08 March 2006
The economic recovery in Europe is expected to continue. GDP in the euro area is forecasted to grow by 2.0 per cent in 2006, remaining lower than in most other parts of the world. Inflation in the euro area is expected to reach 1.9 per cent this year. The labour market situation will only improve marginally.
Macroeconomic policies in the euro area are heading towards an undesirable mix of monetary and fiscal policies. The ECB is likely to tighten monetary policy, whereas the stance of fiscal policy will probably remain more or less unchanged. Such a mix is inimical to growth.
For reasons of long-run sustainability, structural budget deficits in the euro area should be reduced. This would leave room for a looser monetary policy than would otherwise be possible. Key to a better policy mix is a restoration of incentives for fiscal discipline, which were watered down by the 2005 reform of the Stability Pact. One way of achieving this could be for the ECB to reform its monetary policy framework, involving a rise in the inflation target, conditional on a strengthening of fiscal policy institutions. A small group of fiscally responsible EU states could also take the lead by entering into enhanced fiscal policy co-ordination.
Global Imbalances
Huge global imbalances have emerged as a result of the massive current account deficits of the US. The US deficit is largely matched by surpluses in Asia, oil-exporting countries and a few European countries. Correction of global imbalances will require substantial depreciation of the US dollar, though the extent of the adjustment cannot be precisely estimated.
The correction of global imbalances could lead to a prolonged fall in the external demand for European products as well as to increased competition from US firms. A large enough fall of the dollar could cause substantial negative wealth shocks arising from reductions in the value of Europe’s dollar-denominated assets.
The risk of a financial crisis will increase if a large fall in the dollar is accompanied by a drop in US and worldwide output. It would be difficult to deal with such a crisis under the current frameworks for monetary and fiscal policy. The sizeable government budget deficits in some large EU countries imply that fiscal policy may not enjoy the necessary room for manoeuvre in such a situation.
Economic Growth in the European Union
Growth performance among the EU-15 countries has been mixed. While it has been sluggish in France, Germany and Italy, several other EU countries have done well. Some successful countries, such as Finland, Ireland, Sweden and the UK, have relied strongly on the introduction of new technologies, in particular information technology. Greece and Spain have also been successful but have relied on traditional capital accumulation and increased labour input.
The Lisbon Strategy, which focuses on the role of knowledge-based industries, should adopt a more flexible approach. Countries on the technology frontier should continue to rely on knowledge-based sources for growth. Other countries would be better advised to rely mainly on accumulation of traditional capital and increases in labour input, while they approach the high-tech frontier via technology transfer.
The key areas for growth policy include improvements in education and IT adoption, together with measures that enhance competition among firms. Fostering innovation and improving entrepreneurial activities in the EU is vital for economic growth.
Prospects for Education Policy in Europe
Educational systems are under pressure in many countries. On the one hand, the costs of education are soaring as both enrolment rates and the length of studies trend upward, while the cost per pupil grows as fast as GDP per capita. On the other hand, there is a perception that standards and achievements are going down.
Large disparities are evident between countries in terms of achievements in reading, mathematics and science, occurring even among countries that are similar in economic and demographic terms. The amount of resources devoted to primary and secondary education does not seem to have a large impact, whereas the structure of school systems seems to matter a lot.
Simply devoting more resources to education or pursuing naïve targets – such as a reduction in class sizes – are not effective ways to improve school systems. Instead, policies should focus on a better organisation of schools.
Increasing parental choice and fostering competition among students to get into good schools as well as among schools in order to attract good students seem to be more effective policy reforms. If designed well, such reforms do not lead to unfair or non-egalitarian practices.
Mergers and Competition Policy in Europe
Merger activity is gathering pace in Europe. The policy challenge lies in how to achieve cost-cutting increases in firm size from restructuring in the face of globalisation, while simultaneously maintaining sufficient competition. This requires that obstacles to hostile and cross-border mergers be removed, while care is taken not to promote European champions that end up being effectively protected from bankruptcy. Competition policy should not enforce low concentration in natural oligopoly industries, where only a small number of firms can survive.
The 2004 reform of the merger control procedures in the EU was a step in the right direction. But further checks and balances should be introduced, and the lobbying influences by national governments and large firms minimised. One possibility would be to create an administrative panel, independent of prosecutors and investigators, that gives a public recommendation to the Commission or even takes final decisions. Failing this, a debate should be opened about the need for an independent European competition agency similar to the US Federal Trade Commission.
About EEAG: The European Economic Advisory Group at CESifo (EEAG) consists of a team of eight economists from seven European countries. It is chaired by Seppo Honkapohja (Universities of Helsinki and Cambridge) and includes Lars Calmfors (University of Stockholm, vice chairman), Giancarlo Corsetti (European University Institute, Florence), John Kay (St. John’s College, Oxford), Gilles Saint-Paul (University of Toulouse), Jan-Egbert Sturm (ETH, Zurich), Xavier Vives (IESE, Barcelona), and Hans-Werner Sinn (Ifo Institute, Munich). All members participate on a personal basis. They do not represent the views of the organisations they are affiliated with. The aim of this report is to comment on the state and the prospects of the European economy. With the support of the Ifo Institute it provides a European economic forecast and discusses topical economic issues that are of general interest to policy makers, managers, academics and the European public in general.
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