On 17 February, Belgium's Prime Minister Guy Verhofstadt forwarded a document to his counterparts with a view to the Spring European Summit on 22 and 23 March. The paper sets out detailed suggestions for a “Community strategy on growth in the European economy” (see yesterday's EUROPE, p.6). The text is published in full in our EUROPE/Documents series (in French, English and German).
A EUROPEAN 'PENTATHLON'
A COMMUNITY GROWTH STRATEGY FOR THE EUROPEAN ECONOMY
The Stability Pact is and remains the vital instrument in promoting the health and success of EU monetary union and the euro. The Pact has successfully steered the countries of the euro zone towards a healthy budgetary policy. Balanced budgets and diminishing government debts are essential preconditions for growth and employment. They also instil consumer confidence and promote lower interests rates and increased investment. Otherwise, however, the Stability Pact has provided little or no guidance and has failed to lead to a practical growth strategy for either the European Union or the euro zone.
Hence the development five years ago of the Lisbon Strategy. The strategy contains several laudable objectives and targets (including that target of "making the EU the most competitive knowledge-based economy in the world by 2010"), which we fear will not on the whole be achieved since the method employed - the so-called open coordination method - is far too informal. After all, simply compiling results tables and reports comparing the methods used and results achieved by different Member States has little effect and by which the European Union is coming to resemble an economic think tank. Although the adjustments to the Lisbon Strategy currently being proposed do improve the approach, the impression is created that two of the three pillars (social and sustainable development) are getting less attention. There is indeed a global action plan and each Member State must draw up a national plan clearly indicating step by step how it intends to achieve the goals set out in this global plan. But it remains to be seen whether relying on Member States' goodwill will be sufficient.
Anyway, they keep on focusing almost exclusively on national measures by individual States. That gives the impression that the problems facing the European economy differ widely from one country to the next and are therefore best dealt with at national level. The fact is that at the beginning of the 21st century we have a single European economy, with a single currency and a single (albeit incomplete) market, with its own strengths and specific structural weaknesses. But through an ambitious and collective Community approach we have nevertheless succeeded in largely eliminating customs barriers to movements in goods and capital, and overcoming monetary disarray. The high point of this approach was the introduction of the euro on 1 January 2002. Why not now employ the same ambitious Community approach in attempting to bring about a competitive European economy? What's more, by favouring a national rather than Community-based approach, we risk seeing the uniqueness of the European social model being overshadowed and undermined by a battle between the national measures implemented by individual Member States. Social and fiscal dumping in national action plans threatens to overpower a coherent and coordinated Community approach to problems - a threat that is all the more real following the recent enlargement of the European Union. In a nutshell, national action plans are good but they can never replace an overall growth strategy which is what we require now in the wake of the Stability Pact and the Lisbon goals. This kind of overall Community growth strategy will also ensure that the Stability pact remains solid. This overall European growth strategy must start by pinpointing and analysing the weaknesses in the European economy in order to intervene effectively and provide a clear response to those weaknesses.
What shape is the European economy in today?
Average growth figures remain low in comparison to other world growth centres. The average growth in GDP between 1992 and 2002 was 1.9% in the euro zone as compared with 3.3% in the United States. OECD forecasts also show Europe lagging behind, with growth in the euro zone at 1.7% compared to 2.7% in the OECD countries, 3.65% in the United States and up to 8.8% in China. Employment rates are also dropping. Total employment in the euro zone between 1991 and 2002 grew by 6.51%, compared to 17.03% in the United States. In light of these figures, it is difficult to speak of a real revival in the European economy, but we can at least comfort ourselves with the knowledge that at least the balance of trade in the EU is more or less even. But it would be a fundamental oversight to think that little or nothing is going on. Under the surface, over the past ten years there has been a dramatic change. There has been a shift in Europe - or more specifically from the EU-15 to the new Member States. But most important of all is the fact that a quarter of the EU's imports (EU-15) now come from China, Japan and the Asian tigers, a shift that has resulted in huge trade deficit with this area over the past decade. This deficit now stands at almost €100 million and is also considerably higher than the trade surplus we traditionally book with respect to the United States (Annex 1). It is also an indicator that this is just the beginning.
There are many reasons for this change. Globalisation of the world economy is in full swing and new players are emerging every day. This is a threat as well as an opportunity. New markets are opening up and large volumes of new consumers are emerging. The challenge is that all this growth is threatening to pass the European economy by since on account of the latter's internal shortcomings and structural weaknesses.
What are these structural weaknesses and what is the reason behind them?
The financing of the European social model, certainly in the EU-15, has undermined the productive mechanisms in society and it is above all Europe's substructure which is in the greatest danger.
The response of Member States to this challenge varies widely, certainly following the enlargement of the EU to 25 Member States. There is a risk of dumping which not only affects the European social model but also undermines the coherence of the internal market.
The European internal market is also incomplete and progress is far too slow.
Too little emphasis is placed on research in Europe.
There is no political support for a response to any of these challenges.
To draw an analogy from the world of sport, Europe is competing in a 'pentathlon' to become the most competitive knowledge-based economy in the world without resorting to doping (dumping), i.e. to become the most competitive knowledge-based economy in world without destroying the European social model.
It goes without saying that in order to win this pentathlon, Europe must forge ahead down new paths. Simply doing nothing and looking on as the industrial basis of our economy is further dismantled and shifted to new countries such as the Asian growth centres is clearly not an option. And to repeat once again, neither must we allow ourselves to be caught up in social or fiscal dumping either inside or outside EU borders. In short, neither doing nothing nor a frantic race between Member States to push down the price of social protection or the public infrastructure are acceptable since in both cases we are threatening to destroy the social model on which the European Union is based.
What, then, is the way forward? What route will guarantee success in this pentathlon? How can we enable a competitive European economy to emerge strongly without substantially affecting the social progress achieved over the past decades?
The path ahead is based on five cornerstones: convergence, tax reform, research, global market and political guidance.
Convergence
Convergence does not mean harmonisation but rather paving the way for standardisation. Convergence involves establishing a range within which the economies of the various EU Member States must develop in order to collectively form a more integrated and more competitive European economy. The maximum limits of this range indicate the values which must not be exceeded if the economy is to remain strong. By contrast, the minimum limits within the range indicate the values which must be achieved in order to guarantee a basis for social protection and sustainable development. These maximum and minimum values therefore apply to the those main elements which will be decisive for the socio-economic climate such as the flexibility or rigidity of the labour market, the duration of an individual's working life, the level of protection for workers, the extent of government outlays, fiscal pressure on companies and so forth. Using ranges instead of fixed standards or vague goals takes into account more effectively than in the past the specific characteristics of each national economy; for example, while one country focuses on industry another concentrates more on services, and different countries have different forms of social protection. On the other hand, these ranges must be relevant, in other words the distance between the minimum and maximum values should not be too great either. The range must be set in such a way that it actually encourages countries to adapt: the minimum values should be enough for them to become involved in the progress of the European social model while the maximum values should enable them to make a substantial contribution towards a more integrated and effective European economy. Take the weight of government for example. It is generally accepted that in a society either without a government or with a poorly equipped administration prosperity will not increase significantly. Infrastructure, the rule of law and social programmes which prevent exclusion all work as a catalyst for the economy and play a key role in boosting productivity and prosperity. Eventually there comes a time when additional government spending no longer generates increased prosperity; on the contrary, in fact, prosperity begins to decline as further government growth saps the meagre resources of the private sector where they could be more productively used. For each trend a minimum and maximum percentage could be set, within which each country could then attempt to establish its optimum value. The same could be done for fundamental social rights, but of course without jeopardising Member States' freedom to operate their own system of social protection. In short, by setting minimum and maximum levels for each of the key components that substantially affect the economic and social environment, we can formulate a practical convergence code which could be applied throughout the European Union. In the euro zone itself and in the countries shortly hoping to join it, such a code should be an essential criterion to be achieved within the context of the requirements set out in the Stability Pact. In any case, such a convergence code would avoid the situation we currently have with the open coordination method where either nothing happens at all or the Member States rush blindly into forcing social costs down and in doing so end up in an endless downward spiral of social dumping.
Tax reform
A substantial overhaul of the taxation system is needed in Europe to boost the European economy in relation to the rest of the world. The European economy is a very open one, with imports accounting for 25% of final expenditure in the European Union. This is considerably more than in the United States (14.5%) and Japan (9.5%). In addition to the openness of European markets, one of the main reasons for this is that in terms of the cost price of goods and services, we are proving less and less of a match for new growth centres in other parts of the world (China, the Asian tigers, the Russian Federation). To a large extent, this cost price is determined by the high taxes levied on workers, employees, the self-employed and companies. In fact, today we are undermining the productive forces in our society. The fiscal and parafiscal pressure required to finance our social model in Europe (EU-15) is over 40% of GDP as compared with approximately 26% in the United States and Japan. More significant still is the accumulated value of these fiscal and parafiscal pressures. A little under 70% of such pressure is exerted in the form of direct taxation and social contributions, in other words income which places direct pressure on production. This not only causes production costs to rise but also undermines workers' motivation. Looking to compensate for this weakness in the European economy in the form of protectionism is fundamentally wrong. Europe thrives on free trade. Export from the EU-15 rose last year to €12 billion. The establishment, too, of significant social protection in respect of emerging growth centres to cause their production costs to rise more or less to the level of our own is also unrealistic. Therefore, the only path we can follow is that of a fundamental change in the way we finance our social model ourselves, in other words a massive shift from direct taxation and social contributions to indirect taxation. After all, indirect taxes are neutral levies; they do not weigh directly on production costs. They do not affect exports. They are levied in the same manner on both imported goods and services and those produced at home. There are borne by both the working and non-working population. Economic research invariably indicates that in the event of a major shift from taxation of income to taxation of consumption, real growth will increase significantly. Accordingly, a drop in income tax of 1% of GDP, together with an increase in consumption tax of 1% of GDP would generate extra growth in excess of 1%. This effect is certainly to be anticipated in countries such as Belgium and Germany which derive barely 28.8% and 29.7% of government income respectively from direct taxation when the average for the European Union as a whole is 33% (Annex 2). To prevent distortions of the internal market, the only solution is an overall, pan-European approach. This must take the form of a set timetable under which the average amount during the first phase is increased to 40% in order to progress in the second phase to a balance between direct and indirect taxation.
Completion of the internal market
The European Commission's Second Implementation Report of the Internal Market Strategy 2003-2006 speaks volumes. There is little if any convergence between prices in the European market. The service sector remains far too fragmented and according to the Official Journal of the European Communities, the market for public contracts is struggling along at a rate of a mere 16%. The introduction of the Community patent and the simplified system of mutual recognition of vocational qualifications have been severely delayed. But above all, there has been a general tardiness in transposing directives pertaining to the internal market and in the majority of Member States this delay is increasing. Hence the need for greater use of directly applicable measures such as regulations. In the medium term, in each case we must seize - as far as possible - the new opportunities afforded by the European Constitution. After all, Articles I-36 and I-37 stipulate that the measures currently used to implement framework laws - i.e. directives -- may be effected via directly applicable instruments. On the other hand, we must look into how we can automatically transpose directives or at least the most important aspects of them. In practical terms, if directives pertaining to the internal market have not been transposed within the specified time period, the main elements of such directives should enter into force once the specified time period has elapsed. Instead of sunset clauses whereby when the specified time period has elapsed the measure is automatically voided, directives pertaining to the internal market should instead contain sunrise clauses, under the terms of which a specific number of previously determined components of the directive would automatically enter into force at a given time by interpreting national legislation in accordance with the directives despite there being no full or formal transposition.
Substantial increase in research
In terms of research and development, at a rate of 1.93% of GDP the European Union lags far behind the United States (2.76% of GDP) and, above all, Japan (3.12% of GDP) - and this is despite the fact that government's contribution in this area is higher in Europe (34.7%) than it is in North America (30.2%) and Asia (18.2%). In the European Union, it is mainly smaller countries such as Finland (3.51%), but also Belgium (2.33%) which rank higher than average in percentage terms, but whose scores are lower when it comes to government contributions (26.1% and 21.5% respectively). Europe also ranks poorly in terms of patents. In terms of the number of patents registered with the European Patent Office (EPO indicator expressed as number of patents per million inhabitants) we are failing to keep pace with the United States and Japan. With the United States Patent and Trademark Office (USPTO indicator, also expressed as number of patents per million inhabitants) European countries and Europe in general perform poorly (Annex 3). There is a similar picture in terms of the production and export of high-technology products. In the European Union (EU-15) today, 17% of export is classed as high-technology as compared with 27% in the United States and 23% in Japan. The only way to overcome these figures is to allocate substantially more money for research and development within the framework of Community financing in addition to national action plans drawn up by individual Member States. In practical terms, this means that when the new financial mechanisms for the period 2007-2013 get under way, half of all spending on competitiveness (Section 1a) should be allocated to R&D, while a quarter of regional spending by the Member States in receipt of structural funds (Section 1b) should be set aside for research and development projects. In short, this means that under the new financial mechanisms for the period 2007-2013 spending on R&D should be systematically increased to 16% of total commitments and 18% of overall payments.
New political guidance
All these measures require fresh political guidance. The stipulated targets have not been met using open coordination method. Simply comparing provisions and results in various Member States has proved insufficient. On the other hand, the introduction of a convergence code and new instruments in terms of the internal market and research and development must produce better results quickly. The key in this respect is once again that the European Commission plays a greater role. In practical terms, the Commission should be solely responsible for implementing the new growth strategy and monitoring compliance with the convergence code. The Commission should not only coordinate the above-mentioned Community instruments but should also conduct a growth test to determine how each national measure taken by a Member State of the European Union or the euro zone conforms to the growth strategy set out in the convergence code. These include both measures of which a Member State has notified the Commission and studies of a policy being pursued by a Member State which was initially launched by the Commission. In addition to a more prominent role being played by the Commission, more detailed guidance from the Member States is also essential - as the Kok report rightly pointed out. Simply appointing a member of the government responsible for the area in question is not enough. Each country should also set up a special parliamentary committee consisting of members from both its national parliament and the European Parliament to oversee this move.
The European pentathlon is an ambitious project both in terms of its goals and of the instruments required to achieve them. However, taking on such a challenge is the only way in which we can really make the European economy one of the most successful in the word by 2010 while at the same time safeguarding our social model. European heads of state and government have a choice: they can content themselves with comparing tables and action plans, or they can launch on top of it a new Community project following in the footsteps of the euro and the internal market.
ANNEX 1 Trade flows from the EU15
Tab: Import & Export EU15 (1992 and 2003)
EU 15 EXTERNAL trade by main trading partners
- For the table, please refer to the paper version -
ANNEX 2 Indirect taxation
Share of indirect taxes in total tax revenues
- For the table, please refer to the paper version -
ANNEX 3 O&O
Number of European (EPO) and US (USPTO) patents (per million inhabitants)
- For the table, please refer to the paper version -