Structural reforms in Europe

The euro area has recorded a disappointing economic performance over recent years. Its per capita income grew on average by 1.3% between 2000 and 2005, compared to 1.9% in the US over the same period.

The main explanatory factor behind these developments is the diverging trend in hourly labour productivity growth between the euro area and the US. Hourly labour productivity in the euro area increased on average by 1.2% between 2000 and 2004 (against 2.4% in the 1980s and 1.8% in the 1990s) compared to 2.8% in the US over the same period (against 1.3% in the 1980s and 1.5% in the 1990s). These disparities can broadly be explained by differences in technological progress and the diffusion of innovation.

This notwithstanding, the euro area witnessed a slight improvement in labour utilisation, which increased on average by 0.2% per year between 2000 and 2004. This mainly reflects the rise in the euro area employment rate from 61.5% in 2000 to 63.6% in 2005, which corresponds to the creation of more than 11 million new jobs over the same period.

Remarkably, employment growth in the euro area showed resilience to the economic slowdown at the beginning of this decade. However, the employment rate in the euro area remains low by international standards. As the OECD has also stressed, the lack of sufficient structural reform in Europe is a major cause of the gap in economic growth between the euro area and the US.

There are four key priorities for reform in Europe, namely, getting people into work, increasing competition, unlocking business potential and supporting an innovative environment.

First of all, well-functioning labour markets are needed. Necessary labour supply-side measures include the reform of tax and benefit systems to increase incentives to work. Measures aimed at reconciling family with professional life, such as the provision of childcare, may also raise participation rates. Furthermore, the use of flexible forms of work, such as part-time and temporary work, may also provide further working incentives. To stimulate labour demand, there is a need to promote wage flexibility and address labour market rigidities.

Increasing competition is the second prerequisite for better economic performance. Europe should step up measures to boost services market competition in order to support a higher level and growth rate of labour productivity and promote a more dynamic economy. In this context, an internal market for services and the adoption of the EU Services Directive would constitute an important step forward.

The third prerequisite for higher growth in the euro area is the unlocking of business potential by creating an entrepreneurial-friendly economic environment and lowering administrative costs imposed by the public sector. The immense importance of this issue is increasingly appreciated and several initiatives at national or EU level aim at “better regulation”.

Fourth, to fully exploit productivity potential, labour and product market reforms need to be complemented by policies that help to diffuse innovation, including measures to support higher investment in research and development. To be most effective, these measures need to be accompanied by efforts to improve the labour force’s level of education and expertise in such a way that human capital is continuously adjusted to labour market needs.

Since the launch of the Lisbon strategy in 2000, progress with structural reforms has been made in some areas. However, all in all, the reforms have not been far-reaching enough and many measures still need to be implemented.

Against this background, the mid-term review of the Lisbon strategy in 2005 led to a re-launch of the process by shifting the strategy’s focus more strongly on growth and employment. As an outcome of this process, all EU countries have prepared so-called National Reform Programmes that outline the necessary structural reform measures for the years 2005-2008. Applying comprehensive structural reforms is of particular importance for the euro area countries, in order to increase wage and price flexibility and the resilience to shocks, facilitate structural adjustment, raise potential output growth and job creation, and reduce price pressures, thereby facilitating the task of the single monetary policy.

Also, the ECB’s monetary policy has a role to play in supporting the implementation of structural reforms. A credible monetary policy aimed at maintaining price stability in the medium term contributes to a stable economic environment. In a stable macroeconomic context both the areas where reforms are needed and the benefits of reforms are made more visible, thus supporting their acceptance.

All in all, the economic strategy of Europe is on the right track, there is a consensus on the appropriate objectives and agreement on the right institutional setting to be set in place. The next decisive step is to put these plans into practice. The earlier this happens, the earlier economic activity, employment and innovation in Europe can be lifted to a higher level and standard.

Mr Trichet is a special guest speaker at the 2006 OECD Forum.

References

ECB (2006), “Competition, productivity and prices in the euro area services sector”, ECB Occasional Paper Series, No.44.

ECB (2005) “The Lisbon strategy–Five years on” in ECB Monthly Bulletin, July. OECD (2005, 2006), “Going for Growth”

©OECD Observer May 2006




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