Source: EURLEX
Language: en
Format: md

**COMMISSION OF THE EUROPEAN COMMUNITIES**

**Brussels, 15.05.1996**
**COM(96)211** **final**

##### **Commission's Recommendation** **for the Broad Guidelines of the Economic Policies** **of the Member States and the Community**

**drawn up in conformity with article** **103** **(2) of the**
**Treaty establishing the European Community**

EUROPEAN COMMISSION

### **Commission's Recommendation** **for the Broad Guidelines of the Economic Policies** **of the Member States and the Community**

drawn up in conformity with article 103 (2) of the
Treaty establishing the European Community

I. BROAD ECONOMIC POLICY GUIDELINES FOR THE COMMUNITY

AND THE MEMBER STATES

II. EXPLANATORY MEMORANDUM

11.1. PROGRESS REPORT ON THE 1995 BROAD ECONOMIC POLICY GUIDELINES

11.2. ECONOMIC OUTLOOK

_A&-_

**-** **Il** **-**

**Table** **of contents**

**I.** BROAD ECONOMIC POLICY GUIDELINES FOR THE COMMUNITY

AND THE MEMBER STATES 1

**1.1.** **Main objectives and general guidelines** **1**

**1.2.** **Macroeconomic policy mix conducive to growth, employment and convergence 2**

**1.3.** **Price and exchange rate stability** **3**

**1.4.** **Sound public finances** **5**

**1.5.** **Better functioning of product and service markets** **7**

**1.6.** **Fostering employment and labour market reforms** **8**

II. EXPLANATORY MEMORANDUM 10

**11.1** **Progress report on the implementation**

**of the 1995 Broad Economic Policy Guidelines** **10**

11.1.1. Introduction 10

11.1.2. Price and exchange rate stability 13

11.1.3. Sound public finances 16

11.1.4. Competitiveness 21

11.1.5. Employment and the labour market 23

**11.2.** **Economic outlook** **26**

11.2.1. Growth prospects 26

tl.2.2. Employment trends 28

H.2.3. Convergence 29

_**4i>**_

### **I. Broad Economic Policy Guidelines for the** **Community and the Member States**

**1.1.** **Main objectives and general guidelines**

Contrary to expectations prevailing at the time of the adoption of the 1995 Broad

Economic Policy Guidelines, the Community's economy experienced a marked slowdown

in economic activity over the last twelve months and a renewed rise in unemployment.

Whereas inflation declined broadly as anticipated and price convergence strengthened,

progress towards sounder public finances proceeded at an insufficient pace and was made

more difficult by the economic downturn.

As a result, the Community did not succeed in making significant progress towards

realising important economic objectives such as those stipulated in Article 2 of the Treaty,

namely the promotion of sustainable, non-inflationary growth and a high level of

employment. This failure to reduce the gap between aspirations for and the realisation of

economic and social well-being is the major cause of the present less confident mood in the

Community.

Nonetheless, the Community enjoys quite favourable economic fundamentals. Inflation is

historically low and contained, interest rates are falling, exchange rates are progressively

being brought into line with underlying conditions, world trade is expanding at a healthy

pace and investment profitability has been improving and, in overall terms, is noticeably

higher than in the second half of the 1980s. However, rising long-term interest rates in

1994, the currency turmoil in the spring of 1995, persistent structural weaknesses and

deteriorating confidence have prevented these fundamentals from asserting themselves

during 1995 and early 1996. With the impact of the first two factors progressively fading

out, allied with an end to destocking, expectations centre on a rebound in economic activity

in the second half of this year. The pace of the expected recovery will mainly be

determined by the extent to which the policy mix becomes more conducive to growth and

succeeds in restoring confidence. The opportunities offered by the expected recovery

should be fully seized upon to accomplish the necessary degree of convergence in order to

ensure a successful transition to Economic and Monetary Union on 1 January 1999.

Meeting these challenges will primarily require a macroeconomic policy strategy geared

towards growth and stability. Appropriate structural initiatives in both the goods and

_**A**_ _**L**_

services markets and in the area of labour market reform should accompany and reinforce a

durable rebalancing of the macroeconomic policy-mix.

In essence, therefore, the present Guidelines corroborate and augment the policy

recommendations outlined in previous exercises. If this strategy does not yet seem to

deliver satisfactory results in the Community at large, this is because it has been

implemented with insufficient vigour and credibility. All actors are therefore encouraged

to conduct their economic policies with a view to contributing to the achievement of the

objectives of the Community (Article 102a of the Treaty), to demonstrate with action what

has been promised since more than two years and to co-ordinate better their economic

policies. The latter is not only a Treaty obligation (Article la) but also a practical

obligation made all the more critical by the increased integration of the economies of the

Member States.

It should be underlined that the present guidelines constitute not only the logical

dénouement of the analyses undertaken in the context of the Commission's 1996 Annual

Economic Report but also take into account the opinions prepared by the European

Parliament and the Economic and Social Committee on the latter report.

**1.2.** **Macroeconomic policy mix conducive to growth, employment and**

**convergence**

Achieving the Community objectives in terms of growth, employment and convergence

will continue to require the establishment of a stable, investment-enhancing, short and

medium-term macroeconomic policy mix, characterised by:

(i) a stability-oriented monetary policy;

(ii) sustained efforts to consolidate the public finances in most Member States consistent

with the timetable and the objectives of the Treaty; and

(iii) nominal wage trends consistent with the price stability objective as well as real wage

developments consistent with the conditions for strengthening employment-creating

investment.

To relaunch the recovery process and to strengthen medium-term growth and job-creation,

a durable détente of the macroeconomic policy mix is essential. The more the stability task

of monetary policy is facilitated by appropriate budgetary measures and wage

developments, the more monetary conditions, including exchange rates and long-term

interest rates, will be favourable to growth and employment. In such a context, monetary

policy can contribute substantially, in accordance with the spirit of Article 105(1) of the

**-3** **-**

Treaty, to the achievement of the Community's objectives as laid down in Article 2 of the

Treaty.

High and sustained economic growth over the medium term, driven by capacity-expanding

investment is essential:

(i) to reduce significantly and durably the Community's unacceptably high level of

unemployment and to combat the spread of social exclusion;

(ii) to make the necessary improvement in the competitiveness, and in particular the

productivity, of the Community economy compatible with the safeguarding, in the

context of an open market economy, of the basic social values which characterise the

Union; and

(iii) to ensure the lasting success of Economic and Monetary Union in which stability,

competitiveness and employment must be assured concurrently.

Responsibility for bringing about the desired détente of the macroeconomic policy mix is

assumed by three different groups of actors (central banks, national governments and the

social partners). Efficient co-ordination between actors and between countries is essential

in order to ensure policy consistency. The Commission will intensify its dialogue with the

social partners on macroeconomic issues and invite the EMI to participate in these

meetings. The social dialogue itself should also be intensified, where possible and

according to prevailing traditions, at the national level.

To reinforce both the credibility of the macro-economic policy framework and the

efficiency of the co-ordination process within the Community, Member States should

present updated and politically strengthened convergence programmes. These programmes

should clearly demonstrate that the planned policy measures to improve convergence go

hand in hand with the promotion of growth and employment in the medium term. The

Commission and the Council will assess their consistency at the Community level with a

view to a tightening-up of the surveillance of economic policies under Article 103(3) of the

Treaty.

**1.3.** **Price and exchange-rate stability**

The achievement and maintenance of a stable macroeconomic environment is a

precondition for achieving sustained medium-term growth. For this purpose, and given

that inflation in the Community on average is expected to fall to 2 _[X]_ _A_ per cent this year, the

Community should aim to keep it at this low level and to make further progress towards

reaching 2 per cent.

**-4-**

At present, ten of the Member States already respect the objective established in previous
guidelines exercises of a rate of inflation [1] of no more than 2 to 3 percent as a step towards

price stability and in the United Kingdom inflation is close to 3 per cent. In the seven

countries (Belgium, Germany, France, Luxembourg, the Netherlands, Austria and Finland)

where inflation is below 2 per cent and in Denmark and Ireland, where it is just above 2 per

cent, the anti-inflation credibility of the monetary policy framework is generally firmly

established and the task is to consolidate this performance over the medium term. In

Sweden, where inflation has recently come down significantly, and the United Kingdom,

policies should aim at maintaining and, where appropriate, reinforcing anti-inflationary

policies.

Those countries where inflation is expected to be between 3 and 5 per cent in 1996 (Spain,

Portugal and Italy), should endeavour to reduce inflation further to below 3 per cent by

1997. Spain and Portugal should persevere with their existing policies with a view to

achieving the desired inflation range in the near future. In Italy, the conduct of fiscal

policy will in essence dictate the pace of progress with regard to the establishment of

exchange rate credibility and in anchoring low inflation expectations.

Despite visible progress in Greece over recent years, it is evident that efforts must be

continued and enhanced. In this regard, emphasis should be placed in particular on the

maintenance of the corrective fiscal policy stance operated over the last two years as well

as continuing with the prudent monetary and exchange rate policies evident since the early

1990s.

As stressed in the previous Guidelines, all Member States must continue to treat their

exchange-rate policies as a matter of common interest within the framework of the

European Monetary System and, where appropriate, its exchange rate mechanism. The

exchange rate movements in early 1995 pointed to the need for several Member States to

put their overall policy framework on a more credible footing. Policies credibly and

resolutely geared towards a rebalancing of the policy mix and achieving price stability, as

recommended in the present Guidelines, will not only be conducive to an appropriate

alignment of exchange rates within the Community but also at the world level. For

countries which are not currently participating in the exchange rate mechanism, these

policies would also contribute to creating the conditions, where appropriate, for such

participation.

**As measured by the** **12** **month average of the annual change** in **the interim** indices of consumer prices

**1.4.** **Sound public finances**

Some, but only limited, progress towards fiscal consolidation was made last year in the

Community. Slippages relative to announced budgetary targets only partially reflected the

adverse impact of the growth slowdown. Insufficient credibility of budgetary policies

contributed importantly to the currency turbulence in the spring of 1995, sapped economic

confidence and led to doubts in financial markets regarding the likelihood of a successful

realisation of the Community's single currency goal.

Meanwhile, a large number of countries have taken significant steps to consolidate their

public finances in 1996 and, in many cases, also in 1997. Nevertheless, the still

unsatisfactory state of the public finances in the Community should lead Member States to

review and, where necessary, to strengthen their fiscal consolidation plans. Credible, pre

announced and socially balanced efforts to reduce high budgetary imbalances will allow for

a revival in confidence, for the transformation of the expected recovery into a durable, job

creating, medium-term, growth process and for a sound transition to EMU on 1 January

1999.

While the economic conditions are presently less favourable than anticipated at the time of

the adoption of the 1995 Guidelines, a further delay in the inevitable consolidation process

is not a justifiable option. Any postponement risks provoking an adverse financial market

reaction and would aggravate the consolidation task in future years. In the present

circumstances, a policy of allowing the automatic stabilisers to work is therefore largely

inappropriate in the vast majority of Member States. Progress made in reducing structural

budget deficits this year will of course persist and reinforce consolidation when cyclical

conditions improve. Moreover, the adverse near-term growth impact of credible reductions

in budget deficits is likely to be limited provided that the appropriate Hanking conditions,

in both the monetary and structural area, are set in place.

On the basis of the adjustment measures decided up until early-May 1996, the net

borrowing of general government in the Community as a whole is likely to fall to just

below _VA_ per cent of GDP in 1997, which compares with a deficit of 5 per cent in 1995.

Virtually all Member States should aim at lowering the budget deficit to, at most, 3 per

cent of GDP in 1997, as a step towards the objective of close to balance in the medium

term. In this respect, it is encouraging that several countries have recently announced and

are implementing substantial measures to redress budgetary imbalances.

As regards the individual Member States, 12 of the 14 Member States with convergence

programmes (the exception being Luxembourg) are committed to reducing their deficits to

3 per cent of GDP or below by 1996 or 1997 at the latest. Two of these countries

-6

(Denmark and Ireland) already respect the 3 per cent budget deficit reference value and

they should consequently move towards the achievement of more ambitious medium-term

targets.

As regards the remaining ten countries, the additional effort needed to respect the 3 per

cent reference value is undoubtedly feasible and should be pursued vigorously. Within this

group, several countries (Germany, France, Austria, Finland, Sweden) have this year

announced substantial measures or reinforcements with a view to achieving a reduction in

their budget deficits to 3 per cent of GDP or less in 1997. These countries, as with the

Netherlands, should resolutely implement their programmes of fiscal consolidation and, if

necessary, strengthen them in order to ensure that their objectives are fully met.

In Belgium both the impact of weaker-than-anticipated output growth on tax revenues and

social transfers and the non-recurrent nature of some of the measures previously taken

require supplementary efforts to respect the 3 per cent reference value in 1997. The

Belgian government is firmly committed to specifying the necessary measures during the

preparation of its 1997 budget in June-July of 1996. In the United Kingdom, substantial

reductions in the budget deficit are expected to continue over the next two years mainly as

a result of planned expenditure restraint. But to respect the convergence programme

targets, further action is needed both to compensate for the fiscal slippage in 1995 and an

expected less rapid budgetary improvement in the short run which is partly due to lower

growth than previously predicted. Finally, in Spain and Portugal, a determined

implementation of the budgetary component of the convergence programmes is required,

with special attention to be given in Spain to a re-evaluation of the social security system.

With regard to the two remaining Member States, Italy needs to introduce significant

measures to achieve and improve upon the planned budgetary consolidation which remains

the central policy priority in terms of restoring market confidence. Action should primarily

focus on the fight against tax evasion, on greater budgetary discipline of local authorities

and on improved efficiency of the public administration. As regards Greece, sustained

efforts on a wide range of fronts, most notably a continuation of the existing privatisation

initiatives, an expansion of the tax base and current expenditure reductions, are all required.

Although the extent, timing and design of consolidation measures need to be tailored to

country-specific conditions, some general principles have been identified in previous

Guidelines exercises. These include:

(i) restraining expenditure increases, as opposed to further increases in the overall tax

burden, is widely regarded as a more credible and efficient option. Among the issues

which should be addressed are the need to place pension provisions on a sustainable

**-7-**

footing, to curb the rise in health care costs and to reduce distortionary and costly

subsidies,

(ii) re-directing, to the greatest extent possible, government spending towards productive

activities such as investment in infrastructure, human capital and active labour market

measures, while not endangering the necessary reduction in budget deficits;

(iii) improving the efficiency of public services through _inter alia_ more flexible

management practices, better incentives for public employees, and in some cases

increased use of privatisation and user-fees to the extent that Member States judge it

compatible with their objectives;

(iv) ensuring that a reduction in the overall tax burden, which is desirable in most Member

States, is conditional upon initially putting the budget deficit on a firm downward path.

In the interim, however, Member States stand to gain from a broadening of the tax

base and a modification in tax structures so as to reduce the tax burden on labour. In

particular, reductions in non-wage labour costs at the lower-end of the wage scale

should be considered.

**1.5.** **Better functioning of product and service markets**

To foster growth, and thus employment, whilst maintaining low inflation, it is essential that

action on the macro side is added to by measures aimed at ameliorating the functioning of

product and service markets in general and at generating higher competition and a more

flexible functioning of the price mechanism in particular. This will essentially require a

further reinforcement of competition policies and a curbing of state aids in full respect of

the objectives of Article 130a of the Treaty concerning economic and social cohesion.

It is also crucial to fully exploit the internal market potential in an open and competitive

environment through the transposition into national law and effective enforcement of single

market legislation. In sectors where transposition is lagging behind, a particular effort is

needed to present all necessary proposals to national parliaments before the end of 1996.

To enhance the Community's competitiveness, measures aimed at promoting innovation, at

favouring the emergence of the information society and at achieving a working

environment more conducive to initiative and to the development of SMEs should be

swiftly implemented. ' Of course, in these areas the individual Member States largely hold

the key. However, the potency and effectiveness of national actions, which are essential,

can be significantly added to via co-ordination and appropriate actions at the Community

level. At this level, among the wide range of activities currently being pursued, specific

attention should be given to a number of recent proposals of the Commission. Action to

remove the remaining obstacles to the effective implementation of the TENs projects

-8

should be initiated. Further work is also needed to ease the impediments currently

hampering the development of the SME sector. A more co-ordinated R & D effort is

required both at the level of **the** Member States themselves and between the latter and

specific EC-funded research programmes. The Commission will also pursue its policy to

improve competition in EU-markets. Finally, to increase the job-creating potential of

environmental policies, these policies should - to a greater extent than at present - rely on

market-based instruments, including fiscal ones, both at the national and Community

levels.

**1.6.** **Fostering employment and labour market reforms**

More than 2'/2 years after the publication of the Commission's While Paper on Growth,

Competitiveness and Employment and with the Essen employment strategy set in place for

some time, the Community finds itself with a dismal employment record over the period in

question. Although the expected recovery will lead to renewed job creation and will

reverse the current upward trend in unemployment, it is likely that more than 17 million

people will still be unemployed in 1997 in the Community. Assuring a sustained and

significant improvement in employment and unemployment requires not only durable,

high, economic growth and efficient product and service markets, but also a broad range of

labour market reforms.

Eliminating existing rigidities as well as ensuring a more efficient operation of labour

markets is at the heart of national efforts to ensure both a tension-free and stronger

medium-term expansion and a more employment-creating growth pattern. Member States

have been making efforts to reform their labour markets. They are encouraged to intensify

their actions while ensuring both equity and efficiency in the social protection system. The

implementation of policies aimed at improving the occupational and regional mobility of

the labour force and at enhancing the efficiency of employment services should reduce

bottlenecks which could lead to an early end to the growth process.

Suitable policies should be conducted in order to adapt the whole educational system —

including vocational training ~ both to the needs of markets and to the improvement of

human capital, thereby fostering the growth potential of the economy. In this respect,

priority should be given to enhancing the employability of young people, women and the

unemployed, in particular low skilled, inexperienced labour, and to reducing skill

mismatchs on the labour market by providing training better fitted to the changing needs of

the labour market.

A higher labour-content of growth should be favoured by the maintenance of appropriate

average wage trends and in some cases by a larger wage differentiation according to

qualifications, regions and, to some extent, sectors and firms. A reduction in the labour

costs of low-productivity jobs, either through direct wage developments (e.g. by

introducing entry wages in appropriate cases) or through a targeted reduction in non-wage

labour costs, should increase the incentives to the employment of low-skilled labour. Such

measures should be compatible with Community competition policy. Adaptations, at the

firm level, of working-time and work organisation will also act in this direction. Finally,

the promotion of local and regional initiatives in the field of new services containing a high

labour-intensive dimension, such as those identified in the Communication from the

Commission on a European strategy for encouraging local development and employment

initiatives, should also be encouraged.

All the above elements are featured in the Community's common employment strategy,

initiated at the Essen European Council and refined subsequently at both the Cannes and

Madrid Councils. The procedures adopted at these European Councils need to be made

more efficient. In this respect, Member States' multi-annual employment programmes

must be developed further, to make them more effective instruments in the area of labour

market policy. Furthermore, the Commission's initiative to mobilise all actors around the

top priority of fighting unemployment is aimed at making maximum use of the existing

instruments at the level of the Union.

                      - 10
#### IL EXPLANATORY MEMORANDUM

**11.1** **Progress** **report** **on the implementation of the**
**1995 Broad Economic** **Policy** **Guidelines**

_**II.**_ _**1.1.**_ _**Introduction**_

In conformity with the Maastricht Treaty, Broad Economic Policy Guidelines were adopted

in December 1993, July 1994 and again in July 1995. Following mandates from the

European Council, the implementation of the 1993 Guidelines was assessed in December

1994. The execution of the 1994 Guidelines was examined on two separate occasions,

once in December, and again in June 1995.

This document reviews, following a request from the Cannes-European Council, the

progress made in implementing the 1995 Broad Economic Policy Guidelines [2] since their

adoption by the EcoFin Council in July of last year. In an attempt both to streamline the

surveillance procedures and to present the necessary information and analysis for the

adoption of the new guidelines, an assessment of the past guidelines will henceforth form

an integral part of the Commission's explanatory memorandum. Such an assessment

constitutes a valid test of the degree of commitment of the individual Member States to

shared policy responsibilities. Because of the medium-term orientation of economic

policies, this report examines trends evident since the adoption of the first guidelines

Recommendation in 1993.

The policy issues raised in the 1995 Guidelines were addressed against a background

where the economic recovery process, which commenced towards the second half of 1993,

had apparently become firmly established. The pace and composition of the economic

expansion in 1994 had given rise to optimism that growth rates of the order of 3 per cent

could be realised in both 1995 and 1996.

Since then, however, there has been a marked slowdown in growth. An extended analysis

of the factors behind the slowdown was presented in the Commission's 1996 Annual

Economic Report with only the key points of that analysis being summarised here. The

quarterly rates of GDP growth of the order of _VA_ to 4 percent (annualised rate) witnessed

throughout most of 1994 decelerated to around 2 percent in the second and third quarters of

1995 culminating in virtual stagnation in the last quarter of last year. This lower than

expected output performance was reflected in adverse labour market developments. The

An initial review of the 1995 guidelines took place in December 1995.

**11** **-**

moderate rise in overall employment in the Community since the middle of 1994 came to a

standstill towards the end of 1995. Particularly in the countries which were hardest hit by a

worsening in their competitive position following the exchange rate crisis of spring 1995,

employment trends turned markedly negative. But also in several other countries, the

economic slowdown brought employment gains to a halt. In sum, employment is

estimated to have grown by only _Vi_ a per cent last year in the Community as a whole.

Apart from the fading of the initial impulse from stockbuilding, the significant slowdown

during 1995 essentially reflected two adverse developments in financial markets. Firstly,

the marked rise in long-term interest rates on world and Community financial markets

during 1994 appear to have exerted a stronger-than-expected restraining influence on

companies' and households' spending decisions in 1995. The rise in yields varied

considerably across EC Member States, reflecting _inter alia_ their economic performance,

policy stance and credibility. In particular, long-term interest rates rose significantly more

in countries whose public finances were not yet perceived by the'markets as having been

put on a clearly sustainable downward path.

Table 1

Nominal interest rates

(per cent)

**Dec.**

**1994**

**April**

**1995**

Jan.

1996

April

1995

Dec.

1993

6.6

6.2

5.7

8.3

5.8

8.8

5.7

9.0

6.3

(6.8)

Dec.

1994

Long-term [2 ]

8.3 7.9

8.8 8.8

7.5 7.1

11.5 12.1

8.1 7.8

8.6 8.7

11.9 13.0

7.6 7.2

7.6 7.4

11.5 12.1

10.3 9.4

10.7 11.5

8.5 8.4

(90) (8.9)

April

1996

6.7

7.3

6.4

9.3

6.5

7.6

10.1

6.4

6.5

9.2

7.5

8.4

8.1

7.6

Jan.

1996

6.5

7.0

5.9

9.5

6.5

7.2

10.2

5.9

6.2

9.4

7.0

8.3

7.4

7.3

April

1996

3.3

4.0

3.3

14.1

7.8

3.9

5.1

9.4

2.9

3.0

7.6

3.9

6.6

6.0

5.3

B

DK

D

GR

E

F

IRL

I

NL

A

P

FIN

S

UK

EUR

**Dec.**

**1993**

**7.2**

**7.3**

**6.1**

19.9

**8.9**

**6.5**

**6.3**

**8.6**

**5.6**

**5.8**

11.7

**5.9**

**7.7**

**5.3**

**6.9**

17.9

**8.2**

**5.9**

**6.3**

**9.0**

**5.4**

**4.8**

10.5

**5.7**

**8.2**

**6.4**

**6.6**

**5.4**

**6.2**

**5.3**

**Short-term** **[1 ]**

**5.3**

**6.9**

**4.6**

3.6

4.4

3.5

14.6

8.9

4.7

5.4

9.9

3.3

3.7

8.5

4.2

8.4

6.4

5.8

17.2

**9.4**

**7.7**

**6.8**

10.8

**4.7**

**4.5**

10.8

**6.0**

**8.9**

**6.7**

**7.2**

' Three-month money market rate.

2 Yield on benchmark 10 year bonds, unless for EUR until April 1995 where data refer to

yields on government bonds..

_Source:_ Commission's Spring 1996 forecasts.

Secondly, and perhaps more importantly, the currency turmoil in the spring of 1995 had a

significant impact on the economies of the appreciating as well as the depreciating

countries. It was triggered by a marked weakening of the US-dollar in the wake of the

Mexican Peso crisis. But the subsequent sizeable and abrupt movements between EC

currencies seem to reflect the deeper, underlying, problem of the lack of credibility of

-12

national budgetary consolidation plans and structural reforms and/or perceived risks of

renewed inflationary tensions in a number of individual Member States. In Germany and

the countries whose currencies are closely linked to the DM, the appreciation of the

exchange rate implied a considerable tightening of overall monetary conditions, in spite of

an easing in short-term interest rates, and a

worsening of competitiveness and industry

profitability. This in turn had knock-on effects

on investment and led to a marked deterioration

in business confidence. On the other hand, in

countries whose currencies depreciated

significantly, the short-term boost to export

market shares was to some extent offset by

lower growth on export markets, and by rising

interest rates and the erosion of consumer

purchasing power from higher inflation on the

home market. Furthermore, at the level of the

Community as a whole, si/.eable and abrupt

intra-Community exchange rate movements

jeopardise the proper functioning of the internal

market, leading inevitably to suboptimal

resource allocation.

Table 2

N o m i n a l e f f e c t i v e e x c h a n g e r a t e s

Index, August 1992 = 100

Dec.

1994

103.3

102.2

103.1

82.9

78.2

102.4

94.5

72.7

"Î04.3

102.8

88.3

915

77.5

87.1

80.2

Jan.

1996

105.9

106.8

106.7

80.2

80.6

106.7

94.3

71.8

107.0

105.5

89.6

95.8

83.2

82.1

84.6

April
1995

107.9

107.2

109.3

82.9

77.1

106.3

93.3

63.2

109.0

107.3

90.2

96.8

73.0

83.2

80.4

April.
1996

104.6

105.4

104.9

80.9

80.2

106.0

94.6

73.9

105.8

104.2

89.3

91.1

84.8

82.4

83.6

B

DK

D

GR

E

F

IRL

1

NL

A

P

FIN

S

UK

EUR

Dec.

1993

99.9

100.5

100.8

87.5

78.4

100.9

92.8

75.1

102.6

101.5

8/7

8?.5

74 6

887

78.2

_Source:_ Commission.

The above developments point to the need for increased policy co-ordination at the

international level. They also clearly highlight the adverse impact on growth, employment

and confidence of insufficient actions in those policy areas, directly under Member States'

own responsibility, needed to further rebalance the policy-mix as recommended in the 1995

Broad Economic Policy Guidelines.

The progress review given below follows the four broad headings used in the Council

Recommendation namely: price and exchange rate stability; sound public finances;

competitiveness and employment and the labour market.

-13

**//.** _**1.2.**_ _**Price and exchange rate stability**_

_stability_ ~ The 1995 Guidelines reaffirmed the objective, set in the 1993 and 1994

exercises, of a _**rate of inflation of no more than 2 to**_ _3_ _**percent,**_ as a step towards price

stability, adding that this target was likely to be achieved in the majority of Member States

in 1996.

Chart 1

**10**

o

**INFLATION**

Interim indices of consumer prices*
(March 1996 - average over 12 months)

Range indicated jn the
Guidelines

**B DK D GR E** **F** IRL **I** **L** **NL A** **P FIN S UK**

" Interim Indices of Consumer Prices represent the first stage of a process towards
Community harmonisation of _national_ CPI calculations ItMt. M

Indation has been on a steady

downward Irend in (he

Community since 1991 with

the rate of increase of the

deflator of private consumption

falling from around 5/4 percent

to a little over 3 percent last

year, with most Member States

. achieving the inflation

objective already in 1995. As

regards developments so far in

1996, consumer price inflation in the Community in March of this year, as measured by the

12 month average of the annual change in the interim indices of consumer prices (IICPs) [3],

stood at 2.9 percent. In ten of the Member States, inflation was within the range indicated

by the Guidelines and in the majority of them the rate of inflation even stood at below 2 per

cent. In the United Kingdom, inflation was close to 3 per cent. Of the remaining Member

States, Portugal has come relatively close to the range in recent months. In Spain and Italy,

inflation is falling visibly following last year's blip which reflected the combined impact of

their currency depreciations and increases in indirect taxes. Finally, further marked

progress was achieved last year in Greece but the disinflation process seems to have lost

momentum in recent months. However, this development is related to exogenous factors.

This relatively encouraging inflation performance since the adoption of the Guidelines

reflects the combined impact of several forces. It incorporates not only influences such as

a persistent, and even widening, negative output gap and subdued raw material price

developments but also structural improvements in such areas as central bank independence,

wage behaviour and competition. The notable success in bringing inflation down in

several Member States and appropriate actions by the monetary authorities in countries

whose currencies depreciated, has led to an enhanced credibility of anti-inflationary

policies. Wage developments were fairly moderate last year broadly moving in line with

3 These IICPs represent the first stage of a process towards harmonisation of CPI calculations The IICPs and the
subsequent HICPs (Harmonised Indices of Consumer Prices), which will commence in January 1997, will be used in
the context of the evaluation of compliance with the Maastricht inflation criterion

**-14**

price increases in most Member States, with nominal compensation of employees per head

accelerating mildly to _3_ _[l]_ _A_ percent in the Community as a whole. This figure compares with

an annual average rate of increase of close to 6 percent over the period 1991-93. Real unit

labour costs contributed to improved profitability by declining by about I pel cenl or more

in many Member States and by 1.3 per cent in the Community as whole, thereby respecting

the Guidelines recommendation.

Table 3

Inflation developments

_(% change_ _pa.)_

**Private consumption**
**deflator**

Nominal compensation
of employees per head

Real unit labour costs

1993

3.3

1.6

4.3

10.1

6.5

2.2

4.9

3.7

5.2

3.1

4.6

9.1

1.0

4.4

4.3

4.0

**1994**

**3.0**

**1.7**

**2.7**

**10.8**

**4.9**

**1.8**

**2.7**

**4.6**

**24**

**2.4**

**3.0**

**5.2**

**1.3**

**3.-1**

**2.5**

**3.2**

**1995**

**1.5**

**1.8**

**2.0**

**9.3**

**4.6**

**1.6**

**2.5**

**5.7**

**20**

**1.1**

**2.2**

**4.2**

**1.1**

**27**

**2.6**

**3.0**

1994

4.8

3.6

3.2

11.9

3.1

2.1

3.2

3.0

3.4

2.3

3.1

5.2

3.5

5.4

3.5

3.2

1995

1.9

3.3

3.8

12.5

2.4

2.4

3.1

5.2

3.9

3.0

3.8

4.6

5.3

3.0

3.1

3.5

1993

-0.4

-1.5

-0.1

-0.4

-0.5

0.1

-1.7

-24

_-?{•>_

06

03

0.8

-6.6

-1.4

-2.6

-1.0

1994

-0.7

-3.0

-2.6

1.3

"* -3.4

-1.9

-2.0

-40

-0.9

-2.5

0.6

-1.4

-2.9

-1.1

-2.4

-2.5

1995

-15'

0.5

-0.7

1.9

-2.6

-0.3

-2.6

-3.1

08

-0 1

-0.3

-3.5

-0.4

-2.4

-1.0

-1.3

B

DK

D

GR

E

F

IRL

1

L

NL

A

P

FIN

S

UK

EUR

**1993**

**3.1**

**0.3**

**3.9**

13.7

**5.5**

**2.2**

**1.7**

**5.4**

**7.0**

**2.3**

**3.4**

**7.1**

**4.2**

**5.7**

**3.5**

**4.1**

_Source:_ Commission's Spring 1996 forecasts.

Nevertheless, in some countries wage trends were disappointing; not only in those where

the disinflation process has not yet been completed but also for instance in Germany where

wage settlements were relatively high compared with the stated inflation objective of the

monetary authorities. Together with the appreciation of the DM, these wage agreements

contributed to the erosion of competitiveness and profitability in the internationally

exposed sectors. In Italy, wage costs accelerated in 1995 but the rate of increase remained

slightly below inflation. Continued vigilance is necessary to avoid the development of a

wage-price spiral which, if it were allowed to get hold, would raise the future costs of

achieving price stability. In Finland, wages rose significantly in both nominal and real

terms in 1995. However, due to the moderate two-year incomes policy agreement, the rise

in wages and salaries will decelerate substantially in 1996 and 1997.

—
_Exchange rate stability_ Following the exchange rate turmoil of Spring 1995, a broad

degree of stability slowly began to re-emerge over the months to September 1995. Among

the factors contributing to this process was a strengthening of the US dollar in the months

-15

through to August, a monetary easing by the Bundesbank in March and reinforced efforts

at budgetary consolidation in several Member States. This benign situation was to some

extent interrupted in September with a renewal in exchange rate volatility amongst

European currencies. The factors responsible for this re-emergence of tensions included a

renewed weakening of the dollar and specific economic and political factors in a number of

Community countries allied to a resumption of concerns with regard to the prospects for

EMU. However, despite this interruption, calm has returned to the markets with the

currency movements in the period 1994-95 having been largely reversed in the early

months of this'year.

The currencies of Greece, Italy and the United Kingdom have continued to be outside the

ERM. Of the three new Member States, only Austria entered the ERM at the beginning of

1995.

Developments in relation to short- and long-term interest rates in 1-995 in part reflected the

tensions on the foreign exchange markets. The Bundesbank cut the discount rate on four

occasions since March 1995 against the background of slow money supply growth and

better inflation prospects in Germany, thereby providing most other Member States with

the necessary room to follow suit. Having widened sharply amid the exchange rate

tensions in the spring, short-term interest rate differentials with respect to corresponding

rates in Germany narrowed in most Member States in the course of 1995. The pace of

narrowing in differentials has varied among Member States and has in most cases reflected

developments in their exchange rates against the DM. Significant differentials remain in

several Member States where financial markets remain concerned at the credibility of anti

inflation and/or budgetary policies.

At the long end of the market, the sustained decline in interest rates in 1995 (following the

increase in 1994) was sharply reversed in the early months of this year. The recent rise

across the Community largely reflects spillover effects from developments in the United

States, where evidence of buoyancy in the economy has been seen as heightening the

possibility of a monetary tightening by the Federal Reserve. As with short-term interest

rates, the trend in differentials between Germany and other Member States has been

generally downward, although substantial differentials persist in some Member States

where exchange rate credibility remains closely tied to inflation and/or budgetary

developments.

-16
###### **_II. 1.3. Sound public finances_**

Many countries came out of recession in 1993 with serious budgetary imbalances. The

need for urgent action in this area was recognised in the earlier Guidelines exercises.

Unfortunately, many Member States, despite the relatively good economic conditions

prevailing in 1994 and early 1995, had not made substantial inroads into their budgetary

problems at the time of last year's Guidelines exercise.

The public finance objectives of the 1995 Guidelines were that in the short run Member

States should not only rely on the positive benefits which were expected from the workings

of the automatic stabilisers to improve their budgetary positions but that they must also

take full advantage of all the growth opportunities to step up fiscal consolidation by

reducing structural deficits. Member States were urged to reduce their budget deficits to

below 3 percent of GDP as soon as possible. Any additional room for manoeuvre provided

by stronger than expected growth or a more favourable interest rate evolution was

recommended to be used to accelerate the process of budgetary consolidation.

_Developments_ _in_ _1995_ ~ In overall terms, the budgetary position of a large majority of

the Member States registered some progress in 1995. However, the degree of improvement

was insufficient given both the extent of the fiscal difficulties to be surmounted and the

official commitments to do more. The sharp cyclical slowdown experienced in some

Member States over the course of the year, and especially in the last quarter of 1995,

obviously made progress towards sounder public finances more difficult. However, fiscal

slippages in several countries were a clear factor behind the overall insufficient

improvement in the underlying budgetary positions, as measured by the Commission

services estimates of the cyclically-adjusted budget balances.

In fact, general government net borrowing in the Community in 1995 came down by only

half of a percentage point to a still unacceptably high level of 5 percent of GDP, which is

substantially higher than the figure anticipated at the time of the drafting of the Guidelines

in May of last year. Of the budgetary adjustment which took place, roughly half of the

improvement was due to non-cyclical factors; the estimated reduction in the cyclically
adjusted budget deficit _(_ _[l]_ _A_ of a percentage point ) was smaller than expected earlier.

At the level of actual budget deficits, ten of the fifteen Member States have registered some

progress in 1995, varying from gains of _[ l]_ _A_ a percentage point m the case of Portugal to

nearly 3 percentage points in Greece. Nine of these ten countries also registered an

improvement in their structural deficits. The exception was Finland where the widening in

the adjusted deficit was mainly explained by the timing of tax repayments. Four countries,

namely Denmark, Greece, Italy and Sweden, achieved improvements in their cyclically

                     - 17

adjusted deficits of between 1 and 3 percentage points. All the latter four Member States,

with the exception of Denmark, still have deficits well above the 3 per cent of GDP

reference value at the start of 1996. Belgium, Spain, France and the United Kingdom

achieved discretionary reductions of the order of a _[ X]_ _A_ to _VA_ of a percentage point.

Table 4

Actual and cyclically-adjusted general government budget balances

(per cent of GDP)

1995

0.8

2.1

-1.0

2.9

0.7

0.8

-0.4

1.9

-1.9

-0.2

-1.7

0.4

0.7

2.7

0.8

0.5

**Actual budget balance**
**(level)**

1995

0.5

1.6

-0.9

2.6

0.4

0.5

-2.0

1.3

-2.0

-0.2

-1.6

0.2

12

1.1

0.6

0.3

**1994**

**-5.3**

**-3.5**

**-2.5**

-12.1

**-6.9(2)**
**-5.8**

**-2.0**

**-9.0**

**2.2**

**-3.2**

**-4.5**

**-5.8**

**-6.3**

108

**6.8**

**-5.5**

**1995**

**-4.5**

**-1.4**

**-3.5**

**-9.2**
**^.2(** **[2]** **)**

**-5.0**

**-2.4**

**-7.1**

**0.3**

**-3.4**

**-6.2**

**-5.4**

**-5.6**

**-8.1**

**6.0**

**-5.0**

Change in actual
budget balance*

1994

1.4

0.4

1.0

2.1

0.6

0.3

0.4

0.6

0.4

-0.0

-0.2

1.3

17

1b

1.0

0.8

1993

0.4

-1.0

-0.7

-1.9

-3.3

-2.0

0.1

0.0

1.0

0.7

-2.2

-3.7

-2.2

-4.5

-1.5

-1.1

Change in cyclicallyadjusted balance'

1993 1994

2.6

-0.7

1.0

-0.9

-1.1

-0.4

1.3

1.4

2.3

-1.4

-2.2

0.7

-1.7

-1.5

0.2

B

DK

D

GR

E

F

IRL

1

L

NL

A

P

FIN

S

UK

EUR

**1993**

**-6.7**

**-3.9**

**-3.5**

**-14.2**

**-7.5**

**-6.1**

**-2.4**

**-9.6**

**1.8**

**-3.2**

**-4.3**

**-7.1**

**80**

-123

**-7.8**

**-6.2**

1.2

-1.3

0.8

2.2

0.7

-0.4

-0.5

0.4

0.1

-0.3

-0.5

1.8

0 3

03

0 1

0.3

1) Commission services estimates. A "+" indicates an improvement; a "-" indicates a deterioration in the budget balance.

2) This time series includes social security contributions still on a cash basis. Preliminary accounting on an accruals basis by national sources

shows figures of -6.2 per cent of GDP for 1994 and -5.8 per cent of GDP for 1995. The time series will be updated on an accruals basis

once certain issues concerning the correct application of statistical definitions have been clarified.

Source: Commission's Spring 1996 forecasts.

The five remaining countries experienced a worsening in both their actual and cyclically

adjusted budget deficits. As regards cyclically-adjusted budget balances, deteriorations of

around a _VA_ of a percentage point were registered in the Netherlands, _VA_ of a percentage

point in Germany and between _VA_ and 2/4 percentage points in Ireland, Luxembourg and

Austria. In the case of Germany, the overrun was partly due to unexpected revenue

weakness. In Ireland, against a background of strong growth, policy appears to have been

pro-cyclical although special factors, such as the social security settlement were also at

play. Despite some slippage, Luxembourg, as with Ireland, still respects the Maastricht

budgetary reference value. Finally, in Austria although the new government is tackling the

problem, it is clear that there was a serious budgetary deterioration in 1995. Efforts to

reverse the structural deterioration which occurred last year are appropriate in all these five

Member States but are especially necessary in those countries with cyclically-adjusted

deficits in excess of 3 per cent of GDP.

-18

On a more positive note, the bulk of the fiscal adjustmeni which took place over (he hist

two years was centred on the spending side, with the share of government expenditure in

GDP falling by about 1% percentage points in the Community as a whole, though

remaining above 50 per cent of GDP. A drop in the government spending ratio was a

common trend amongst a large majority of Member States. Furthermore, in all countries,

with the exception of Portugal, there was a decline in non-interest expenditure.

Table 5

Receipts, expenditures and interest payments of general government

_(in_ _%_ _of_ _GDP)_

1995

544

59.7

49.8

46.0

46.0

54.3

39.7

51.8

41.3

51.9

53.1

44.8

58.4

67.6

43.6

50.8

1 Receipts

(of which) Interest payments

1994

50.4

588

46.8

35.8

41.0

48.9

39.5

45.2

44.6

50.8

48.1

38.0

54.6

59.6

36.4

45.9

1995

499

583

463

36.8

39.9

49.3

37.3

44.8

41.6

48.6

46.9

39.4

52.8

59.5

37.6

45.7

1993

56.3

62.2

50.0

48.5

49.5

55.5

41.3

57.0

43.2

56.3

53.7

43.4

61.9

72.6

43.7

52.5

1993

10.5

7 8

3 3

12.8

5.2

3.7

6.7

12.1

0.4

6.4

4.3

6.7

4.6

6.2

2.9

5.5

1994

10?

7 1

34

142

5 1

3.8

5.9

10.7

0.4

6 1

4 1

5.8

5.1

6 8

3.3

5.3

1995

9 ?

6 7

3.8

12.9

5.4

3.7

5.2

11.2

0.3

5.8

4.3

5.8

5.4

7.1

3.7

5.4

Expenditure

1994

556

62 3

493

48.0

47.9

54.7

41.6

54.2

42.4

54 1

52.6

43.8

60.9

70.4

43.2

51.4

B

DK

D

GR

E

F

IRL

1

L

NL

A

P

FIN

S

UK

EUR

**I** **1993**

49.6

58.3

465

34.4

42.0

49.3

38.9

47.4

45.0

53.1

49.4

36.3

53.8

60.3

35.9

46.2

_Source:_ Commission's Spring 1996 forecasts.

As regards government receipts, a moderate decline was noticeable in the Community as a

whole and in several Member States. A rather marked drop in the proportion of

government receipts to GDP occurred in the Netherlands, Austria and Luxembourg over

the last two years. Conversely, the tax burden showed a rising tendency in Greece, France,

**Portugal** and the United Kingdom.

**1993**

**Level**

137.9

80.1

48.2

111.8

60.5

45.4

97.5

119.4

6 2

81.1

628

672

57.3

76.0

48.5

66.2

The insufficient degree of progress in

reducing the Community's government

budget deficits was reilccted in the

average debt/GDP ratio figures for the

Community which increased in 1995 by

three percentage points to over 71 percent.

While the inclusion in the German figure

of the unification-related debt take-over

by the Gerrrian federal government,

essentially the Treuhand-anstalt, was

clearly an important factor in explaining

the increase for the Community as a

whole, it should be noted that the debt-to

GDP ratio continued to worsen in a total

_o(_ 9 Member States in 1995. In

Luxembourg and Finland the debt ratio

Table 6

B

DK

D

GR

E

F

IRL

1

L

NIL

A

P

FIN

S

UK

EUR

Gross government debt

(pot cent of GOP)

136.0

76.0

50.4

110.4

63.1

48.3

91.1

125.6

5.9

77.6

65.0

70.0

59.5

79.3

50.2

6 8 2 '

**1994**

**Level** **Annual**

**Change**

1995

Level Annual

Change

-1.9

**-4.1**

+2.2

**-1.4**

+2.6

+29

-6.4

+6.2

-0.3

-3.5

+22

+28

+2.2

+3.3

+ 17

+2.0

1337

71.9

58.1

111.5

657

524

85.5

1248

5 9

790

694

71 6

' 59.6

799

540

71 2

-2.3

-4.1

+7.7

+ 1.1

+26

+4.1

-5.6

-08

0.0

+ 1 4

+4.4

+ 1 6

0.0

+06

+3.8

+3.0

_Source:_ Commission's Spring 1996 forecasts.

did not change, whereas Denmark, Belgium, Ireland and Italy managed to reduce their debt

ratios by between almost 1 and 6 percentage points. Finally, it should be stressed that

rising debt ratios in a majority of Member States at a time of overall budgetary

improvement demonstrates the need for an intensification of fiscal retrenchment efforts.

In overall terms therefore, the

contribution of discretionary fiscal

consolidation has been less than had

been hoped for in 1995. This failure

to fully realise earlier expectations is

disappointing given that the

importance of making steady

progress towards meeting the fiscal

convergence criteria has been

publicly acknowledged by Member

States in their national convergence

programmes. It is also disappoint

ing given the extent of the fiscal

divergence which continues to

persist, as reflected in the LcoFin

Council decisions with regard to the

existence of Treaty-defined

a) Figures in brackets are revised official targets, not submitted
as convergence programmes at Community level
b) Average for 1995-97
c) Financial year 1995/96
_Source_ Commission's Spring 1996 forecasts

Table 7

Government deficits in 1995:

Convergence programme (CP) projections

and latest Commission (COM) forecasts

COM

4 5

1.4

3.5

9.2

6.1

5.0

2.4

7.2

34

6.2

5.4

5.6

8.1

6.0

CP(a)

3.8(4.3)
3.0

2 to 3

107

5.9

4.2/4.1 (5.0)

<3

4.7(7.5)

3.7

4 %

3 _V._ (b) 5.8)

5.3

9.0

3 _V_ (C)

B

DK

D

GR

E

F

IRL

I

NL

A

P

FIN

S

UK

**Date**

6/92 (6/94)
11/94

11/93

6/94

7/94

11/93 (7/95)

6/94

9/92 (6/95)
10/94

5/95

11/93 (10/94)

9/95

6/95

3/95

-20

excessive deficits.

_Budgetary outlook_ — The crucial task facing a large number of countries is to continue to

make progress towards putting their public finance positions onto a firmer footing. With

regard to actual budget deficits, the vast majority of countries are forecast to reduce their

deficits in 1996. Nevertheless, on the basis of concrete measures announced so far and the

more prolonged than expected pause in the recovery, progress would appear insufficient

when compared with the targets set both in the Guidelines and in national convergence

programmes. Only 3 Member States (Denmark, Ireland and Luxembourg) are now likely

to have deficits below the 3 percent reference value this year compared with an expectation

of 7 countries at the time of the adoption of the 1995 Guidelines.

Since the adoption of the Guidelines in July 1995, almost all the Member States have

announced new budget proposals for 1996 and, in some cases, for 1997. These proposals

all aim for further reductions in government deficits this year and next, to 3 per cent of

GDP or below by 1997 at the latest in all countries except Greece and Italy. Particularly

sizeable packages of adjustment measures were announced by the governments in Belgium

in September 1995 (tax increases and expenditure cuts), Finland in September 1995

(expenditure cuts in 1996 and 1997, Italy in September 1995 (measures to fight tax

evasion, increases in social security contributions and cuts in transfers to non-government

institutions), France in August 1995 (fiscal measures to reduce the central government

deficit), in November 1995 (fundamental reform of the social security system) and in May

1996 (expenditure cuts and restoration of social security account), by the newly formed

government in Austria in April 1996 (expenditure cuts, tax increases and reform measures

aimed at the pension system) and by the German government also in April 1996

(expenditure cuts).

Slower economic growth, on average in 1996, than expected when most of these budget

plans were drawn up is making deficit reduction more difficult this year. Several Member

States have already announced additional measures (e.g. freezes on certain expenditure

items in Germany and France ) to offset some of the slippage caused by the impact of the

weaker growth on tax revenues and social transfers, and others are likely to do so in the

coming months.

Provided that all the measures which have been decided are fully implemented by the

respective Member States then a substantial correction of underlying budgetary positions is

in prospect. However, it must be reiterated that, while these measures are clearly welcome,

-21 

in a number of cases they are still insufficient in relation to both the size of the problem to

be addressed and the targets set in national convergence programmes.

_**11.1.4.**_ _**Competitiveness**_

The 1995 Guidelines reiterated the importance of implementing reforms aimed at

strengthening the underlying growth forces and enhancing the dynamism and

competitiveness of the Community economies.

It is clear that'the major onus is on the individual Member States to provide the conditions

in which a truly competitive environment can be established and sustained. This can only

be done by correctly focusing economic, fiscal and social policies in order to ensure that

they continue to remain consistent with the Member States objectives in this area. These

national efforts need however to be complemented and reinforced by action at the

Community level.

At the Community level, the importance of fully exploiting the opportunities provided by

the internal market needs to be continuously stressed. As of April 1996, the global rate of

transposition of internal market Directives was 89.7 percent. Denmark has the highest rate

of transposition (96.6 %) followed by the Netherlands, the United Kingdom, Luxembourg

and Spain. The sectors which continue to present the most problems in terms of the

implementation of White Paper directives are public procurement, insurance and

intellectual and industrial property.

Action on the competitiveness front is being intensified in the context of the Commission's

recent proposal for a Confidence Pact for Employment to reinforce efforts in the particular

areas of research and development, Trans-European networks and in encouraging dynamic

small and medium-sized enterprises (SMEs).

This initiative by the Commission reinforces the actions already taken in the Community

in a large number of areas dealing with competitiveness. The Community has continued its

efforts over the last number of years to complement the single market initiative by setting

in place an effective competition framework to ensure the successful operation and

efficiency of Member State enterprises. The following are the most important

developments:

- The Commission presented important initiatives in the area of telecommunications last

year with the objective to ensure a greater liberalisation of the regulatory framework.

Such liberalisation is crucial to the Community's ambitions in relation to the

Information Society. The implementation of full competition in telecommunications

**-22**

markets affects the competitiveness of the whole Community economy. The

Commission also presented initiatives concerning the Community's postal services.

Competition policy has also been taking on growing importance in boosting the

competitiveness of the Community's industries. In 1995, the Commission has reviewed

the Community frameworks for aids to SMEs, to shipbuilding and to R&D.

Action has been undertaken in the area of legislative and administrative simplification

The Competitiveness Advisory Group, consisting of high level experts and

industrialists, presided over by Mr Ciampi, was nominated by the Commission and

presented a report to the Madrid European Council in December 1995.

The Madrid European Council took note of a Commission report on the key role that

could be played by SMEs as a potentially important sector for generating growth and

employment opportunities. The Commission's report, however, pointed out that these

SMEs needed support through specific measures and a business-environment favourable

for the development of SMEs. The Council therefore asked the Commission to make

proposals to realise SMEs potential, to improve their competitive position and to

encourage them in their business activities both in Europe and internationally. The

Commission, in response, approved on 20 March 1996 a proposal for a new Multi
annual Programme for SMEs for 1997-2000 [4] which has been submitted to the Council.

Some progress was also achieved last year with regard to Trans-European networks

(TENs) in the transport, telecommunications and energy sectors. The Madrid European

Council urged Member States to give top priority to the effective implementation of

TEN projects and asked the EcoFin Council to take the necessary decisions to

complement the financial resources currently earmarked for these networks.

Community actions in the context of the Structural and Cohesion Funds, aimed at

bolstering the physical and human capital of the weaker Community regions, continue

to make an important contribution to the balanced development of all areas.

Finally, environmental protection initiatives are being actively pursued by the

Community internally and at the level of international fora. To increase the job-creating

potential of environmental policies, the Madrid European Council emphasised that such

policies should be based upon market instruments, including fiscal instruments.

Document COM(96) 98 final of 20 March 1996.

-23

**//.** _**1.5.**_ _**Employment and the labour market**_

The 1995 Guidelines emphasised the crucial role to be played by more active and more

efficient labour market policies in achieving both a high rale of economic growth over

many years and in increasing the capacity of that growth to generate jobs. As discussed in

section 1, growth trends in 1995 were generally disappointing, with the pace of output

expansion being insufficiently high to generate a substantial increase in employment. But

provided that resolute progress will be made in further rebalancing the macro-economic

policy framework, the Community could progressively move towards a sustained,

employment-creating, growth path.

One vital element of the Community's strategy for job creation is the importance of

increasing the number of jobs associated with a given level of output ("the employment

content of growth"). It should be noted, however, that it is difficult to assess whether

underlying progress is being made in this area on the basis of observations for only a short

period of lime. This is because measured labour productivity varies considerably over the

economic cycle, reflecting the lagged response of employment to changes in economic

growth. Nevertheless, the available evidence seems to indicate that there has been some

improvement in the employment content of growth in a few countries, but no significant

change in the majority of countries or for the Community average.

Table 8

Growth, employment and productivity

**Real GDP growth (%** **pa.)** **Employment (%** **p.a.)** **Labour productivity (%** **pa.)**

_**Memo**_ _**Memo**_ _**Memo**_
**74-85** **86-90** **91-95** **74-85** **86-90** **91-95** **74-85** **86-90** **91-95**
**f995** **1995** **1995**

**B**

**DK**

**D**

**GR**

**E**

**F**

**IRL**

**NL**

**A**

**P**

**FIN**

**S**

**UK**

**EUR**

**USA**

**JAP**

**1.9**

**2.6**

**1.9**

2 0

3.0

2.2

**8.6**

3.0

3.2

**2.4**

**1.8**

**2.5**

**4.2**

3.0

**2.4**

2.5

**2.0**

**0.9**

**-0.3**

**0.5**

**-0.2**

**10**

**-1.4**

**0.1**

**0.1**

**0.9**

**0.5**

**-0.1**

**0.7**

**-0.4**

0.3

0.8

-0.2

0.0

18

0.7

**1.1**

0.3

1.5

**0.9**

**3.3**

**0.8**

**1.0**

0.6

3.1

1.9

0.7

1.1

0.2

1.0

1.8

**13**

**2.1**

**1.5**

**0.4**

**1.5**

**-0.3**

**0.9**

**2.7**

**1.2**

**3.8**

**-0.4**

**2.5**

**1.4**

**-0.1**

**-0.6**

**2.2**

**1.6**

**0.6**

**0.6**

**15**

**0.3**

**2.1**

**1.5**

**19**

**16**

**3.4**

**2.1**

**3.7**

**1.8**

**1.2**

**2.0**

**1.6**

**2 6**

**2.4**

**1.0**

**1.6**

**2 0**

**0.5**

**3.0**

**1.7**

**2.4**

**2 6**

**0.7**

**1.8**

**12**

**3.3**

**2.3**

**-0.3**

**1.2**

**0.9**

**1.5**

**2 9**

**2.3**

**2.4**

**2 0**

**1.1**

**0.5**

**1.3**

2.0

18

13

**1.4**

**1.1**

**4.8**

**1.1**

2.4

**1.9**

2.0

**1.1**

-0.8

0.1

**1.2**

1.3

2.2

1.3

**-0.4**

**-0.4**

**0.0**

**0.9**

**-0.4**

**-0.1**

**1.5**

**-1.0**

**2.7**

**0.7**

**1.1**

**-0.4**

**-3.6**

**-2.2**

**-1.2**

**-0.5**

**1.0**

**08**

**1.8**

**2.0**

**1.7**

**2 5**

**1.9**

**2.2**

**3.8**

**2.8**

**1.8**

**1.9**

**2.2**

**2.2**

2.7

1.8

**1.4**

2.0

2.3

3.6

3.0

**1.4**

3.4

**19**

**4.5**

**3.2**

4.6

3.0

4.6

**3.1**

**3.0**

**5.1**

3.4

2.3

3.3

3 3

2.8

4.5

**1.9**

**1.2**

**19**

**1 0**

**1.2**

**2.4**

**3.6**

**2.4**

**1.5**

**1.2**

**2.2**

**3.9**

**3.2**

**1.2**

**1.5**

**1.9**

**0.6**

**3.0**

**1.6**

**1.1**

**2 2**

**1 1**

**03**

**1.0**

**4.6**

**3.4**

**0.7**

**1.0**

**1.9**

**3.1**

**2.0**

**1.4**

**1.8**

**1.9**

0 6

0.6

_Source:_ Commission's Spring 1996 forecasts.

**-24-**

In Spain, labour market reforms introduced in the most recent years seem to have

contributed to a very strong employment growth in 1995 (2.7 per cent against a background

of 3 per cent GDP growth) and this is expected to continue in 1996. Also in France, the

Netherlands and to a lesser extent Belgium, recent measures seem to have contributed to a

somewhat more favourable employment response to growth in 1995 than would have been

expected on the basis of historical trends. For Denmark the favourable employment

response may be partially due to the active labour market policies pursued. Essentially

reflecting buoyant economic activity, Ireland experienced very strong employment growth

in 1995 for the second consecutive year. In contrast, the employment performance in

Germany has been hampered by a continuing shake-out in the country's large

manufacturing industries under the pressure of a deterioration in international cost

competitiveness, while significant job losses have been experienced in Italy in those

service sectors increasingly exposed to competitive pressures and hurt by several years of

very weak domestic consumption growth.

The Guidelines also underlined the importance of both the 5 priority areas identified by the

Essen European Council and of the latter's call to Member States to implement this strategy

by preparing multi-annual programmes spelling out their policy intentions in this area. By

providing a coherent presentation of the existing or planned national measures for the

implementation of the strategy, these programmes should become an important instrument

for monitoring and assessing progress in implementing labour market policies. To ensure

their effectiveness, they should be better coordinated with the convergence programmes,

indicating that the achievement of convergence, growth and employment is inextricably

linked. Some changes in their present content and format will also be required, including

national targets for specific measures and greater emphasis on medium and longer-term

issues.

The first assessment of the progress achieved in implementing the Community's

employment strategy was presented in a joint report from the EcoFin and Social Affairs

Councils and the Commission to the Madrid European Council. The report highlighted and

commended the major efforts deployed by the Member States since Essen, in particular the

acceptance by countries of the necessity of adopting an integrated approach based on the

link between macroeconomic and structural employment policies. However, it also

stressed that if a decisive improvement in the Community's employment situation was to be

realised then an additional impetus would have to be given to labour market reforms in the

Member States. A range of measures were singled out in the report as being essential to

the strengthening of national initiatives in relation to employment reforms. On the basis of

the recommendations contained in the joint report, the Madrid European Council urged

Member States to prioritise a number of areas of action in their multi-annual employment

**-25-**

programmes. On the basis of the programmes and a set of indicators, the joint effort to

improve both the employment situation and the effectiveness of measures will be assessed

at the Community level.

Finally, since Madrid the debate on labour market reform has centred on, and is

encapsulated in, the proposal of the Commission President for a Confidence Pact for

Employment. The Pact is intended to give substance to the Madrid Council's affirmation

that the objective of job creation remains the key policy priority for the European Union

over the coming years. The macroeconomic and structural policy framework of the pact

will be based on the strategy developed in the present and previous Guidelines with the

relevant Community instruments also being used to engender dynamism, growth and

employment. The Pact aims at arriving at concrete policy commitments involving the

Social Partners with measures specifically related to employment creation.

**26-**

**11.2.** **Economie** **outlook**

The worsening economic climate in late 1995 and early 1996 has complicated the task of

making progress towards the objectives of reducing unemployment and restoring sound

public finances in the Community. However, a recovery in economic activity is expected

to take place in the second half of 1996 and in 1997. This will lead to renewed job creation

and reverse the current upward trend in unemployment. But in order to achieve a

significant and durable reduction of unemployment, it is necessary to maintain strong

growth of economic activity over a sustained period and to make further progress in the

area of structural reform.

_**11.2.1.**_ _**Growth prospects**_

The recent economic slowdown, job insecurity and uncertain income prospects have

sapped confidence among consumers. Business confidence has suffered from large

unwarranted shifts in exchange rates, from the absence of clear signs of a pick-up in final

demand and from persistent structural weaknesses. Nevertheless, signs are emerging that

the decline in confidence has come to a halt and demand may be picking up again in a

number of countries. Consequently, economic activity in the Community is expected to

bottom out in the course of the first half of this year.

On the basis of sound supply-side fundamentals (in

particular low inflation and relatively strong average

investment profitability) and more favourable

monetary and financial conditions, the Community

economy is expected to see a recovery in the second

half of 1996, reinforced by the end of the ongoing

stock adjustment. The expansion is expected to

gradually strengthen in 1997. In the Commission

services' latest Economic Forecasts, economic

growth in the Community as a whole is expected to

be around 1 _[ l]_ _A_ per cent this year followed by growth

of around 2'/ 2 per cent in 1997. The upswing is

expected to be driven by relatively strong extra

Community exports, a renewed strengthening of

capital formation and continued moderate but

gradually accelerating private consumption.

Table 9

Real GDP

(Real annual percentage change)

**1995**

**1.9**

**2.6**

**1.9**

**2.0**

**3.0**

**2.2**

**8.6**

**3.0**

**3.2**

**2.4**

**1.8**

**2.5**

**4.2**

**3.0**

**2.4**

**2.5**

1996

1.1

1.3

0.5

2.0

2.0

1.0

5.6

1.8

2.6

1.8

0.7

2.3

3.0

1.2

2.4

1.5

**1994**

**2.2**

**4.4**

**2.9**

**- 1.5**

**2.1**

**2.7**

**6.7**

**2.1**

**3.3**

**2.7**

**3.0**

**1.0**

**4.0**

**2.6**

**3.8**

**2.8**

1997

2.3

2.7

1.8

2.5

2.9

2.1

4.9

2.7

3.0

2.5

1.1

2.8

3.6

2.0

3.0

2.4

B

DK

D

GR

E

F

IRL

1

L

NL

A

P

FIN

S

UK

EUR

**1993**

**-1.6**

**1.5**

**-1.2**

**-1.0**

**-1.2**

**-1.5**

**3.1**

**-1.2**

**0.0**

**0.2**

**0.4**

**-1.2**

**-1.2**

**-2.2**

**2.2**

**0.6**

_Source:_ Commission's Spring 1996 Forecasts.

**- 27** **-**

In Germany, France and a number of neighbouring countries, the adverse effects of the

strong currency appreciation in spring 1995 will gradually subside, partly due to a

significant reversal of the initial currency overshooting. Aided furthermore by a

considerable reduction in interest rates and an expected restoration of confidence, activity

is expected to pick up during 1996, strengthening into 1997. In Italy, Sweden, Spain and

other countries, a continued rebalancing of the macroeconomic policy-mix, which has

helped their currencies regain, to varying degrees, lost ground, is likely to help lower short

and long-term interest rates and spur confidence, thereby supporting a recovery in domestic

demand no later than the second half of 1996 while reducing the reliance on exports for

growth. In the United Kingdom, the recent easing of monetary conditions, improvements

in the housing market and a favourable competitive position should sustain continued, non

inflationary growth.

Nevertheless, the economic outlook remains subject to substantial uncertainties. In

countries whose currencies appreciated in 1995 the effects of competitiveness losses have

not yet been fully overcome, and in most countries whose currencies depreciated in 1994

95 interest rate differentials relative to the DM remain relatively high. In the current

apprehensive climate and given high unemployment, the positive response of business and

consumer spending to improved monetary and financial conditions and to the reduction in

fiscal imbalances could be weaker or take place later than normal.

Furthermore, if progress towards sounder public finances and structural reform were to be

hampered by rising social and political resistance, this would undermine the credibility of

stated economic policy objectives and might add to doubts amongst some observers as to

whether a sufficient number of Member States would be ready to participate in EMU at the

starting date of 1 January 1999. Such developments would likely lead to an increase in

long-term interest rates and could create a risk of tensions in foreign exchange markets.

This would have severe implications for the chances of a renewed and sustained recovery

and job creation.

However, some of the uncertainties surrounding the outlook may also point in a positive

direction. Since the Community is currently enjoying favourable underlying economic

fundamentals and the rebalancing of the policy-mix is expected to continue, the revival in

economic activity could surprise in a positive manner once confidence is restored.

28

_**11.2.2.**_ _**Employment trends**_

_Employment_ -- Given the anticipated weak expansion of economic activity in early 1996,

employment trends are expected to remain weak in the months ahead. However, provided

economic growth picks up as forecast, job creation should turn positive again in the course

of the second half of 1996 and gain momentum in 1997. Overall employment is forecast to
###### grow by a meagre [ l] A of a per cent this year and by V* of a per cent next year.

Not all Member States are expected to share in

this modest pick-up in job creation in 1996. In

Germany and Austria, employment is expected

to fall considerably. If this prediction holds

true, 1996 will be the fifth consecutive year of

job losses in Germany where the economy is

**B**

Table 10

**Labour market prospects**

**Employment**
**growth**

**(percent per year)**

**Unemployment rate**

**(% of labour force)**

```
1995 1996 1997 1995 1996 1997

```

17.2

9.2

8.8

10.9

**0.4**

10.1

6.1

9.3

9.1

22.5

11.7

13.4

11.8

9.0

22.1

11.7

12.8

11.7

**9.8**

**5.8**

**9.4**

0.7

0.7

-0.1

1.2

1.5

0.6

1.7

0.4

2.6

1.4

-0.4

0.5

2.1

1.0

1.0

0.6

9.9

6.8

8.3

beset by a high relative cost level. In most **DK** **1.5** 0.0 0.7 6.8 6.1 **5.8**

**D** **-0.3** -0.8 -0.1 8.3 9.3 **9.4**

other Member States, the expectations of job **GR** 0.9 1.0 1.2 9.1 9.1 9.0
growth have likewise been revised E 2.7 1.4 1.5 22.9 22.5 22.1

**F** 1.2 0.0 0.6 11.5 11.7 11.7

downwards. In Belgium, Denmark, France **IRL** 3.8 2.3 1.7 14.4 13.4 12.8
and Portugal, employment is now expected to **I** -0.4 0.2 0.4 11.8 11.8 11.7

**L** 2.5 1.7 2.6 2.9 3.0 2.9

stagnate or fall this year. On the other hand, **NL** 1.4 1.0 1.4 7.3 7.2 7.0
employment creation is expected to remain **A P** -0.1 -0.6 -1.0 -0.1 -0.4 0.5 4.0 7.2 4.6 7.4 5.1 7.2
relatively strong (1 per cent or more) in **FIN** 2.2 1.7 2.1 17.2 16.3 15.0
Greece, Spain, Ireland, Luxembourg, the **S UK** 0.6 1.6 0.9 0.6 1.0 1.0 9.2 8.8 8.8 8.4 8.3 8,0
Netherlands, Finland and the United Kingdom. **EUR** 0.6 0.2 0.6 10.9 10.9 10.8

On current growth assumptions, employment _Source:_ Commission's Spring 1996 Forecasts.

is forecast to pick up more widely in 1997.

But with significant job shake-outs expected to continue in the manufacturing sector,

employment growth is expected to remain negative in Germany and, due to low economic

growth, also in Austria.

**DK**

**D**

**GR**

E

**1.5**

**-0.3**

0.9

2.7

1.2

9.1

22.9

11.5

14.4

11.8

**F**

**IRL**

**I**

**L**

**NL**

**A**

**P**

**FIN**

**S**

**UK**

**EUR**

2.2

1.6

0.6

0.6

3.8

-0.4

2.5

1.4

-0.1

-0.6

2.9

7.3

4.0

7.2

3.0

7.2

4.6

7.4

2.9

7.0

5.1

7.2

15.0

8.3

8,0

10.8

16.3

8.8

8.4

10.9

-0.1

0.0

-0.8

1.0

1.4

0.0

2.3

0.2

1.7

1.0

-1.0

-0.1

1.7

0.6

0.9

0.2

_Source:_ Commission's Spring 1996 Forecasts.

_Unemployment trends —_ Against the background of sluggish job growth in the

Community in 1996-97, unemployment is expected to rise further in the coming months,

before starting to head downwards slowly in the course of the second half of 1996. For the

year as a whole, the unemployment rate is expected to remain unchanged at last year's level

of almost 11 per cent of the civilian labour force. Next year, it may decline slowly to _\(?A_

per cent on average, possibly reaching _WA_ per cent by the end of the year.

The trends in unemployment in the individual Member States are largely a reflection of the

expected employment trends. This year, the jobless rate is expected to rise significantly

                               - 2 9 

(by _Vi_ a percentage point or more) in Germany and Austria although relative to the

Community average joblessness remains relatively low in the latter country. Belgium,

France and Portugal may also see a deterioration and the slow growth of employment is

sufficient only to stabilise unemployment in Italy.

On the other hand, unemployment is likely to continue falling in six Member States. This

includes the three countries which are hardest hit by high unemployment (Ireland, Finland

and Spain) although the level of joblessness continues to be extremely high in these

countries. In all three, the impact of strong employment growth on the jobless figures is

partly off-set by a significant increase in the labour force. The most positive developments

are expected in the United Kingdom and Denmark where a further reduction of around _Vj_ a

percentage point is expected to bring the unemployment rate to a level significantly below

the Community average. In 1997, the level of unemployment is forecast to fall to varying

degrees in all Member States except three countries. In Germany and France, the jobless

rate is likely to stabilise and in Austria it may rise further.

For the Community at large, recent growth and unemployment trends have been

disappointing. Progress towards the objectives stated in Article 2 of the Treaty, namely the

promotion of sustainable, non-inflationary growth and a high level of employment, have

not been adequate. And recent as well as prospective developments has cast doubts on the

feasibility of achieving the objectives set out in the Commission's 1993 White Paper on

Growth, Competitiveness and Employment of creating 15 million additional jobs and

cutting unemployment by half (relative to its 1994 level) by the year 2000. Therefore,

resolute efforts in both the macroeconomic and the structural fields aimed at strengthening

sustainable job creation must be undertaken.

_**11.2.3.**_ _**Convergence**_

_Price stability —_ Progress in reducing inflation in the Community and in the Member

States is expected to continue this year and next. Average inflation in the Community, as

measured by the deflator of private consumption, is expected to fall to some 2!/ 2 per cent

this year and stay slightly below that level in 1997.

The outlook for low and falling inflation is due not only to the recent widening and the

expected persistence of a negative output gap in the Community economy, but also to the

reinforced anti-inflation credibility of the economic policy framework. This credibility is

well established in Germany and in the countries whose currencies are closely linked to the

**30-**

DM. In a number of other countries, monetary Table 11

**Price and wage** **trends** **[1 ]**

policy has been conducted with considerable (Annual percentage change)

success with the aim of bringing inflation down **Prices** **Nominal wages**

**per head**

to a pre-set target. In Italy, Sweden, Spain and **1995** **1996** **1997** **1995** **1996** **1997**
Portugal, anti-inflation credibility has been **B** **TT** **To*** **_,** **"TT** **1.7** **TT**

**DK** **1.8** **1.8** **2.4** 3.3 **3.9** **3.6**

enhanced by the establishment of central bank **D** **2.0** **1.6** **1.6** 3.8 **2.6** **2.4**

independence and in Finland by significant **GR** **9.3** **8.3** **7.0** 12.5 11.1 **9.6**

**E** **4.6** **3.6** **3.2** 2.4 **3.8** **3.6**

moves towards that goal. In these countries, the **F** **1.6** **1.8** **1.6** 2.4 **2.3** **2.5**

conduct of fiscal policy has a particularly **IRL** **2.5** **2.3** **2.4** 3.1 **4.0** **5.0**

**5.7** **4.1** **3.5** 5.2 **5.4** **4.8**

important role to play in anchoring low **2.0** **1.7** **2.1** 3.9 **3.5** **3.8**

inflation expectations and in maintaining the **NL** **1.1** **1.9** **2.0** 3.0 **1.9** **2.5**

**A** **2.2** **2.1** **1.6** 3.8 **3.0** **2.9**

credibility of the currency. In all of them, a **P** **4.2** **3.1** **3.0** 4.6' **4.6** **4.0**

determined anti-inflationary stance of monetary **FIN** **1.1** **1.0** **1.5** 5.3 **4.0** 4.0

**S** **2.7** **1.7** **2.5** 3.0 **5.2** 4.5

policy combined with more credible efforts to **UK** **2.6** **2.7** **2.5** 3.1 **3.6** 3.6
place the public finances on a sound footing **EUR** ' Private consumption deflator and nominal compensation **3.0** **2.6** **2.4** 3.5 **3.4** 3.2
has, at various times, led to a significant per employeo, respectively.

_Source:_ Commission's Spring 1996 Forecasts.

appreciation of their currencies from previous

lows. This is likely to further help the process

of disinflation and, in turn, should facilitate a gradual relaxation of the monetary policies

which have been restraining domestic demand in these countries.

**Price and wage** **trends** **[1 ]**

(Annual percentage change)

**Prices** **Nominal wages**
**per head**

**1995**

**1996**

**To***

**1996**

**1997**

**_,**

**1.7**

**3.9**

**2.6**

**1997**

**TT**

**3.6**

**2.4**

**9.6**

**3.6**

**2.5**

**5.0**

**4.8**

**3.8**

**B**

**DK**

**D**

**GR**

**E**

**F**

**1995**

**TT**

**"TT**

3.3

3.8

**2.4**

**1.6**

**2.0**

**1.6**

**3.0**

**1.5**

**2.5**

**2.5**

**2.4**

**1.8**

**2.0**

**9.3**

**4.6**

**1.6**

12.5

2.4

2.4

11.1

**3.8**

**2.3**

3.2

**4.0**

**5.4**

**3.5**

**1.9**

**3.0**

**4.6**

**4.0**

**5.2**

**3.6**

**3.4**

**2.5**

**2.9**

**4.0**

4.0

4.5

3.6

**IRL**

**1.8**

**1.6**

**8.3**

**3.6**

**1.8**

**2.3**

**4.1**

**1.7**

**1.9**

**2.1**

**3.1**

**7.0**

**3.2**

**1.6**

**2.4**

**3.5**

**2.1**

3.1

5.2

3.9

3.0

3.8

4.6'

5.3

3.0

3.1

3.5

**NL**

**A**

**P**

**FIN**

**S**

**UK**

**EUR**

**2.5**

**5.7**

**2.0**

**1.1**

**2.2**

**4.2**

**1.1**

**2.7**

**2.6**

**3.0**

**1.0**

**1.7**

**2.7**

**2.6**

' Private consumption deflator and nominal compensation
per employeo, respectively.

_Source:_ Commission's Spring 1996 Forecasts.

In the Community as a whole and in the majority of Member States the rise in nominal

compensation per employee is expected to remain compatible with the need to lock in low

inflation and promote job creation. On average, nominal wages are expected to increase by

about _VA_ per cent this year and slightly less next year, against the background of an
expected inflation rate of around _2_ _[]]_ _A_ per cent per year. Real wage costs arc likely to

continue expanding at a rate below productivity growth, thereby contributing to a further

rise in overall business profitability.

In some low-inflation countries, particularly in Germany, relatively subdued demand and

the competitiveness losses associated with currency appreciation have limited the extent to

which labour costs can be passed on to prices, implying a significant squeeze on profit

margins in the exposed sectors. Obviously, wage trends cannot adjust instantaneously to

movements in exchange rates and in cases of clear overshooting, a market-induced

correction of exchange rates is certainly the most desirable option. Still, in order to

safeguard the country's competitive position and its attractiveness for private sector

investment, it is essential to contain pay settlements whilst at the same time implementing

measures to enhance productivity and employment.

**-31** **-**

Conversely, in some depreciating countries, especially Italy, real wages are expected to

recover some of the ground lost over previous years. In these countries, there is a risk that

workers will seek to catch up too rapidly on previous years' losses in purchasing power

through higher pay claims thereby fuelling a price/wage spiral. Instead, continuing

adequate wage behaviour in combination with credible fiscal rectitude should engender an

appreciation of these currencies, thereby lessening (imported) inflationary pressures. Such

a policy mix was successfully implemented in Sweden last year. But in 1996, the rate of

nominal wage increases in Sweden is forecast to rise significantly despite the expected

deceleration in consumer prices. This wage behaviour risks being in conflict with the

stability objective and docs not appear to adequately reflect the need to maintain and create

jobs. Moreover, allied with the considerable appreciation of the Krona, it may threaten its

external competitive position.

Inflation (deflator of private consumption) is expected to stay below 3 per cent in 1996-97

in the countries which already satisfy this goal. And in the seven countries where inflation

did not exceed 2 percent last year (Belgium, Denmark, Germany, France, Luxembourg,

Netherlands and Finland) it is expected to remain below that value this year and next (with

the possible exceptions of Denmark and Luxembourg). The 1995 Broad Guidelines

contained a recommendation that countries with an inflation rate in the range of 2 to 3 per

cent should aim at progressing towards or below 2 per cent. In this regard, some progress

is expected to take place in 1996 (Ireland, Austria and Sweden) but, at least on current

forecast assumptions, less so in 1997 (due to a possible upward movement in Denmark,

Ireland, Luxembourg and Sweden).

Visible progress is expected to take place in the four countries where inflation currently

exceeds 3 percent. Assuming continued efforts, inflation in Spain and Portugal is likely to

approach the upper limit of the Guidelines objective (3 per cent) by 1997. Against the

background of a marked slowing in import price increases and no further indirect tax

increases, consumer price inflation in Italy is expected to decelerate to _VA_ per cent in 1997.

In Greece, with more determined efforts, especially on the budgetary front, it should be

possible to reduce inflation further than the 7 per cent currently anticipated for 1997.

_Budgetary_ _outlook for_ _1996-97_ — A large number of Member States have taken

significant steps to consolidate their public finances in 1996 and, in many cases, also in

1997. According to the Commission services' estimates of cyclically-adjusted fiscal

balances, present budget plans imply a reduction in the underlying fiscal deficit of the order

of % of a percentage point of Community GDP in 1996 and, on currently known policies, a

further _VA_ a percentage point in 1997. Nevertheless, in the latest forecasts of the

**32-**

Commission services, which take into account slower growth than previously foreseen, the

outlook is for a considerably smaller reduction in the general government net borrowing in

the Community in 1996 than had previously been envisaged. The average fiscal deficit is

expected to be reduced by _[ l]_ _A_ a percentage point to just below 4!/ 2 per cent of Community

GDP in 1996 (versus _VA_ per cent of GDP forecast in Autumn 1995).

The Economic Forecasts include a scenario for 1997 on the basis of measures which have

already been adopted or announced in sufficient detail. This does not include general

policy intentions for which specific measures are not yet known. The forecasts take into

account the economic policy packages announced in detail during April and early May by

the German, French, Austrian and Swedish governments. However, they do not

incorporate the planned adjustment measures recently announced by the Belgian

government for 1997 because the measures to be taken were not known in sufficient detail

at the time of the elaboration of the forecasts. In addition to those mentioned, a number of

other Member countries are expected to take measures to improve their budgetary position

between now and 1997. On the basis of currently known measures, and aided by

improving cyclical conditions and low interest rates, the scenario for 1997 points to a

reduction in the average actual budget deficit to _VA_ per cent of GDP next year.

Table 12

**Actual and cyclically-adjusted**

**general government budget balances**

(percent of GDP)

Table 13

    - General government gross debt

(percent of GDP)

**1997'**

130.6

687

62.4

111.4

68.0

57.8

77 3

122.8

6.8

_787_

739

718

632

796

562

74 3

Annua!

change

**Actual balance**

_**Level**_

**1995** **1996** **1997**

**Cycl.** **adj. balance**
_**Annual**_ _**change**_ _**[1 ]**_

**1995** **1996** **1997** **[1 ]**

1996

-1.5

-0.9

3.4

0.3

2.1

3.7

-4.2

-0.3

0.3

0.4

3.0

0.6

2.9

0 9

1.5

2/

1997 [1 ]

-1.6

-2.3

0.9

-0.4

0.2

1.7

-4.0

-1.7

0.9

-07

1.5

-0.4

0.7

-1.2

0 7

0.4

**Level**

**1996**

132.2

71.0

61.5

111.8

67.8

56.1

81.3

124.5

6.2

79.4

72.4

72.2

62.5

80.8

555

73.9

**1995**

133.7

71.9

58.1

111.5

65.7

52.4

85.5

124.8

5.9

79.0

69.4

71.6

59.6

799

54.0

71.2

**-3.7**

**-0.6**

**-2.9**

**-6.9**

**-3.7**

**-3.0**

**-1.6**

**-5.2**

0.3

**-2.9**

**-3.1**

**-3.7**

**-1.6**

**-3.1**

**-3.7**

**-3.4**

B

DK

D

GR

E

F

IRL

I

L

NL

A

P

FIN

S

UK

EUR

' Based on currently announced measures.

_Source:_ Commission's Spring 1996 Forecasts.

**0.5**

**1.6**

**-0.9**

**2.6**

**0.4**

0.5

**-2.0**

1.3

**-2.0**

**-0.2**

**-1.6**

0.2

**-1.2**

1.1

**0.6**

0.3

**1.8**

**1.0**

**0.3**

**1.0**

1.5

1.1

**0.3**

**0.8**

0.4

**0.2**

**2.2**

**0.9**

1.5

2.8

1.5

**0.9**

**-0.9**

**-0.2**

1.2

**0.8**

**0.7**

**0.9**

**0.6**

**0.8**

**-0.6**

0.4

2.0

0.5

0.7

1.5

0.3

0.8

**B**

**DK**

**D**

**GR**

E

**F**

**IRL**

**NL**

**A**

**P**

**FIN**

S

UK

EUR

**-4.5**

-1.4

-3.5

-9.2

6.2 [3 ]

-5.0

-2.4

-7.1

0.3

-3.4

-6.2

-5.4

-5.6

-8.1

-6.0

-5.0

**-3.2**

**-0.9**

**-3.9**

**-8.1**

**-4.8**

**-4.2**

**-2.0**

**-6.3**

0.7

**-3.5**

**-4.6**

**-4.4**

**-3.3**

5.2

**-4.4**

**-4.4**

' Based on currently announced measures.

_1_ A positive number denotes an improvement in the
cyclically-adjusted balance.

3 This time series includes social security contributions
still on a cash basis. Preliminary accounting on an
accruals basis by national sources shows figures of •
5.8% of GDP for 1995. The time series will be

updated on an accruals basis once certain issues
concerning the correct application of statistical
definitions have bet::i clarified.

_Source:_ Commission's Spring 1 996 Forecasts.

**33**

The expected degree of budgetary improvement is insufficient to halt (he rise in the average

gross debt-to-GDP ratio in the Community, which is projected to increase by almost 3

percentage points to 74 per cent of GDP this year before roughly stabilising at that level in

1997. In 1996, debt ratios are expected to rise in all Member Slates except four (Belgium,

Denmark, Ireland and Italy) but in 1997 debt ratios are expected to stabilise or fall in about

two thirds of the Member States.

All countries except Germany and the Netherlands are forecast to reduce their _actual_

deficits in 1996, but progress is generally expected to fall short of the targets set both in

national convergence programmes and in the 1995 Guidelines. Only 3 Member States

(Denmark, Ireland and Luxembourg) are expected to have actual deficits below the 3

percent reference value this year. Particularly large reductions in the budget deficit (close

to 1 percentage of GDP or more) are expected this year in Belgium, France, Greece, Spain,

Italy, Austria, Portugal, Finland, Sweden and the United Kingdom.

In the "unchanged policy" scenario for 1997, Germany, France, the Netherlands and

Finland would join the group of countries with deficits below the Maastricht reference

value and Austria and Sweden are expected to come very close to this value. In a number

of countries, where further measures have not yet been disclosed in sufficient detail the

additional effort required to reach the 3 per cent reference value would be of the order of _VA_

percent of GDP (Belgium, Spain, Portugal, and the UK). Only in Italy and in Greece is the

deficit expected to exceed the reference value by a wider margin in the current scenario

with the deficit forecast at _5_ _[l]_ _A_ and 7 percent of GDP, respectively.

***** *****

Faced with an unsatisfactory growth and employment performance, there is an urgent need

to relaunch the recovery process in the Community. The challenge facing policy-makers is

to generate a renewed strengthening of confidence and job creation over the short-run while

enhancing the conditions for stronger growth and employment over the medium term. This

requires both the provision of a supportive macroeconomic policy framework, entailing a

sound rebalancing of the macroeconomic policy mix, and intensified efforts in structural

policies to reduce unemployment and enhance the Community's competitiveness. The

Commission's 1996 Annual Economic Report gave a detailed analysis of the available

policy options in the current situation. Furthermore, the Commission has received opinions

_of_ the European Parliament and the Social and Economic Committee on this report and

**34**

discussed it with the Social Partners. Against this background, the Recommendation for

the 1996 Broad Economic Policy Guidelines sets out the policies which are necessary for

achieving the Community's objectives in terms of growth, employment and convergence.

**1**
### **3 )**

**ISSN 0254-1475**

## **COM(96) 211 final**

# **DOCUMENTS**

###### **EN 10** **Catalogue number : CB-CO-96-237-EN-C** **ISBN 92-78-04429-6**

**Office for Official Publications of the European** **Communities**

**L-2985** **Luxembourg**