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REPORT FROM THE (ECOFIN) COUNCIL TO THE EUROPEAN COUNCIL (STOCKHOLM, 23/24 MARCH 2001

KEY ISSUES PAPER ON THE 2001 BROAD ECONOMIC POLICY GUIDELINES

Introduction

1. A year ago, in Lisbon, the European Union set itself a new strategic goal for the next decade: to become the most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion. In fulfilling these ambitions the Union faces key challenges. In the short term, it should maintain the growth momentum. In the medium and longer term, it has to raise its growth potential, inter alia, to cope with the impact of population ageing, which otherwise could threaten the basis for growth and welfare in the longer term. To address these challenges a sound macroeconomic policy mix and comprehensive economic reforms are called for.

2. The Broad Economic Policy Guidelines (BEPGs) are at the center of the economic policy co-ordination process and they provide the framework for the definition of the overall policy objectives and orientations for the EU. They will identify the responsibilities of the Community and the Member States, and the role of social partners.

3. In order to support the policy strategy set out in the BEPG, the Eurogroup will enhance economic policy coordination within the euro area in line with the conclusions of the Nice European Council.

4. Last year's guidelines have been forwarded to other relevant Council formations for them to assume responsibility for implementation in their respective areas. At the same time, these Council formations have been invited to pursue work with a view to the formulation of the BEPGs for the coming year, and to make their contributions available by the end of January each year.

5. The Ecofin Council has welcomed the valuable contributions by the Employment and Social Policy Council and the Internal Market, Consumer Affairs and Tourism Council. The present document sets out the key issues on which the Council invites the European Council to focus its discussion in the part of its meeting that has a direct bearing on the BEPGs.

2. Current economic situation

By building upon its sound economic fundamentals and its growth and stability-oriented framework, the Union should be able to maintain healthy growth in economic activity and employment despite an external economic environment which is becoming less favorable.

6. The EU's economic performance has improved considerably over recent years. In its fourth year of expansion, the EU enjoyed vigorous economic growth of about 3½ % in 2000. Price stability was maintained and 2½ million jobs were created. At the same time, the unemployment rate fell to its lowest level since 1991. Despite the deterioration in the terms of trade, profitability of investment remains favourable. Thus, domestic conditions are largely favorable. However, with 14½ million unemployed - 8 % of the labour force - the situation on the labour market is still unsatisfactory. Full employment was therefore set out as a goal for the Union in Lisbon.

7. This year's BEPGs will have to be formulated in a context of a less supportive global economic environment. In the US there is now growing evidence of a marked slowdown in growth. At the same time, the Japanese economy continues to perform weakly, showing few signs yet of improvement. Emerging market economies, especially those heavily reliant on export to these two countries, are being negatively affected. Furthermore, oil prices, while having come down from the high level attained last autumn, are likely to remain at relatively high levels.

8. The EU economies have not been unaffected by these developments. Export demand has weakened and business and consumer confidence has come down, albeit from high levels. So far, however, the EU seems to have withstood these adverse developments rather well with indications of somewhat slower growth, but still at healthy rates and with employment rising further.

9. Looking ahead, the less supportive international economic environment means that the EU has to rely more upon its own strengths. These include the growth and stability-oriented framework for macroeconomic policy and the single market as well as the increased dynamism of the economy, fostered by structural reforms. The single currency provides the euro area with an additional source of strength, in providing it with a better protection to external shocks and in contributing to a stable trade environment with less exposure to exchange-rate fluctuations. The EU economy should therefore be ready to serve as a major source of growth in the global economy with employment further increasing and inflation remaining under control. However, the risks posed by the global developments underline the need for a sound macroeconomic policy-mix in tune with the present needs.

3. Main elements of the policy strategy

3.1 Preserving the recovery through a sound macroeconomic policy mix

With indications of a marked global economic slowdown, one important focus for the guidelines should be the challenge for policy-making in the EU posed by the less favorable external economic environment. Budgetary policies should continue to be geared to the achievement of public finances close to balance or in surplus, so as to support the price-stability orientation of monetary policy, and thereby to foster continued economic growth and employment creation. At the same time, the establishment of sound public finances is fundamental for dealing with the budgetary consequences of the ageing populations.

10. A major prerequisite is to maintain the hard-won stability, which has underpinned the improvement in growth and employment. The key to higher growth and employment is the combination of a growth and price stability oriented macro-economic policy with sustainable structural reform.

11. Despite sharp increases in oil prices and the weakening of the euro exchange rate, the ECB has successfully pursued its prime objective to maintain price stability in the euro area. Looking ahead, it seems reasonable to expect consumer price increases, which were boosted by earlier rises of oil and import prices, to come down. A stronger euro, moderate wage developments, and a stabilization of oil prices at somewhat lower levels, should contribute to lower inflationary pressure.

12. Outside the euro area, inflation developments have also been favorable for a long time. Global economic slowdown is likely to contribute to the reduction of inflation.

13. Turning to budgetary policies, Member States' actual budgetary positions improved somewhat in 2000 while the underlying position for the EU as a whole was broadly neutral. Cyclically adjusted budget balances were not improved where there were clear opportunities to do so in view of signs of economic overheating.

14. The challenge for fiscal policy is now to continue to gear budgetary policies to the achievement of public finances close to balance or in surplus. Furthermore, they should be guided by the need to avoid pro-cyclical stances that lead to exacerbated swings in economic activity and unsustainable structural balances. To this end, cyclically adjusted budget balances are used when assessing budget positions. In this context, the Council sees the need for:

â Meeting last year's commitment in the BEPGs for a budgetary position of close to balance or in surplus, as a rule, in 2001; use budgetary margins stemming from better than expected growth to achieve budgetary positions in 2001 better than the objectives set in the stability and convergence programme updates;

â Member States to prepare budgets for 2002 in keeping with the commitment to avoid pro-cyclical fiscal policies. An appropriate balance and sequencing have to be drawn between running down public debt, cutting taxes and financing public investment in key areas. Possible tax cuts should be designed so as to maximize their contribution to growth and employment and to ensure their sustainability over time, implying that they would have to be accompanied by firm control of public expenditure.

15. The recommendations outlined above imply continued responsible fiscal policies over the coming years. This would support the price-stability orientation of monetary policy and thereby foster continued economic growth and employment creation. The scope for this would be further increased if the prospects for inflation continue to abate.

16. Wage settlements in line with productivity developments are crucial for the attainment of a sound macroeconomic policy mix. The Social Partners should be called upon to continue to act in a responsible manner, thereby enhancing prospects for increased growth and employment

3.2 Strengthening the EU economy's potential for growth

3.2.1. Labour market reform

In the EU as a whole, unemployment remains unacceptably high while labour shortages have emerged in certain sectors and regions. Efforts need to be strengthened to boost employment through improved education and training, reforms of tax and benefit systems, reviews of labour market regulations and institutions and higher wage adaptability. In the long-term, a diminishing share of the working-age population may hamper potential growth. Therefore, measures to increase labour supply, in particular among women and older workers, are required in order to ensure higher output growth and sustainable public finances.

17. The functioning of the labour market needs to be improved to allow higher output growth and to improve conditions for coping with the challenge of an ageing population and enhancing social cohesion. The still high structural unemployment and low participation rates in the context of the emergence of labour market shortages, in particular sectors or regions, is a cause for great concern. This points to inappropriate incentive structures or other factors restraining people from working or increasing their labour supply, skill mismatches, and a lack of occupational and geographical mobility.

18. Policy action should focus on remedying these shortcomings, notably by making sure that work pays, promoting training and life-long learning, by reforming regulations and removing obstacles that constrain people from entering or remaining in the labour market. In this context, the Council sees the need for further progress on:

â Reforming tax and benefit systems so as to promote greater participation in working life and job creation; high effective marginal tax rates, generated by the interaction between taxes and income-related benefits, should be reduced. Some progress has already been made with tax reforms. But this is not enough. It needs to be complemented by further reforms of benefit systems. They should address their incentive effects, duration, eligibility and enforcement with a view to increasing employment.

â Promoting labour market participation, as the share of the working-age population will diminish due to demographic developments. There is a clear scope for increasing labour supply, particularly among women and older workers. Female labour market participation may be strengthened by diminishing tax disincentives; pursuing equal opportunities and providing better and extended child care facilities. The rate of employment among older workers may be promoted by making later retirement more attractive through further reforms of early retirement schemes and pension systems and by enhancing life-long-learning.

â Addressing skill-shortages through more efficient opportunities for education, training, and life-long learning. Specific labour market programmes should be aimed at groups with weak attachment to the labour market; and the functioning of employment services should be improved.

â Addressing large regional unemployment differences; by tackling obstacles to capital and labour mobility, within and between Member States. In parallel, wage formation processes should be allowed to reflect more adequately differences in labour markets and productivity.

â Reviewing labour market regulation and institutions to diminish obstacles to labour demand and supply which they may pose.

3.2.2. Financial markets: efficiency and integration

The creation of an integrated European financial market is of key importance for reaching the goals in the Lisbon strategy. Implementation of the various measures in the Financial Services Action Plan (FSAP) and the Risk Capital Action Plan (RCAP) are at the center of this effort. The momentum of work should be speeded up and more ambitious time limits set. However, for this to be achieved a more efficient legislative procedure must be found. Therefore, the basic conclusions of the Committee of Wise Men on the regulation of European securities markets should be endorsed and a European Council Resolution concerning a more efficient securities markets regulation adopted.

19. At present, the EU lacks a truly integrated financial market. As a result, businesses and households face unnecessarily high costs in making financial transactions and in raising capital. The Council considers that a truly integrated European financial market providing good access to capital in order for businesses to invest, grow and create jobs, will be essential in fulfilling the Lisbon ambitions. Financial integration will ensure both a better allocation of resources and a more efficient intermediation of savings among the Member States. It will further enhance EU economic performance by extending financing opportunities for investors. This is particularly important for innovative small and medium-sized enterprises, which have become a prime source of economic wealth and employment creation.

20. There is an urgent need for a more harmonized regulatory framework across the Union if the economic benefits of financial integration are to be maximized. In this respect, insufficient progress is being made in implementing the Financial Services Action Plan (FSAP). The Ecofin Council fully supports the basic features of the proposals made by the Committee of Wise Men, chaired by Mr Lamfalussy, outlining a new and more efficient legislative procedure in the securities area. The proposed regulatory reform has to be implemented in a way to ensure that the deadline for implementing a truly single financial market for 2005 is met. In addition, the securities' market proposals in the FSAP should be given priority to secure an integrated securities' market by the end of 2003.

21. Fast progress has to be made also with the other parts of the Financial Services Action Plan, in accordance with an ambitious timetable.

3.2.3. Product market reform

Accelerating reforms in product markets is essential for higher growth and employment and increased consumer benefits. Reform efforts need to be strengthened to realize the full benefits of the Internal Market. Action is needed to increase competition, speed up the opening of markets for network industries and public procurement, enforce an EU-wide market for services and to improve the entrepreneurial climate. State aids should be reduced and the functioning of competition and regulation authorities strengthened. Trade with third countries should be further liberalized.

22. The creation of the internal market has fostered competition in EU product markets. This has contributed to lower and converging price levels between Member States with obvious benefits for consumers, and a rationalization of production contributing to the competitive strength of goods and services companies.

23. In a similar way, the further opening of world trade will be instrumental in modernizing the European economy and serving the consumer, while at the same time benefiting third countries. The forthcoming guidelines should therefore signal the Community's continued commitment to trade liberalization, and opening a new trade round within the WTO.

24. Significant progress has been made in the functioning of product markets. However, the Council sees the need for priority action to:

â Fully implement internal market legislation through an accelerated reduction of transposition deficits.

â Modernize competition rules and ensure their application by active, independent competition authorities;

â Eliminate technical barriers to trade and open up the public procurement market inter alia by agreeing on the public procurement legislative package;

â Create a Europe-wide market for services by removing regulatory constraints on cross-border activities and market entry.

â Speed up and set clear timetables for the opening of markets in network industries such as electricity, gas, railways, transport, postal services; and foster competition in already liberalized network industries; ensure that consumers reap the full benefit of increased competition through the setting up of independent regulatory authorities and the adoption of transparent and appropriate market regulation, taking account of universal service obligations.

â Reduce ad hoc and sectoral State aids;

â Further reduce the administrative burden and barriers for business by introducing simpler and more transparent procedures, one-stop shops for company start-ups and by simplifying business tax systems; increase the efficiency of public administration.

3.2.4 The transition to a more dynamic, knowledge-based economy

Enhancing and encouraging the transition to a knowledge-based society is crucial to reach the Lisbon strategic goal. Further actions should be taken to stimulate the private sector’s engagement in R&D and innovation, strengthen the legal and regulatory frameworks and improve skills and qualifications.

25. Increased investments in human capital are required both in the public and private sector in order to move faster to a more knowledge-based growth and strengthened European competitiveness.

26. Business and citizens in the EU have been slow to embrace the opportunities of the knowledge-based society. Consequently, EU is lagging behind the United States in important areas such as investment in new technology, R&D and internet penetration. To facilitate the transition to the knowledge-based society, priority should be given to:

â Stimulating the private sector's involvement in R&D through an increased supply of trained researchers, strengthened incentives and the promotion of venture capital as well as improving university-business links to promote knowledge transfer and a better commercialization of R&D results;

â Strengthening the legal framework that rewards investments in R&D and new technologies, in particular in the field of intellectual property rights, including the proposed Community patent and the utility model;

â Implementing the e-Europe action plan; promoting trust and expanding the use of ICT by strengthening network security and strengthening the regulatory framework for digital transactions, in particular with respect to e-commerce and electronic signature directives, to expand the use of ICT;

â Improving skills and qualifications to address both the lack of highly qualified ICT personnel and to improve the basic skills of populations to foster social inclusion;

â Creating broad education networks in the academic area to develop open, high-quality study opportunities with a stronger European and international orientation and recognised, internationally attractive degrees.

3.3 Preparing for population ageing

The challenge of ageing populations will become a reality in virtually all Member States from around 2010 onwards. In addition to the need for attaining and maintaining budget positions close to balance or in surplus in the short term, Member States should over the coming years pursue more ambitious budgetary policies to reduce public debt burdens, to ensure fiscal sustainability, and to prevent an increase in the tax burden, in particular on labour. The challenge posed by ageing populations also requires action in other respects. In particular, higher employment rates, especially for women and older workers, must be promoted, and public pensions, healthcare and programmes providing long-term care for the elderly must be reviewed and where necessary reformed. By addressing the challenge of ageing populations now, Member States can contribute to the resolution of a potentially problematic common issue.

27. The need for sound macroeconomic policies and comprehensive economic reforms is amplified by the challenge posed by ageing populations that is visible on the horizon. On present trends, the EU’s working age population will fall by approximately 40 millions and the old age dependency ratio more than double between 2015 and 2050. Furthermore, tentative calculations

point to increased expenditures on public pensions in the order of 3-5 % of GDP during the period 2010 and 2050. In addition, expenditure on health care and care for the elderly is expected to increase substantially. Member State governments should therefore act now and make use of the window of opportunity that currently exists, in order to contribute to the resolution of a potentially problematic common issue.

28. The declining share of the working age population will make it harder to bring about the labour supply required for an increase in productive capacity. This further underlines the necessity of making better use of existing human resources, in order to maintain a sufficiently broad basis to run the economy and to shoulder the financial costs involved. Efforts will therefore be needed to increase labour market participation, in particular among women and older workers.

29. Due to the additional strains on public expenditure caused by these demographic developments there is an urgent need to ensure long-term sustainability in public finances and to achieve structural improvements through reducing debt burdens and associated interest payments at a faster rate. In addition, the fiscal sustainability of pension systems, health care and programmes providing long-term care for the elderly should be reviewed and reforms made, where necessary.

30. Pension reforms have to address, depending on their respective nature, different issues: the balance and link between contributions and entitlements, funding, investment restrictions, retirement age and indexation rules. The establishment of an EU legal framework to ensure that pension funds enjoy a truly single market will also be important, thus enhancing the performance of pension funds and promoting, at the same time, security for beneficiaries. The development of pension funds could also increase risk capital for European companies, thereby underpinning growth and employment. Important questions relating to pension policies, which reflect a wide range of issues, are being examined in a number of fora, including the Economic Policy Committee. It is important that this work should be coherent and taken forward in a consolidated manner.

31. Member states should develop strategies for addressing the longer-term demographic challenge and present them in conjunction with their Stability and Convergence Programmes. The strategies should be examined in the context of multilateral surveillance.

4. The forthcoming guidelines

The Council believes that the 2001 guidelines should build on the progress made over the last year and give a clear direction to the future course of policy, in particular for 2002. The guidelines should:

- be challenging, reflecting the ambitious objectives set at Lisbon, and where needed accelerate and intensify existing actions;

- be precise in setting concrete targets and clear dates by which the targets should be met.

32. The Lisbon summit concluded that the BEPG should focus increasingly on medium- and long-term implications of structural policies and on reforms aimed at promoting economic growth potential, employment and social cohesion, as well as on the transition towards a knowledge–based economy. A growth- and stability-oriented macroeconomic policy mix, as backed by the Cologne process, has to be complemented by comprehensive economic reforms. The Cardiff and Luxembourg processes are mandated to deal with their respective policy areas in greater detail. Last year’s guidelines had already been framed in response to the Lisbon agenda. The Council considers that, in a spirit of continuity, the forthcoming guidelines should be ambitious, focus on action in the next year, be precise on the targets and draw, where possible, on evidence from agreed economic and social indicators on the progress made and serious challenges which remain for the EU if it is to meet the Lisbon objectives. In the same spirit, the forthcoming guidelines would also deal with the promotion of sustainable development.

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