EU Economic Survey 2012

The origins of the crisis lie in inadequate financial oversight, insufficiently prudent and disciplined fiscal policy, and weaknesses in structural policies during the upswing of the credit cycle that gave rise to serious imbalances.

 The EU27 economy is in a serious downturn driven by the euro area sovereign debt crisis and on-going weaknesses in the wake of the financial crisis. It has left many countries with weak banking systems, poor public finances and high rates of unemployment. Through close trade linkages and the financial system, the ensuing crisis in the euro area could have a significant negative impact on the European economy as a whole. These effects are having a dampening effect on growth in the United Kingdom, where the recovery is also subdued due to continued fiscal and financial retrenchment, while Sweden is growing only moderately. Despite strong linkages to the euro area, central and Eastern European countries (EU12) are likely to maintain stronger growth on average than the EU15 economies but some continue to face large fiscal deficits and financial fragilities, as well as high unemployment.

Longer-term prospects are for growth to be weaker than over the past twenty years and to slow over the coming decades under current policies: potential growth is projected at an annual rate below 2%. It is influenced by population ageing, both in EU15 and EU12 countries, which would lead to an overall reduction in the working-age population in the absence of major pension reform or large immigration flows and by sluggish productivity gains.

Structural weaknesses in labour and product markets contribute to low productivity and employment, as well as slow growth. An ambitious programme of structural reforms is needed to achieve a sustainable improvement in the growth prospects. Peer reviews of structural policies are now linked through the EU Semester process to other high-profile policies on budgetary and economic stability. A euro area country could even in principle be required to undertake structural policy measures in the context of the new Macroeconomic Imbalances Procedure, which is backed by financial sanctions. However, it remains to be seen how effectively these mechanisms will be enforced, notably with respect to structural policies.

EU labour markets have structural weaknesses that hinder job creation. There are large imbalances of supply and demand of labour between and within countries. Overall employment rates are low due to modest participation rates and persistently high unemployment rates in some countries. Groups with weak attachment to the labour force, such as women, immigrants, older and younger workers are most affected, especially in southern and Eastern Europe. In particular, youth unemployment in the EU rose to an unprecedented 21% in 2011. Labour market regulations and tax-benefit systems fall largely outside EU competences and require reforms at national level. However, removing obstacles to labour mobility within Europe and achieving a coherent framework for labour migration would help to make the labour market work better. The recognition of professional qualifications across the EU should be further developed. The Blue Card should be used effectively to make it more attractive to high-skilled workers. With demographic changes underway, most EU countries expect growing shortages of skilled labour or workers in specialised activities.

The weak growth performance in the EU has been accompanied by growing social problems and rising inequality. This reflects in part the high unemployment, the development of dual labour markets and detachment from the labour market of vulnerable workers, such as young people with little work experience, older workers or those with low skill levels. The redistribution of wealth as the result of developments in financial markets also contributed to that. The richest tenth of the population in most EU countries has been capturing a growing share of national income over time, while those in the lower half of income distribution have tended to gain less.

One of the European Union’s strongest tools to boost growth is the binding instruments and communautaire approach that underpin the Single Market project. Strengthening the Single Market (see Single Market Act II) should be at the centre of EU policy action. The EU’s internal market remains fragmented in terms of trade and financial integration, services; significant barriers remain in sectors including government procurement, energy, telecommunications, transport and postal services. Specific measures are required in each sector, such as simplifying tendering procedures for government procurement and full ownership unbundling in power generation and transmission (3rd Energy Package). The main obstacles are market regulations at national level and poor implementation of existing Single Market requirements**. There should be a clear annual report on the implementation of the Single Market for each country, both in a legal and, more importantly, in a practical sense. More rigorous political and economic sanctions could be used for failure to make sufficient progress in opening markets, including loss of access to EU funds.

         The growth of trade between the EU and the rest of the world has weakened since the crisis and there is a risk of rising protectionist pressures and growth consequences. During the crisis, the EU has largely maintained the overall openness and transparency of its trade and international investment policies. Policy intervention has mainly focused on the financial sector, although other sectors, notably automobiles, construction and tourism, received support within the context of the EU state aid rules. To promote further trade integration, efforts should be stepped up to advance the Doha round to strengthen the multilateral system.

          Integration of the financial system has advanced well in some areas but remains patchy so far in others. New European Supervisory Authorities (ESAs) have been created in banking, securities markets and insurance to strengthen microprudential oversight of cross-border institutions. The European Systemic Risk Board (ESRB) has been created to oversee macroprudential risks. The new Single Rule Book approach being set out in legislation currently under consideration will support a better managed form of financial integration by reducing the scope of national discretion. This will help to ensure that the Single Market develops further and on a more sustainable basis.

An important factor for future growth will be the ability of EU countries to reap the benefits of globalisation. This depends on the good functioning of labour and product markets, the innovation framework and the education system, and a fair sharing of the costs and benefits of globalisation. The need to adapt to sustain growth is likely to increase as emerging countries move up the value chain and become more likely to compete directly with a wider range of products currently produced in European economies. Innovation is essential to supporting long-term growth. Europe continues to lag behind the United States in terms of innovation performance, while some emerging countries are rapidly increasing their capabilities in innovation-related higher education and research. Academic research in Europe is not enough connected to business activities (EIB, 2009). Although innovation policies remain largely at national level, the EU is pursuing an ambitious agenda and its Innovation Strategy sets out a broad set of actions to ensure that ideas are translated into innovative goods and services that create growth and jobs. In 2011, the Commission proposed a substantial reorientation of EU support for innovation as part of the “Innovation Union” and with a single strategic framework, Horizon 2020***, to fund spending.

Achieving sustainable growth requires management of the environmental consequences, although this challenge also creates opportunities to build a new growth model. These issues form an integral part of the EU 2020 strategy****, which includes the “20-20-20” objectives to reduce greenhouse gas emissions, increase the share of renewables and increase energy efficiency. The EU has taken an important leadership role in international efforts to combat climate change by pressing for all countries to negotiate a legally binding agreement under the UN Framework Convention on Climate Change. The European Union is well on track to meet its target of a 20% reduction in emissions by 2020 relative to 1990, which has been assisted by the sharp drop in emissions due to the weak economy.

*Excerpts from OECD Economic Surveys – EUROPEAN UNION, MARCH 2012
**The European Commission sought to relaunch the Single Market project with the 2011 “Single Market Act” Communication. The twelve key legislative actions it identifies should be passed by the end of 2012 as planned.
***The EU Framework Programme for Research and Innovation
****The EU has set itself ambitious targets with the EU 2020 strategy http://ec.europa.eu/europe2020/documents/related-document-type/index_en.htm). Many of the necessary reforms require changes in national policies and institutions.