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Not to be released before
22 February 2005, 00:01 GMT
Improving the foundations
for sustained economic growth
Selected Policy Issues
in the UNECE Region
UNECE launches its Economic
Survey of Europe 2005 No. 1
Strengthening growth and competitiveness
in Europe
Geneva, 18 February
2005 - The overall growth performance
of the European economy has been disappointing
in recent years. Output and productivity
growth have fallen behind the United States.
There are also increasing concerns about
risks of declining competitiveness in
the face of increasing supply of medium-
and high-tech products from low-cost countries
driven by FDI. High long-term unemployment
has been a major concern for many years.
Sustaining higher rates
of growth of both output and employment
is a condition sine qua non for preserving
the European model with its strong concern
for social cohesion. The adjustment pressures
arising from the intensification of international
competitive pressures associated with
globalization, rapid technological change,
as well as population ageing, all make
this challenge even more difficult.
The Lisbon Agenda adopted
by the European Union in March 2000 was
designed to create a competitive and dynamic
European economy at par with the United
States by 2010. But progress has been
falling significantly short of the intermediate
targets fixed for 2005, as countries failed
to deliver the agreed actions, partly
reflecting an overloaded policy agenda
and conflicting targets. This was one
of the main conclusions of the Kok report
(published in November 2004), which reviewed
the Lisbon Strategy.
The European Commission
has recently proposed a revitalization
of the Lisbon strategy, with the main
focus on measures to raise Europe’s
growth potential and create more jobs.
The Commission emphasized the shared responsibility
between the European Union and its member
States as regards the delivery of reforms
and other policy measures required to
meet the Lisbon targets. It has therefore
proposed a European Partnership for Growth
and Employment, which should also involve
the social partners.
The proposed Lisbon
Action Programme focuses largely on supply
side measures to raise growth and employment.
These include inter alia the completion
of the Single Market, improved business
regulation, and the promotion of technological
innovation, especially the development
and diffusion of ICT as well as the associated
increase in R&D spending. But there
is also a proposal to step up expenditures
for enhancing and improving the European
infrastructure (especially energy and
transport).
More generally, market
outcomes are not determined solely by
supply but by the interaction of the forces
of supply and demand. It will be difficult
to meet the targets of the Lisbon Agenda
in a context of weak growth of domestic
demand.
Raising Europe’s
growth potential will not only require
impulses from both the demand and supply
side, but also a sufficiently flexible
macroeconomic policy framework (i.e. mainly
fiscal and monetary policy) that is “as
supportive of growth as possible”
as indicated in the Kok Report.
It is thus important
that a sensible reform of the Stability
and Growth Pact be achieved as soon as
possible. The recent proposals made by
the European Commission that would lead
to greater emphasis on public debt and
medium- and long-term fiscal sustainability
in the fiscal surveillance process go
in the right direction, but it may not
be easy to achieve a consensus on these
matters.
The prospects
for EMU accession by new EU member States
EU membership raises
a number of policy challenges. On the
macroeconomic front, the new members are
expected to meet the Stability and Growth
Pact criteria pertaining to inflation,
long-term interest rates, government deficits,
public debt and exchange rate stability,
and eventually to enter the Economic and
Monetary Union (EMU). Three economies
(Estonia, Lithuania and Slovenia) joined
ERM-2 in the second month of their EU
membership, opening the way for their
accession to EMU by 2007. Cyprus, Latvia,
Malta and Slovakia also appear to be committed
to a relatively early adoption of the
euro. But this process can be expected
to take longer time in the Czech Republic,
Hungary and Poland.
Nominal convergence in
the EU-10 is a multi-speed project. The
majority of the 10 economies have failed
so far to satisfy the EMU inflation criterion,
which partly reflects the ongoing process
of productivity catch-up. None of the
10 new member States fulfil the exchange
rate stability and legal requirements
necessary for entry into the euro zone.
The legal criteria include the independence
of the central bank in pursuit of price
stability and other legal norms of the
EMU. But fiscal consolidation remains
the principal macroeconomic policy challenge
in most new member States. A number of
countries exceeded the 3 per cent threshold
for the deficit to GDP ratio in 2003 and
2004.
However, strict abidance
by the EU fiscal framework may impose
unnecessary rigidities for some of the
new member States. In particular, these
economies need to undertake a lasting
effort to improve their public infrastructure,
which is an essential precondition for
a successful catching up to higher productivity
and income levels. Even more than the
most developed members of the EU, the
new members would benefit from a possible
relaxation of some of the constraints
on government borrowing for financing
public investment. Relaxing these constraints
would help prevent counterproductive fiscal
tightening in these economies.
Another difficult challenge
facing the EU-10 will be to maintain exchange
rate stability preceding entry into the
euro zone. The fundamental problem is
the so-called trilemma of international
finance – with open capital markets
and a fixed exchange rate a country loses
control over domestic monetary policy.
In practical terms this means that the
monetary authorities may not have sufficient
instruments to achieve exchange rate stability
and price stability at the same time.
There is the possibility that the two
targets will not be consistent with one
another and thus cannot be achieved simultaneously.
It is also possible that with these targets
to satisfy, these countries will be forced
to ignore what should perhaps be the most
important target – rising levels
of employment.
The prospect of EU membership
as a catalyst of reforms in south-east
Europe
The agenda for the next
round of EU enlargement focuses on candidates
from south-east Europe. In 2004, Bulgaria
and Romania closed all the negotiation
chapters and are scheduled to join the
EU in 2007. Accession negotiations with
Croatia and Turkey are expected to start
very soon. The realistic prospect of EU
membership is an important stimulus to
the economic reforms in these countries.
The preparation for accession to the EU
defines a broad reform agenda with clearly
specified goals and the means to achieve
them, and establishes strong and clear
incentives for policy makers. The institutionalization
of the policy commitments within a tight
schedule of accession negotiations helps
both to accelerate and provide direction
to the reform process.
The policy process and
agenda in the other parts of south-east
Europe, however, lack the clear direction
that can be seen in the EU candidate countries.
Reform progress in individual countries
hinges on their success to establish clear,
long-term policy goals as national priorities
and for these goals to be accepted by
a significant majority of their populations.
The absence of such a consensus about
the general direction of reform in some
of these countries is one of the stumbling
blocks to their economic transformation.
Structural and institutional
reforms remain an important challenge
for the whole south-east European region.
The reforms of health care and pension
systems are either at an early stage or
have not yet started at all. Public institutions
for a market economy in most of these
countries are still underdeveloped and
this has a negative effect on the business
environment. The protection of property
rights, including law and contract enforcement,
is generally weak; the public administration
is widely perceived as inefficient and
lacking in transparency; and corruption
is still widespread.
An integrated set of
structural reforms focused on increasing
employment (employment rates being excessively
low at present) is one of the areas where
success could bring wide-ranging benefits
not only for labour market development
but also for strengthening social cohesion,
which is a crucial dimension of human
capital development. Policies aimed at
reducing inequality – without diluting
incentives to work – can also have
a positive effect on future growth prospects.
In particular, greater social solidarity
will help to create a general consensus
about the nature and direction of the
reform process, which, in turn, will increase
the probability of it being maintained.
Aside from Turkey, market
fragmentation in the region limits investment
and decreases the ability of these countries
to reap the benefits of scale economies.
More progress is needed to create some
type of umbrella over all of the free
trade agreements that exist in this region
with the aim of ensuring consistency and
making the rules of origin less difficult
to fulfil. Ideally, a customs union might
be the most desirable alternative, but
achievement of this objective is unlikely
due to a number of practical considerations
such as Bulgaria and Romania joining the
EU.
The policy challenge of economic
diversification in the CIS
The key factor behind
the current economic boom in the resource-rich
CIS economies has been the expansion of
their extractive industries (especially,
the crude oil and natural gas sectors)
coupled with a surge in world commodity
prices. The narrow base of the recovery
exposes these economies to fluctuations
in the highly volatile global commodity
markets, making them vulnerable to external
shocks. The central policy issue is whether
and how public policy can help to broaden
the growth base and reduce the excessive
reliance on natural resources in the medium
and longer term.
The economic argument
underlying diversification policies is
that a comparative advantage in the international
division of labour should not be regarded
as something given once and for all. Comparative
advantage (as revealed in the structure
of net exports) changes over time as a
result of shifts in the pattern of physical
and human capital accumulation. But new
areas of comparative advantage will only
be cultivated if properly developed by
venturing entrepreneurs.
Based on the experiences
of other countries, the broad paradigm
of a policy framework targeting economic
diversification in the CIS economies should
incorporate key ingredients such as:
-
A coherent long-term
strategy outlining the main goals
to be achieved. Importantly, the formulation
of long-term goals should involve
a broad public debate;
-
An incentive structure
that will stimulate economic agents
to act in a direction consistent with
the policy goals as well as the mechanisms
of coordination and management of
conflicting interests (for example,
between the public and private sectors);
-
An appropriate
framework of public institutions with
delegated authority to implement the
related policies;
-
Adequate funding.
Resource-rich economies can in principle
draw on the rents associated with
natural resources to fund the strategies
targeting new areas of comparative
advantage.
There is no unique policy
model of economic diversification; success
as well as failure can take many different
forms, and this applies with full force
to the related policy agenda in the CIS.
But experience of other countries unambiguously
suggests that the adequacy and quality
of the institutional arrangements is probably
the key factor of success in implementing
diversification policies. In other words,
the normative policy rules and objectives
must be matched by an appropriate institutional
framework in the broader sense of formal
and informal “rules of the game”.
Recent experience suggests
that the most effective institutional
arrangements targeting economic diversification
are those that engage all the relevant
stakeholders (both from the public and
from the private sector) in the process
of policy design and in its implementation,
and steer them towards the common goal.
Instead of “picking winners”
in the sense of traditional industrial
policy, this approach involves a more
flexible strategic alliance in which the
government and the private sector exchange
information and ideas, and coordinate
their actions in the development of new
activities, products or technologies.
Diversification policies
require specific skills from the government
agencies that will be involved in implementation.
A public administration with adequate
capacity is in fact a precondition for
engaging in any large-scale government-sponsored
programmes. Capacity building efforts
thus emerge as an important policy step
that should be assigned high priority,
especially in the lower-income CIS countries.
Economic diversification
in the CIS region should be regarded as
a long-term policy goal. It requires an
integrated and consistent policy framework
that relies on comprehensive reforms in
many areas and calls for a lasting and
dedicated policy effort.
For further information please contact:
UNECE Economic Analysis
Division
Palais des Nations
CH - 1211 Geneva 10, Switzerland
Phone: +41(0)22 917 20 84
Fax: +41(0)22 917 03 09
E-mail: [email protected]
Web site: http://www.unece.org/ead/ead_ese_new.htm
Ref: ECE/GEN/05/P05