See content page for download (PDF) of single chapters or the entire issue.
This report is the third annual report by the European Advisory Group at CESifo. It includes five chapters, each addressing a set of emerging policy issues in the euro area and in the European Union as a whole. The executive summary provides a brief synopsis of the report and presents the main conclusions of the group as regards both analysis and policy proposals.
The first chapter discusses the current economic situation and the future outlook for Europe stressing the cause and implications of a strong euro as well as the need for a common fiscal framework through an improvement of the Stability and Growth Pact.
The second chapter discusses the political constraints that prevent governments from implementing labour market reforms and identifies factors and conditions that, in the current situations could soften political opposition. In addition, it analyses alternative policies that are effective in reducing unemployment, while encountering much less opposition than labour market reforms.
The third chapter analyses current pay-setting arrangements in Europe as well as the prospect of reform. It reviews the positive experience of many small European countries that have achieved real wage moderation through co-ordinated collective bargaining as well as the experience of countries where the achievements of collective bargaining are arguably much less positive. In either case, European countries would benefit from more diversity in relative wages.
The fourth chapter reviews some aspects of the new draft constitution for the European Union, pointing to possible undesirable consequences from including non-discrimination as a general rule in the European constitution.
The fifth chapter presents a “primer” on the ten new members of the EU starting in May 2004. It summarises the income and structural differences between them and the old members of the EU and analyses a number of economic policy issues regarding growth, migration, public finances, trade, foreign direct investment and capital mobility.
The sixth chapter discusses the challenge to macroeconomic stabilisation in the ten new members of the EU during the convergence process posed by liberalised capital markets.The focus is on financial and currency fragility created by dangerously high volatility of capital flows and possible policies to reduce macroeconomic vulnerability to a crisis.
While growth in Europe was disappointing in 2003, there are indicators that point to a moderate recovery in 2004. The first chapter of our report presents our forecasts and a discussion of the macroeconomic outlook. In our forecasts, European GDP will grow at a rate as high as 2 percent in 2004, once again lagging significantly behind the United States.The global macroeconomic imbalances imply a risk of further dollar depreciation, undercutting European growth and potentially creating tensions about the appropriate fiscal and monetary policy mix in the euro area. The failure of the Ecofin Council to enforce the fiscal rules in the Treaty and in the Stability and Growth Pact in November 2002 has already created a discrepancy between the legal rules and their application.This implies a dangerous vacuum. In the 2003 EEAG report we presented a proposal aimed at improving the Stability and Growth Pact which links the size of maximum budget deficits to the stock of public debt.The proposal also aims at reducing political conflicts of interest in the enforcement of the new improved rules by moving these decisions to the European Court of Justice. Better fiscal rules can prevent the current institutional crisis from depriving Europe of a much needed common fiscal framework.
Because of political constraints, the margin of manoeuvre for governments to combat unemployment with radical labour market reforms is typically quite narrow. The second chapter identifies a set of policies to reduce unemployment that would encounter much less political opposition. These include liberalising product markets; introducing a simple “firing tax” that would be paid to the worker as severance payment instead of the current system of legal procedures; replacing welfare payments for the poor with in-work benefits such as earnedincome tax credits (a proposal was formulated in the 2002 EEAG report); and ensuring that the search activity of the unemployed be tightly monitored, with sanctions in the form of reduced benefits if search is not active.
But, as shown by the United Kingdom, Spain and more recently Germany, a severe crisis and a sense of urgency can help to implement reforms that would otherwise be politically doomed. A critical point has been reached in a number of European countries, not so much because of overall macroeconomic performance (the current slowdown is milder than the previous one), but because of budgetary problems (including the adverse consequences of labour market rigidities for the financing of valuable benefits such as pensions and health care as well as for long-run living standards) and the feeling that “globalisation” is making the burden of labour rigidities unbearable. This is somehow “good news”, but also “bad news” in the sense that the expected economic recovery may cause governments to diminish their reform efforts. This would be regrettable, since a recovery would make the immediate costs of reform much easier to bear.
An important dimension of labour market reform concerns pay-setting arrangements, which have significant implications for both macroeconomic performance (by affecting the level of real wages) and economic efficiency (by defining incentives for achieving higher productivity). The third chapter analyses current pay-setting arrangements in Europe as well as the prospect of reform. A main conclusion is that most Western European countries would benefit from more diversity in relative wages. This applies to small European countries that have achieved real wage moderation at the aggregate level through highly co-ordinated collective bargaining as well as to a country like Germany where wages are determined at the sectoral level. Acceding countries are advised to stick to their current (Anglo-Saxon type) systems of industrial relations, with limited importance for collective bargaining and decentralised bargaining at the level of the individual firm if such collective bargaining does take place. Pay-setting systems are very slow to change: it takes a very long time or extraordinary circumstances to achieve radical changes. Therefore, specific recommendations for individual countries, that are to have an effect in the medium term, must be limited to improvements of the existing bargaining systems, which for historical reasons may differ fundamentally among countries.
In the fourth chapter we review some aspects of the new draft constitution for the European Union. It is, we believe, not the intention of the European Union to give to its courts the policy-making vote that the Supreme Court of the United States has assumed. But the assertion of ‘non-discrimination’ as a fundamental European value to be written into the constitution invites this very consequence. We fully share the objectives of those who argue for measures against discrimination: the elimination of racism, the advancement of women in public and business life, greater support for disabled people, and the establishment of a true common market in which national origin ceases to be of economic relevance. Yet there is a danger that the necessarily pragmatic pursuit of policies to achieve these objectives will be overtaken by the semantic interpretation of exactly what constitutes discrimination and non-discrimination if non-discrimination were to be included as a general rule in the European constitution. Some forms of “discrimination” are in fact essential in a well-functioning society. For instance, without statistical discrimination for insurance purposes, asymmetric information between economic agents would make many important insurance markets disappear, with possibly high costs in terms of general welfare. Similarly, in our proposal of welfare state reform included in the 2003 EEAG report, we stress that delayed integration of new foreign workers into the national welfare system could prevent an undue scaling back of the welfare state, which would be damaging for both national and foreign workers.
What should European citizens expect from the accession of ten new members in the EU in May 2004? The fifth chapter of the report presents a “primer” on acceding countries, summarising the income and structural differences between the new and the old members of the EU and analysing a number of economic policy issues regarding growth, migration, public finances, trade, foreign direct investment and capital mobility. Our analysis emphasises that convergence of the new countries’ income to the EU average will be a very long process with considerable uncertainty about modalities and possible structural and policy problems emerging along the way. This conclusion counters the widespread view that problems in acceding countries are quite minor because convergence will be relatively quick. The few examples of rapid and successful convergence, such as Ireland, are the exception rather than the rule. Large-scale migration, unemployment, financial instability and fiscal imbalances will prevail for some time. Existing studies tend to downplay the importance of the impact of accession on the current EU member states, stressing that the main effects are likely to be felt at the sectoral and/or regional level. But the uncertainty surrounding the economic and policy problems in the post-accession phase is enormous. If anything, the large differences in the rate of return of capital in acceding countries and the rest of the EU suggest that the implications of accession for Western European countries are larger than suggested by the weight of acceding countries’ GDP in total EU GDP. Migration and trade can substantially influence the current problems in the labour markets and of the welfare states in most current EU countries.A major problem will be the decline in the wages of low-skilled workers in the current EU countries. Ultimately, this decline is associated with gains from trade in the enlarged EU area: ideally it should result from a smooth and rapid structural adjustment process. But a wage decline cannot easily be administered with the present pay-setting institutions, especially in countries where the welfare system pays high replacement incomes. We therefore fear that the transition will be unnecessarily difficult for some of the existing EU economies, unless they find effective and socially acceptable ways to reform their institutions, so as to allow for the necessary wage flexibility in the near future (our proposals are discussed in Chapter 2 of this report as well as in the 2002 EEAG report).
How soon should acceding countries enter the EMU? The sixth chapter of the report reconsiders the challenge to macroeconomic stabilisation during the convergence process posed by liberalised capital markets. A number of factors inherently linked to convergence are likely to create financial and currency fragility and lead to dangerously high volatility of capital flows. There is no single strategy that could be recommended to all acceding countries as regards macroeconomic stabilisation on the road to the euro. Countries that are already able to sustain hard pegs (mostly small countries) should be helped to achieve a smooth and fast transition to the euro. Delaying participation in ERM II is instead a realistic option for countries that are currently unable to sustain such hard pegs. Here the policy priority is the reduction of domestic imbalances, achieving a sustainable fiscal stance and stabilising inflation at the correct relative prices. For both groups of countries, the convergence criteria in terms of inflation, interest rates, debt and deficits provide desirable targets to guide policy and should not be relaxed. Once countries enter ERM II, the risk of crisis is somewhat reduced, but not eliminated, by letting acceding countries make full use of the 15 percent bilateral exchange rate bands.
Report on the European Economy Vorstellung und Bestellinformation
EEAG European Economic Advisory Group at CESifo Vorstellung und derzeitige Mitglieder
Vorstellung der EEAG Video, 4 min.
Login EEAG members Password forgotten?
RSS