European Commissioner for Economic and Monetary
Economic Governance: Addressing the Challenges
European Economic and Social Committee (EESC) Plenary Meeting
Brussels, 15 February 2006
Ladies and Gentlemen,
It is a great pleasure for me to be here at this Plenary Meeting of the European Economic and Social Committee. The EESC is a much appreciated source of advice for the Commission’s activities. Your opinions, as a result of either formal consultation or your own initiative, are an excellent way for us to hear, and to listen to, the views of organised civil society.
Already on many occasions your Committee has given advice on issues related to economic policy coordination. And on your agenda today you again have two own-initiative opinions in this area. We obviously share the view that good economic governance is a matter of great importance for the European Union! So I am very pleased to share with you my thoughts on this issue.
There is also a third opinion on your agenda, which deals with the creation of a common consolidated corporate tax base in the European Union. I will touch upon this as well but will not go into great depth since it is clearly a matter for my colleague Commissioner Kovács.
Good economic governance – in so far as it fosters macroeconomic stability and structural reform – is conducive to a better macroeconomic performance. So I will comment on the progress we are making in these areas.
There are three issues I would like to focus on today:
I will conclude with a few words about the cooperation between the Commission and the EESC.
1. Macroeconomic stability
One of the main achievements of the Economic and Monetary Union (EMU) has been the creation of macroeconomic stability in Europe. The “stagflation” of the 1970s and early 1980s was a salutary experience for Europe. An inappropriate monetary and fiscal policy response to the two major oil price shocks resulted in output stagnating and prices soaring. This was surely a costly demonstration of the consequences of a weak macroeconomic policy framework.
EMU has delivered low and stable inflation rates. Consumer price inflation has come down from rates around 7 per cent in the 1980s and above 4 per cent in the early 1990s to around 2 per cent today. However, headline inflation has been a little above the 2 percent ceiling for some time now. This partly reflects the impact of higher oil prices.
Securing low inflation is the best contribution that monetary policy can make to sustainable growth over the longer term.
Firstly, because low inflation makes it easier to observe changes in relative prices. This allows households and firms to make better informed consumption and investment decisions, which promotes efficiency. Secondly, investors will be less likely to demand an “inflation risk premium” to compensate for holding riskier assets. In other words, low inflation improves the efficiency of capital markets, which also fosters economic growth. Thirdly, price stability reduces the need for households and firms to divert scarce resources from productive uses in order to hedge against inflation. Again, this promotes efficiency and thus long-run growth.
In addition, EMU has eliminated exchange rate risk within the euro area. This has improved price transparency, eliminated “exchange risk premia”, stimulated financial market integration and made intra-euro area transactions cheaper. These factors should all contribute to higher growth in the euro area.
Fiscal discipline has also helped to underpin macroeconomic stability in EMU. The reduction of budget deficits since the early 1990s has helped to create more favourable conditions for investment and boost confidence. In the short run, sound fiscal positions have allowed the automatic stabilisers to operate relatively freely in response to economic downturns. In the medium and long run, the Pact promotes sustainable public finances and favours a reallocation of public resources in line with government priorities. It provides an appropriate framework for prudent budgetary management that is conducive to growth. It is thus in the economic self-interest of all countries.
While the experience with the Pact has been positive overall, its application during the first years of EMU revealed some shortcomings and hence the need for reform, and a revamped SGP was agreed to in March 2005. The Opinion prepared by Ms Florio and Mr Burani of this Committee on the reform of the Stability and Growth Pact (SGP) is rather critical. I would like to respond to it by presenting my views on the SGP reform and arguing that the revised Pact is in fact working well in practice.
The reform strengthens the economic rationale of the rules. Let me give three concrete examples:
I strongly believe that full implementation of the revised SGP will bring better results than partial implementation of the original Pact. This is not just wishful thinking. There are very convincing arguments that a rules-based framework that has a sound economic basis and allows room for judgement will lead to better outcomes. Let me just stress three key elements.
Finally, I would like to point out that our initial experiences with the revised Pact have been encouraging and suggest a renewed sense of national ownership of the framework. In the cases of Italy and Portugal, the revision of the Pact allowed deadlines for the correction of excessive deficits to be set that were realistic about the appropriate speed of adjustment. The case of the UK also confirmed that the new Pact is being implemented as it should be.
Overall, I believe that the SGP reform struck the right balance between the economic rationale and simplicity, between allowing more room for judgement and maintaining the rigour of the rules-based system. If we Full implementation of its provisions would go a long way towards addressing the main challenges currently faced by fiscal policy in the EU.
It is clear, then, that EMU has greatly contributed to macroeconomic stability through low inflation, the euro and fiscal consolidation. Nevertheless, I see scope for further progress towards macroeconomic stability in Europe, not only among the new Member States, which are understandably still in the convergence process, but also among the older ones.
Now I would like to turn to the medium- and long-term challenges Europe is facing, and in particular the need for structural reform.
2. Structural reform: main challenges and the renewed Lisbon Strategy
The most pressing challenges that Europe currently faces are the lack of growth and new jobs, the growing competitive pressures from an integrating world economy, and the consequences of the ageing of the population. The way we tackle these fundamental challenges will be crucial for the future prosperity of the Union and the well-being of its citizens.
After a prolonged slowdown, there are early signs that the EU’s economic outlook is improving. Despite this good news, the EU economy still lacks resilience in the face of shocks. Potential growth remains low at around 2%. Europe’s labour force is still grossly underutilised as witnessed by low employment rates as well as high and persistent unemployment.
Moreover, demographic projections are quite unfavourable for Europe. This will put strains on the sustainability of public finances in many EU countries. According to the EPC and Commission report endorsed yesterday by the ECOFIN Council, the EU’s old-age dependency ratio is projected to double in the next half-century so that Europe will go from having four people of working-age for every elderly citizen to only two. This means that the effect of population ageing alone might reduce the rate of potential growth by nearly half between 2031 and 2050, to 1.3%. This, as you can imagine, will put the sustainability of the European social model under pressure. Expenditure on pensions and health care is on the increase while the reduction of labour supply will jeopardise our ability to maintain high economic growth.
Finally, the European economy is part of an increasingly integrated world economy. The challenge is to make globalisation work to the EU’s advantage. And we can. We must use it to make the EU more competitive. A recent report by the Commission shows that the present phase of globalisation could bring substantial income gains over the next half century – but only if we fully exploit the opportunities. However, it will also require considerable short- to medium-run economic adjustment in some sectors of the European economy.
How can we meet the challenges I have just described? First, we need to step up our potential growth, by becoming more productive and increasing employment. And second, we must make the EU a global and dynamic economy, more resilient and adaptable. This would enable us to move to growth sectors and processes and to embrace new markets while cushioning the internal social and economic adjustment.
To do this we need to put in place a comprehensive set of EU-wide structural reforms in product, labour and capital markets. We need more investment to increase our human, physical and knowledge capital, and we need to reorganise our economy. And these structural reforms need to be underpinned by appropriate growth- and stability-oriented macroeconomic policies.
The 2005 Spring European Council recognised the urgency of action to strengthen Europe’s competitiveness and boost its growth potential, and re-launched the Lisbon strategy with a stronger focus on raising growth and employment. Policy advice on how precisely to achieve this is provided by the Integrated Guidelines package, which includes the EU’s main policy coordination instruments, the Broad Economic Policy Guidelines and the Employment Guidelines. The governance of the strategy has been modified to take the form of a partnership between the Community and the Member States. This has resulted in a clearer and more streamlined distribution of tasks and responsibilities.
As a first step, Member States submitted their National Reform Programmes in the autumn of 2005. These Programmes set out the Member States’ own reform strategies, which follow the general directions given by the Integrated Guidelines but are tailored to their individual needs. The Annual Progress Report published by the Commission at the end of January assesses the National Reform Programmes and the progress of the re-launched strategy, and shows that the EU is on the right track. Nevertheless, the path ahead remains long and demanding. The report also identifies four areas for urgent action: knowledge and innovation; business potential; globalisation and ageing; and energy policy. Measures in these areas should be implemented by 2007 and complement the medium-term priorities specified in the Integrated Guidelines.
As I’ve mentioned, an important element of these Integrated Guidelines are the Broad Economic Policy Guidelines – the BEPGs. They are the Union’s key economic policy instrument for advancing the Lisbon agenda. I am therefore glad to note that this Plenary is also discussing the BEPGs and I share the assessment in your draft opinion prepared by Mr. Metzler. Sound and sustainable macroeconomic policies and broad-based structural reforms are essential for confidence, growth and raising potential output. The standard of living we enjoy in the future will depend on progress in building the knowledge economy. As you rightly stress, this will require sustained efforts to improve education, training and research – the building blocks of a highly innovative economy.
3. Common Consolidated Corporate Tax Base
Turning to the forthcoming opinion of rapporteur Mr. Nyberg on the creation of a common consolidated corporate tax base in the European Union, I cannot emphasise strongly enough just how important such a common tax base is for companies doing business Europe-wide.
Contrary to what some may think or would like us to think, this debate is not about stopping tax competition or about violating Member States’ rights to decide on tax rates. The debate is really about removing important tax obstacles to the Single Market in order to unleash the full employment and growth potential of the European economy. Studies show that companies with subsidiaries in another Member State have higher tax compliance costs than companies with only domestic subsidiaries. Studies also show that harmonising tax bases would bring GDP and welfare gains.
I am sure the European Economic and Social Committee will agree with me that a common tax base should ideally meet the following four criteria.
I am very pleased that the 25 Member States have chosen to collaborate with the European Commission on the common consolidated corporate tax base project. I hope that this Committee will support the initiative. But I am confident that goodwill and common sense will enable us to rapidly find a viable solution.
4. Summary and reflections on future enhanced cooperation between Commission and EESC
To recap the main points of my argument today:
I would like to conclude my presentation with some reflections on the future cooperation between the Commission and the EESC. As I already mentioned, the EESC has made a significant contribution to the review of issues related to economic governance in the EU and the euro area. The two opinions on the agenda of the February Plenary are the results of fruitful discussions in the EESC’s study groups and in the Section on EMU and Economic and Social Cohesion. DG ECFIN has very actively participated in the preparatory work, giving its position on the assessment and recommendations made in the draft opinions, while the debates organised by the EESC with Mr Jean Pisani-Ferry and Mrs Berès have also provided useful background.
However, even closer inter-institutional relations and improved cooperation would be welcome. This would enable us to better exploit the potential synergies between our organisations. A new framework agreement was signed to this end on 7 November 2005, advocating a more active role for the EESC in the preparation of Community action and closer cooperation with the Commission. The first step in this will be to choose issues of common strategic interest, and then decide how to coordinate our work on those issues to achieve the best result. Personally, I would be more than happy to discuss issues of common interest with you in this Plenary on a more regular basis. So thank you once again for inviting me today.