The European Commission: Hold tight your purses, focus on reforms!
Ralitsa Kovacheva, 15 June 2011
Fiscal consolidation, pension reform, education and training, measures to boost employment – these are the main recommendations of the European Commission to the Member States after the evaluation of their strategic papers under the European semester. The recommendations are based on the National Reform Programmes, the Stability Programmes (for the eurozone countries) or the Convergence Programmes (for non-euro area countries). For the member states with bailouts (Greece, Ireland, Portugal, Romania and Latvia), the only recommendation is for them to observe the Memoranda of Understanding with the EU and IMF, where clear conditions are fixed.
The European Commission also recommends the introduction of binding budgetary rules (the so called debt brake), including at local level; reforms of social security systems; measures aiming financial sector stability, and if the stress tests show a need – restructuring of the non-viable financial institutions; reducing the tax burden on labour; ensuring that wage developments are in line with the productivity and competitiveness; reforms in the labour market and removal of unjustified restrictions.
Follow the course!
There are several countries whose recommendations are rather comments on their situation, than recommending something in particular, except for a “Go ahead!” - for example, Estonia, Finland, Luxembourg. The pension systems, employment and education are major emphases in their recommendations.
Germany also doesn't get any criticism in terms of fiscal consolidation - Berlin will reduce its budget deficit to the limit of 3% in 2011 - two years earlier than the deadline set by the Council. Apart from purely economic preconditions, apparently the country has decided this time to give a good example, after it is repeatedly reminded that exactly France and Germany first broke the Stability and Growth Pact, which led to a loosening of fiscal discipline in the EU. Although the public debt has increased by 10 percentage points in 2010, it is expected this year to start decreasing to 75.5% of GDP in 2015.
Some risks to the financial stability may arise from possible measures to support the financial market, notes the recommendation, as well as from the fiscal discipline at Länder level. It is recommended Berlin to address the structural weaknesses of the financial sector and especially the need for restructuring of local banks (Landesbanken).
Given the aging, Germany has to boost labour market participation, to reduce taxation on labour and to remove unjustified restrictions on certain professions.
Not without some sarcasm (though it emanates from between the lines and is a matter of interpretation), it is noted that, although Germany has taken a number of commitments under the Euro Plus Pact (which was initiated exactly by Berlin), ”several policy areas remain unaddressed in the Pact commitments (e.g. restructuring of Landesbanken or the tax wedge on labour) or are only touched upon (opening the services sector and network industries to greater competition).”
Although the French economy did not suffer severely from the crisis and in 2010 it fully recovered with a growth of 1.5%, the public finances have been in tatters. The budget deficit jumped from 3.3% in 2008 to 7.5% in 2009 and the debt will reach 86% in 2012 before starting to decline slightly. In view of these figures, France has to make a fiscal effort of more than 1% per year until 2013 to correct its excessive deficit. “Moreover, it would be appropriate to use all windfall revenues to accelerate the deficit and debt reduction.”
There is a finding in the French recommendation that comes just in time, given Bulgarian Government's intentions to increase the minimum wage. One of the biggest problems for France is its deteriorated trade balance - a sign that French companies have been losing competitiveness. The explanation lies with increased labour costs, after the minimum wage was reintroduced in the 2003- 2005 period. Moreover, “the French minimum wage is still among the highest in the European Union”.
In order to promote employment, it is recommended Paris to reconsider its tax system and shift the tax and social security burden on consumption and environment. However, though having one of the highest labour burden, there is a large percentage (11%) of exemptions from tax and social security payments, which puts at risk the public finances.
There is another thing, which is useful to be read in Bulgaria, where people often envy the social benefits of the French - too strict employment protection legislation is a problem and together with the influential trade unions and collective bargaining it hinders the country's competitiveness. The same is evident from the recommendations to Spain and Italy. France has yet to carry out the pension reform, announced in 2010 – to increase gradually the minimum retirement age from 60 to 62 years (!) and to eliminate the early retirement schemes.
Italian economy (as it was called by the Economist magazine - “the Achilles heel of the euro”) has long been plagued by sluggish growth – between 2001 and 2007 the average real GDP growth was around 1%, which was half the euro area average. In 2008-2009 the economy contracted by 7% which led to public debt of 120% of GDP. So the key priorities of Rome are “durable and credible consolidation” and growth-enhancing measures. It is also recommended in the plaintext - wages to be aligned to productivity growth, collective bargaining to be reformed and attention to be paid to undeclared work which “remains an important phenomenon in Italy”.
A specific challenge facing the country is reducing economic disparities between the North and the South – a very old problem. Italy is the third largest recipient of EU cohesion funds - for the period 2007-2013 the country accounts for 8% of the total cohesion policy budget, as much of the funds is directed precisely to measures for economic convergence between the more industrialised North and the poor South. However, “halfway through the programming period, the share of EU funds actually mobilised is only 16.8% and it is much lower in the southern Convergence regions.” Therefore, one of the important recommendations is to increase growth-enhancing expenditure, co-financed by cohesion policy funds.
the country at which all eyes are focused after Portugal has been “rescued”. Not for the first time the European Commission notes the ambitious consolidation conducted by the Spanish Government, which inspired confidence even in financial markets. Madrid is committed to reduce its deficit below 3% of GDP by 2013. The public debt continues to grow and from 60.1% of GDP in 2010 is expected to reach 69% at the end of the programme period.
The big challenge is, however, the implementation of budgetary targets on a regional level, where consolidation is not running with the required pace. The government plans to introduce a spending rule based on medium-term nominal GDP, which to be mandatory at both central and local level. Another serious risk to the country arises from the state of the financial sector and especially the regional savings banks, the restructuring of which should be completed by the end of September 2011.
The aging of the population will exert increasing pressure on the budget because the cost of pensions as a share of GDP is growing and without a pension reform it will seriously outweigh the EU average. The Government's proposal for pension reform has been already agreed with the trade unions, but it still has to be approved by Parliament.
Meanwhile, the unemployment rate exceeded 20% in 2010 and is the highest in the EU. 41.6% of the young people and 26.4% of low-skilled workers are unemployed. At the same time the level of early school leaving reached 31.2% in 2009. However, the employment statistics in Spain, as well in Italy, do not reflect the informal employment which should also be addressed. Alike Italy and France, Spain has a problem with collective bargaining, which creates wage-inertia and hinders competitiveness. “Higher wage growth coupled with lower productivity growth than in the euro area contributed to persistently higher inflation in Spain,” the Commission notes.
The United Kingdom
Aging is a very serious problem in the UK too, because its long-term cost is above the EU average and without a consolidation effort the debt would reach 128% of GDP by 2020. The Commission urges the British government to pursue its ambitious programme, aiming to reduce the deficit from 9.9% in 2010-11 to 1.7% in 2015-16, mainly through expenditure restraint. From 78.7% in 2010-11 the debt is expected to reach 87.2% in 2013-14 before starting to decline slowly in 2020, but it will still remain above 80%.
However, the Commission warns that cutting costs should not come at the expense of growth-enhancing expenditure. It recommends improving significantly the access to banking and non-banking financing of the private sector, particularly small and medium enterprises. The government should place comprehensive reforms in the housing sector, including in the mortgage market and property taxation.
The UK has also a problem with growing unemployment among the young people, which reached a level of 20% in 2010. One of the reasons is the lack of qualification - the level of early school leavers is above the EU average - 15.7% (EU - 14.4%). “While the share of people aged 25-64 having attained high skill levels is particularly high in the UK, there are weaknesses at intermediate skills level, with the share of people in this group currently below the EU average.”
A very typical problem for the country is the high number of children living in jobless households - 17.5%, which is the highest in the EU (10.2% EU average). Particularly serious is the situation for single parent households, who have neither the financial incentive to work, nor the opportunity to use childcare services.
is imposed by itself. The next generation of Europeans will work harder than the previous one to pay its debts. The faster we realise that, the more painlessly the necessary reforms will be implemented. These reforms, as you see, are valid for all and unless conducted we won’t need another crisis to bring the problems to light. Moreover, this time they cannot be covered by generous social benefits because there is no money. Someone must first earn it.
euinside`s analysis of the recommendations to the new EU member states read here.