that may exacerbate the 
external imbalance (GL 2). 

In  order  to  address  the  structural  problems  in  the  labour  market,  Estonia  is 
recommended to: 

2. 

3. 

adopt policies with particular emphasis on re-integrating the long-
term  unemployed,  particularly  in  regions  worst  hit  by  the 
restructuring of the economy, by promoting vocational training and 
life-long  learning,  and  by  setting  up  an  effective  institutional 
framework that is supporting job creation (GLs 4, 6 and 8). 

encourage  social  partners  to  ensure  that  wage  developments—
including changes to the minimum wage legislation—do not hinder 
employment growth, and hold up the recovery in the labour market 
(GL 3and 5). 

In order to improve conditions for increasing productivity, Estonia is recommended 
to: 

4. 

5. 

improve  the  efficiency  and  quality  of  the  education  system  and 
vocational  training  in  order  to  reduce  the  mismatch  on  the  labour 
market (GL 13). 

implement  the  R&D  strategy  approved  in  2001  and,  in  particular, 
promote  the  stronger  involvement  of  the  business  sector  in  R&D 
spending (GL 13).  

In order to develop effective competition in network industries: 

6. 

proceed with the liberalisation of the electricity market, strengthen 
the independence of the regulator and ensure effective competition 
in telecommunications (GL 9). 

30 

 
 
 
19. 

Hungary 

Following  a  relatively  high  real  GDP  growth  of  3.5 per  cent  in  2002,  real  GDP 
growth  in  2003  slowed  to  below  3 per  cent.  While  unemployment  is  among  the 
lowest of the acceding countries, the participation rate is very low compared to the 
EU  average.  Serious  structural  shortcomings  in  the  labour  market  render  further 
increase  in  employment  difficult:  notably  a  lack  of  regional  mobility,  skill 
mismatches and disincentives from the benefit systems. Achieving a high degree of 
sustainable  convergence  requires  regaining  and  maintaining  competitiveness  at  a 
sustainable  high  level.  A  return  to  reasonable  real  wage  development  and  the 
creation  of  a  more  investment-promoting  environment  seems  therefore  crucial  in 
order to ensure a balanced medium-term growth.  

After the high fiscal deficit of 9.3 per cent of GDP in 2002, fiscal policy became 
restrictive  again  in  2003.  However,  the  general  government  deficit  still  reached 
5.9 per  cent  of  GDP.  The  significant  overshooting  of  the  fiscal  deficit  targets 
during  the  last  two  years  contributed  to  the  consumption-driven  widening  of  the 
current  account  deficit  to  above  5  ½ per  cent  of  GDP.  Together  with  other 
problems in the macroeconomic policy mix (such as the high real wage growth and 
very high real interest rates) and the high volatility of the exchange rate, this has 
led  to  a  general  loss  in  financial  markets’  confidence  and  to  a  loss  in  overall 
competitiveness.  

Policies  in  Hungary  should  aim  at  achieving  a  high  degree  of  sustainable 
convergence, in particular as regards the consolidation of public finances. Hungary 
implemented a number of structural reforms and has achieved important catch-up 
with the EU. However there are areas which pose further challenges to the country. 
Hungary should aim to adopt measures in order to make the education system more 
effective  and  R&D  has  to  be  encouraged  in  order  to  achieve  higher  productivity. 
Competition  in  the  network  industries  needs  to  be  further  improved  and  the 
independence  of  the  regulators  has  to  be  strengthened.  Against  this  background, 
Hungary faces five major challenges:  

•  Ensure  a  further  reduction  of  the  general  government  deficit  on  a  sustainable 

basis,  

•  Increase  employment  rates  and  address  the  structural  problems  in  the  labour 

market, 

•  Enhance  cost-competitiveness  by  pursuing  policies 

that 

induce  wage 

moderation, 

•  Improve conditions for increasing productivity, 

•  Develop effective competition in network industries.  

31 

 
 
 
Ensure  a  further  reduction  of  the  general  government  deficit  on  a 
sustainable basis  

After  the  high  deficit  of  9.3 per  cent  of  GDP  in  2002,  fiscal  policy  became 
restrictive  in  2003.  However,  the  general  government  deficit  of  2003  was  still 
5.9 per cent of GDP. While for 2004 a further reduction of the deficit is foreseen, 
the  starting  position  for  the  achievement  of  the  2004 deficit  target  seems  rather 
difficult.  While  initially  aiming  at  comprehensive  public  finance  reforms,  a 
significant  number  of  expenditure  items  have  not  been  addressed  at  all  in  the 
budget  of  2004,  and  still  seem  not  to  have  been  considered  in  the  consolidation 
plans.  Meanwhile,  savings  are  intended  to  result  mainly  from  cuts  in  current  and 
operational expenses. The previous expansionary fiscal stance, along with high real 
wage  growth,  contributed  to  high  domestic  demand  and  an  increasingly 
consumption-driven  widening  of  the  current  account  deficit,  to  somewhat  above 
5½ per cent of GDP. A reduction in the high government sector level of borrowing 
is also crucial in order to improve the current account. Households’ savings can not 
be  expected  to  be  sufficient  to  finance  the  rise  in  private  investment  (including 
those  related  to  EU  accession).  This  is  expected  to  put  further  pressure  on  the 
current  account.  Even  maintaining  the  present  current  account  deficit,  while 
allowing  investment  to  take  place,  would  thus  require  additional  budgetary 
constraint.  A  return  to  sustainable  policies  in  Hungary  has  to  be  based  on  a 
consolidation of public finances.  

Increase  employment  rates  and  address  the  structural  problems  in  the 
labour market  

Hungary has one of the lowest unemployment rates among the acceding countries 
(5.8 per cent in 2003). However, this is accompanied by a stagnating labour force 
and a low participation rate (59.7 per cent in the 15-64-year age-bracket for 2002) 
compared to the EU average. Consequently, the low unemployment rate does not 
reflect the substantial disengagement from the labour market and the high level of 
inactivity particularly in the end-of career working age population.  

The  labour  market  is  also  characterised  by  structural  shortcomings.  Regional 
differences can mostly be observed in the form of increasing urbanisation and the 
East-West  axis,  with  a  less  developed  infrastructure  and  higher  unemployment  in 
the  Eastern  part  of  the  country.  Internal  mobility  is  low  in  international 
comparison, with housing and transport as  the  main impediments. Furthermore, a 
significant number of unemployed are young adults (the youth unemployment rate 
is 11.4 per cent). 

Enhance  cost-competitiveness  by  pursuing  policies  that  induce  wage 
moderation  

While showing a slight improvement since the beginning of 2003, Hungary’s cost 
competitiveness has shown a significant deterioration in the years 2000-2002. The 
decline in cost competitiveness was partly due to the fast increase in wages. Real 

32 

 
 
 
wage growth exceeded productivity growth in the last three years, led by a rise in 
minimum wages and by the public sector, but also by a delayed adaptation of the 
corporate  sector  to  the  new  low-inflation  environment.  Although  wage  growth 
slowed down towards the end of the year, real wages still grew by 9.2 per cent in 
2003  (with  7.3 per  cent  in  the  business  sector  and  12.7 per  cent  in  the  public 
sector).  They  have  negatively  influenced  cost-competitiveness,  and  led  to 
decreasing  employment  in  some  low-skill  segments  of  the  labour  market.  While 
this  process  has  contributed  to  a  change  in  the  structure  of  industrial  production 
towards high skilled labour, increasing unit labour costs have led to a deterioration 
in  the  overall  competitive  position  of  the  country,  not  just  in  labour-intensive 
activities.  

Improve conditions for increasing productivity 

Productivity growth has been decreasing since 2000, although it remained slightly 
above  the  average  of  the  new  Member  States.  While  labour  productivity  growth 
was 4.2 per cent in 2000 it decreased to 2.4 per cent in 2003. Factors contributing 
to the slowdown in productivity growth have been the relatively low level of R&D 
(0.95 per  cent  of  GDP  in  2001),  inefficiencies  in  the  education  system,  and 
instability in the business environment.  

While some measures have been taken to improve the flexibility of the education 
system in order to better adapt to the changing needs of the labour market, there is 
still a lack of “middle-skilled” and high-skilled workers in the labour market. The 
number  of  PhD  students  is  increasing  but  many  terminate  their  studies  before 
obtaining  their  diploma.  The  number  of  total  tertiary  graduates  in  science  and 
technology per 1000 of population (aged 20-29) has been decreasing during the last 
years:  in  2001  it  was  3.7  which  is  one  of  the  lowest  in  the  EU.  In  the  field  of 
research and development, applied research is lagging behind, partly due to the still 
low  level  of  business  R&D  expenditures,  despite  fiscal  incentives,  and  limited 
cooperation between companies and research institutes. Public R&D expenditures 
are  also  relatively  low,  not  only  as  a  share  of  GDP  but  also  as  a  share  of  total 
government  expenditures  (R&D  expenditures  by  the  government  represented 
0.9 per cent of total government expenditures in 2001). Another factor which might 
negatively affect productivity growth is the frequently shifting policy environment. 
Regulations  and  government  strategies  have  often  been  changed  during  the  last 
decade,  which  reduced  the  predictability  of  policies  and  trust  in  the  government, 
and hampered longer term planning.  

Develop effective competition in network industries 

While  liberalisation  has  started  in  most  of  the  network  industries,  effective 
competition is still limited in these sectors. One of the most liberalised markets is 
telecommunication. However, even in this market, competition is restricted due to 
the strong dominant position of the previously State owned enterprise in the fixed 
line market and the quasi duopoly situation on the mobile market. Electricity and 
gas markets have been opened up for big customers. However, long-term purchase 
agreements and the low availability of interconnection capacities continue to pose 

33 

 
 
 
obstacles to competition in electricity. Finally, in certain of these sectors the State 
has retained its capabilities to intervene in the activities of the network regulators. 
This  is  the  case  in  the  electricity  and  gas  markets  where  the  government  has  the 
possibility to influence prices.  

Country specific recommendations to Hungary 

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

In  order  to  ensure  a  further  reduction  of  the  general  government  deficit  on  a 
sustainable basis, Hungary is recommended to:  

1. 

reduce the general government deficit in a credible and sustainable 
way within a multi-annual framework in line with the decisions to 
be  taken  by  the  Council  in  the  context  of  the  forthcoming 
budgetary surveillance exercise (GL 1). 

In order to increase employment rates and to address the structural problems in the 
labour market, Hungary is recommended to: 

2. 

3. 

through  appropriate  measures 

strengthen  labour  supply  by  removing  obstacles  to  regional 
mobility 
the  housing  and 
transportation  policy,  and  by  encouraging  disadvantaged  groups 
(ethnic  minorities,  disabled and homeless people) to (re-)enter the 
labour market (GL 7 and 8). 

in 

ensure  that  the  tax  and  benefit  systems  support  employment  and 
provide  incentives  to  enter  or  remain  in  the  labour  market  (make 
work pay- principle) –  the high tax burden of labour force should 
be further reduced (GL 4). 

In  order  to  enhance  cost-competitiveness  by  pursuing  policies  that  induce  wage 
moderation, Hungary is recommended to: 

4. 

encourage  a  reform  of  wage  setting  which  allows  wages  to  better 
reflect  productivity.  Promote  multi-annual  wage  agreements  with 
the social partners in order to keep real wage development in line 
with productivity growth (GL 5). 

In  order 
recommended to: 

to 

improve  conditions  for 

increasing  productivity,  Hungary 

is 

5. 

promote the stronger involvement of the private sector in R&D and 
innovation,  strengthen  the  link  between  business  and  research 
institutions,  ensure  sufficient  resources  to  improve  the  quality  of 

34 

 
 
 
research  and  support  the  transfer  of  knowledge  through  FDI  (GL 
13). 

6. 

7. 

improve  the  efficiency  of  the  education  system,  increase  its 
flexibility  in  order  to  better  adapt  to  the  skill  needs  of  the  market 
and ensure adequate resources for vocational training and education 
(GL 13). 

ensure  stability  of  legislation  and  government  policies  to  create  a 
business  environment,  more  supportive  to  entrepreneurship  (GL 
11). 

In  order  to  develop  effective  competition  in  network  industries,  Hungary  is 
recommended to: 

8. 

proceed  with  the  liberalisation  of  the  network  industries,  increase 
effectiveness  of  competition  and  the  independence  of  the  network 
regulators (GL 9). 

35 

 
 
 
20. 

Latvia 

Robust  economic  performance  was  registered  in  Latvia  in  recent  years  despite  a 
weak external environment. It is expected that GDP growth will remain at potential 
growth of 5-6 per cent per year in the medium term. Private consumption and gross 
fixed capital formation have been particularly strong and are the driving factors for 
growth. Despite high private consumption growth, inflation remained modest over 
the last five year. However, inflation is expected to reach relatively high levels this 
year; but could fall to 3 per cent by 2006/07. External trade has expanded rapidly 
and  since  imports  are  outpacing  exports,  the  current  account  deficit  has 
increased  to  9.1  per  cent  of  GDP  in  2003  and  is  expected  to  remain  at  this  high 
level  in  the  medium  term.  Latvia  made  remarkable  progress  implementing 
structural  reforms  in  recent  years,  but  still  faces  some  challenges,  including  the 
functioning  of  the  public  administration,  that  could  impair  Latvia’s  absorption  of 
EU structural funds. These challenges if not fully met, may weaken Latvia’s ability 
to stay on a path of strong growth. 

The  unemployment  rate  declined  slowly  and  varies  considerably  across  regions. 
The smooth functioning of the labour market is hampered by a number of structural 
problems, including inadequate education and training systems, skills mismatches 
and low geographical mobility. Competition on Latvian product markets has been 
boosted by the privatisation of most State-owned companies, and the level of State 
aid remains lower than the EU average. The few remaining competition problems 
are mainly concentrated in network industries. Although Latvia benefits from low 
labour  costs  and  taxes,  the  low  level  of  labour  productivity  remains  a  major 
concern. 

The  decreasing  trend  in  the  general  government  deficit  was  interrupted  in  2002, 
when it rose to 3 per cent of GDP, from 1.6 per cent in 2001. In 2003 better than 
expected  tax  revenues  and  close  monitoring  of  expenditure  by  the  government 
helped to reduce the general government deficit to 1.8 per cent of GDP and in 2004 
the  deficit  is  planned  to  be  2 per  cent  of  GDP.  However,  Latvia’s  fiscal  position 
depends  on  the  strength  of  the  commitment  to  ensure  budgetary  discipline; 
consequently,  a  pro-cyclical  stance  characterizes  Latvia’s  fiscal  policy.  On  the 
other hand, the general government debt remains low at 15.6 per cent of GDP. 

Policies  in  Latvia  should  aim  at  achieving  a  high  degree  of  sustainable 
convergence, in particular as regards the consolidation of public finances. Both the 
further  consolidation  of  public  finances  and  solutions  to  address  the  under-
utilisation  of  Latvia’s  human  resources  need  to  be  supported  by  policies  which 
assist  in  perpetuating  the  strong  growth  performance  into  the  medium  and  long 
term. This requires in particular a strengthening and diversification of the growth 
and  employment  base  by  fostering  the  entrepreneurial  climate.  Furthermore,  the 
productivity  level  needs  to  be  raised  and  Latvia  should  prepare  for  the  eventual 
transition  to  a  knowledge-based  economy.  Against  this  background,  Latvia  faces 
four major challenges:  

36 

 
 
 
•  Address  the  sizeable  current  account  deficit,  to  which  an  appropriate  fiscal 

policy should contribute, 

•  Improve conditions for increasing productivity, 

•  Address the structural problems in the labour market, 

•  Develop effective competition in network industries. 

Address  the  sizeable  current  account  deficit,  to  which  an  appropriate 
fiscal policy should contribute 

Latvian  domestic  demand  for  imported  goods  remains  stronger  than  the  external 
demand for Latvian goods, thus, the current account deficit has increased to 9.1 per 
cent of GDP in 2003. Export growth in 2002 and 2003 was very strong despite the 
international  slowdown;  however,  imports  grew  even  faster  than  exports.  In  the 
next  few  years  the  trade  balance  is  expected  to  worsen  even  more,  because  of 
strong  and  growing  investment  needs  as  the  economy  continues  to  develop  and 
restructure. This will lead to a broadening of the current account deficit. Although 
export prices grew faster than import prices in 2003, the terms of trade do not show 
consistently  favourable  developments  over  the  last  years,  thus  adding  uncertainty 
regarding potential future pressures on the current account. 

The modest pace of fiscal consolidation was disrupted by fiscal slippage in 2002, 
despite  strong  economic  growth  of  the  Latvian  economy.  In  2003,  the  general 
government  deficit  is  estimated  to  be  1.8 per  cent  of  GDP.  This  owes  mainly  to 
better-than-expected  tax  revenues,  following  both  improvements  in  tax  collection 
and a higher-than-expected growth. Even though the Latvian authorities maintain a 
commitment to balancing the budget in the medium term, the current pro-cyclical 
fiscal stance, combined with rapidly a changing political scene and a rather limited 
ability  of  the  government  to  increase  tax  revenues  in  a  period  of  high  economic 
growth, put Latvia in a difficult position from which to meet future spending needs. 
These spending pressures are also likely to exacerbate the current account deficit. 
In  the  face  of  a  weak  external  demand  and  already  high  domestic  demand,  a 
spending surge in late 2002, strong credit growth, in spite of the Central Bank of 
Latvia’s  interest  rate  increases  in  November  2003  and  again  in  March  2004,  and 
further fiscal loosening are a cause for concern. The key economic policy challenge 
is to avoid a pro-cyclical fiscal stimulus that could overheat domestic demand and 
aggravate the current account deficit. 

Improve conditions for increasing productivity  

Labour productivity in Latvia is the lowest in the EU (under 40 per cent of the EU-
15  average).  Over  the  period  1995-2003,  it  has  increased  relatively  to  the  EU 
average  but  its  growth  rate  slowed  down  in  recent  years.  Several  factors  bear  on 
Latvia’s productivity performance. First, although reforms have been initiated, the 
educational system still suffers from efficiency, contents, and external partnerships 
problems,  and  the  links  between  higher  education  and  industries  are  still 

37 

 
 
 
underdeveloped. Second, despite fiscal and other indirect measures taken R&D – in 
particular  the  share  of  business  R&D  -  and  innovation  activities  appear  to  be 
limited, both because of a lack of public funding and the absence of critical mass 
for most Latvian companies to carry out research activities. Productivity growth is 
also  constrained  by  the  low  level  of  entrepreneurial  activity  as  companies  face 
in  accessing  finance,  and  a  nascent 
heavy 
entrepreneurial  culture.  Despite  high  levels  of  business  investments,  productivity 
levels are still held back by low capital deepening and a still relatively low level of 
physical  infrastructure.  All  these  factors  also  contribute  to  explain  why  Latvia 
remains  specialised  in  relatively  low-tech  sectors  and  in  transit  activities  without 
much value-added. 

local  regulations,  difficulties 

Address the structural problems in the labour market 

The Latvian labour market displays a number of structural shortcomings, the main 
being  high  regional  differences  in  unemployment,  and  a  high  share  of  long-term 
unemployment  and  youth  unemployment.  In  2002,  the  participation  rate  reached 
68.8 per cent and the employment rate was 60.5 per cent. The unemployment rate 
was 12.1 per cent at the end of 2002 and has declined in 2003. 

The smooth functioning of the labour market is hampered by a number of structural 
problems.  First,  the  under-utilisation  of  human  resources  stems  from  feeble 
entrepreneurial climate. Latvia has the lowest rate of business start-ups in the EU, 
which  underlines  the  necessity  to  facilitate  entrepreneurship  and  the  development 
of small and medium size enterprises, in this way fostering the employment base. 
Second, the labour tax wedge is high in Latvia and creates a disincentive to work in 
the official economy. In addition, given the low wages, even modest social benefits 
make  working  or  returning  to  work  costly  decisions  and  therefore  discourage 
labour market participation. Third, the high rate of unemployment reflects to some 
extent  skills  mismatches  between  labour  supply  and  demand.  Moreover,  the 
education system fails to meet the demand for more flexible and modern forms of 
training.  The  Latvian  authorities  have  recently  proposed  a  comprehensive  reform 
of the education system to better adapt it to the requirements of a market economy, 
however, implementation of the reform might be both costly and lengthy. Finally, 
regional discrepancies in employment and unemployment are also the result of low 
geographical  mobility,  which  could  be  enhanced  through  improvements  in 
transport infrastructure. 

Develop effective competition in network industries. 

Steps to liberalise network industries have only been recently taken place with full 
liberalisation of voice telecommunications in 2003 and progressive liberalisation of 
other network industries to comply with EU legislation. All network industries are 
still  dominated  by  the  respective  incumbents  -  some  of  them  being  gradually 
privatised – facing low effective competition and benefiting from the absence of a 
real  choice  of  supplier.  Low  effective  competition  has  several  sources.  In  some 
cases, technical and practical barriers impede competition to develop, as is the case 
in telecommunications, where local loop unbundling, carrier selection and number 

38 

 
 
 
portability  are  trailing  behind.  In  some  other  cases,  the  legal  base  for  more 
effective  competition  is  not  yet  fully  in  place,  such  as  in  energy.  One  additional 
source of low effective competition is a lack of interconnection. Latvia’s railways 
connections  are  not  well-developed  with  Baltic  neighbours  and  other  European 
countries.  In  gas,  the  Latvian  market  is  still  dominated  upstream  by  very  few 
importers  and  is  de  facto  dependent  on  Russian  gas  supply.  Finally,  cross-border 
interconnections in electricity between Baltic States and other Member States may 
be insufficient to cope with long-term demand. 

Country specific recommendations to Latvia 

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

In  order  to  address  the  sizable  current  account  deficit,  to  which  an  appropriate 
fiscal policy should contribute, Latvia is recommended to: 

1. 

reduce the general government deficit in a credible and sustainable 
way within a multi-annual framework in line with the decisions to 
be  taken  by  the  Council  in  the  context  of  the  forthcoming 
budgetary surveillance exercise (GL 1 and 2). 

In order to improve conditions for increasing productivity, Latvia is recommended 
to: 

2. 

3. 

4. 

increase  the  efficiency,  quality  and  accessibility  of  the  education 
and  training  systems,  and  their  responsiveness  to  the  labour 
markets’ needs (GL 13 and 14). 

encourage R&D and innovation, in particular in the business sector 
(GL 13 and 14). 

encourage an entrepreneurial culture (GL 11). 

In  order  to  address  the  structural  problems  in  the  labour  market,  Latvia  is 
recommended to: 

5. 

6. 

revise the tax and benefit system in order to make work pay more, 
in particular by increasing the efficiency of social spending (GL 4). 

strengthen  labour  supply  by  pursuing  efforts  to  better  adapt  the 
qualifications  of  the  workforce  to  the  requirements  of  the  labour 
market  and  by  facilitating  labour  mobility,  especially  through 
improvements in transport infrastructure (GL 7 and 13). 

39 

 
 
 
In  order  to  develop  effective  competition  in  network  industries,  Latvia  is 
recommended to: 

7. 

8. 

take  legal  measures  to  enhance  effective  competition  in  network 
industries and to strengthen the role of the regulator (GL 9). 

increase  physical  interconnections  with  other  European  networks 
(GL 9). 

40 

 
 
 
21. 

Lithuania 

In spite of a weak external environment, Lithuania’s macroeconomic performance 
remained  particularly  strong  in  the  last  two  years.  Real  GDP  growth  accelerated 
rapidly  to  8.9 per  cent  in  2003,  primarily  supported  by  strong  investment  and 
private  consumption,  although  export  growth  remained  robust.  A  large  nominal 
effective  appreciation  of  the  litas,  together  with  strong  productivity  growth  that 
attenuated wage inflation, led to a decline in price levels. The decline (measured in 
HICP) amounted to 1.1 per cent in 2003. Strong economic growth was positively 
reflected  in  the  labour  market,  although  high  unemployment  remains  as  a  major 
weakness in the Lithuanian economy.  

The  decreasing  trend  in  the  general  government  deficit  initiated  in  2000  was 
interrupted  in  2003,  when  the  deficit  increased  slightly  to  1.7 per  cent  of  GDP, 
from  1.4 per  cent  in  2002.  Significant  increases  in  both  current  and  capital 
expenditure, partly associated with EU accession related expenditure, are approved 
in  the  budget  for 2004  and  are  expected  to  result  in  a  further  rise  of  the  deficit. 
Fiscal  consolidation  is  expected  to  resume  in  2005.  Moderate  budget  deficits  in 
previous years have contributed to maintaining sustainable current account deficits, 
which  have  to  a  large  extent  been  financed  by  foreign  direct  investment.  The 
currency board arrangement has proved a successful nominal anchor for monetary 
policy,  contributing  to  macroeconomic  stabilisation  and  historically  low  inflation 
rates. The enhanced macroeconomic stability has allowed for a decreasing trend in 
interest rates in the last few years, contributing to high domestic credit growth and 
consequently to rapid growth of investment and consumption.  

Policies  in  Lithuania  should  aim  at  achieving  a  high  degree  of  sustainable 
convergence.  The  labour  market  is  a  source  of  concern.  Decreasing  the  high 
unemployment rate and a further consolidation of public finances will be crucial to 
enhance  macroeconomic  stability  in  the  medium  term.  Preserving  Lithuania’s 
competitiveness  will  be  of  paramount  importance  for  a  rapid  and  sustained 
convergence with the EU economies. Further structural changes will be necessary 
to  maintain  the  current  productivity  growth  trend,  which  is  required  to  close  the 
substantial productivity gap between Lithuania and the EU average. In this regard, 
adapting  the  education  system  to  the  needs  of  the  labour  market  and  developing 
R&D  and  innovation  are  required  to  facilitate  much-needed  progress  towards  the 
transition  to  the  knowledge-based  economy.  Against  this  background,  Lithuania 
faces four major challenges:  

•  Address the structural problems in the labour market, 

•  Maintain low general government deficits, 

•  Improve conditions for increasing productivity, 

•  Develop effective competition in network industries. 

41 

 
 
 
Address the structural problems in the labour market 

Despite  visible  improvements  in  the  labour  market  in  the  last  two  years,  the 
unemployment  rate  remained  high  at  12.7 per  cent  in  2003  and  major  structural 
weaknesses  persist.  Large  regional  disparities  are  evident,  with  several  regions 
recording  unemployment  rates  around  20 per  cent.  The  youth  unemployment  rate 
remained  high  at  23 per  cent  in  2002,  whereas  the  long-term  unemployment  rate 
stood at 7 per cent. Close to 17 per cent of employment lies in the low-productivity 
agricultural  sector,  where  significant  labour  shedding  is  likely  to  take  place  and 
exert upward pressure on unemployment in the next years.  

Major  structural  shortcomings  in  the  labour  market  are  related  to  the  limited 
occupational  and  geographic  mobility  of  the  workforce,  mismatches  between 
supply  and  demand  of  skills  and  education  deficiencies.  Despite  enjoying  high 
participation rates in higher education, professional qualifications of the Lithuanian 
workforce  are  often  specialised  in  areas  that  do  not  match  properly  the  current 
demand  for  skills.  Labour  shortages  are  emerging  in  the  areas  of  information 
technologies,  management  and  several  categories  of  engineering.  Enhancing  the 
links  between  educational  institutions  and  business  would  help  to  better  adapt 
vocational  training  and  tertiary  education  to  the  current  needs.  At  the  same  time, 
lifelong learning activities, which are essential to increase the workforce’s capacity 
to  adapt  to  future  demands,  are  currently  at  one  of  the  lowest  levels  among  the 
acceding  countries.  Further  efforts  to  improve  the  quality  and  availability  of 
vocational training would be beneficial, especially in the least developed regions. 
The  high  share  of  low-qualified  workers  in  unemployment  calls  for  special 
attention  to  training  activities  for  this  category  of  workers.  Improving  the 
educational  infrastructure,  particularly  in  poorer  regions,  would  contribute  to 
establishing better framework conditions for attracting investment and increase the 
workforce’s  capacity  and  willingness  to  move.  Further  efforts  to  improve  the 
business  environment  would  help  to  create  employment  and  offset  redundancies 
stemming  from  industrial  and  agricultural  restructuring.  The  unemployment 
benefits system needs to be streamlined, the size of unemployment benefits are not 
linked  to  previous  wages,  coverage  of  the  insurance  is  not  clearly  defined  in  the 
legislation  and 
the 
unemployment insurance system are unclear. 

the  contributions  and  benefits  of 

links  between 

the 

Maintain low general government deficits  

The  authorities  have  held  to  their  fiscal  consolidation  plans.  Accordingly,  the 
general government deficit decreased from 5.7 per cent of GDP in 1999 to 1.4 per 
cent  in  2002.  However,  the  deficit  reversed  its  decreasing  trend  and  picked  up 
slightly  to  1.7 per  cent  in  2003.  Against  the  background  of  higher  revenue 
collection  than  expected  in  the  first  half  of  2003,  the  government  decided  to 
allocate additional expenditure by means of a supplementary budget in July 2003. 
The  amendments  resulted  in  significant  increases  in  current  expenditure  that 
prevented  a  further  reduction  of  the  deficit  in  2003,  mainly  in  the  form  of 

42 

 
 
 
compensations  for  the  loss  of  rouble  savings8  (about  0.4 per  cent  of  GDP)  and 
agricultural  subsidies  (0.2 per  cent  of  GDP).  The  2004  budget  foresees  a  further 
increase  of  the  deficit,  largely  related  to  a  surge  in  public  investment  and  higher 
expenditure related to the social security system and public sector wages, as well as 
significant  transition  costs  of  the  pension  reform.  Spending  pressures  stemming 
from  high  investment  needs  and  sizeable  fiscal  obligations  and  contingent 
liabilities denote a risk for the consolidation of public finances in the medium-term.  

Despite  efforts  made  to  improve  the  tax  system,  there  is  considerable  room  for 
improvement as regards the efficiency of tax collection. Government revenues as a 
percentage of GDP have decreased from 38.1 per cent in 1998 to 33.8 per cent in 
2002, while expenditure has remained largely stable. Additional expenditure to the 
budget plans is frequently allocated in the second half of the year, which prevents a 
faster  consolidation  of  public  finances.  A  pro-cyclical  fiscal  policy  stance  could 
entail  some  risks  as  additional  spending  pressures  are  intensifying.  Although  low 
budget deficits have contributed to alleviate pressures on the current account in the 
last  years,  fiscal  policy  might  need  to  play  a  role  in  mitigating  a  potential 
deterioration  of  the  private  sector’s  savings-investment  balance,  which  could  be 
stimulated by the present rapid credit growth dynamics.  

Improve conditions for increasing productivity 

Lithuania has had high productivity growth after the Russian crisis in 1999, but the 
productivity  level  is  still  very  low  at  42 per  cent  of  the  EU  15  average.  Also  the 
recent  high  productivity  growth  seems  to  have  been  partly  caused  by  one-off 
effects  due  to  better  capacity  utilisation  of  existing  resources.  With  a  GDP  per 
capita  level  at  39 per  cent  of  the  EU  15  average  in  2002  a  high  and  sustainable 
productivity  growth  is  necessary  to  reduce  the  income  gap  with  the  EU.  In  this 
respect,  deficiencies  of  the  education  system  and  the  low  level  of  R&D  and 
innovation are a handicap. 

Firstly,  despite  high  public  spending  on  education  and  a  high  number  of  tertiary 
graduates  there  is  a  mismatch  between  the  skills  acquired  in  the  education  and 
training systems and the needs in the business sector as described in the first key 
challenge.  The  government  is  preparing  a  program  for  the  implementation  of  an 
education strategy stretching to 2012, but further efforts may be necessary to adapt 
the  education  and  training  systems  to  the  future  needs  as  the  economic  structure 
develops. Secondly, a large share of the current economic structure is based on low 
technology activities. A change of the structure will require higher R&D and more 
innovation,  which  currently  are  among  the  lowest  in  the  new  Member  States. 
Maintaining high levels of FDI could act as a catalyst through knowledge transfer 
and thereby contribute to faster structural changes in the economy towards higher 

8 

The government committed to compensate citizens for the loss of rouble savings 
in  the  first  years  of  transition  and  to  restitute  ownership  rights  or  pay  pecuniary 
compensations  for  real  estate  property  confiscated  during  Soviet  times.  The 
outstanding amounts to be paid accounted for about 6.7 per cent of GDP at the end 
of 2003. 

43 

 
 
 
                                                 
value-added  sectors  and  improved  productivity.  Further  development  of  the 
physical  infrastructure  could  also  contribute  to  maintaining  the  high  productivity 
growth.  IT  expenditure  has  increased  slightly  from  a  very  low  level  and  low  IT 
penetration could be a hindering factor for improving productivity. 

Develop effective competition in network industries 

Despite  deregulation  in  most  network  industries,  effective  competition  remains 
weak  in  all  of  them,  except  mobile  telephony  and  road  transport.  The  fixed 
telephony market was fully liberalised in January 2003, but the incumbent is still 
the only player in the market. The telephone market regulator does not yet seem to 
have  adequate  resources  to  effectively  promote  competition.  The  implementation 
of  the  EU  legislation  on  railway  market  opening  has  not yet  been  completed  and 
the infrastructure is poorly developed, especially the interconnections with Poland.  

The  opening-up  of  the  energy  markets  have  led  to  few  visible  benefits  for 
consumers  and  high  concentration  ratios  persist,  both  in  supply  and  distribution. 
The  electricity  market  was  opened-up  for  large  customers  in  January  2002, 
corresponding  to  a  fourth  of  the  electricity  consumption.  Further  deregulation  is 
foreseen  in  steps  and  a  privatisation  of  electricity  distributors  is  currently 
underway.  However,  about  80  percent  of  all  electricity  is  produced  by  a  nuclear 
power  plant  and  a  lack  of  interconnection  capacity  with  other  acceding  countries 
prevents integration with the EU electricity market. Also the gas market has been 
liberalised  for  large  customers,  corresponding  to  80 per  cent  of  consumption. 
However,  there  are  few  independent  players  in  the  market  and  there  is  no 
interconnection with the Western European gas network. 

Country specific recommendations to Lithuania 

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

In  order  to  address  the  structural  problems  in  the  labour  market,  Lithuania  is 
recommended to:  

1. 

2. 

enhance  regional  mobility  and  reduce  skill  mismatches,  whilst 
ensuring the efficiency of education, retraining measures and other 
active labour market policies (GL 4, 7 and 8). 

improve  the  combined  incentive  effects  of  taxes  and  benefits  (GL 
4). 

In  order  to  maintain  low  general  government  deficits,  Lithuania  is  in  particular 
recommended to:  

3. 

pursue low budget deficits in a credible and sustainable way within 
a multi-annual framework in line with the decisions to be taken by 

44 

 
 
 
the  Council 
surveillance exercise (GL 1). 

in 

the  context  of 

the  forthcoming  budgetary 

4. 

avoid pro-cyclical fiscal policies that prevent a further reduction of 
the  general  government  deficit,  in  particular  by  avoiding  budget 
amendments  that  allocate  additional  expenditure  in  response  to 
higher than expected revenues (GL 2). 

In  order 
recommended to: 

to 

improve  conditions  for 

increasing  productivity,  Lithuania 

is 

5. 

6. 

improve  the  efficiency  and  quality  of  the  education  and  training 
systems and their responsiveness to labour market needs (GL 13). 

promote  R&D  and  innovation,  strengthen  the  links  between 
research  institutes  and  the  business  sector  and  support  knowledge 
transfer through FDI and higher IT penetration (GL 13). 

In  order  to  develop  effective  competition  in  network  industries,  Lithuania  is 
recommended to: 

7. 

8. 

pursue  liberalisation  and  enforce  effective  competition  in  energy, 
telecommunication and railway markets (GL 9). 

create  and  improve  interconnection  capacities  with  neighbouring 
EU Member States (GL 9). 

45 

 
 
 
22. 

Malta 

The  increasingly  open  nature  of  the  Maltese  economy,  large  dependence  on 
tourism revenues and its small  size  make the economy increasingly vulnerable to 
external  economic  and  geopolitical  shocks.  The  difficult  international  economic 
environment  in  the  last  two  years  and  restructuring  of  the  public  sector  brought 
about modest economic growth, mostly fuelled by large public consumption. Real 
GDP growth is currently far below its estimated potential.  

Despite sluggish economic growth, unemployment did not increase substantially in 
the period January-October last year (5.7 per cent in October 2003), although some 
deterioration  is  expected  in  subsequent  months,  linked  to  the  restructuring  in  the 
shipyard  industry  and  in  the  manufacturing  and  tourist  sectors.  Malta’s  general 
progress in adopting the acquis has not been accompanied by the accomplishment 
of crucial  economic reforms  against the backdrop of accession to the EU in  May 
2004. The restructuring of the public sector and reduction of state aid and subsidies 
and  the  reform  of  the  pension  and  healthcare  systems  have  been  postponed, 
resulting  in  a  negative  impact  on  economic  growth,  employment  generation  and 
public  finance.  The  comparatively  low  employment  rate,  particularly  among 
women,  remains  a  cause  of  concern.  In  a  context  of  little  efforts  to  consolidate 
public  finances,  lower  than  expected  GDP  growth  in  2003  and  mounting  public 
expenditure  have  further  deteriorated  the  general  government  deficit,  placing 
pressure  on  the  current  account  balance.  Policies  in  Malta  should  pursue  a  high 
degree  of  sustainable  convergence,  in  particular  as  regards  the  consolidation  of 
public finances. With this aim in mind, momentum in the reform of the pension and 
healthcare  systems,  and  public  sector  has  to  be  regained.  Despite  some  progress, 
the  degree  of  competition  in  some  areas  remains  insufficient  and  privatization 
efforts  need  to  be  pursued.  Against  this  background,  Malta  faces  three  major 
challenges: 

•  Ensure a reduction of the general government deficit on a sustainable basis and 

the long-term sustainability of public finances, 

•  Increase employment rates, especially among women, 

•  Encourage effective competition taking into account the specific characteristics 

of the small domestic economy. 

Ensure  a  reduction  of  the  general  government  deficit  on  a  sustainable 
basis and the long-term sustainability of public finances. 

In  order  to  tackle  the  high  general  government  budget  deficit  of  9.7 per  cent  of 
GDP  in  2003,  the  government  plans  to  implement  a  series  of  measures  and  to 
strengthen tax enforcement to boost revenue. It is interesting to note that non-tax 
revenues are expected to grow faster than tax revenues. This is primarily due to the 
revenue  collected  under  the  foreign  registration  scheme  and  due  to  the  EU 
Budgetary  Compensations  in  the  framework  of  the  Copenhagen  Package. 
Regarding  direct  taxation,  some  reduction  is  planned  due  to  the introduction of  a 

46 

 
 
 
five-tier tax band (until now, three-tier band) and the increase in the threshold of 
income to be taxed.  

On the expenditure side, high outlays for public sector wages, pensions and health 
care  expenditure  are  a  risk  for  the  sustainability  of  public  finances.  Regarding 
current expenditure, higher control of appropriations of welfare benefits and other 
assistance  programmes,  in  addition  to  a  reduction  in  subsidies  are  desirable. 
However,  due 
in  modernising  and  building  of  new 
infrastructure, capital expenditure may keep the overall expenditures at a high level 
(around 50 per cent of GDP), although a fall is foreseen in 2006 (to 46.6 per cent of 
GDP).  

to  persistent  needs 

The  population  ageing  implies  a  significant  fiscal  risk  to  the  long-term 
sustainability  of  public  finances,  in  particular  due  to  a  relatively  high  level  of 
government  debt.  The  expected  rapid  increase  in  the  old-age  dependency  ratio 
between  the  years  2000  and  2050  (from  18 per  cent  to  38.6 per  cent)  is  to  exert 
significant  fiscal  pressure  on  public  finances  in  the  future.  While  a  reform  of  the 
1st pillar of the pension scheme is being planned, it is unclear when it is going to 
be implemented.  

The substantial level of outstanding state guarantees (22 per cent of GDP in 2002) 
is  menacing  the  government’s  fiscal  position.  The  government  plans  to  limit  the 
issuance of the new guarantees in the future (a decline in the stock to 15 per cent of 
GDP in 2006), which is to be done by a stricter enforcement of the budgetary rules 
governing  the  issuance  of  the  guarantees.  This  should  contribute  to  the  planned 
medium-term decline in the level of the implicit contingent liabilities and alleviate 
the  existing  risk  exposure,  arising  from  the  issued  letters  of  comfort  or  credit 
facilities.  Overall,  the  general  government  gross  debt  amounted  to  72 per  cent  of 
GDP in 2003. 

Increase employment rates, especially among women 

In Malta, the labour market seems to be sufficiently flexible to adjust to economic 
shocks  without  generating  long  periods  of  high  unemployment.  However,  in 
September 2003 the employment rate (53.7 per cent) was low compared to the EU 
average.  The  relatively  low  employment  rate  was  attributable  to  a  low  female 
employment rate (33.1 per cent) as the equivalent male figure (74.2 per cent) was 
higher than the EU average. The increase in total and female employment rates is 
of paramount importance to widen the base for social security contributions, in the 
light of the ageing population. In this respect, some measures to encourage female 
participation have been recently undertaken. 

As  the  government  realizes  the  importance  of  raising  female  participation  in  a 
scenario  of  falling  birth  rates  and  an  ageing  population,  initiatives  aiming  at 
increasing  the  female  participation  rate  are  included  in  the  Employment  and 
Industrial Relations Act (ERA), which came into force in December 2002 and was 
complemented  by  eight  legal  notices  (one  of  those  concerns  the  Parental  Leave 
Entitlement Regulation). Other initiatives in this field are a Childminding Scheme, 

47 

 
 
 
a  Gender  Equality  Action  Plan  and  gender  mainstreaming  in  the  public  service. 
Furthermore, the accomplishment of the privatization process and the trimming of 
the public sector may contribute to a more efficient deployment of resources to the 
advantage of the private sector and boost economic efficiency and employment. 

High taxes on wages distort both demand and supply for labour, while activity is 
diverted  to  the  informal  economy.  The  gap  between  the  minimum  wage  and 
unemployment  benefit,  especially  for  the  larger  families,  remains  very  low  and 
reduces  incentives  to  work.  Early  retirement  schemes  used  as  a  means  to 
restructure  public  sector  entities  should  be  also  limited,  efforts  being  directed 
towards re-training. The ERA also regulates part time employees and contracts of 
services  for  a  fixed  term  in  order  to  increase  flexibility  in  the  labour  market. 
Vocational education activities have increased since 2001, when the Malta College 
for  Arts,  Science  and  Technology  was  set  up,  although  further  efforts  should  be 
made  to  both  improve  the  success  rate  in  secondary  education  and  reduce  the 
number  of  early  school  leavers.  Three  new  institutes  in  the  fields  of  Mechanical, 
Engineering, Agribusiness and Community Services have been created in 2003. It 
is  important  to  note  the  exceptionally  high  level  of  lower  secondary  education 
attainment, and very low attainment at upper secondary and tertiary levels. 

Encourage  effective  competition 
characteristics of the small domestic economy  

taking 

into  account 

the  specific 

A  significant  number  of  reforms  have  been  introduced  to  increase  competition  in 
the  Maltese  economy.  In  the  network  industries,  the  telecommunication  sector  is 
now  liberalised,  whilst  the  postal  services  sector  is  being  opened-up.  In  air 
transport, the monopoly of groundhandling activities has been removed following 
an  international  call  for  tenders.  Concerning  the  maritime  transport,  the 
implementation of the acquis has to be completed. In some sectors of the Maltese 
economy, competition is weak, such as the wheat milling and feed grains, and the 
shipbuilding  sector,  where  state  aids  have  to  be  reduced  in  conjunction  with  the 
restructuring process.  

Country specific recommendations to Malta  

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

In  order  to  ensure  a  reduction  of  the  general  government  deficit  on  a  sustainable 
basis and the long-term sustainability of public finances, Malta is recommended to: 

1. 

reduce  the  government  deficit  in  a  credible  and  sustainable  way 
within  a  multi-annual  framework  in  line  with  the  decisions  to  be 
taken  by  the  council  by  the  context  of  the  forthcoming  budgetary 
surveillance exercise (GL 1). 

48 

 
 
 
In  order  to  increase  employment  rates,  especially  among  women,  Malta  is 
recommended to: 

2. 

3. 

4. 

streamline  the  tax-benefit  system  interaction  to  strengthen  the 
incentives  to  work  and  reduce  taxation  on  labour  to  improve  its 
competitiveness (GL 4). 

improve the quality of secondary education and vocational training 
(GL 8). 

strengthen retraining of labor to make it more adaptable in the case 
of  labor-shedding  and  facilitate  the  return  to  work  of  middle-age 
women (GL 8). 

In  order  to  encourage  effective  competition  taking  into  account  the  specific 
characteristics of the small domestic economy, Malta is recommended to: 

5. 

pursue the efforts to increase competition in certain sectors such as 
network industries, food industries, and shipbuilding (GL 9). 

49 

 
 
 
23. 

Poland 

After  a  record  of  strong  growth  during  most  of  the  1990s,  Poland  experienced  a 
sharp economic slowdown in 2001-2002. Since the end of 2002, the recovery has 
gradually gained strength, and real GDP growth accelerated to 3.7 per cent in 2003. 
In  2004,  growth  is  likely  to  reach  its  potential  level  estimated  at  around  4.5 per 
cent.  

Despite  remarkable  progress  in  recent  years,  Poland  still  faces  serious  structural 
problems  that  may  impair  its  capacity  to  stay  on  a  path  of  strong  growth.  The 
unemployment  rate  has  increased  rapidly  since  1999  and  is  now,  at  about  20 per 
cent,  the  highest  among  the  acceding  countries.  In  parallel,  the  employment  rate 
has fallen markedly and almost half of the working age population is without work. 
The smooth functioning of the labour market is hampered by a number of structural 
problems, including limited responsiveness of wages to labour market conditions, 
disincentives  from  the  tax  and  benefit  system,  skills  mismatches  and  low 
geographical mobility.  

Poland’s fiscal position has deteriorated significantly since 2000, as a result of both 
cyclical factors and the relaxation of fiscal policy. The general government deficit 
increased from 1.8 per cent of GDP in 2000 to 3.6 per cent in 2002. Until recently, 
the authorities have shown some reluctance to tackle the fiscal problems, including 
the rapidly rising debt ratio. The public finance reform adopted by the government 
early this year envisages substantial spending cuts but postpones the needed fiscal 
adjustment until 2005.  

Policies  in  Poland  should  aim  at  achieving  a  high  degree  of  sustainable 
convergence,  in  particular  as  regards  the  consolidation  of  public  finances. 
Moreover, stability-oriented macroeconomic policies need to be complemented by 
structural  reforms  aiming  at  improving  Poland’s  growth  performance.  In  addition 
to  the  under-utilisation  of  human  resources,  the  relatively  low  productivity  level 
limits  the  capacity  of  the  Polish  economy  to  increase  both  actual  and  potential 
output growth. To address this issue, continued efforts are needed to improve the 
education  and  training  system  and  also  to  create  favourable  conditions  for  R&D 
and  technology  transfer.  In  addition,  the  economy,  in  particular  the  agriculture 
sector,  calls  for  more  restructuring  and  there  is  room  to  improve  the  business 
environment. Against this background, the challenges facing Poland are to: 

•  Urgently address the deep-seated structural problems in the labour market, 

•  Ensure a reduction of the general government deficit on a sustainable basis and 

the long-term sustainability of public finances, 

•  Improve conditions for increasing productivity, 

•  Speed  up  the  restructuring  of  the  economy  and  accelerate  privatisation  in 

industry, 

•  Improve the business environment. 

50 

 
 
 
Urgently address the deep-seated structural problems in the labour market 

Poland has the highest unemployment rate (19.8 per cent in 2002) and the lowest 
employment  rate  (51.5 per  cent)  among  the  acceding  countries.  The  employment 
rate is exceptionally low among elderly people and young people. In addition, the 
Polish labour market displays the following features: a high youth unemployment 
rate,  a  high  long-term  unemployment  rate,  significant  differences  across  regions 
and a high share of unemployed in rural areas. 

The smooth functioning of the labour market is hampered by a number of structural 
problems.  First,  the  concentration  of  unemployment  in  particular  regions  and 
among certain groups reflects in part the imperfect adjustment of wages to regional 
differences  in  productivity  and  individual  skill  levels.  The  wage-setting  process 
lacks  flexibility  and  in  particular  has  proved  so  far  ineffective  in  imposing  wage 
discipline  in  state-owned  enterprises  and  in  the  general  government  sector.  In 
addition,  the  nationally-set  minimum  wage  is  high  relative  to  average  wages  in 
many  regions  and  hence  contributes  to  the  persistence  of  high  unemployment 
among young and low-skilled workers.  

Second, the labour tax wedge is high in Poland and creates a disincentive to work 
in  the  official  economy.  In  addition,  the  combined  effects  of  tax  and  benefit 
systems  make  working  or  returning  to  work  a  costly  decision  and  therefore 
discourage  labour  market  participation.  Tightening  the  eligibility  criteria  for 
disability pensions and phasing out early retirement benefits would be a first step 
towards increasing the attractiveness of work.  

Third,  the  high  rate  of  unemployment  reflects  to  some  extent  skills  mismatches 
between  labour  supply  and  demand.  Moreover,  education  levels  in  the  adult 
population  are  relatively  low.  The  Polish  authorities  have  recently  launched  a 
comprehensive reform of the education system to better adapt it to the requirements 
of  a  market  economy.  Finally,  regional  discrepancies  in  employment  and 
unemployment  are  also  the  result  of  low  geographical  mobility,  which  could  be 
enhanced  through  reforms  of  the  housing  market  and  improvements  in  transport 
infrastructure.  

Ensure  a  reduction  of  the  general  government  deficit  on  a  sustainable 
basis and the long-term sustainability of public finances 

Poland’s  fiscal  position  has  deteriorated  significantly  since  2000,  only  partly  for 
cyclical  reasons.  The  general  government  deficit  reached  3.6 per  cent  of  GDP  in 
2002 and is estimated to have increased further to 4.1 per cent in 2003. The fiscal 
expansion over the last two years is to a large extent due to a loosening of the fiscal 
stance.  Fiscal  policy  is  expected  to  remain  pro-cyclical  in  2004.  The  government 
has recently adopted a public finance reform which provides for savings in social 
spending  and  administrative  expenditure  over  the  period  2004-2007.  However, 
there  remains  uncertainty  with  regard  to  the  approval  of  the  full  fiscal  reform 
package  by  Parliament.  Reining  in  the  government  deficit  is  also  crucial  to 
maintain  the  current  account  deficit  at  sustainable  levels,  especially  in  case  the 

51 

 
 
 
current savings-investment surplus of the private sector should diminish sharply in 
the coming years. 

The deterioration of fiscal accounts together with the slowdown in privatisation has 
resulted in a sharp increase in the government debt ratio since 2001. Although still 
relatively  low  by  international  standards,  the  debt  level  is  rapidly  rising  and 
approaching the thresholds that trigger corrective mechanisms under the fiscal rules 
laid  down  in  the  Polish  Constitution  and  the  Public  Finance  Act.  In  view  of  the 
government’s  growing  borrowing  needs,  the  exposure  of  the  budget  to  foreign 
exchange  risk  and  risks  stemming  from  contingent  liabilities,  debt  dynamics  is  a 
major matter of concern. 

Contingent  liabilities  constitute  potentially  a  serious  risk  to  the  sustainability  of 
public finances. State-owned companies in the sectors in need of restructuring are 
an  important  source  of  such  liabilities.  The  stock  of  outstanding  guarantees  is 
rapidly increasing and will put pressure on public finances in the coming years. 

The demographic structure in Poland is still relatively favourable. Nevertheless, the 
pension  system  underwent  a  major  reform  in  1999in  order  to  adjust  it  to  the 
demographic  and  labour  force  changes  and  to  counter  the  consequences  of  the 
expected sharp increase in the old-age dependency ratio (from 18 per cent in 2000 
to 50 per cent in 2050). 

Improve conditions for increasing productivity 

labour 
Despite  reasonable  productivity  gains  over 
productivity per person employed (in PPS) in Poland was less than half that of the 
EU15 in 2002 and below the average of the new Member States. The catching-up 
process is therefore not satisfactory yet. This relatively low productivity level may 
be explained by various factors.  

the  period  1995-2002, 

First,  there  is  the  high  share  of  employment  in  agriculture,  a  sector  with 
particularly  low  productivity  levels.  The  difficulty  of  new  firms  to  grow  and  the 
lack of mobility may be slowing down the transition of workers from agriculture to 
other  activities.  Second,  Poland  remains  below  the  EU15  average  in  terms  of 
investment  in  ICT  and  R&D.  The  low  level  of  business  investment  in  R&D  is 
particularly problematic (only 30 per cent of the total R&D expenditure is financed 
by  firms).  Reasons  cited  include  insufficient  cooperation  between  research 
establishments  and  business  and  the  fact  that  for  firms  short-term  financial 
considerations tend to override long-term interests. An increase in the skills of the 
workforce  is  also  to  be  achieved  by  promoting  tertiary  education  and  life-long 
learning.  The  low  productivity  is  indeed  related  to  the  structural  problems  in  the 
labour  market,  particularly  a  mismatch  between  skills  taught  in  the  education 
system and those required by the market place, together with a need for investment 
in physical infrastructure. 

52 

 
 
 
Speed up the restructuring of the economy and accelerate privatisation in 
industry  

After  a  slow  start,  privatisation  peaked  in  2000  (as  testified  by  a  peak  in  FDI  of 
5.7 per  cent  of  GDP  which  was  boosted  by  a  few  large  one-off  privatisation 
transactions), but it has slowed down again since then, as the most attractive assets 
have been sold. The traditional sectors remain state-owned (among others mining, 
chemicals,  defence  sectors  and  railway).  In  these  sectors,  the  Polish  government 
has favoured a policy of consolidation before privatisation with the aim of creating 
“national champions” able to compete on EU markets. The pressure to limit short-
term social disruption and the substantial consultation required with social partners 
and  several  ministers  slow  down  the  privatisation  process.  As  a  result,  the 
attractiveness  of  firms  to  be  privatised  is  considerably  reduced,  often  deterring 
potential investors. Yet, there is evidence that the FDI inflows have contributed to 
restructuring  the  manufacturing  sector  and  improved  the  export  capacity  and 
distribution  networks.  This  is  partly  because,  following  privatisation,  strategic 
investors  have  injected  substantial  equity  capital  and  know-how  into  their  firms 
which has resulted in large productivity gains. 

The  liberalisation  of  the  electricity  and  gas  sectors  has  started.  Local  and  long-
distance  telecommunication  services  were  fully  liberalised  in  January  2002  and 
international  services  since  January  2003.  However,  the  level  of  competition  in 
network  industries  is  not  satisfactory.  In  the  gas  sector,  there  is  currently  no 
unbundling at all. In telecommunications, the incumbent has retained its dominant 
position  in  the  market.  Prices  for  international  calls  are  among  the  highest. 
Moreover,  the  Competition  Office  has  repeatedly  found  the  incumbent  guilty  of 
using its dominant position to the disadvantage of competitors.  

State aid remains high (in form of tax and social security arrears) and state-owned 
firms  have  large  debts  to  other  companies,  damaging  those  companies’  finances. 
With  respect  to  the  enforcement  record,  shortcomings  have  been  identified  in  the 
handling of rescue and restructuring aid as well as research and development aid. 

Improve the business environment  

Poland has made substantial progress in developing a large SME sector thanks to 
recent reforms. In particular, a new enterprise register is being set up, which creates 
a  “one-stop  shop”  for  firms  from  January  1,  2004.  Since  January  2004  a  single 
19 per  cent  corporate  tax  is  also  in  application.  Finally,  a  new  solvency  law  was 
adopted in 2003 bringing the bankruptcy framework in line with the requirements 
of a modern market economy. The SME sector accounts for around two-thirds of 
employment and half of GDP and exports in Poland. However, SMEs continue to 
face difficulties in growing. Despite the recent reforms to support entrepreneurship, 
the  firm  size  remains  small  and  the  entrepreneurship  environment  can  still  be 
improved. This is due to the lack of human capital, the lack of labour mobility, the 
underdeveloped 
telecommunication 
networks), the high tax-burden (social security contributions in particular) and the 
liquidity constraints. These factors limit company creation and growth. Therefore, 

infrastructure  (especially 

the  road  and 

53 

 
 
 
there  are  concerns  that  the  problems  just  mentioned  may  reduce  Poland’s 
attractiveness to foreign investors (FDI). 

Country-specific recommendations to Poland 

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

In  order  to  urgently  address  the  deep-seated  structural  problems  in  the  labour 
market, Poland is in particular recommended to:  

1. 

2. 

3. 

increase  the  flexibility  of  the  wage-setting  process  to  ensure  that 
wages better reflect differences in productivity across skills, firms 
and regions (GL 5). 

lower the tax burden on labour, together with efforts to widen the 
tax  base  on  labour  and  to  improve  the  efficiency  of  the  tax 
collection and enforcement system, and reform the tax and benefit 
systems  to  eliminate  financial  disincentives  to  work,  in  particular 
high  inactivity  traps  for  married  couples,  and  to  increase  the 
efficiency of social spending (GL 4). 

strengthen  labour  supply  by  pursuing  efforts  to  better  adapt  the 
qualifications  of  the  workforce  to  the  requirements  of  the  labour 
market and by removing obstacles to regional mobility, especially 
through  reforms  of  the  housing  market  and  improvements  in 
transport infrastructure (GL 7 and 13). 

In  order  to  ensure  a  reduction  of  the  general  government  deficit  on  a  sustainable 
basis  and  the  long-term  sustainability  of  public  finances,  Poland is  recommended 
to: 

4. 

5. 

reduce the general government deficit in a credible and sustainable 
way within a multi-annual framework in line with the decisions to 
be  taken  by  the  Council  in  the  context  of  the  forthcoming 
budgetary surveillance exercise (GL 1 and 2). 

monitor  the  reform  of  the  pension  system  to  counter  the  expected 
increase  in  the  old-age  dependency  ratio,  and  take  measures  to 
reduce the fiscal risk stemming from the rising stock of contingent 
liabilities (GL 15 and 16). 

In order to improve conditions for increasing productivity, Poland is recommended 
to: 

54 

 
 
 
6. 

7. 

pursue  and  reinforce  efforts  to  improve  the  efficiency  and  quality 
of  the  education  and  training  system  and  its  responsiveness  to 
changing skills requirements (GL 13). 

promote R&D and innovation, in particular in the business sector, 
and support the transfer of knowledge through FDI (GL 13).  

In order to speed up the restructuring of the economy and accelerate privatisation 
in industry, Poland is recommended to: 

8. 

9. 

reduce the overall level of State aids, whilst reorienting aid towards 
horizontal objectives (GL 9 and 14). 

encourage  market  entry  and  effective  competition  in  network 
industries while pursuing a greater connectivity of national markets 
(GL 9).  

In order to improve the business environment, Poland is recommended to: 

10. 

continue  reducing  administrative  burden,  simplifying  regulation 
and  supporting  the  growth  of  SMEs,  in  particular,  by  improving 
access to finance (GL 11). 

55 

 
 
 
24. 

Slovakia 

After  a  stabilisation-induced  slowdown  in  1998,  Slovakia’s  real  GDP  growth  has 
steadily accelerated and exceeded 4 per cent in 2003, for the second year in a row. 
Nevertheless, output has not yet fully reached its estimated potential. 

The  growth  performance  has  been  underpinned  by  intensified  structural  reforms. 
Prime  examples  were  the  restructuring  and  privatisation  in  the  banking  and  non-
financial sectors. However, this did not come without cost: the unemployment rate 
ratcheted up to more than 19 per cent in 2001 and still amounts to around 17 per 
cent. A broad array of structural shortcomings in the labour market – notably a lack 
of  regional  mobility,  disincentives  from  the  benefit  systems,  wage  inflexibilities, 
and skill mismatches – have been hampering its re-absorption capacity and are only 
being tackled now. 

Public finance reforms have been very limited until recently as well and the general 
government  deficit  was  5.7 per  cent  of  GDP  in  the  election  year  of  2002.  The 
expansionary  fiscal  stance  contributed  to  a  domestic  demand  boom  and  an 
increasingly  consumption-driven  widening  of  the  current  account  deficit  to  more 
than 8 per cent of GDP. The government in office since 2002 has started to tackle 
the root causes of the fiscal deficit, thus supporting a significant narrowing of the 
current account deficit in 2003. 

Policies  in  Slovakia  should  aim  at  achieving  a  high  degree  of  sustainable 
convergence, in particular as regards the consolidation of public finances. Both the 
further  consolidation  of  public  finances  and  solutions  to  the  under-utilisation  of 
Slovakia’s  human  resources  need  to  be  supported  by  policies  which  assist  in 
perpetuating the strong growth performance into the medium and long term. This 
requires  in  particular  a  strengthening  and  diversification  of  the  growth  and 
employment  base  by  fostering  the  entrepreneurial  climate  through  an  improved 
legal  framework  and  judicial  and  administrative  capacity  building.  Furthermore, 
the productivity level needs to be raised and Slovakia should prepare itself for its 
eventual  transition  to  a  knowledge-based  economy.  Against  this  background, 
Slovakia faces four major challenges:  

•  Ensure  a  further  reduction  of  the  general  government  deficit  on  a  sustainable 

basis, 

•  Continue to address the deep-seated structural problems in the labour market,  

•  Improve the business environment and support entrepreneurship, 

•  Improve conditions for increasing productivity.  

56 

 
 
 
Ensure  a  further  reduction  of  the  general  government  deficit  on  a 
sustainable basis 

The  general  government  deficit  decreased  from  5.7 per  cent  of  GDP  in  2002  to 
3.6 per  cent  of  GDP  in  2003,  thereby  supporting  a  significant  narrowing  of  the 
current  account  deficit.  The  major  part  of  a  comprehensive  agenda  of  public 
finance reforms has already been passed. These reforms will support further deficit 
reductions and assist in keeping the current account deficit in sustainable territory 
if private net saving should become less favourable again. The scope and speed of 
reforms  have  been  remarkable.  However,  they  also  lead  to  non-negligible 
uncertainties with respect to the budget execution in 2004 and beyond. Risks stem 
in  particular  from  the  fundamental  nature  of  the  tax  reforms,  notably  the 
introduction of a flat income tax rate of 19 per cent for corporates and individuals. 
These  reforms  make  revenue  forecasts  relatively  uncertain.  Uncertainties  also 
remain  on  the  expenditure  side,  including  with  respect  to  further  health  reform 
measures.  

Continue  to  address  the  deep-seated  structural  problems  in  the  labour 
market 

Slovakia  has  one  of  the  lowest  employment  rates  (around  57  per  cent)  and  the 
second  highest  unemployment  rate  (currently  around  17 per  cent)  in  the  acceding 
countries.  Employment 
the  age  group  over  55. 
Unemployment is concentrated among  the young (below 24) and the low  skilled. 
Regional disparities are high. The underlying structural deficiencies of the labour 
market are multi-faceted and are now being addressed more decisively.  

is  particularly 

low 

in 

Incentives to work and to leave the informal sector are being strengthened by social 
benefit and pension reforms, including an increase  of the retirement age to  a still 
relatively low level of 62. Regional mobility is being enhanced by financial support 
for  commuters  and  housing  benefits  but  continues  to  be  limited  as  the  transport 
infrastructure  and  the  functioning  of  the  housing  market  improve  only  gradually. 
long-term 
Skill  mismatches  hinder 
unemployed,  although  retraining  measures  are  being  intensified.  A  still  low 
alignment  of  the  education  system  with  the  requirements  of  a  market  economy 
contributes to persistent youth unemployment.  

the  reintegration  of 

in  particular 

the 

Job  creation  has  been  fostered  by  recent  amendments  to  the  labour  code,  which 
allow  more  flexible  work  relationships.  However,  the  wage  setting  mechanism  is 
not  yet  flexible  enough  and  does  not  sufficiently  cater  for  enterprise-specific 
conditions.  In  particular,  the  possibility  of  administrative  extensions  of  collective 
wage agreements to enterprises that have not participated in the negotiations runs 
counter  to  this  goal.  In  addition,  minimum  wages  may  have  negative  effects  on 
labour demand and may insufficiently reflect local labour market conditions.  

Slovakia’s far-reaching income tax reform, effective since the beginning of 2004, 
will  strengthen  both  job  creation  and  the  willingness  to  work.  In  contrast,  the 

57 

 
 
 
combined health and social contribution rates have only been lowered to a still very 
high level of almost 48 per cent of gross salary.  

Improve the business environment and support entrepreneurship 

Over the recent years, the government has introduced a number of measures aimed 
at  improving  the  business  environment.  The  procedure  for  setting  up  a  new 
business  has  been  significantly  simplified  and  shortened.  New  bankruptcy 
legislation  is  being  prepared  that  should  replace  the  current  system  under  which 
bankruptcy proceedings last excessively long and allow virtually no scope for the 
restructuring  of  troubled  companies.  The  business  environment  was  further 
strengthened by, for example, the substantial acceleration in price liberalisations in 
2003 and the introduction of a new collateral law. 

Despite  these  improvements,  there  still  seem  to  be  important  barriers  to 
entrepreneurship  in  Slovakia.  The  gross-birth  rate  of  new  enterprises  is  relatively 
low.  According  to  business  surveys,  the  degree  of  legal  uncertainty  remains  a 
fundamental  weakness.  This  stems  from  the  often  insufficient  and  unstable 
legislative framework and, in particular, weak legal enforcement, which frequently 
suffers from lack of quality, timeliness and transparency. 

Improve conditions for increasing productivity 

While retaining relatively high labour productivity growth, the level of productivity 
is still low (around 58 per cent of the EU average in 2003). Factors contributing to 
this situation are the lack of flexibility of the education system, coupled with low 
education expenditures and the weak R&D and innovation activity. 

The education system does not seem to respond appropriately to the labour market 
needs. This is particularly the case for secondary schooling which often produces 
graduates  with  obsolete  skills.  Moreover,  the  share  of  tertiary  graduates  is  very 
low. The high share of long-term unemployed poses an additional challenge for the 
vocational  and  training  programmes.  Furthermore,  expenditure  on  education  has 
dropped  to  one  of  the  lowest  levels  among  the  new  Member  States  in  2001. 
Responding  to  these  problems,  the  government  has  taken  first  steps  towards 
rationalising  the  system,  improving  its  efficiency  and  increasing  the  sources  of 
financing. 

In 2002, the expenditures on R&D accounted for only 0.59 per cent of GDP, less 
than  in  most  of  the  acceding  countries.  Innovation  activity,  as  measured  by  the 
number of patent applications, is very low. The government has undertaken some 
measures  to  improve  the  situation  regarding  R&D  (e.g.  by  improving  the 
legislative  framework  for  R&D),  and  is  committed  to  increasing  the  public 
resources available for R&D support. 

58 

 
 
 
Country specific recommendations to Slovakia 

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

In  order  to  ensure  a  further  reduction  of  the  general  government  deficit  on  a 
sustainable basis, Slovakia is recommended to:  

1. 

reduce the general government deficit in a credible and sustainable 
way within a multi-annual framework in line with the decisions to 
be  taken  by  the  Council  in  the  context  of  the  forthcoming 
budgetary surveillance exercise (GL 1). 

In order to urgently continue to address the deep-seated structural problems in the 
labour market, Slovakia is in particular recommended to:  

2. 

3. 

4. 

strengthen  labour  supply  by  removing  obstacles  to  regional 
mobility  and  by  reducing  skill  mismatches,  whilst  ensuring  the 
efficiency  of  retraining  measures  and  other  active  labour  market 
policies (GL 4, 7 and 8).  

generate additional labour demand by allowing for more flexibility 
in the wage setting mechanism (GL 5 and 18).  

lower the very high combined health and social contribution rates, 
while observing the overall budgetary consolidation constraints, in 
particular  by  additional  health  system  reform  measures  and  by 
considering  additional  adjustments  in  the  pay-as-you-go  pillar  of 
the pension system, in particular a further increase of the retirement 
age (GL 4 and 16). 

In  order  to  improve  the  business  environment  and  support  entrepreneurship, 
Slovakia is recommended to: 
5. 

strengthen the legislative framework supportive to entrepreneurship 
and  improve  its  enforceability  by,  in  particular,  adopting  the  new 
bankruptcy legislation and increasing the capacity and transparency 
of the judicial system (GL 11 and 12). 

In  order 
recommended to: 

to 

improve  conditions  for 

increasing  productivity,  Slovakia 

is 

6. 

7. 

improve  the  efficiency  and  quality  of  the  education  and  training 
system and its responsiveness to changing skills requirements (GL 
13). 

encourage  R&D  and  innovation  and  support  the  transfer  of 
knowledge through FDI (GL 13). 

59 

 
 
 
25. 

Slovenia 

Over  the  last  decade,  Slovenia  has  exhibited  stable  growth;  real  GDP  has  grown 
steadily  at  3-5 per  cent  since  1993.  After  a  recent  slow-down,  GDP  growth  is 
expected  to  pick  up  and  gradually  draw  closer  to  the  potential  output  growth, 
estimated at around 4 per cent.  

Despite a broadly sound economy and commendable achievements in many policy 
areas,  certain  weaknesses  remain.  Unexpected  shortfalls  have  led  to  the  repeated 
introduction  of  supplementary  budgets  in  recent  years.  However,  general 
government deficits are relatively small and fiscal consolidation seems currently to 
be  well  on  track.  While  having  declined  steeply  in  the  last  two  years,  relatively 
high inflation (5.7 per cent in 2003) is still a cause of some concern and has been 
recognised  as  a  key  policy  challenge.  The  government  designed  an  apt  policy  to 
lower inflation in a sustainable way, aiming to create conditions to be able to fully 
reap  the  benefits  of  EU  accession.  It  has  pursued  structural  reforms  with  the 
objective to facilitate price liberalisation. Currently, administered prices represent 
16 per cent of the CPI – the lowest share of all the acceding countries. However, 
given ineffective competition in the utilities, and insufficient flexibility in both in 
the financial sector and the labour market a sustainable reduction of inflation still 
needs to be confirmed.  

The restructuring process of the economy has negatively affected the situation on 
the  labour  market;  employment  in  manufacturing  industry  fell  markedly  over  the 
period 1996-2000. A shift of labour from this sector to the service sector buffered 
the economic and social distress, while early retirements were used to attenuate a 
rise  in  total  unemployment.  Although  the  overall  picture  concerning  the  labour 
market  in  Slovenia  is  positive,  structural  unemployment  problems  persist.  The 
proportion  of  long-term  unemployment  is  high,  in  particular  amongst  older,  low-
skilled persons. Furthermore, the low employment rate of workers over 55 years of 
age is a cause of concern, especially with regard to the challenges stemming from 
an ageing population. 

In order to create the necessary job opportunities and facilitate participation in the 
labour market, leading in turn to a further improved economic performance in the 
future,  continued  efforts  to  promote  entrepreneurship,  to  stimulate  the  innovative 
capacity of the business sector and to enforce effective competition in all segments 
of the economy are required. Policies in Slovenia should aim at  achieving a high 
degree  of  sustainable  convergence.  Against  this  background,  Slovenia  faces  four 
major challenges:  

•  Lower inflation in a sustainable way, 

•  Increase employment rates, especially for older workers, 

•  Improve conditions for sustained productivity growth, 

•  Promote  the  development  of  effective  competition  in  all  segments  of  the 

economy, notably in network industries. 

60 

 
 
 
Lower inflation in a sustainable way 

Although  decreasing,  inflation  remains  relatively  high.  For  2003,  the  rate  of 
inflation stood at 5.7 per cent, down from 7.5 per cent a year before. The ongoing 
decline  is  an  encouraging  development,  although  it  seems  partly  attributable  to 
special factors – related to ceilings on administered price rises and indirect taxes as 
well as frequent adjustments of excise duties on oil. Inflationary pressure continues 
to be fed by lack of competition in various sectors, inflexible labour markets, and 
still  widespread  indexation  mechanisms.  Furthermore,  other  important  factors 
contribute  to  inflation’s  perseverance;  an  accommodating  monetary  policy  and  a 
steady, but now slowing, depreciation of the currency, in particular, add to inflation 
inertia.  

In the run-up to EU accession, the government made inflation a policy priority and 
adopted  a  co-ordinated  anti-inflation  policy  measures  accordingly.  A 
comprehensive price control plan was  enforced, regulating the administered price 
rises and tax changes in a way not to exceed the inflation rate at the end of the year. 
As regards the objective of proceeding towards a generalised de-indexation of the 
economy,  a  step  forward  was  made  in  2003  with  the  official  abolition  of  interest 
rate  indexation  (the  ‘basic  interest  rate’  or  TOM)  and  the  social  agreement  on  a 
new  wage  adjustment  method.  A  forward-looking  indexation  has  already  been 
introduced  for  public  sector  wages,  taking  effect  in  July  2004,  whereas  for  the 
private  sector  such  a  policy  yet  needs  to  be  negotiated.  Moreover,  the  public 
finance stance needs to be adjusted flexibly. Also, a more swift implementation of 
structural  reforms  is  necessary  for  a  sustained  disinflation  and  an  improved 
economic performance. 

Increase employment rates, especially for older workers 

The  employment  rate  in  Slovenia  –  with  63.4 per  cent  in  2002,  close  to  the  EU 
average  –  is  one  of  the  highest  among  the  acceding  countries.  Also,  the 
unemployment rate – decreasing steadily since 1998 to have reached 6.0 per cent in 
2002  –  ranks  amongst  the  lowest  in  the  group.  Nevertheless,  its  long-term 
component  is  high  at  around  60 per  cent,  principally  among  older,  low-skilled 
workers  over  55  years  of  age.  With  other  structural  imbalances  present  in  the 
labour  market  (youth  unemployment,  unemployment  of  disabled  persons,  gender 
unemployment  gap,  low  educational  level  of  the  unemployed,  high  regional 
disparities)  to  increase  employment  of  elderly  has  been  identified  as  a  particular 
important challenge. In 2002, the unemployment rate for persons aged 55-64 was 
3 per  cent,  while  the  employment  rate  stood  at  24.5 per  cent,  a  figure  very  low 
compared  to  the  EU  average  of  40.1 per  cent.  This  is  a  consequence  of  the  low 
retirement  age,  which  in  2001  averaged  only  57  years.  The  restructuring  of  the 
economy  has  pushed 
(or 
unemployment).  As  a  result  of  the  pension  reform  introduced  in  2000,  the 
retirement age has already slightly increased. However, the impact of this reform 
will only gradually be reflected in a higher employment rate for older persons. A 
large gap between the employment rates for older workers in Slovenia and the EU 
is expected to persist.  

relatively  young 

individuals 

retirement 

into 

61 

 
 
 
The main orientation of the employment policy is thus to address the problems of 
unemployment for elderly people and to stimulate active forms of increasing their 
employability.  This  is  particularly  important  in  view  of  the  growing  risks  of 
financial unsustainability resulting from unfavourable demographic developments. 
The old-age dependency ratio is expected to rise from 20 per cent in 2000 to 38 per 
cent  in  2025  and  66 per  cent  in  2050.  Furthermore,  the  promotion  of  work  and 
active working life is the necessary precondition for combating poverty and social 
exclusion. 

Improve conditions for a sustained productivity growth 

The  level  of  productivity,  while  the  second  highest  amongst  the  new  Member 
States,  remains  well  below  the  EU-15  average  (69.5 per  cent  in  2003).  Labour 
productivity  growth  in  Slovenia  was  relatively  rapid  over  the  period  1995-1999, 
with  an  average  annual  rise  of  4.8 per  cent.  However,  it  decelerated  thereafter 
(2 per  cent  on  average  in  1999-2002),  placing  Slovenia  amongst  the  least 
performing acceding countries in this period of time. Two elements may hamper a 
more rapid development in productivity:  

First,  the  entrepreneurial  activity  of  the  active  population  remains  relatively  low, 
notably  because  the  administrative  burdens  affecting  both  business  creation  and 
existing  businesses  are  still  high.  Efforts  have  already  been  made  to  simplify 
procedures  for  start-ups.  However,  the  business  legislation  and  administrative 
environment could be further improved since bureaucratic and lengthy procedures 
as well as difficulties in buying land for industrial use still persist.  

Second, there is a lack of effectiveness of R&D expenditure to build on relatively 
good  achievements  in  basic  research  in  terms  of  transfer  of  know-how  to  the 
business  sector,  of  patenting  and  of  product  or  process  innovation.  With  R&D 
expenditures  reaching  1.6 per  cent  of  GDP  in  2001,  Slovenia  ranks  first  amongst 
the  new  Member  States  but  still  remains  below  the  EU  average,  despite  strong 
growth  in  direct  public  funding  of  R&D  and  the  introduction  of  fiscal  incentives 
for  business  R&D.  Slovenia  also  ranks  first  amongst  the  new  Member  States  in 
terms of patent applications with the European Patent Office, but its performances 
in this field (41 per million inhabitants in 2001) are well below the EU average. In 
addition,  the  share  of  researchers  employed  in  the  business  sector  is  low  as 
compared to the public sector (one-third and two third respectively) and innovative 
activity appears to be weak in the high tech sector.  

Promote  the  development  of  effective  competition  in  all  segments  of  the 
economy, notably in network industries. 

Slovenia has proceeded towards increasing liberalisation in product markets and in 
network  industries,  but  effective  competition  needs  to  be  enhanced.  In  particular, 
while  the  Competition  Protection  Office  is  mandated  with  adequate  powers  to 
exercise  control  over  restrictive  agreements  and  any  abuse  of  dominant  position 
and  mergers,  its  administrative  capacities  both  in  terms  of  financial  and  human 
resources  are  insufficient  to  ensure  its  proper  functioning.  Moreover,  the  current 
legislation does not allow it to set deterrent fines on anti-competitive behaviour. 

62 

 
 
 
In  recent  years,  Slovenia  has  started  liberalising  its  network  industries.  In 
telecommunications,  legal  market  opening  was  introduced  in  2001  and  an 
independent  regulatory  agency  was  created 
in  2002.  However,  effective 
competition  has  not  yet  appeared  in  fixed  telephony  for  inland  calls  where  the 
incumbent  still  holds  100 per  cent  of  market  share.  The  high  price  of  network 
interconnections  together  with  regulated  low  price  levels  for  both  local  and 
national calls are the main barriers to the entry of new operators in fixed telephony. 
As regards the energy sector, large electricity customers (66 per cent of electricity 
consumption  in  Slovenia)  are  free  to  choose  their  supplier  and  since  2002  the 
largest ones are allowed to purchase electricity from abroad. However, the scope of 
international exchanges is limited to a maximum of 20 per cent of total electricity 
consumption. In gas, the largest consumers are since 1 January 2003 free to choose 
their own supplier (accounting for 50 per cent of gas consumption in Slovenia), but 
in practice they can not switch to another supplier because of long-term contracts 
up to 2007 with the incumbent. 

Country specific recommendations to Slovenia 

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

In order to lower inflation in a sustainable way, Slovenia is recommended to: 
1. 

step-up structural reforms aimed at liberalising administered prices 
and  advance  further  with  de-indexation,  in  particular  of  the  wage 
setting mechanism (GL 5). 

In  order  to  increase  employment  rates,  especially  for  older  workers,  Slovenia  is 
recommended to:  
2. 

review the tax and benefit systems, with a focus on labour market 
the  measures 
participation  of  older  workers,  and  reassess 
promoting active ageing by means of lifelong learning activities, as 
well  as  address  the  imbalance  between  temporary  and  permanent 
work conditions (GL 4, 8). 

In  order  to  improve  conditions  for  sustained  productivity  growth,  Slovenia  is 
recommended to: 
3. 

further  reduce  the  time  and  costs  necessary  to  set  up  a  new 
company  and  simplify  the  administrative  procedures  affecting 
businesses (GL 11). 
promote  R&D  and  innovation  in  the  business  sector  and  improve 
the quality of the tertiary level education system (GL 13). 

4. 

In order to promote the development of effective competition in all segments of the 
economy, notably in network industries Slovenia is recommended to: 

5. 

the  administrative  capacity  of 

strengthen 
the  Competition 
Protection  Office,  ease  the  entry  of  new  competitors  in  network 
industries,  and  facilitate  the  purchase  of  lands  for  industrial  use 
(GL 9). 

63