CELEX: 51991PC0185
Language: en
Date: 1991-05-23
Title: PROPOSAL FOR A COUNCIL DECISION ADOPTING THE ANNUAL ECONOMIC REPORT 1990/91 ON THE ECONOMIC SITUATION IN THE COMMUNITY AND DETERMINING THE ECONOMIC POLICY ORIENTATION FOR THE COMMUNITY IN 1991

22. 7. 91                           Official Journal of the European Communities                        No C 190/19
          Proposal for a Council Decision adopting the annual economic report 1990/91 on the economic
          situation in the Community and determining the economic policy orientation for the Community in
                                                   1991 — Revision
                                                    (91/C 190/02)
                                                  COM(91) 185 final
                                  (Submitted by the Commission on 24 May 1991)
          THE COUNCIL OF THE EUROPEAN COMMUNITY,
          Having regard to the Treaty establishing the European Economic Community,
          Having regard to Council Decision 90/141 /EEC of 12 March 1990 on the attainment of progressive
          convergence of economic policies and performance during stage one of economic and monetary
          union, and in particular Article 4 thereof (*),
          Having regard to the proposal of the Commission,
          Having regard to the opinion of the European Parliament,
          Having regard to the opinion of the Economic and Social Committee,
          HAS ADOPTED THIS DECISION:
                                                        Article 1
          The Annual Economic Report 1990/91, annexed to the present Decision is adopted, and the
          economic policy orientations for the Community put forward in the report are adopted.
                                                        Article 2
          This Decision is addressed to the Member States.
          H OJ No L 78, 24. 3. 1990, p. 23.
                                                                   !
 ---pagebreak--- No C 190/20                              Official Journal of the European Communities                           22. 7. 91
                                  ANNUAL ECONOMIC REPORT 1990/91: REVISION
           Section I of the March version of the Annual Economic Report 1990/91 which discussed the
           short-term outlook will be replaced by the first two sections on the economic situation and
           outlook.
           Section II of the previous report, relating to economic policy tasks during Stage I of economic and
           monetary union, remains valid. Its main recommendations as well as eventual adjustments are
           developed in section HI of the present report.
                                                            CONTENTS
                                                                                                           Page
           Introduction                                                                                      21
             I. THE ECONOMIC SITUATION IN 1990 AND EARLY 1991                                                21
                A. Growth slowdown in the Community                                                         '21
                     1. The worsening of the international environment                                       22
                        1.1. The United States                                                               22
                        1.2. Central and Eastern Europe                                                      23
                        1.3. The fluctuations of the US dollar                                               23
                    2. A cyclical adjustment within the Community                                            24
                    3. The Gulf crisis and the fall in business and consumer confidence                      26
                B. Recession in the United Kingdom                                                           26
                C. German unification                                                                        27
                D. Inflation and employment                                                                  28
            II. THE OUTLOOK FOR 1991 AND 1992                                                                29
                A. The risk factors                                                                          29
                B. The policy concerns                                                                       30
                     1. Profitability, growth and employment                                  .>             30
                    2. Inflation                                                                             31
                    3. Budgetary convergence                                                                 32
                    4. Inadequacy of saving                                                                  33
           III. POLICY CONCLUSIONS                                                                           34
                A. Maintain stability and growth climate                                                     34
                B. The development of Community potential                                                    34
                     1. Complete the internal market                                                         35
                    2. Improve economic and social cohesion                                                  35
                    3. Structural adjustment                                                                 36
                    4. The environmental challenge                                                           37
                C. Policies for improved convergence                                                         37
                     1. Price and cost convergence                                                           37
                    2. Convergence of budgetary policies                                                     39
                    3. Convergence of external positions                                                     42
 ---pagebreak--- 22. 7. 91                                   Official Journal of the European Communities                                  No C 190/21
               THE EUROPEAN COMMUNITY IN THE 1990s: TOWARDS ECONOMIC AND MONETARY
                                                                  UNION
                        INTRODUCTION                                     These comprise the restoration of profitability during the
                                                                         1980s; some progress made in reducing unsustainably large
                                                                         budget deficits; the implementation during the past decade of
The economic outlook for the Community in the current year               structural reforms aimed at a better functioning of markets;
is much less favourable than it appeared in autumn last year.            the achievement of a more sustainable pattern of external
In the Community, output is expected to increase by less than            balances and, last but not least, the European integration
1,5% in 1991, half the rate recorded in 1990. As a result,               prospects.
growth in employment is likely to slow down significantly to
less than 0,25%. This small increase in employment will,
however, be more than offset by the expected increase in                 These factors have contributed to the relatively good
the labour force leading to a consequent rise in the                     performance during the 1983 to 1990 period. To further
unemployment rate to 8,7 % in 1991. Despite the slowdown                 improve the basis for sustained non-inflationary growth
in activity, inflation is expected to remain broadly stable at a         during the period ahead with the aim of entering the final
relatively high level (5%).                                              stage of EMU, policy makers must seek to consolidate and
                                                                         enhance the gains already made through a continued pursuit
                                                                         of the strategy that has been at the basis of the improved
The deterioration in the Community's economic                            performance during the 1980s.
performance expected in 1991 is only partly explained by
events in the Gulf region. The increase in oil prices in the
second half of 1990 and the erosion of business and                      With such policies, the recent economic slowdown in the
consumer confidence that followed are, without doubt, a                  Community is expected to be reversed during the course of
direct result of the Gulf crisis. Some Community countries               the year. In 1992 the overall situation is expected to improve
were, however, already experiencing difficulties well before             with output growth reaching 2,25 %. Due to lag effects,
August 1990. External demand was slowing down, with                      however, employment growth is expected to remain at the
negative effects on investment growth, and the necessary                 level of 1991 (0,2 %) entailing a further modest rise in the
correction of macroeconomic imbalances was dampening                     unemployment rate to 9,2 %.
internal demand in some countries.
                                                                         A climate of stability is an essential prerequisite for the
Despite the current slowdown of activity in the world                    development of the Community's potential. Monetary and
economy, prospects for a resumption of stronger growth are               fiscal policies have therefore to maintain a cautious stance.
 good. The Gulf crisis now seems to have had smaller and                 Fiscal policy ought to support to a larger extent monetary
probably more transitory effects on confidence, inflation and            policy. The standstill of budget consolidation is from this
growth than initially feared. And there are incipient signs              viewpoint a cause for concern. Particularly since stage one
 that the relatively pronounced cyclical downturn in some                 of economic and monetary union tightens convergence
 industrial countries, including the United States and the                requirements in the fields of prices and costs, budgetary and
 United Kingdom, is bottoming out.                                       external positions. A considerable adjustment has still to be
                                                                          carried out by some member countries. Hence speedy
                                                                          implementation of the policy recommendations is essential
 The fundamentally healthy underlying growth conditions                   to prepare succesfully the transition to full economic and
 in the Community should therefore reassert themselves.                   monetary union.
                                     I. THE ECONOMIC SITUATION IN 1990 AND EARLY 1991
                A. Growth slowdown in the Community
                Over the past year the world economy has had to adjust to a number of events: the dismantling of the
                centrally planned economies of Eastern Europe, German unification, growing uncertainties in the
                Soviet Union and finally the Gulf crisis. The Community has weathered this difficult international
                situation relatively well, not least because of the powerful stimuli emanating in the short-term from the
                German unification process and more durably from the progressive implementation of the Single
                Market Programme. Overall, however, a further slowdown of real GDP growth in the Community
                could not be prevented: real growth is likely to drop to only 1,5 % in 1991, about half the rate
                recorded in 1990, and about two percentage points less than 1989 (Table 1).
 ---pagebreak--- No C 190/22                               Official Journal of the European Communities                                  22. 7. 91
                                                              TABLE 1
                                              The EC economy at the turn of the decade
                                                                                            (annual percentage charges)
                                               1984—1987      1988       1989         1990    1991 {')      1 9 9 2 (>)
          Real GDP                                + 2,6        + 4,0     + 3,3       + 2,7     + 1,4          + 2,3
          Employment                              + 0,6        + 1,6     + 1,6       + 1,6     + 0,2          + 0,2
                      2
          Inflation ( )                           + 5,1        + 3,7     + 4,9       + 5,0     + 5,0          + 4,6
          Investment                              + 3,3        + 9,0     + 6,7       + 4,3     + 0,8          + 3,7
             of which equipment                   + 6,1      + 10,4      + 8,4       + 4,7     + 0,2          + 4,4
          Real unit labour costs                  -1,1         -1,1      -0,7        + 0,6     + 0,3          -0,7
          (') Forecast.
          (2) Private consumption deflator.
          A number of factors have contributed to this outcome, such as:
          — the deterioration of the international environment,
          — a cyclical adjustment within the Community,
          — the Gulf crisis and the concomitant fall in business and consumer confidence.
          1.       The worsening of the international environment
                   From early 1990 until the first quarter of 1991 the external environment has deteriorated
                   continuously; economic activity slowed down considerably in the United States, Canada and
                   Australia and the restructuring in Central and Eastern Europe brought about a contraction of
                   activity. Finally the Gulf crisis exacerbated weak trends in most countries and particularly in
                   the Middle East and Latin America. Real GDP growth outside the Community slowed down
                   from 3,2 % in 1989 to 1,7 % in 1990 and is likely to slow further in 1991 to less than 1 %. As a
                   result import demand by the world outside the Community only grew by some 4 % in 1990 and
                   is forecasted to grow by 2,75 % in 1991, less than half as much as before (7,4 % in
                   1989).
          1.1.     The United States
                   The long expected and largely cyclical slowdown in the United States started around mid-1989
                   and became more pronounced throughout 1990. Sharp declines were registered in consumer
                   expenditures, in residential construction and business investment. The unavoidable tightening
                   of monetary policy in 1989 in combination with rising private sector indebtedness, which was
                   followed in 1990 by credit restrictions resulting from tighter standards for financial
                   institutions, have put a brake on domestic demand.
                   Demand was further reduced by the oil price in the second half of 1990. As a result real GDP
                   growth dropped from 4,6 % in 1988 to 1,0 in 1990 and will again be very weak in 1991, even if
                   a recovery gets underway later in the year (Table 2).
 ---pagebreak--- 22. 7. 91                                 Official Journal of the European Communities                                  No C 190/23
                                                                   TABLE 2
                                                    United States, main economic indicators
                                                                                            (in percent or percent of GNP)
                                                       1984—1988        1989         1990      1991 (')       1992 (>)
               Real GNP                                   + 4,4         + 2,8        + 1,0       + 0,1         + 1,6
               Domestic demand                            + 4,6         + 2,2        + 0,5      -0,5           + 1,4
               Investment                                 + 6,5         + 2,7        -0,1       -3,1           + 5,7
               Consumer prices                            + 3,5         + 4,5        + 5,0      + 4,5          + 4,9
                                 2
               Fiscal balance ( )                         -3,9          -2,0         -2,4       -1,8           -2,4
               Current account                            -2,9          -1,9         -1,8        -0,3          -0,9
               (') Forecast.
               (2) General government.
          1.2. Central and Eastern E u r o p e
               To integrate their countries in the world economy, the new democratically elected governments
               in Central and Eastern Europe have initiated comprehensive reform programs. The boldness
               and frontloaded nature of these reforms make the beginning of the reform process a critical
               phase. While curcial market oriented policies are being implemented progressively, the
               behaviour of economic agents is adapting only gradually to the new environment and
               production is severely constrained as much of the obsolescence of the capital stock was brought
               out under exposure to world market prices. In these circumstances it is inevitable that output
               would decline at the initial stage.
               Moreover, the necessary restructuring has to take place in a rather unfavourable environment:
               most countries face large domestic and external imbalances accumulated over years, while at
               the same time the system of mutual trade in the framework of the Council of Mutual Economic
               Assistance has collapsed, entailing a serious terms of trade loss for the Central and Eastern
               European countries. These difficulties were compounded by the oil price rise and the slowdown
               of demand in the Western world.
          1.3. T h e f l u c t u a t i o n s of t h e US d o l l a r
               Besides the loss in demand following the recession in the US-Community exports to the rest of
               the world suffered in 1990 from a loss of competitiveness resulting from the appreciation of the
               European currencies vis-d-vis the dollar. At the end of February 1991, the dollar value of the
               ECU was about 2 0 % higher than the average for 1989. Since then, the dollar has recovered
               most of this loss. The yen fluctuated over the same period even more sharply, its value in ECU
               being in August 1990 more than 28 % lower than in 1989 on average. The value of the yen
               recovered subsequently more than 10 percentage points of this loss. The loss in competitiveness
               was one of the factors behind the slowing in exports and consequently in investment growth in
               the Communtiy since 1989. This illustrates that despite its internal growth, the Community
               could not avoid a sizable loss of competitiveness to translate into a decline in export growth
               which affected in turn investment.
               Community export growth (EUR-10 without Germany and United Kingdom) declined as a
                result from 7,3 % in 1989 to 5,4 % in 1990 with a further slowing to 4,2 % likely in 1991. The
                slowdown was particularly marked in the case of Italy, France, Belgium and Luxembourg.
                Exports to markets outside the Community slowed down even more sharply and were only
               partially compensated by increased exports to Germany.
                Despite these large exchange rate fluctuations and the liberalisation of capital movements, the
                EMS has not experienced major tensions, although positions of the different currencies within
               the ERM changed over time and interest rate differentials were gradually reduced.
 ---pagebreak--- No C 190/24                      Official Journal of the European Communities                                 22. 7. 91
            A cyclical adjustment within the Community
            To some extent the slowdown of demand was also a cyclical phenomenon after the strong
            recovery in the second half of the 1980s. Investment in particular expanded markedly during
            the period 1987 to 1990, by a yearly average of more than 7%. Hence some downward
            adjustment was inevitable when external demand weakened, spare capacity increased (Graph
            1) and monetary policy was tightened.
                                                            Graph 1
                                         Capacity utilization in manufacturing (in %)
            Even if the cyclical downswing in the Communtiy has not fundamentally affected its growth
            potential, the oudook for profitability of investment has nonetheless deteriorated since 1990:
            the continuous decline in real unit labour costs going on since 1981 (the best proxy for company
            profitability) has come to an end. Profitability has no longer been recovering since 1989. The
            deterioration has been particularly marked in the United Kingdom from 1989 to 1991, and is
            likely in Germany in 1991. But also in Italy, Ireland, the Netherlands, Belgium and
            Luxembourg the profit improvement of the previous years has been halted or reversed. The
            increase is mainly due to high nominal increases in compensation per head, above 7% per
            annum in 1990 and 1991 in the Community on average (Table 3).
                                                            TABLE 3
                                   Nominal wages, real wages and real unit labour costs
                                                                                                   (% change)
                                             1986—1988          1989          1990      1991 (»)   1992 (»)
                                                             Nominal co mpensation per employee
            EUR-10 (2)                           + 6,2          + 6,6        + 7,7       + 6,9      + 6,3
            Germany                              + 3,3          + 2,8        + 4,1       + 6,4      + 5,5
            United Kingdom                       + 7,9          + 8,9        + 10,9      + 8,5      + 6,8
            EUR-12                               + 6,0          + 6,2        + 7,6       + 7,1      + 6,2
 ---pagebreak--- 22. 7. 91                      Official Journal of the European Communities                                   No C 190/25
                                               1986—1988         1989            1990       1991 (>) 1992 (>)
                                                                Real compensation per employee
                     2
          EUR-10 ( )                              + 1,9         + 1,2          + 2,4         + 1,6    + 1,5
          Germany                                 + 2,5         -0,2           + 1,5         + 2,8    + 1,2
          United Kingdom                          + 3,2         + 2,8          + 3,4         + 1,9    + 1,6
          EUR-12                                  + 2,2         + 1,2          + 2,4         + 1,9    + 1,5
                                                                      Real unit labour costs
          EUR-10 (2)                              -1,2          -1,3           + 0,5         -0,2     -0,5
          Germany                                 -0,7          -1,6           -   1,2       + 1,0    + 0,1
          United Kindom                           +0            + 2,6          + 3,0         + 1,3    -2,3
          EUR-12                                  -0,9          -0,7           + 0,6         + 0,3    -0,7
          (') Forecast.
          (2) EUR-10 = EUR-12 minus Germany and United Kingdom.
          Policies over recent years have, to some extent, contributed to this development. The liquidity
          ratio (M2/3 over nominal GDP) for the Community, although also influenced by financial
          innovation and other structural adjustments on money and capital markets, increased
          relatively sharply in 1987 and again in 1989 (Graph 2). It is therefore at least questionable
          whether despite rising short term interest rates, monetary policy was sufficiently consistent
          with potential growth over the period till 1989, as excess liquidity was allowed to build up,
          thereby underpinning the basis for large wage claims. In 1990 there was a much smaller
          increase in the liquidity ratio, reflecting the tightening of monetary policy in an attempt to
          prevent the oil price rise from feeding into a wage-price spiral.
                                                             Graph 2
                                    Growth money supply (M2/3) and GDP — Eur-12
                                                                           (annual % change)
                                         1    1    1    1    1  1   T    1    1     1  1 —
                                       1M1       IMS       «M      1M7       MM       W»1
                                   * Forecast
                                 ** Deflated by GDP price deflator
                               \ \ \ Change in liquidity ratio
 ---pagebreak--- No C 190/26                            Official Journal of the European Communities                                   22. 7. 91
          3.      The Gulf crisis and the fall in confidence
                  In addition to the abovementioned factors, the sharp, but short-lived rise in oil prices resulting
                  from the Gulf crisis led to a deterioration in the terms of trade in the Community and a decline
                  in real disposable income that affected consumption and investment. In the event that oil prices
                  had remained high, this would have affected member states quite differently. Indeed, while
                  overall energy intensity of production has been reduced sizably since 1973 in nine Community
                  countries, it has increased in Spain and particularly Greece and Portugal owing to the transition
                  in those countries to a production structure with a greater industrial content.
                  The subsequent drop in oil prices to pre-conflict levels reversed most of the unfavourable direct
                  income and price effects of the higher oil price. The oil price in mid April 1991 was at about
                  $ 19 per barrel (spot market price for Brent oil) compared to around $ 32 per barrel, in the
                  fourth quarter of 1990.
                  However, the Gulf crisis led to a sharp rise in uncertainty in the second half of 1990 and the
                  early part of 1991. Confidence was severely eroded among consumers, in industry and in
                  construction (see Graph 3)„with adverse repercussions on consumption and investment plans.
                  While the main factor responsible for the sharp business deterioration, the Gulf conflict, has
                  disappeared, there are few signs yet of a reestablishment of a more favourable sentiment:
                  according to the first business survey after the end of the conflict, only consumers and the
                  construction sector seemed to have regained some confidence; in industry on the contrary the
                  deterioration in sentiment has stopped, but there is as yet no clear sign of a revival. A return of
                  confidence in industry is, however, crucial for a recovery of investment.
                                                                              Graph 3
                                             Confidence indicators — Eur-12 (business surveys)
                                                                              Eur-12
                                                                                            i construction
                                        8-                               \/"Y
                                                                                                '•'A
                                                       r';\            •  ;
                                                                            ' \      / "
                                                                                            y        1A V industry
                                                 l/
                                       10-                                                            li V.
                                                                                consumers
                                                                                                        u/w
                                       16-
                                                                                                             *'' 7
                                       20
                                       M-    r J i t i i i i i t i i i   TT l l ' I I M  II   i i ii ii i i i r r r r
                                          jan apr Jul oct jan apr Jul oct jan apr jul oct jan apr
                                                  1988                     1960                 1990            1991
           B. Recession in the United Kingdom
          At its peak in 1988 the rate of expansion of domestic demand in the United Kingdom reached about
           8 %, far in excess of the growth in capacity. Induced by this strong expansion, inflationary pressures,
           accommodated initially by a lax monetary policy, became apparent on the price and wage front and in
 ---pagebreak--- 22. 7. 91                              Official Journal of the European Communities                               No C 190/27
          the external account. Monetary policy then changed towards an increasingly restrictive stance with a
          progressive increase of short-term interest rates through the latter part of 1988 and 1989. However,
          the monetary squeeze implemented was slow to produce the intended results. Inflation has been
          persistent, influencing in turn wage settlements. The highly restrictive monetary policy resulted in a
          steep drop in activity from the second half of 1990 on. GDP growth slowed to 0,6 % in 1990 and a
          sharp decline in output of some 2 % is expected in 1991, mainly as a result of a sharp fall of investment
          ( - 10,75% in 1991) and a decline in private consumption (-1,75% in 1991). Despite this
          slowdown in activity, nominal wage trends have remained strong, rising by 10,5 % in 1990 and likely
          to slow only to 8,5% in 1991. In 1992, output is expected to pick up again.
          The current account deficit reached a peak in 1989 at 4,8% of GDP and improved markedly to a
          deficit of 2,3 % in 1990 and a forecast of about 1 % in 1991 as imports weaken in line with falling
          domestic demand.
          C. German unification
          In contrast to the rest of the Community, economic activity accelerated further in Germany as a result
          of the tax reform, unification and the ensuing expansionary impulse of fiscal policy. Real GDP growth
          accelerated from 3,3 % in 1989 to 4,7% in 1990 (for data on Germany, see box). Particulary private
          consumption, was stimulated while also investment witnessed a strong expansion.
                                         STATISTICAL PROBLEMS FOR GERMANY
              All the data on Germany in this year's Annual Economic Report relate to West Germany. Due
              to major statistical problems it is not yet possible to present reliable data for the whole of
              Germany. Of course, the data on the budget deficit reflect the transfers from West to East
              Germany, while also the current account data incorporate these transfers.
          The high level of activity led to a strong increase in employment in 1990 and 1991 and a resulting
          sharp drop in the unemployment rate from 6,1 % in 1988 to 4,5 % in 1991 (harmonized definition of
          the Statistical Office of the Community). The tightening of the labour market has, however, also
          resulted in increased wage demands that put an end to the continuous decline in real unit labour costs.
          The expansion of domestic demand and deliveries to the Eastern part of Germany could not be met by
          domestic supply, resulting in sharply increased imports.
          The abrupt integration of the centrally planned East German economy into a market system as a result
          of unification, implied a fast and steep adjustment of the East German economy entailing a substantial
          cost to bridge the transition period. The cost of unification would swell the fiscal deficit from a small
          surplus in 1989 to a deficit of around 2,2% of GDP in 1990 and around 4,7% in 1991 despite sizable
          increases in taxes.
          The massive transfers to East Germany also resulted in a swing in the current account from a large
          surplus in 1989 into presumably a small deficit in 1991.
                                                                                                        t
          The developments in the West contrast sharply with those in East Germany which undergoes a
          dramatic adjustment process: a fall of 50% in industrial production and underemployment
          amounting to some 35 % of the labour force (including short-time workers) is expected by the end of
          1991. Output is generally acknowledged to be falling by two-digit figures both in 1990 and 1991 as
          new investment and the creation of working places is not yet sufficient to offset the loss of output and
          employment in the old industries. A slight recovery is expected in 1992 with the help of growth in
          investment as well in equipment as in construction.
 ---pagebreak--- No C 190/28                              Official Journal of the European Communities                                 22. 7. 91
          D. Inflation and employment
          Inflation has been relatively well contained since the start of the Gulf crisis. Although higher oil prices
          did push up rates of consumer price increases between August and October 1990, there are few signs
          that they have become embedded in the ongoing wage and inflation process. So far monetary policy
          seems to have succeeded in preventing the creation of a wage-price spiral. Indeed consumer price
          inflation is even subsiding: the average rate of consumer price inflation in the Community, which
          peaked in October 1990 at 6,3% was down to 5,3% in March 1991.
          Still at 5 % for the year 1991, the excepted average rate of inflation in the Community is worryingly
          high for a period of slowing growth. With lower oil prices such a level could indicate underlying cost
          push pressures (Graph 4). Also worrying from the point of view of EMU is that between 1988 and
           1990 price developments diverged within the Community (Graph 5).
                                                                 Graph 4
                                       Prices, costs and money supply growth (Eur-12, in %)
                                                           M2/3 per unit of output
                                             nominal unit labour costs
                                         0-|    ,   ,  ,    ,     ,  ,    ,   ,    ,  1   |
                                              1M1     «M        1«M     1M7      1tM     1M1
                                          Forecasts
                                                                 Graph 5
                              Inflation convergence (consumption price deflator) (annual % change)
                                    26
                                      * Forecast
                                             H i Eur-7        •     Eur-3       H i Eur-2
                                     Eur-7:B,Dk,D,F,Irl,L,Nl.       Eur-3: Sp.I.UK.   Eur-2: Gr,P.
 ---pagebreak--- 22. 7. 91                              Official Journal of the European Communities                               No C 190/29
          Employment growth has lagged the slowdown in activity resulting in a cyclical slowing of productivity
          (see Graph 6). Employment continued to grow in 1990 at the same rate as in 1989 (1,6%). The
          growth was particularly strong in Germany, reflecting partly an increased availability of skilled labour
          from East Germany and Eastern Europe. But also in the other Community countries, with the
          exception of Greece, the United Kingdom and Denmark, employment growth was robust. In 1991,
          employment growth in the Community is excepted to slow down to 0,2%. This small increase in
          employment will however be largely offset by the expected increase in the labour force. The continued
          fall in the unemployment rate since 1986 is expected to be reverse and increase from 8,2 % in 1990 to
          8,7% in 1991.
                                                             Graph 6
                                                      The productivity cycle
                                    4
                                    3
                                    2
                                    1
                                    0
                                      1980                  1086                1890   1992
                                      R^N Difference between GDP and employment growth
                                          II. THE OUTLOOK FOR 1991 AND 1992
           At the end of thefirstquarter of 1991 the main factors that underlie the present downswing have either
           disappeared or turned around: the Gulf crisis has been resolved, oil prices have returned to their
           pre-conflict levels, economic activity in the United States in excepted to recover in the second half of
           the year, the dollar has reversed its downward trend and confidence is gradually being restored.
           The fundamentally healthy underlying growth conditions in the Community should therefore reassert
           themselves. The decline in real growth is expected to bottom out during the course of the year so that
           activity would gradually recover in the second half of the year: real GDP growth would increase from
           1,25 % in 1991 to 2,25 % in 1992 mainly under the influence of a pick-up in consumer demand and
           investment.
           A.   The risk factors
           These relatively favourable expectations hinge crucially on a recovery of the consumer and business
           climate. Any delay in recouping the erosion of confidence could weaken the economic performance of
           the Community. With consumer optimism restored and real incomes basically unaffected and even
           slightly increasing, consumer demand should gradually pick up.
 ---pagebreak--- No C 190/30                           Official Journal of the European Communities                                    22. 7. 91
          The recovery of investment in 1992 partly relies on the assumption that the deterioration in the wage
          situation was only temporary and that per capita real wage increases will come down again from
          2,25% on average between 1986 to 1991 to 1,5% in 1992. If such a development were not to
          materialize, profitability would not improve for the third consecutive year for the Community as a
          whole, which would depress expectations for investment. A further weakening of economic activity in
          combination with a continued fall in profits might further deteriorate the situation.
          Another risk factor is the instability of the US dollar. The dollar's behaviour has been very volatile over
          recent years. Although a further decline now seems less likely, it can still not be excluded if the
          expected US recovery does not establish itself in 1991. But also a strong upward shift in the value of the
          dollar would not be without adverse consequences for the Community: although this would improve
          competitiveness, it would also considerably strengthen inflationary impulses through higher import
          prices from outside the Community.
          B. The policy concerns
          The still ongoing cooling-off does not require any significant change of policies. Against the
          background of continuing positive growth fundamentals, forces are gradually taking shape that
          should lead to an early recovery of activity: the increase in household income, the downward tendency
          of long term interest rates, lean inventories during the course of 1991 are all factors pointing to an
          imminent reacceleration of growth. There are a few areas though where developments are less
          satisfactory and further progress would be warranted.
           1.     Profitability, growth and employment
                 The improvement in growth fundamentals during the 1980s was not brought about
                  spontaneously but was a result of a consistent set of policies aiming at revigourating the
                 European growth performance aided by a relatively favourable international environment.
                 Besides sustained demand expectations, wage developments will play a critical role to bring
                  about the economic recovery. Continued wage moderation is an important condition to
                 strengthen employment-creating investment and is needed to make new inroads in the still high
                  unemployment rate.
                 The relatively unfavourable recent wage developments have not yet seriously affected the
                 medium-term outlook for profits in the Community. Profitability had improved considerably
                 during the 1980s and the recent deterioration has not changed that picture fundamentally. The
                  net return on the capital stock had, however, not yet recovered its average level of the period
                  1961 to 1973, because more capital is now employed per unit of output (see Graph 7). A
                 •further increase in the investment ratio would be welcome in view of the still high level of
                  unemployment. This would require the re-establishment of unambiguous expectations on a
                  further improvement of the level of profitability.
 ---pagebreak--- 22. 7. 91                         Official Journal of the European Communities                              No C 190/31
                                                               Graph 7
                                  Profitability indicators, Eur-12, indexes 1961—1973 = 100
                                 120
                                 110-
                                                                       nat operating surplus
                                                                       per unit of GDP
                                 100
                                                            net return on net capital stock
                                  60 I i i i i i i i i i i i i i i i r i i i i i i i i i i i i i i
                                     1M1      tttft  ItTO      1«T«      1M0       « M        WM'
                                    Forecast
             Wage moderation is an essential prerequisite to stimulate employment-creating investment.
             Increases in real wages must remain below increases in total factor productivity so as to avoid
             switches to more capital intensive forms of production and further improve the employment
             content of growth. Indeed, the unemployment rate, at 8,2 % in 1990, remains unacceptably
             high and will increase again in 1991 and 1992. It needs to be further lowered. The
             intensification of wage pressures in the presence of such high levels of unemployment seem to
             suggest rigidities in the functioning of the labour market.
             While the outlook for 1991 is not yet a matter of concern, the large wage increases granted in
             Germany constitute a potential threat. They risk undermining price stability in the country that
             had the best price performance of EMS countries in the past and whose currency therefore
             served as an anchor. Moreover, if these increases were to spread to neighbouring countries the
             situation could become really disturbing and create a cost push inflation. The situation is the
             more worrying as there could be a tendency for such higher increases in wages to be more
             readily accepted in these countries since they would not erode external competitiveness. They
             could erode, however, profitability and could thereby undermine the growth, investment and
             employment potential of the economy.
             The wage situation in the United Kingdom, is also still not satisfactory although some
             improvement is expected in 1991 and 1992. Membership of the ERM is providing the
             framework for a more rational setting of wages.
             Also in Portugal, Greece, Italy and Spain expected wage developments, while not threatening
             profitability, are nonetheless not yet conducive to a better nominal convergence. In the other
             Community countries, there seems to be less reason for concern in as far as the assumed wage
             behaviour will be validated.
          2. Inflation
             Moderate wage developments are not only important to improve the employment situation,
             but also for better nominal convergence within the Community. Together with wage
             developments, the inflation performance has to be carefully monitored. While an improved
 ---pagebreak--- No C 190/32                       Official Journal of the European Communities                                    22. 7. 91
             convergence of consumer price levels is expected, regrettably this is at a higher level of inflation
             mainly as a result of the deterioration in the price performance in Germany. From the point of
             view of the required nominal convergence in EMU, the situation is not satisfactory.
          3. Budgetary convergence
             Not only in the field of prices is there a lack of improved convergence, also in the budgetary
             area, there has been no further progress since 1989. The process of budgetary consolidation
             that began in most countries around 1983 has come to a standstill. In fact much of the
             improvement registered over the last years seems to be mainly due to the favourable cyclical
             situation and may even imply a structural deterioration of budget balances (see Graph 8). For
             the Community as a whole, net borrowing is estimated to increase from 3 % of GDP in 1989 to
             4 % in 1990 and 4,5 % in 1991. Hence there is a clear need to strengthen the budgetary
             consolidation efforts in most countries.
                                                           Graph 8
                              Structural and cyclical changes in budget balances (in % of GDP)
                                     b d k d g r e f i r l i l n l p u k
                                    b d k d g r e f i r l i l n l p u k
                                        1990                    l^-l cyclical balance
                                                                J d total balance
                                                                     structural balance
                                   b d k d g r e f i r l i l n l p u k
 ---pagebreak--- 22. 7. 91                     Official Journal of the European Communities                               ^oCB^n^
          decent budgetary trendsmthe community are not only dis^uieung in light of the desired
          convergencetowardseconomicandmonetaryunion,butalsomacontextofgrowingscarc^
          of capitalmmeworldeconomy,which has been exacerbated through theopemngofEastern
          European countries. Over and abovethat,themajormdustrial countries have increased the
          drawing on net savings from the rest of the world in recent years, mainly asaresult of the
          reducuonoftheexcesssavingsupplyfrom]apanandparticularlyGermany^Graph^^.Private
          saving remained fairly stable during the r ^ ^ s , m e d e c l i n e i n household savingbeing
          compensated by an mcrease in corporate savmg.Ta^esmglemostimportantfactorbehmd the
          declme in mdustrial country savings is the excessive government budget deficits in the major
          countries.Afailure to redress their situation would not only reduce the domestic growth
          potential of these countries,but also jeopardize efforts to reverse the unsustainable and
          undesirablenetresourcetlowfromdevelopingto industrial countriesthathaspersisted during
          thei^Os
                                                                Graph 9
                         Saving and investment in the major industrial countries (in % of GDP)
                                                        EC — USA — Japan
                                M
                                M
                                t*
                                ftt
                                to
                                     1
                                        • • • • • • ' ' • • • '  I I I I I I I 1—1 • I I • • L
                                  •M         UN        Wl         Wit      1MB       WW        MM
                                                                   EC
                                 M     —-      - - - - - - - -
                                       national saving
                                 M
                                 •4
                                 It
                                 to
                                      • •            i i i i i • i • • • i
                                             mm         m         wn        ma        im       m»
          A global shortfall of savings could translate in a continued and significant tightening of global
          capital markets, with very high long-term interest rates. In this context it should not be
          forgotten that the reduction in investment demand in 1990 and 1991 has allowed the public
          sector to absorb a langer share of savings so far without undue further pressure on real interest
          rates. In these conditions real long-term interest rates may remain high, and could even rise
          again if investment demand were to recover strongly.
 ---pagebreak--- No C 190/34                            Official Journal of the European Communities                                  22. 7. 91
                                                 III. POLICY CONCLUSIONS
          To sustain economic growth and employment, the Community will have to rely more on its own
          potential. A climate of stability is an essential prerequisite for its development. Therefore the
          Community will have to maintain prudent and balanced monetary and fiscal policies. These policies
          will at the same time help to preserve the favourable growth fundamentals. The completion of the
          internal market, the continued implementation of structural policies and further improvements in
          economic and social cohesion and in the environment will in turn strengthen the Community's
          potential.
          The deterioration in short-term growth prospects in the Community does not alter the fundamental
          positive assessment of the underlying potential of the Community economy. Provided appropriate
          policies are followed, confidence should pick up again and investment activity could resume its strong
          growth leading to renewed significant job creation.
          To meet the challenges it is all the more important that policy coordination is strengthened in
           accordance with the decision on multilateral surveillance for Stage One. Multilateral surveillance is
          covering a wide range of macroeconomic and structural policies to ensure convergence of economic
          policies and performances in the Member States with the aim of maintaining or improving the
          conditions for a sustainable, employment creating growth.
          A. Maintain stability and growth climate
          Monetary policy will have to remain vigilant to quell inflationary pressures. The divergent cyclical
          positions of the member countries and the steadying of exchange rate expectations have provided
           some scope for reducing interest rate differentials without undermining the exchange rate
           commitment. In the absence of a common monetary policy during the transition to the final stage of
           economic and monetary union, however, monetary policy will have to be gearded as well to the
           domestic price situation as to exchange rate considerations. Unless inflationary pressures subside
           clearly and in the absence of greater support from fiscal policy ther is no room for a relaxation of
           monetary policy in the Community.
           Fiscal policy needs further tightening not only with a view to better convergence in Stage One of
           economic and monetary union, but also as a contribution to increasing global savings and relieving the
           pressure on monetary policy. With budgetary revenues less forthcoming and outlays on
           unemployment increasing, some deterioration of budget balance seems inevitable in 1991 as a result of
           automatic stabilizers. To further the process of consolidation, however, it would seem appropriate
           that the cyclical deterioration of the budget position would only partly be reflected in the total budget
           balance so that structural improvement would be resumed. The rules aimed at limiting public sector
           deficits and indebtedness, which the Community is in the process of defining in the framework of the
           Intergovernmental Conference, could be an important contribution for sound medium-term budget
           balances. As a matter of fact already now, during the transition period, these rules should serve as an
           informal guideline to assess budget balances to ensure that sufficient progress would be achieved in
           Stage One.
           Rising wage pressure in a context of a still high level of unemployment points to the need for more
           fundamental structural reform in labour markets to strengthen employment creating investment.
           There seems to be a good case for encouraging a more active labour market policy with greater
           emphasis on retraining than on provision of unemployment support. Further obstacles to employment
           creation should be removed and wage setting procedures should allow a fuller reflection of differences
           in productivity so as to improve adjustment of demand and supply of labour.
           B. The development of Community potential
           The general policies which must be implemented to curb the re-emergence of inflationary pressures
           and inflation divergences are also those needed to create the conditions for the realization of the great
           Community projects: economic and monetary union, completion of the internal market, economic
           and social cohesion. At the same time, these projects complement the policies being implemented at
           the national level.
 ---pagebreak--- ^ Be^l                               Official journal of the European Communities                             ^ocr^og^
       t.   C o ^ ^ ^ ^ ^ ^ ^ ^ ^ ^ r ^
          Tosecure its economic future,Europe has embarked onaprogramme for creatmgamarket of
          continental dimensions. One of the main constraints the Community still faces on the
          competitive world stage is the fragmented nature of its markets, which makes it difficult to
          produce at optimum levels,holds back technological progress and impedes development ofthe
          services sector, where growth is particularly strong. The opening of the Community frontiers
          will enhance competition. Increased specialisation and efficiency of production will greatly
          improve consumer choice
          The internal market programme is the decisive driving force in adding to Community growth
          prospects and prosperity. Economic operators are increasingly anticipating the highly
          competitive environment which will prevail and the new operating conditions and
          opportunities which will e^ist by 1 ^ ^ . An increasing number of firms ha^e begun to operate
          on greatly enlarged market horizons and are actively changing their strategies. In addition to
          the positive growth effects stemming from the abolition of internal border controls, and the
          removal of techmcalbarrierstothefreemo^ementof goods andser^ices, particularly as
          regards the latter in the financial services sector, growth will also be attributable to the positive
          effects arising ftomthe necessary testructunng in mdustnaland^er^ices sectors and from
          positive changes in marketing strategies.
          In the single market,an effecti^eCommunity competition policy isessential since measures and
          practices aimed at reducing or avoiding competition n u c h a s increased subsidies or market
          sharing agreements^ would reduce these positive effects. Tocrowntheachie^ementof the
          internal marketwithasmgle currency in the near future would — as recent business surveys
          show — further bolster the positive mood of management.
          The high expectations that ha^e been created mustnotbedisappomted.Therefore the deadline
          o f l ] a n u a r y l ^ ^ for completing the internal market must be respected.Idence,it is essential
          thatthe remaining decisions inrespectoftheproposalscontainedinthel^^^hitel^apermust
          be taken as soon as possible, significant progress has already been achieved and decisions ha^e
          been taken in all areasof economicactnaty. TheCommission has already tabledall the
          proposals contained in the whitepaper, ando^er twoDthirds ha^e been approved by the
          Council. The Commission is turning its attention to the problems of implementation ^some
          ^ ^ o f t h e so farre^uirednationalimplementingmeasuresha^e been taken^and to the proper
          functioning of the single market. Uecisionsha^e still to be taken in important fields relating to
          the complete removal ofinternal border controls.TheCouncil must gi^e priority to these areas
          ^which include the approximation of indirect taxation rates^ and monitor the situation o n a
          regular basis to ensure that decisionsaretaken such thatprogresstowardsremo^mg completely
          the internal borders becomes irreversible,as is the case for the rest ofthe programme.member
          states ought to accelerate the rateofimplementation of decisions aud to eliminate all delays by
          theendoft^t
          The impro^ementofeconomic and socialcohesionwill also strengthengrowthprospects.
          Abo^ea^eragegrowth in the less favoured countries would contnbutetoe^pandingthe growth
          potential of the Community economy as whole.
          The strengthening of economic and social cohesion and the ob^ecti^e of a harmonious
          development across European regions ha^e been reaffirmed in Article 1^0 of the single Act.
          Abo^ea^erage growth in those countries and regions,as has been the case in recent years in
          ^pain,Portugal and Ireland,but notmC^reece,has started to reduce the income gap ^Table^
          and has expanded the growth potential in the Community asawhole.The gap remains sizable
          though,and will re^uirealong^term effort of catching^up.
 ---pagebreak--- No C 190/36                          Official Journal of the European Communities                                                 22. 7. 91
                                                                   TABLE 4
              The catching-up process in the Comunity. GDP (*) at current market prices and purchasing parities per
                                                   head of population (Eur-12 = 100)
                                            Greece                   Spain                   Ireland              Portugal
              1986                           55,9                     72,8                    63,4                  52,5
              1987                           54,1                     74,7                    64,4                  53,7
              1988                           54,2                     75,7                    64,7                  53,7
              1989                           54,0                     76,9                                          54,9
                                                                                          \67^,
              1990                           52,9                     77,8                    68,6                  55,6
              1991                           52,6                     79,2                    68,7                  57,1
              1991—1986                     -3,3                     + 6,4                   + 5,3                 + 4,6
              (l) Reference to GDP may overstate progress to the extent that income transfers to abroad may have outpaced nominal
                  GDP growth.
              The economically stronger countries could contribute to this process by the maintenance of a
              dynamic growth pattern and the opening of markets to trade. The doubling of the Structural
              Funds and the simultaneous strengthening of the financial instruments will make available to
              Greece, Portugal and Ireland resources equivalent to between 3 and 5 % of GDP in 1993. They
              support the considerable improvement in structural policies achieved so far. Economic and
              social policies on the national and Community level have to provide the basis for a continuous
              relative growth of real GDP, without inflationary pressure and unsustainable internal and
              external imbalances. The catching-up countries will, however, remain primarily resonspible
              for their own development through the pursuit of appropriate policies.
           3. Structural adjustment
              Structural policies improve the capacity of Member States' economies to adjust. They enhance
              flexibility in goods and factor markets and should lead to an improvement in the extent and
              speed of response of prices in those markets to changes in market conditions. Structural policies
              thereby reduce the potential size and duration of adjustment costs associated with
              disturbances.
              Beyond the internal market programme, Member States have engaged in a number of structural
              improvements to be able to cope with increased competition on the unified market. So far the
              major initiatives fell within the liberalization of financial markets and the restructuring of
              personal and corporate taxation.
              Governments and the Community have taken initiatives to improve the capacity of labour
              markets to cope with change and policies for education and vocational training are being given
              high priority in many Member States. They are an important instrument for the absorption of
              the long-term unemployed. Structural policy initiatives for labour market flexibility will need
              further emphasis.
              Also in the public sector, structural reform has to be carried further so as to improve the
              efficiency of the public sector and to ensure transparent and fair competition between private
              and public enterprises.
              Higher economic efficiency and improved resource allocation should not only be sought within
              the Community, but also in the world. The Uruguay Round is a cooperative effort to promote
              trade and economic growth. As the world's largest trading block, the Community has a natural
              interest in a successful conclusion of the Round. It is at the same time an instrument to provide a
              better platform for its weaker trading partners, in particular the Central and Eastern European
              and the developing countries.
 ---pagebreak--- 22. 7. 91                              Official Journal of the European Communities                              No C 190/37
                 The environmental challenge
                 Just as the previous oil shocks helped to break the parallelism that was perceived in the fifties
                 and sixties between economic growth and energy use, there is presently a growing awareness,
                 that was given added impetus through the Gulf crisis, that the link between economic growth
                 and pollution needs to be broken. Experience in Eastern European countries, which have a
                 much higher level of pollution than the richer Community countries, shows, however, that the
                 link is not straightforward. The Community's better performance is no reason for complacency
                 and needs to be substantially improved. There does exist, though, a clearer link between the
                 price mechanism and pollution. Often market prices do not reflect the full environmental cost
                 to society of their production or use. Moreover, private economic agents are not inclined to
                 take into account the environmental effect of their activities, when taking consumption or
                 investment decisions.
                 At the centre of any comprehensive policy to address the pollution problem (beyond the
                 inevitable need for regulatory instruments), is therefore the need to internalize these external
                 environmental effects in order to give the right signals to market participants.
                 The aim is to transform the patterns of economic growth in such a way as to reach a sustainable
                 development path. A reinforced policy of environmental protection would not necessarily
                 represent a constraint on private business, but could offer significant market opportunities for
                 those pioneering environmentally friendly products and production processes.
                 There is now a broad consensus that more use of economic and fiscal instruments should be
                 made in environmental policy, but that the optimal policy would still consist of a balanced mix
                 of market-based and traditional regulatory instruments. The main examples of economic and
                 fiscal instruments have been identified as taxes, charges or fiscal incentives, deposit refund
                 systems, tradable emission permits and financial aid or subsidies. In the case of taxes and
                 charges, the impact on the competitive position of the Community and the priorities of the
                 internal market ought to be given due consideration.
                 In view of the importance of the international dimension of pollution close international
                 coordination is called for. Within the Community there is ,a need for a minimum of
                 harmonization in order to avoid policy instruments being in potential conflict with other
                 Community objectives and to ensure compatibility of instruments among Member States when
                 the issue is transnational.
          C. Policies for improved convergence
          While the Community has significantly improved its econbmic convergence performance since the
          beginning of the decade, some worrying divergence has emerged between 1988 and 1990. Serious
          problems remain in some countries and in some areas. Convergence requirements will furthermore be
          tightened as a result of the multilateral surveillance. The significant progress already realised is
          testimony to the prositive effects of the discipline imposed by the exchange rate mechanism of the
          EMS. In fact, the present convergence positions of Member States are closely correlated with their
          degree of exposure to this descipline.
          1.     Price and cost convergence
                 The degree of price convergence is most marked among those countries which have respected
                 the narrow band of fluctuation from the outset. The average rate of inflation (private
                 consumption deflator) in this group of countries has been close to, or below, the three per cent
                 mark since 1986, although the rate has been rising recently. The dispersion in the individual
                 rates of inflation is lower than in the 1960s and the gap between the highest (3,8% in
                 Luxembourg) and the lowest (2,5% in Denmark) rates of inflation for 1990 is just over one
                 point (Table 5).
 ---pagebreak--- No C 190/38                          Official Journal of the European Communities                                                     22. 7. 91
                                                                 TABLE 5
                            Inflation convergence in the Community in the second half of the 1980s (')
                                                        1986            1989             1990           1991 (2)         1992 (2)
            EUR-12                                     + 3,8           + 4,9            + 5,0            + 5,0            + 4,6
                                                                                                                      3
                                                              Countries with low and converging inflation ( )
            EUR-7                                      + 1,2           + 3,3             + 2,8           + 3,2            + 3,6
            Belgium                                    + 0,5           + 3,5             + 3,5           + 3,2            + 3,6
            Denmark                                    + 2,9           + 5,1             + 2,6           + 2,4            + 2,6
            Germany                                    -0,2            + 3,1             + 2,5           + 3,5            + 4,2
            France                                     + 2,9           + 3,5             + 3,0           + 3,1            + 3,2
            Ireland                                    + 4,3           + 3,9             + 2,6           + 3,0            + 3,0
            Luxemburg                                  + 1,1           + 3,4             + 3,8           + 3,5            + 3,5
            Netherlands                                + 0,2           + 2,9             + 2,6           + 2,8            + 2,9
                                                                         Countries with high inflation
            EUR-3                                      + 5,7           + 6,0             + 6,7           + 6,3            + 5,3
            Italy                                      + 5,7           + 5,8             + 6,2           + 6,3            + 5,6
            Spain                                      + 8,6           + 6,6             + 6,4           + 5,9            + 5,3
            United Kingdom                              + 4,4           + 5,9            + 7,2            + 6,5           + 5,1
                                                                     Countries with double-digit inflation
            EUR-2                                      + 18,1          + 13,8           + 16,9           + 14,6          + 11,3
            Portugal                                   + 13,8          + 12,8           + 13,6           + 11,5          + 9,8
            Greece                                     + 22,1          + 14,7           + 20,5           + 18,0          + 13,0
            (') Private consumption deflator.
            (2) Forecast.
            (3) Countries which registered low and converging inflation rates in the second half of the 1980s; they are the countries
                which participated from the outset in the narrow band of the EMS.
            The price convergence in these countries up to 1990 already broadly corresponds to what might
            be required for the transition to the final stage of EMU. This convergence in the rate of inflation
            has been accompanied by a clear deceleration in the rates of increase in nominal unit labour
            costs.
            The acceleration of inflation in 1990 and 1991 in these countries and particularly in Germany
            in 1992, cannot be considered satisfactory from the point of view of stability and needs
            therefore to be rolled back as soon as possible. Particularly since the main source of inflation
            seems to be higher wage costs.
            A second group of countries had in 1990 an inflation rate which is still double that of the first
            group. Italy, which belongs to the narrow band, and Spain, which joined the wider band in
            1989, have also made significant progress since the beginning of the 1980s, but they still show a
            much less favourable convergence position. Italy faces strong wage pressures with nominal unit
            labour costs rising by more than 9 % in 1990 against less than 5 % for most of the original
            participants in the narrow-band. These countries should gradually improve their inflation
            performance over the next two to three years to the level of the narrow band countries. This will
            require that the claims on resources of the different sectors of the economy be made more
            compatible with each other. Setting more ambitious but realistic inflation targets and pursuing
            them by stability oriented monetary and fiscal policies may help to create a stability
            environment and may contribute to provide a reference framework for wage
            developments.
            The United Kingdom, which belongs to the wider band of the Exchange Rate Mechanism, is
            experiencing a high rate of inflation (more than 7 % in 1990 for the deflator of private
 ---pagebreak--- 22. 7. 91                         Official Journal of the European Communities                                No C 190/39
             consumption adjusted for the impact of local government taxation changes) and a large current
             account deficit (about 2,25% of GDP in 1990). The current recession of the economy will
             bring some improvement on both fronts in 1991 and 1992. The main problem for the United
             Kingdom's economy is the excessive increase in wage costs. What is even more worrying is that
             wage settlements are still running at a high rate and are only showing limited signs of reacting to
             the slowdown in the economy. The composition of the retail price index may also partly
             explain this development. After entry of the pound sterling into the ERM, expectations are
             favourably affected creating a better prospect for the United Kingdom to reduce inflation.
             Portugal still has a very high rate of inflation (over 13 % in 1990). Nominal unit labour costs
             are still growing too rapidly (14,5 %). A persistent effort will be needed to reduce inflation
             progressively to the level in the narrow-band. Such an endeavour remains possible as
             experience in other countries has shown. In 1982 and 1983, when exchange rate policy in the
             EMS became tighter, Ireland had rates of inflation comparable to that now experienced by
             Portugal. The more flexible exchange rate policy implemented since October 1990 and the
             framework for wage moderation recently agreed with the social partners should help to put
             downward pressure on inflation, allowing early participation in the ERM.
             The Greek economy is characterized by serious imbalances in many areas, which call for radical
             measures. The rate of inflation exceeded 20 % in 1990, and the budget deficit has reached
             unprecedented levels in the Community, leading to a rapidlyrisingpublic debt to GDP ratio. A
             serious adjustment effort is essential, and should be sustained over the medium-term. The
             Greek Government's medium-term programme proposes significant adjustments which are
             expected to lead to a sizable decline in inflation in 1992.
          2. Convergence of budgetary policies
             Convergence must not only be fostered from the cost and price side, but public authorities also
             have to reduce their claims on resources, so as to avoid unsustainable imbalances, to improve
             the supply side of the economy and to create room for manoeuvre when adverse developments
             have to be addressed.
             In the budgetary area, progress in convergence has been distinctly less marked than for prices
             and costs. In about half the number of Member States the level of the budget deficit gives causes
             for concern. As indicated the process of consolidation has come to a standstill. Further progress
             is essential because unsustainable fiscal positions undermine over the medium and longer term
             the credibility of the commitment to monetary stability and impair the conduct of economic
             policy.
             A new budgetary problem has emerged in Germany. Unification has led to a sizable
             deterioration in its fiscal position. Recent measures adopted in January and February 1991
             increasing social contributions, income taxes and excise duties would provide the State with
             extra revenues amounting to some 1 % of GDP in 1991. This would result in limiting the public
             borrowing requirement to 4,7 % of GDP in 1991 (Table 6). Although the use of national
             savings to solve a temporary domestic problem can hardly be challenged, the size and
             abruptness of the swing in the federal budget position is from the conjunctural point of view not
             without risks. The strong demand from the former GDR, supported by large budgetary
             transfers required to avoid an economic breakdown in the five new Lander, may strain
             production capacity in West Germany, putting pressure on inflation and appreciating the
             exchange rate in real terms. To guard against these dangers and to avoid an overburdening of
             monetary policy, a more ambitious tightening of the fiscal stance would be appropriate.
             Moreover greater emphasis might be put on reducing expenditures and particularly subsidies to
             regions that are no longer peripheral as a result of unification.
 ---pagebreak--- No C 190/40                      Official Journal of the European Communities                                        22. 7. 91
                                                         TABEL6
                                   General Government net lending (+) or borrowing ( - )
                                                                                                 (in percent of GDP)
                                                1985       1987       1989         1990      1991 (•)      1992 (')
            EC                                  -4,6       -4,2        -3,0        -4,1        -4,6          -4,4
                                                              High deficit /high debt countries
            Greece                            -13,8       -12,4      -19,2        -18,9      -15,4         -10,7
            Italy                             -12,5       -11,1      -10,1        -10,6      -10,0         -10,0
                                                                    High debt countries
            Belgium                             -8,5       -7,0        -6,6        -6,0        -6,4          -6,1
            Ireland                            -11,2       -9,1        -3,5        -3,4        -3,8          -3,5
            Netherlands                         -4,8       -6,6        -5,0        -5,7        -4,8          -4,9
            Portugal                           -10,1       -6,8        -3,4        -5,8        -5,5          -5,0
                                                                       Other countries
            Denmark                             -2,0       + 2,4       -0,5        -1,5        -1,3          -1,1
            Germany                             + 1,1      -1,9        + 0,2       -2,2        -4,7          -3,9
            Spain                               -6,9       -3,2        -2,7        -3,7        -2,7          -2,0
            France                              -2,9       -1,9        -1,4        -1,6        -1,6          -1,5
            Luxemburg                           + 5,3      + 1,2       + 3,1       + 4,2       + 1,7         + 1,6
            United Kingdom                      -2,8       -1,3        + 1,0       -0,5        -2,2          -3,1
            {') Forecast.
            In Greece and Italy progress has been fairly limited. In Italy, the fiscal position deteriorated
            again slightly in 1990, and shows limited signs of improving despite repeated attempts at
            correction. The necessary reduction in the rate of inflation will have to go in tandem with
            significant reductions in budget deficits that allow first a stabilization, and then a reduction in
            the level of debt as a percentage of GDP that is now exceeding 100 % (Table 7). A disinflation
            process not accompanied by an appropriate budgetary adjustment woud result in an even faster
            rise in the public debt ratio, as was also the case in Belgium in the early and middle eighties.
            Given the unsustainable debt position of Italy, any postponement of corrective action only
            increases the adjustment effort that ultimately will have to be carried out, as the snowballing
            interest charges crowd out other expenditures.
 ---pagebreak--- 22. 7. 91                       Official Journal of the European Communities                                       No C 190/41
                                                      TABLE 7
                                  Gross public debt in the Community countries
                                                                                                 (in percent of GDP)
                                                1986          1989          1990        1991 (J)         1992 (»)
          Belgium                              123,7         128,9         127,5         128,1            127,8
          Italy                                  88,4         98,6         100,7         103,3            105,8
          Ireland                              115,3         103,8          99,8          97,4             95,2
          Greece                                 65,1         82,9          86,3          86,0              83,3
          Netherlands                            71,7         78,0          78,5          78,8              79,9
          Portugal                               68,4         71,2          67,3          63,8              61,6
          Denmark                                66,9         62,5          62,4          62,3              61,7
          Germany                                42,7         43,6          43,0          45,4              47,2
          Spain                                  48,0         44,6          45,2          44,5             43,7
          United Kingdom                         57,7         45,1          43,2          44,4             45,6
          France                                 34,1         35,7          36,4          37,3              37,8
          Luxemburg                              13,4           8,5           6,3          4,7               3,2
          EUR-12                                 58,3         58,6           58,6         60,0              61,0
          (') Forecast.
          In Greece, the budget deficit, at more than 18 % of GDP in 1990, has led to a rapid increase in
          the gross public debt ratio, from less than 30 % of GDP in 1980 to about 86 % in 1990. The
          adjustment efforts undertaken by the Greek Government are expected to result in a sizable
          reduction of the budget deficit this year and next. Sustained efforts over several years will be
          needed, however, before sufficient convergence will be achieved.
          Also in Belgium, the Netherlands and Portugal the level of the budget deficit is worrying for
          economic and monetary union. The public debt ratio is still very high and has not yet fully been
          stabilized. The fiscal deficit should be reduced further so as to bring the public debt ratio on a
          clearly declining trend. In Belgium the public debt ratio is still excessively high (128 % of GDP
          in 1990). The budget deficit is still too large to put the public debt ratio on a downward path, if
          growth slows or interest rates rise. The double government norm aiming at freezing in real
          terms non-interest expenditures and at keeping constant the deficit in nominal terms, should be
          applied to all levels of government. Only its strict and global application will ensure that the
          public debt ratio will be progressively reduced, which is essential to guarantee long-term
          stability. In the Netherlands, the public debt ratio, though not as high as in the case of Belgium
          and Ireland, is still not fully stabilized. Some tightening of fiscal policy would be warranted.
          The budgetary situation in Portugal also needs to be improved in parallel with the disinflation
          process so as to maintain the progress in stabilizing the public debt ratio.
          Ireland has already reduced its budget deficit substantially, so that the public debt ratio is on a
          clearly declining trend. This trend should now be continued.
          In a last group of countries, including Denmark, Spain, France, Luxembourg and the United
          Kingdom, the budgetary position in terms of net lending or borrowing and public debt seems to
          be under control and does not present the Community with a convergence problem. The
          increase in the budget deficit in the United Kingdom, although partly attributable to the
          recession, nevertheless calls for attention. The general assessment does not detract, however,
          from the need, also valid for the other countries, to improve the structural features of their
 ---pagebreak--- No C 190/42                            Official Journal of the European Communities                                  22. 7. 91
                 public finance to benefit the supply side of the economy, to prepare for the single market of
                 1992 and to increase budgetary flexibility as required by a better policy mix. This will
                 particularly involve improving the structure of expenditure and receipts, winding down in
                 some cases the share of expenditure in GDP and lessening the tax burden.
                 Moreover, a few of these countries continue to suffer from strong inflationary pressures and
                 large external deficits, such as the United Kingdom and Spain, or from high foreign debt, such
                 as Denmark. Hence, there is a need to maintain a cautious budgetary policy in these
                 countries.
                 Convergence of external positions
                 In an integrating economy with fully liberalized capital movements and increasing exchange
                 rate fixity, convergence of current account balances is to be judged in a different context and the
                 appropriateness of current account imbalances has to be individually assessed.
                 Spain is confronted with a high current account deficit (more than 3,5 % of GDP in 1990). A
                 current account deficit per se would not be worrying in the Spanish case as long as it
                 corresponds to capital imports financing rapid growth in productive investment. Such capital
                 imports, though, exerted strong upward pressure on the exchange rate. What gives cause for
                 concern, however, is the rapidity of the deterioration of the current account position which was
                 still in equilibrium in 1987. However, the deficit is expected to stabilize in 1991 and 1992. If
                 exchange rate stability is to be maintained, the rate of growth of unit labour costs in Spain must
                 soon be brought below that of its main trading partners so as to improve its competitive
                 position. This would also create the conditions for the continued strong growth needed both to
                 reduce the persistently high levels of unemployment and to allow the catching-up process to
                 continue. These considerations also apply to Greece where the external position has
                 deteriorated sharply in recent years and only modest improvement is expected in 1991 and
                 1992.
                 In Italy the external position, while not yet giving cause for concern, nevertheless calls for a
                 critical look at wage developments to preserve external competitiveness. In the United
                 Kingdom some improvement is expected in the external position, largely as a result of the drop
                 in domestic demand. Still cost developments will need to be monitored carefully to avoid a
                 renewed deterioration of the current account once domestic demand picks up again.
                 The current account positions of the initial narrow band countries appear broadly sustainable.
                 The German external surplus, which had given cause for concern in the recent past, is being
                 eliminated from 1991 on as a consequence of the unification process. Considerable progress
                 has been made in Denmark, where in 1990, for the first time since the early sixties, the current
                 account has turned into a surplus and is expected to stay so in 1991 and 1992. This has been
                 achieved, however, at a considerable cost in terms of growth. A further improvement in the
                 competitive position, migth help to consolidate this improvement, at higher levels of activity
                 and employment.
          With appropriate monetary, budgetary and structural policies, internal inflationary pressures can be
           absorbed, thus preserving the positive fundamental growth conditions of the Community. At the same
          time, the development of the Community potential will improve the supply side of the economy and
          contribute to resume its medium-term growth trend. Such policy mix fulfils at the same time the
          requirements for a successful move towards economic and monetary union.
 ---pagebreak--- 22. 7. 91                                    Official Journal of the European Communities                                No C 190/43
                                             MAIN ECONOMIC INDICATORS 1988 to 1992
                                                     COMMUNITY, USA AND JAPAN
(a) GDP at constant prices (')                                          (b) Domestic demand at constant prices
    (annual % change)                                                       (annual % change)
              1988       1989     1990 (*)    1991 (»)   1992 (*)                     1988        1989    1990 (*)  1991 (*) 1992 (*)
B              4,6        3,9        3,7         2,25     2,5           B              4,1         4,9        3,6    2,25      2,25
DK             0,5        1,2        1,6         1,5      2,25          DK           -1,7          0,3      -0,8     0,25      1,5
D              3,7        3,3        4,7         2,75      1,75         D              3,8         2,7        5,1    3         2,5
GR             4,1        2,8        0,1         0,75      1,5          GR             7,0         3,3        2,5    0,75      2
E              5,2        4,8        3,7         3        3,5           E              7,1         7,8        4,6    3,5       4,25
F              3,6        3,6        2,8         1,5      2,5           F              3,8         3,2        3,2    1,75      2,75
IRL            3,9        5,9        5,2         1,75     2,25          IRL            0,4         6,0        5,5    1,5       1,75
I              4,2        3,2        2,0         1,75     2,5           I              5,0         3,6        1,9    2         3
L              5,5        6,1        3,7         3        3,25          L              3,6         7,8        3,7    4,25      3,75
NL             2,7        4,0        3,3         2,75      1,75         NL             1,6         4,9        3,8    2,25      1
P              3,9        5,4        4,0         2,75     2,75          P              7,4         4,0        5,8    5,25      4,5
UK             4,6        2,2        0,6       -2,25      2,25          UK             8,0         3,1      -0,1   -3          2,5
EC             4,0        3,3        2,7         1,25     2,25          EC             5,0         3,7        2,8    1,5       2,75
USA            4,5        2,8        1,0         0         1,5          USA            3,3         2,2        0,5  -0,5        1,5
JAP            5,7        4,9        5,6         3,75     4             JAP            7,3         5,7        5,8    4         4,5
(c) Deflator of private consumption                                     (d) Balance on current transactions
    (annual % change)                                                       (as a % of GDP)
                1988       1989     1990 (*)   1991 (*)  1992 (*)                     1988        1989    1990 (*)  1991 (*) 1992 (*)
B                1,6        3,5        3,5       3,25       3,5         B              1,5         1,1        0,7      1        1
DK               4,9        5,1        2,6       2,5       2,5          DK           -1,2        -1,2         0,8      1,5      2,5
D                1,3        3,1        2,5       3,5       4,25         D              4,2         4,7        3,0      0      -0,25
GR              14,2       14,7       20,5      18        13            GR           -2,0        -4,8       -5,7     -5       -4
E                5,1        6,6        6,4       6,75      5,25         E            -1,1        -3,2       -3,5     -3       -3,25
F                2,9        3,5        3,0       3         3,25         F            -0,3        -0,1       -1,0     -0,75    -1
IRL              2,5        3,9        2,6       3          3           IRL            1,7         1,3        2,7      2,25     1,75
I                5,2        5,8        6,2       6,25      5,5          I            -0,8        -1,4       -1,4     -1,25    -1,5
L                2,8        3,4        3,8       3,5       3,5          L             33,5        34,4       29,3     26,5     24,75
NL               0,4        2,9        2,6       2,75      3            NL             2,5         3,3        4,0      4        4
P               10,0       12,8       13,6      11,5       9,75         P            -4,4        -2,9       -0,1     -1,25    -2,25
UK               4,9        5,9        7,2       6,5       5            UK           -4,6        -4,8       -2,3     -1       -1,25
EC               3,7        4,9        5,0       5         4,75         EC             0,1       -0,1       -0,2     -T),5    -0,75
USA              4,0        4,5        5,0       4,5       5            USA          -2,5        -1,9       -1,8     -0,25    -1
JAP            -0,1         1,7        2,4       2,75      2,5          JAP            2,8         2,1        1,2      1        1
(*) Based on theforecastsof May 1991.
(>) GNP for USA and Japan from 1989 onwards.
 ---pagebreak--- No C 190/44                                       Official Journal of the European Communities                                   22. 7. 91
(e) Number of unemployed                                                     (f) General government lending and borrowing
    (as % of the civilian labour force)                                          (as a % of GDP)
                1988         1989        1990 (*)   1991 (*)  1992 (*)                     1988        1989   1990 (»)  1991 (»)  1992 (*)
B               10,0           8,5          8,1        8,5       8,25        B              -6,6      -6,7     -6,0      -0,25     -6
DK                6,5          7,7          8,6        9         8,75        DK               0,5      -0,5    -1,5      -0,25     -1
D                 6,1          5,5          5,1        4,5       4,75        D              -2,1         0,2   -2,2      -4,75     -4
GR                7,6          7,5          7,5        8,75      9,25        GR           -15,5      -19,2    -18,9    -15,5      -10,75
E               19,3          17,1         16,1      16         15,5         E              -3,3       -2,7    -3,7      -2,75     -2
F                 9,9          9,4          9,0        9,25      9,5         F              -1,8       -1,2    -1,6      -1,5      -1,5
IRL             17,4          16,0         15,1      16         16,75        IRL            -5,2       -3,5    -3,4      -3,75     -3,5
I               10,8          10,7          9,8        9,75      9,5         I            -10,9      -10,1    -10,6    -10        -10
L                 2,1          1,8          1,7        1,5       1,5         L                2,1        3,3     4,2       1,75       1,5
NL                9,3          8,7          8,1        7,75      7,75        NL             -5,2       -5,0    -5,7      -4,75     -i
P                 5,6          4,8          4,6        4,75      5,25        P              -5,4       -3,4    -5,8      -5,5      -5
UK                8,5          7,0          5,7        8,5      10,75        UK               1,1        1,0    -0,5     -2,25     -3,25
EC                9,7          8,9          8,2        8,75      9,25        EC             -3,7       -2,9     -4,1     -4,5      -4,5
USA               5,5          5,3          5,4        6,5       6,5         USA            -2,0       -1,7     -2,4     -1,75     -2,5
JAP               2,5          2,3          2,1        2,25      2,25        JAP              2,1        1,8      2,2      1,75       2
(g) Total employment                                                         (h) Real compensation of employees per head
     (annual % change)                                                            (annua] % change) (*)
                1988          1989       1990 (*)   1991 (*)   1992 (»)                     1988       1989   1990 (•)  1991 (»)  1992 (*)
B                 1,5          1,1          1,0       0           0          B               0,8        0,6      2,3       2,5      2,5
DK             -0,0          -0,6         -0,7      -0,25         0,25       DK            -0,9       -1,6       1,0       1         1
D                 0,8          1,4          2,8       1,75        0,75       D               1,7      -0,2       1,5       2,75     1,25
GR                1,6          1,5          0,4     -0,25         0          GR              3,7        4,1      0,6     -2       -0,25
E                 3,5          3,6          2,6       1,5         1,75       E               1,1      -0,5       1,2       1,25      1
F                 0,7          1,2          1,2       0,5         0,5        F               1,2        1,2      1,8       1,5       1
IRL               0,4        -0,1           2,1       0,25        0,5        IRL             2,9        2,2      3,0       3,25     2,5
 I                0,9          0,2          1,4       0,5         0,5        I               4,0        3,1      3,9       1,75     2
L                 3,1          4,0          2,4       1,25        1,5        L               0,5        3,0      1,8       2,5      2,25
NL                1,4          1,6          1,9       1           0,5        NL              1,1      -2,4       1,6       2         1,75
P                 0,1          1,0          2,5       1           0,5        P               3,1        0,8      3,7       5,25     4,75
 UK               3,3          2,8          0,6     -2,5        -2           UK              2,9        2,8      3,4       2         1,75
EC                1,6          1,6          1,6       0,25        0,25       EC              2,1         1,2     2,4       2,5       1,5
USA               2,8          2,3          0,4     -1            1          USA             1,9      -0,7     -0,1        0        0,5
JAP               1,6          1,9          2,0       1,5        .1,5        JAP             3,4        2,2      1,7       1,25      1,5
(*) Based on the forecasts of May 1991.
{') Deflated by the deflator of private consumption.
 ---pagebreak--- 22. 7. 91                                     Official Journal of the European Communities                                   No C 190/45
(i) Investment in construction at constant prices                        (j) Investment in equipment at constant prices
    (annual % change)                                                        (annual % change)
                1988          1989   1990 (»)   1991 (•)  1992 (•)                      1988      1989      1990 (*)  1991 (*)   1992 (•)
 B              15,0           9,6       5,7     -1        3             B               17,7      19,0        9,9         3,5     4
 DK            -3,1          -4,6     -3,8       -3        0,25          DK             -7,5        6,6        2,3       -1,25     4,75
 D                4,7          5,1       5,2       3,25    2             D                7,7       9,8       12,9         8,75    5,75
 GR               7,6          2,1       0,7       0       4             GR              10,8      17,3       10,4         6      10
 E              12,6          14,9      10,7       6,5     7,5           E               16,5      12,1        1,2         2,5     5,75
 F                6,2          6,6       2,3       1,25    2,25          F                8,9       8,1        5,3        1        2,5
 IRL           -0,7            9,8       8,4       1,5     3             IRL              5,6      14,1        6,8         3,75    4,5
 I                3,7          3,9       2,5       0,75    2,5           I                6,4       5,2        3,5         1,25    5,25
 L                9,9          8,8       5,9       5,5     4,5           L              -5,4       14,9        5,6         6,25    5,75
 NL             11,8           2,6       2,5     -0,25     0,25          NL               6,8       5,5        6,0         2,75    0,25
 P              10,1           3,5       6,5       6,25    6             P               23,2       7,7        8,5         5,25    5,5
 UK               6,1        -0,5        0,1     -3,25     2             UK              17,7       8,4      -3,7     -17          3,5
 EC               6,4          5,3       3,8       1,5     3             EC              10,4       8,6        4,7        0,25     4,5
 (k) Gross fixed capital formation at constant prices                    (1) GDP per head
     (annual % change)                                                       (EC = 100), at current prices and current PPS
                1988         1989    1990 (•)   1991 (•)  1992 (•)                     1960       1973       1986     1991 (»)   1992 (»)
 B              13,5          13,6       7,6        1       3,5          B               95,4    101,2       100,6      104,4     105,1
DK             -6,6            0,2    -1,0        -2,25     2,25         DK            118,3     113,1       117,0      108,5     108,9
 D                5,1          7,1       8,8        6       4            D             117,9     111,1       114,0      113,8     112,3
GR                8,8          8,6       5,2        3       7            GR             38,6       56,8       55,9       52,5      52,3
 E              14,0          13,7       6,7        5       6,75         E               60,3      79,0       72,8       79,3      80,5
F                 8,5          5,8       4,0        1,25    2,5          F             105,8     110,4       110,1      108,9     109,1
IRL               4,6         11,3       7,5        2,75    3,75         IRL             60,8      58,9       63,4       68,9      69,0
I                 6,7          5,1       3,0        1       4            I               86,5     93,3       103,0      103,6     104,0
L              -5,5           13,4       5,8        5,75    5            L             158,5     141,9       126,2      133,0     134,9
NL                9,4          3,0       4,1        1,25    0,25         NL            118,6     113,1       106,0      103,9     103,3
P               15,0           7,5       7,5        5,75    5,75         P              38,7       56,4       52,5       56,7      57,1
 UK             14,8           4,8    -1,9      -10,5       2,75         UK           128,6      108,5       105,4      101,3     101,3
EC                9,0          6,7       4,3       0,75     3,75         EC           100,0      100,0       100,0      100,0     100,0
USA               5,0          2,7    -0,1        -3        5,75         USA           189,6     161,6       155,7      147,3     145,6
JAP             12,6          11,0      10,8       5        6,5          JAP            55,8      96,3       110,7      121,7     124,0
(*) Based on the forecasts of May 1991.
Source: Commission services.