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Private sector indebtedness, house prices, faster wages growth compared to productivity, and loss of export market shares - these are the risky points for the European macroeconomic stability, according to its first common assessment. For the first time in its history the EU has started a macro-economic surveillance over its member states, aimed at early detection and correction of existing or emerging imbalances. The catch is that this process starts at a time when Europe is struggling to contain the debt crisis, while trying to achieve economic growth which makes it even more difficult.

The procedure for prevention and correction of macroeconomic imbalances has been introduced as part of the new legislation on enhanced EU economic governance. The aim is to supplement the fiscal surveillance carried out under the Stability and Growth Pact. The procedure has started with the European Commission's Alert Mechanism Report, presented on February 14 by Olli Rehn, EU Commissioner for Economic and Monetary Affairs. Based on a three-year period data (2008-2010) the Commission has assessed the EU member states according to a scoreboard of 10 indicators for external and internal imbalances.

The indicators for external imbalances and competitiveness are current account deficit, net investment position, real effective exchange rate, export market shares and nominal unit labour cost. Internal imbalances are assessed on the basis of house prices, private sector credit flow, private sector debt, public debt and unemployment. There are certain thresholds the surpassing of which indicates a problem.

The 12 monitored

On the basis of this initial review the Commission has identified 12 countries where the situation requires further in-depth analysis: Belgium, Bulgaria, Cyprus, Denmark, Finland, France, Italy, Hungary, Slovenia, Spain, Sweden and the United Kingdom. Countries with rescue loans (Greece, Ireland, Portugal and Romania) are excluded from the procedure because they are already under increased economic surveillance. For each of the 12 countries a thorough analysis will be made and where necessary the countries will receive recommendations for corrective actions. And if a member state does not comply it could face sanctions.

"The purpose of today's report is not a 'name and shame' exercise", Commissioner Olli Rehn noted. It is also not to put countries in "grey" and "black" lists, as some media were quick to do. The purpose of the exercise is to assess the evolution of indicators over time, taking into account the most recent developments and outlook, in order to see the direction of development of individual countries and at the same time - the common trends. Therefore, the indicators should not be interpreted mechanically but a number of additional factors must be taken into account. For example, Sweden is included in the list of countries subject to enhanced monitoring because, despite its trade surplus and strong savings of the private and public sector, there has been a steady (over the last fifteen years) growth of house prices and hence - increased indebtedness of the private sector. The same trend exists in Denmark and Finland too.

Poland has crossed over the thresholds for current account deficit and net international investment position (like most of the new member states), but the Commission notes that this should be reviewed in the context of the catching-up process and these deficits have been financed to a large extent by foreign direct investments and EU funds.

In the case of Bulgaria it is clear that the change of the indicators, compared with the three-year long period of study, has been taken into account. The high current account deficit, accumulated in the years before the crisis, thanks to the large foreign direct investment and private credit growth is expected to turn into a slight surplus in 2011. The catching-up effect has also been taken into account but from another perspective: "Bulgaria shows one of the highest rises in ULC [Unit Labour Costs] in the EU although the wage increases, from very low base level, are part of the ongoing convergence process but could slow the catching-up process over the medium and longer run." As you can see, in this case the catching-up is not a mitigating factor for increased labour costs but quite the opposite - the disproportionate increase of wages compared to productivity can reduce competitiveness and hence - to slow the catching up process. Another factor that puts Bulgaria among the countries subject to further consideration is the sharp increase in private debt, mostly due to corporate debt.

Where is Germany?

However, the situation of the surplus countries is more interesting. Even when the macroeconomic imbalances procedure was discussed in the European Parliament and especially during the negotiations between the Parliament and the Council, one of the most contentious issues was whether the current account surplus should also be considered a problem. The main argument of the proponents of the so-called ‘symmetry’ was that large surpluses of some countries (notably Germany) were due to large deficits of other countries, mostly in the periphery of the eurozone. But the analysis of the European Commission shows that countries that exceed the indicative threshold of 6% surplus are Luxembourg (because of its specialisation in financial services) and Denmark (because of its exports of services, oil and gas), while the Netherlands and Germany are below the limit.

However, at the presentation of the report journalists were especially excited namely by the German situation, asking whether since Germany is not criticised that meant that all must follow the German model of low wages. Commissioner Olli Rehn replied that he would not describe German wages as low, but rather that Germany controlled the nominal unit labour costs. In other words, productivity is growing faster than wages. The Commission notes though, that "the declining trend in productivity contributed to the accumulation of macroeconomic imbalances and competitiveness losses in the pre-crisis period in a number of Member States."

This report is for countries with the most pressing and urgent problems that have serious fiscal difficulties and loss of competitiveness, Mr Rehn explained. The Commission will devote a separate analysis to countries with current account surpluses, especially in terms of the problems in the eurozone. As to Germany, the report notes that there is a process of rebalancing because in recent years domestic demand has been increasing and the country has lost export market shares, so the surplus has also decreased.

Some more than others

"While the EU as a whole has lost global export market shares, some Member States have lost more than others," the report states: Belgium, Denmark, Germany, Spain, France, Italy, Cyprus, the Netherlands, Austria, Finland, Sweden and the UK. France, for example, has marked market shares contraction that is amongst the largest in the EU whilst losing competitiveness as well: "the reduction in profitability of French companies and the implications for investments are relevant factors that deserve further analysis." In recent years Finland has also lost competitiveness because productivity has fallen while wages have remained unchanged.

For comparison - Poland has gained new export markets, while managing to limit the increase of labour costs.

A serious concern in many EU countries is increased indebtedness of the private sector, as in more than 12 countries it exceeds the indicative threshold of 160% of GDP. The reasons are different, as well as the relevant factors. In countries like Belgium, Cyprus, Slovenia and Sweden the major contributor to the private sector debt are the non-financial corporations, while in Denmark, the Netherlands and the UK it is the household sector and the high house prices. During the pre-crisis decade house prices in the EU were increasing by an average of 40%, while in some countries the annual growth rate reached 20% to 35%. The sharp decline in prices, accompanied by problems in the construction sector (Spain) is equally worrying, as is the continuing price increase elsewhere along with growing private debt (Sweden, Denmark, Finland).

Private sector indebtedness is particularly worrying if it is coupled with high public debt, as is the case of Belgium and the UK. Italy, in turn, has a huge public debt but not an excessive private debt. Spain and Hungary are examples of high external debt of both the private and public sector.

The unemployment rates for the last three years exceed the limit of 10% in Estonia, Spain, Latvia, Lithuania and Slovakia, but in many countries the level is rather high and the trend is upward, the report notes. In the case of Spain, which has the highest unemployment rates in the EU, the Commission notes that this is partly due to the downsizing of the construction sector after the burst of the housing bubble and the economic recession, but also to "a sluggish adjustment of wages".

What does the report actually tell us? That we are all in the same boat. The pre-crisis decade created many illusions and bubbles, house prices grew, together with wages and debts. But all this is over now. In most European countries things are getting back to normal - in some countries more easily, in others more painfully. But it is clear to all that the imbalances in the euro area have contributed to the deepening and amplification of the debt crisis. And if it were once possible, there is no longer a way some countries to grow without the rest or other countries to spend at the expense of the others.