Alternative Perspectives on Economic Policies in the European Union

Alternative Perspectives on Economic Policies in the European Union Edited by

Philip Arestis and Malcolm Sawyer

International Papers in Political Economy

International Papers in Political Economy Series Series Editors: Philip Arestis and Malcolm Sawyer Titles include: Philip Arestis and Malcolm Sawyer (editors) ALTERNATIVE PERSPECTIVES ON ECONOMIC POLICIES IN THE EUROPEAN UNION FINANCIAL LIBERALIZATION Beyond Orthodox Concerns.

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Alternative Perspectives on Economic Policies in the European Union Edited by

Philip Arestis and

Malcolm Sawyer

© Selection and Editorial Matter © Philip Arestis & Malcolm Sawyer 2006; individual chapters © contributors 2006 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2006 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN-13: 978–0–230–01891–4 hardback ISBN-10: 0–2300–1891–2 hardback This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Alternative perspectives on economic policies in the European Union/ edited by Philip Arestis and Malcolm Sawyer. p.cm.––(International papers in political economy) Includes bibliographical references. ISBN 0–230–01891–2 (cloth) 1. European Union countries––Economic policy. 2. European Union countries––Economic conditions. I. Arestis, Philip, 1941 - II. Sawyer, Malcolm C. III. Series. HC240.A78284 2006 337.1’42--dc22 10 15

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Contents List of Tables

vi

List of Figures

vii

Preface

viii

1

Macroeconomic Policy and the European Constitution Philip Arestis and Malcolm Sawyer

1

2

EU Financial Integration: Constraints and Alternatives Marica Frangakis and Jörg Huffschmid

37

3

The Reform of European Regional Policy: Underlying Debates Marisol Esteban

4

5

Assessment and Alternative Proposals on European Structural Policies: Why It Is Right to Support both the Common Agricultural Policy and Research and Innovation Policy Jacques Mazier Labour Market Policies in the European Union John Grahl

Index

86

129 169

203

v

List of Tables Table 1.1 Recent macroeconomic performance 3 Table 1.2 Overview of decisions relating to the Stability and Growth Pact 20 Table 2.1 Corporate finance structure in the euro area, USA and Japan (% GDP) 53 Table 2.2 Banking intermediation and foreign ownership of banks in NMS and in EU–15, 2003 54 Table 2.3 Areas of action envisaged by the Financial Services Action Plan 1999–2005 58 Table 2.4 The EU financial services sector organisational committee structure 60 Table 3.1 Commitment appropriations by cohesion objective 2007–2013 103 Table 3.2 Financial Perspectives 2007–2013. Comparison between the European Commission (February 2004), the LP proposal (June 2005) and the FA (December 2005). Differences by spending priority 2006, 2007–2013 110 Table 3.3 Main changes in Cohesion policy proposed by the LP and brought about by the FA 112 Table 5.1 EU–15 EES targets and outcomes (per cent) 188

vi

List of Figures Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure

Figure

2.1 Economic Growth in the EU-15, 1960–2004 2.2 Unemployment in the EU-15, 1960–2004 2.3 Wage Share in the EU-15, 1960–2004 2.4 Rate of Profit, total economy, in the EU-15, 1960–2003 2.5 Investment Share in the EU-15, 1960–2004 2.6 Market capitalisation and equity trading on european stock exchanges, 1960–2004 2.7 Cost-income-ratio of commercial banks in major OECD countries, 1992–2001 2.8 EU-15 financial integration across market participants 3.1 Financial perspective 2007–2013 3.2 Expenditure on Cohesion policy, 2000–2013 3.3 Financial perspectives 2007–2013. Comparison between EC proposal, the LP proposal, the FA and planned 2006 spending by main spending priority. Annual average 3.4 Convergence and competitiveness objectives 2007–2013 by region

vii

40 41 42 43 44 47 49 56 102 103

109 121

Preface This is the second volume of the new series of International Papers in Political Economy (IPPE). The new series will consist of an annual volume with four to five papers on a single theme. The objective of the IPPE will continue to be the publication of papers dealing with important topics within the broad framework of Political Economy. The original series of International Papers in Political Economy started in 1993 and has been published in the form of three issues a year with each issue containing a single extensive paper. Information on the old series and back copies can be obtained from Professor Malcolm Sawyer at the University of Leeds (e-mail: [email protected]). The theme of this second volume of five papers is alternative perspectives on the political economy of the European Union in the aftermath of the rejection of the proposed European Constitution.

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1 Macroeconomic Policy and the European Constitution Philip Arestis University of Cambridge and the Levy Economics Institute

Malcolm Sawyer University of Leeds and the Levy Economics Institute

Abstract The draft European Constitution sets out in considerable detail the economic thinking of the European Union. In this chapter we reflect on macroeconomic policy in the European Union (EU); in particular, how it is embedded in the draft constitution and to make proposals for a different approach. We focus on four questions, which have particular significance for the conduct of macroeconomic policy. These are: What should the objectives of economic policy be? What is the underlying ‘model’ of the policies which are in the draft EU constitution? Should there be a federal Europe or a collection of nation-states? And how can the democratic deficit be corrected? The chapter proceeds by putting the European Constitution in context, and then reviewing the objectives of macroeconomic policy. We then discuss critically the neo-liberal agenda underlying economic policies in the EU. We then turn our attention to the single currency and a federal Europe, and with democratising the European Central Bank (ECB). The remaining sections discuss issues on the euro exchange rate, and policies for the achievement of full employment. JEL Classification: E60, E61, E63 Key words: European Constitution, European Union, macroeconomic policy

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Alternative Perspectives on Economic Policies in the European Union

1. Introduction The draft European Constitution sets out in considerable detail the economic thinking of the European Union (EU). The ‘no’ votes in France and the Netherlands in mid-2005 have provided for a ‘period of reflection’, and we intend to use that period to reflect on macroeconomic policy in the EU; in particular, how it is embedded in the draft Constitution and to make proposals for a different approach. In doing so, we focus on four questions which have particular significance for the conduct of macroeconomic policy. The questions are: (i) What should the objectives of economic policy be? (ii) What is the underlying ‘model’ of the policies which are in the draft EU Constitution, and is a neo-liberal agenda being imposed? (iii) Should there be a federal Europe or a collection of nation-states? (iv) How can the democratic deficit be corrected? It has often been argued (not least by the British government) that the proposed Constitution was no more than a ‘tidying up’ exercise with administrative changes to ease decision-making in an enlarged EU. It is also argued that many features of the proposed European Constitution to which objections were raised did not represent changes from the previous Treaties of Amsterdam and of Nice, and that a vote against the new Treaty would merely mean the status quo in which the features objected to remained. We have to recognise that is the case, and notably in the context of this chapter the Stability and Growth Pact (SGP) and the ‘independence’ of the European Central Bank (ECB) are prime examples. Section 2 attempts to put the European Constitution in context, while Section 3 turns its attention to the objectives of macroeconomic policy, and Section 4 discusses critically the neo-liberal agenda. Section 5 turns attention to the single currency and a federal Europe, with Section 6 focusing on democratising the ECB. Section 7 considers issues concerning the euro exchange rate, and Section 8 outlines policies for the achievement of full employment. Finally, Section 9 summarises and concludes.

2. The European Constitution in context The work of the European Convention in 2003 and 2004 provided a timely opportunity to fundamentally reform the macroeconomic policy-making frameworks of the euro area. The first years of the euro, and indeed the years preceding the launch of the euro, have not seen the

Philip Arestis and Malcolm Sawyer 3

most favourable economic performance in the euro area countries, and the deflationary climate created by the economic institutions of the euro area has been a major factor in this. Macroeconomic performance had been sluggish since 2001 (and this has continued through to the end of 2005 as we write) with slow growth and rising unemployment, which have been particularly pronounced in Germany and Italy. The recent economic performance of the eurozone and some of the major countries is outlined in Table 1.1. When the European Convention began its work drawing up the draft Constitution, the strains and problems of the SGP were becoming clear to all, with many countries having exceeded the 3 per cent GDP budget deficit limit laid down in the SGP in time of economic slowdown. The drawing up of a constitution presented a considerable opportunity to make fundamental changes to the SGP (and macroeconomic policy more generally) both in terms of the objectives of macroeconomic policies and of the instruments of policy. But that opportunity was spurned.

Table 1.1 Recent macroeconomic performance 2001

2002

2003

2004

2005

Eurozone Growth rate Unemployment Inflation

1.9 7.9 2.4

0.9 8.3 2.3

0.7 8.7 2.1

2.1 8.9 2.1

1.3 8.6 2.3

Germany Growth rate Unemployment Inflation

1.2 7.4 1.9

0.1 8.2 1.3

–0.2 9.0 1.0

1.6 9.5 1.8

0.8 9.5 2.0

France Growth rate Unemployment Inflation

2.1 8.4 1.8

1.2 8.9 1.9

0.8 9.5 2.2

2.3 9.6 2.3

1.5 9.6 2.0

Italy Growth rate Unemployment Inflation

1.8 9.1 2.3

0.4 8.6 2.6

0.3 8.4 2.8

1.2 8.0 2.3

0.2 7.7 2.2

Note: Growth rate is per cent change in GDP; unemployment is rate as per cent of civilian labour force; inflation is per cent change in the harmonised index of consumer prices. Figures for 2005 are forecasts as of November 2005 Source: Economic Forecasts, Autumn 2005–2007: growth picks up, European Economy, No. 5. 2005, Office for Official Publications of the EC, Luxembourg, KC-AR-05-005-EN-C.

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Alternative Perspectives on Economic Policies in the European Union

From the reports of the working groups of the Convention there appears to have been no serious consideration of alternatives. Since the Convention’s work ended, the strains on the SGP have increased, with more countries breaking the budget deficit limits, and disquiet with the SGP has also increased. The precise operation of the SGP was eased in the agreement of March 2005, but the central features of the SGP remain and the ECB expressed its ‘serious concern’. The following give a flavour of the limited changes which were made. ‘The two nominal anchors of the Pact – the 3% of GDP reference value for the deficit ratio and the 60% of GDP reference value for the debt ratio – have proven their value and continue to be the centrepiece of multilateral surveillance. However, the European Council noted in June 2004 the need to strengthen and to clarify the implementation of the Stability and Growth Pact, in order to foster transparency and national ownership of the EU fiscal framework and to improve enforcement of its rules and provisions. . . . The Pact has to be applied across countries in a fair and consistent way and be understood by public opinion. The Council reaffirms that a rules-based system is the best guarantee for commitments to be enforced and for all Member States to be treated equally’ (Council of the European Union, 2005, p. 22). ‘In making the proposals for a reform of the Stability and Growth Pact, the Council gave due consideration to enhance the governance and the national ownership of the fiscal framework, to strengthen the economic underpinnings and the effectiveness of the Pact, both in its preventive and corrective arms, to safeguard the sustainability of public finances in the long run, to promote growth and to avoid imposing excessive burdens on future generations’ (Council of the European Union, 2005, p. 23). ‘The Member States, the Council and the Commission should reaffirm their commitment to implement the Treaty and the Stability and Growth Pact in an effective and timely manner, through peer support and peer pressure, and to act in close and constructive cooperation in the process of economic and fiscal surveillance, in order to guarantee certainty and effectiveness to the rules of the Pact’ (Council of the European Union, 2005, p. 24). The draft Constitution often managed to combine statements which are poorly defined but which are rather menacing. In Article III–69, it is stated that there shall be compliance with ‘the following guiding principles: stable prices, sound public finances and monetary conditions’. At one level this sounds eminently sensible, for who could be in favour of unsound finance?. But at another level it is an almost meaningless phrase for what constitutes ‘sound finance’: What does it imply for the balance between revenue and expenditure, or for the level of and rate of change of public

Philip Arestis and Malcolm Sawyer 5

debt? In Article III–92, there is talk of ‘the sustainability of the government financial position; this is apparent from having achieved a government budgetary position without a deficit that is excessive’ which is close to a tautology but also it is not realised that any government deficit is sustainable in the sense that the debt to GDP ratio does not explode.1 We would advocate that the finances of the governments of the EU be designed to achieve the highest sustainable level of economic activity and to overcome deficient private aggregate demand, and that this will often require budget deficits. Budget deficits in those circumstances are sustainable and can be financed, and we would regard that as ‘sound finance’. But we suspect that ‘sound finance’ is used here as a euphemism for a budget in balance or surplus. Thus, it is intended as a way of bringing in anti-Keynesian and deflationary policies based on an outmoded ideology. The neo-liberal agenda of the Constitution is well illustrated by the reference to ‘an internal market where competition is free and undistorted’ (Article I–3.2), though many would question whether competition can ever be ‘free and undistorted’. But later there is reference to ‘a highly competitive social market economy’ (Article I–3.3), which in no way defines what is meant by a social market economy. By implication there is no indication on which range of activities will take place outside of the market, or whether the market is to control all of economic life. In the context of the EU, where the agreement of 25 countries would be required to implement any change, the Constitution should be limited to the expression of general principles. We would argue that any specifics of economic policy should not be included in a constitution.

3. Objectives of macroeconomic policy There are (at least) two questions which arise in connection with the SGP (and economic policy more generally). The first one is whether the instruments and objectives of economic policy should be included at all in a constitution. Putting the instruments of economic policy into a constitution is highly restrictive, and limits the development of alternative instruments. For example, the ‘independence’ of the central bank is a current economic policy fad, and enshrining that in the Constitution makes unnecessary difficulties when the current fashion changes. The second question is: What should be the objectives and nature of macroeconomic policies at the European level be? We will spend the rest of the chapter seeking to answer that question. But given what we have just said, we do not consider that macroeconomic policies should be embedded into any form of the Constitution. It would be appropriate for

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Alternative Perspectives on Economic Policies in the European Union

a constitution to set out the enduring objectives of the EU, and for those to include those of full employment, equitable income distribution and the elimination of poverty, and the pursuit of sustainable development. The pursuit of the achievement of those values would come from, inter alia, macroeconomic policies; but macroeconomic policies inevitably change over time. A quick comparison of the thinking on macroeconomic policies in say the 1960s with those of the 1980s and the current ones would illustrate the speed with which changes in thinking on macroeconomic policies occur. A constitution in its nature cannot be readily changed, and that is reinforced in the context of the EU where a change to the Constitution would require the agreement of all 25 countries. We then have two basic objections to the form which the Constitution took with regard to economic policies. First, a constitution is not the relevant place for setting out economic policies. Second, the policies which are set out in the draft Constitution are wrong-headed and detrimental to the population of the EU (and one might add detrimental to the development of the EU itself). The European Constitution imposes as a constitutional requirement that national governments balance their budget over the cycle and are subjected to the upper 3 per cent limit, even though many countries have broken this limit repeatedly. It would be much more appropriate if the Constitution imposed the objectives of economic policy, including full employment and sustainable economic development. The key objectives of macroeconomic policies, in our view, are the achievement of full employment, the promotion of sustainable and equitable growth, the removal of poverty and a less unequal distribution of income. The achievement of these objectives require, among other matters, the use of macroeconomic (monetary and fiscal) policy to secure high levels of aggregate demand and the building of adequate productive capacity. Calls for more ‘flexible’ labour markets are largely irrelevant where full employment is concerned, which requires high levels of demand and of capacity. Thus, we argue for a reorientation of macroeconomic policy with the major objectives of full employment and sustainable growth, with a full role being played by fiscal and monetary policy in the pursuit of those objectives.

4. The neo-liberal agenda The Economic and Monetary Union (EMU) is a major experiment in the use of a pre-Keynesian, or indeed new Keynesian, variety of macroeconomic policy, in effect what has come to be known as the ‘new

Philip Arestis and Malcolm Sawyer 7

consensus’ macroeconomics (see, for example, Arestis and Sawyer, 2005). The present policy and institutional framework for the euro area can be readily summarised. The ECB, which is ‘independent’ of the political authorities in the European Commission and national governments and of the European Parliament, is entrusted with using monetary policy to pursue ‘price stability’, which has been interpreted as inflation below but near to 2 per cent per annum and that ‘it shall support general economic policies in the Union in order to contribute to the achievement of the Union’s objectives’. The monetary policy instrument is the use of interest rates and it foregoes forms of monetary policy such as credit controls. There is a requirement for the EU budget to be balanced each year and hence no fiscal policy is exercised at the EU level (and the EU budget is itself rather small at just over 1 per cent of EU GDP). The fiscal policy of national governments is (in principle) subject to conformity with the SGP. The SGP imposes an upper limit of 3 per cent of GDP on budget deficits, with the view that budgets will be broadly in balance or in small surplus over the business cycle. An automatic exemption is in place for falls of GDP of more than 2 per cent and discretionary exemptions for falls in output of between 0.75 and 2 per cent, which would represent very major recessions. A system of non-interest-bearing deposits, which could turn into fines, is also in place, but it has not been invoked despite a number of budget deficits exceeding 3 per cent (in the face of economic slowdown but not of declining output). The ECB is the only federal economic agency, but its remit is the control of inflation, which has been persistently above the target level. The ECB appears to have been slow to recognise the beginnings of the slowdown in economic activity, and when it did recognise the slowdown it did not cut interest rates in an aggressive manner on a par with the US Federal Reserve System. But the ECB has been faced with inflation at or above its target level alongside an economic slowdown. The attention paid to its mandate and its religious focus on establishing ‘credibility’ with the financial markets pushed it towards maintaining a tight monetary policy. It is unlikely that economic policy pursued by any government or institution is fully consistent either internally or with some theoretical paradigm. However, in view of the approach adopted by the EMU, and the theoretical positions put forward by its officials (see, for example, Issing, 2003, and European Commission, 2000, for recent expositions), it can be thought of as embedded in the ‘new consensus’ macroeconomics paradigm. We argue that the approach can be viewed as ‘new consensus’ through its emphasis on the supply-side determined

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equilibrium level of unemployment (the ‘natural rate’ or the non-accelerating inflation rate of unemployment, or NAIRU), its neglect of aggregate demand (particularly in the long run) and of fiscal policy, and the elevation of monetary policy at the expense of fiscal policy. 4.1. Main theoretical elements of the EMU model We postulate that the economics of the EMU can be understood as based on the following elements listed below, which we would argue justify the description of a New Consensus Macroeconomics (NCM) variety. These elements are as follows2: (i)

The market economy is viewed as essentially stable, and it is argued that macroeconomic policy (particularly discretionary fiscal policy) may well destabilise the market economy. Markets, and particularly the financial markets, make well-informed judgements on the sustainability of economic policies, especially so in the current environment of open, globalised, capital and financial markets. (ii) Monetary policy is taken as the main instrument of macroeconomic policy, with the view that it is a flexible instrument for achieving medium-term stabilisation objectives: it can be adjusted quickly in response to macroeconomic developments. Indeed, monetary policy is the most direct determinant of inflation, so much so that in the long run the inflation rate is the only macroeconomic variable that monetary policy can affect (see, for example, ECB, 2003c). Fiscal policy is no longer viewed as a powerful macroeconomic instrument (in any case it is subject to the slow and uncertain legislative process). It is recognised that the budget position will vary over the course of the business cycle in a counter-cyclical manner (i.e. deficit rising in downturn, surplus rising in upturn), which helps to dampen the scale of economic fluctuations (i.e. act as an ‘automatic’ stabiliser). But these fluctuations in the budget position take place around a balanced budget on average over the cycle. The budget (at least on current account) can and should be balanced over the course of the business cycle. Fiscal policies ‘based on clear mandates and rules reflect a macroeconomic policy design that is generally preferable to the ad-hoc discretionary co-ordination of day-to-day policy action in the face of shocks’ (ECB, 2003c, p. 37). Monetary policy has, thus, been upgraded and fiscal policy has been downgraded. (iii) Monetary policy can be used to meet the objective of low rates of inflation (which are desirable in this view, since low, and stable,

Philip Arestis and Malcolm Sawyer 9

rates of inflation are conducive to healthy growth rates).3 However, monetary policy should not be operated by politicians but by experts (whether banks, economists or others) in the form of an ‘independent’ central bank (ECB, 2003c, pp. 40–41). Indeed, those operating monetary policy should be more ‘conservative’, that is place greater weight on low inflation and less weight on the level of unemployment than the politicians (Rogoff, 1985). Politicians would be tempted to use monetary policy for short-term gain (lower unemployment) at the expense of long-term loss (higher inflation). An ‘independent’ central bank would also have greater credibility in the financial markets and be seen to have a stronger commitment to low inflation than politicians do.4 (iv) Credibility is recognised as paramount in the conduct of monetary policy to avoid problems associated with time-inconsistency. This is an argument that reinforces the requirement of central bank independence. It is argued that a policy which lacks credibility because of time-inconsistency is neither optimal nor feasible (Kydland and Prescott, 1977). The only credible policy is the one that leaves the authority no freedom as to how to react to developments in the future, and that even if aggregate demand policies matter in the short run in this model, a policy of non-intervention is preferable. It is precisely because of the time-inconsistency and credibility problems that monetary policy should be assigned to a ‘credible’ and independent central bank. Such a central bank should be given as its sole objective that of price stability. (v) Inflation targeting is preferred to money supply targeting. Inflation targeting is neither a rule nor discretion (in practice only degrees of discretion prevail): it is rather a framework for monetary policy whereby public announcement of official inflation targets, or target ranges, is undertaken along with explicit acknowledgement that low and stable inflation is monetary policy’s primary long-term objective. This improves communication between the public and policy-makers and provides discipline, accountability, transparency and flexibility in monetary policy. Inflation targeting has been described as ‘constrained’ or ‘enlightened’ discretion, in that inflation targets serve as a nominal anchor for monetary policy. As such, monetary policy imposes discipline on the central bank and the government within a flexible policy framework. For example, even if monetary policy is used to address short-run stabilisation objectives, the long-run inflation objective must not be compromised, thereby imposing consistency and rationality in policy choices (in

10 Alternative Perspectives on Economic Policies in the European Union

doing so, monetary policy focuses the public’s expectations and provides a reference point to judge short-run policies). Although the ECB allegedly does not pursue an inflation targeting policy (Duisenberg, 2003; Issing, 2003; see also below in this contribution), it does, nonetheless, pursue a monetary policy strategy with ‘the clear commitment to the maintenance of price stability over the medium term’, which ‘implies a stable nominal anchor to the economy in all circumstances’ (ECB, 2001, p. 49). (vi) The level of economic activity fluctuates around the NAIRU, and unemployment below (above) the NAIRU would lead to higher (lower) rates of inflation. The NAIRU is a supply-side phenomenon closely related to the workings of the labour market.5 The source of domestic inflation (relative to the expected rate of inflation) is seen to arise from unemployment falling below the NAIRU, and inflation is postulated to accelerate if unemployment is held below the NAIRU. However, in the long run there is no trade-off between inflation and unemployment, and the economy has to operate (on average) at the NAIRU if accelerating inflation is to be avoided. In the long run, inflation is viewed as a monetary phenomenon in that the pace of inflation is aligned with the rate of interest. Monetary policy is thus in the hands of central bankers. Control of the money supply is not an issue, essentially because of the instability of the demand for money that makes the impact of changes in the money supply a highly uncertain channel of influence. (vii) The essence of Say’s Law holds that the level of effective demand does not play an independent role in the (long run) determination of the level of economic activity, and adjusts to underpin the supply-side determined level of economic activity (which itself corresponds to the NAIRU). Shocks to the level of demand can be met by variations in the rate of interest to ensure that inflation does not develop (if unemployment falls below the NAIRU). The main theoretical elements of the NCM can be put together to form a more formal model amenable to further analysis, to which we now turn. 4.2. A formal new consensus macroeconomics model Most of these general ideas can be seen as formalised (explicitly or implicitly) in what has become known as the ‘new consensus’ of macroeconomics (see, for example, Arestis and Sawyer, 2004a). This ‘new

Philip Arestis and Malcolm Sawyer 11

consensus’ can be summarised in the following three equations: g g ⫹a2E(Yt⫹1 )⫺a2[Rt⫺Et( pt⫹1)]⫹s1 Ytg⫽a0⫹a1Yt⫺1

pt⫽b1Ytg⫹b2 pt⫺1⫹b3( pt⫹1)⫹s2

(with b2 ⫹b3⫽1)

g ⫹c2( pt⫹1⫺pT ) Rt⫽RR*⫹Et ( pt⫺1)⫹c1Yt⫺1

(1.1) (1.2) (1.3)

where Yg is the output gap, R the nominal rate of interest, p the inflation, pT the inflation target, RR* the ‘equilibrium’ real rate of interest (i.e. the rate of interest consistent with zero output gap which implies from Equation (1.2) a constant rate of inflation) and si (with i = 1, 2) the stochastic shocks. Equation (1.1) is the aggregate demand equation, Equation (1.2) is a Phillips curve and (1.3) is a monetary policy operating rule which replaces the old LM curve. There are three equations and three unknowns: output, interest rate and inflation. This model has a number of additional, and relevant, characteristics. Equation (1.1) resembles the traditional IS, but expenditure decisions are seen to be based on intertemporal optimisation of a utility function. There are both lagged adjustment and forward-looking elements; the model allows for sticky prices (the lagged price level in the Phillips-curve relationship) and full price flexibility in the long run. The term Et ( pt+1) in Equation (1.2) reflects central bank credibility. A central bank that credibly signals its intention to achieve and maintain low inflation will be ‘rewarded’ by lower expectations on the rate of inflation. The inclusion of term Et ( pt+1) in Equation (2) indicates that it may be possible to reduce current inflation at a significantly lower cost in terms of output than otherwise. This is an important element in ECB monetary policy (see, for example, Duisenberg, 1999; Issing, 2003). The operating rule implies that ‘policy’ becomes a systematic adjustment to economic developments rather than an exogenous process. Also, it contains no stochastic shock implying that monetary policy operates without random shocks. It contains the neutrality of money property, with inflation determined by monetary policy (i.e. the rate of interest), and equilibrium values of real variables are independent of the money supply. The final characteristic we wish to highlight is that money has no role in the model; it is merely a ‘residual’, and this is more extensively discussed in Arestis and Sawyer (2003a, 2003b; see also 2003c). The three relationships that summarise the ‘new consensus’ contain all the essential elements of the theoretical framework of the EMU (see

12 Alternative Perspectives on Economic Policies in the European Union

also ECB, 2003a). There are, however, two important differences worth highlighting here, though pursued further in the section that follows. The first is that ECB denies that it pursues inflation targeting. Duisenberg (2003) is adamant that the ECB approach does not entail an inflation target: ‘I protest against the word “target”. We do not have a target . . . we won’t have a target’. The second is that in the ECB view the demand for money in the euro area is a stable relationship in the long run – most central banks would suggest the opposite in the case of their economies.6 4.3. ECB stance on economic policies Although the ECB has been granted independence with a remit to use monetary policy to target inflation, this has not stopped it seeking to intervene in a broader range of policies. The ECB may be free of political control but it is subservient to a particular neo-liberal economic doctrine, along the lines sketched above. It has persistently called for a tight fiscal policy. A recent statement illustrates this: ‘With respect to the Stability and Growth Pact, discussions now need to be brought to a convincing conclusion with an outcome that safeguards fiscal discipline. The credibility of the excessive deficit procedure needs to be fully preserved. This is not only fundamental for macroeconomic stability and cohesion in the euro area but also for confidence and growth prospects in all Member States’ (ECB, 2005a, p. 7). Furthermore, ECB (2005b), in an assessment of the March 2005 reform of the SGP (see sub-section 5.2 below for more details on these reforms), concludes that ‘The reform of the SGP creates an opportunity for renewed commitment to the conduct and enforcement of sound fiscal policies that meet both shorter- and longer-term budgetary challenges. A rigorous and consistent implementation of the revised rules is needed to underpin the credibility of the EU fiscal framework and confidence in prudent fiscal policies’ (p. 73). It has also argued for labour market ‘reforms’ to increase so-called labour market flexibility on the basis that aggregate demand and macroeconomic policy are irrelevant for unemployment but that supply-side measures can reduce unemployment. ‘In order to decisively overcome the obstacles towards greater employment growth and to reduce the trend or structural level of unemployment, further comprehensive labour market reforms are of the essence’ (ECB, 2004b, p. 7). ‘Given the signs that the economic recovery will continue, it is particularly important that fiscal policies and structural reforms play their part in improving the economic fundamentals of the euro area. It is regretful that recent fiscal developments have not been helpful in this respect. A growing number of countries are reporting significant imbalances and fiscal consolidation

Philip Arestis and Malcolm Sawyer 13

efforts fall disappointingly short of commitments. In order to strengthen confidence in a sustainable upswing, it is now essential that clarity about the future course of consolidation of fiscal policies is re-established in all countries concerned. This requires credible measures with an emphasis on structural expenditure reform so that imbalances are redressed, tax/benefit systems become more growth-friendly and social security systems are put on a sound financial footing. These measures, together with a revived momentum towards effectively implementing structural reforms in labour and product markets, would provide very valuable support to the current economic upswing’ (ECB, 2004a, p. 6). This advocacy of labour market ‘reforms’ is consistent with the theoretical framework outlined above in which it can be seen that demand has no long lasting effects on output, and in which the supply-side of the economy is viewed to determine the level of economic activity. It is a stage further to argue that relevant changes in the labour market will lead to changes in the level of unemployment but a stage which is often followed. But the evidence that labour market flexibility favourably impacts on the level of employment is weak. It does not readily fit with the low levels of unemployment experienced in many countries, which were then or have subsequently become members of the EU, and the generally much higher levels of unemployment experienced from the mid-1970s onwards. It also does not fit with the variations in the current unemployment experience: the rate of unemployment in the EU countries in 2004 ranged from 4.5 per cent in Ireland and 4.6 per cent in the Netherlands to 11.5 per cent in Spain, where the correlation between unemployment and labour market ‘rigidity’ is not self evident. The wide range of unemployment within a country (e.g. Spain, where in 2004 it varied from 5.5 per cent in Comunidad Foral de Navarra to 17.1 per cent in Andalucia) cannot be explained in this framework since labour market institutions are similar across the regions. A study by Baker et al. (2002) provides empirical evidence on labour market regulations and unemployment for 20 Organization for Economic Cooperation and Development (OECD) countries spanning the 40 years from 1960 to 1999. Different time periods and different combinations of variables are utilised. The most comprehensive measure of labour market institutions and policies utilised can only account for a minor part of the differences in the evolution of unemployment. The evidence in Baker et al. (2002) provides little or no support for the labour market rigidity, and in general explanations that relate to labour market institutions. An index of the extent of labour market deregulation in the 1990s is constructed, but this variable too showed no meaningful

14 Alternative Perspectives on Economic Policies in the European Union

relationship between labour market deregulation and shifts in the NAIRU. The same study poses the question of ‘reverse causation’ in the studies they discuss, to conclude that ‘While clearly not universal, this evidence of reverse causation provides serious grounds for viewing test results showing a correlation between high unemployment and long benefit duration’ (p. 28). Palley (2001) by accounting for micro- and macroeconomic factors, and also for cross-country economic spillovers, concludes that unemployment in Europe emanates from ‘self-inflicted dysfunctional macroeconomic policy’ (p. 3). An OECD (1999) study is more damning to the ‘labour-market-flexibility’ thesis. It covers the period from the late 1980s to the late 1990s and utilises new and improved data on employment legislation in 27 OECD countries. It utilises multiple regression analysis and other techniques, so that it is able ‘to control for other factors that can influence unemployment’ (p. 88). The study demonstrates that employment protection legislation (a measure of labour market flexibility) has small or no impact at all on total unemployment.7 Consequently, dismantling employment protection would not solve the current unemployment malaise in the 27 countries considered in the study. These studies do not give support to the view that labour market ‘reforms’ are needed to reduce unemployment. The current requirements are for a more stimulatory macroeconomic policy including expansionary fiscal policy and lower interest rates, and for the creation of productive capacity especially in regions and countries with high unemployment.

5. The single currency and a federal Europe We suggest that in an economic environment of the EU kind, it is paramount that economic policies do not work in isolation. Co-ordination of economic policies is paramount if full employment and price stability are to be achieved. How we perceive economic policies would work with the latter objectives to be met is the subject matter of this section. We begin discussing economic policies in isolation with fiscal policy first, followed by monetary policy and exchange rate policy in this order. We then put together the co-ordination dimension in its proper perspective as we see it. 5.1. Co-ordination of fiscal policies There is, however, a basic requirement for some co-ordination of fiscal policy across member countries. In part this arises from the recognition

Philip Arestis and Malcolm Sawyer 15

that fiscal policy has a significant impact on the well-being of economies. There are (at least) two reasons for supporting co-ordination. First, the euro area (or the EU) as a whole requires a mechanism for responding to adverse economic shocks which impact all economies – that is shocks which are widespread rather than being limited to a few countries. A co-ordinated fiscal policy is required to confront a co-ordinated shock. Second, there are important spillovers between countries in the integrated economies of the EU: expansion of demand in one country raises demand for the product of other countries, and in the EU context where there is relatively little trade outside of the EU, most of the demand effects will be felt by other member countries. Co-ordination of fiscal policy would mean that one country’s fiscal policy would take into account the effects of fiscal policy in other countries. The question then arises as to what type of co-ordination should be sought and the mechanisms to achieve the co-ordination. There are (at least) two broad approaches to fiscal policy. The first, which is closely reflected in the present SGP, is to aim for some form of balanced budget, albeit allowing the budget position to vary over the business cycle. The second is to use the budget deficit in pursuit of economic objectives such as high levels of employment. The first approach is concerned with the budget being balanced over some time horizon and the objective of fiscal policy becomes the balance of the budget. There is some recognition that there may be some ‘automatic stabilisers’ in play such that in an economic downturn, the budget position tends to move into deficit and that helps to cushion the economic downturn. But there is no recognition that the general achievement of high levels of demand may require budget deficits (in the case where a high level of demand would generate a surplus of savings over investment). The second approach views fiscal policy as one of the instruments of economic policy, which can be used to strive for specified economic objectives. A budget deficit or surplus (or indeed balance) is not then sought to meet some predetermined figure but rather is used in conjunction with other policies to maintain high levels of demand in the economy. One of our major criticisms of the SGP is that some predetermined budget deficit limit is imposed, whether or not that budget deficit serves the macroeconomic objectives well. By focusing on limits on budget deficits, what should be the other objectives of macroeconomic policy, such as high levels of economic activity, are overlooked. There have been many calls to operate the SGP in a ‘more flexible’ manner. The flexibility may take the form of raising the upper limit on

16 Alternative Perspectives on Economic Policies in the European Union

budget deficits, taking a more relaxed view on countries whose deficit exceeds 3 per cent (or whatever limit is set). But these calls do not address the major issues. At present the SGP has in place rules which are only observed in the breach, bringing the notion of rules into disrepute, and a so-called more flexible approach would not resolve that issue except through obscuring the rules sufficiently that no one knew what they were. But any rule which maintains the notion that national governments should be constrained to balance the budget over the cycle or to limit the size of the deficit in any particular time period do not address the major problems of the SGP. The SGP in effect imposes a ‘one-size-fits-all’ fiscal policy on all countries, no matter what their economic circumstances are. There is no reason to think that a budget balanced over the business cycle suits all countries (or indeed any). A well-known identity (though generally forgotten by advocates of the SGP) drawn from the national income accounts tells us that (Private Savings minus Investment) plus (Imports minus Exports) plus (Tax Revenue minus Government Expenditure) equals zero, which is in symbols: (S⫺I )⫹(Q⫺X)⫹(T⫺G)⫹0

(1.4)

Individuals and firms make decisions on savings, investment, imports and exports. For any particular level of employment (and income), there is no reason to think that those decisions will lead to (S⫺I )⫹(Q⫺X)⫹0

(1.5)

But if they are not equal to zero, then (G ⫺ T ), the budget deficit, will not be equal to zero, since (G⫺T )⫽(S⫺I)⫹(Q⫺X)

(1.6)

The SGP in effect assumes that any level of output and employment is consistent with a balanced budget (G ⫺ T ⫽ 0), and hence compatible with a combination of net private savings and the trade position summing to zero. But no satisfactory justification has been given for this view. Another suggestion for amending the SGP is that the budget deficit constraint be shifted from the present one of upper limit of 3 per cent of GDP and view that the budget should be balanced over the cycle to

Philip Arestis and Malcolm Sawyer 17

one in which these limits apply to the current account of the budget with investment funded by borrowing. As a practical matter, this would represent an improvement in that more leeway would be available for budget deficits to be used for fiscal policy purposes. However, it still does not overcome the major problems of the SGP. First, it retains in place the view that the budget (albeit the current account) should be in overall balance and that the budget position should conform to some arithmetic rule. It relates the size of the budget deficit to the needs for public investment, which shift over time. Second, for these purposes this distinction between the current account and the capital account is irrelevant. For an individual it may be recommended that borrowing be limited to capital expenditure on the basis that the anticipated financial returns from the capital expenditure will be sufficient to meet the interest payments on the borrowing. But, in general, the government does not receive a direct financial return on its capital expenditure, since it does not sell the output produced by the capital equipment. There can be indirect returns in so far as government investment (e.g. in infrastructure) aids growth and thereby high tax returns. But some forms of government investment (e.g. in defence equipment) clearly do not aid growth, and many forms of government current expenditure such as education and health do contribute to growth and higher future taxes. Third, a rule that requires balancing the budget (whether current account or total) over the cycle with an upper limit on deficit in any particular year necessarily runs into the ‘one-size-fits-all’ problem. There is no reason to think that the appropriate size of the capital account and the appropriate size of the budget deficit would coincide. Some countries would have more requirements and uses of capital investment than others, and some countries would have need of greater budget deficits than others. There is no reason to think that the requirements for public investment would match the requirements for budget deficit. Public investment should be determined by the costs and benefits of such investment, and the budget deficit by reference to striving to attain macroeconomic objectives such as full employment. The second approach to fiscal policy indicated above can be linked with a ‘functional finance’ approach (Lerner, 1943; Kalecki, 1944; see also Arestis and Sawyer, 2004b) in which budget positions should be set to pursue macroeconomic objectives including the highest sustainable level of employment. Budget deficits should be incurred in so far as they are necessary to achieve these objectives, and should not be subject to arbitrary rules (such as balanced budget over the cycle).

18 Alternative Perspectives on Economic Policies in the European Union

5.2. On the Stability and Growth Pact Under the present arrangements, national fiscal policies could be said to be co-ordinated by the SGP, though subordinated may be a better word than co-ordinated (except that in the outturn the rules of the SGP have frequently been broken). The rationale for the present form of co-ordination comes from the notion of spillover effects between national economies and the interests of one country in the effects of other countries’ fiscal policy. In the approach taken here, the case for co-ordination of fiscal policies arises from the following considerations: (i)

when the euro area (or the EU) is impacted by shocks (e.g. general rise in price of oil) which effects all of the economies (albeit not to the same extent), a co-ordinated response to a generalised shock is appropriate; (ii) there are likely to be substantial spillover effects between national economies given the extent of trade between them, and hence a fiscal stimulus in one country will raise demand in neighbouring countries. The setting of fiscal policy in one country then needs to take into account what is happening to fiscal policy in neighbouring countries; (iii) monetary and fiscal policies both affect the level of aggregate demand, exchange rate and perhaps the rate of inflation, and that points towards co-ordination between monetary and fiscal policies. The co-ordination of national fiscal policies faces many difficulties. A major one arises from the issues of what are the aims of fiscal policies and what are perceived to be the effects of fiscal policy. Under the present arrangements it could be said that the aim of fiscal policy is a balanced budget and that the perceived effects of budget deficits are generally negative (e.g. leading to high interest rates and inflation). It is clearly difficult for two (or more) individuals (or countries) to co-ordinate their activities if the purpose and effects of co-ordination are matters of dispute among the parties concerned. Thus, we would argue, co-ordination of national fiscal policies needs to be based on a shared set of objectives – and here we advocate the inclusion of the objectives of high and sustainable levels of demand and economic activity. Co-ordination would also benefit greatly from shared views on the need for active fiscal policy and on the effects of fiscal policy. And this requires a sharp change from the prevailing ‘conventional wisdom’ embedded in the SGP. A rather more direct form of co-ordination of fiscal policy would come from the development of EU fiscal policy. The development of

Philip Arestis and Malcolm Sawyer 19

such a policy would require a large increase in the scale of the EU budget and the ability of the EU to operate a budget deficit (or indeed a budget surplus). The requirement for a significant EU budget was acknowledged in the MacDougall Report of 1977 (European Commission, 1977, Vol. I:14) which estimated an amount of 7.5 per cent of EU GDP as necessary to manage a monetary union. Goodhart and Smith (1993) and Currie (1997) argue that a rather lower figure for the EU budget provided that it was well targeted to aid stabilisation would suffice, but their figures of around 2 per cent would still be double the current level of the EU budget. We would favour a somewhat larger figure, say of the order of 5 per cent, which would include measures to enhance investment and economic development in the less prosperous regions. But the significant point here is the need for an EU budget which is not constrained to be balanced as at present and which can be utilised for EU wide stabilisation purposes. Further reservations include the separation of the monetary authorities from the fiscal authorities. The decentralisation of the fiscal authorities inevitably makes any effective co-ordination of fiscal and monetary policy difficult. Since the ECB is instructed to focus on inflation while the fiscal authorities will have a broader range of concerns, there will be considerable grounds for conflict. A serious implication of this is that the SGP is in danger of becoming the ‘instability’ pact. This suggests a need for the evolution of a body, which would be charged with the co-ordination of EMU monetary and fiscal policies. In the absence of such a body, tensions will emerge in the real sector when monetary policy and fiscal policy pull in different directions. The SGP in effect resolves these issues by establishing the dominance of the monetary authorities (ECB) over the fiscal authorities (national governments). The SGP has sought to impose a ‘one size (of straitjacket) fits all’ fiscal policy – namely that over the course of the cycle national government budgets should be in balance or slight surplus with a maximum deficit of 3 per cent of GDP. It has never been shown (or even argued) that fiscal policy ought to be uniform across countries. The SGP imposes a fiscal policy, which may in the end fit nobody. The experience with the operation of SGP since its introduction in January 1999 is very telling. It became apparent at an early stage that it did not work as it had been intended, and that changes were necessary. Following intensive and highly controversial discussions among EU officials, on revisions of the SGP suggested by the Commission and by member states, the ECOFIN Council adopted, on 20 March 2005, a proposal on improving the implementation of the SGP. Those proposals were endorsed

20 Alternative Perspectives on Economic Policies in the European Union

subsequently by the European Council. The ECOFIN Council’s report now forms part of the SGP. Interestingly enough, during the process of reforming the SGP the ECB consistently insisted on the need for a sound fiscal framework in EMU. In a statement of the Governing Council on 21 March 2005, the ECB stated that ‘Sound fiscal policies and a monetary policy geared to price stability are fundamental for the success of Economic and Monetary Union. They are prerequisites for macroeconomic stability, growth and cohesion in the euro area. It is imperative that Member States, the European Commission and the Council of the European Union implement the revised framework in a rigorous and consistent manner conducive to prudent fiscal policies’ (ECB, 2005b, p. 61). Table 1.2 chronicles the various stages that those discussions went through culminating to the lukewarm changes currently in place. So much so that the SGP is not taken seriously at all. The death of the SGP is probably a better description of what actually was the result of the revamped SGP in March 2005. Table 1.2 Overview of decisions relating to the Stability and Growth Pact February 2002: European Commission recommends that early warning be given to Portugal for having missed its budget target for 2001 by a wide margin (projected deficit for 2001 was 2.2 per cent). Also to Germany whose projected deficit for 2001 was 2.6 per cent. February 2002: ECOFIN Council decided not to endorse the European Commission’s recommendation, thereby abrogating the ‘early warning’ signal. That was based on the commitment by Germany and Portugal to take action to avoid the occurrence of excessive deficits in the future. October 2002: European Commission recommends that excessive deficit exists in Portugal; deficit in 2001 of 4.1 per cent and in the absence of a rectifying budget, the 2002 deficit could be above 3.5 per cent. November 2002: ECOFIN Council decides that Portugal has excessive deficit; the 2001 deficit was revised to 4.1 per cent. November 2002: European Commission recommends to give early warning to France; in fact, France refuses to start cutting deficit in 2003, thereby breaking promises made under the SGP); European Commission projects deficit of 2.7 per cent (2002) and 2.9 (2003). January 2003: European Commission recommends that excessive deficit exists in Germany (in October 2002 Germany admits that it will break SGP for the first time). January 2003: ECOFIN Council decides that excessive deficit exists in Germany; deficit in 2002 expected to be 3.8 per cent. ECOFIN Council also decides to give an early warning to France. May 2003: European Commission recommends that excessive deficit exists in France; in 2002 deficit is 3.1 per cent and forecasts for 2003 estimate it to be 3.7 per cent.

Philip Arestis and Malcolm Sawyer 21 Table 1.2 (Continued) June 2003: ECOFIN Council decides that excessive deficit exists in France. October 2003: France admits of breaking the SGP for third successive year in 2004. European Commission gives it until 2005 to comply. Germany confirms it will also break pact for third year. November 2003: Germany tries to draw the SGP’s remaining teeth by calling for countries that ‘co-operate’ to be exempted from possible sanctions. November 2003: ECOFIN Council suspends disciplinary procedures against France and Germany. European Commission shows grave concern. January 2004: European Council pledges to take ECOFIN to the European Court of Justice for allowing France and Germany to flout the SGP rules. The ECB in the words of its President ‘respects the Commission’s decision to seek legal clarity’ (Trichet, 2004). July 2004: European Court of Justice condemned ECOFIN for ‘suspending’ the SGP’s recommendation on deficit reduction, but upheld the right of national governments to ignore these recommendations and all the disciplinary procedures that were so painstakingly attached to them in 1996. September 2004: European Commission announces proposals for the reform (although the Commission prefers to call them ‘an evolution’) of the SGP (in response to the June 2004 European Council call for proposals by the Commission that strengthen and clarify the implementation of the SGP). March 2005: The European Commission proposal are adopted formally by the EU Finance ministers (ECOFIN), subsequently endorsed by the European Council. The agreement went through marathon meetings with a great deal of acrimony, which nearly put a hold to the reformed SGP. The main points of the agreement are: more budgetary consolidation in good times; more flexibility in reducing deficits in bad times; more focus on cutting the debt to GDP ratio; more room for manoeuvre for countries carrying out structural reforms; countries with sound finances allowed to run small deficits to invest. These changes aim ‘to improve governance, strengthen the preventive arm, and improve the implementation of the corrective arm’ (ECB, 2005b, p. 60) of the original SGP

6. Democratising the European Central Bank Within the euro area there has to be a single central bank discount rate. Monetary policy inevitably suffers from the ‘one-size-fits-all’ problem. The setting of an interest rate which rules across many economic areas poses difficulties – the rate which is appropriate for a country experiencing high demand and perhaps inflationary pressures is not the same as that appropriate for one facing low demand and perhaps deflation. Indeed, monetary policy may address the average inflation picture but cannot address differences in inflationary experience across the euro

22 Alternative Perspectives on Economic Policies in the European Union

area countries. Further, what reason is there to think that what is in effect a single fiscal policy (balanced budget over the cycle) is appropriate for all? This policy arrangement suffers from three major defects. First, if inflation is induced by a demand shock (i.e. a higher level of demand pushes up inflation), then a policy to influence aggregate demand, and thereby it is hoped inflation, may have some validity. But such a policy is powerless to deal with cost inflation or supply shock inflation. A supply shock would lower (raise) output while raising (lowering) inflation. Further, the extent to which the domestic interest rate can be changed is circumscribed by exchange rate considerations and are likely to take some time to have any impact on aggregate demand (and then the impact may be rather small). Indeed the British monetary authorities (and others) talk in terms of a two-year lag between the change in interest rates and resulting impact of changes in aggregate demand on the rate of inflation. Interest rates are likely to influence investment expenditure, consumer expenditure, market interest rates and asset prices, expectations and the exchange rate. These changes in turn influence domestic and external demand, and then inflationary pressures. In addition interest rate changes can also have distributional effects, whether between individuals or between economic regions. Second, changes in interest rates have only a limited impact on aggregate demand. But further in so far as interest rates do have an impact it comes through effects on investment and on the exchange rate. High interest rates have long-term detrimental effects through reducing future productive capacity and through the impact of foreign trade. We have surveyed elsewhere (Arestis and Sawyer, 2004a) the results of simulations of the effects of monetary policy using macroeconometric models. The survey is based on work undertaken for the ECB, for the Bank of England and for the Federal Reserve. The conclusion of that survey is that the effects of interest rate changes on inflation tend to be rather small – typically a 1 percentage point change in interest rates may dampen inflation by 0.2 to 0.3 per cent after two years. Third, monetary policy may address the average inflation picture but cannot address differences in inflationary experience across the euro area countries. At the time of writing, and for the past few years, there is evidence of significant disparities in inflationary experience despite the convergence of inflation that was required by the Maastricht criteria (and indeed a number of countries would not now satisfy the inflation convergence conditions of the Maastricht Treaty). At the time

Philip Arestis and Malcolm Sawyer 23

of writing, the most recent figures available (for October 2005) indicate annual inflation rates varying from 0.8 per cent (Finland) and 1.5 per cent (Netherlands) to 3.5 per cent (Spain) and 3.7 per cent (Greece).8 Further, the impact of interest rate changes is likely to differ markedly across countries. The objectives and mode of operation of the ECB must be changed. The objectives of the ECB should conspicuously include growth and employment variables, and not merely inflation. The reformulated ECB should be required to act as lender of last resort and not merely possess the potential to act as such. Moreover, the ECB should adopt a more pro-active stance regarding bank surveillance and supervision. The proposal for the reformulation of objectives readily follows from what has been previously said: the ECB should be charged with setting interest rates in a manner that encourages growth and full employment, rather than merely inflation. Further, EMU institutional arrangements are required for the operation of an EMU fiscal policy, and to ensure that monetary authorities do not dominate economic policy-making; serious co-ordination of monetary and fiscal policies is paramount, just as the European Convention suggests, but it would have to go hand-in-hand with the other changes to which we have just alluded. These are important institutional changes. In terms of economic policy, further changes are required. Monetary policy has become virtually synonymous with variations in the interest rate, which have an uncertain effect on the rate of inflation and economic activity. Alternative forms of monetary policy should also be considered (Arestis and Sawyer, 2005). Explicit forms of credit control implemented by the central bank, or other government agencies, could be used to supplement interest rate policy. There are wellknown difficulties with the use of credit controls. They can be evaded (legally or otherwise) through switching from regulated to unregulated forms of credit including the development of products which fall outside the range of regulation and the switch of lending to overseas sources. Credit controls may have some effect in restraining credit and thereby expenditure, but the relaxation of credit controls may do little to stimulate expenditure during a downswing. Credit controls may have a role to play in slowing down the development of asset price bubbles, which may be worthwhile in so far as the extent of the subsequent downturn is a function of the extent of ‘irrational exuberance’. These are circumstances which may be better tackled by controls over the volume of credit rather than attempting to prick the bubble through traditional monetary policy measures that use

24 Alternative Perspectives on Economic Policies in the European Union

the price mechanism of interest rate increases. Appropriate forms of credit control may be focused on sectors where ‘overexuberance’ is developing, rather than use the blunt instrument of interest rate changes which impacts on all sectors of the economy. Credit controls may be implemented in a variety of forms, and those which operate through reserve ratio requirements would appear to be feasible. The major changes which are required in respect of monetary policy are: (i) A reformulation of the objectives of the ECB to include high and sustainable levels of employment and economic growth (and indeed these objectives should also be firmly embedded in the European Constitution). (ii) The ECB must be made accountable to the European Parliament, and its statutes changed so that it can clearly be involved in the coordination of fiscal and monetary policies, and indeed that ultimately it can take instructions from other European bodies such as ECOFIN. There are some other changes which would also be desirable. Any reference to the growth of the money supply should be discarded in recognition that a central bank cannot in any way control the growth of the money supply. The development of alternative instruments of monetary policy should also be considered. The role of the ECB in securing stability in the European financial system should be emphasised and a clear requirement made that the ECB act as a lender of last resort. The ECB ‘shall be independent in the exercise of its powers and in the management of its finances. Union Institutions, bodies, offices and agencies and the governments of the Member States shall respect that independence’ (Article I–29), and ‘When exercising the powers and carrying out the tasks and duties conferred upon them by the Constitution and the Statute of the European System of Central Banks and the European Central Bank, neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body’ (Article III–80). But being independent of political influence does not mean being independent of ideology. A cursory reading of the Monthly Bulletin of the ECB (as illustrated above) will reveal the persistence of its advocacy of ‘fiscal consolidation’ (i.e. reduction of public expenditure) and of ‘labour market flexibility’. The ECB has been given the objective of price stability, but its advocacy of policies extends well

Philip Arestis and Malcolm Sawyer 25

outside its mandate and constitutes the pursuit of its own agenda. It is debatable whether this advocacy of fiscal consolidation and labour market flexibility and its pronouncements of the ‘pensions problem’ are consistent with the mandate of the ECB to support the economic policies of the EU. It could be said here that if the ECB is indeed supporting the policies of the EU, that shows the extent to which the EU has bought into the neo-liberal agenda. But if the policies advocated by the ECB are not fully in support of the objectives of the EU, then the ECB is running counter to its mandate. The rationale behind an ‘independent’ central bank comes from the notion that monetary policy is a technical matter best handled by ‘experts’. But further, and the driving force behind the establishment of independent central banks around the world, is the notion that politicians cannot be trusted with economic policies. It is assumed that there is a trade-off between inflation and unemployment in the sense that lower unemployment in the short term will raise inflation in the near future. Stimulating macroeconomic policies in the short term may lower unemployment, but cannot, it is argued, do so in the long term (i.e. lower unemployment below the so-called ‘natural rate of unemployment’). Politicians are likely to be tempted to engage in expansionary policies especially ahead of elections to gain the benefits of lower unemployment but at the cost of storing up future inflation. In contrast, it argued, non-elected bankers, unconcerned with securing re-election, with more ‘conservative’ concerns (i.e. giving greater weight to avoiding inflation and less weight to reducing unemployment as compared with politicians) will not have the inflationary bias that politicians appear to have. This stress on avoiding inflation can be reinforced by giving the ‘independent’ Central Bank some form of low inflation price stability mandate. The ECB’s assessment of the level of economic activity is completely impervious to the behaviour of interest rates. Bibow (2003) puts it aptly: ‘Ex ante interest rate policies never seem to conflict with economic growth in ECB policy communications and assessments. Ex post economic developments do not appear to have been related to interest rate developments either’ (p. 5). The ECB rationale is that monetary tightening would not pose any risk to economic activity. Such policy keeps inflationary expectations under control, thereby sustaining confidence in price stability, which stimulates economic activity. This is rather surprising in view of the work undertaken on the transmission mechanism in the euro area (ECB 2002, October), which shows that monetary policy has strong real effects, especially so in ‘that investment is a main

26 Alternative Perspectives on Economic Policies in the European Union

driving force, with a contribution of more than 80 percent to the total response of gdp after three years’ (p. 47).10 Monetary policy (regrettably) has become the central macroeconomic policy tool of the EMU, and the manner in which it is operated tells us much about the underlying philosophy of the EMU. The decisions of the ECB on interest rates are then seen to have significant implications for the eurozone economies (though we doubt whether interest rates have very much influence, Arestis and Sawyer, 2004a). The actual operation of monetary policy in the form of open market operations is indeed a technical matter, and requires technical expertise. But decisions on interest rates should be taken, in an informed manner with advice on the impact which interest rates may have, by a democratically accountable body. In the context of the EMU this requires that the ECB is embedded into the democratic decision-making process. The ECB should be fully answerable to the European Parliament, and its decisions and operations subject to full scrutiny by that body. But the ECB should also be incorporated within the decision-making processes of ECOFIN, representing the national governments. We would also argue for ECOFIN to be broadened to include representatives of the European Parliament. At the present time, too much power in terms of macroeconomic policy making is in the hands of the European Commission. The Commission views itself as the guardian of the SGP and seeks to impose the operation of the SGP onto national governments. In line with our arguments above, recognising a role for the co-ordination of fiscal policies, there should be co-ordination at the EU level, but not within the straitjacket of the SGP. A number of reservations may be raised in terms of the efficacy of this monetary policy. First, there is the problem of the ‘one-size-fits-all’ monetary policy. For example, the Governor of the Bank of England argued, in an interview on German television on 20 December 2001, that such policy is risky and that ‘The same monetary policy is not necessarily the best for every country at the same time’ in such a diverse economic area. The Governor also suggested in an interview on BBC radio on 21 December 2001 that unlike monetary policy in a single country where ‘mitigating factors’ exist, such as labour migration and fiscal redistribution, these factors ‘are not present to any significant degree at the euro area level’. There is, thus, no way a country can offset undesirable effects of a too high or a too low rate of interest imposed by the ECB. The second impinges crucially on the problem of the transmission mechanism of monetary policy in the euro area since, as Duisenberg

Philip Arestis and Malcolm Sawyer 27

(1999) concedes, ‘Relatively little is known as yet’ about it. Consequently, ‘One important challenge for the Eurosystem is to obtain better knowledge of the structure and functioning of the euro area economy and the transmission mechanism of monetary policy within it, so that policy actions can be implemented accordingly’ (p. 189). Third, considerable doubt may be cast on the effectiveness of monetary policy in terms of responding to recession and as a means of controlling inflation (for an extensive discussion on this general point see Arestis and Sawyer, 2004a). There has been a reluctance to cut interest rates in the face of recession (with the USA a notable exception in this regard). The ECB has failed to meet its inflation target of below 2 per cent since its inception (and has presided over widely differing inflation rates within the euro area). Fourth, the inflation target of below 2 per cent can be argued to be too low. The consequence is that deflationary policy is continuously pursued. This has a number of implications, of which two stand out here. The first is that it is very difficult to see how full employment with no inflation can be achieved. The deflationary thrust to the policies ensures not only that unemployment rises in the present but also serves to depress investment and capital formation, thereby harming future prospects for employment. The second is a serious concern about the distributional effects of contractionary policies. Moderate rates of inflation improve the relative position of low-income groups, and deflationary policies deteriorate it (Nordhaus, 1973). Blinder (1987) concurs with the contention that contractionary monetary policies distort income distribution against low-income groups (see also Forder, 2003). Fifth, in terms of the impact of interest rates on expenditure, there are questions relating to the magnitude of the impact, timing and variability of the time lags involved. Sixth, since interest rate policy has a range of effects, such as on aggregate demand and the exchange rate and also distributional effects, the objectives of monetary policy should reflect that, and should thus be recast to include growth and high levels of employment alongside inflation. Seventh, exchange rate changes are expected to have small effects on the EMU economy. Its relatively closed nature in terms of international trade (with imports and exports amounting to less than 10 per cent of GDP) means that variations in the exchange rate of the euro will have much less impact on prices than in more open economies. Presumably the implication is that the euro area does not need an exchange rate policy.

28 Alternative Perspectives on Economic Policies in the European Union

7. The euro exchange rate The euro has become the second major currency in the world after the dollar. The euro, of course, replaced another major currency (DMark) and some other not quite so major currencies such as the French franc. The euro can be viewed as the second currency after the dollar when considered in terms of the size of the eurozone economy, the use of the euro for international trade and the degree to which other countries have linked their currency to the euro. The exchange rate between euro and dollar has become particularly important for a large chunk of international trade. The volatility of the euro–dollar exchange rate becomes significant not only for the eurozone and the USA, but also for those countries who have linked their currency to either the euro or the dollar. But the exchange rate has gone through major gyrations – the value of the euro started at $1.18 at its launch, fell to a lowest value of $0.82 (in November, 2001) and then rose to reach a level of over $1.35 in January 2005, since falling back to around $1.18 in December 2005. These swings in the euro–dollar exchange rate do not only impact on the USA and the euro area countries, since many countries link their currency with either the dollar or the euro, and consequently their own exchange rate position is much affected by the euro–dollar exchange rate oscillations. These large movements in the exchange rate are not conducive to decision-making with regard to participation in trade or to undertaking foreign investment. The volatility of the exchange rates not only discourages trade but also exacerbates the vulnerability of national economies to external events. As the exchange rate fluctuates, imports and exports, and then the distribution of employment and output between countries, are subject to ups and downs. The importance of the exchange rates between the dollar, euro and the yen, and the harmful effects of the volatility of exchange rates strongly point towards the development of mechanisms, which could help to stabilise the trilateral exchange rates. The volatility between the three major currencies affects most international trade since many currencies are linked with one (or more) of those major currencies. The existing volatility, associated with speculative bubbles in the exchange markets, could well be having detrimental effects on trade and foreign direct investment.11 Any attempt to stabilise the exchange rate of the euro would necessarily involve the ECB and other central banks, and co-ordination between the central banks would be particularly important. Interest

Philip Arestis and Malcolm Sawyer 29

rates would be used to influence the exchange rates, but it is interest rate differentials which are particularly relevant, and hence the need to co-ordinate interest rate decisions in order to arrive at the required interest rate differential. But the reliability of the effect of interest rate changes on the exchange rate weakens the usefulness of interest rates in this regard. Interest rates are currently used to target the rate of inflation, though much of the effect of interest rates on inflation may come through the exchange rate. The policy indicated here requires a broadening of the remit of central banks to clearly include an exchange rate target. The interest rate instrument is likely to be rather ineffectual in this regard, and hence direct intervention by central banks in the exchange markets would generally be required. The ability of a single central bank to intervene in the exchange markets is limited by its own reserves. The combination of central banks is in a much stronger position to intervene, in part as they have a greater volume of reserves. But the main reason is that while a central bank is limited by its own foreign reserves, the central bank of the currency, which is not under pressure can buy to an unlimited extent the currency under pressure. Any policy seeking to establish stable exchange rates between the major currencies would require some significant institutional changes within the EU, including changes in the objectives of the ECB to include that of the external value of the currency, and interest rates would have to be set with regard to their effects on the exchange value of the euro. A policy which seeks to establish stable exchange rates between the major currencies requires some significant institutional changes within the EU. Indeed a range of changes would be required for any policy which seeks to achieve a target exchange rate for the euro, whether or not in co-operation with other countries. The target exchange rate would be set by the Council of Ministers of the Eurogroup, and the ECB would be required to support that policy (through its interest rate policy and through interventions in the foreign exchange markets). Thus the objectives of the ECB would have to be changed to include that of support of the external value of the currency, and interest rates would have to be set with regard to their effects on the exchange value of the euro. The overall responsibility for the pursuit of an exchange rate policy should lie with the Council of Ministers of the Eurogroup. International negotiations would be in the hands of that group of ministers, and this could be aided by the creation of a permanent apparatus to support those negotiations and their implementation. It is very important for the EMU to formulate an official exchange rate policy and abide by it. At the moment the slightest indication by

30 Alternative Perspectives on Economic Policies in the European Union

any of the EMU officials on the exchange rate results in ‘brutal’ (according to the ECB chairman) gyrations in the euro exchange rate with inevitable and undesirable uncertainties creeping in that hurt an already fragile economy, with unacceptably high rates of unemployment. A recent example is the statement by the Dutch Finance Minister, who argued that the euro’s appreciation was ‘evolving within acceptable margins’ (Financial Times, 28 December 2004). The euro achieved a new high against the dollar as a result. In the midst of this gloomy picture the ECB is reluctant to lower interest rates, which would help the euro exchange rate to reach a more palatable rate. If anything, though, the ECB is contemplating and leaning towards a rise of the rate of interest; in fact the euro area rate of interest was raised on 1 December 2005, in the midst of no inflation to worry about and a great deal of slack.

8. Achieving full employment The achievement of full employment does require an appropriate high level of aggregate demand. This translates into some combination of increased demand for consumption, for investment, for public expenditure and for exports. Whether such a level of aggregate demand would require a substantial budget deficit inevitably depends on what happens to the other sources of demand in the equation. But a high level of aggregate demand is only one condition for the achievement of full employment. In the context of the euro area, there are further significant obstacles to the achievement of full employment. The first is the lack of productive capacity in many regions to provide high levels of employment. In 2004, the EU’s estimates of the output gap was –0.4 per cent, and hence output was estimated to be around 0.4 per cent below the trend level of output. Yet unemployment in the euro area in that year was 8.9 per cent and hence if output had been on trend it would have had little impact on the level of unemployment. In a similar vein, the OECD’s estimates of the non-accelerating wage rate of unemployment (NAWRU) average of 8.1 per cent for the euro area for 2004 is close to the actual experience of 8.9 per cent.12 Interpreting the NAWRU as an indicator of a capacity constraint suggests capacity problems. In this context, higher levels of aggregate demand would place pressure on capacity and could well have some inflationary consequences. The second obstacle is the disparity of unemployment, in that a general increase in demand would push some regions to or even above full employment. The third problem is that there has been incomplete convergence of business cycles across euro area countries, suggesting the

Philip Arestis and Malcolm Sawyer 31

need for differentiated policies across countries (and specifically differentiated fiscal policies). But even if there were convergence of business cycles, the cyclical movements would be around, with quite different levels of unemployment. These considerations suggest that the restoration of full employment in the euro area will take much more than a level of aggregate demand. It will require the creation of sufficient capacity to support full employment, and the substantial reduction of regional disparities. But the creation of high levels of aggregate demand remains a necessary, though not sufficient, condition for the creation of full employment. At the present time, the euro area lacks any significant policies which address the unemployment issue: it lacks the power to create high levels of aggregate demand to promote investment or to reduce regional disparities. The achievement of high levels of economic activity without inflationary pressures then requires three elements, in addition to high levels of aggregate demand. First are the institutional arrangements for collective wage determination and price setting which are conducive to low inflation. Wage determination within the EU is currently undertaken on a decentralised and fragmented basis, even where it is (or has been) centralised within a particular national economy. The institutional arrangements for collective wage determination at the EU level do not currently exist, and this effectively rules out any possibilities for the operation of incomes policy or similar policy for the next few years. There are a number of examples in Europe (within and outside the EU) of centralised institutional arrangements, which have been conducive to relatively low inflation: for example Austria, Germany, Norway and Sweden.13 Second, in addition to the construction of the relevant institutional arrangements discussed so far, it is necessary to construct a well-functioning real economy, which is also conducive to combining low inflation with high levels of economic activity. We take the view that a major element of that would be the construction of a level and location of productive capacity, which is capable of providing work to all who seek paid employment. This would imply that not only is the general level of productive capacity be raised, but also that much of that increase directed towards the less prosperous regions of the EMU. This would require the enhancement of the functions of the European Investment Bank (EIB), or a similar institution, to ensure high rates of capital formation, appropriately located across the EMU. Third, the present disparities in regional unemployment levels (and also in labour market participation rates) within the EU would suggest

32 Alternative Perspectives on Economic Policies in the European Union

that even if full employment were achieved in some regions, there would still be very substantial levels of unemployment in many others. In the presence of such disparities in unemployment, the achievement of a low level of unemployment overall (not to mention full employment) would be difficult. This problem is compounded by the fact that within the EMU not only is there high unemployment on average, but there is at the same time a severe shortage of highly qualified labour in many member countries. On top of all these problems, there is still very low or even negligible mobility within the EMU (Fertig and Scmidt, 2002). Inflationary pressures would build up in the fully employed regions even when the less prosperous regions were still suffering from significant levels of unemployment. Interest rates would then rise to dampen down the inflationary pressures in the prosperous regions without consideration for the continuing unemployment in other regions. Therefore, a further recommendation would be to have a revamped EIB to supplement the activities of the ECB, with the specific objective of enhancing investment activity in those regions where unemployment is acute. Enhanced investment activity will thus aim to reduce the dispersion of unemployment within the framework of reducing unemployment in general. This could be achieved through encouraging longterm investment whenever this is necessary by providing appropriate finance for it.

9. Summary and conclusions This contribution has concerned itself with macroeconomic policies and the European Constitution. In doing so it has attempted to throw light on a number of questions: the objectives of economic policy; the underlying ‘model’ of the policies, which are portrayed in the proposed EU Constitution; the nature of the imposed neo-liberal agenda; the question of whether the Constitution proposes a federal Europe or a collection of nation-states; and the way democratic deficits might be corrected. The answers to these questions clearly suggest that the recent ‘non’ and ‘nee’ votes should be welcome. A great deal more thinking and ingenuity are vital before a relevant and acceptable EU Constitution might be acceptable. We may conclude that the two arguments posed in the introduction to this paper find full support. These two arguments relate directly to the issues of the proposed Constitution: (i) the proposed Constitution is no more than a ‘tidying up’ exercise with administrative changes to ease decision-making in an enlarged EU and (ii) many features of the

Philip Arestis and Malcolm Sawyer 33

proposed European Constitution do not represent changes from previous Treaties, such as those of Amsterdam and Nice. The latter argument, we argue, is particularly relevant in the cases of the SGP and the ‘independence’ of the ECB. Above all, though, our analysis strongly supports the desirability of retaining a great deal of the key elements of the European social model. Where changes are needed, and in some cases they may very well desperately needed, revisions should retain the social dimension so much missing from the proposed European Constitution.

References Arestis, P. and Sawyer, M., (2002), The Bank of England macroeconomic model: Its nature and implications, Journal of Post Keynesian Economics, 24(4), 529–545. Arestis, P. and Sawyer, M., (2003a), Macroeconomic policies of the economic and monetary union: Theoretical underpinnings and challenges, International Papers in Political Economy, 10(1), 1 –54. Arestis, P. and Sawyer, M., (2003b), Does the stock of money have any causal significance, Banca Nazionale del Lavoro, 56(225), 113–136. Arestis, P. and Sawyer, M., (2003c), Reinventing fiscal policy, Journal of Post Keynesian Economics,26(1), 4–25. Arestis, P. and Sawyer, M., (2004a), Can monetary policy affect the real economy?, European Review of Economics and Finance, 3(3), 9–32. Arestis, P. and Sawyer, M., (2004b), On fiscal policy and budget deficits, Intervention, Journal of Economics, 1(2), 65–78. Arestis, P. and Sawyer, M., (2005), The nature and role of monetary policy when money is endogenous, Cambridge Journal of Economics, 29(6), 959–974. Arestis, P., Biefang-Frisancho Mariscal, I., Brown, A. and Sawyer, M., (2003), Asymmetries of demand for money functions amongst EMU countries, Investigación Económica, LXII(245), 15–32. Arestis, P., Brown, A. and Sawyer, M., (2001), The Euro: Evolution and Prospects, Cheltenham: Edward Elgar Publishing. Baker, D., Glyn, A., Howell, D. and Schmitt, J., (2002), Labour market institutions and unemployment: A critical assessment of the cross-country evidence, Working Paper 2002–17, Center for Economic Policy Analysis, New School University, New York, USA. Bibow, J., (2002), The monetary policies of the European Central Bank and the euro’s (mal-) performance: A stability oriented assessment, International Review of Applied Economics, 16(1), 31–50. Bibow, J., (2003), Is Europe doomed to stagnation? An analysis of the current crisis and recommendations for reforming macroeconomic policymaking in euroland”, Working Papers Series, No. 379, Levy Economics Institute of Bard College, New York. Blinder, A., (1987), Hard Heads, Soft Hearts, Reading, MA: Addison Wesley. Council of the European Union, (2005), Presidency conclusions, European Council, Brussels, 22–23 March 2005, Document 7619/1/05 REV 1. Currie, D., (1997), The Pros and Cons of EMU, London: HM Treasury (Published originally by the Economist Intelligence Unit, January 1997).

34 Alternative Perspectives on Economic Policies in the European Union Duisenberg, W.F., (1999), Economic and monetary union in Europe: The challenges ahead, in New Challenges for Monetary Policy, proceedings of a Symposium Sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 26–28, pp. 185–194. Duisenberg, W.F., (2003), Introductory statement, and questions and answers, ECB Press Conference, 8 May, Frankfurt, Germany. European Central Bank (ECB), (2001), Monthly Bulletin, March, Frankfurt, Germany. European Central Bank (ECB), (2002), Monthly Bulletin, October, Frankfurt, Germany. European Central Bank (ECB), (2003a), The relationship between monetary policy and fiscal policies in the euro area, Monthly Bulletin, February, pp. 37–49, Frankfurt, Germany. European Central Bank (ECB), (2003b), Monthly Bulletin, March, Frankfurt, Germany. European Central Bank (ECB), (2003c), The need for comprehensive reforms to cope with population ageing, Monthly Bulletin, April, pp. 39–51, Frankfurt, Germany. European Central Bank (ECB), (2004a), Monthly Bulletin, June, Frankfurt, Germany. European Central Bank (ECB), (2004b), Monthly Bulletin, October, Frankfurt, Germany. European Central Bank (ECBa), (2005a), Monthly Bulletin, March, Frankfurt, Germany. European Central Bank (ECBb), (2005b), The reform of the stability and growth pact, Monthly Bulletin, August, pp. 59–73, Frankfurt, Germany. European Commission (MacDougall Report), (1977), Report of the Study Group on the Role of Public Finance in European Integration. Brussels: European Commission. European Commission, (2000), Public Finances in EMU, Brussels: European Commission. Fertig, M. and Schmidt, C.M., (2002), Mobility within Europe – What do we (still not) know?, Discussion Paper, No. 447, March, Institute for the Study of Labor, Bonn, Germany. Forder, J., (2000), The theory of credibility: Confusions, limitations, and dangers, International Papers in Political Economy, 7(2), 1–40. Forder, J., (2003), Central Bank independence: Economic theory, evidence, and political legitimacy, mimeo, Balliol College, Oxford University, United Kingdom. Ghosh, A. and Phillips, S., (1998), Warning: Inflation may be harmful to your growth, IMF Staff Papers, 45(4), 672–710. Goodhart, C.A.E. and Smith, S., (1993), Stabilization, European Economy, Reports and Studies No.5/1993, The Economics of Community Public Finance, pp. 417 – 455 HM Treasury, (2003), EMU and Trade, London :HMSO Issing, O., (2003), Evaluation of the ECB’s monetary policy strategy, ECB Press Conference and Press Seminar, 8 May, Frankfurt, Germany. Kalecki, M., (1944), Three ways to full employment in Oxford University Institute of Statistics, The Economics of Full Employment, pp. 39–58, Oxford: Blackwell.

Philip Arestis and Malcolm Sawyer 35 Kuttner, K. and Mosser, P., (2002), The monetary transmission mechanism: Some answers and further questions, Economic Policy Review, Federal Reserve Bank of New York, New York City, United States. Kydland, F. and Prescott, E.C., (1977), Rules rather than discretion: The inconsistency of optimal plans, Journal of Political Economy, 85(3), 473–492. Lerner, A., (1943), Functional finance and the federal debt, Social Research, February, 38–51. Nordhaus, W., (1973), The effects of inflation on the distribution of economic welfare, Journal of Money, Credit, and Banking, 5(4), 465–504. OECD, (1999), Economic Outlook, May, Paris, France. Palley, T., (2001), The role of institutions and policies in creating high European unemployment: The evidence, Working Paper Series, No. 336, Levy Economics Institute of Bard College, New York. Rogoff, K., (1985), The optimal degree of commitment to an intermediate monetary target, Journal of International Economics, 35(1), 151–167. Stiglitz, J., (2003), Too important for bankers: Central Banks’ ruthless pursuit of price stability holds back economic growth and boosts unemployment, The Guardian, 10 June. Trichet, J-C., (2004), Introductory statement, and questions and answers, ECB Press Conference, 5 February, Frankfurt, Germany.

Notes 1. The simple algebra gives the relationship b = d/g where b is the debt to GDP ratio, d the deficit to GDP ratio and g the nominal rate of growth. This relationship also indicates that the aim for a balanced budget over the cycle and a debt to GDP ratio of 60 per cent are incompatible. With a nominal growth rate of 5 per cent per annum, a 60 per cent debt ratio would allow an average deficit to GDP ratio of 3 per cent. 2. More details on the euro area theoretical framework may be found in Duisenberg (1999), Issing (2003), Arestis, Brown and Sawyer (2001), Arestis and Sawyer (2005), Bibow (2002, 2003), to mention only but a few relevant examples. Our approach extends that in Arestis, Brown and Sawyer (op. cit.) and Arestis and Sawyer (op. cit.). 3. Issing (2003) puts it in the following way: ‘Widespread consensus: even low inflation entails significant costs’. This statement should be judged against evidence provided by Ghosh and Phillips (1998), where a large panel set that covers IMF countries over the period 1960–96 is utilised, to conclude that ‘there are two important nonlinearities in the inflation–growth relationship. At very low inflation rates (around 2–3 percent a year, or lower), inflation and growth are positively correlated. Otherwise, inflation and growth are negatively correlated, but the relationship is convex, so that the decline in growth associated with an increase from 10 percent to 20 percent inflation is much larger than that associated with moving from 40 per cent to 50 per cent inflation’ (p. 674). However, the point at which the non-linearity changes from positive to negative is thought to deserve a great deal more research. The statement of Issing (2003) should also be judged in terms of statements like ‘there is an optimal rate of inflation, greater than zero. So

36 Alternative Perspectives on Economic Policies in the European Union

4. 5.

6.

7.

8. 9.

10. 11.

12. 13.

ruthless pursuit of price stability harms economic growth and well-being. Research even questions whether targeting price stability reduces the tradeoff between inflation and unemployment’ (Stiglitz, 2003). See Forder (2000) for an extensive discussion and critique of the notion of credibility. The March 2003 issue of the ECB’s Monthly Bulletin puts it as follows: ‘the outlook for the euro area economy could be significantly improved if governments strengthen their efforts to implement structural reforms in labour and product markets. Such reforms are important to ultimately raise the euro area’s production potential, improve the flexibility of the economy and make the euro area more resilient to external shocks’ (ECB, 2003b, p. 6). A point repeated in the April 2003 issue of the Monthly Bulletin (ECB, 2003c, p. 6). Our own empirical work (Arestis et al., 2003) suggests that the demand for money differs between the component countries of the EMU and that the demand for money is unstable in a number of those countries. The employment protection legislation is defined broadly and covers all types of employment protection measures resulting from legislation, court rulings, collective bargaining or customary practices. The OECD (1999) study considered a set of 22 indicators, summarised in an overall indicator on the basis of a four-step procedure (pp. 115–118). Statistics taken from Eurostat website. In the year prior to May 2003, the highest annual rates were recorded in Ireland (3.9%), Portugal (3.7%) and Greece (3.5%); the lowest rates were observed in Germany (0.6%), Belgium and Austria (both 0.9%). Thus there was a near 3 per cent differential between the three countries with highest inflation and the three with the lowest inflation. See also Arestis and Sawyer (2002) and Kuttner and Mosser (2002). One recent review, undertaken for the HM Treasury (2003) in the UK, concluded that ‘even from this subset of evidence, is that negative impacts are not very large’. But they go on to say that ‘estimates of the maximum gains to trade from the complete elimination of exchange rate volatility are in the region of 15 per cent, while the consensus estimate of these studies is typically less than 10 per cent’ (p. 28). The figures in this and the preceding sentence derived from OECD Economic Outlook databank (accessed in November 2005). The idea of a state-funded ‘buffer fund’ to stabilise employment in cases of difficulties is a relevant suggestion. The trade union movement in Sweden has proposed this idea, recently. Finland has already been operating such a ‘buffer fund’, but it is not state-funded and it is only a tenth of the one suggested in the case of Sweden.

2 EU Financial Integration: Constraints and Alternatives Marica Frangakis Nicos Poulantzas Institute, Athens

Jörg Huffschmid University of Bremen

Abstract The rapid growth of European financial markets is embedded in an environment of declining growth and continuous redistribution of income in favour of profits which are not re-invested into the productive cycle but channelled onto the financial markets. The main driving forces therefore shift from organising finance for productive investment to creating opportunities for financial investment. Monetary and financial market policies of the European Union (EU) are facilitating this development through (1) the privatisation of financial institutions and increasing parts of the public social security systems, (2) the introduction of the Euro and the set-up of the euro-zone and (3) by creating a single European market for financial services with the main aim of reducing the costs and increasing the speed for cross-border financial transactions. Since the late 1990s, financial integration has become central to the EU policy agenda, as set out by the Lisbon Strategy 2000–2010. A new regulatory framework mainly pertaining to the capital and money markets has been set up, while the main emphasis centres at present on the removal of obstacles to merger and acquisitions in banking and in the asset management area. EU financial integration policy caters mainly for efficiency. The few safeguards for stability and for consumer protection are insufficient and there is no perspective for workers protection against the consequences of capital market driven mergers and acquisitions. These are the aspects on which a progressive financial market policy should concentrate most. In particular, the creation of an integrated European financial market should be embedded in a social and economic environment in which financial stability, economic efficiency and social inclusion are the guiding 37

38 Alternative Perspectives on Economic Policies in the European Union

principles. To ensure financial stability the mission of the ESCB must be broadened, the Basle 2 framework should be changed, special measures against excessive financial speculation should be taken and tight cooperation amongst financial supervisors in the EU is necessary. Economic efficiency in financial markets can be enhanced when distortions caused by different tax systems and tax competition are removed and special financial instruments for the implementation of public development objectives are retained. In the area of social inclusion proposals for the guarantee of universal access to the financial system, for high minimum standards of consumer protection and for the inclusion of workers’ interests into the framework of a European financial market are formulated. JEL Classification: F36, G28, O16 Keywords: European integration, Financial markets policy.

1. Introduction The financial services sector employs about 3.2% of all persons employed in the EU–25, that is about 6.4 million people (European Commission, 2004: 42). It consists of banking, insurance, stock exchanges and securities trading firms and a number of smaller subsectors. In spite of its moderate size, the sector is extremely important, because together with the European System of Central Banks (ESCB) it forms the basic financial infrastructure necessary for the functioning of the European economy. Since the beginning of the 1990s, the financial sector has been affected by the overall and world-wide neo-liberal strategy of counter-reform envisaging a comprehensive roll-back against the social achievements of the post-war period. One central pillar of this strategy is financial liberalisation, i.e. the removal of capital controls and other non-tariff barriers to cross-country capital flows. As a consequence, financial markets exploded during the 1990s in terms of turnover and market capitalisation on European stock exchanges.1 This generated an intense process of restructuring of the financial sector, which is still evolving. It raises a number of severe problems for economic development, financial stability and for consumers and employees. This chapter deals with the following points: In Section 2 the underlying long-term trends and environment and the “surface development” of the European economy in general in which the financial services sector developed since the 1990s are discussed. Section 3 examines the changing structure of the financial

Marica Frangakis and Jörg Huffschmid 39

services sector and the main political and regulatory changes surrounding it. Special attention is given to the EU financial integration policy as it has evolved since the late 1990s. Lastly, Section 4 presents proposals for progressive European policies for the financial sector and financial markets.

2. The economic environment: Long-term decline and financial turbulence 2.1. Long-term trends: Weak growth, high unemployment, redistribution from bottom to top The long-term development of the EU – at least of the major continental countries which determine the overall statistical picture – can be characterised by three decisive features: declining growth, rising unemployment and a marked redistribution of income and wealth from the bottom to the top. These features emerged in the mid-1970s when a major break in the development of European economies took place, as can be seen from Figures 2.1–2.3. Low growth, high unemployment and falling wage shares are linked to each other in two vicious circles: a small one between low growth and rising unemployment and a wider one between low growth, leading to high unemployment, which makes the position of unions and workers difficult and imposes relatively lower wages upon them. This reduces domestic demand and to the extent that this is not offset through increasing international expansion works as a brake upon growth. This pattern of European economic development has immediate consequences for financial markets and financial service providers. It leads to the accumulation of profits and high incomes (see Figure 2.4) which are not recycled – as consumption or investment expenditure – into the domestic re-productive cycle (see Figure 2.5) but held and invested as financial assets. The resulting abundant liquidity – the Bank for International Settlements (BIS) called it recently “surfeit”2 – is directed either as FDI abroad or it is invested into domestic and foreign bonds, equity and real estate. Hence, the rapid expansion of financial markets as a counterpart of weak productive performance with high profits. It is important to note the shift in the driving forces of the financial markets during the last two decades: From markets driven by corporations willing to invest (or households wanting to buy houses or durable consumer goods or Governments with budget deficits) and looking for external finance they were gradually transformed into markets driven

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68

* adjusted to changes in the structure of employment

Figure 2.3 Wage Share in the EU-15, 1960–2004 Source: European Economy, Nr. 71, 2001, Statistical Annex, Table 32, European Economy, Nr. 4/2004 Statistical Annex, Table 32.

120

Rate of profit*

110

100

90

80

70

60 1960

62

64

66

68

1970

72

74

76

78

1980

82

84

86

88

1990

*net returns on nat capital stock, 1960 = 100

Figure 2.4 Rate of Profit, total economy, in the EU-15, 1960–2003 Sources: European Economy 63, 1997, p.28; EC Economic Data pocket book, 7-8/2003, S.33

92

94

96

98

2000

2

25

Investment share as % of GDP

24 23 22

21 20 19 18 1960

62

64

66

68

1970

72

74

76

78

1980

82

84

86

88

1990

92

94

96

98

2000

2

Figure 2.5 Investment Share in the EU-15, 1960–2004 Source: European Economy Nr. 71, 2001, Statistical Annex, Table 19, European Economy, Nr. 4, 2004, Statistical Annex, Table19.

Marica Frangakis and Jörg Huffschmid 45

by money-holders looking for profitable investment opportunities. The historical background for these changes were, on the one hand, a farreaching liberalisation of capital movements after the termination of the Bretton Woods system, and on the other hand, a rapid development of information and (tele)communication technologies which allowed the transfer of capital to any financial centre in the world within very short time. Before this background the transformation of financial markets was driven by three main factors (see Huffschmid, 2002: 38–42): Firstly, the polarisation of income distribution towards higher profits and income of the upper classes on the one hand and lower wages and social benefits on the other hand weakened private mass consumption and therefore the incentive to channel profits and high incomes into productive investment. This left firms and rich persons with unused liquidity. This abundance of liquidity was, secondly, enhanced by the efforts of most governments of OECD countries to “consolidate” their budgets and diminish their public debt and deficits. In the EU this tendency was particularly strong and it was turned into a legal obligation through the Maastricht Treaty of 1992 and the Stability and Growth Pact of 1997. It made an important and stable channel of absorption of liquid resources less accessible. Thirdly, the volume of financial capital was further inflated, because in spite of abundant liquidity the demand for credit remained high and even increased during the last decade. The reason for this is that financial investors – and particularly the growing segment of institutional investors – preferred leveraged investment on financial markets which would – if profits on capital used were higher than interest payments on bank loans – boost profits on their own capital. The result of these three factors was a huge wave of mobile capital in search for profits all over the world. This shift from traditional finance for investment to financial investment sounds harmless but contains new dynamics and new problems of modern capitalism. These can be concretised in three dimensions (see ibid: Chapter 4): Firstly, on the systemic level, there emerges a new dimension of financial instability, if large amounts of liquid capital are floating around the world and can, through their sheer mass and herd behaviour of speculative investors, generate unsustainable booms and bubbles with subsequent crashes in the economies of whole regions and many vulnerable countries. Secondly, on the corporate level, large financial investors interested in quick profits through rising share prices, can exert strong pressure and enforce exclusively shareholder value oriented management strategies which are harmful not only for

46 Alternative Perspectives on Economic Policies in the European Union

employees but also for the long-term outlook for the firms as a whole; this is no threat for investors who at the peak of a short-term rally sell their shares at a high price and do not have to bear the subsequent losses. Thirdly, in the political arena, large investors can exert enormous pressure on governments in threatening to exit the country; pushing for low taxes, cuts of social benefits and the loosening of workers or environmental protection etc. as the price for staying. This powerful threat is at the root of the current competitive race to the bottom between nations and regions. Together these three dimensions shape the face of capitalism, in which the financial investor has to a considerable extent replaced the individual entrepreneur and the technocratic manager as the driving force of development at least in the developed countries. 2.2. Boom, bust and stagnation: The last decade in the euro-zone On the basis of this underlying and rather steady long-term development trend in Europe, the short-term view reveals much more motion, shaped by business cycles and by inherent and relatively independent movements of financial markets. Looking at this “surface development” of the EU one can roughly subdivide the past decade into three phases with different dynamics. 2.2.1. The boom The years from the mid to the end of the 1990s were marked by relatively robust growth (weaker than in the 1960s and 1980s but stronger than in the first half of the 1990s), driven mainly by three factors: the general cyclical upswing, the dynamics of new technologies and the strong growth of financial markets, leading to the financial bubble of 1999 and 2000. All three factors together created the impression of a “new economy” based on knowledge and driven by new technology and liberalised finance. The crisis of the euro-system of 1992/1993 was over and the financial crash in the “miracle countries” of South East Asia had left the European economy rather unaffected. The overall growth dynamic was able to offset the job-destroying effect of rationalisation, and overall employment rose slightly, in the economy in general and in the financial services sector in particular. Stock market prices exploded, banks shifted their focus from lending to investment banking and institutional investors such as mutual and pension funds and insurance corporations led the race. One marked reflection of this short phase was the strong rise in market capitalisation and the even steeper rise in equity turnover on European stock exchanges (see Figure 2.6).

20 18 16

Trillions $

14 12 10 8 6 4 2 0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Equity turnover

1,4

1,3

1,7

2,1

3,2

3,8

5

7,3

10,7

12,6

19,1

11,5

9,9

10

13,2

Market capitalisation

2,4

1,7

2,4

3,2

3,4

4

4,9

6,1

7,9

10

9,4

7,5

6,5

8,7

10,4

Quelle: World Federation of Exchanges

Figure 2.6 Market capitalisation and equity trading on european stock exchanges, 1960–2004

48 Alternative Perspectives on Economic Policies in the European Union

2.2.2. The crisis Early in 2000, the financial bubble burst and the economy went into recession which lasted until mid-2002. The financial sector was particularly affected by the crisis, because it had been particularly involved in the boom. Unlike industrial firms the balance sheets of financial institutions contain almost exclusively financial assets, i.e. securities (equity and bonds ) or claims against debtors. The stock market crash led to a devaluation of the assets of financial investors in Europe on average by about 60%. This affected banks, insurance and investment firms alike. Banks were additionally hit because of the increase of non-performing loans, which created the need for large and unexpected write-offs of bank claims. It is important to see that the financial crisis of 2000 to 2002 is not the result of cost overruns or of revenue falls in the traditional regular bank or insurance business. The cost–income ratio, which was the most important indicator for the performance of regular business activities of banks was in three of the four biggest financial markets in the EU in 2001 lower than 10 years earlier (see Figure 2.7). The crash was mainly the result of the hectic and often very speculative investment activity of banks and insurance companies in the stock market build-up, which was supported by badly founded or flatly unfounded loan policies. 2.2.3. Unstable recovery The last three years have seen a recovery of the European economy. In terms of investment, production and employment, this recovery was remarkably weak (at least for Germany, France and Italy), with lasting unemployment, while at the same time profits rose steeply since the midst of 2003. Most large financial actors have managed to remove bad loans from their balance sheets and to handle the financial market losses through write-offs (which means to a large extent at the expense of tax revenue). The long-term pattern of low growth, rising profits and income redistribution from the bottom to the top and social polarisation has re-established itself very clearly and it creates new opportunities for the financial industries. The constellation for the European financial sector is now rather similar to that of 10 years ago: increasing financial assets piling up in an environment of slow growth, weak domestic demand and hence little stimulus for productive investment. It is a precarious situation with increased risks of investor short-termism, financial speculation, herd behaviour and the build-up of financial bubbles. When these burst the damage affects not only the speculators but also via the collapse of

Cost-income ratio

120 100 80 60 40 20 0 1992 1996 2000 2001

France 72,5 80,1 67,3 64,9

United Kingdom 65,9 62,1 55,4 57,4

Germany 63,7 65,6 73,5 73,5

Italy 65,6 66,7 56 55,3

Figure 2.7 Cost-income-ratio of commercial banks in major OECD countries, 1992–2001 Source: OECD, Bank Profitability. Financial Statements of Banks, 2002 edition, Paris 2003.

USA 65 62,6 61,2 59,3

Japan 70,1 75,8 73,1 106,6

50 Alternative Perspectives on Economic Policies in the European Union

credit chains the banking and financial sector. From there further channels of contagion extend to restrictions on credit for non-financial firms and households, falling private consumption as a result of collapsing asset prices (“wealth effect”) or the sudden devaluation of currencies and subsequent distortions in international trade relations. This inherent instability of the overall situation has not been addressed or contained by the changes in the political and regulatory environment to the financial services sector, to which we now turn.

3. EU financial integration – Structures, trends and policy 3.1. Overall framework A number of major developments in the past two decades form the overall framework within which financial integration policy in the EU has evolved, in terms of structures, trends and policy. Namely, the Single Market programme of 1985, the privatisation of financial institutions and partly of social security systems and the introduction of the euro in 1999. The Single Market programme, as a main pillar of the European construction, since the founding of the European Economic Community, changed its orientation in a very important way, following the submission by the Commission and the acceptance by the European Council of the “White Paper on the Completion of the Single Market” in June 1985. This envisaged a “revolutionary new approach” to European integration: The replacement of the concept of “harmonisation” of different national regulations into one common regulatory framework for the whole Community, by that of “mutual recognition”, which extended the principle of competition to national rules competing against each other, thus reducing the number of harmonisations still regarded as necessary to a minimum of about 300 throughout the EU. On this basis, the European Single Act was adopted in 1986 and came into force in 1987, which foresaw the implementation of the four basic freedoms until the end of 1992, the freedom of movement of goods, services, capital and people throughout the EU. Financial services were earmarked as a particularly important sector to liberalise. The principle of “mutual recognition” with limited harmonisation of rules throughout the Union remains the main pillar of the Single Market. This should lead to a “European passport” meaning that every firm with a licence to operate in one member country would have the right to operate in every other member country without any further admission procedures in that country. Supervision over the activities of

Marica Frangakis and Jörg Huffschmid 51

a firm in every member country should be exercised by the authorities of the home country (principle of home country control). However, in the services sector in general and in the financial services sector in particular the opening up of markets remained rather limited and different for different segments: more for banks and less for insurance, almost zero for investment and pension funds. Therefore in 1999, the EU financial integration policy was given a new impetus. Furthermore, it took a central position in the Lisbon Strategy, decided by the European Council in March 2000. The second development, which needs to be taken into account in discussing the EU financial integration policy, is related to privatisation. This took place in two forms, which were relevant to the financial services sector. Firstly, the privatisation of financial institutions in France, Italy, Greece and Portugal, where many commercial banks and insurance companies had been in public ownership from the beginning or had been nationalised after World War II or even as late as in the 1980s as in the case of French banks and insurance corporations. This process has been largely terminated and reversed and today the great majority of financial institutions are private in the EU, with some remarkable exceptions like the German publicly owned savings banks and Länderbanken. Secondly, privatisation has affected the systems of social security, primarily pension systems. Since the late 1980s there has been strong pressure from the side of the OECD and later on, in its famous report of 1994 “Averting the Old Age Crisis” from the World Bank to privatise at least partly the public-pay-as-you-go pension systems which were dominant in most countries and which were regarded as unsustainable with regard to ageing populations. This pressure was taken up by the EU Commission and led to strong recommendations to reduce the benefits of the public-pay-as-you-go-systems and fill the gap through private savings and investment. It is remarkable that the EU, which has no formal competence for social policies, developed a special new procedure for this case, the “open method of co-ordination” (OMC) which has now been extended to other areas and has become an instrument for intervention where the EU has no formal competence to intervene. Pension reforms in this direction have for instance been successfully carried out in Germany, Austria and Greece, and similar attempts to modernise the social security systems are on the agenda in other countries. This, of course, creates wonderful business opportunities for the financial industry, and it is by now becoming increasingly clear that the forces behind the

52 Alternative Perspectives on Economic Policies in the European Union

pension reform movement were and are the interests and activities of large insurance companies and other institutional investors rather than the “demographic time-bomb”. In this context it is interesting that the OECD has by now become much more cautious in recommending privatisation as a solution to the demographic problems (see OECD 2005). Lastly, the importance of the introduction of the euro and the ESCB for 11 countries in 1999 (Greece joined in 2002) for the financial system in the EU lies in two factors: Firstly, the introduction of a single currency replacing 12 former currencies put a definite and irreversible end to any kind of currency speculation between the countries of the eurozone and thus contributes to financial stability. Secondly, the delegation of the competence for monetary policy to one single institution, the European Central Bank (ECB) with the overarching and (almost) exclusive goal of price stability creates a number of problems. Most important is the disregard for the role of monetary policy for growth and employment, which are, however, largely affected by the conditions under which credit is made available. Monetary policy of the ECB has certainly contributed to the weakness of economic development in Europe. Another problem is that the single monetary policy of the ECB cannot respond appropriately to the different economic situations of different countries in the euro-zone. A third problem is the absence of explicit mechanisms and instruments against speculative bubbles, systemic instability and banking crises and financial crashes. The ECB has never publicly accepted the role of a lender of last resort. 3.2. The current state of financial integration in the EU The structure of the financial system of the EU–15 has been changing over time from a traditionally bank-based to a more market-based one and in this sense, becoming more integrated. In particular, debt securities and equity are increasingly providing alternative sources of credit in the EU–15, although the dominant source remains that of bank loans. As shown in Table 2.1 below, the bulk of external debt financing to euro area non-financial corporations still relies on bank loans. However, debt security issuance increased significantly, especially following the introduction of the single currency. Furthermore, equity issuance rose steeply between 1999 and 2001, largely as a result of the privatisation of a number of state-owned companies and a large number of new company listings, especially in the telecommunication, media and technology sectors. Although these trends were dampened by the stock market upheaval of the early 2000s, they have not been reversed. Thus, stock market

Marica Frangakis and Jörg Huffschmid 53 Table 2.1 Corporate finance structure in the euro area, USA and Japan (% GDP)

Bank-loans to non-financial corporations Euro area USA Japan Total stock market capitalisation Euro area USA Japan Debt securities from non-financial corporations Euro area USA Japan

1990

1995

2000

2003

na 43.5 102.8

35.1 33.5 89.8

40.8 39.2 72.4

41.8 39.1 59.5

19.9 53.5 90.3

27.9 93.5 73.7

85.8 155.0 70.9

53.9 129.6 63.4

4.6 22.3 8.5

4.8 22.9 10.4

5.7 24.1 14.7

7.2 22.6 16.5

Source: De Buc et al. (2005).

capitalisation in relation to GDP in the euro area remains above its 1990s level, even though it has fallen from the height reached in 2000 (ECB, 2005b). Furthermore, the volume of debt securities issued by non-financial corporations in the euro area has been steadily rising, in relation to GDP, although it is still considerably lower than its US counterpart. Following the accession of the 10 new member states (NMS) in May 2004, the structure of the EU financial system has become especially diversified, mainly due to the low level of financial intermediation in the NMS and their different historical paths of financial development. In particular, the NMS display a low level of financial intermediation, a high level of foreign involvement, while banks dominate (Caviglia et al., 2002). For example, in 2003 the ratio of market capitalisation to GDP for the EU–15 was 68%, as opposed to 24% for the NMS and 19% for the former transition countries. The average ratio for the NMS is thus close to that of other emerging markets, such as Brazil, Mexico and Turkey (ECB, 2005a). Similarly, banking intermediation, in terms of the percentage of bank assets in relation to GDP is less than half of that in the EU–15, as shown in Table 2.2 below. On the other hand, the significance of banks as opposed to markets in the NMS is shown by the fact that the relation of domestic bank credit to stock market capitalisation is approximately 2.8, as opposed to 1.8 in the euro area (Caviglia et al., 2002). In the case of the transition economies, this reflects the privatisation pattern applied, which relied on the rehabilitation of their banking systems. In Cyprus and Malta, on

54 Alternative Perspectives on Economic Policies in the European Union Table 2.2 Banking intermediation and foreign ownership of banks in NMS and in EU–15, 2003 Country

Cyprus Czech Republic Estonia Hungary Latvia Lithuania Malta Poland Slovakia Slovenia EU–15

Banking intermediation (total assets as% of GDP)

Foreign ownership of banks (% of total bank assets)

234.9 96.9 78.9 71.7 84.9 39.6 405.7 56.0 86.8 72.5 280.0

12.3 96.0 97.5 82.3 46.3 95.6 67.6 67.8 96.3 36.0 24.0

Source: CEC, Financial Integration Monitor, 2005a, Background document

the other hand, offshore banks have played a significant role in the development of their financial sectors3. A further feature of the banking sector of the NMS is the high level of foreign ownership. As shown in Table 2.2 above, in five out of the ten countries, more than 80% of the total assets of commercial banks are owned by foreign concerns.4 This is significantly greater than crossborder ownership in the EU. Overall, it may be argued that there is at present a dual financial system in the EU, in terms of structure, that of the EU–15 and that of the NMS and especially of the former transition countries. Within this diverse pattern of financial structure, banks dominate across the EU–25, although financial markets are gaining ground, making for increasing financial integration in the EU. Diagnosing the actual state of the EU financial integration is a complex task due to the definitional and measurement problems involved, as well as the diversity of the EU structures. According to the ECB, financial integration is expected to take place when the following requirements are met: (i) product specification is defined on a market-wide basis, (ii) the rules and practices of any particular market are harmonised across the area and (iii) a common infrastructure is in place (ECB, 2003). The following are examples of financial markets, where one or more of these conditions hold.

Marica Frangakis and Jörg Huffschmid 55 









The unsecured interbank money market, the overnight interest rate swap market, as well as derivatives markets (including both money market futures contracts and government bond futures) are integrated to the extent that the definition of the product is fully standardised and/or all market participants use the same standardised products and market infrastructure and follow the same market rules. The secured money (repo) market presents a lower level of integration, mainly as a result of the segmentation of the infrastructure, especially with regard to securities clearing and settlement. The government bond market also has a lower level of integration, insofar as market specification is not harmonised. Securities markets remain fragmented due to a lack of harmonisation of product specification. Equities market integration is also relatively low.

A more synthetic view of financial integration has been put forward by the European Commission, as shown in Figure 2.8 below, depicting the level of integration in terms of price convergence, cross-border volume, market access and the availability of pan-European infrastructures across different types of market participants, where the number of shaded boxes denotes a scale index from 0 to 3. E.g. where no boxes are shaded, integration is practically non-existent, i.e. ‘0’; where all three boxes are shaded, integration is full or close to full, i.e. ‘3’ (CEC, 2004). As we can see, financial institutions operate in the most integrated environment, as opposed to households, which operate in the most fragmented one, reflecting the diversity in retail market structures, arising from different borrower and product characteristics, business models, allocational practices, etc. Non-financial corporations operate in a financial environment, which is not yet fully integrated. Overall the general tendency is twofold (a) one of advancing integration in those areas of the financial system which were directly influenced by the monetary convergence undertaken in the 1990s (money market; government bonds) and (b) one of slow integration in the longterm (mortgage; corporate loan) credit markets (Adam et al., 2002). In between these two extremes, integration proceeds at varying rates, depending on how close to each of these two poles a particular sector is. 3.3. EU financial integration policy Until recently, the regulation of the EU financial services sector concerned mainly banks. Until the late 1970s, banking in most of the EU states was highly regulated, while there was little co-ordination among

EU-15 financial integration across market participants Financial Institutions Prices/rates Cross-border services Establishment Pan-European infrastructures Product availability Colour = high; Blank = low/no integration Figure 2.8 EU-15 financial integration across market participants Source: CEC, Financial Integration Monitor 2004.

Non-financial companies

Consumers

Marica Frangakis and Jörg Huffschmid 57

countries. The First Banking Directive in 1977 provided a minimum level of harmonisation, stipulating that bank supervisors should cooperate and that foreign identity was not a ground for refusing a bank license. It left national regulatory differences intact. In the 1980s, there followed a period of deregulation at the national, as well as at the EU level. Since the late 1980s, however, the tendency to deregulate has been combined with a renewed attempt at harmonising regulation for the industry as a whole in the EU (Danthine et al., 1999). In particular, the Single European Act gave rise to three groups of directives: the Second Banking Directive of 1989, harmonising banking authorisations and prudential supervision systems; the Investment Services Directive (ISD) of 1993, dealing with the cross-border activities of investment firms; and the Solvency Ratio and the Capital Adequacy Directives (CAD) of 1989 and 1993, respectively, defining the prudential regulation of banks and investment firms within the EU. Since the late 1990s, a new thrust at market liberalisation, as well as re-regulation on the EU level, has been made. Its central objective is to increase the level of competitiveness of the EU economy, making it comparable to that of the US economy by 2010. In the case of finance, the substitution of “arm’s length” finance for “relationship” finance, following the US paradigm, is at the core of the EU policy initiatives.5 Two Plans – the Financial Services Action Plan (FSAP) and the Risk Capital Action Plan (RCAP) – form the basis of the new approach to the EU financial integration. It is worth noting that member state governments were unanimous in adopting these plans. This is a measure of the political expediency attached to the project of financial integration. 3.3.1. Financial services action plan (1999–2005) More specifically, in 1999, the European Council and the European Parliament endorsed the FSAP (CEC, 1999). The duration of the Plan was set at six years, 1999–2005. By comparison to the length of time the evolution of the EU financial integration policy has taken, it may be argued that the FSAP is an example of politics under pressure. The FSAP is structured on the basis of the principal policy objectives and the relative order of priorities as shown in Table 2.3. Progress under the FSAP – in terms of new legislation – has been impressive in two senses, that of the amount of new measures and that of overcoming a political impasse, where one had existed in the past.6 There have however been exceptions. The Takeover Bids Directive 2004/25 is such an exception.

58 Alternative Perspectives on Economic Policies in the European Union Table 2.3 Areas of action envisaged by the Financial Services Action Plan 1999–2005 I. Wholesale — securities and derivatives – markets ➢ Removing outstanding barriers to raising capital on an EU-wide basis ➢ Common legal framework for integrated securities and derivatives markets ➢ Moving towards a single set of financial statements for listed companies ➢ Providing legal security to underpin cross-border securities trade ➢ Promoting cross-border restructuring through mergers, takeovers, etc ➢ Creating the necessary conditions for asset managers to optimise the performance of their portfolios II. Retail financial services ➢ Promoting information for cross-border provision of retail financial services ➢ Elimination of non-harmonised consumer-business rules ➢ Promoting the resolution of consumer disputes ➢ Creating a legal framework for new distribution channels and distance technologies on a pan-European scale III. Prudential rules and supervision ➢ Adjusting prudential legislation to international standards ➢ Regulating the prudential supervision of financial conglomerates ➢ Promoting cross-sectoral and regional co-operation amongst authorities on issues of common concern IV. Wider conditions ➢ Eliminating tax obstacles to financial market integration Source: CEC (1999).

More specifically, Directive 2004/25/EC of the European Parliament and the Council of 21/4/2004 on takeover bids allows national authorities to deviate from the central rules in particular instances. For example, under the “principle of reciprocity” member states may exempt domestic companies from the ban on anti-takeover devices, when the bidding company comes from a jurisdiction permitting their use. This concerns restrictions on securities transfers and voting rights as well as the right of the board of the target company to issue shares, without prior shareholder authorisation (“poison pills”). In order to overcome the constraints imposed by the “diluted” takeover bids directive, the European Commission proposes to review Article 16 of the Banking Directive (2000/12/EC),7 as well as the application of the Treaty-based freedom of capital movements (Articles 56–60) in the area of cross-border bank mergers and acquisitions, in order to detect cases where supervision has been “misused for protectionist purposes”.

Marica Frangakis and Jörg Huffschmid 59

3.3.2. Risk capital action plan (1999–2003) The RCAP was agreed upon at the same time as the FSAP, for a five-year period, which expired in 2003. Its central objective was to develop an integrated market for equity financing of Small and Medium sized Enterprises (SMEs) (venture capital and buy-outs), by way of eliminating the existing regulatory and administrative barriers to competition at both the Community and the national level. It included a number of measures, which were in common with the FSAP, as well as measures beyond it, such as taxation, research and development, entrepreneurship and public funding through state aid and the European Investment Fund (EIF), the ‘equity’ arm of the European Investment Bank (EIB). The model of equity financing adopted by the RCAP is that of the US venture capital market, which in 2002 was nearly twice as large as that of the EU – 0.20% of GDP as opposed to 0.11% of GDP in the EU. The main sources of funds are banks, pension funds and insurance companies. The full involvement of pension funds is in fact considered as one of the pre-conditions for the development of a mature venture capital market in the EU. 3.3.3. Lamfalussy process The original FSAP process ran into two kinds of difficulty: on the one hand, reaching agreement on, and then enacting, legislation proved to be a slow and complicated process; on the other, certain issues arose – particularly regarding technical aspects of security trading, such as clearing and settlement – which had not been included in the original agenda but which would be of great importance to financial integration. As a result, the Lamfalussy Process was instituted, whereby two new, intermediary levels of policy formulation intervene between the passing of legislation by the Council and the European Parliament on the basis of a proposal by the Commission under the co-decision procedure and its implementation by member states. These involve two new committee structures, as shown in Table 2.4. Although the new committees are to operate within the political mandate given to them, they are endowed with a significant autonomy vis-à-vis the Council and the Parliament. This is a new element in terms of European governance, whereby government officials, the EU technocrats and industry representatives assume a decisive role in the formulation of policy in broad areas of the EU affairs and even in drawing up legislation. Therefore, the fact that consumers are under-represented, while trade union and employee representatives are completely absent

60 Alternative Perspectives on Economic Policies in the European Union Table 2.4 The EU financial services sector organisational committee structure Banking

Insurance and occupational pensions

Securities (including UCITS)

Regulatory committee (Level 2)

European banking committee (EBC)

European insurance and occupational pensions committee (EIOPC)

European securities committee (ESC)

Committee of supervisors (Level 3)

Committee of European banking supervisors (CEBS)

Committee of European insurance and occupational pensions supervisors (CEIOPS)

Committee of European securities regulators (CESR)

Source: CEC (2003).

is a shortcoming of the EU financial services policy, and a measure of the democratic deficit inherent in the process of the EU integration. 3.3.4. Financial services policy (2005–2010) With the FSAP practically at its end, the European Commission has produced a White Paper on Financial Services Policy for the period 2005–2010, setting out its policy objectives, priorities and political orientations. The main strands of policy are as follows: 



 

“dynamic consolidation” towards an integrated the EU financial market; removing the remaining economically significant barriers to the circulation of capital; implementing, enforcing and evaluating the existing legislation and enhancing supervisory co-operation and convergence, as well as strengthening the ties between the EU and other global financial centres.

The central philosophy remains one of laissez-faire, as was that of the FSAP before it, the economic benefits of which are considered to be unquestionable, insofar as the free circulation of capital is directly related to “high levels of financial stability, consumer benefits and consumer protection” (CEC, 2005b: 3).

Marica Frangakis and Jörg Huffschmid 61

In particular, while consumer protection is stated as one of the main financial policy concerns, this is to be achieved mainly through greater consumer awareness, i.e. the onus of shielding against the vicissitudes of the market is shifted to consumers themselves, who need to “develop the skills and knowledge needed to understand increasingly complex financial products . . . (in order to) make well-informed (investment) decisions on the basis of this information” (CEC, 2005c: 18). As specified by the White Paper, primary responsibility for this lies with member states, while the Commission undertakes to promote an exchange of views on financial education, literacy and best practice. In the case of financial stability, the dangers that are inherent in financial integration – in terms of the possible spill-over effects of a system failure affecting several financial markets and/or groups on a EUwide basis – are recognised. However, the relevant recommendations rely on existing policy arrangements. For example, it is stated that “new structures should only be developed if all possibilities for co-operation under the current framework have been exhausted and if there is compelling evidence that . . . this framework cannot fulfil its financial stability and integration objectives or meet the requirements of European legislation” (CEC, 2005c: 11). The possibility that a fully fledged financial crisis may have erupted by then, threatening the stability of the EU economy is not considered. Overall, the White Paper follows the general argument and financial policy framework already set out by the Plans and especially by the FSAP, extending it to sectors left out by it and in particular to the retail financial services and to the asset management sector. The main emphasis is on consolidation, rather than on new policy formulation. However, the interests of society at large are either underplayed and/or subsumed under the general heading of the (assumed) economic benefits of the free circulation of capital. Should this approach be put to the test in case of a financial crisis or of corporate misdeeds and ensuing financial distress, society – be it consumers, investors, employees or tax payers – will bear the brunt. This asymmetry of the EU financial services policy is left largely unexplored. 3.4. Implications of policy for stability and inclusion Financial market integration is an integral, as well as a central part of the EU economic and political agenda of the current decade. Its implications for stability, inclusion and consumer protection have not been adequately discussed. Although the “Green Paper on Financial Services Policy” which preceded the White Paper mentions the need for

62 Alternative Perspectives on Economic Policies in the European Union

“adequate and effective levels of prudential control, financial stability and a high level of consumer protection”(CEC, 2005c: 3), the actual measures proposed in these areas are either minimal – adding little to what already exists – or schematic. We shall go on to look into each of these areas. 3.4.1. Stability The existing EU prudential regulation and supervisory framework consists of (i) an extensive set of policy co-ordinating committees and (ii) adopting and adjusting to international standards and in particular to the Basle Accord and its successor, Basle 2. 3.4.1.1. EU supervisory framework. The guiding principle in this area is that “the existing institutional arrangements are appropriate, but that further enhancement of their functioning is needed, in particular through closer cross-sector and cross-border co-operation among the authorities” (CEC, 2002: 30). In this sense, the issue of supervision is only marginally touched upon by the present financial market integration policy. The existing institutional arrangements include the following. National supervisory structures. Three models of supervisory structures coexist: (i) that of separate competencies along the borderlines of financial sectors (Greece, Spain, France and Portugal, with a variant in Finland and Luxembourg); (ii) that of total consolidation of supervisory responsibilities across financial sectors in a single agency (Austria, Germany, Denmark, Sweden, UK and likely to be established in Belgium); and (iii) that of the consolidation of supervisory responsibilities by objectives across sectors (Netherlands and Italy). Generally, there is a broad move away from the first model towards the other two, with the merger of banking and securities supervision as a possible intermediate step. Central banks are extensively involved in the prudential supervision of the financial services sector and especially of the banking sector in all cases, albeit the precise form of their involvement varies from country to country. EU Co-ordinating committees. Their main task is to promote co-operation between national supervisory authorities. There are three in banking, two in insurance and four in the securities market. These are being replaced by the committees constituting the Lamfalussy Process, described above. Memoranda of understanding. These are bilateral agreements between the supervisory authorities of the EU member states. They have no legal force, their main purpose being to detail the supervision of financial institutions and markets.

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Role of the ECB. The ECB has not been given powers to supervise commercial banks or other private financial institutions. Furthermore, the Treaty defines its central objective as one of controlling inflation. Such a narrow specification assumes that no episode of financial instability will ever happen in the European economy. Should one occur, it is not clear whether the ECB will take on the role of Lender of Last Resort, or how promptly it may do so. 3.4.1.2. Adjusting to international standards of prudential regulation. The EU capital adequacy framework is based on existing Basle standards. This is being adjusted to take into account the new, Basle 2 agreement. Accordingly, the EU is preparing a new capital adequacy directive (CAD 3), which will apply Basle 2-type standards to all the EU banks and investment firms authorised under the ISD. More specifically, the BIS capital adequacy guidelines for international banks constitutes the first attempt of the leading industrial countries to fight international financial instability in a co-ordinated way. The Basle Accord, signed in July 1988 and adopted by more than 100 countries, sets a minimum target of 8% of a bank’s risk-weighted assets for its equity capital. In view of the shortcomings of this Accord, a new framework, Basle 2, has been elaborated; to be implemented as of 2006. This is based on three “pillars”: (a) capital adequacy (or solvency) regulation; (b) supervisory review process and (c) disclosure requirements. Accordingly, it introduces three new elements. Firstly, it creates a closer link between capital charges and underlying risks. Secondly, it gives greater reliance on internal risk management practices by sophisticated institutions. Thirdly, it places new emphasis on market discipline by improving public disclosure, especially in relation to a bank’s risk exposure. The Basle 2 proposals have met with widespread criticism. In particular, the following arguments have been put forward: Basle 2 deals only with banks and bank-related institutions. No specific rules are designed for other financial institutions, such as pension funds, mutual funds and hedge funds. Basle 2 is designed for large banks. These are able to implement sophisticated and costly risk management. On the other hand, the new guidelines are not adapted for small banks which will be under pressure to merge with large banks in order to comply with the new rules. Also, the new guidelines propose to use external credit ratings to assess the risk faced by small lending institutions. But most small business firms do

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not have credit ratings. Hence, Basle 2 will put such firms in a difficult position. Basle 2 is not adapted to developing countries. Banks in these countries are generally not in a position to build sophisticated risk management systems. Thus, they may be forced to merge with large banks in developing countries, in order to comply with Basle 2. Also, ratings do not exist for many developing countries and private sector borrowers in developing countries. For example, in November 2000, only 54 developing countries were rated by Standard & Poor’s. It is not clear whether the new capital charges will be lower or higher than in the earlier Basle guidelines. But there is a strong risk that the new guidelines will have pro-cyclical effects due to the fact that ratings are often downgraded during a slow down or a crisis. Hence Basle 2 is likely to have perverse effects on some firms and on developing countries if the availability of credit is reduced when they are facing difficulties. 3.4.1.3. Quasi-privatisation of supervision. The use of private rating agencies amounts to no less than the quasi-privatisation of banking supervision. In the case of the EU, it has been estimated that the Basle II/CAD 3 proposals slightly reduce overall bank capital requirements. On average, a fall of 5.3% is expected, although a significant redistribution of regulatory capital between banks and between banking systems of different countries, depending on the composition of financing business, will occur. In particular, where retail lending is prevalent, a decline in the minimum level of regulatory capital required to support the banking system is expected, especially where financial institutions are in a position to employ sophisticated risk models. Conversely, where lending to sovereigns, large corporations and investment banking business is dominant, few, if any, reductions in regulatory capital requirements are expected to take place. Such a reduction is considered to be too small to endanger the stability of the EU financial services sector (PricewaterhouseCoopers, 2004). Overall, the evolution of the prudential regulation and supervisory framework has not kept pace with the increasing rate of integration in the financial services sector of the EU. This reflects the order of priorities of the current EU policy and the commitment of its economic and political elites to market liberalisation. In this sense, the EU policy is subject to a fundamental flaw. While its professed aim is to promote integration, it does not take full account of its implications for stability, that is, of the increased risks to which the EU financial system thus

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becomes exposed. This is especially the case, in view of the recent enlargement of the EU to include a large number of states, the financial sectors of which are in a precarious position due to their historical background and evolution. 3.4.2. Social inclusion The relationship between financial liberalisation and development, on the one hand, and social inclusion or cohesion, on the other, goes through a number of channels. Namely, the growth channel and the access to credit and financial services channel. In addition, the issue of consumer protection may be considered to constitute an element of social inclusion. 3.4.2.1. The growth channel. This is based on the neo-classical belief that market liberalisation mobilises savings, thus encouraging investment and growth, which eventually benefits, or “trickles down” to, if not the whole of society, at least a large part of it. This methodological, as well as ideological, approach largely permeates the EU’s, and especially the Commission’s, view of financial liberalisation. This view however tends to ignore the fact that markets often fail and when they do so, negative externalities, such as financial crises and social hardship, occur. In fact, empirical studies have shown that financial liberalisation gives rise to financial crises of increasing frequency and severity (Arestis, Luintel and Luintel, 2004). Another aspect of the growth channel pertains to efficiency in the use of resources. In particular, the liberalisation of capital movements and the single European market have put the member states under increasing competitive pressure. Thus, different tax regimes for corporate profits and capital incomes have become competitive parameters, leading to investment decisions based on tax differentials. While the probability of such distortions is lower for investment in production facilities, it is considerably higher for investment in financial services. Financial market taxation for regulatory purposes is however beyond the strategic policy concerns of the EU. 3.4.2.2. The access to credit and financial services channel. The neoclassical view argues that financial liberalisation leads not only to increased growth, but also to better access to credit. Although greater competition may indeed increase financial options for savers and borrowers, it is not clear that it improves the access of small firms and disadvantaged social groups to credit and financial services. For example, companies with insufficient equity in their capital base may find it hard

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to obtain credit, especially if they are not able to produce acceptable collateral. Similarly, small customers and the poor may find it difficult to secure credit following financial liberalisation and the resulting weakening of relationship finance. Therefore, deepening financial integration improves access to credit, only where it develops the institutional structure and new instruments to satisfy the financial needs of small enterprises and the poor (Arestis and Caner, 2005). 3.4.2.3. Consumer protection. The objective of consumer protection has been given some attention in the EU’s programme for financial integration, although hardly sufficient by comparison to the extent of market deregulation that has been introduced. More specifically, consumer protection in the area of the EU financial services is provided by the FIN-NET network, which aims at resolving cross-border legal disputes between consumers and financial service providers and by the FIN-USE, a newly established group, which is to deliver opinions on legislative initiatives affecting users of financial services and to identify key financial services issues affecting them. Although both initiatives represent positive developments, they are inadequate by comparison to the multiplicity and complexity of the issues involved. Also, they address computer-literate consumers – be they individuals or SMEs. Generally, consumers of retail financial services are suspicious of enterprises in this sector. This suspicion is justified by the boom and bust pattern of financial developments in the late 1990s and the early 2000s both in the EU and globally. Furthermore, the suspicions of consumers will impact not only on retail services but also on the financial markets and the general process of integration as their concerns for safety and liquidity will hold back the development of financial intermediation in general. Therefore, if the EU objective of an integrated financial sector is to be achieved, consumer confidence needs to be re-established. However, in the absence of a Europe-wide drive for substantively higher standards, the EU approach – involving market liberalisation, minimal harmonisation of regulatory standards, mutual recognition of supervisory regimes and home country control over financial enterprises – makes this difficult. The not obviously legitimate desire for rapid integration impedes the pursuit of more complete and effective consumer protection (Grahl, 2003). Overall, the on-going transformation of European finance from a bank-based to a market-based system of financial relations represents a clear political commitment to the liberalisation of the EU member states’

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financial markets and their re-regulation along the EU lines, with special emphasis on the development of capital markets. This has profound implications for the social and economic relations in which finance is embedded. Hastening this process will add to the pressures being felt by European society and especially by its most vulnerable sections.

4. Alternatives: Taming European finance: Stability, efficiency and inclusion The preceding section criticises the biased way in which financial market policy has been conducted, albeit it does not question the potential benefits of financial integration in Europe. A large European financial market could indeed be a considerable achievement for the European economy and beneficial for the European Social Model. It could promote financial stability, facilitate access to the payment and credit system for individuals and enterprises and contribute to efficient economic development while giving better services to consumers. But integrated financial markets do not automatically generate these positive effects. To ensure them a political framework for, and political intervention into, the market mechanism is required. Financial stability needs strong supervision of financial institutions, safeguards against both monetary chain reactions and excessive financial speculation and the continuous provision of credit to a broad range of firms (including small and medium enterprises). Efficient economic development must avoid distortion of capital flows through tax competition and public authorities must be able to support political choices of main regional and structural development directions through public institutions including public banks. Social inclusion in financial markets needs efficient European rules and instruments to guarantee universal access to basic financial services, consumer protection against fraud and overly risky activities of financial institutions. It also requires workers’ protection against the deterioration of their working conditions through a new exclusive emphasis on shareholder value or as a consequence of takeovers. The following sub-sections discuss the tools and instruments to achieve the objectives of financial stability (4.1), economic efficiency (4.2) and social inclusion and consumer protection (4.3) in an integrated European financial market (see Huffschmid, 2005). 4.1. Financial stability Financial stability is an important national and international public good. But it is not a ‘common good’, because individual actors on financial markets do not take into account the risks to other actors, and to the

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system as a whole, which result from their actions. In addition, today a considerable share of the profits of banks and other financial institutions stems from speculative operations.8 For large financial traders and speculators, the cost of financial stability would be high. Therefore the pursuit of international financial stability not only raises the problem of how to co-ordinate private choices so as to counteract the short-sightedness of markets and private players. It must also be the subject of deliberate political measures against the interests and resistance of actors who benefit from the existing instability. To achieve financial stability is not a question of unleashing market efficiency through liberalisation and deregulation; it is a matter of implementing efficient and, if necessary, coercive policies, such as investment constraints, capital requirements, taxation of speculative transactions or control of capital flows. The present financial system does not provide efficient safeguards against the sudden outbreak of a financial crisis with very high costs and strong contagion effects, although it must also be seen that the greater role of securitisation can contribute to financial stability to the extent that the supply of funds does not go through banks and therefore an asset price collapse is less threatening for the system as a whole (see Boyer, Dehove and Plihon, 2004). Improvement and introduction of new elements are therefore necessary. They can be divided into four groups of measures: a. b. c. d.

macroeconomic supervision and emergency plans, improvement of capital requirements for financial institutions, special measures against excessive financial speculation and national consolidation and tighter European co-ordination of financial supervision.

4.1.1. Macroeconomic supervision and emergency plans Macroeconomic financial stability is based on a well-functioning monetary and credit system. The responsibility for this should be clearly assigned to the ESCB, which is currently not in a good position to fulfil this task. (see Grahl, Huffschmid, Plihon, 2002: Section 3.2) The exclusive focus of the ESCB on price stability should therefore be broadened so as to include not only employment and growth (see Arestis, McCauley and Sawyer, 2001) but also systemic financial stability. It is necessary to reinforce the EU’s central capacity to confront issues of systemic stability and to undertake active, macro-prudential, measures in response to malfunctions in the increasingly integrated European financial sector. Mechanisms for the collective supervision of financial actors and markets – such as the European Committee on

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Banking Supervision – should be strengthened and the role of the ECB as a lender of last resort should clear and unambiguous. Clear contingency plans are needed to deal with possible banking crises and collapses of asset prices. In the formation of monetary policy and the setting of interest rates asset markets should play a greater role, because there are interactions between credit and securities, which in a case of crisis can run in both directions – for example, a shortage of bank credit can impair the functioning of stock markets, while a collapse in asset prices can provoke a wave of bad debts, undermining the balance sheets of the banks. In both cases the crisis could have an impact on one member country only and thus lead to very sharp asymmetries in the effects of common policies. But crisis might also exceed the intervention capacities of individual countries and trigger an EU-wide process of contagion. In either situation, confusion as to responsibilities for intervention or delay in taking emergency measures could have the most serious consequences. 4.1.2. Capital requirements The Basle 2 conception can be criticised for its pro-cyclical and structurally polarising implications and for the quasi-privatisation of banking supervision by the introduction of private risk assessment procedures – both internally (through the use of the banks’ own risk assessment models) and externally (through reliance on private creditrating agencies). As an alternative we propose the following three measures to improve the current Basle 1 framework: 1. The system of standardised risk weights for particular groups of debtors should be maintained and be complemented for particularly risky kinds of loan recipients, for instance hedge funds or offshore institutions. Risk weights should be externally determined by the financial supervision authorities and should remain constant over time. Such a standardised pattern has two advantages compared to the individualised approach envisaged in the Basle 2 framework: Firstly, it implies a certain degree of cross-subsidisation: within each group of debtors capital requirements are the same for loans to all members of the same group regardless of their individual financial status. Although this – very moderate – cross-subsidisation of the weaker by the stronger debtors contradicts the logic of a single firm it will – if not excessively extended – improve systemic stability because it works against the polarising mechanism of an individualised approach. Secondly, the rigidity of capital requirements over time operates as a kind of automatic stabiliser, because as far as external

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requirements are concerned credit conditions do not deteriorate in a recession and do not improve in a boom. 2. For the determination of the group-specific risk weights, the financial supervision authorities should use the national central banks (NCBs) as public rating agencies. NCBs have lost many of their previous functions with the advent of the eurosystem. They dispose of large and detailed statistical databases, long experience and highly qualified personnel. This makes them the natural basis for rating procedures, which are not driven by private profit considerations and conflicting interests and loyalties – as is often the case with private rating agencies. In developing rating standards, NCBs should cooperate closely with each other within the ESCB, but they could also take account of the national specificities of the groups of debtors which they are evaluating. A differentiated treatment of such specificities by public agencies could be further developed into an instrument of differentiated control of credit flows into specific countries, regions or sectors. Where NCBs currently fulfil functions of national financial supervision, their new rating activities must be strictly separated from these to avoid conflicts of interest. This can be done through outsourcing and the setting-up of separate public entities. 3. The range of risk weights should be extended to more than 100%. For particularly risky loans – which are for instance used for investment in hedge funds or trades in derivatives – coefficients of 150% or more should be set. 4.1.3. Specific measures against financial speculation Although a certain degree of financial speculation is necessary to enable hedging activities which have a stabilising effect, excessive speculation, driven by herd behaviour, has often led to cumulative processes, increased volatility, turbulence and bubbles on financial markets which, when they burst, can be the cause of severe financial crises (see Kindleberger, 1996, Chapter 2). Some safeguards against excessive financial speculation can be provided through monetary policy and capital requirements, others through enhanced transparency and reporting requirements both for institutions such as hedge funds and for risky positions in certain derivatives. But more is needed. Particularly very short–term trading and selling on secondary equity markets are often more harmful than useful for the smooth functioning of the economy and should therefore be constrained. A soft way of doing this is the introduction of a securities transaction tax, which could be differentiated according to holding periods. It should apply only to

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trades on secondary markets, and not be levied on the issue and first buying of shares and comparable securities. Therefore it would not be an obstacle to external financing for firms and governments. Government bonds could be excluded from this tax in order to avoid obstacles to the liquidity management of financial institutions. For stronger waves of speculation, the transaction tax should be complemented by a high but regressive capital gains tax, the rate of which should fall as the holding period of the security lengthens. As to currency speculation, we take up the proposal for a moderate currency transaction tax (CTT), following the concept developed in the 1970s by James Tobin. The intense discussion of this proposal has come to the general conclusion that it would be feasible even if introduced only by the EU, and that it would gather a substantial amount of revenue. Other aspects such as the impact on financial markets in general remain more controversial.9 However, it seems clear that in times of strong turmoil in the foreign exchange markets a low Tobin tax would be rather inefficient. It has therefore been proposed that this low fixed rate be complemented by a second flexible rate, which would serve as a circuit breaker against massive short-term currency flows (see Spahn, 2002). Although it is desirable that such a two-tier system be set up on a worldwide level, its unilateral introduction would also be possible and effective – although to a lesser extent. The tax, even if it is levied at a lower rate (for instance 0.1%) than Tobin proposed (1%), would yield considerable revenues. It is proposed to use the proceeds from the CTT to promote economic and social development in poor third world countries. Another way to deal with currency speculation is a co-ordinated exchange rate policy with target zones, an exchange rate stabilisation fund and intervention on the currency markets. In the case of destabilising capital inflows or outflows, the EU could and should reintroduce and apply temporary capital controls. In spite of all the liberalisation rhetoric, this instrument has never been completely relinquished by the Community. It is – at least in indirect form – present in Article 59 of the current EU Treaty.10 The cost of such capital controls can be lower and their efficiency much higher than the costs of other forms of market intervention and the costs would be in any case lower than the costs of a financial crisis triggered by excessive flows of capital. Although the size of the euro-zone is so great that such measures would only be needed in exceptional circumstances, smaller monetary systems, including those of the NMS before they adopt the euro, are more likely to face this kind of emergency and the EU should uphold their right to use capital controls as an effective response.

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4.1.4. National consolidation and tighter European co-operation in financial supervision In the last few years, in many of the EU members a process of institutional concentration of financial supervision has taken place on a national basis. This process is positive and should be intensified. Institutional consolidation should not be restricted to concentrating bank supervision in one authority, like in France. It should aim at the establishment of one regulatory authority for the whole financial services sector, as was set up in 2000 in Great Britain and in 2002 in Germany.11 It should lead to a powerful authority with extensive competence and strong instruments including the right to obtain full information from financial institutions, to conduct independent inquiries and to withdraw business licences and impose other sanctions upon institutions which do not comply with the rules. To strengthen the European dimension of financial supervision, it is in the first place necessary to expand the stock of common harmonised rules for the structure and behaviour of the financial services sector. For the institutional implementation of European financial supervision, two models are conceivable. The first is to set up one European institution corresponding to the centralisation of monetary policy. This model raises two groups of problems: On the one hand, such strong centralisation pre-supposes a stable set of harmonised rules, which at present are non-existent. Centralisation of European financial supervision can therefore be only conceived as a last step in a long process of ever-closer co-ordination and harmonisation. On the other hand, even then a centralised financial supervision institution on the European level would hardly be in a position to take into account the specific structures, problems and needs of national financial sectors and deal with them in an appropriate way. Therefore the second model assigns the implementation of the common harmonised rules to national supervisory authorities which can also best take account of the particular national specificities. In this case a tight European co-ordination is needed, which should lead to a set of common binding rules, and eventually result in a set of European directives, which will then be transformed into national legislation and be applied by the national authorities. Unlike the European Securities Committee (ESC), which came out of the Lamfalussy process, parliamentary control over supervision legislation should not be limited to the right to intervene after the event; it should instead remain in every stage under the full control of the Council and the European Parliament.

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4.2. Economic efficiency Apart from speculation, the efficiency of financial markets to direct financial resources into their most profitable use can be undermined in two ways. Firstly, capital can be diverted through tax considerations based on different tax policies in the EU. Secondly, the dynamics of financial markets may lead to short-term operations to raise asset prices, which are not compatible with long-term sustainable economic development. Against the first danger, tightly co-ordinated tax policies with regard to corporate and capital taxes are necessary. To correct structural distortions driven by financial market short-termism, the public authorities should be able to intervene in the structure of finance via public banks. 4.2.1. Tax policy We do not share the view of the EU authorities that tax competition in general is beneficial and that only discriminatory treatment of corporate or capital profits is harmful and to be eliminated. Tax competition via reduction of tax rates and tax bases can lead, even when it is not discriminatory, to harmful consequences. It can either undermine the public revenue base and thus weaken the potential of governments to intervene in and shape the economy according to political and social priorities. Or it can shift the tax burden in favour of firms and capital owners, i.e. upper income classes at the cost of the poorer ones. In reality often both happen at the same time. To constrain tax competition and thus enhance economic efficiency, the following measures are recommended for corporate profits and capital income, that is of interest income, dividends and capital gains. 4.2.1.1. Taxation of corporate profits. Theoretically by far the most efficient means of taxation of financial income is the full harmonisation of tax bases and tax rates within the EU. This would remove the incentives for tax competition and relocation for reasons of tax arbitrage. However, such a move is not only politically very unrealistic under the present circumstances, but it will also pose a number of difficult problems for the reshaping of the structure of public finance in various member countries. Therefore, although the goal of full harmonisation should not be given up as a long-term perspective, other measures should be taken for the foreseeable future. As such measures we propose: – Firstly, to accelerate the harmonisation of the corporate tax base (including accounting and valuation standards) which is currently pursued with priority by the EU.12

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– Secondly, to impose a minimum tax rate of 40% in all member countries in order to make tax competition less attractive. – Thirdly, to introduce the world income principle in the sense that worldwide profits of a corporation are taxed in the ‘value basis’ country (at the domestic rate) where the main operating basis of this firm lies, i.e. where the largest parts of value are created. Taxes paid in other countries are deductible from the tax obligation in the value basis country. Under such a regime ‘double taxation conventions’ would have to be revised, with the likely effect that most of them become pointless and will be terminated. As long as income taxes are not harmonised throughout the EU – and this is still more unrealistic and probably also less desirable than the harmonisation of corporate taxation – full mutual information about the capital income of the EU citizens in the other EU countries and co-operation in enforcing national income tax regimes throughout the EU is the best way to deal with capital income. The EU should extend this regime which, for most countries from 2005 onwards, will operate only for interest income to dividends and other forms of capital income. It should do so even if the US, Switzerland and other financial centres do not co-operate. If the EU is determined to apply this rule there are instruments to enforce co-operation and to limit the damage of non-cooperation. A model for such enforcement could be the US: The tax authorities in 2000 wrote letters to major financial institutions throughout the world, requesting them to provide regular information about the capital incomes of the US citizens and threatening to complicate or cut financial relations between the US firms and non-cooperating banks. Subsequently the US Internal Revenue Service concluded contracts with the same content with several European banks (see Bach, 2001: 120/1). This unilateral measure could be the model for a corresponding response on the part of the EU, and it is hard to see how the US could demand co-operation from other countries but at the same time refuse to co-operate in turn with those countries. The problem of the EU is not that there are no means to implement strong tax rules. The problem is the lack of political determination to apply them. In this context, the requirement of unanimity for all legal steps with regard to taxation is a real obstacle to progress and should eventually be removed. But even before this happens if there were political consensus among the main financial centres to proceed in the proposed way it would hardly be possible – and in any case not be very efficient – for the other EU members to openly offer opportunities to circumvent such measures.

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4.2.2. Public banks The main orientations and directions of economic development – infrastructure, utilities, basic research and the provision of other public goods – should, in a democratic society, not be left exclusively to market forces but be in the last instance determined by democratic discussions and democratic decisions about the appropriate frameworks. If the markets do not follow these public guidelines and if economic incentives do not work efficiently enough, governments must have the instruments to provide finance through public financial institutions. This applies to the national and – often even more so – to the regional level. Public banks can be efficient and necessary instruments to implement regional, industrial and technological development strategies and to pursue social objectives such as the provision of affordable housing or universal access to the financial system. Most national and regional governments still own such financial institutions. They should be explicitly acknowledged as instruments to provide public goods or services of general interest and therefore be exempt from the European competition rules. On the EU level, the roles of the EIB and the EIF for the implementation of development priorities inside the EU should be reinforced. 4.3. Inclusion To ensure that the potential benefits of financial liberalisation really materialise and reach all members of society special measures must be taken with regard to universal access to such services, to users and to workers protection. They are necessary to counter the tendencies of financial providers to respond to increased competition by restricting their supply only to attractive groups of customers and regions and to abuse the asymmetry in information and market power between financial enterprises and individual customers for unfair and fraudulent behaviour of the latter. 4.3.1. Universal access to basic financial services In modern societies, access to basic financial services is vital for participation in social life and must therefore be treated as a public good. The provision of this good is a social and political responsibility even where financial services are completely or mostly supplied by private firms. Access to financial services in this sense includes two dimensions: The first dimension is the right of every individual to access to basic financial services regardless of the income or social status of that individual. Regulations to this purpose exist in different member countries, but they are often rather vague and not very efficient13 and differ

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substantially from each other. Guidelines as to the minimum content of basic financial services should be elaborated and adopted on the EU level through directives. They should include the right to a bank account, to a bank card to withdraw money from ATMs at least of a certain network, to make and receive payments, and to a number of free money transfers per month. For welfare recipients and other lowincome individuals, these services should be granted without charge by all credit institutions. To avoid an unfair distribution of the costs for meeting these obligations, a fund should be created to which all credit institutions contribute according to their financial assets and from which they are reimbursed according to the number of free low-income accounts. The second dimension of the universal access to financial services is the regional one. Credit institutions must be within a reasonable regional reach of users to realise the right of access for everyone. Traditionally this function was often fulfilled by the national postal services. However, these are increasingly transformed into legal corporate entities, and subsequently deregulated and privatised. During this process the financial services branch is downsized, and often outsourced and sometimes sold to private banks without any infrastructural mandate. It is therefore necessary to counter the tendency to regional desertification with regard to the availability of financial services. One way of ensuring this is the preservation of public savings banks, which play an outstanding role in Germany. Where such banks do not exist private commercial banks should be obliged to set up a minimum number of service points in every region. They could consist of networks of different density for ATMs (high density) and other financial services (lower density). To cover the costs of maintaining such a network for financial inclusion, a fund solution similar to the one for basic bank services for low-income groups is conceivable. An alternative would be to subsidise banks to the extent to which they take part in such networks. As a part of providing public goods or “services of general economic interest” such subsidies should not be regarded as conflicting with the EU competition law. 4.3.2. Consumer protection In spite of official rhetoric, consumer protection is presently still a subordinated and widely neglected aspect of the EU’s policies for financial markets (see FIN-USE, 2004). Financial liberalisation and deregulation have not brought always economic benefits and in some cases have caused considerable damage both to households (particularly those

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with modest incomes), to small firms, and to the social fabric. Therefore the EU should change its priorities in financial services policy to restore public confidence and the legitimacy of the EU actions in this field. Such a reorientation would not have a negative impact on growth and investment. In the present context of financial disorder, the subordination of consumer interests to “market-creating” integration may even be self-defeating because consumer suspicion will hold back financial development and deprive many financial companies of new resources. On the other hand, the gradual restoration of confidence in financial institutions would tend to support a socially responsible integration project and to make for a wider and more stable supply of financial resources. To this end, consumer protection must regain greater weight than it currently has. It must go beyond the setting up of a European network FIN-NET, which deals with complaints with regard to financial services but has neither formal competence nor power. Self-regulation which is often recommended by financial firms as an appropriate instrument to safeguard consumer interests has not prevented many cases of mis-selling and unfair dealing of financial services providers with their customers. The strong asymmetry of information and power between large providers and small users of financial services makes the latter, individuals and small enterprises, vulnerable with regard to misbehaviour of the former. It will not disappear with financial liberalisation, even if this results in stronger competition, which is not self-evident. Against the common interests of providers to maintain this asymmetry, stronger statutory regulations are necessary to protect consumers. It is necessary to introduce high, Europe-wide, legal minimum standards of consumer protection, summed up by the ‘caveat venditor’ rule: the seller is responsible. Provisions to this effect should be integrated into the directive proposal for consumer loans currently under discussion (see European Commission, 2002) and replace Article 9 of this proposal (about ‘responsible lending’) which is completely insufficient. In retail markets where individuals confront large and sophisticated companies, and where a single decision – on borrowing and lending – can have enormous implications for long-run welfare, the most effective regulatory principle is to oblige the providers of financial services to investigate thoroughly the interests (and not only the ability to pay) of their customers. Credit advanced to households without such investigation should be irrecoverable; savers should be indemnified if a failure to consult their interests leads to losses. Regulations to this effect should be introduced into the rules of corporate governance for the financial industry.

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European legislation on minimum standards of consumer protection in financial services should not be developed in a Lamfalussy procedure but under full participation of consumer interest groups. It may be desirable to leave much of the detailed regulation of financial products and practices to national authorities. On the EU-level the adoption of minimum standards is preferable to full harmonisation, because it allows countries with higher standards to maintain these. At the same time a process and timetable for upward convergence should be envisaged. One of the most important cornerstones for European consumer protection is the rejection of the principle of home country control and its replacement by the principle of consumer country control. This would avoid the unmanageable effort for the user of financial services to obtain and correctly evaluate information about many different legislations and give them the safety of the national legal framework in which the user lives. It would also take into account the different financial structures, habits and cultures which have developed in different countries and should be taken as an asset and not as an obstacle to financial stability. More concretely, European consumer protection in financial services should include the following: 4.3.2.1. Standardisation of certain retail services. Frequently, enterprises in the financial sector engage in excessive and spurious product differentiation. This is made possible by the marked information asymmetries between suppliers and customers. The outcome corresponds to the classical analysis of monopolistic competition: excess capacity, wide margins between costs and prices, a loss of scale economies, heavy and dysfunctional marketing expenditures. In such situations the authorities should be empowered to require a simplification of product descriptions. This again implies that regulators should have power over products not just over marketing procedures. The financial enterprises argue that such regulation threatens innovation, but this is unconvincing because many of the financial “innovations” which are introduced in this sector are without value and serve only to confuse. 4.3.2.2. Enforcement of socially responsible behaviour by commercial enterprises. Similarly, profit-making financial actors themselves should be constrained to respect social objectives in their commercial activities, for example, to avoid discrimination against lower-income customers. German and French enterprises which close production facilities are required to draw up ‘social plans’ in the interests of their employees.

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Similar rules should apply, on a Europe-wide basis, to the withdrawal of financial services from communities with inadequate alternative provision. It is interesting that this kind of constraint can be found in the US, although this is not an aspect of the US system, which attracts the attention of the EU elites. The Community Reinvestment Act (CRA), enacted in 1977, aims to ensure a flow of credit to low-income communities and all banks above a certain size are required to participate. Although the CRA was something of a dead letter under the Reagan administration, it was reinforced in the 1990s, and there is now an effective if imperfect monitoring system to ensure compliance. (see www.ffiec.gov/cra/default.htm) 4.3.2.3. Protection of non-profit and publicly owned enterprises. In many countries, mutual and other non-profit enterprises in the retail financial sector, and the provision of financial services by publicly owned enterprises have come under pressure – from deregulation and liberalisation (the British Building Societies) and from the European competition regime (the public Sparkassen and Landesbanken in Germany). But such institutions provide important public goods such as financial services for low-income households and communities, the support of local initiatives and certain forms of redistribution and collective insurance which would not be provided by purely commercial enterprises. There is also a general interest in the development of the ‘social sector’ of European economies. In consequence, the competition regime for European retail financial services must permit national, regional and local governments to subsidise the provision of such services, or themselves to provide them. 4.3.2.4. Constraints on GATS negotiations. The liberalisation of financial services is a prominent issue on the General Agreement on Trade in Services (GATS) agenda of liberalisation of trade in services in general. In the financial sphere as elsewhere, such liberalisation can threaten important aspects of public provision. The EU is the best-placed trading bloc to resist the introduction of liberalisation rules, which compromise consumer protection, and to ensure that financial companies entering the European market are constrained to observe the highest possible standards. Such conditionality for the liberalisation of the financial sector would in the long run reinforce European competitiveness and attract customers for European financial services. 4.3.3. Workers protection Workers are often the victims of increasingly deregulated financial markets. On the one hand they feel the pressure which a new shareholder

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value orientation introduces into all aspects of industrial relations. On the other hand financial takeovers of firms by institutional investors often are followed by closures and/or relocations of plants with severe consequences for workers. Remedies against harmful consequences for workers through the activities of financial market agents should consist in strengthening the right of workers to participate in the control of the firm with a veto right in matters of employment and work conditions. This is of course difficult to implement because structures and provisions in Europe are very different among member countries and because the resistance of management and owners against such introduction of elements of democracy into the organisation and management will be strong and adamant. In relation to takeovers, specific rules for the protection of workers interests should be developed. In 2004, a takeover directive was adopted (Directive 2004/25/EC of 21 April 2004), which leaves it to member states to decide how far companies are allowed to protect themselves against hostile takeovers. In this area the effort of the Commission to create an area of financial expansion without any constraint was not successful and there remains room to shape conditions for takeovers which take account of interests and concerns of the target firm. The main concern in the discussion preceding this directive has been the protection of the interests of minority shareholders. Interests of workers, which are at least as much affected by takeovers, have been given very little attention and relate to the information of employees and their representatives and to their right to formulate a separate opinion on the effects of the takeover on employment. It is reasonable to enhance this protection to the interests of workers considerably. This could be done by imposing social obligations upon the buyer, above all to guarantee – at least for a certain time – the number of jobs and refrain from tightening pay and work conditions. There should be strong vetoing powers against closures and relocations of plants after a takeover. Where they are clearly shown to be unavoidable – in the context of a corporate strategy about which workers representatives must be fully informed – there should be adequate compensation to dismissed workers and to the region affected by the measure. Again it is necessary to give these rules concrete expression in each national legal system, and this should be facilitated by Article 14 of the takeover directive requesting to respect relevant national provisions. The EU should adopt a directive with three clear mandates for workers protection in the case of cross-country takeovers: Firstly, it should oblige the parties concerned to

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elaborate and take the measures mentioned above. Secondly, it should define certain minimum standards for workers protection. Thirdly, European minimum standards should not lead to the reduction of standards where they are already higher than the required minimum.

5. Summary and concluding remarks It has been argued in this chapter that the strong growth of financial markets in the EU has been embedded in and partly been a consequence of weak growth and high profits which were not re-channelled into the productive process but invested on financial markets, causing increasing turnover velocity and higher weight of the securities segment in the financial sector. The EU policies have facilitated and accelerated financial liberalisation throughout the EU with primary emphasis on cost reduction and speed disregarding problems of systemic stability and efficiency and of consumers and workers protection. These neglected aspects should be put in the centre of more progressive financial market policies. The main idea is that the creation of an integrated European financial market should not be governed by the exclusive aim of reducing costs and increasing the speed of financial transactions. Instead integration should be embedded in a social and economic environment in which financial stability, economic efficiency and social inclusion are the guiding principles. To ensure financial stability the mission of the ESCB must be broadened, the Basle 2 framework should be changed, special measures against excessive financial speculation should be taken and tight co-operation among financial supervisors in the EU are necessary. Economic efficiency in financial markets can be enhanced when distortions caused by different tax systems and tax competition are removed and special financial instruments for the implementation of public development objectives are retained. In the area of social inclusion, proposals for the guarantee of universal access to the financial system, for high minimum standards of consumer protection and for the inclusion of workers’ interests into the framework of the European financial market were formulated. However, the policy perspective should reach beyond this horizon of improved financial market policies. It should also envisage tackling the basic economic problems which have led to the enormous extension and to the instability of financial markets in the EU: weak economic growth, high unemployment and income redistribution from the bottom to the top. These are linked to each other in a vicious circle of economic stagnation and social polarisation which are the roots of the

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recent financial market problems. Tackling these roots requires not only a better financial market policy but also a better economic policy at large: A policy for more sustainable growth, full employment, and a redistribution of income in favour of salaries, wages and social benefits.

References Adam, K., T. Jappelli, A. Menichini, M. Padula and M. Pagamo (2002), Analyse, compare and apply alternative indicators and monitoring methodologies to measure the evolution of capital market integration in the EU, CSEF, University of Salerno. Arestis, P., A. Caner (2005), Financial liberalization and poverty: Channels of influence, in P. Arestis and M. Sawyer (eds), Financial Liberalization : Beyond Orthodox Concerns (Basingstoke: Palgrave). Arestis, P., A.D. Luintel and K.V. Luintel (2004), Does financial structure matter?, WP No. 399 (The Levy Economics Institute of Bard College, 2004). Arestis, P., K. McCauley and M. Sawyer (2001), An alternative stability pact for the European union, Cambridge Journal of Economics,25, 113–30. Bach, S. (2001), Kapitaleinkommensbesteuerung zwischen Wettbewerb und Harmonisierung, W. Müller, O. Fromm and B. Hansjürgens (eds), Regeln für den europäischen Systemwettbewerb. Steuern und soziale Sicherungssysteme (Marburg: Metropolis) pp.105–32. BIS (2005), Bank for International Settlements, 75th Annual Report, 1 April 2004–31 March 2005, Basel, 2005. Boyer, R., M. Dehove and D. Plihon (2004), Financial Crises. Analysis and Proposals, (Paris: Documentation Francaise). Caviglia, G., G. Krause and Ch. Thimann (2002), Key features of the financial sectors in EU accession countries, Ch. Thimann (ed.), Financial Sectors in EU Accession Countries (Frankfurt am Main: European Central Bank), pp. 15–30. CEC (1999), Financial services: Implementing the framework for financial markets – Action Plan, COM, 232. CEC (2002), Report on the Implementation of the 2001 Broad Economic Policy Guidelines, ECFIN/16/02. CEC (2003), Financial services: Commission presents measures to improve regulation of banking, insurance and investment funds, IP/03/1507. CEC (2004), Financial Integration Monitor, SEC (2004) 559, April. CEC (2005a), Financial Integration Monitor, SEC (2005) 927, June. CEC (2005b), White Paper on Financial Services Policy 2005-2010, COM (2005) 629. CEC (2005c), Green Paper on Financial Policy in the EU 2005-2010, COM (2005) 177. De Buc, Louis, Gabe de Bondt, Alessandro Calza, David Marques Ibanez, Adrian van Rixtel and Silvia Scopel (2005), Financing Conditions in the Euro Area, Occasional Paper Series, No. 37, October, ECB, Frankfurt. Danthine, J.P., G. Giavazzi, X. Vives, and E.L. Von Thadden (1999), The Future of European Banking,, Monitoring European Integration 9, CEPR. Directive 2004/25/EC of the European Parliament and of the Council of 21 April 2004 on takeover bids, Official Journal of the European Union L142 of 30.4.2004, pp.12–23.

Marica Frangakis and Jörg Huffschmid 83 ECB (2003), The integration of Europe’s financial markets, Monthly Bulletin, 53–66, October. ECB (2005a), Banking Structures in the New EU Member States, January. ECB (2005b), European Central Bank, Structure of the euro area economy, www.ecb.int/mopo/eaec/html/index.en.html European Commission (2002), Proposal for a directive on the harmonisation of the laws, regulations and administrative provisions of the Member States concerning credit for consumers, Com (2002) 443 final of 11 September 2002, (Brussels). European Commission (2004), Employment in Europe 2004, Brussels. European Commission (2004), Financial Services. Turning the Corner. Preparing the challenge of the next phase of European capital market integration. Tenth Report, (Brussels, 2 June). FIN-USE Forum (2004), Financial Services, Consumers and Small Businesses. A User Perspective on the Reports on Banking, Asset Management, Securities and Insurance of the Post FSAP Stocktaking Groups, Brussels. Grahl, J. (2003) “Problems of Financial Integration in the EU”, Contribution to the UACES Conference, Newcastle, September. Grahl, J., J. Huffschmid and D. Plihon (2002), Europäische Finanzmärkte. Struktur, Entwicklung, Politik, Probleme und Alternativen (Brussels). Huffschmid, J. (ed.) (2005), Economic Policy for A Social Europe. A Critique of Neo- liberalism and Proposals for Alternatives, (Houndsmills, New York: Palgrave Macmillan). Huffschmid, J. (2002), Politische Ökonomie der Finanzmärkte, (Hamburg: VSA 2002). Kindleberger, Ch.P. (1996), Manias, Panics and Crashes. A History of Financial Crises, 3rd edition (London: Macmillan). New Rules for Global Finance Coalition (ed) (2003), Debating the Tobin Tax Washington D.C. OECD (2003), Bank Profitability. Financial Statements of Banks, 2002 edition, (Paris: OECD). OECD (2005), Ageing and Pension System Reform. Implications for Financial Markets and Economic Policies, Financial Market Trends Volume 2005 Supplement 1, Paris. PricewaterhouseCoopers (2004), Study on the financial and macroeconomic consequences of the draft proposed new capital requirements for banks and investment firms in the EU, Final Report, 8/4/2004. Rajan, R. and Zingales, L. (2002) “Banks and Markets: The Changing Character of European Finance” in: The transformation of the European Financial System, Second ECB Central Banking Conference. Spahn, B.P. (2002), Zur Durchführbarkeit einer Devisentransaktionssteuer, Gutachten im Auftrag des Bundesministeriums für Wirtschaftliche Zusammenarbeit und Entwicklung (Frankfurt a.M.).

Notes 1. Stock market capitalisation in the euro area quadrupled from 20% of GDP in 1990 to 86% in 2000; it fell to 47% in 2002 and rose to 57% in 2004 (see ECB, 2005).

84 Alternative Perspectives on Economic Policies in the European Union 2. In its latest Annual Report (2004/2005: 9/10), the BIS discusses this problem rather broadly as a potential source of financial instability and turbulence. But the diagnosis of the phenomenon is very much biased towards a too lax monetary policy with too low interest rates, which generate high demand for credit. The recommendation therefore goes more or less openly to increase interest rates. An alternative explanation for excess liquidity emphasises the strong redistribution of income as a source of high unemployment and weak growth, and remedies would be more active fiscal policies with strong elements of redistribution in the reverse sense, together with a more accommodating monetary policy – and with more active trade unions insisting on higher wage increases than were achieved since the 1990s. 3. Both Cyprus and Malta are currently phasing out their offshore financial centres. In particular, Cyprus will abandon the existing framework of offshore business tax preferences by 2005, while it is extending supervision to all domestic businesses currently outside its scope. 4. Furthermore, Western banking groups own a significant share in the total assets of foreign banks in these countries. The groups most actively involved include KBC (Belgium), Bank Austria/Creditanstalt, Raiffeisen and Erste Bank (Austria), Citibank (USA), Unicredito and Banca Commerciale Italiana (Italy), Société Genérale (France), ING (Netherlands) and Commerzbank (Germany). 5. “Arm’s length” finance refers to market-based financial systems – where capital is raised from and returned to arm’s length parties – as opposed to “relationship” finance – where capital essentially circulates within a set of related firms and institutions (Rajan and Zingales, 2002: 126). 6. One such area is the 10th Company Law Directive on cross-border mergers, the first proposal of which was tabled by the Commission in 1984. In 2001, the Commission withdrew its initial proposal, submitting a new one, in view of the fact that the question of worker involvement had been dealt with in the context of the European Company Statute. 7. According to Article 16 of the Banking Directive: “The member states shall require any natural or legal person who proposes to hold, directly or indirectly a qualifying holding in a credit institution first to inform the competent authorities, telling them of the size of the intended holding. Such a person must likewise inform the competent authorities if he proposes to increase his qualifying holding so that the proportion of the voting rights or of the capital held by him would reach or exceed 20%, 33% or 50% or so that the credit institution would become his subsidiary. The competent authorities shall have a maximum of three months from the date of the notification provided for in the first paragraph to oppose such a plan if, in view of the need to ensure sound and prudent management of the credit institution, they are not satisfied as to the suitability of the person referred to in the first subparagraph, they may fix a maximum period for its implementation”. 8. Which is partly reflected in the share of net revenues from financial operations in their total net income for banks – particularly large commercial banks – in the major EU countries throughout the 1990s (see OECD, 2003). 9. Perhaps one could make the proposal more acceptable to critics of the concept by exempting foreign exchange swaps from the tax. The reason for this is that such swaps do not establish open positions and are frequently used as

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10.

11. 12.

13.

instruments for liquidity management. For a detailed discussion of the arguments in favour and against the CTT see New Rules (2003). Article59 of the Treaty on European Union: “Where, in exceptional circumstances, movements of capital to or from third countries cause, or threaten to cause, serious difficulties for the operation of Economic and Monetary Union, the Council of Ministers, on a proposal from the Commission, may adopt European regulations or decisions introducing safeguard measures with regard to third countries for a period not exceeding six months if such measures are strictly necessary. It shall act after consulting the European Central Bank.” Although in Germany some part of supervision over banks was retained by the Bundesbank (see Grahl, Huffschmid, Plihon, 2002: Section 2.3.2). Although the Commission has recently observed that reluctance and scepticism of member states with regard to this harmonisation are growing (see European Commission, Communication, 2003: 5). In France for instance, where, since the ‘loi Aubry’ of 1998 against social exclusion, every individual has a right to a bank account, about five million persons are, according to a report of Le Monde of 10 June 2004 (p. 18), in fact excluded from bank services.

3 The Reform of European Regional Policy: Underlying Debates Marisol Esteban Basque Country University

Abstract The aim of this chapter is to analyse the key issues associated with the process of reform of European Regional policy for the next programming period 2007–2013. Future European Union (EU) Cohesion policy will be the result of three intertwined debates – the reform of the Cohesion policy itself, the next Financial Perspective 2007–2013, and the EU Constitutional Treaty – in the context of both enlargement, which has doubled the gap between European regions, and slow progress of the EU in meeting the goals of growth and competitiveness set up by the Lisbon Agenda. Even though the debate points to the necessity of reforming especially Common Agricultural Policy (CAP) and the EU Cohesion policy, in order to ensure efficient operations in an enlarged EU, it needs to be stressed that, to a great extent, the motor of reform has come from financial concerns. Future Cohesion policy will increasingly be concentrated in promoting growth and job creation in the less favoured regions of the less favoured countries of the Union, which means a shifting of resources from the less favoured regions and countries of the EU–15 to the new Member States. JEL Classification: R10, R50, R58 Keywords: Regional policy, Cohesion policy, European Union, policy reform, Financial Perspective, Constitutional Treaty.

1. Introduction The aim of this chapter is to analyse the key issues associated with the process of reform of the European Union (EU) Regional policy,1 the only 86

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policy of the EU that has addressed explicitly economic and social inequalities on a territorial basis. It is thus a very specific policy involving a transfer of resources between Member States via the budget of the EU for the purpose of supporting economic growth and sustainable development through investment in people and physical capital. This also means that the concept of cohesion that has been applied at the European level has not been a passive one that redistributes income but a dynamic policy that seeks to create resources by targeting the factors of economic competitiveness and employment, especially where unused potential is high. Future EU Cohesion policy will be the result of three intertwined debates – the reform of the Cohesion policy itself; the next Financial Perspective 2007–2013, that may provoke the reform of other European policies, e.g. Common Agricultural policy (CAP); and the EU Constitutional Treaty – in the context of both enlargement, which has doubled the gap between European regions and slow progress of the EU in meeting the goals of growth and competitiveness set up by the Lisbon Agenda. The importance of the current debates for the future evolution of the EU is recognised by all. The linkage between different decision-making processes currently under way in Europe becomes more evident as time passes. While the relationship between the approval of the reform of the Structural Funds and the approval of the Financial Perspective for the period 2007–2013, in the context of enlargement of the Union, always appeared to be heavily connected, the influence of the problems faced during the process of ratification of the EU Constitution has been an unexpected outcome, which may have significant consequences for Cohesion policy in Europe. Although the European Commission (EC) has wanted to separate the debates on enlargement of the Union, from those of the EU Constitution, the reform of Cohesion policy and the next mid-term Financial Perspective – that is from that of its Agricultural and Structural policies – connections between them do clearly exist. This chapter will analyse first the proposals made by the EU on the reform of the EU Cohesion policy for the next programming period 2007–2013 looking at the new objectives and policy architecture being put forward as well as the financial provisions (Section 2). Second, while the signing of the Constitutional Treaty would represent a first agreement on the future of Cohesion policy which needs to be examined, the relevance for our purposes lies more in the difficulties met during the process of ratification, which may facilitate the adoption of important reforms of some of the most significant European policies (Section 3); and, finally, the debates carried out on the future of Cohesion policy

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and the next mid-term Financial Perspectives for the period 2007–2013 need to be discussed (Section 4) to get an insight into the positions taken by Member States. 2. The reform of the European Union Cohesion policy: The European Commission proposals The European Commission (EC) launched the debate over the future of the EU Cohesion policy after 2006 in January 2001 with the publication of the Second Report on Economic and Social Cohesion (European Commission, 2001) which developed a set of conclusions, recommendations and questions with the view to opening up a debate on the future of Community Cohesion policy in an enlarged EU. The debate has involved the EU institutions and agencies, Member States and regional and local authorities, as well as the relevant economic and social interests, non-governmental organisations, universities and other academic institutions, which have submitted their proposals to the EC.2 Following a prolonged period of debate and research the Commission put forward several key documents in 2004: its budgetary proposals for the period 2007–2013 (February) closely followed by the Third Report on Economic and Social Cohesion (February) and the formal legislative proposals for the reform of the Structural Funds (July) to be presented to the European Parliament and the Council of Ministers for a new Cohesion policy to take effect before from 1 January 2007, which are the basis of current debate and negotiations.3 2.1. European Commission proposals for Cohesion policy: The context The Third Report on Economic and Social Cohesion “A New Partnership for Cohesion, Convergence, Competitiveness, Cooperation” provides the Commission’s view not only on the spatial impacts of regional and other European policies and Member States’ policies but also makes proposals for the reform and improvement of future policy strategies. This Report emphasises the role that Cohesion policies should play in meeting the goals of the Lisbon Agenda. Slow economic growth over the period 2001–2004 resulted in rising unemployment, with all the social implications this entails; low levels of innovation and use of Information and Communication Technology (ICT); and low level of the growth of productivity. Therefore, the objectives of growth and competitiveness are at the heart of EC’s proposals. This bad economic performance, especially when compared with the US, suggests fundamental problems that need to be overcome if growth in

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the EU is to be sustained once recovery gets under way. The areas of investment in physical and human capital and innovation and use of ICT are especially considered to boost both productivity and employment. These areas need to be improved not only in Central parts but throughout the Union. This growth strategy need not to ignore the wide disparities in output, productivity and employment that still persist between regions and countries, which have highly increased following the EU enlargement. The major factors explaining these disparities seem to be structural deficiencies in key factors of competitiveness: inadequate endowment of physical and human capital (of infrastructure and work force skills), a lack of innovative capacity, of effective business support and low level of environmental capital (a blighted natural and/or urban environment). If the EU is to realise its economic potential, then all regions, wherever they are located, need to be involved in the growth effort. The cost of not pursuing a strong Cohesion policy to tackle disparities may then be measured not only in terms of a loss of personal and social well-being but also in economic terms, in a loss of potential real income and higher living standards. Given the interdependencies inherent in an integrated economy, these losses are not confined to the less competitive regions or to individuals who are not working or who are in unproductive jobs but affect everyone in the Union. Therefore “strengthening regional competitiveness throughout the Union and helping people fulfil their capabilities will boost the growth potential of the EU economy as a whole to the common benefit of all. And, by securing a more balanced spread of economic activity across the Union, it will reduce the risk of bottlenecks as growth occurs and lessen the likelihood of inflationary pressure bringing growth to a premature end. It will equally make it easier to sustain the European model of society and to cope with the growing number of people above retirement age and so maintain social cohesion” (European Commission, 2004a, p. viii). The growing interdependency of all the EU regions is continuously emphasised by the Commission. Therefore, according to the Commission’s view, these disparities cannot be solved by the market itself, but countries and regions need assistance in overcoming these structural deficiencies and in developing their comparative advantage in order to be able to compete both in the internal market and outside. Similarly, people need to be able to access education and training in order to develop their capabilities wherever they live. In conclusion, if Cohesion policy was important 15 years ago when it was strengthened, it is even more so nowadays in the face of the widening of disparities which enlargement entails.

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2.1.1. Regional disparities in the EU: Situation and trends in the context of enlargement Disparities in income and employment across the EU have narrowed over the past decade, especially since the mid-1990s. Despite this narrowing of disparities, large differences still remain and the extent of the differences between the EU countries have widened much further when the new Member States have joined the EU. Average GDP per head in these 10 countries is under half the average in the EU–15 and only 56% of those of working age are in jobs as against 64% in the EU–15. According to the Commission’s view, regions suffering from structural weaknesses, which limit their competitiveness and prevent them from contributing fully to sustainable economic growth in the EU, tend to be those which suffer from low productivity, low employment and social exclusion. Regions with problems of competitiveness, however, are not confined to the so-called Cohesion countries and the new Member States. A number of regions, despite adequate endowment of infrastructure and human capital, have deficient innovative capacity and difficulty in sustaining economic growth. These tend to be old industrial regions or those with permanent geographical and other characteristics, which constrain development. Moreover, the result of enlargement is to add just under 5% to the EU GDP but almost 20% to the Union’s population. As a result, average GDP per head in the EU of 25 Member States is around 12½% less than the average in the EU of 15. For 18 regions with GDP per head at present below 75% of the EU–15 average with population totalling around 19 million, including Malta, this will mean that their income per head is no longer below the 75% threshold (the so called statistical effect of enlargement). In this context, the Commission interestingly points out that “since the regions concerned have exactly the same structural weaknesses after enlargement as before, there is a compelling case for maintaining support” (European Commission, 2004a, p. x). 2.1.2. Impact of European policies on economic and social Cohesion This view is reinforced by analysis made by the Commission on the role played by European Cohesion policy: Even though public expenditure in Member States (47% of GDP on average) is a great many times larger than the amount spent by the EU on Cohesion policy (0.4% of EU GDP), the EU Cohesion policy performs a valuable role in tackling the underlying causes of regional disparities across the Union in income and employment, despite its small size.4 The reason lies in the fact that Member State policies involving public spending are mainly directed at

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providing basic services and income support, while the EU Cohesion policy is focused on reducing the structural disparities which directly affect the economic competitiveness of regions and the employability of people. Empirical analyses carried out to elaborate the Third Report5 show not only that growth of GDP, employment and productivity in Objective 1 regions has exceeded that in the rest of the EU since the mid-1990s, in particular, but that convergence has been most pronounced in the least prosperous regions among these. It also indicates that structural interventions have boosted growth in the Cohesion countries both by adding demand and strengthening the supply side of the economy. Structural intervention has also encouraged a growth of trade between Cohesion countries and other parts of the Union and closer integration.6 Spending on Objective 2 regions has been concentrated on the reconversion of old industrial sites and business support services (together accounting for around half the total), while 20% went on human resource development and 10% on support of R&D and ICT. Although the interventions have had positive effects, evaluation studies conclude that these might have been greater if both the areas eligible for support and the scale of operations funded had been bigger and if the time horizon for projects (three years) had been longer. Agricultural, rural development and fisheries interventions seem to have led to some diversification of agricultural production and a growth of activities, such as agri-tourism and environmental services, while helping to renovate villages and develop public services. Nevertheless, despite the emphasis put by the Commission to highlight the positive contribution of European policy to regional convergence, evidence, provided by the Commission itself, on cohesion across Europe over the last two decades is mixed. Since 1995 there have been greater reductions in disparities between Member States than between regions across the EU and these disparities have even grown within some Member States (Hungary, Poland, the Czech Republic, the UK and Sweden, although to a relatively low level in the latter).7 There is a substantial body of academic research on these issues. There is also considerable debate over the causes of this persistence in regional inequality and, hence, the role of EU regional policy in tackling these disparities.8 Some argue, and provide statistical evidence, that there are underlying forces of divergence that would otherwise increase regional disparities (e.g. through increasing returns, trade and endogenous growth leading to concentration and clustering of activity) and that the EU regional policy has been relatively successful in maintaining

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regional cohesion overall, and prompting convergence in some cases and/or some periods of time, especially in Objective 1 regions (Braunerhjelm et al., 2000; Beugelsdijk and Eijffinger, 2005; Faíña and López-Rodríguez, 2004). Others have argued that there is no statistical evidence that Structural Funds have had a positive impact on productivity growth in the poorer regions (Boldrin and Canova, 2001), or that there are underlying forces of convergence that would otherwise decrease regional disparities (e.g. through labour mobility and structural reform – the decline of low productivity sectors and their replacement with higher productivity sectors) and EU regional policy has in many cases undermined these forces, preventing convergence (Midelfart-Knarvik and Overman, 2002). Some authors consider that it is not possible to attempt general conclusions on the impact of the European Regional policy on the EU regions since the effects depend largely upon the regional institutional and socio-economic capacity and, therefore, they may vary across regions with similar economic characteristics measured in terms of per capita income (Bailey and De Propis, 2002; Dudek, 2001; Getimis, 2003). Following this line or argument, some authors (Cuadrado-Roura and Marcos Calvo, 2005) have recently questioned the validity of using GDP per capita or even productivity or employment levels as the indicators of regional economic and social cohesion, as most of the studies have done so far. They propose to integrate into the analysis other elements such as level of education, R&D investment, demographic structure, activity rate and its distribution, unemployment, living conditions, etc. In many cases the results thus obtained differ from those provided by the earlier studies. This approach might appear to be useful not only to establish the regional effects of the policies but also to determine eligibility criteria. 2.1.3. The policy strategy: Narrowing regional disparities in income and employment by narrowing disparities in regional competitive factors Cohesion policy strategy should be directed at strengthening regional competitiveness. The factors favouring sustained economic development and employment in a competitive environment are threefold. First, they must have suitable levels of both physical infrastructure (efficient transport, telecommunications and energy networks, educational and health facilities and social support services of various types, good environmental facilities and so on) and human capital (a labour force with appropriate levels of skills and training). Second, in the new knowledge-based economy, regions must have the capacity to innovate

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and to use both existing know-how and new technologies effectively as well as to follow a development path, which is sustainable in environmental terms. Lastly, there is a growing consensus about the importance for regional competitiveness of good governance, in the sense of efficient institutions, productive relationships between the various actors involved in the development process and positive attitudes towards business and enterprise. The issue of administrative capacity for designing, implementing and managing development programmes at regional level remains a concern particularly in the new Member States. The Commission stresses the interaction between economic, employment and social policies: “Economic development must go hand in hand with efforts to reduce poverty and to fight exclusion. Promoting social integration and combating discrimination is crucial to prevent social exclusion and to achieve higher rates of employment and economic growth, notably at regional and local level. Equally, providing comprehensive support to those most disadvantaged, such as ethnic minorities and early school leavers, can be important in securing economic and social gains throughout the EU” (European Commission, 2004a, p. xii). 2.1.4. A critical review on the effectiveness of Structural Fund management Even if the review of Structural Funds regulations in 1999 attempted to simplify the system and decentralise day-to-day management to Member States, the Commission carries out a critical analysis of the efficiency of the current system and recognises major shortcomings: “the need before the new funding period is to review the regulations with a view to increasing the effectiveness of the system and further reducing its complexity” (p. xxi). Although expertise in managing the Funds has increased over time, improving the effectiveness of programmes remains a key challenge. The control procedures required are often regarded by Member States as unwarranted given the costs involved and as duplicating national systems.9 Monitoring was an essential part of the system, but evaluations suggest that it has not been as effective as expected, partly because of the difficulty of collecting meaningful information. Moreover, the focus on financial issues rather than strategic ones tends to lead to funds being spent where they are most easily absorbed instead of where they might be most effective. Evaluation has also improved over time, but still varies considerably between Member States in the way it is implemented. More involvement of regions and Member States in the process might make it more useful and relevant. Management systems have in

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many cases become more decentralised over time which, according to evaluations, has tended to increase their effectiveness by making them more responsive to regional needs. 2.2. European Commission proposals for Cohesion policy: The proposals for reform Following analyses and debates, the Commission10 took the view that an ambitious Cohesion policy was needed to be implemented throughout the Union and proposed to change the EU Cohesion policy in several important aspects which were outlined in the Third Cohesion Report: a broader rationale; a new architecture; a new delivery system; and a new system of state aids. 2.2.1. A broader rationale for Cohesion policy: The challenges for the future The EC holds the view that in an enlarged Union more cohesion efforts will be needed to ensure economic and social convergence between regions by assisting restructuring or diversification processes; that is, the traditional objective of the EU Regional policy should be not only maintained but reinforced. However, the EC has introduced an important innovation in the objectives of the EU Cohesion policy, by broadening cohesion efforts beyond addressing traditional spatial imbalances in income and employment towards promoting balanced development across the entire EU territory. According to this line of argument, the whole of the Union faces challenges arising from a likely acceleration in economic restructuring, as a result of globalisation, trade opening, the technological revolution, the development of the knowledge economy and society, an ageing population and growth in immigration. Finally, a particular emphasis is put upon recent economic difficulties faced by the EU, especially in some of the traditional leading economies, i.e. France and Germany. Thus, Cohesion policy becomes heavily linked to the economic and social priorities of the Union. Cohesion policy should make an important contribution to the aims set out in Lisbon (2000): a strategy to make Europe the most successful and competitive knowledge-based economy in the world by 2010, which has been widened in Nice (2000) and Gothenburg (2001) adding a strategy on social inclusion and a new emphasis on protecting the environment and securing a sustainable pattern of development. Cohesion policy should make an important contribution to realising these aims. In effect, growth and cohesion are seen as mutually supportive. By reducing disparities, the Union helps to ensure that all regions and

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social groups can contribute to, and benefit from the overall economic development of the Union. Promoting competitiveness will boost the growth potential of the EU economy as a whole. This view is especially evident in the arguments given to support continuing intervention of the EU Cohesion policy outside the least-developed countries and regions. Given the interdependencies inherent in an integrated economy, problems are not confined to the less competitive regions or to individuals who are not working or who are in unproductive jobs but affect everyone in the Union. Strengthening regional competitiveness through well-targeted investment throughout the Union and providing economic opportunities, which help people fulfil their capabilities, will underpin the growth potential of the EU economy as a whole to the common benefit of all. Besides, by securing a more balanced spread of economic activity across the Union, regional policy helps to reduce the pressures of over-concentration, congestion and bottlenecks, and geographical handicaps (e.g. islands and mountain areas). The cost of not pursuing a vigorous Cohesion policy to promote growth and tackle disparities is therefore measured not only in terms of a loss of individual and collective well-being but also in economic terms, in a loss of potential real income and higher living standards. Therefore, the Third Cohesion Report proposes that all regions should be eligible for the EU support, though adequately targeted and implemented to the different problems encountered. This leads us to the proposals for policy-making reform for the period 2007–2013. 2.2.2. A new architecture for Cohesion policy for the period 2007–2013 According to the EC view, there seems to be an agreement between actors involved in the EU Regional policy on the existence of a number of matters which are important for cohesion of the Union as a whole: competitiveness, sustainable development and economic and social restructuring. In consequence, the Commission’s proposal suggests that Cohesion policy should concentrate in a number of limited priorities, reflecting the Lisbon and Gothenburg strategies. The next generation of programmes will be organised around three headings: (1) convergence, (2) regional competitiveness and employment and (3) territorial co-operation. 2.2.2.1. Convergence: Supporting growth and job creation in the least-developed Member States and regions. Convergence programmes concern the less-developed Member States and regions which in accordance with the EC Treaty (Article 158) are the top priority of Cohesion policy. This

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objective will concern, first and foremost, those regions in which per capita GDP is less than 75% of the Community average. The key objective of Cohesion policy in this context would be to promote growthenhancing conditions and factors leading to real convergence. Strategies should plan for the development of long-term competitiveness and employment. Programmes would be financed by the financial resources of the European Regional Development Fund (ERDF), the European Social Fund (ESF) and the Cohesion Fund. As before, these regions would be strictly defined at the NUTS II level, on the basis of current data, and would comprehend about 27% of the EU–25 population (most of the new Members, except some capital cities, and regions in Greece, Portugal, Spain, Italy and Eastern Germany). The Commission proposes that temporary support (a unique phasing out period) should apply under this heading to those regions where per capita GDP would have been below 75% of the Community average as calculated for the Union of 15 (the so-called statistical effect of enlargement), in the interest of equity and to allow those regions to complete the process of convergence (mainly regions in Spain, Germany and the UK). Support under the Cohesion Fund would apply to countries with a GDP below 90% of the EU–25 average. This would include all the new Members, Greece and Portugal. No transition arrangements are proposed to compensate the statistical effect to compensate the loss of Cohesion Fund Status to Spain. 2.2.2.2. Regional competitiveness and employment: anticipating and promoting change. While interventions in the less-developed Member States and regions remain the priority of Cohesion policy, the analysis of the Third Report confirms that there are, to different degrees, important challenges that concern all the EU Member States. In particular, Member States, regions and citizens will have to adapt to a world experiencing rapid economic and social change and restructuring, trade globalisation and a move towards a knowledge-based economy and society. They will also have to tackle the particular challenges that derive from an ageing population, growing immigration, labour shortages in key sectors and social inclusion problems. For Cohesion policy outside the least-developed Member States and regions, the Commission proposes a two-fold approach. (1) Through regional programmes, Cohesion policy would help regions and the regional authorities to anticipate and promote economic change in industrial, urban and rural areas by strengthening their competitiveness and attractiveness, taking into account existing

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economic, social and territorial disparities. The single funding source for the new programmes would be the ERDF. The eligible areas would not be decided at the EU level as with current Objective 2 regions. The EC would allocate “financial envelopes” to Member States potentially on the basis of criteria such as GDP per head, unemployment and population density. The Member States would then have the responsibility for allocating resources within the countries. The Commission also proposes a transitions support (Phasing in) for regions currently eligible for Objective 1 not fulfilling the criteria for the convergence programmes even in the absence of the statistical effect of enlargement. (2) Through national programmes, the Cohesion policy would help people to anticipate and to adapt to economic change, in line with the policy priorities of the European Employment Strategy, by supporting policies aimed at full employment, quality and productivity at work, and social inclusion. The single funding source for the new programmes would be the ESF. 2.2.2.3. European territorial co-operation: promoting the harmonious and balanced development of the Union territory. Building on the experience of the present INTERREG initiative, the Commission proposes to create a new objective dedicated to furthering the harmonious and balanced integration of the territory of the Union by supporting co-operation between its different components on issues of Community importance at cross-border, trans-national and interregional level. Action would be financed by the ERDF and would focus on integrated programmes managed by a single authority in pursuit of key Community priorities linked to the Lisbon and Gothenburg agendas. In principle, all regions (defined at NUTS III levels) along the external and internal borders, terrestrial as well as maritime, would be concerned by cross-border co-operation. The aim would be to promote joint solutions to common problems between neighbouring authorities, such as urban, rural and coastal development and development of economic relations and networking of SMEs. In this context, the Commission has proposed a new legal instrument in the form of a “European Grouping of Cross-Border Cooperation (EGCC)”,11 in order to allow Member States, regions and local authorities to address – both inside and outside Community programmes – the traditional legal and administrative problems encountered in the management of cross-border programmes and projects. The aim would be to transfer to this new legal structure the capacity to carry out co-operation activities on behalf of public authorities.

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Therefore, the Commission has put forward an integrated approach to Cohesion policy whose efficacy lies, precisely, upon “its adaptability to specific needs and characteristics of the territories” (p. xxxi). While recognising the different circumstances and challenges, the Commission considers that the next generation of programmes should be defined in such a way that the different territorial problems and opportunities (urban centres, outermost regions, many islands, mountain areas and rural areas) can be addressed without multiplying the number of programmes or the number of instruments. Thus, the Community Initiatives of the period 2000–2006 (URBAN, EQUAL, LEADER⫹ and INTERREG) would be discontinued and integrated into mainstream programming. Similarly, the EC proposes the integration of different instruments in support of rural development and the fisheries sector into a new Rural Development and Fisheries Instrument under the CAP, to simplify and clarify Community intervention. 2.2.3. The reform of the delivery system Responding to widespread criticisms on the workings of the EU Cohesion policy, the EC is proposing to make significant changes to the way in which policy is implemented. The proposal intends to increase the efficiency, transparency and accountability of Cohesion policy. This requires, first and foremost, the definition of a strategic approach for the policy spelling of its priorities, ensuring co-ordination with the system of economic and social governance and allowing for a regular, open review of progress made. Therefore, there is the need to reinforce the institutional capacities at all levels of government throughout the Union. It is believed that the way that policies are implemented has a decisive effect on their effectiveness. The EC holds the view that the delivery mechanism for Cohesion policy has demonstrated its capacity to deliver quality projects of European interest on the ground while maintaining high standards in the management and control of public expenditure. Consequently, these elements should be maintained: multi-annual programming, partnership, co-financing and evaluation of performance and quality. However, the Third Report underlines the need to tackle certain difficulties encountered in the implementation of current programmes, which have been pointed out by almost all actors involved in the debates, by introducing a number of reforms. First, to encourage a more strategic approach to programming of interventions: The Commission proposes that an overall strategic document for Cohesion policy should be adopted by the Council, after an opinion

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of the Parliament, defining clear priorities for Member States and regions.12 Each year, the European institutions would examine progress on the strategic priorities and results achieved on the basis of progress reports by Member States. Second, to introduce further decentralisation of responsibilities to partnerships on the ground in the Member States, regions and local authorities. Further simplification is thus to be attempted through increased subsidiarity, leading to decentralisation. Third, to reinforce the performance and quality of programmes cofinanced through a reinforced, more transparent partnership and clear and more rigorous monitoring mechanisms: The principle of automatic de-commitment (the n ⫹ 2 rule) would be maintained and evaluation tasks should need to be redefined to become more strategic and result oriented.13 And finally, to simplify the management system by introducing more transparency, differentiation and proportionality while ensuring sound financial management: The number of Funds would be limited to three (ERDF, ESF and Cohesion Fund) which would operate under the “one programme one Fund” principle. National rules would determine eligibility of expenditure with some exceptions. Below certain thresholds of expenditure, control could rely on a declaration of assurance by an independent national control body. 2.2.4. A new system of state aids Against the background of the EU enlargement and European Council decisions to move towards “less and better targeted State Aid”,14 the Third Report on Economic and Social Cohesion made important proposals for the future of state aids which are consistent with the Guidelines on National Regional Aid15 for 2007–2013 proposed by the EC in September 2005 (European Commission, 2005c). The regions with GDP per capita below 75% of the average (convergence priority) should remain eligible for the state aid regime as defined in accordance with Article 87.3(a) of the Treaty. For the regions affected by the “statistical effect”, these would be eligible under Article 87.3(c) but with a gradual reduction of state aid limits to bring them down form Article 87.3(a) levels at the beginning of the period to Article 87.3(c) levels by 2013.16 Other regions (outermost regions, islands, sparsely populated areas, areas with high unemployment, etc.) would also be earmarked for Article 87.3(c) support.17 Other regions, eligible for the competitiveness and employment priority, would have to abandon the current system, whereby it draws up

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detailed lists of eligible areas at sub-regional level, but would have to operate aid schemes in line with general state aid rules. In sum, these proposals would result in significant reductions in eligibility for regional aid in the longer standing Member States. In order to reduce the impact, the EC has undertaken to introduce more flexibility for Member States by way of consolidating and extending the use of block exemptions (notably, SMEs, training and employment) for activities which have limited effects on intra-Community trade. Therefore DG Competition resources will concentrate on cases that significantly distort competition and trade. 2.3. European Commission proposals for Cohesion policy financing In February 2004, the EC launched the debate over the next mid-term Financial Framework for the period 2007–2013 and put forward its political project: “Building our common Future. Policy challenges and Budgetary means of the Enlarged Union 2007–2013” (European Commission, 2004b), which laid out the general EU’s goals, principles and instruments. This general framework was followed by a series of detailed policy proposals in July 2004, covering all areas of intervention including Cohesion policy.18 The EC considers that future challenges would require a substantial increase of financial capacities of the Union, but proposes to stick to current “own resources” ceilings of 1.24% of Gross National Income (GNI), with appropriations for payments averaging 1.14% of GNI, and to rebalance the budget to allow space for the new priorities. In cash terms, the EU would spend an average of €146,670 million per year over the 2007–2013 period. This compares with an amount of €120,688 million for 2006 (the final year of the current period) and would represent an increase of 31% in planned EU spending from 2006 to 2013. The proposal reorganises the budget into three main priorities and five main headings to simplify financial management: (1) Sustainable development including competitiveness and cohesion (Heading 1) and sustainable management and protection of natural resources (Heading 2); (2) European citizenship which hinges on the completion of an area of freedom, justice, security and access to basic public goods (Heading 3); (3) Europe as a global partner, inspired by its core values in assuming regional responsibilities, promoting sustainable development, contributing to civilian and strategic security (Heading 4), and Administration costs (Heading 5). The sustainable development objective is closely linked to the Lisbon Agenda – the transformation of the EU into a dynamic knowledge-based economy, with sustainable economic growth and greater social cohesion

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– which entails, following the Commission’s analysis, addressing the mutually reinforcing aspects of competitiveness and cohesion. Three main areas of intervention are considered. First, competitiveness for growth and employment (subheading 1a), envisaging spending on the areas of competitiveness of enterprises, research and technological development, trans-European networks, education and training and social policy agenda. Second, cohesion for growth an employment (subheading 1b), concentrating spending on convergence, competitiveness and employment and territorial co-operation. And third, sustainable management and protection of natural resources: agriculture, fisheries and environment, with distinct headings for rural environmental policy and market related expenditure and direct payments. Comparing planned spending in 2013 with 2006 (Figure 3.1) the most significant changes are: 









The new budget subheading named “competitiveness” undergoes the highest increase (194%) going from €8,791 million in 2006 to €25,825 million in 2013. Cohesion policy spending (excluding rural development) would increase by 31%, from €38,701 million in 2006 to €50,960 million in 2013. Total financial resources for cohesion would amount to €344,910 million over the period 2006–2013, representing 0.42% of GNI. Agricultural spending would remain almost static – 3% increase over the period. Yet, while market related expenditure and direct payments would decrease by 3%, rural and environmental policy spending would increase by 26%. Significant increases are also planned for EU internal policies (freedom, justice, security) and external relations – 162% and 40%, respectively, from 2006 to 2013.

The detailed budgetary framework for Cohesion policy was put forward in the proposal for the general provision on the Structural and Cohesion Funds (European Commission, 2004d). The breakdown of budgetary resources between cohesion objectives reflects the concentration on the least-developed regions as shown in Table 3.1. The simulations in Figure 3.2 made up by the Commission show a progressive concentration of Cohesion policy expenditure on the new Member States (N-12), even though it would reach just over 50% of the total by the year 2013, while a further 50% would be spent in old Member States’ regions.

102 Alternative Perspectives on Economic Policies in the European Union Commitments appropiations (Million

per year at 2004 prices)

180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 2006

20 07

5. Administration

2008

2009

2010

2011

20 12

2013

4. The EU as a global partner

3. Citizenship, freedom, security and justice 2.a Rural and environmental policy

2.b Agriculture

1b. Cohesion

1a. Competitiveness

Figure 3.1 Financial perspective 2007–2013 Source: Own calculations from European Commission (2004b, p. 29).

3. The EU Constitution and the reform of the Cohesion policy: A postponed debate The signing of the Treaty establishing a Constitution for Europe19 in Rome on 29 October 2004 appeared to be an important step for the EU: The completion of a large process of transformation from an economic community to a political union. Taking into account that “Member States do not share a single model of Europe”20 and the wide differences in the positions of different Members States with respect to the future of Cohesion policy, it seems relevant to ask oneself how was it possible to agree on these issues in the Constitutional Treaty. To answer this

Marisol Esteban 103 Table 3.1 Commitment appropriations by cohesion objective 2007–2013 Cohesion priorities

%

%

Convergence Regional convergence and employment Statistical effect National convergence (Cohesion Fund) Outermost regions Regional competitiveness Regional competitiveness and employment Phasing in regions Territorial co-operation Cross-border co-operation ERDF contribution to ENPI Trans-national co-operation Exchange of experience & co-operation networks Technical assistance TOTAL

100.00 67.34 8.38 23.86 0.42 100 83.44 16.56 100 35.61 12.12 47.73 4.54

78.54

17.22

3.94

0.3 100

Source: Own calculations from European Commission (2004d).

EUR million (at 2004 prices)

70,000 60,000

Rural development deduction (left axis) Expenditure in EU15 (left axis) Expenditure in N12 (left axis)

% OF EU27 GNI

Expenditure in N15 as % of GNI in EU27 (right axis)

50,000 40,000 30,000 20,000

Expenditure in N12 as % of GNI in EU27 (right axis)

10,000 0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

0.52 0.48 0.44 0.40 0.36 0.32 0.28 0.24 0.20 0.16 0.12 0.08 0.04 0.00

Figure 3.2 Expenditure on Cohesion policy, 2000–2013 Source: European Commission (2004a, p. xxxviii).

question it is necessary to analyse firstly the main Constitutional provisions governing Cohesion policy. The main innovation is that for the very first time the territorial dimension – the backbone of regional policy – has been fully incorporated into the objectives of the Union. Thus, Article I–3 of the Constitutional Treaty establishes “The promotion of economic, social and territorial cohesion, and solidarity among Member States” as one of

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the main objectives that must guide the Union in the defining and implementation of all is policies. The Constitution obliges the Union, as the EC Treaty (Article 158) already had done, to undertake a specific policy to pursue this general objective. Article III–220 states: “In order to promote its overall harmonious development, the Union shall develop and pursue its action leading to the strengthening of its economic, social and territorial cohesion. In particular, the Union shall aim at reducing disparities between the levels of development of the various regions and the backwardness of least favoured regions”; and adds a new paragraph listing the types of regions particularly concerned by Union action: “Among the regions concerned, particular attention shall be paid to rural areas, areas affected by industrial transition, and regions which suffer from severe and permanent natural or demographic handicaps such as the northernmost regions with very low population density and island, cross-border and mountain regions”, which to a great extent corresponds to current practice. Moreover, there is also continuity in the obligation for Member States to conduct and co-ordinate their economic policies in such a way as, in addition, to attain the objectives of economic, social and territorial cohesion. Similarly, the formulation and implementation of the Union’s policies and actions and the implementation of the internal market shall take into account those objectives and shall contribute to their achievement, as well as the action it takes through the Structural Funds, the European Investment Bank and the other existing financial instruments (Article III–221). The Constitution maintains also the obligation of the Commission to submit a report to the European Parliament, the Council, the Committee of the Regions and the Economic and Social Committee every three years on the progress made towards achieving economic, social and territorial cohesion and on the manner in which the various policies and actions have contributed to it. It also suggests the convenience to accompany the report by the appropriate proposals. These future reports will be a continuation of the practice introduced by the “Reports on Social and Economic Cohesion” back in 1996.21 Similarly, the tasks of the ERDF remain the same as well as the objective of the Cohesion Fund (Articles III–222 and III–223). In conclusion, no major innovations are introduced by the EU Constitution as far as the tasks, objectives and instruments of European regional policy are concerned. It seems to sanction current practice, without introducing any major novelty. In fact, Convention discussions

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(Borrell et al., 2003) focused on central institutional questions such as the adequacy of European institutions, the role of national parliaments, the new rules on decision-making, and even the role of regions in Europe. And yet, at the same time, some of the most influential Member States (e.g. the UK and the Netherlands) have been putting forward proposals for substantial reform of Cohesion policy, aimed at concentrating the EU structural support on those Member States that have a per capita GDP below the EU average. Some authors (Brücker and Weise, 2002) advised strongly about the need to introduce changes into the existing Treaties “to lay down that the EU’s structural policy is to be concentrated on the members states with a clearly under-average per capita GDP”, since “in future Art.158 of the EC Treaty will prove an obstacle, for under this Community sets itself the particular aim of reducing the differences in the state of development of the various regions (. . .). Otherwise, future reforms might be jeopardised by legal constraints”. Cordero Mestanza22 (2002) also held the view that these legal provisions were a guarantee for a continuation of current European regional policy and would prevent European institutions from substantial reforms. The explanation for this apparent contradiction is twofold: (1) Some flexibility clauses (already present in current Treaties) have been incorporated into the Constitution which may allow future radical reforms without modifications of the Treaty and (2) a specific application of the principle of subsidiarity to the design and implementation of Cohesion policy. These two mechanisms did not make it necessary discussions on these matters, which, undoubtedly, would have made it difficult to reach an agreement and facilitated the consensus-making process around the Constitutional text. In fact, Article III–221 states that in order to attain the objectives of economic, social and territorial cohesion “European laws or framework laws may establish any specific measure outside the Funds, without prejudice to measures adopted within the framework of the Union’s other policies”. But, more importantly “European laws shall define the tasks, the priority objectives and the organisation of the structural funds, which may involve grouping the Funds, the general rules applicable to them and the provisions necessary to ensure their effectiveness and the coordination of the Funds with one another and with the other existing Financial Instruments” (Article III–223). Therefore, while the Constitution apparently “freezes” current Cohesion policy, in fact it incorporates a high degree of flexibility (already entrenched in current Treaties) which may allow for a substantially different European Cohesion policy from what we know today.

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As with the earlier Treaties, ratification by all Members States is needed for the new Constitutional Treaty to enter into force. The Member States are proceeding in accordance with their own constitutional provisions, involving ratification either by Parliament or by a referendum. But the results of both referenda in France and the Netherlands have introduced a big uncertainty in the entire process and nobody seems to be capable at the moment on making any forecast on the matter. Ratification has become a real hurdle for European politicians but, unexpectedly, some see a possibility has been open for some needed major changes in European policy making, particularly in the areas of Agriculture and Cohesion policies.

4. Key issues in the debate over the reform of Cohesion policy and Member States perspectives 4.1. The financial debate Since the publication of the Second Cohesion Report (European Commission, 2001), the EC has tried to put forward a whole range of arguments to support the need for an increased budget for the Union. But it has failed dramatically to convince the wealthiest Member States. It pointed out that past experience of reforming Cohesion policy revealed an increasing tendency for discussion at Member State (Council) level to concentrate on financial aspects and argued that a more logical order would be to begin with the content – and, in particular, to identify priorities for future Cohesion policies – before going on to address issues relating to the delivery system and financial allocations. But, inevitably, financial issues have been at the centre of the debate since the beginning of the reform process. It has to be taken into account that traditionally, the main objective of most Member States in Structural Fund negotiations has been to maximise their budgetary receipts and this has continued to be a crucial factor. The debate on necessary reforms of the EU policies and the financial implications of the EU enlargement has been dominated by contradicting demands of netpayers and receivers of transfers, of old and new Members. It will therefore be necessary to develop a compromise between the different positions because it is impossible to pay net-transfers to the new Members, support current receivers of transfers, at the same time, to keep the budget stable. However, the debate has not only a financial focus, it also points to the necessity of reforming especially CAP and the EU Cohesion policy, in order to ensure efficient operations in an

Marisol Esteban 107

enlarged EU. But, to a great extent, it needs to be stressed that the motor of reform has come from financial concerns. A conflict between countries over the allocation of funds from 2007 onwards was foreseen. Weise (2002) made a good prediction: “The future organisation of expenditure-related EU policies might very well be considered to be ‘political dynamite’” (p. 3). The intimate links between decisions on Cohesion policy and decisions on overall financial issues and policies of the EU have always been recognised: “The definition of the financial envelope for Cohesion policy (whether in absolute terms or as a percentage of GDP) must be postponed to the decisions on the overall budgetary structure”.23 Therefore, it might be relevant to look into the different positions taken by the Member States to fully understand the keys of current debate.24 Several countries heavily support the Commission’s proposal on the issue of financial resources. Unsurprisingly, these are Spain, Portugal, Greece, Belgium and most of the new Member States. For example, Spain, in 2001, stated that “Spain fully shares the Commission’s assessment that its financial endowment will possibly require a greater volume of resources.” By May 2004, the Spanish Secretary of State for Finance and Budget Miguel Ángel Fernández Ordóñez at the Third Cohesion Forum held in Brussels, considered that the proposal of the EC was “a minimum”. “Agreement below this level would be very difficult.” Similarly, Manuela Ferreira Leite, minister of state and finance of Portugal, at the same Forum, considered “that the proposals put forward by the Commission constitute a minimum of necessary resources to meet the objectives we have fixed for an enlarged European Union of 25 Member States”. Moreover, the new Member States have argued that financial allocation for Cohesion policy should be maintained at least at the existing ratio of 0.45% of the EU GDP to meet the requirements and needs of the new existing situation and some of them (e.g. Hungary, Lithuania) support even an increase in cohesion expenditure. Only the Czech Government is showing a more flexible and comprehensive view. However, the richest countries of the EU have taken a totally different position. All the statements made by the governments of Austria, Sweden, France, Germany, the Netherlands and the UK have argued the need for budgetary restraint. In December 2003, they wrote a letter to the Commission stating clearly their position: “We see . . . no room for an EU budget near the current ceiling of own resources. Average expenditure during the next financial perspective should in our view be

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stabilised around current expenditure levels and should not exceed 1.0% of GNI, including agriculture spending within the ceiling set by the European Council in October 2002.”25 As net contributors they are not willing to increase their share as the EC proposals would entail and, in turn, various countries have proposed some in depth reforms of the EU policies, particularly for CAP and the EU Cohesion policy. Such a change would make it possible to lower the Structural Funds budget: “A level of 0.45% of the EU GDP, which has been mentioned in Commission reports, is unacceptable, since in practice this would mean a substantial rise in absolute terms. The level should be considerably lower.” These countries have put forward a further argument to support their position. As a result of the 4% absorption cap on Member States’ Structural and Cohesion fund receipts, a Structural Funds budget beyond the level they propose will penalise many of the poorer Member States, as their contributions will rise to fund programmes in wealthier Member States, but their receipts will remain the same. In fact, the EC arguments supporting its financial proposals were directed to this group of countries in an attempt to change their views. “A ceiling around 1% of GDP, would fail to meet the European Council commitments on agricultural payments, would undermine the phasing in of cohesion policy in the 10 new Member States, and would jeopardise the existing levels in other policies, let alone to implement the new priorities. Under such a scenario, the EU would have to . . . reduce support for rural development, one of the key objectives of CAP reform, . . . drastically decrease cohesion support in the current Member States in the face of major problems of lagging development, unemployment and social exclusion . . .. In brief, the message would be that the Union has given up on these tasks” (European Commission, 2004b, p. 28). However, all the efforts made by the Commission26 have failed so far to change the position of the wealthiest countries that are not willing to increase their financial burden. A third group of countries have adopted an intermediate position, mainly Italy, Ireland, Finland, at a later stage France even if being a signatory to the 2003 letter, and the Czech Republic. All of them are cautious about financial issues, and argue for budgetary discipline, but at the same time are supportive of essential parts of both Cohesion or/and Agricultural policy and do not want to jeopardise their position with respect to these policies. They would agree on some reduction in the proposals made by the EC, but only on the condition that certain provisions of the policies, which are beneficial to them, are maintained.27

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The need to reach a compromise between these distant positions has been acknowledged by all, since the next financial framework must be agreed by unanimity of all Member States. Thus, the Luxembourg Presidency (LP), in an attempt to reconcile the various conflicting interests, channelled a final proposal at the meeting of the European Council on 16–17 June 2005, but failed to generate an agreement, which finally was reached under the UK Presidency in December 2005.28 A comparison of the EC and the LP proposals and the Final agreement (FA) can be found in Figure 3.3 and Table 3.2. According to the views of the wealthiest Member States, the LP proposal and the FA maintained total commitments for appropriations within the ceiling of 1% of GNI, with led

Commitments appropriations (Million

per year at 2004 prices)

160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 2006 expenditure Financial Perspective 2000−2006

Proposal European Commission 2004, annual average

Proposal Luxembourg Presidency 2005, annual average

5. Administration & compensations 3. Citizenship, freedom, security and justice 2a. Rural and environmental policy

Final agreement december 2005, annual average

4. The EU as a global partner 2b. Agriculture

1b. Cohesion

1a. Competitiveness

Figure 3.3 Financial perspectives 2007–2013. Comparison between EC proposal, the LP proposal, the FA and planned 2006 spending by main spending priority. Annual average Source: Own calculations from European Commission (2004b), Council of the European Union (2005a, 2005b).

Table 3.2 Financial Perspectives 2007–2013. Comparison between the European Commission (February 2004), the LP proposal (June 2005) and the FA (December 2005). Differences by spending priority 2006, 2007–2013

1(a) Competitiveness 1(b) Cohesion 2(a) Rural and environmental policy 2(b) Agriculture 3. Citizenship, freedom, security and justice 4. The EU as a global partner 5. Administration Total

EC proposal (2007–2013)*

LP proposal (2007–2013)*

132,755 13.0% 344,910 33.6% 103,581 10.1% 301,074 29.4% 18,505 1.8% 95,590 9.3% 28,620 2.8% 1,025,035 100.0%

72,010 8.3% 306,508 35.3% 82,696 9.5% 295,105 34.0% 11,000 1.3% 50,010 5.8% 50,300 5.8% 867,629 100.0%

FA (2007– 2013)*

Difference (EC–FA)*

72,120 ⫺60,635 8.4% 307,619 ⫺37,291 35.7% 78,139 ⫺25,442 9.1% 293,105 ⫺7,969 34.0% 10,270 ⫺8,235 1.2% 50,010 ⫺45,580 5.8% 51,100 22,480 5.9% 862,363 ⫺162,672 100.0%

Difference (LP – FA)*

%Δ 2006 – FA†

%Δ EC – FA†

%Δ LP – FA†

110

17.2

⫺45.7

0.2

1,111

13.3

⫺10.8

0.4

⫺4,557

⫺9.1

⫺24.6

⫺5.5

⫺2,000

⫺4.3

⫺2.6

⫺0.7

⫺730

6.2

⫺44.5

⫺6.6

0

⫺36.4

⫺47.7

0.0

800

112.5

78.5

1.6

⫺5,266

2.1

⫺15.9

⫺0.6

Million € at 2004 prices 2006: Planned spending 2006; EC, FA: Annual average for the period 2007–2013. Source: Own calculations from European Commission (2004b); Council of the European Union (2005a, 2005b). *

†

Marisol Esteban 111

necessarily to a combination of shifts in the balance between different spending priorities. All policy priorities reflect the financial cutback, but with different emphasis. While agricultural spending (market related activities and direct payments) would remain almost unchanged in absolute terms – with a decrease of only 2.0% – the resources directed at the reform of this policy (development of rural areas and protection of nature and the environment) would have been cut by a 24.6%. The limited reduction in Cohesion policy spending (10.8%) is due to two main reasons: (1) the significance of the challenges of enlargement and the need to meet the expectations of the new Members and (2) the need to facilitate the transition to the new situation of the old Member States which traditionally have received structural funding, and thus gain their support for the proposal. Undoubtedly, the most significant cuts would have been endured by the new priorities (citizenship, freedom, security and justice and Europe as a global partner) and, what is more significant, by the priority 1a “Competitiveness for growth and employment” which refer to the actions linked most heavily with the aims of “a more dynamic and better connected Europe”. Therefore, it is not without reason that British Prime Minister Tony Blair spoke at the European Council in June 2005 that the EU financial priorities were with the “old Europe” instead of supporting the “new Europe”. With respect to Cohesion policy the main changes proposed by the LP and brought about by the FA are summarised in Table 3.3. The contents of the LP proposal and the actual FA are very similar. The major differences lie mostly in a series of additional transitional arrangements for regions in several countries. As compared with the EC proposal, a higher amount of resources is concentrated on the Convergence objective, that is, on the least-developed regions of the Union, even though they would receive a lower total amount of resources (€251,230 million as compared to €269,029 million planned by the Commission). As a consequence, planned spending available to conduct a regional policy across the EU territory would decrease to a significant extent (from €62,084 to €48,789 million) as well as that related to border co-operation (from €13,796 to €7,500 million). Transitional provisions were maintained but the total amount would decrease for the regions affected by the statistical effect and the regions that would not have qualified for the Convergence objective even within EU–15. However, a new transitional provision was introduced for those countries affected by the statistical effect in relation to support from the Cohesion Fund. In fact, this was a way to content Spain, which is the only country which would loose that

112 Alternative Perspectives on Economic Policies in the European Union Table 3.3 Main changes in Cohesion policy proposed by the LP and brought about by the FA

Total Cohesion spending Division between the three priorities

Transitional arrangements: “Phasing out” (Convergence objective)

“Phasing out” (Cohesion Fund)

“Phasing in” (regional competitiveness and employment objective)

Proposal of the European commission (February 2004)

Proposal of the LP ( June 2005)

FA (December 2005)

€344,910

€306,508

€307,619

million (2004 prices) 1. Convergence: 78% 2. Regional competitiveness and employment: 18% 3. Territorial cooperation: 4%

million (2004 prices) 1. Convergence: 82.3% 2. Regional competitiveness and employment: 15.2% 3. Territorial cooperation: 2.5%

million (2004 prices) 1. Convergence: 81.7% 2. Regional competitiveness and employment: 15.8% 3. Territorial cooperation: 2.4%

Higher support to that established for the so-called “phasing out” regions in the period 20002006 No provisions are made

Lower support. Allocation of funds will combine GDP criteria and unemployment criteria

Lower support. Allocation of funds will combine GDP criteria and unemployment criteria

The allocation shall be degressive over 2 years, with a total amount of €2,050 million Lower support. Allocation of funds will combine GDP criteria and unemployment criteria

The allocation shall be degressive over 7 years, with a total amount of €3,250 million Lower support. Allocation of funds will combine GDP criteria and unemployment criteria

Similar support to that established for those regions no longer eligible for Objective 1 in the period 2000–2006

Marisol Esteban 113 Table 3.3 (Continued)

Maximum support to any given Member State (Country capping) Additional provisions

Proposal of the European commission (February 2004)

Proposal of the LP ( June 2005)

FA (December 2005)

4% of national GDP

A maximum of 4%, depending on GDP level

A maximum of 3.7893%, depending on GDP level

No provisions are made

Transitional arrangements are established for several regions in Poland, Cyprus, Finland, Portugal, Austria, Sweden and Great Britain

Transitional arrangements are established for several regions in Poland, Hungary, Czech Republic, Cyprus, Finland, Portugal, Spain, Austria, Sweden, Great Britain, Estonia, Latvia, Italy, France and Germany

Source: Own elaboration from European Commission (2004a, 2004b), Council of the European Union (2005a).

condition due to enlargement. Finally, in order to contribute to the objectives of adequately concentrating cohesion funding on the leastdeveloped regions and Member States and reducing disparities in average per capita aid intensities resulting from capping, the maximum level of transfer to each individual Member State would be established in relation to the country’s GDP level, which has been a long-time demand of most of the new Member States. Despite the debates over the need to reform Agricultural and other European policies, the FA only includes that all Member States agree to review in the future all aspects of the EU Budget, including the CAP, to be led by the EC, with the recommendation that it begin in 2008. In fact, the FA represents a redistribution of the EU spending to finance the process of enlargement. All wealthier countries have paid for but this is especially so for those countries which so far have received a large

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proportion of Cohesion Funds and have been massive net recipients such as Spain. One must look at the different and conflicting positions taken by Member States on these reforms, and particularly on Cohesion policy, the focus of this paper, to grasp the motivations behind the changes and compromises taken. It is to these positions that we know turn, concentrating on those aspects most related to the future of Cohesion policy. 4.2. The re-nationalisation debate Regardless of the adaptations of different instruments, the new names of the priorities or the changes in the articulation of different mechanisms, there is no conceptual change in the proposals made by the EC on the future of Cohesion policy for the period 2007–2013 as compared to previous periods of Structural Funds programmes and instruments. It continues to be a regionally based strategy to be implemented throughout the EU, concentrated on the least-developed regions and regions with structural problems. The debates have been very circumscribed to the script established in the reflections and directions put forward by the EU mainly in the Second and Third Reports on Economic and Social Cohesion. In general terms, there were no explicit institutional declarations against the reform proposals and their “continuity” philosophy. However, it would be erroneous to think of unanimity between countries. There have been contributions made by different Member States which imply some basic disagreement with the orientations being made by the Commission and a break with past European Cohesion policy. They have become to be known as proposals for the re-nationalisation of the EU regional policy, since they focus on national rather than regional disparities as the criterion to get access to Community funding. In fact, however, they combine a national approach with a regional funding system. These positions were taken by the EC as minority positions, as negotiation strategies, and to a great extent were overlooked. The first proposal for a radical change of the EU Cohesion policy was made by the Netherlands in 2002–2003 (The Government of the Netherlands, 2003a, 2003b), based upon a study made in 2001 by an Interdepartmental Policy Study (IBO, 2001) on “the European Union Structural Policy in the Context of Enlargement of the EU”. This report offers interesting insights not only over the future of Cohesion policy but also over the future of the Financial Perspectives of the EU. The Dutch view on future Cohesion Policy was made clear: “intensive efforts must be made towards making European structural policy as efficient as possible, in order to do justice to its original aim of strengthening

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the social and economic cohesion of the whole EU. High priority will have to be given to the development of the new member states that join. . . . [I]f the policies remain unchanged, EU enlargement will lead to higher expenditure than was provided for in Berlin, partly because more member states will be joining than had been foreseen. . . . The amount to be reserved for enlargement in the next Financial Perspectives will either have to be funded by new resources or savings on a reform of the existing policy, or a combination of both. . . . Even aside from the [financial] considerations, the Cabinet is of the view that the structural and cohesion policies must be reformed. . . . It therefore endorses the preference expressed by the IBO working group for the reform variant (cohesion approach) under which a national focus is chosen for the allocation of European resources. . . . If this cohesion approach does not win sufficient support at the European level, the Cabinet is prepared for a debate about the re-nationalisation of structural policy in the member states. . . . Whatever the final outcome of the discussion on structural policy reform, the principle of “fair share” should remain the point of departure. This means that the Dutch financial position in relation to that of current, comparable Member States is not allowed to be changed for the worse. . . .The Cabinet believes that reform of the European structural policy must be seen in conjunction with reforms to the CAP, in order to keep the development of the EU budget as a whole manageable, in line with the expenditure constraints in place since Berlin” (The Government of the Netherlands, 2003b, pp. 7-9). One has to look at the conclusions of the IBO study to fully understand the scope of the proposed reforms. The group worked from the basic assumption that one of the most important aims of the EU is the promotion of economic and social cohesion and examined possible ways of improving and rationalising how this aim is pursued within the structural policy. It pointed out that structural policy has a strong regional focus which should be reviewed in light of enlargement with States whose GNP lies, in most cases, well below the EU average. It also questioned whether the regional focus leads to an optimal distribution of European resources if, when structural support is given to a region, no account is taken of the prosperity of the Member State within which that region is located. This results in significant financial flows between relatively rich countries. . . . Finally, the added Community value of the structural policy was also questioned. The IBO working group investigated a number of possible reform variants and presented four main ones: (1) Focus on Objective 1 (the regional approach); (2) Re-nationalisation of structural policy; (3) The

116 Alternative Perspectives on Economic Policies in the European Union

cohesion approach; and (4) The mixed approach. Of the variants studied, the group recommended the cohesion approach (This would entail giving structural support only to Member States with a per capita GDP of less than the EU average), under which national prosperity rather than regional prosperity is decisive for the allocation and the amount of the support granted. This proposed reform to the system, whereby the richer countries can no longer claim resources from the Structural Funds, would free-up resources to ease the accession of twelve new, relatively poor Member States. The emphasis would, therefore, be placed on the poorest members, which will be the new states in particular. Of the existing EU–15, only Spain, Portugal and Greece would qualify for support under this system. This proposal made by the Dutch government is very similar to one of the alternatives contemplated in a study sent by the German Government to the EC in 2001 (Weise, 2001, 2002). This report concluded that enlargement could be financed without overstepping the current upper limit for the EU budget by introducing reforms of the EU policies that, nevertheless, were advisable with or without enlargement. Central elements of the reforms proposed are the reduction of income support payments in the CAP and, “the concentration of Structural Funds on the most needy member states”. Two different scenarios of reform are used and compared with the Status Quo EU–27 (current EU–25 plus Bulgaria and Romania): 



Moderate reform of both structural and agricultural policies: This scenario increases the income threshold for maximum support from 75 to 80% of the EU average. But even then some of the current beneficiaries would lose a share of their funding; full compensation would only be provided at around 86%. The share of the structural fund allotted to other types of support is reduced from over 30 to 10%. As regards agricultural policy, the direct income-support transfers are maintained. However, in this scenario half of the sum allotted must be funded by the national budgets. Substantial reform of both structural and agricultural policies: As regards structural policy, this means that only member states whose national per capita GDP is less than 90% of the EU average will now receive maximum support. The reduction of regional disparities within the rest of Member States (e.g. eastern Germany or southern Italy) is seen, in accordance with the principle of subsidiarity, as being a national problem. The substantial reform of agricultural policy consists in decoupling direct transfers from production and gradual total

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abolition of these transfers (a step which would only be completed after the end of the scenario period). Both scenarios simulate a generous transitional regulation for the regions losing their eligibility for support from the EU’s structural policy: their funding would be gradually phased out by 2013. The DIW Berlin study gives information on the consequences in financial terms (net payments) of the three scenarios considered for the various members, which provides some insights into the actual positions defended in the negotiations by the big Member States. “The Status Quo scenario is most beneficial for France in 2013, while the Moderate Reform scenario favours Spain and Italy. Germany and the UK have the greatest interest in the substantial reform. Of the two reform scenarios, France is also more likely to support the substantial than the moderate reform, because a national co-financing of direct income support payments is assumed for agriculture, and these are incorporated into the net burden of the individual Member States. Italy clearly comes off worst in the Status Quo scenario, while the Substantial reform scenario is the worst solution only for Spain. The other 10 Member States would largely benefit from a substantial reform. The 12 accession candidates would receive lower net transfers in the reform scenarios than under the Status Quo” (Weise, 2001). Yet, the influence of different levels of reform on the net transfer to the new Members is comparatively slight because of the limits on the absorption capacity for structural policy payments. These proposals for reform have never been made by the German Government but it has always cited efficiency issues as regards the reform of Cohesion policy: “while fully supporting the principle of economic and social cohesion, [the German government] considers that this objective could be met more efficiently with a stronger concentration of funds on the most needy regions” (Bachtler and Wishlade, 2004, p. 43). This position should be understood in the light of the different interests of German sub-national authorities (Länder), which have different perspectives between them and from those of the national government. But perhaps the most ambitious and comprehensive proposal for reform of the European Cohesion policy has been made by the UK Government (UK Government, 2003a, 2003b). The document “A modern regional policy for the United Kingdom” (HM Treasury, 2003) outlined the proposals for EU Cohesion policy reform in close connection to the Government’s approach to developing UK’s nations and regions. While the proposal considers that time for reform has come there is not a big criticism of the past EU regional policy: New times and needs call

118 Alternative Perspectives on Economic Policies in the European Union

for a new policy strategy. According to UK’s view, the Commission’s proposal does not go far enough in the reforms needed, and while the “Cohesion approach” put forward by the Dutch Government “would reduce the wasteful recycling of money between the more prosperous Member States, it lacks a framework to tackle issues at European level . . . . It is only by taking a holistic approach, creating a framework which promotes and enables modern, flexible, locally led policies, devolved to the most appropriate level, that the right environment can be created for every region to develop its potential to the full” (HM Treasury, 2003, p. 30). A special care is taken to make this proposal comply with the mandate of Article 158 of the EC Treaty (Article III–220 of the Constitutional Treaty) and other legal provisions reviewed above, thus demonstrating that substantial reform of the policy may not require reform of current legal provisions. The arguments supporting UK Government’s reform, to a great extent, are similar to those used by the EC itself. There is recognition of the need for a continuing EU dimension to regional policy. The targets set at the EU level to raise its performance on employment, productivity and social cohesion would only be reached if every nation and region within the EU, in new as well as in wealthier Member States, is able to reach its full potential on these dimensions. This would require tackling the market and social failures that vary greatly from place to place. Hence, Europe needs a new framework for regional policy, which recognises the profound diversity between Member States, and supports them in their promotion of regional prosperity. Decisions must be taken as close as possible to local people while working towards the common European goals of more and better jobs and greater economic and social cohesion. The relationship between the reform proposal and the new financial context brought about by enlargement is not hidden: “In addition, as a strong supporter of enlargement, a further Government objective is to concentrate EU budgetary support on the relatively less prosperous states, including new Member States, whilst taking into account their absorptive capacity. The Government’s approach to the overall EU budget is characterised by its concern for effectiveness, value for money, budget discipline, achieving a fair deal for the UK, and respect for the EU principle of subsidiarity” (UK Government, 2003b). A modern regional policy is not just for the poorest nations and regions. It must enable every region and every locality to develop to its full potential. A dynamic policy must be locally led, within a framework which is flexible and enabling yet ensures proper accountability. In a

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domestic context, this means substantial devolution; in an EU context, subsidiarity. While the greatest opportunities and, correspondingly, the greatest responsibilities lie at the national, regional and local level, there are several activities where the EU has an important enabling role: coordination of the EU policies; assistance for Member States which do not yet have the institutional structures and financial strength to fully develop and pursue their own devolved and decentralised regional policies or to develop their national labour markets; the exchange of best practice; a more effective, proportionate and responsive approach to state aid approval based on robust economic foundations; supporting capacity building of institutions and infrastructure in those Member States which need it. An EU Framework for Regional Policy would offer a logical and structured basis for delivering this through: 





common principles which are based on broad EU-wide, outcomefocused objectives and founded on the Lisbon priorities to achieve Treaty obligations; flexibility for devolved and decentralised domestic policies to support these objectives; and separation of aims from means, distinguishing policy from funding. Regional assistance in the more prosperous Member States (i.e. Member States with greater than 90% of the average EU GNP per capita) would be funded domestically. This could be subject to possible transitional Community support, though to keep administrative costs to a minimum it might be that this funding period should be kept as short as possible. Less prosperous Member States would continue to receive Community support, which would, as now with the Cohesion Fund, be determined in proportion to national prosperity. There could also be a continuing role for EU financial support for small EU added-value initiatives such us current Community Initiatives INTERREG or EQUAL.

This proposal would have a negative impact on some British nations and regions and, therefore, some provisions are put forward to compensate for this eventual loss: “We would therefore guarantee that, by increasing UK Government spending on regional policy, UK nations and regions receive a level of resources which ensures they do not lose out from the UK’s proposals on Structural Funds reform, for example from transitional funding they would have automatically received from the application of the eligibility criteria to EU–25 instead of EU–15.”

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Additionally, reform of regional policy should be coupled with an indepth reform of Common Agricultural policy. In this respect, “[t]he UK Government is a firm advocate of the need to transfer more funding from Common Agricultural Policy (CAP) production support and income subsidy to the CAP rural development budget” (UK Government, 2003b). In sum, the key argument of the UK’s proposal is that while there is no doubt about the continued need for strong regional policy at the EU level and in all Member States, “we believe that it is both fair, and the most effective use of funds, to concentrate the EU’s financial and administrative resources on the poorest Member States, where they will add most value” (UK Government, 2003a). Obviously, the difficulties of negotiation at EU level of this proposal are well acknowledged in the reform documents. The reactions to these proposals were quite diverse. On the one hand, Member States like Austria and Sweden have found these approaches an excellent contribution to the debate and showed their willingness to further the discussion. On the other, Italy, Greece, Spain, Portugal, Finland, Ireland, Belgium or France considered that these proposals did not represent any advance compared with a Cohesion policy defined on a regional basis. Moreover, while they recognised that the priority should be for countries and regions where development most lags behind, they also considered that EU Cohesion policy appropriately financed was also required in non-lagging regions, with problems of territorial development. The emphasis on different types of problems depends very much on country specific issues. For instance, Finland constantly insists in the situation faced by peripheral regions suffering from permanent problems: low population density, permanent natural handicaps, peripherality, long distances and poor accessibility. France, in turn, highlights the themes of territorial development both for areas of low density and for highly urbanised areas. 4.3. The eligibility criteria Traditionally, the main objective of most Member States in Structural Fund negotiations has been to maximise their budgetary receipts, and this has continued to be a major factor in current negotiations. A critical issue here has been the definition of regional eligibility criteria to be entitled to financial support under the three objectives defined by the Commission. According to latest figures (2002) on GDP per head for every one of the regions of Europe published by Eurostat, the regions eligible for support under the Convergence and Competitiveness and Employment objectives can be seen in Figure 3.4. Many of the contributions of different Member States deal with these issues.

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Figure 3.4 Convergence and competitiveness objectives 2007–2013 by region Source: http://europa.eu.int/comm/regional_policy/sources/graph/maps/pdf/ pib20012002.pdf

122 Alternative Perspectives on Economic Policies in the European Union

4.3.1. The regions affected by the so-called statistical effect and transition arrangements The Commission proposed a temporary support for the regions affected by the so-called statistical effect. In fact, these regions have performed an active lobby to defend their common interests during the reform process. Most of the regions affected by the “statistical effect” made a common Position Paper in which they did not pinpoint major disagreements with the overall proposals under discussion, so long as the so-called “statistical effect” would be neutralised. In this respect, they considered that transitional arrangements (“Phasing out” of Convergence objective) were not sufficient regarding the specific problems of the affected regions. They demanded that the regulation for the period from 2007 onwards should include a special arrangement treating them as Objective 1. Moreover, they also defended that Member States with a GDP per capita below 90% of the EU average (Cohesion countries) should also receive combined cohesion and Structural Funds support. These regions stressed that “future cohesion policy cannot be financed mainly at the expense of the regions lagging behind in the current Member States”. But this issue has not only concerned the regions, but also the Member States where they are located. Thus, as the Member State most affected by these side effects of enlargement, a recurrent theme put forward by the Spanish Government has been to guarantee the existence of satisfactory transitional provisions. In this event, from the 17 Spanish Autonomous Communities, four would become Phasing out (of the convergence objective) regions, three would be considered Phasing in (the competitiveness and employment objective) regions and three would still be eligible for the Convergence objective. Moreover, Spain also asked for a transition period in relation to the Cohesion Fund, which the Commission did not even consider. 4.3.2. The new Member States All new Member States fully support Cohesion policy as an important instrument of economic and social development and they stress the view that efforts should be made to continue pursuing it, even to strengthen it. For these countries, the highest priority should be clearly the reduction in social and economic disparities and, therefore, the focus of EU Cohesion policy should be on the least developed regions and areas.

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Therefore, Structural Funds should be concentrated in the regions under Objective 1 and the limit of per capita GDP of 75% of the EU average should be preserved as the main criterion to define such areas. In the same way they support the continuation of the Cohesion Fund, if not to strengthen it, in those Member States having the GDP below 90% of the EU average. While some of the countries – i.e. Slovak Republic, Slovenia – consider that the main areas to be supported are transport infrastructure and environment, others – i.e. Lithuania, Czech Republic – consider that the scope of areas assisted by the Cohesion Fund should be widened to include the energy sector in particular. However, two positions may be distinguished as far as the application of the Cohesion policy across the entire Union. While some countries, e.g. the Slovak Republic, support the idea that Cohesion instruments should be used also in regions other than those eligible for Objective 1 as an important instrument to ameliorate economic and social imbalances and to meet the Lisbon strategy goals, others, – i.e. Lithuania, Czech Republic – even if allowing for interventions all across the Union, especially in the area of employment and human resources, consider that Cohesion policy should mostly benefit the least-developed regions and Objective 1 programmes should receive even a larger share of the total financial allocation for the period 2007–2013. Accordingly, they support the existence of a “Phasing out” period for the regions affected by the statistical effect (though limited in duration and decreasing over time and significantly lower than support for Objective 1 regions) while, on the contrary, they consider that a “Phasing out” period should not apply for the Cohesion Fund. A further issue refers to the application of a maximum assistance ceiling at 4% of GDP. Some countries (Lithuania) consider that this inevitably contributes to growing disparities among more and less developed regions. In their opinion, an appropriate solution will have to be found, possibly combining it with other indicators (GDP per capita, unemployment rate, etc.), thus allowing for flexibility, to discuss its application on the case-by-case basis. Similarly, the Czech Republic proposed to reinforce the principle of solidarity by establishing different levels of co-financing – the more developed Member States should be capable of supplying more national co-financing for their underdeveloped regions than poorer Member States. In the same way, Hungary proposed that Community support provided should be in line with the economic and social situation of the region, and take into account the prosperity of the Member State in question. The highest intensity of support should be available for the regions most in need of development.

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5. Conclusions Reform of Cohesion policy has become a central issue in current debate over the future of the EU. Future EU Cohesion policy will be the result of three intertwined debates: the reform of Cohesion policy itself; the next Financial Perspectives 2007–2013 that may provoke the reform of other European policies, e.g. CAP; and the EU Constitutional Treaty. The debate has not only a financial focus, it also points to the necessity of reforming especially CAP and the EU Cohesion policy, in order to ensure efficient operations in an enlarged EU. But, to a great extent, it needs to be stressed that the motor of reform has come from financial concerns. Future Cohesion policy will increasingly be concentrated in promoting growth and job creation in the less-favoured regions of the less-favoured countries of the Union, which means a shifting of resources from the less-favoured regions and countries of the EU–15 to the new Member States.

References Bachtler, J. and Wishlade, F. (2004), Searching for consensus: The debate on reforming EU Cohesion Policy, European Policies Research Paper, No. 55, November (Glasgow, UK: European Policies Research Centre, University of Strathclyde). Bailey, D. and De Propis, L. (2002), The 1988 reform of the European Structural Funds: Entitlement or empowerment?, Journal of European Policy,9(3), 408–428. Beugelsdijk, M. and Eijffinger, S.C.W. (2005), The effectiveness of Structural Policy in the European union: An empirical analysis for the EU–15 in 1995–2001, Journal of Common Market Studies, 43(1), 37–51. Boldrin, M. and Canova, F. (2001), Inequality and convergence in Europe’s regions: Reconsidering European regional policies, Economic Policy, 16(32), 205–253. Borrell, J., Carnero, C. and López Garrido, D. (2003), Construyendo la Constitución Europea. Crónica Política de la Convención (Madrid: Real Instituto Elcano de Estudios Internacionales y Estratégicos). Braunerhjelm, P., Faini, R., Norman, V.D., Ruane, F. and Seabright, P. (2000), Integration and the Regions of Europe: How the Right Policies Can Prevent Polarization. Monitoring European Integration 10 (London: Centre for Economic Policy Research). Brücker, H. and Weise Ch. (2002), The EU on the eve of Eastern enlargement. The European Convention should seize the opportunity to introduce reforms, Economic Bulletin, 12/2002 (Berlin: DIW Berlin. German Institute for Economic Research) http://www.diw.de/english/produkte/publikationen/bulletin/docs/eb02/ n02_12dez_1.html Cordero Mestanza, G. (2002), El futuro de la Política Regional europea después de la próxima ampliación: el estado del debate, Investigaciones Regionales, 1, 179–208. Council of the European Union (2005a), Note from the Presidency to the Council of the European Union on the Financial Perspective 2007–2013, No. 10090/05.

Marisol Esteban 125 Council of the European Union (2005b): Note from the Presidency to the Council of the European Union on the Financial Perspective 2007-2013, no. 15915/05. Cuadrado-Roura, J.R. and Marcos Calvo, M.A. (2005), Disparidades regionales en la Unión Europea. Una aproximación a la cuantificación de la cohesión económica y social, Investigaciones Regionales, 6(Primavera), 63–89. Dudek, C.M. (2001), The European Union’s effect upon regional economic development and regional governments’ policy-making ability, Regional & Federal Studies, 11(1), 101–125. European Commission (1996), First Cohesion Report 1996 (Luxembourg: Office for Official Publications of the European Communities). European Commission (2001), Second Report on Economic and Social Cohesion (Luxembourg: Office for Official Publications of the European Communities). European Commission (2004a), Third Report on Economic and Social Cohesion (Luxembourg: Office for Official Publications of the European Communities). European Commission (2004b), Building our common future: policy challenges and budgetary means of the enlarged union 2007–2013 (COM(2004)101). European Commission (2004c), Financial Perspectives 2007–2013 (COM(2004)487). European Commission (2004d), Proposal for a council regulation laying down general provisions on the European Regional Development Fund, the European Social Fund and the Cohesion Fund (COM(2004)492). European Commission (2004e), Proposal for a Regulation of the European Parliament and of the Council on the European Social Fund (COM(2004)493). European Commission (2004f), Proposal for a Council Regulation establishing a Cohesion Fund (COM(2004)494). European Commission (2004g), Proposal for a regulation of the European Parliament and of the council on the European Regional Development Fund (COM(2004)495). European Commission (2004h), Proposal for a regulation of the European Parliament and of the council establishing a European grouping of cross-border cooperation (EGCC) (COM(2004)496). European Commission (2005a), Third progress report on cohesion: Towards a new partnership for growth, jobs and cohesion (COM(2005)192 – Not published in the Official Journal). European Commission (2005b), Cohesion Policy in support of growth and jobs: Community strategic guidelines, 2007–2013 (COM(2005)0299). European Commission (2005c), Guidelines on National Regional Aid for 2007–2013 (Draft Communication from the Commission) (http://europa.eu.int/comm/ competition/state_aid/regional/communication_en.pdf). European Union (2005), Treaty Establishing a Constitution for Europe (Luxembourg: Office for Official Publications of the European Communities). Faíña, J.A. and López-Rodríguez, J. (2004), European regional policy and backward regions: Implications towards EU enlargement, European Journal of Law and Economics, 18, 5–32. Getimis, P. (2003), Improving European union regions. Policy by learning from the past in view of enlargement, European Planning Studies, 11(1), 77–87. HM Treasury, Department of Trade & Industry and Office of the Deputy Prime Minister (2003), A modern regional policy for the United Kingdom (United Kingdom, March).

126 Alternative Perspectives on Economic Policies in the European Union IBO (Interdepartmental Policy Study) (2001), The financing of the EU structural policy in the context of the enlargement of the EU (The Hague, February) http:// europa.eu.int/comm/regional_policy/debate/document/futur/research/ibo_0901.pdf Midelfart–Knarvik, K.H. and Overman, H.G. (2002), Delocation and European integration: is structural spending justified?, Economic policy, 17(35), 322–359. The Government of the Netherlands (2003a), Key document on the future of economic and social cohesion policies. http://europa.eu.int/comm/regional_policy/ debate/document/futur/member/dutchposition1.pdf The Government of the Netherlands (2003b), Cabinet standpoint concerning the interdepartmental policy study (IBO) on “European Union Structural Policy in the context of the enlargement of the EU. http://europa.eu.int/comm/ regional_policy/debate/document/futur/member/dutchposition2.pdf UK Government (2003a), UK Government position on the future of EU regional policy – Statement to Parliament, 17 September 2003. UK Government (2003b), EU Structural and Cohesion Funds – Statement to Parliament, 11 December 2003. Weise, C. (2001), EU eastern enlargement can be financed – Increased need for reforms. Scenarios for the 2007 and 2013 EU Budgets, Economic Bulletin 10/21 (Berlin: DIW Berlin. German Institute for Economic Research). http://www.diw.de/ english/produkte/publikationen/bulletin/docs/eb01/n01_10okt_1.html Weise, C. (2002), How to finance eastern enlargement of the EU, Discussion Paper, No. 287 (Berlin: DIW Berlin, German Institute for Economic Research). http://www.enepri.org/DIW-Enlargement-and-budget-dp287-2002.pdf.

Notes 1. For the purposes of this paper European Regional policy has been equalled to European economic, social and territorial Cohesion policy, since they are interchangeable concepts in the literature. 2. All the contributions to the debate about the future of Cohesion policy beyond 2006 submitted to the EC may be found at the website http://europa.eu.int/comm/regional_policy/debate/forum_arch_en.htm 3. European Commission (2004a, 2004b, 2004d, 2004e, 2004f, 2004g). 4. It should be remembered that the Structural Funds and the Cohesion Fund are concentrated on assisting the least prosperous parts of the Union. In the 2000–2006 period, the amount transferred to Objective 1 regions is equivalent to 0.9% of GDP in Spain and over 2½% of GDP in Greece and Portugal. More significantly, these transfers are estimated to add some 3% to investment in Spain and 8–9% in Greece and Portugal, as well as 7% in the Italian Mezzogiorno and 4% in the German new Länder (the so-called leverage effect) (European Commission, 2004a, p. 140). 5. These conclusions are based upon a number of studies carried out for the Commission by different research institutes across Europe. A list of all sources may be found in (European Commission, 2004a, p. 178). 6. For instance, in Spain GDP in 1999 is estimated to have been some 1½% higher than it would have been without intervention; in Greece, over 2% higher; in Ireland, almost 3% higher and in Portugal, over 4½% higher. In addition, GDP in the new German Länder is estimated to have been increased by around 4% as a result of intervention (European Commission, 2004a, p.148).

Marisol Esteban 127 7. These data are drawn form (European Commission, 2005a). Apart from the EU–15 countries, the Czech Republic, Slovakia, Poland and Hungary were also included in the study. In general, it is not unusual for economies that are in a catching up process to experience increases in internal disparities, reflecting an initial geographical concentration of growth, to be followed at a later stage by a more even pattern of development. 8. For a historical survey of this literature see Braunerhjelm et al. (2000). 9. In fact, the need to improve and simplify management systems has become a constant in all the contributions made by Member States during the process of debate and negotiations. 10. European Commission (2004a, 2004b). 11. European Commission (2004h). 12. The Commission released a document in July 2005 containing a proposal of such a strategic document: “Cohesion Policy in Support of Growth and Jobs: Community Strategic Guidelines, 2007–2013” (European Commission, 2005b). 13. By applying the “n ⫹ 2 rule” the Commission shall automatically decommit any part of a commitment which has not been settled by the payment on account or for which it has not received an acceptable payment application by the end of the second year following the year of commitment. Communication C(2002) 1942 from the Commission on the application of the n ⫹ 2 rule under Article 31(2) of Regulation (EC) No 1260/1999 (Structural Funds). 14. Information on the EC proposals for the reform of the State Aid system in the EU, and the consultation process currently under way, is available on the DG Competition website (http://europa.eu.int/comm/competition/ index_en.html). 15. On the basis of Article 87.3(a) and Article 87.3(c) of the EC Treaty, State aid granted to promote the economic development of certain disadvantaged areas within the EU may be considered to be compatible with the common market by the Commission. This kind of State aid is known as national regional aid. National regional aid consists of aid for investment granted to large companies, or in certain limited circumstances, operating aid, which is both targeted on specific regions in order to redress regional disparities. Increased levels of aid granted to SMEs located within the disadvantaged regions over and above what is allowed in other areas is also considered as regional aid. 16. Unless, by the year 2009, the relative wealth of any of the regions has declined below 75% of the average EU–25. 17. The list of geographical areas which will be included under this heading is a matter of intense discussion between the EC and Member States. 18. European Commission (2004c, 2004d, 2004e, 2004f, 2004g). 19. See European Union (2005). For an official short review of EU Constitution, see “A Constitution for Europe: Fact Sheets” (http://europa.eu.int/scadplus/ constitution/index_en.htm). It also provides a very useful correspondence table, by article, between the Constitutional Treaty and existing Treaties. 20. As Mr. Barroso admitted (Press Conference at the European Commission, Brussels, 21 September 2005). 21. See European Commission (1996, 2001 and 2004). 22. High-ranking official of the Spanish government, Ministry of the Budget, European Regional policy affairs.

128 Alternative Perspectives on Economic Policies in the European Union 23. Conclusions of the Presidency, Informal Ministerial Meeting on Cohesion Policy, Rome, 20 October 2003. 24. Where no reference is made, the position of each Member State or region may be found at the website of the Community mentioned above. 25. Quoted in Bachtler and Wishlade (2004, p.42). 26. For instance, the second Communication of the Financial Perspectives 2007–2013 (European Commission, 2004c) tried to “recall the value added of the EU action as well as the expenditure required to further the political project proposed by the Commission for 2007–2013”. 27. Other financial issues were also dealt with in the negotiations but, due to space limitations, will not be analysed here (e.g. correction of budgetary imbalances or the British “rebate”). 28. This agreement will have to be approved by the European Parliament where future problems might arise as several political forces have announced their negative vote if the budget is not modified. Nevertheless, it seems that the margin for change is very limited, at least until the future financial reform is under way.

4 Assessment and Alternative Proposals on European Structural Policies: Why It Is Right to Support both the Common Agricultural Policy and Research and Innovation Policy Jacques Mazier University of Paris North

Abstract The British Prime Minister Tony Blair has recently put in the centre of the debate on European economic policy the question of the place of the Common Agricultural Policy (CAP) which would represent a too important share of the European budget while, at the same time, almost no support would be given to the research and innovation policy. It would be a policy of the past incapable to face the main issues of the future. Agriculture policy might be renationalised to devote most of the European Union (EU) budget to the policy more turned towards research and innovation. The debate is welcomed but the British position is too simplistic. Structural policies are not reduced to CAP and innovation policy. Regional policy is a matter of concern, and also are competition policy which plays a dominant role, industrial policy which is almost inexistent at the European level and trade policy which has been at the origin of the European construction but is now inscribed in the WTO framework. A critical assessment of the policies followed in these fields at the European level since the 1980s will be made in Section 2. Alternatives proposals will follow in Section 3, showing how it is possible and necessary to conciliate CAP and innovation policy with other structural interventions. The proposed measures make up a coherent programme. JEL Classification: F13, L5, O24, R58, Q18 129

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Key words: European structural policies, industrial policy, research policy, Common agricultural policy, trade policy

1. Introduction The British Prime Minister Tony Blair has recently put at the centre of the debate on European economic policy the question of the place of the Common Agricultural Policy (CAP) as representing too large a share of the European Union (EU) budget while, at the same time, almost no support is given to the research and innovation policy. This would be a policy of the past incapable to face the main issues of the future. Agricultural policy might be renationalised to devote most of the EU budget to policy more turned towards research and innovation. The debate is welcome but the British position is too simplistic. The problem must be appreciated in a broader perspective to assess how structural policies can support European growth and development. Structural policies are not to be reduced to the CAP and innovation policy. Regional policy is a matter of concern but also competition policy which currently plays a dominant role, industrial policy which is almost inexistent at the European level and trade policy which has been at the origin of the European construction but is now inscribed into the WTO framework. A critical assessment of the policies followed in these fields at the European level since the 1980s will be made in a first part. Alternatives proposals will follow in a second part, showing how it is possible and necessary to conciliate CAP and innovation policy with other structural interventions.

2. An assessment of European structural policies: Too weak and too market biased 2.1. From the Treaty of Rome to the Single Market Structural policies had a somewhat ambiguous position during the first stages of the European construction. No provision had been made in the Treaty of Rome, except for the agricultural sector. The only policy mentioned was competition policy, as the result of a Franco–German compromise. Germany was very attached to the competition policy which was adopted by France as a counterpart for the implementation of the CAP. In practice, Community monitoring worked with relative pragmatism. From the 1960s to the 1970s, state interventions were multiplied because of the economic crisis. Apart from the CAP, numerous structural interventions were decided in declining sectors, in some

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high-technology sectors with uneven results; in R&D where interventions have remained modest; the importance of the European Fund for Regional Development (EFRED) set up in 1975 increased with the successive enlargements. In the mid-1980s, the belief that European construction would work around both a harmonisation process and a space structuring process implemented through common policies had largely disappeared. Each year the Community budget, though extremely small, was the occasion of fierce bargaining. The successive CAP reforms proved strenuous. In spite of occasional obvious progress, technological policies could only mobilise very modest amounts of money and had great difficulty promoting efficient cooperation patterns. The 1986 Single Act came as a refoundation of the European economic integration project. The market was presented as the only alternative in order to overcome the deadlock of the European construction. The logic of competition was strengthened at all levels. All the advantages expected from the Single Market resulted from scale economies and cost reductions due to increased competition. Innovation was also to be stimulated by the reinforcement of competition, thus contributing to amplify the virtuous circle of growth and productivity. In practice, the results were far from those expected by the European Commission. A faster growth did not happen. The mere abolition of non-tariff barriers did not manage to create a Single Market. National markets continued to be characterised by the strong specificities that usually underpin private behaviour. To a certain extent, true barriers have subsisted and econometricians have rediscovered the ‘frontier effects’ (the border separating two countries exerts a decisive impact on trade patterns). They have remained strong, even if attenuated. By being too much oriented towards the issues of economies of scale and the stimulation of an intra-European competition, European integration failed to grasp the new stakes in international competition. The Commission’s monitoring of the State aids was reinforced so as to eliminate the interventions likely to alter the operation of the competition mechanism. Only a few aids were allowed to R&D, regional development (in certain cases) and, more generally, general-purpose aids aimed at improving the firms’ environment. The restrictions were introduced to national interventions were not compensated by a sufficient enlargement of the Community’s own interventions. Technological programmes were developed in the 1980s and 1990s but have remained too modest. The reform of the structural funds that are destined to the less developed regions allowed their doubling from 1987 to 1993, but

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they only account for 0.3% of GDP and suffer from the multiplicity of protagonists. 2.2. The insufficiency of innovation and industrial policies 2.2.1. An inadequate research and innovation policy The difficulty to turn scientific breakthroughs into industrial and commercial successes had already been pointed out in the White Book on employment and competitiveness (European Commission, 1993). The deterioration of exterior performances was noticeable in the 1980s and 1990s in the two key sectors of information and communication technologies and biotechnologies. The reasons for this are many but largely lie in the inadequacy of research policy, both at Community and national levels. Compared with US policies, national policies based on very diversified national innovation systems have lacked homogeneity and coordination. Budgets have been in general inadequate. In Europe, the average R&D effort accounts for approximately 1.9% of GDP against 2.5% in the USA and in Japan and no country, except for Sweden, exceeds the US level. The RD Framework Programme (RDFP) has suffered from several handicaps: 







 



The inadequate commitment of big companies that have been reluctant to cooperate on major projects and have often limited their contribution to second-level projects. The complexity of the procedure which has represented an obstacle for medium-sized firms. The multiplicity of objectives which is little compatible with regulation uniqueness. The perversity of the necessity to reach unanimous decisions which has prevented the concentration on priority projects and lead to a multiplicity of minor interventions. The inadequate nature of the pre-competitiveness notion. The utilisation by some countries of the RDFP as a substitute for decreasing national budgets. Its own low budget: €15 billion for the 5th RDFP from 1998 to 2002.

The EUREKA programme is an intergovernmental cooperation mechanism based on firms’ initiatives, whose flexibility is often acknowledged. Yet it has lost its importance because of the disengagement of some states, the reduction of the size of funded projects and a decrease of funds available.

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Several improvements have recently been made. Since the relinquishment of the rule on unanimous decisions in June 1999, there has been more selectivity within the RDFP. It is now possible to exceed the precompetitiveness criterion and this should allow projects that are nearer to industrial application to be financed. At the 2000 Lisbon summit, member states asserted their commendable willingness to catch up in the knowledge-based economy. But the allocated budget was extremely limited, the overall strategy remained essentially liberal with almost no concrete measures. The budget for the 6th RDFP (2002–2006) is only slightly higher with regard to the issues at stake (€17.5 billion). Community research will be focused on excellent networks and large integrated projects. Such an approach, which is sometimes justified when it is necessary to concentrate the means of action, is likely to marginalise innovative, but more specific, projects which will not be financed by the Community. 2.2.2. A lack of industrial policy at the European level There is no real place for the notion of industrial policy at Community level and many member countries are not familiar with it. It was only recognised in 1994 as ‘industrial competitiveness policy’. Theoretically, it is limited to horizontal measures aimed at improving the firms’ environment, but in practice, they are rarely explained. It is subject to the almighty competition policy. In the high technology fields, the RDFP framework has been the only instrument gradually implemented at Community level. Its shortcomings have already been dealt with. The lack of an overall policy in this field is illustrated by several sensitive cases where decisions have been taken erratically. It first concerns specific programmes such as the Galileo GPS project which was reintroduced at the March 2002 Barcelona Summit. These projects could have decisive driving effects on European research groups and help to the set up of cooperation networks. The absence of a European policy for high-speed telephone services (UMTS) and the mere recourse to national tenders have had particularly harmful consequences. Conversely, a well-designed European standardisation has been a powerful instrument to strengthen European firms’ position, as illustrated by the GSM standard for mobile phones. National regulatory agencies were set up in several service sectors (telecommunications, electricity) within the framework of liberalisation policies. Their operating methods raise problems with regard to democratic principles and the respect of public service activities. European

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regulatory bodies and their links with national agencies remain to be determined. The shortcomings are even greater in infrastructure programmes, which often appear as the necessary complements to the liberalisation policies implemented in public services. The traditional instruments of national industrial policies based on the large projects and public procurement logic have been thoroughly challenged by liberalisation policies and technological changes. The accumulated experience and the results that were obtained are significant but they have not been transposed at European level. The most striking example is that of public infrastructure investments, and more particularly trans-European transport networks. The 1993 Delors Programme never came to be implemented since it had been opposed by the Finance Minister Council on account of the budget stabilisation policies of the early 1990s. Only 14 projects of trans-European transports were decided in Essen in 1994. Out of these 14 projects, only three have now been completed and two have not even started. The deadlocks can partly be explained by the fact that those projects were the mere juxtaposition of national projects that did not take the cross-border links into account and thus leading to illcoordinated efforts. In addition, infrastructure investments were slashed for budget reasons and road transport continued to be privileged. Yet, rail freight transport is little developed in Europe, contrary to the situation in the USA, and represents a major source of congestion and pollution. Drawing the lessons from the past failures, new orientations were recently decided within the framework of a trans-European transport scheme, with the definition of a ‘community interest’ for the selection of projects and the awarding of a ‘European label’. The work should no longer be coordinated at intergovernmental level and each project would be piloted by a single appointed operator having the status of a European firm. Although progress has been made in the field of design in this particular area, it still shows many shortcomings if a wider goal is to be decided. The budget is too low, even for projects that only concern trans-European transport networks (€23 billion between 2003 and 2006). Many key areas in terms of long-term growth are not covered. 2.3. The pre-eminence of the competition policy 2.3.1. Control of anti-competitive agreements and concentration supervision The European control of anti-competitive agreements aims at sustaining a high level of competition, which is supposed to be a strong factor

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in securing efficiency. Little consideration is given to the economic dimension whereas it ought to be acknowledged that in many sectors firms’ competitiveness is based on the narrow and sustainable links which may exist between the different actors. This prevailing approach is too doctrinal and it does not provide national control bodies with sufficient room for assessment. Prior to the key merger control regulation of 1989, it was difficult for the Commission to intervene in mergers and acquisitions, although it tried in some cases to do this by defining a merger as the establishment of a kind of cartel. Since the early 1990s, the definition of a ‘pertinent market’, on which the risk of a dominant position is assessed, has often been limited to the European, or sometimes national, level. This was a static approach, taking only into account the impact on effective competition without integrating the future evolution of markets. Recently the Commission has begun to take world market perspectives into account. Concentration is more limited in Europe than in the USA and medium-sized firms are weaker. Cross-border mergers and acquisitions between European firms are few. The Aérospatiale–DeHaviland case, soon followed by the Boeing–Douglas McDonnell merger and more recently by the refusal of the Volvo–Scania and Schneider–Legrand agreement illustrates the problems at stake. However it must be underlined that the performance of merged firms is not always an improvement. According to the Commission, its credibility is at stake and its rigorous attitude vis-à-vis European firms gave it the means to refuse the Honeywell–General Electric merger in September 2001. In practice, refusals are extremely rare (18 merger refusals over the last ten years out of 1900 notified mergers). 2.3.2. The control of national aids is too rigid National State aids are banned so that unilateral practices should not lead to distorting effects and affect competition. In theory, only generalpurpose aids that do not help some particular firms or sectors are allowed. In practice, some dispensations have already been accepted for the aids meant at helping the regions in difficulties, small and mediumsized firms, as well as for those in favour of the environment or R&D. The existing control devices correspond to a unilateral strategy of national aid reduction based on assessment criteria that are overly macro-economic. They lack coherence and do not try to articulate national aid control and existing Community policies.

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2.3.3. The opening of public services to competition Public services correspond to the supply of goods and services that are essential to people’s daily lives and to each individual’s fundamental rights. They contribute to the economic, social and geographical cohesion of a nation. They can be provided either by administrations, public or private companies, under certain conditions. They have been at the heart of the policy of liberalisation and opening to competition since the 1990s. Several factors are put forward in order to justify this evolution. Some activities, like telecommunications, that used to yield increasing returns to scale have turned into activities whose yields are now decreasing under the effect of technological innovations, thus rendering the monopolistic situation obsolete. The segmentation of activities, like in rail transport or electricity, has allowed the division of public companies into several segments, and some of them have been subjected to competition or privatised. These ‘theoretical’ reasons serve, in many respects, as an image to hide the decline of the ‘public service’ concept under the pressure of the liberal trend in a context of economic and budget austerity. The narrowing of the public service scope was accompanied by a change in the criteria that justify public intervention. Traditional ones (growing returns, externalities) tend to disappear in favour of the nature of the information. The difficulty to contractualise an activity on account of the hidden nature of information is a means to justify the maintaining of a public operator. All this has made the dismantling of the public sector easier, some segments of activities have completely left the public sector while some others have been delegated. Whenever a public service is contracted out to a private operator, the State will subsidise the additional costs that are inherent in any public service on the basis of a list of activities that are excluded from the competitive sphere. Such an approach underestimates the difficulties linked to the dismantling of network companies into distinct profit-making centres. By going too far in the division of activities (infrastructures and operation, but also production, distribution and trade) the companies’ technical culture as well as the quality and safety of supply may be imperilled. Avoiding the drifts of privatised systems and the risks of deteriorating public services has become a major stake for regulating authorities. The answers they are trying to bring today, notably through the promotion of competition and the preservation of a ‘universal service’, remain very incomplete. In the EU’s founding treaties, the basic principle of competition remains though ample room is made for ‘general interest economic

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services’ by allowing national governments to determine, with a relative autonomy, the scope of their public services. In practice, the Commission’s directives have interpreted the founding documents. Since the early 1990s, they have dealt with the issue of public services, taking each sector separately. These directives have essentially consisted of liberalizing whole economic sectors of activities and they have led to a gradual opening to competition as well as contributed to a contraction of the scope of the public service sector. On account of the great variety of national models and the necessity to harmonise competition, the public service issue has not been wholly examined. However, three points ought to be noted because they allow more active interventions. The fact that the Commission’s directives mention the notion of ‘network’, characterised by increasing returns in some segments of activities, justifies the maintaining of monopolies in the corresponding sectors and allows public interventions, without clearly defining their nature. The ‘universal service’ obligation is also mentioned in sectoral directives, with the following definition ‘a cluster of minimum services of a given quality, accessible to everyone at an affordable price’. Lastly, the ‘general interest economic services’ mission has been reasserted in recent documents. These documents have so far been little enforced. 2.4. European trade policy: Weak and too liberal 2.4.1. From the Treaty of Rome to the WTO From the start, an important role was given to the common trade policy in order both to suppress tariff barriers and to allow the Community to express a unique viewpoint at international negotiations. The main goal was to promote international free trade. But the progressive dismantling of the common tariff barrier meant the disappearance of an essential instrument of the trade policy. It also proved extremely difficult for the Community to control the non-tariff interventions that tended to proliferate in the late 1970s in a context of industrial restructuring. In the early 1980s, Europe was in a weak position against its two major partners’ protectionist policies and the proliferation of unilateral measures. The climax came with the adoption by the USA of the ‘Super 301’ within the 1988 Trade Act framework and its renewal ever since. The Community had a certain number of instruments at its disposal (anti-dumping and anti-subsidies procedures, safeguard clause and a ‘new instrument’) which, until recently, were not used or used with extreme reluctance. With the implementation of the Single Market, the opening of public procurement and the early stages of the liberalisation of services took place unilaterally, without any counterpart from our

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non-European partners. In the GATT negotiations, the European Community got trapped in a confrontation with the USA over their bilateral disagreements while the latter were carrying out their own bilateral negotiations over the opening of foreign markets. The absence of willingness in the field of trade policy reflected some deeply rooted divergences among European nations. Unlike the USA and Japan, there was little solidarity between European firms. The presence of firms with foreign capital and the strategic alliances between European and non-European firms added to the existing divergences. The UK and northern European countries had long been used to free trade practices and were more penetrated by non-European capital. Ireland massively resorted to foreign investment as part of its catchingup strategy. Germany, taking advantage of its competitive industrial activities, was always in favour of free trade in spite of the gradual erosion of its position worldwide. Differences in specialisation have also played a key role. France, with its specialisation in agriculture, aerospace and military industries, was in direct competition with the USA. In the early 1980s, proposals aimed at strengthening the trade policy have been much debated upon. It seemed difficult to outbid the USA’s trade policy by elaborating a central document similar to the American Trade Act or, more simply, by reformulating the existing texts. The EU did not have the same political influence as the USA and non-member countries would have been less sensitive to European retaliatory measures. The EU did not have strong enough assets to take full advantage of a strategy of opened markets. Lastly, the divergences among European countries were important. Another reason for the weakness of Europe is the absence of connection between trade policy, coming under the Commission, and foreign policy which is by nature intergovernmental, with a High representative, but devoid of any real existence or means. However, a new economic order was established with the WTO’s setting up. Theoretically, unilateral instruments could no longer be used. The ‘Super 301’ was renewed in the USA, but actually unenforceable. The remaining instruments (anti-dumping measures and protection clauses) could only be used under special conditions, at the risk of judicial proceedings. The USA though have never given up unilateral actions but were condemned within the Dispute Settlement Body’s (DSB) framework and had to find compromises. The failure of the September 2003 Cancun summit was a turning point with the emergence of a serious conflict between North and South. Southern countries thought they had been cheated since the Marrakech agreements. They had given in on the Intellectual Property

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Right Agreement, which proved more costly for them than expected, in exchange for more liberal practices in the agricultural and industrial sectors. Yet the EU, and mostly the USA, failed to honour their commitments. The USA largely increased their subsidies to their farmers and reached a compromise with Europe on the agricultural issue. The EU did not carry out the gradual dismantling of the textile sector that had been planned and postponed until 2005. In such a context, developing countries have been able to form coalitions, lacking in homogeneity, but likely to have a decisive influence in discussions, first of all within the G20, where many emerging countries are gathered, and then within the G90, which is a larger group. The EU made a series of mistakes during negotiations by betting on the heterogeneity of the G20 coalition and overemphasizing the ‘Singapore issues’. Developing countries have appeared as new protagonists in international negotiations but the USA do not seem embarrassed by this new configuration. They can reassert their commitment to multilateralism while continuing to be actively addicted to bilateralism. The Geneva deal in July 2004 did not change the global context a great deal. The deadlock in the trade talks had been released. The main point has been the agreement of the EU and the USA to progressively eliminate export subsidies and other forms of export support in the agricultural sector, but without a precise agenda and plenty of exceptions. 2.4.2. Strategic trade policy and North–North relations The liberalisation of trade was already well under way in the last stages of the Uruguay Round in 1994. However, the significant weakness of average tariff protection rates should not conceal the tariff peaks, which remain very significant in the USA and Japan for some specific goods while being limited in the EU. The gains to be expected from an additional and total liberalisation for manufactured products are weak. However, they mostly concern developing countries. The EU’s trade policy towards other Northern countries, notably the USA, is essentially a matter of trade strategy policy. Standards, public procurement and intellectual property rights (IPRs) have long been used by developed countries so as to promote and protect their own industries. Thanks to their large, unified market and their powerful administration, the USA has a more favourable position than Europe. The impact of the US military and space programmes in high-technology sectors and the role of normalisation to protect the US market are welldocumented issues. By comparison, Europe was in a weak position, with its partitioned markets and competitive programmes.

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The completion of the Single Market made the enlargement of market sizes possible, in compliance with the original goal, but without the necessary accompanying measures to benefit from this new advantage. The opening of public procurements was achieved unilaterally without any negotiated counterpart from the USA. There have been very few European programmes lying on public procurements and likely to stimulate demand in high technology sectors. As far as normalisation is concerned, there have been uneven results such as the failure in high definition television and the success in mobile phones. The USA opened a new area of attack in 1980 with IPRs in order to recover their international supremacy (Coriat, 2002). The 1980 BayhDole Act instituted a system of licences for public research products and stated the US preference for them. Then the USA gradually imposed the recognition of the US companies’ IPRs through the negotiation of successive bilateral agreements. After IPRs had become part of the Uruguay Round Agenda, the 1994 Marrakech Agreement on IPRs compelled the signatories to abide by the new US standards. This agreement generalised and extended patent rights. A switch was operated from a system in which there were major differences between national situations on account of important discrepancies in development levels to a very standardised one, largely serving the USA’ own interests. Since the 1980s, the USA have built up a decisive advantage as regards to patents taken out, which allows them to increase the value of and protect their leadership. Imitation catching-up strategies have become riskier and more costly on account of the increased penalties imposed on imitators. The EU has experienced a cumulative backwardness in the field of IPRs, with less developed patenting practices, the absence of a unified patent at European level and a higher costs for taking out patents. European patent law was first introduced in 1977 but the name has somehow been usurped. Indeed, though the patent is examined by all countries when it is taken out, the name, when issued, becomes national and peculiar to each country, and duties are paid to each National Office. The true European patent, although announced since 1973, still does not exist. The weak and blurred legal outlines of emerging technologies have contributed to hamper the R&D efficiency. They have also prevented the EU from acting as a significant counterbalance to the USA in international negotiations. 2.4.3. Trade policy towards Southern countries Developing countries fear the rules imposed on them within the WTO framework might be ill-adjusted to their development level and appear

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too constraining. They reckon Asian countries would never have been able to set off their development process if the WTO’s current rules had been forced on them. They plead for more flexibility in the enforcement of those rules so as to take each country’s specificity into consideration. On this aspect, the EU as well as the USA have appeared as too favourable to the enforcement of across-the-board rules and turnkey institutions. The current agreement on IPRs seems costly for imitating developing countries, even if the 40 less-advanced countries will not be concerned by this agreement until 2016. The case of drugs is an illustration of the problem at stake while representing, to a certain extent, an exception (Jennar, 2003). The 2001 Doha Declaration admitted the impact of patent regulations on the price of drugs and the necessity to enforce the agreement on IPRs so that everyone could have access to drugs. As regards ‘public health crises’, emerging countries with pharmaceutical industries were thus allowed to produce generic drugs without the patent holder’s authorisation and the other developing countries could, for their part, resort to the import of those generic drugs. All the implementation details of the Doha Declaration were the occasions of hard negotiations and the 2003 Geneva Agreement made the conditions under which developing countries can resort to such imports of generic drugs more drastic. In those negotiations, the EU aligned itself too much with the US position. The EU and Asian countries reintroduced the ‘Singapore issues’ in the Cancun negotiation, which constituted a deadlock vis-à-vis developing countries. The ‘Singapore issues’, in their ‘international investment’ section, essentially took up the terms of the Multilateral Investment Agreement (MIA) promoted by the OECD and abandoned in 1998. Developing countries consider that regarding their belated development, they are entitled to give preference to their own economies, favour their national champions, protect their public markets and compel foreign investors to accept joint ventures and facilitate the dissemination of new technologies. Similarly, they fear that ‘easier trade’, i.e. the reduction and harmonisation of the administrative procedures linked to international trade, might mean very high application and elaboration costs for them. Even though the EU ultimately backed up on two points (competition and international investment), it remained too rigid throughout the negotiation and favourable to the enforcement of the same rules for everyone. Developing countries think they are marginalised within the WTO even though the balance of power started to take a new turn in Cancun.

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The penalty system within the DSB framework is meant to solve conflicts between developed countries but is ill-adjusted to developing ones. Trade sanction threats do not have the same weight when they come from developing countries or emerging ones. In case of conviction, there is no provision for prejudice compensation, but only the possibility to increase tariffs proportionately to incurred losses, which leaves little margins for developing countries. Conversely, this system is a means to protect oneself against a country that would be condemned but unable to pay. The condemned country must also lower its tariffs on the corresponding goods but here again this sanction may be more difficult to impose when a small country is opposed to a big one. This asymmetry in sanction mechanisms is problematic. Social standards are another major stake in the relations with developing countries (Cling et al., 2003). The debate on this issue has calmed down since the failure of the 1999 Seattle Conference where the EU and the USA proposed to analyse the links that could be made between social standards and trade policy. Their proposal was rejected by developing countries because they likened it to disguised protectionist instruments. According to several studies, there is a link between the respect of social standards and development but the causality relation plays both ways and these studies often tend to be somewhat reductive. Although this question is no longer on the discussion agenda, the non-respect of basic labour standards by many countries remains a serious problem (principle of free association and effective recognition of the right to collective bargaining, elimination of any kind of forced labour, abolition of child labour and suppression of professional discrimination). The multilateralism/bilateralism/regionalism debate has strong implications for developing countries. On the whole bilateralism is unfavourable to small countries, which have to make larger concessions. That is why the EU has decided to apply a moratorium on free trade bilateral agreements since 1999, unlike the USA where they have proliferated. Multilateral liberalisation is not favourable to developing countries because they lose the preferential treatments they could take advantage of. The EU has widely developed regional agreements and is in favour of a regional integration process. The drawback with the latest agreements is that they call into question the asymmetries that developing countries could take advantage of and benefit processes in which parallel liberalisation takes place on both sides (reduction of tariffs in exchange of an easier access to Northern markets). But this so-called symmetry is actually detrimental to the Southern countries. Mediterranean countries

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are opening their markets to European products that will increasingly penetrate them while agriculture is not included in those agreements. Moreover the dismantling in 2005 of the Multifibre Agreement which was giving an advantage to small producers, thanks to their quotas, is playing largely in favour of China and other Asian countries to the detriment of Mediterranean countries. 2.4.4. The negotiations within the General Agreement on Trade in Services framework The liberalisation of services trade represents the new stake in the future negotiations with the General Agreement on Trade in Services (GATS), which was signed in 1994. The stake is essential as many services are socially produced in accordance with specific national standards that are the very foundations of our societies. All services are concerned, including education and health, with the exception of regalian ones. The negotiation process is progressive but all sectors are due to be concerned by the liberalisation trend through successive bargaining waves. This general framework is particularly worrying for public services and the European social model (Jennar, 2003). In terms of the global liberalisation of services prospects, no reference whatsoever is made to the specificity of public services. The participating nations jointly determine, on the basis of mutual concessions, the sectors to be liberalised, but all exceptions and restrictions must be re-examined every five years. The WTO then decides whether the conditions that justified those restrictions are still acceptable. In case of dispute and if a complaint is lodged by a participant, the WTO’s DSB – a court whose validity may be questioned with regard to democratic principles – will be the only one to judge on final appeal. The WTO is ruled by a British ‘common law’ principle according to which the law is empirically established through the DSB judgments. The European Commission has appeared as a zealot of the liberalisation process. The liberalisation proposals of March 2003 on highly sensitive subjects had not been submitted to any democratic consulting. Besides the horizontal commitments which, among others, paved the way for the short stay of non-Europeans in highly skilled sectors, the proposals for sectoral liberalisation are considerable in postal and environmental services, transport and telecommunications. If the right to impose universal service goals in postal or telecommunication services is maintained, the procedure allows the speeding up of the liberalisation process and to overcome Member States’ reluctances. Liberalisation within the GATS becomes non-reversible and the remaining obstacles are likely to be removed at a later stage in negotiations. Though education, health or

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cultural activities are not concerned for the moment, there is no guarantee for the future. 2.5. Common Agricultural Policy: efficient and necessary, but needing reforms The CAP is often criticised by pro-free trade liberals and supporters of developing countries’ farmers, as well as for its agricultural productivism and excessive budgetary cost. However, though no one today questions the need for deep reforms, the situation is quite complex and not so clear-cut. Agricultural policies laying on solid foundations have largely shown their efficiency, even if pernicious effects have appeared and corrections to those effects have started. In this instance, like in many others, the market is usually put forward as the only way out of the current difficulties, though it does not provide a satisfying answer and hardly brings any solution to developing countries’ agricultural sector. 2.5.1. The foundations of agricultural policies One of the main justifications of agricultural policies rests with the unsatisfactory management of agricultural markets and the ensuing major instability of agricultural prices. Their volatility is well known, with its extremely negative effects, not so much for rich countries’ consumers as for producers, notably in developing countries. The impact of fluctuating prices is considerable as farmers, particularly in poor countries, are risk averse, especially when this risk is linked to price fluctuations. When faced with such risks, they reduce their production. A price hike often – but not automatically – leads to a production increase. The macroeconomic consequences of such phenomena are very noticeable (Boussard, 2003). The evolution, over centuries, of cereal yields in France and the USA shows quite clearly the radical change since the late 1930s. Yield growth is much faster after that period than before, which largely helped to compensate for the shortages caused by the Second World War. The reason for this is simple: in the USA, as of 1935, prices were guaranteed by Roosevelt as well as in France by the Wheat Office in 1936. More stable prices then allowed farmers to increase their income, invest and improve their productivity quite substantially. Two theories account for the volatility of agricultural prices. The first one relates it to exogenous factors, essentially climatic hazards, but even though they undeniably play a role, they do not account for everything. The second theory refers to the poor efficiency of agricultural markets. Demand remains rigid for food products, especially for basic products. In case of shortage, consumers are ready to pay very high prices to meet

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their needs. In case of surpluses, they are never willing to increase their consumption, even when prices are slashed. It is then difficult for the market to find its equilibrium. Prices are unstable and no longer reflect production costs. These questions have fuelled an abundant literature on the erratic – or not – nature of agricultural products’ prices (Burton, 1993; Boussard, 1996). They lead to the idea that in order to reduce fluctuations the price setting mechanism has to be changed. This was confirmed by history, as of 1935, with the US policy of administered agricultural prices, which literally boosted output. All in all, wheat prices in real terms have fallen by three quarters in the USA since the 1930s. The US consumers and taxpayers have largely benefited from this situation, regardless of the huge amounts of money spent by the treasury to subsidise the US agricultural policy. Most countries in the world then imitated the US model after 1935 and decoupled their agricultures and the market. The CAP was inspired by the US agricultural policy, but also took specific aspects into consideration, notably by seeking to ensure the EU’s food supply independence. These policies, which are still enforced in spite of the rise of liberalism, have been largely successful, notwithstanding today’s numerous difficulties. 2.5.2. Problems raised by the CAP Prices that are guaranteed at near production cost level lead to agricultural surpluses and resource waste. This could be noticed in Europe as well as in the USA for cereals, and in the Ivory Coast for cocoa. A likely solution would be the implementation of administered prices, jointly with a regulated supply including individual production quotas, so that global controlled output should remain slightly inferior to domestic consumption. Marginal adjustments would then be imposed by the market. Past experiences testify to the feasibility of such a scheme, which essentially applies to basic products. Faced with rising surpluses and increasing budgetary costs, the CAP has been altered since the early 1980s, in 1984, first, with the introduction of quotas on dairy produce and then with the 1992 reform which deeply changed the system for cereals, oilseeds and beef. Financial support was granted according to the number of cultivated hectares or cattle heads in exchange for a significant decrease in guaranteed prices and the obligation to leave fallow. Agriculture does not only produce basic products but also semi-luxury products (flowers, spring vegetables, …) for which there is a more complex regulation. The notion of product quality plays an increasing role. There

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are no major agricultural policy problems for these products because they are generally little subsidised and the market is more efficient when demand is elastic. More basically, agriculture also produces externalities (landscapes, pollution due to intensive methods of production, etc).The problem is then entirely different because the market cannot play any role. Landscapes and, more generally speaking, the public goods that are produced by a multifunctional agriculture are hard to assess (Allaire & Dupeuple, 2003). As regards pollution, a reliable system of administered prices, for inputs as well as outputs, could lead farmers to adopt nonpolluting techniques. Provided technical solutions can be found to solve the different problems, a major difficulty crops up since ‘our society does not know what it wants’. The market is of no help in this sector (no one will pay for a pretty landscape, for instance). Democratic procedures are hard to implement. However, collective decisions play a role (to clean up a river or preserve a landscape) even if they are costly. These questions have been partially tackled in the CAP reforms under way since 1999. Under Germany’s pressure, the Agenda 2000 stressed the importance of reaching ‘fair agricultural practices’. In France, the agricultural framework law has integrated the multifunctional aspect of agriculture, which is not only expected to produce as much as possible, but also to take care of the environment and produce rural amenities. The state-funded ‘regional development contracts’ to help those farmers committed to environmentally friendly practices or to the production of amenities were meant to further the process but in reality little was achieved. The recently adopted CAP reform of June 2003 follows the same logic in so far as it is aimed at increased financing of both rural development and environmental protection. The recognition of rural development as an objective of policy implies a shift from an exclusively sectoral interest to a mix of sectoral and territorial interests which corresponds to the recognition that the rural problems cannot be solved only with agricultural policy, but require enhancing the diversification of the rural productive structure. However, the European policy for rural development since its origin was conceived as an accompanying policy to the CAP rather than as a policy with its own autonomy and objectives. Although at present these two sides of policy exist side by side in the CAP, their relative importance is still very unequal. Agriculture is at the origin of major income inequalities and the CAP, by linking financial support to output and then to cultivated hectares, has

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undoubtedly rewarded big farms. This concern was partially addressed in the 1999 CAP reform and the possibility was given to member countries to adjust their subsidies according to farm size. Portugal, the UK and France made a very moderate usage of this opportunity. Quite significantly however, one of the first measures taken by Mr Raffarin’s government in France in May 2002 was to interrupt the adjustability of European subsidies. Lastly, the CAP’s protectionist nature is said to be detrimental to developing countries. For instance, European sugar beet producers would hinder the full development of sugar cane in Brazil and elsewhere. The Euro–Mediterranean agreements liberalised industrial products only, for which European countries have a decisive advantage, but agricultural goods were not included, thus limiting Mediterranean countries’ comparative advantages for many products in this sector. The CAP is not the only one to be concerned since the US subsidies to cotton producers caused a fall in cotton prices, thus leading to the ruin of small individual African producers. But this argument ought to be taken with care. The developing countries’ comparative advantages must be increased and exploited through structural policies that are well adapted to those countries. Those advantages are not ‘natural’ and do not lie only on favourable factors such as climate or low labour costs. They must be transformed gradually. The full integration of developing countries’ agriculture to international trade requires specific instruments and cannot lie on free trade only. The Cairns-led liberal crusade, which brings together not only emerging countries with high agricultural potentialities, such as Brazil or Argentina, but also developed countries like Australia or Canada, is very hypocritical. Indeed, if its argument is apparently favourable to developing countries’ agriculture, it also advocates a liberalisation which, if implemented, would actually reinforce the extensive agriculture of richly endowed emerging countries like Brazil or Argentina, but not really the small individual farmers in Brazil’s Nord Este or Africa who would be wiped off. Let us also recall that if the EU’s agribusiness has posted important trade surpluses against the USA since 1999, it has also shown a deficit against the rest of the world, particularly important and rising with Brazil, Argentina, Mexico and other Latin-American countries (Pouch & de Lorgeril, 2004). The poorest countries’ agriculture stands no chance if the market mechanisms are given more freedom. Conversely, two orientations ought to be considered if one admits that agricultural and food products are different from other goods. On the one hand, in the poorest countries it would then be necessary to sustain an

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agriculture capable of bringing enough income so as to maintain activities in rural areas, while integrating such a policy to a more global development strategy. On the other hand, in developed countries it would be indispensable to limit the production and exports of goods, using quotas for instance, which underlines the necessity to reform the CAP. 2.5.3. Reform proposals Such real problems have led to several reform proposals and the CAP has actually been altered since the 1980s. Since the late 1990s, pressure for a more radical reform has been reinforced by increasing budgetary constraints, the issues to the Eastern enlargement and the WTO’s international negotiations. The general trend has been to reintroduce free trade, while correcting its drawbacks. A return to free trade would have devastating effects because the basic instability of agricultural prices would certainly not be a satisfactory solution for developing countries. There have been hopes that futures markets would bring some relief (Carfantan, 2002), but they do not match the depth of the problem. Futures markets allow individual farmers to protect themselves but certainly do not wipe off price fluctuations or their drawbacks at macroeconomic level. In practice, four series of proposals may be distinguished. The CAP’s re-nationalisation, i.e. its suppression, is particularly attractive for the UK, but not only there. It is also to be found in Sapir’s report (2003). In this perspective it is proposed to free imports of agricultural products in conjunction with a system of guaranteed prices for farmers. The difference between guaranteed and market-determined prices would be compensated by subsidies that would be renationalised and autonomously managed by each state. Such a position is apparently clever as it is both open to developing countries’ imports and coherent with free trade principles. Yet, it poses several problems. Consumers would bear the effects of the strong instability of agricultural prices. The setting of guaranteed prices is not easy, and neither is that of production levels. If they are not limited, the risk of overproduction is serious. Compensatory payments do not fit in with the WTO’s framework. Lastly, agricultural product exporting countries that would mostly benefit from such reform are not really developing countries. The Commission is trying to reform the CAP so as to reduce its cost in view of the enlargement and renew with budgetary margins within a community budget limited to 1.27% of GDP and to make it acceptable in international negotiations. The Commission’s position is to change the nature of the existing subsidies by putting an end to surface or cattle-head

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linked subsidies and switching to a new type of subsidies related to agricultural practices and the production of amenities. Subsidies would thus no longer be linked to production and production itself, as well as prices, would become market-oriented. Such a position, not unlike Germany’s (whose aim is also to reduce its net budgetary contribution), will encourage ‘fair practices’. However, its reference to the market, which remains essential, poses a problem since it has historically been unable to ensure a proper regulation of the agricultural sector. The compromise reached by the Agriculture ministers in June 2003 is a strange mixture, lacking coherence and essentially aimed at making a better impression at the WTO meetings. The decoupling will start in 2005 or 2007 according to the countries. It will only be partial for certain products (beef, mutton and cereals), while others will not be concerned at all (olive oil and sugar). Intervention prices for cereals will not be lowered. With a view to the eastern enlargement, agricultural problems play a key role. A cost (the reduction of agricultural employment without a satisfactory compensation for other sectors, rising normalisation-related costs and prices, increased competition, environmental risks) and benefit (modernisation and productivity gains, aids) assessment suggests that costs might prevail over benefits. Community subsidies have been limited to 25% of today’s amounts per hectare or cattle head, gradually increasing so as to reach 100% in 2013. This ceiling which is frowned upon by applicant countries is justified, in the Commission’s opinion, by the constraints imposed by the current budget (only a community budget increase could ease the situation), the fear of an uncontrolled rise of agricultural surpluses if subsidies were more important (the setting up of quotas could be a solution) and lastly the problems linked to the redistribution of internal revenues for applicant countries if subsidies were too high compared with average national incomes. The international negotiations within the WTO with the USA and developing countries raise a last series of questions. The debate made a bad start within the WTO with Anglo–Saxon countries seeking to preserve and promote their interests under the cover of attractive proposals (the acceptance of subsidies encouraging ‘fair practices’, the gradual reduction of subsidies with distorting effects, the defence of developing countries by the Cairns group member countries which aims at giving advantage to highly productive agricultural countries rather than to the poorest developing ones). Following the failure of the 1996 Farm Act which had introduced the decoupling of subsidies and output and led to a significant decrease of the US agricultural incomes, the USA within the 2002 Farm Bill framework

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renewed with a policy of guaranteed prices, even if they put to the fore again, quite hypocritically, their willingness to reduce their agricultural subsidies and return, in the long run, to free trade. The failure of the Cancun summit has shown the new ability of the main emerging countries to face efficiently the Euro–American couple by federating a rather heterogeneous coalition of Southern countries (the G22 which then became the G20). The US refusal to suppress the subsidies to cotton producers and the rigidities of the European positions on other subjects have also contributed to the blockage. However the implication of the central demand of the G20, the suppress of all the subsidies to the Northern farmers, must be questioned. The total liberalisation of agricultural products trade would be far from favourable to most Southern and Northern farmers. It would first benefit the emerging countries’ big farmers, like Brazil and some members of the Cairns group. The less advanced developing and Mediterranean countries’ farmers, whose export capacities are limited, would be eliminated and the same would apply to those in Northeast Brazil. This clearly appears in several detailed studies that were carried out per country and per product (Fontagné and Jean, 2003). In order to modernise their agricultures which still guarantee a minimum income to a large part of their populations, these countries need structural policies and specific subsidies that are far removed from the sole principles of liberalisation. The Geneva deal in July 2004 did not change the global context a great deal. The main point has been the agreement of the EU and the USA to progressively eliminate export subsidies and other forms of export support in the agricultural sector, but with plenty exceptions and without a precise agenda. 2.6. The limited efficiency of the regional policies and their planned reduction In the EU–15, regional disparities are substantial, roughly the double of what is observed in the USA. Whereas a catching up process has been observed regarding the income per capita at the national level since the beginning of the 1980s, the regional configuration is more diversified. However since the 1990s, the increase of the regional disparities is more pronounced. Regional disparities of rate of unemployment are also important. Lastly the innovation activities are more geographically concentrated than the production activities at any regional level. Regional policies in the EU are implemented at three different levels, local, national and European. In a restrictive sense, they only concern public interventions with a regional dimension. But the regional impact of

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national (fiscal policy, social transfers, education, public services) and European policies (research, agricultural policy, competition policy) may be greater and cannot be ignored. Since the accession of the Southern European countries, the European regional policy has reached a rather important level, as the Structural funds and the Cohesion funds represented yearly 0.45% of the EU GDP between 1994 and 1999, with financial contributions far higher for the Southern countries (4% of GDP in Portugal, 3.7% in Greece, 2.8% in Ireland and 1.7% in Spain). But, for the period 2000–2006, a decrease was planned, with €260 billion for the whole structural measures (0.4% of EU GDP each year), €195 billion for the Structural funds, €18 billion for the Cohesion funds and the rest for the applicant countries. Three objectives have been retained for the Structural funds: 1. Promote the development and structural adjustment of regions whose development is lagging behind (with a GDP per capita less than 75% of the EU average) and which would receive an amount of 70% of the total Structural funds. 2. Support the economic and social conversion of areas facing structural difficulties. 3. Support the adaptation and modernisation of policies and systems of education and employment (long term and youth unemployment, persons excluded from the labour market). The efficiency of Structural funds in reducing regional disparities is questionable. According to some authors, they seem not to have a great impact (Fagerberg et al., 1999) or, though econometrically significant, have had only a limited impact. According to other studies, they could explain half of the convergence observed between 1989 and 1993. Following the results of national modelling, they could have fairly increased the growth of the Southern countries during the years 1994–1999 (Cour and Nayman, 1999). Structural funds invested in infrastructures contributed a third of the reduction of productivity gaps between the Spanish regions during the 1980s. Their impact on private investment would also have been positive for the Cohesion countries. But, in the case of Portugal, this effect would have been more important when the investments were realised in the richest regions. Public infrastructures have strengthened convergence between countries by accelerating the growth of the most advanced regions of the poorest countries, without reducing internal intra-regional inequalities (Martin, 1999). The efficiency of Structural funds would be marked more especially as the concerned region is rich.

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On a more practical plan, the elaboration and implementation of projects financed by Structural funds suppose complex interactions between the regional, national and European institutions. In many countries the projects management appears too centralised. Owing to the complexity of the European documents, the control requirements at the national level and the co-financing recourse, the consumption of the Structural funds is often very slow. The Eastern enlargement of the EU brings new challenges, which have been clearly diagnosed (Begg, 2002). With the entrance of the candidate countries, the average EU GDP per capita will fall dramatically and take many regions currently receiving Structural funds (with the Objective 1) over the 75% eligibility threshold. This will pose a dilemma as a region in Southern Spain or Eastern Germany that will move above the threshold will have its support reduced, without any change in its absolute GDP per capita. According to the Cohesion report (European Commission, 2002), the number of EU–15 regions below the threshold will drop from 46 to only 19. A distinction can be made between countries with a weak fiscal capacity and the richest ones which believe that they pay too high a net contribution to the EU and regard the Structural funds as a one of the channels through which they can recoup some of their net contribution. The poorest countries, measured with an aggregated indicator, regroup Greece, Portugal and the new entrants. Some countries are not relatively poor, but contain regions which are below the threshold, sometimes significantly, like Spain, Italy and Germany. Lastly, in the other cases, neither the country nor the region is below the threshold, but there are structural and specific problems which allow Structural funds (mainly through Objective 2). As there is a Treaty commitment that obliges the EU to act to lessen regional disparities, the political challenge in the perspective of enlargement would be to raise the threshold, for instance, at the level of the Cohesion funds (90% of EU GDP per capita). But this would raise difficult budgetary constraints with an EU budget limited to 1.27% or even 1% of the EU GDP.

3. European structural policies: Proposals for alternatives European structural policies essentially focus on four areas: competition and trade policies, which play key roles to shape the institutional framework with a small cost for the European budget, regional policy and the CAP, which absorb the main parts of this budget. The scope of research policy, at European level, remains very limited. Industrial

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policy is almost ignored. In practice, most structural policies are implemented at national or regional level. National traditions vary greatly and each government has its own specific methods of intervention. European structural policies need to undergo a complete revamp with the aim of promoting sustainable growth and reducing unequal development. 3.1. A more comprehensive innovation and industrial policy The idea of an industrial policy is largely unknown territory. Competition policy is seen as all-powerful and research policy still in its embryonic stages. However, even Germany is starting to become aware that its industrial foundations are not invulnerable. In several countries, de-industrialisation and the take-overs of some national emblematic firms by foreign groups are worrying developments. The very restrictive notion of ‘industrial competitiveness policy’, as acknowledged in 1993 and 1994 by the European Commission, is still prevailing. The European economy is also handicapped by its backwardness in high technology. Its relative failure to turn its research efforts into solid industrial and commercial advantage is a major handicap. A more comprehensive conception of a European innovation and industrial policy would include four complementary approaches. 3.1.1. A dynamic research and innovation policy 3.1.1.1. The rationalisation of Community procedures aimed at encouraging research. The Community-funded measures aimed at encouraging innovation in small and medium-sized firms ought to be delegated to regional intermediaries in order to ensure greater efficiency. These regional intermediaries would be closer to the firms and better informed on their potentialities. The RDFP procedures have become too complex, and specific rules ought to be implemented according to the nature of the activities that are financed: – in the case of long-term upstream research, more freedom should be offered in the matter of proposals; – as far as industrial research is concerned, the industries concerned should be involved in setting priorities, with a real commitment from bigger firms; – the benefits from the EUREKA programme ought to be mobilised for rapidly executed projects and also in order to bring more specific help to small and medium-sized firms.

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National measures aimed at promoting innovation ought to be rationalised; this would involve a certain integration of Community activities and taking measures to avoid duplication, as well as the sometimes stale intra-European competition. Support of development ought to be developed with refundable aid that would be repaid in the case of successful projects. 3.1.1.2. The implementation of new means. It is essential that various new means be implemented, both regarding the budget policy and the instruments that are mobilised. At budgetary level, increasing the size of the European budget appears essential, and the supplementary effort proposed would represent around 0.4% of the EU GDP. The financial resources of the RDFP could thus be significantly increased within such a new framework. Cooperative scientific programmes, backed by more permanent budgets and autonomous structures, could be initiated in large areas. Technological European agencies aimed at promoting and coordinating activities in the fields of information and biotechnologies could be directly set up at European level. Public European research bodies could be established to perform similar functions, which were already suggested among Sapir’s report proposals (2003). 3.1.2. A progressive elaboration of a European industrial policy 3.1.2.1. The rehabilitation of large public programmes at European level. The experience that has been built up at national level, thanks to traditional instruments based on large projects and public procurement, ought to be partly transposed to the European level in several directions. Technology-intensive programmes in the energy, telecommunications and aerospace sectors have powerful impacts on the firms and laboratories that are involved with them. The development of such programmes at the European level, together with an increase of the corresponding budget, would reduce duplications and permit a better development of synergies. It would also encourage the establishment of research–industry and private–public cooperation networks giving rise to externalities. The impacts and spillover effects from these programmes would thus be expanded. Infrastructure programmes, representing higher budgets, have major structuring effects on participating firms and also play a key role in the growth process through the externalities they generate. Lastly, if well designed and directed, they can contribute to environmental

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improvements and to the reduction of social inequalities. In many cases they appear to be the essential complement to the liberalisation policies that are implemented in network services. Competition is not the only answer and a joint effort at infrastructure programming is necessary. Europe could decide to set up master plans in the fields of rail transports, utilities, telecommunications and postal services. The financing of such programmes would once more necessitates a large budget increase, either at European level or resulting from new instruments that would be devised by the European Investment Bank (EIB). It would also be possible to envisage contributions from private financial institutions in some cases. The actual carrying-out of projects should no longer be reserved for intergovernmental coordination, but in many instances would entrusted to a single body, at European level, in charge of an individual project, in order to avoid the numerous deadlocks that have been observed in the past. Technological and large infrastructure programmes would amount to a global budget of approximately 0.4% of the EU’s annual GDP. 3.1.2.2. The implementation of regulatory instruments. The liberalisation of network services must be accompanied by a regulation policy in order to control the distorting effects apparent in the relations between private and public companies. Once again competition cannot be the only answer. The national regulation agencies that have been set up in various sectors (telecommunications, electricity) ought to be strengthened by giving more room to consumers and making clearer the constraints on public service activities. Regulation should also not be limited to price levels, but should include matters such as guarantees of universal access, level and composition of investment. In order to control competition in those sectors at European level, the setting up of European regulatory bodies seems to be another necessity – it would, of course, be necessary to clearly define links between these bodies and the national agencies. Beyond this, European regulation agencies in the sanitary, food and financial sectors are likely to be set up. 3.1.2.3. The promotion of cooperation and the renewal of sectoral interventions. Policies offering incentives to inter-firm cooperation, at least concerning upstream production activities, and particularly in the hightech sector, ought to be implemented, under the form of financial aids, which would mean a relaxation of the rules on competition. Similarly, sector-oriented policies, aimed at promoting specific infrastructures, helping innovation and making the establishment of

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inter-firm links easier (but without providing individual firms with specific support), could be developed jointly with firms in the sectors involved. The textile sector is one area where such policies could be implemented following the Euro–Med agreement and the end of the Multifibre agreements. Renewable energies and technologies aiding sustainable development could be other important sectors to support. An initiative to promote clean technologies and products would be a way of encouraging sustainable development, offering the firms committed to such goals a considerable advantage for the future. To this end, a whole array of instruments ought to be mobilised (financial aids to innovation, standardisation). 3.1.2.4. A policy of standards and patent. A well-designed policy of standards at the European level might represent a powerful instrument for strengthening the position of European companies, as illustrated by the case of the GSM standard for mobile phones. Such a policy would rely on standard of European dimension with minimum requirement and homogeneity. The reinforcement of all-European standardisation bodies ought to be encouraged. The setting up of a European patent is another crucial stake in order to protect intellectual property in key sectors like biotechnologies or information technologies. In Europe, the cost of patents is much higher than in the USA, and this constitutes a major handicap. A European patent would limit the complexity of the patenting procedure as well as reducing translation and examination costs. 3.1.3. A more pragmatic use of European competition policy 3.1.3.1. The control of anti-competitive agreements with more emphasis on the economic dimension. Competition usually contributes to efficiency and should be maintained and monitored. But preserving a strong competition should not be the only argument to be considered by the European mechanism aimed at controlling anti-competitive agreements. The competitiveness of a business is often based on the close and sustainable links that are established between different protagonists, and more attention should be paid to this dimension. However, strategic alliances should be examined cautiously in order to avoid pure marketing alliances aimed at dominating the market without improving technological efficiency. A less doctrinal approach ought to prevail, with the offer of standard contracts for cooperation agreements and permission for alliances in some cases. Depending on the individual circumstances, more scope for assessment might be left to

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national controlling bodies, which have a better knowledge of individual cases. 3.1.3.2. A more flexible interpretation of the rules on concentration. The changes suggested by the Commission in this matter are limited to an improvement of the existing appeal procedures against decisions, in order to speed them up. This is welcome, but seems insufficient. On two particular aspects, evolution over time suggests that some positive developments can be observed. A more dynamic approach, not restricted solely to the effects of current competition, tends to also integrate the future evolution of markets. The definition of the ‘pertinent market’, on which the risk of a dominant position is considered, is enlarged to encompass the whole world and not restricted only to the European or even to the national dimension, as was occasionally the case in the 1990s. These evolutions must be reinforced. A last point has been raised by the latest attempt by France and Germany to jointly create European business champions. The cases in debate (Sanofi-Aventis, Alstom-Siemens and the possible creation of a naval EADS) correspond to very different economic contexts and there is no simple answer. Strong opposition appeared from the European Commission, which has underlined the necessity of respecting the European rules on free movement of capital and on competition. The past experiences of national or European champions have been very unequal. They can work pretty well in some circumstances, as in the case of Renault or Air France. But this cannot be considered a general law. It depends on the environment and on the national traditions. As a general statement and according to the circumstances, European firms could be authorised to reinforce their positions in relation to their nonEuropean competitors without being penalised. The development of ‘European champions’ in some major sectors of activity could be considered a reasonable objective. 3.1.3.3. Improved links between national aids and Community interventions. The current control mechanisms of national aids ought to be relaxed and made more coherent. Increased relaxation should not mean, as is currently the case, the promotion of a unilateral strategy of national aids reduction. More coherence would imply better links between the control of national aids and existing Community policies, notably as regards those regional aids financed by structural funds, or those to promote research efforts. The search for a better level of intervention ought to be continued in order to encourage more Community interventions

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in certain cases and the continuation of national aids whenever they seem most suitable. 3.1.4. Preserving and reinforcing the public sector The development of a European Social Model requires the construction of public services on a European scale. Under the increasing pressure of competition policy since the 1980s the traditional public services have been dismantled without constructing any substitute at the European level. In this context three different proposals can be made to reinforce the position of the public services. The first proposal would be to give to the public services a derogatory statute regarding the rules of European competition. It would guarantee the freedom of each member country to implement its own concept of public services with its specific tools and sources of financing, especially concerning the balance between private and public activities. In this approach there would be no common standards and no joint institutions to give a coherent structure at the European level, which might be the source of difficulties. A more ambitious proposal would be the adoption of a European directive defining the basis of public services at the European level and setting up of regulatory institutions. This directive would be reduced following sectoral directives to integrate the specificities of each sector. These directives would constitute a counterweight to the competition rules. Various forms of cooperation between firms could be considered. Before further liberalisation and privatisation process, an evaluation of the previous steps would be realised. This assessment would examine not only the performance of the privatised sectors, but also the impact on social and regional cohesion. The European directive would oblige each member states to define the areas of public services and to explicit their national rules. Clear and comparable information about the meaning of public services and the regulatory structures would be available. As in the previous case, because of different historical traditions between countries, important heterogeneity would remain. But some minimum standards could be adopted, referring to areas regarded as the exclusive domain of public provision or domains where private provision should be regulated (universal access, safety, participation of users). These minimum standards could not be used to lower existing higher standards in certain countries. A last option would go beyond and define a common European platform of public services, which would be obligatory for all member states, with common objectives and joint interventions by EU and

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national regulators. In this scenario the logic of increasing competition and liberalisation would be clearly constrained. But this common platform would be difficult to define due the large differences in the national traditions. In the case of European network services, liberalisation policies should be accompanied by an infrastructures planning, particularly in the area of transports and telecommunications. This should include large public investments and the definition of common European rules and standards. These infrastructures programmes would be able to strengthen the potential growth of the whole EU and would be based on a broad evaluation of the networks externalities. 3.2. A new design for trade policy 3.2.1. Another conception of the WTO The functioning of the WTO, as it is today, is one of the main instruments for the dissemination of liberal policies as it imposes across-theboard liberalisation measures without taking into consideration national specificities or unequal development levels. The WTO is largely dominated by big powers which contribute to fixing in advance the main negotiation orientations. Such functioning is increasingly criticised by large coalitions. Three points could be put forward by the EU to promote another conception of the WTO. The democratisation of the WTO is necessary to establish a more balanced functioning. This implies a reinforcement of the developing countries’ weight within the WTO, which goes beyond today’s simple formal rule, i.e. one country, one vote (fixing of agendas, chairs of conferences and working committees). The liberalisation rules should no longer be across-the-board decisions vis-à-vis developing countries and should take their unequal development levels into consideration. The principle of differentiated treatment was emptied of its contents by the liberalisation wave. It ought to be restored within the WTO while taking into account that constraints can no longer be exerted as before because of the existing obstacles to development. Redistribution mechanisms at global level could be included in the WTO’s principles according to the level of development. Developing countries could thus benefit from a more flexible management of IPRs, just like what has already started to be done for drugs, or maintain some protections in terms of market openings, public procurement policies or foreign capital investments. The respect of fundamental rights (the right to health, the respect of fundamental labour laws, the defence of the public services) should be

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put besides the preservation of the environment which has already been recognised by the WTO. It should not be considered as an excuse likely to rekindle protectionist attitudes that would put the free trade principle into question, as often denounced by WTO’s experts. 3.2.2. New orientations for the WTO Northern countries should negotiate favourable asymmetries with respect to developing countries so as to allow them to make up for their development backwardness within the next 20 years. Temporary protection could be accepted jointly with the pursuit of Northern countries’ opening-up their economies of further trade. Contrary to its current positions, the EU would stop forcing some countries to open their markets more widely and to oppose those who refuse to lower their tariffs. A similar asymmetry should also be established for the ‘Singapore issues’. As it has already been decided since July 2004, the EU should no more put them forward, even reduced to public procurement and trade facilitation. Recent regional agreements ought to be similarly altered. While intraarea liberalisation must be encouraged so as to increase regional integration, some asymmetries that are favourable to less developed regions ought to be negotiated. IPR agreements ought to be made more flexible to help developing countries and encourage the development of national industries: reduction of the length of patents, introduction of special dispensations concerning the regulation on imitations. In relation to other industrialised countries, the EU ought to put make clear the specific features of the European model that it intends to preserve without limiting itself to the sole cultural exception. The main ones are the European social model and its implications in terms of health policy, pension system, redistribution policies and the choice for more equity. Public services are also a major issue and are not reduced to a simple universal service. This question also refers to the renegotiation of the GATS that will be dealt with later on. The EU should also aim for a return to a more balanced situation with its partners in three sectors: European public procurements and financial markets that were opened without any counterpart and for which the reciprocity principle should be the rule, the IPRs about which the EU is increasingly on the defensive. The shortcomings of European research as regards IPRs play a key role. Europe’s inability at setting up a true community patent that would be

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valid for the whole Union should also be overcome. The implication of National Offices’ lobbies is partly responsible for the current situation, as well as the poor standard of some national courts competent in the subject, added to the absence of a European court. Besides those typically European weaknesses, the USA’s excessively dominating positions ought to be more firmly fought against (Coriat, 2002). The DSB’s functioning ought to be completely overhauled. While guaranteeing the multilateralism principle, the DSB ought to be de-privatised and placed under control of the United Nations Organisation. The sectors or areas likely to be the subject of unrestricted negotiations within the WTO ought to be clearly separated from those to be placed under the aegis of the United Nations’ competent bodies, so that rules and standards could be fixed. The WTO should then be in charge of applying trade sanctions in this framework. In the case of IPRs on drugs for instance, the World Health Organisation (WHO) ought to be the place where rules concerning IPRs and trade are fixed according to the sanitary situation. For genetically modified agricultural products, trade regulation should be fixed in agreement with the Food and Agricultural Organisation’s (FAO) competent bodies. For social standards trade sanctions could be imposed on countries that do not abide by basic labour laws in order to allow the ILO to fulfil its controlling function. Lastly a global institution coming under the United Nations would cover and coordinate the WHO’s, FAO’s or ILO’s different sectoral bodies that would contribute to the fixing of those standards and regulations. Greater political legitimacy and better coordination would thus be ensured (Cling and alia, 2003). As regards their form, negotiations ought to be conducted on behalf of the EU, not by a Commissioner who makes proposals and then gets mandated to negotiate by the Council, but by a Council representative, a ‘Mr/s Trade’ who would benefit from a clearer political legitimacy as the representative of national governments. 3.2.3. Renegotiating the GATS The 2003 Commission’s liberalisation proposals were, in its own terms, ‘significant and substantial’. Though education, health and culture are left aside and the goal of a universal service is preserved in the postal and telecommunication services, no real guarantee was given for future negotiations within the GATS framework. In its principle, the GATS encourages a gradual and general liberalisation. Various statements show that education and health will be eventually threatened. In order to avoid such a drift, it is essential that the EU’s mandate to negotiate for the whole of Europe should lie on a clear idea of public

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service at European level going beyond the mere notion of a universal service. Public services correspond to the supply of goods and services that are essential to everyday life and to the exercise of the human being’s fundamental rights. They bring an essential contribution to the economic and social cohesion of the territory. They should be given a specific status in negotiations so as to be clearly kept out of any future liberalisation proposal. 3.3. Common Agricultural Policy: An overall reform Since the late 1990s’ budgetary constraints, the new stakes of the Eastern enlargement and WTO’s negotiations have reinforced pressure for radical reform of the CAP. Facing the insufficiency of the reforms proposed, it is preferable to return to Roosevelt’s theory and to admit the existence of an ‘agricultural exception’. Agricultural products cannot only be governed by the sole laws of international trade. Two kinds of proposals can be made regarding first the price support mechanisms, second the rural development policy. 3.3.1. A guaranteed prices system with individual quotas The instability of agricultural markets, by increasing risks, has very negative effects on all agricultural activities which, in the medium term, largely counterbalance the gains resulting from the exploitation of comparative advantages (the risk of desertion and disintegration for European countries’ rural regions, the absence of any short-/mediumterm alternative activity in the poorest countries). The positive effects of trade development can only be effective if the free markets’ perverse ones are corrected by agricultural policy measures in developed as well as developing countries. The lessons from the past show us that this implies price-supporting measures, provided production surpluses are avoided thanks to production control mechanisms. Guaranteed prices systems then ought to be linked to production quotas. These prices must be high enough to lead farmers to produce. Quotas must be individualised and fixed so that the sum of individual (and national) ones is slightly inferior to the EU’s total consumption. Overproduction is thus avoided and the market itself can make the necessary adjustments between European domestic demand and domestic and international supply. In this case imports are therefore free. If such a mechanism were set up within the whole EU, it would help to stabilise the international system. Consumer prices are determined according to international prices and consumers have to bear the consequences of international markets’

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fluctuations. The difference between consumption prices and farmers’ guaranteed prices is compensated by public subsidies. Guaranteed prices differ between one region and another according to development and productivity levels. Production quotas are exchangeable, but not between different regions in order to avoid geographical concentration problems, as was the case abroad (for example, milk in Quebec). Lastly, individual quotas may be used to reduce production, notably in the case of big farms. Production quotas generate rents that can be estimated through the variation of quota prices (since those quotas are tradable). Regular negotiations can be a means to limit an excessive rent increase. Within such a framework, the integration of eastern European countries might take place on a more balanced basis, without any distorting effects between countries since the same rules would apply (guaranteed prices with production quotas so that the sum of quotas should remain inferior to the EU’s total domestic consumption). Quotas would be evaluated in each country on a historical basis, with productions whose future growth potential would be limited, which would eliminate overproduction fears. Guaranteed prices would be high enough so as to ensure a significant evolution of farmers’ income and allow the modernisation of their production methods. They should not be too high however so as to avoid a discrepancy with the evolution of non-agricultural revenues. Similarly, a more balanced solution could be reached as far as Euro–Mediterranean Agreements are concerned. The principle of free imports would imply new opportunities for those countries’ agricultures. The importance of this move should however not be overemphasised since European farmers would continue to benefit from substantial subsidies. Mediterranean countries’ agricultural potentialities should also be put into perspective. Those countries tend to have a deficit of their agricultural trade because of the rise of cereal imports resulting from their population increase. They have to face the necessity to develop their food self-sufficiency, which would mean the setting up of dynamic agricultural policies that would not quite match free trade principles. The CAP reform then appears as a rather secondary matter. This rather balanced proposal raises however two types of problems: The setting of guaranteed prices is always a difficult exercise, implying strenuous negotiations on account of numerous pressures. Past experience over 40 years of CAP suggests that all necessary adjustments would be feasible. The existence of periodic negotiations is a guarantee that the necessary adjustments could be realised.

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This proposal is also out of tune with the WTO’s rules, which is not surprising as it lies on the idea that agricultural products cannot be governed by the sole laws of international trade. Agricultural subsidies, within the WTO framework, are only allowed restrictively. Some are acceptable (‘the green box’: environmental subsidies, rural development subsidies etc.) but lie on the ‘decoupling’ principle (absence of link with output levels or current prices). Others are not acceptable (‘the orange box’: measures to sustain prices or subsidies that are linked to production levels) or should be progressively reduced. The ‘blue box’ category is intermediate and corresponds to the situation where farmers have to limit their production, which may be considered the case with quotas. 3.3.2. Improve the rural development policy The second pillar should address the development of rural areas with a multisectoral, integrated approach. Environmental concerns need to be included as much in agricultural aspects (water, soil, production practices) as in the territorial side (sustainability, impact of tourism and industries, energy production and consumption. . .). There is the need to combine decentralisation – at regional and local level which are likely to be more efficient and effective – with coherent rules of an overall character. Both territorial and sectoral functions should be regulated at European level, establishing the general principles, eligibility of areas and rules of the game. Defensive policies based on generically defined disadvantages are by far predominant over pro-active ones for specific situations. Diversification of activities has already occurred in many areas spontaneously. It has opened new markets and technological opportunities and improving the attractiveness of rural areas. Therefore a more positive and forward-looking rural policy should be encouraged instead of maintaining its defensive and compensating character. 3.4. A continued regional policy in the context of Eastern enlargement European regional policy faces traditional problems due to the complexity of the procedures and the difficulty of management of the projects financed by Structural or Cohesion funds. In some cases, the endowment is underused because of problems of definition and coordination between the different participants; in other cases, the usefulness of projects can be discussed. But the Eastern enlargement of the EU brings new challenges. In this context, three scenarios can be considered.

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If the EU budget limit were to remain at its present level (1.27% of the EU GDP), there would be a strong temptation to reserve the Structural funds, for the main part, for the use of the new members. In the EU–15 regional policies would be renationalised, which would accord with the fact that regional policies are already mainly financed by national and local budgets. Moreover neo-liberals consider that regional problems should largely rely on market mechanisms and on private capital flows. However this prospect raises two kinds of issues. The current EU members, especially the richest ones, would be excluded from any European financing. This situation would be difficult to manage in the long term, the richest countries becoming more and more reluctant to finance a solidarity mechanism from which they would be permanently excluded. On the other hand, the new members, who have made clear their doubts regarding the implementation of any European economic government, would be in a rather paradoxical situation where they would benefit from transfers without accepting a political counterpart. In a more favourable perspective, the EU’s budget could be progressively raised to around 5% of GDP at medium term. This would give more room to manoeuvre, for instance by raising the eligibility threshold for Structural funds to 90% of the EU GDP per capita. A larger number of less-developed regions could benefit from transfers, including some regions in the more advanced countries of the EU–15. Regarding the new entrants, a ceiling of 4% of GDP for the transfers could be adopted due to the limited absorption capacity of the new entrant countries. This would give a cost estimated between 0.18 and 0.38% of the EU GDP, according to whether the estimation is made in current prices or in purchasing power terms. On the whole, this cost would be bearable. Neither of these first two scenarios is very likely, due to the political environment. A new compromise might be sought in two directions at once. As for the previous institutional changes, new Structural funds could be created and dedicated to the new members, which would be financed by borrowing through the EIB and the European Reconstruction Development Bank (ERDB). The present Structural funds could be shared between the EU–15 members and the new entrants, with a re-negotiation of the eligibility threshold, in order to give both groups of countries sufficient funds. Lastly, the procedure of the Structural funds could be reformed in order to improve their efficiency. More autonomy could be given to the local, regional and national development plans with the Structural funds playing a complementary role, without too tight an examination by Brussels’ bureaucracy. High levels of support for

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lagging countries would be linked to broad public investment strategies. Objectives for eligible EU–15 regions would be determined by country and regional indicators in order to increase the consistency. In the short term a proposal of an additional budget of 0.5% of GDP could be presented in order to reduce the regional policy conflict between enlargement, budget problems and ongoing cohesion in the EU. The EU’s 15 regions would get as much as in the 2000–2006 period, and there would be another €22 billion for the accession countries. In this case the 4% limit which was set due to the limited absorption capacity would be lightened. 3.5. Conclusion: A coherent programme for European structural policies The overall cost of all the proposed measures regarding the European structural policies can be estimated at 1.3% of the EU GDP on the medium term (0.4% for research, 0.4% for main projects and 0.5% for regional policy). The CAP will be deeply reformed inside the same budget. Those measures make up a coherent programme. As far as the European industrial policy is concerned, technological programmes, as well as the renewal of sectoral interventions along with standardisation and patent policies, are linked to the research policy. Regulatory policies and main infrastructure programmes are complementary with liberalisation and service networks policies. Research policy and large infrastructure are linked to regional policies. The CAP plays a key role in the preservation of regional balances. National aids ought to be rationalised, not with a view to slashing them, but in order to define the best level of intervention (regional, national, European) and to achieve more effective coordination with European policies. The difficulty to organise such new research or industrial policies at the EU level must not be underestimated. All the European countries are not ready to advance at the same speed. The formal procedure of enhanced cooperation is heavy to implement and restrictive and has not been successful since its first introduction in 1997. More pragmatic way of cooperation could be undertaken between groups of countries ready to explore new forms of cooperation in fields like trans-European infrastructures programmes or Technological European agencies. The new design of the European Trade Policy is based on another conception of the WTO. The liberalisation rules should be applied less uniformly and should take into consideration the level of development and the national specificities. The respect of fundamental rights should be reaffirmed.

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New negotiation lines should be proposed by the EU by offering to the less developed countries favourable asymmetries regarding trade openness, regional agreements or IPRs. Vis-à-vis the other developed countries the EU ought to put forward in its trade policy the specificities of the European Social Model. The functioning of the DSB has to be completely reformed. The DSB should be put under the control of the United Nations with the creation of a new global institution. At the EU level negotiations should be conducted by a represent of the Council with a clearer political legitimacy than a simple Commissioner. Lastly, to avoid the current liberal drift within the GATS framework, the mandate of the EU in the negotiation has to be redefined and lie on a strong notion of the public services. Two kinds of proposals have been made for a complete reform of the CAP based on the idea that agriculture products cannot be governed only by the laws of international trade. A guaranteed prices system with individual quotas would be fixed, so that the total of the individual quotas be slightly inferior to the EU’s consumption. Over production would be avoided and the market would make the adjustment. Individual quotas might be used to reduce production, especially in the case of big farms. In this framework the integration of Eastern European countries and the relations with Euro-Mediterranean countries would take place on a more balance basis. A more proactive and forward looking rural policy, dealing both with agricultural and territorial problems, would be encouraged, instead of maintaining its defensive character. A multisectoral approach, including environmental concerns, would be developed combining decentralisation and coherent rules at the EU level.

References G. Allaire and T. Dupeuple (2003), ‘De la multifonctionnalité de l’activité agricole à la multi-évaluation de la production agricole’, Economie Rurale, 275, juin, pp.51–66. I. Begg (2002), ‘Regional policy in Europe under EMU’, Thematic network EPOC, Workshop Bremen, March. J.M. Boussard (2003), ‘Commerce, développement et volatilité des prix agricoles’, mimeo, INRA. J.M. Boussard (1996), ‘When risk generates chaos’, Journal of Economic Behaviour and Organization, 29(96/05), pp. 433—446. M. Burton (1993), ‘Some illustration of chaos in commodity models’, Journal of Agricultural Economics, 44(1), pp. 38—50. A. Cappelen, J. Fagerberg and B. Verspagen (1999), ‘Lack of regional convergence’ in J. Fagerberg et al. (1999).

168 Alternative Perspectives on Economic Policies in the European Union J.Y. Carfantan (2002), La mondialisation déloyale (Fayard). J.P. Cling, E.M. Mouhoud and J. Capdeviel (2003), ‘Normes sociales: quelles propositions avancer?’, mimeo. E. Cohen and J.H. Lorenzi (2000), Politiques industrielles pour l’Europe, Rapport du Conseil d’Analyse Economique (La Documentation Française). B. Coriat (2002), ‘Le nouveau régime américain de la propriété intellectuelle’, Revue d’Economie Industrielle, 99, 2ème trimestre, pp. 17–32. P. Cour and L. Nayman (1999), ‘Fonds structurels et disparités régionales en Europe’, Lettre du CEPII, 177(mars). European Commission (1993), White book on growth, competitiveness and employment. European Commission (1994a), Industrial competitiveness policy for the EU. European Commission (1994b), Industrial policy in an open and competitive environment, Communication Bangeman. European Commission (2002) Cohesion report. J. Fagerberg, P. Guerrieri and B. Verspagen (1999), The economic challenge for Europe, Cheltenham, UK, Northampton, MA, USA, Edward Elgar. L. Fontagné and S. Jean (2003), ‘OMC: bas de cycle’, La lettre du CEPII, 226 (septembre) pp. 1–4. R. Jennar (2003), ‘Les pièges de l’Accord général sur le commerce et les services’, Oxfam, février Série AGCS, 1, pp. 1–5. R. Lallement, E.M. Mouhoud and S. Paillard (2002), ‘Polarisation et internationalisation des activités d’innovation: incidences sur la spécialisation technologique des nations, Région et développement, 16, pp. 125–162. P. Martin (1999), ‘Public policies, regional inequalities and growth’, Journal of Public Economics, 73, pp. 85–105. T. Pouch (2003), ‘La PAC et l’OMC: éléments de cadrage’, Université de Marne la Vallée, OEP. T. Pouch and C. de Lorgeril (2004) ‘La dynamique des échanges de produits agroalimentaires (1967–2000)’, Economie et Sociétés AG, 26, mars, pp. 507–529. A. Sapir (2003), An agenda for a growing Europe, Report to the President of the European Commission.

5 Labour Market Policies in the European Union John Grahl Middlesex University

Abstract For the last twenty years, European integration has been characterised by an imbalance between economic and social policies. Economic policies, centred on market liberalisation and macroeconomic retrenchment, have increasingly been controlled by the European Union (EU), while social policies are still largely in the hands of the member states. Labour market policies, since they represent the intersection of the economic and social spheres, are of particular interest. A survey of the EU’s labour market policies shows that they are a contested domain, where rival views of the European project come into conflict. These policies take two main forms: a programme of legislation, originally intended to promote an upward convergence in standards, is today threatened with dilution; while a more recent initiative, the European Employment Strategy, an exercise in the “open” coordination of national policies, has, from the start, been heavily influenced by US views of labour “flexibility”. However, both forms of policy could make important contributions to the well-being of European workers, on condition of a basic change in EU strategy. The recent failure of the European Constitution may mean that this basic change is becoming necessary to the survival of the integration project. JEL Classification: J88 Labour Standards, Public Policy, F15 Economic Integration Keywords: European Union, labour market regulation, European employment strategy

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1. Introduction This chapter attempts to survey and assess the labour market policies1 of the European Union (EU). Although the assessment is largely negative, certain positive possibilities are detected in aspects of existing strategies and in the debates around them. Labour market policies have a specific place in the EU, in that they represent an intermediate zone between the economic sphere where the EU has extensive powers and the sphere of social policy, where member states retain almost complete competence. It is also the case that the doctrines which inform these policies are an amalgam – although neoliberal conceptions have predominated since the 1980s, there are also commitments to social partnership, social dialogue and, more recently, to the “European Social Model” (ESM) which are certainly more than cosmetic and which have influenced both the form and the content of EU labour market policies. The most important aspect of these policies is a continuing programme of labour market legislation; this programme is wide-ranging, affecting all but a few aspects of employment relations. Although the labour standards which are promulgated are usually lower than those which prevail in Germany, Sweden and other member states with advanced social models, they usually work to improve the employment conditions of workers in Britain, Ireland, the Mediterranean and the Eastern member states. The main dangers here are that the legislative programme will in future be diluted and that enforcement will be inadequate. The European Employment Strategy (EES), on the other hand, is an interesting experiment in “open coordination” with the potential to improve the quality of labour market interventions in the member states. However, the interventions promoted in the framework of the EES are very ambivalent. They are inspired both by the solidaristic labour market interventions which are well established in the Nordic countries and by much harsher, disciplinary, approaches found especially in the US. Nevertheless, experience with these interventions and debate within the emerging policy community may be moving the EES some way towards the first of these two types. At least this seems to be the outcome of the review of the EES undertaken in 2003. The main dangers with the EES are, firstly, that its effects on member state governments will be very shallow and secondly that the content of the strategy will be determined by very narrow and conservative doctrines. The plan of this chapter is as follows. After a brief examination of the “Social Deficit” in the EU, there are two longer sections. The first of

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these is devoted to labour market legislation and surveys the main content of the legislative programme so far and the role of the notion of social partnership in its formulation. The second surveys the EES, with special emphasis on the “active” employment measures which are one of its main features. There is a brief conclusion: this suggests that in spite of the weaknesses which have been pointed out, a change in political direction could permit the labour market policies of the EU to make a very significant contribution to the welfare of European workers.

2. The “Social Deficit” It is a truism to say that there is an imbalance between economic and social policies in the EU. The EU has enormous power in the economic sphere, power based on its control over external economic relations but above all on its responsibility for the internal market where the Treaties clearly establish its right to promote the “four freedoms”: the free movement of goods, services, capital and labour throughout the territory of the Union. There are no other policy fields where the institutions of the EU have a similar level of competence. Most social policy fields (with a few exceptions which mostly involve employment regulation) are held firmly within the competence of member states, and EUlevel initiatives are only possible using the non-binding procedures of the open method of coordination. The imbalance between the economic and social content of the European project is often, justifiably, deplored. However, it is important to recognise that this imbalance is very deep-rooted and sustained by the political nature of the European project at least since the Single European Act of 1986.2 Until the 1980s, the powers of the EU (strictly of the European Economic Community (EEC) and then European Community (EC) which preceded the EU) were, in practice, restricted by its limited legitimacy even in the economic sphere where, in theory, it enjoyed primacy. Thus the Commission rarely litigated against member states which broke the rules; rather it opened negotiations with the government in question. (This happened, for example, when Tony Benn, responsible for energy in the British government, added to British oil refining capacity in defiance of EU policies. Likewise in the first months of the Mitterrand presidency, France took many protectionist measures which, although they were contrary to EC rules, were not sanctioned by the EU.) The “Luxembourg compromise” was widely seen as giving member states a veto in any issue where they chose to claim that vital national interests were at stake.

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2.1. The Single Act In the 1980s this situation changed: the de jure powers of European institutions in the economic sphere became increasingly also de facto powers. And these powers themselves were greatly enhanced by the Single Act which made it clear that market-led integration would be extended from the manufacturing and agricultural sectors where it was already far advanced, to cover markets for services, financial markets and labour markets. The Luxembourg compromise was jettisoned – the first refusal to accept a claim of “vital” national interests occurred when Britain was not permitted to sabotage an agreement on farm prices in order to pressure the Council of Ministers on other issues. Violations of the competition and market access rules were increasingly likely to lead to litigation and member states increasingly avoided such violations. Why did this shift come about? One important factor was the neoliberal spirit of the times – governments were disillusioned with the national interventionist strategies they had frequently used in the 1970s and were more ready to promote market-oriented policies, including further, market-led, European integration. Another factor may have been the recognition that with an increasing number of member states (twelve by the time of the Maastricht Treaty) it would be necessary to replace diplomatic negotiations by rules in some areas to avoid long delays in decision-making. The pressure of the big corporations is always present in EC policy formulation, and there can be little doubt that most large companies in Europe supported the kind of changes that were made in the 1980s. In fact, it is large corporations which actually exercise the four freedoms – individuals and Small and Medium Enterprises (SME) have much less occasion to do so. The legal situation in the EU since the 1980s is that national governments have no power to block cross-border movements of either resources or outputs and that any attempt to do so will usually be blocked by the courts even in the member state concerned. The rights enjoyed by business enterprises within the EU are thus unique in international law and quite comparable to those which protect inter-state commerce and finance within the US. 2.2. Social policy In the sphere of social policy, on the other hand, competence remains almost entirely with the member states. The exception which proves this rule is that migrant workers from other member states have to be granted access to the social protection regime of the states in which they are working. This provision, established very early in the process of

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integration, was seen as necessary for the mobility of labour and thus as a market integration measure. Although European integration has never involved a serious challenge to the supremacy of member states in the social sphere, there has always been some recognition of a “social dimension” to the integration project, and this has led to certain interventions. These may have been most intense at the very beginning, in the context of the European Coal and Steel Community. The Social Fund established at that time was intended to compensate the losers from integration (in the event, mostly Wallonian coal miners, see Milward, 2000, p. 114). The Social Fund of course survives to this day as a component of the “structural funds” but the refusal by the strongest member states to increase the EU budget means that it is of very limited significance.3 There is obviously no longer any attempt to compensate the losers from the ongoing process of market integration (for example the millions of victims of “transition” in the new member states).4 There are many structures and interventions representing Europe’s social dimension; none of them, however, compromises member state control in this sphere. One can even identify a specific social philosophy characterising EU pronouncements and initiatives on social policy: there is firstly a strong commitment to the notion of “social partnership” and employers and employees are usually referred to in these terms;5 secondly, the official discourse of the EU includes abundant references to the ESM, an abstract notion derived from the specific but very different social models found in individual member states.6 However, this social philosophy does not have the same kind of importance in practice as the commitment to market-led integration in the economic sphere. In the latter, one finds hard legislation and binding decisions; in the realm of social policy, there are declarations and statements of intent. For economics, there is usually qualified majority voting; for social policy, unanimity is required so that each member state retains a veto. Each phase of economic integration is centrally determined; for social policy we have the “open method of coordination”. And so on – the difference in status of the two policy fields is central to the EU. 2.3. The imbalance There are at least two main reasons for this imbalance between economic Europe and social Europe. On the one hand, the same dominant interests which drive forward market integration tend to resist any centralisation of social security or social service provision. Their preference is for

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the regime competition, which might put pressure on member states either to cut back social policy expenditures or to move the tax burden which corresponds to these expenditures away from business and on to workers or consumers. A second reason may be the very loss of economic powers which has taken place, both through European integration and the more general processes of globalisation and economic liberalisation. Just because governments have so little purchase over economic developments, they cling more tightly to their powers over social policy since it is largely through social policy initiatives that they will respond to political or economic pressures. It can be added that the heterogeneity of social systems and social policy priorities is such that it would not be easy to design centralised social policies. The Common Agricultural Policy can be regarded from one point of view as a not very successful European social policy, with the social objective of maintaining farm incomes but bedevilled from the start by conflicting views in different member states of what would be an acceptable farm income. It must be added that this imbalance between economic policy and social policy is very deeply set into the political nature of the EU. While the essence of the EU is the four freedoms, the EU will tend to enjoy such deep support from corporations that it can, in practice, do without any strong feeling of allegiance on the part of individual citizens – indeed it can even weather considerable unpopularity in many member states. Our employers can love the EU on our behalf. An economically interventionist EU, or one that funded ambitious social policies or an EU which imposed heavy regulations with social objectives might forfeit this strong support from business. In those circumstances, its lack of popularity could become a very serious political problem for the EU. The Constitutional Treaty might be seen as an attempt to respond to this dilemma – the form of the Treaty can be seen as a bid for deeper political legitimacy while at the same time, its content tried to preserve the main structures which guarantee corporate support: the outcome of the French and Dutch referenda, however, indicates that there is no easy way to square this circle.

3. EU labour market policies The situation so far described is a simple dichotomy: economic policy – EU; social policy – member states. The limited competence which the EU possesses in labour market policy complicates this picture but does not alter its main features. In structural terms, the two policy fields cannot be completely disjoint: there is an intersection between

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economic and social policies, and labour market/employment policy supplies much of the content of this intersection. But the existence of certain EU powers in labour market policy can be seen as necessary to maintain the basic dichotomy. If member states were completely autonomous in their labour market interventions, they might use this power to undermine or circumvent the EU’s economic rules – by directing subsidies at certain groups of employees, for example. On the other hand, a centralisation of labour market policy in the hands of the EU would be a long step towards an integrated European social policy – for example it would prevent regime competition in some very important domains, such as employment standards and industrial relations. Thus the rather messy division of competence in the labour market field can be seen as functional to the extent that it works to preserve the existing, largely economic, orientation of the EU as well as its essentially “market-creating” approach to economic issues. Although this functionality has probably been necessary to the emergence of labour market policy at the EU level, the actual content has to be explained by more contingent factors. This content divides into two distinct components: labour market regulation, beginning as early as the Treaty of Rome of 1957 and gradually becoming rather more ambitious; and labour market interventions, a much more recent development, involving an exercise in open coordination known as the EES. In principle, one might mention a third form of policy, the representation of labour in EU decision-making, but, as will be suggested below, there is little substance to the processes involved.

4. EU labour market legislation The first general rules promulgated for European labour markets concerned gender equality and arose as early as the negotiations leading to the Treaty of Rome. Although the social economies of both France and Germany exhibited “familialist” (that is to say, patriarchal) characteristics, these were rather more marked in Germany and the French pressed for a commitment to gender equality to avoid competition from underpaid German women workers. From these, rather contingent, beginnings there developed a significant body of EU labour market legislation aimed at the equal treatment of men and women.7 4.1. Health and safety and working time A second important theme in EU labour market regulation concerns the health and safety of workers. The Single European Act, essentially

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concerned with removing non-tariff barriers to intra-EU transactions, did recognise that increased competition within the EU should not rest on inadequate health and safety provision and in consequence the competence of the EU to promulgate health and safety standards (by majority voting in the Council and subject to approval in the Parliament) has a very strong legal basis. A large body of specific safety measures have been introduced by the EU, concerning such issues as handling hazardous substances, the use of visual display equipment and the safe management of construction projects;8 although there is nothing new in the recognition that unregulated employment relations may compromise the safety of workers, the activism of the EU in this sphere makes a positive contribution to the welfare of employees. It was also as a health and safety measure that the Working Time Directive was introduced because the opposition of some member state governments meant that this type of regulation could only be put through on by majority vote. However, the Working Time Directive also shows how member states can vitiate European labour market legislation. On British insistence, the Directive permits a derogation from the specified maximum working week (an average of 48 hours over a reference period of about 17 weeks) if this is agreed between employer and employee. None of the other member states made use of this possibility as they transposed the Directive into their own legal systems but the British most certainly did so. At this point, the fact that trade unionism has disappeared from most of the British private sector became decisive: few British employees were ready to insist on a maximum of 48 hours in the context of individual negotiations with their employer and the Directive simply ceased to be a constraint on employers’ practice.9 The Commission and the Parliament have expressed some concern with this situation in Britain, and especially with the fact that some employers were making agreement to a derogation a condition of recruitment (this is probably illegal). However, little has been done and there seems to be no will to amend the Directive to bring the British into line – indeed the opposite is the case as other member states are more and more attracted to the “flexible” labour markets which, supposedly, characterise the British economy.10 The Working Time Directive also illustrates another problem with EU labour market regulation – that of enforcement. In some sectors of British industry, particularly the construction industry characterised by mass pseudo-self-employment, the provisions of the Directive on holiday pay are more honoured in the breach than the observance.11 In the absence of institutionalised collective bargaining, employer compliance with the law depends either on official inspection and supervision or on

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the initiatives taken by individual employees. Both of these are very weak reeds indeed: most governments today are quite unprepared to commit the resources necessary for effective enforcement of labour market regulations which they often consider to be excessive and an impairment of the market economy; whereas it is in fact the asymmetry in power between employers and individual employees which gives rise to the need to regulate in the first place. These problems of enforcement do not just arise in Britain and Ireland (which is often very close to British practice in employment and social policy) but also in many of the new member states, where individual employees may be in an even weaker position and the state even less capable of effective supervision (Woolfson, 2005). 4.2. The social chapter In the course of the 1980s, the scope of EU labour market legislation was widened and this development culminated in the “Social Protocol” of the Maastricht Treaty. The main motive was probably to compensate, by some initiatives of social significance, for the extremely economistic Single European Act, with its drive to open up markets by removing non-tariff barriers. But, in comparison to the Single Act’s powerful drive to “create markets” the measures taken to “correct markets” through employment regulation seem weak and unimpressive.12 There was first of all the “Social Charter”, a non-binding declaration of workers’ rights issued in 1989. Britain, having reduced the significance of the document by insisting that it had no legal force, then refused to sign. The Charter was much stronger on individual worker rights than on collective ones; thus, there was a very clear repudiation of certain forms of discrimination, but no clear statement of trade union rights. Although the Charter had no legal force it did lead to a Social Action Programme adopted by the Commission and fed into the social provisions of the Maastricht Treaty of 1992. The Conservative British government of the time refused to sign and so the agreement took the form of a Protocol appended to the Treaty which permitted the other 11 member states to use EU institutions to put their agreed policies into effect – this was an early example of two-speed Europe. Subsequently, the New Labour British government elected in 1997 endorsed the agreement which then became a fully established Social Chapter in the Amsterdam Treaty. The Conservative rejection had always looked like a misjudgement even from the point of view of a government committed to labour market deregulation in the name of “flexibility”. This is because in most fields the Social Protocol only permitted

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legislation on the basis of unanimity – thus British abstention deprived the British of the right to veto European labour market legislation. In return, of course, Britain had a derogation from such legislation, but this formal opt-out might not be effective when all other member states had adopted some measure. For example, the other member states agreed to require multinationals with employees in more than one member state to establish European Works Councils to represent their employees on a transnational basis. Britain’s formal derogation from this requirement was worth very little when corporations would be reluctant to exclude their British employees from a structure to which all their other European employees had access. Thus, when New Labour accepted the social agreement, this was a sign rather of a higher level of sophistication in dealing with the EU than of a different approach to labour market issues. New Labour has in fact portrayed itself as serving business interests by resisting the threatening tide of EU regulation. In any case, the Maastricht Treaty extended EU competence beyond health and safety and gender equality to cover also: the information and consultation of workers, working conditions and certain types of intervention in favour of excluded groups. In these areas, majority decisions can be taken and the Parliament has co-decision powers. In addition the possibility of unanimous decisions in certain other fields was recognised: social security, employment protection, representation of workers (including co-determination), the employment rights of nonEU workers and certain types of “active employment measure”. It is of course in these areas that the acceptance of the Social Protocol by the Blair government gives Britain an effective veto. It should be noted, however, that the agreement also explicitly rules out any EU competence at all in the most sensitive issues in employment relations – wages and strikes, which are to be governed only by the member states. In addition, the Maastricht Treaty introduced a new form of legislative process – a corporatist arrangement whereby the social partners themselves draw up legally binding regulations to govern employment contracts. In themselves these arrangements are of limited importance, but since they relate to the official EU ideology of “social partnership,” they are discussed below under that heading. 4.3. Atypical contracts On the basis of the Maastricht Treaty a rather extensive programme of labour market legislation was enacted during the 1990s.13 One broad problem which resulted in a large number of Directives was that of “atypical” employment contracts. The terminology itself points to the

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impact of different legal traditions on employment practice. In many continental countries employment relations are much more tightly circumscribed by law than they are in the Anglo-Saxon legal tradition. In some countries, such as France, there is a specific labour code which replaces the general law of contract and specifies, in rather narrow terms, the obligations of employer and employee. For this reason in many European countries the general drive by employers and governments for employment and labour flexibility was often concentrated on the introduction of new, “atypical” employment contracts. For example, in Spain regular employment contracts gave employees substantial job protection; the labour “flexibility” drive took the form of fixed-term contracts, which were made much easier by legislation in the 1980s, and which in fact rapidly became the norm for younger workers. Similar developments can be seen in France and Germany. Directives regulating atypical contracts were central to the EU legislative programme in the 90s: legislation covered fixed-term work, parttime work and the use of agency workers and had, as a broad intention, the goal of securing that such workers had comparable rights to those of permanent, full-time employees. It is not clear how this legislation should be evaluated. On the one hand, it provides, in some countries, legal rights which did not exist before and which may, to some extent strengthen the position of vulnerable groups of workers. On the other hand, the provisions have little effect in many countries, such as France, Germany and the Netherlands where national labour market regulation is usually much stricter than anything proposed at EU level. There can be a suspicion that this legislation works mostly to legitimise new employer practices without giving genuine compensation to the workers concerned, who remain for the most part, badly rewarded and insecure. Indeed, enforcement issues are very important here. In Britain, for example, workers whose rights are violated can go to an Employment Tribunal; but all that can be obtained there is an individual remedy. Most employees will not litigate in this way, because they do not want to antagonise their employer, because they do not have a good understanding of the law, or because they simply wish to avoid the trouble involved. Thus the law only acts as a very weak constraint on employer practice, a constraint which becomes less effective when unemployment rates are high. 4.4. Employee voice A further important domain of EU employment law concerns what might be called “employee voice systems” – institutions and practices

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designed to give workers a say in the life of their enterprises. Streeck (1997) argues that the legislation here is a very pale reflection of the strong codetermination systems in Germany, which first gave rise to the view that employee voice should be strongly institutionalised across the EU. The original Vredeling proposals, dating back to the early 80s were for a change in company law which would enshrine strong employee voice systems. The proposals were defeated in the European Parliament after very strong lobbying by both UNICE, the European employers’ federation, and the Thatcher government. Debate continued for decades over a European company statute and what it should contain, that is, in what ways European company law should reflect such values as the ESM. The debate was in the end resolved by a purely formal arrangement which makes it possible for a company to be registered at the EU as well as at national level but which avoids any special conditions for such registration. Thus the legislation in this field is a matter, not of company law, but of labour law. The first step, the European Works Council Directive, relates to companies with employees in more than one member state, thus, essentially, to the big multinationals. It requires the establishment of a transnational representative body which can be used for consultation and information of workers. So far these new institutions have not had a major impact on employment relations in the firms concerned; one problem is lack of trust among workers from different countries in a situation where multinationals often make workforces compete for investment. The European Works Council Directive was followed by a Directive requiring the consultation and information of employees in all enterprises with more than 50 employees, but at this point the tendency for EU labour legislation to become more and more permissive becomes even more marked. The British legislation supposedly introducing the Directive into British law does not even require any action by employers: existing voice systems are acceptable unless explicitly rejected by employees and nothing needs to be done unless 10 per cent of employees request it. During the 1990s, the “diversity” of employment relations systems was increasingly put forward as an advantage by the Commission and member states were given wider and wider scope to take national “practices” and “traditions” into account as they transposed EU legislation. The result has been a loss of any ability to reform inadequate national systems, such as those of Britain, Ireland or some of the new member states. 4.5. Other forms of flexibility In Britain, one of the most important forms of flexibility is the use of, supposedly, self-employed workers. The notion is that once workers

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accept this status most of the legal constraints on employers disappear. (In fact courts and employment tribunals are very reluctant to accept that workers are self-employed, perhaps because this would narrow their jurisdiction.) Much EU employment legislation tries to close this selfemployment loophole by referring to “workers” rather than to “employees”. In the field of health and safety, it is probably difficult to evade responsibilities by claiming that workers are self-employed, but once again there are general issues of enforcement. The issue is related to the status of workers sent for brief periods to other countries, since these were often construction workers, supposedly self-employed. Countries such as Germany saw this practice as undermining their established systems of labour market regulation; countries such as Britain, which often sent workers abroad wanted to apply less restrictive domestic regulations – indeed, during the German construction boom of the 1990s lax regulation was perhaps the key factor ensuring the competitiveness of such posted workers. A compromise Directive in 1996 maintained the employment contracts of workers sent to other member states but specified that basic regulations of the host country (health and safety, minimum wages, gender equality) must be applied.14 Once again a very wide measure of diversity was permitted – not only did each host country specify what exceptions to its labour market regime would be acceptable for posted workers, but the specification of a maximum time period over which a foreign worker could be regarded as “posted” was also left to the member states. The issue is likely to gain in importance as the Commission tries to stimulate cross-border trade in services as the main thrust of the next phase of economic integration, since the export of services often necessitates the presence of workers in the importing country: the usual division on this kind of policy issue can be found – between those who favour regime competition and those who wish to protect public goods by general rules governing the integrating economies. 4.6. Working life and the family A domain in which there seems to have been recently more will to constrain employers is that of “work–life balance” and the reconciliation of family and working life – themes important not only from a feminist viewpoint but also from the familialist perspective of Christian Democracy. An important step here was the parental leave directive of 1986, which, it is argued by Falkner and Treib (2004), has had important effects on practice in the member states, even though the formal requirements were not very stringent.

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4.7. Social partnership and the European social model EU labour market policy, including both legislation and the EES discussed below, make frequent reference to two concepts which are seen as providing specific content to social policies (including, as is consistent with French and German rather than Anglo-Saxon terminology, labour market policy) in a European context. The first of these is the notion of “social partnership”, a concept of employment relations as non-adversarial which, however, is clearly distinct from the notion of a “right-to-manage” often favoured in Britain and the US, since it insists on agreement and consensus between the two sides of industry and on some collective aggregation of employee interests (the social partners are supposed to hold a “social dialogue”, which is thus a closely related notion). The two strongest political tendencies in the EU, that is Christian Democracy and Social Democracy, are both committed to this notion of partnership which is expressed in most EU statements on employment and is repeated in the Treaties and other key documents. Clearly, the notion of social partnership is something more than cosmetic: there is a long history of the organised representation of interest groups, including employees, within the EU. The Economic and Social Council brings together these organised interests and gives them an institutionalised voice in EU decision-making. The Maastricht Treaty went further in this corporatist direction, by opening up the possibility for the social partners at the EU level, UNICE and the European Trade Union Confederation (ETUC) (together with CEEP, which represents public sector employers), to determine EU employment law by agreement. When this happens the normal legislative instances, Council and Parliament, retain a veto on the draft directive which emerges from the corporatist negotiations, but this is a simple yes or no decision; the agreed document is not to be amended. In fact this kind of arrangement, giving legal force to the outcome of collective bargaining, already existed in several member states. One can even find some examples in Britain, although in the common law tradition there are problems in making such agreements binding on those who are not party to them, such as firms who do not belong to employers’ association involved. Indeed, such problems of representation also arose when corporatist legislation was attempted at the EU level – there are many employers and workers who can plausibly claim not to have been adequately represented by UNICE or the ETUC. The two main cases where these corporatist procedures have been used are the parental leave directive and the fixed-term contract directive – the former probably having more effect on employment practice than the

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latter. There has been some suggestion that the union side has tended to make many concessions in the negotiations leading to this kind of labour market regulation – just in order to establish the procedure (Falkner, 2000). The employers, on the other hand, have only been ready to negotiate when threatened by ordinary legislation through Council and Parliament. Although the commitment of EU institutions to Social Partnership is genuine, there is also a commitment to labour market “flexibility” which works in the opposite direction, works, that is to say, towards the deregulation of employment, the reduction of social protection and the dismantling of collective, in favour of individualised, bargaining. One can even identify conflicting views inside the Commission – although support for social partnership is widespread, the key DirectoratesGeneral which deal with the internal market and with economics and finance are most closely aligned with the “flexibility” agenda. In fact, successive expansions may have reduced the weight of social partnership thinking in the EU: it was above all in the original member states that this view was strongest: Britain differed at first by the adversarial nature of its employment relations, subsequently by the unilateral triumph of the employers; the new entrants of the 1980s, Greece, Spain and Portugal, did not have the same kind of tradition; in the ex-communist countries the collapse of institutions again tended to reinforce a unilateral, employer-controlled “right-to-manage” approach; the Scandinavian countries relied more on government policies and strong trade unions than on partnership structures to advance the interests of workers. As time has passed the dominance of the “flexibility” over the “partnership” agenda has become clearer. In the 80s, relatively strong employment regulation was seen as at least a symbolic counterweight to the liberalisation and market creation of the Single Act. In the later 90s, however, the countries, above all Germany, where social partnership had previously enjoyed considerable prestige seemed to under-perform while the US and Britain seemed to have increased their growth prospects.15 A second theme in EU thinking, more recently, is an emphasis on the values of the ESM. This is a wider notion than “social partnership”; although partnership is certainly one component of the ESM, it also includes comprehensive systems of social protection together with high quality public services in such fields as housing, health care and education. Use of the singular represents an abstraction from the ESMs found at the member state level, and which are very different from one another although family resemblances can of course be detected. The

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discourse of EU leaderships over the last five or six years makes continual reference to the ESM. As with the notion of social partnership, these references are not vacuous – for one thing, the ESM is seen as a way of differentiating the European project from the US models which are elsewhere so obviously influential on EU policies, for another, the ESMs, in the plural, are still central to politics in the member states. Nevertheless, the ESM is hardly seen as a key political objective. The Lisbon agenda, which continues to dominate the direction of EU policies in the first decade of the twenty-first century, clearly subordinates social objectives to economic ones. Although the EU has taken a number of initiatives on the problem of poverty, these are very much a matter of “open coordination”, of trying to nudge policy at the member state level towards more adequate minimum income schemes, for example, and have not as yet had a detectable effect on outcomes. The EU has also enthusiastically adopted the theme of the “future finance” of the ESM, but this concern appears to be a question of reducing member state pension liabilities by methods which might be seen as an erosion of the ESM. At the same time, there are clear inconsistencies between EU economic strategies and the effective functioning of actual ESMs. At the macroeconomic level, EU pressure for fiscal retrenchment promotes reductions in social expenditures. At the same time, EU structural policies have sacrificed social objectives to the pursuit of competition, as with the ill-fated Bolkestein Directive, which tried to open up key social services to external competition from both EU and non-EU corporations. The rejection of the first version of this Directive in the Council as well as the Parliament (a more dilute form is currently under discussion) demonstrated the widespread fear that integration was unleashing market forces which threatened established social models.16 4.8. A retreat from employment regulation? It is important that the EU is committed, by clauses in its founding documents repeated in all subsequent Treaties, to a levelling up of employment conditions through improvements which maintain the highest standards reached in any member state.17 In general these clauses stand as a legal barrier to regressive policies. Increasingly, however, EU leaderships have claimed that economic advance in itself could be taken as securing these improvements, even though there is little evidence for such a view. In the language of Lisbon, growth and employment are the necessary, and perhaps the sufficient, conditions for social progress while growth and employment are to be secured by market-led integration. In the usual fuite en avant, the complete failure of the Lisbon strategy to

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generate an expansion of either output or employment is only taken as evidence that not enough market-led integration has been achieved. At the same time, the official discourse of the EU is moving away from the commitment to constraining legislation as a way of advancing working conditions. Increasingly official voices echo the employers’ complaints about the burden of regulation and there are even promises that existing employment regulation will be “streamlined”, “simplified” and so on. Since, as was illustrated above, recent legislation has hardly been much more than symbolic, this language may imply an attempt to dilute some earlier measures – the Working Time Directive is sometimes mentioned in this context, although it is hard to believe that it would be politically possible to amend it in a deregulatory sense. On the other hand, one original force behind EU employment law has weakened – the desire of employers in such countries as Germany to avoid competition from other countries on the basis of lower standards. Partly, perhaps, because the other countries today are more likely to be outside Europe, partly because large German companies are today so multinational, the original fear of “social dumping” seems to have given way to a celebration of “regime competition” – the hope that external competitive forces will work to lower standards in Germany. Overall, the following assessment might be made of EU employment legislation. It has little or no impact in France, Benelux, Germany or Scandinavia because in those countries national legislation is usually stricter. Indeed, from the point of view of those countries, EU employment directives might be seen as legitimising a less stringent approach to regulation at member state level. On the other hand, in Britain, Ireland, southern Europe and many of the new member states, the legislation often works to the advantage of employees and reinforces workers’ rights. The problems are: firstly, the dilution of legislation by member state governments who are hostile to it; secondly, the lack of effective enforcement in countries where trade unions do not have a strongly institutionalised role in the enterprise; finally, the increasingly pusillanimous approach of legislators in recent years as they have been more and more reluctant to place real constraints on employers. However, much of the legislation is on balance useful and it could become more so if EU policy in general started to move away from the bankrupt Lisbon agenda. Thus a shift in the political balance might have a major impact – especially in fields, such as health and safety, where EU competence has a very firm legal basis. It would be possible to use health and safety measures to take major steps to improve the well-being of workers.18 Nothing of the kind, however, is on the present agenda.

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5. The Luxembourg process and the EES19 Since 1997, EU labour market policies have gone beyond the issue of employment regulation to embrace also certain types of labour market intervention. At the European Council of Luxembourg, heads of state and government adopted a EES which, while it does not disturb member state competence for these interventions, tries to make member state policies more dynamic and effective by a process of peer review and recommendation. Indeed the EES has become perhaps the paradigmatic example of the “open method of coordination” which is being used to circumvent issues of competence while pushing forward the integration process outside the core domains of economics and the internal market.20 The conjuncture which saw the launch of the EES was one where it was becoming increasingly necessary, from a political point of view, to demonstrate that the EU had other objectives besides market creation. The drive towards the single currency had taken the form of restrictions on macroeconomic policy which had a clearly damaging effect on levels of activity and employment. The Luxembourg Council tried to demonstrate a will to deal with rising unemployment across the EU. It was decided to anticipate the provisions of the Amsterdam Treaty in this respect and to initiate coordination of labour market policies straight away. The actual content of the Luxembourg process was, at least at the start, strongly influenced by the newly elected Labour government in Britain. At the time, the Blair administration enjoyed considerable prestige in Europe because of the scale of its recent victory and its declared wish to repair relations between Britain and the EU after the many frictions of the Conservative era. The actual direction of British labour market policy, however, was probably more influenced by the US than by European examples – in particular, the “New Deal”, essentially an “activation” strategy aimed, first of all, at the young unemployed, drew on the US experiments under the Clinton presidency. The earliest formulations of the EES identified four principal themes for labour market intervention: equal opportunities, especially between men and women and seen as a response to female activity rates substantially below male ones in many countries; “employability”, understood as a lack of elementary skills which was holding many of the unemployed back; “adaptability” which, following the “flexibility” agenda, related to the supposed rigidity of “typical” employment contracts; and “enterprise” which related both to a perceived need for more

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business start-ups and to the hope that some of the unemployed could be helped to go into business on their own account. These themes were known as the four “pillars”. They were sometimes expressed, in an idiom with a more pragmatic resonance, as a series of “gaps”: the gender gap, the skills gap, the adjustability gap and the job creation gap, respectively.21 This alternative language signals the presence of the usual ambivalence (sometimes portrayed as “creative ambiguity”) which characterises EU policy statements: multiple interpretations are invited as a means of achieving, by rhetorical means, a degree of consensus incompatible with any narrow and specific interpretation of the texts involved. In fact, the commitment to social partnership meant that union representatives had to be given, if not a veto, then at least a voice in the open coordination process. Things could be smoothed out if the use of language was sensitive to their susceptibilities. 5.1. The employment targets To render the EES more concrete, quantitative targets were adopted to act as a measure of success and these were expressed in terms of increased employment, rather than reduced unemployment, rates (an overall employment rate of 70 per cent by 2010 was adopted as the main target by the Lisbon Council). There are both advantages and disadvantages to this procedure. The main motive was probably to discourage the use of early retirement strategies and similar devices which had been used to mop up unemployment either in reality or in the statistics (in Britain, as in several other countries, the reclassification of the unemployed as incapacitated was such a device). There are also clear disadvantages – employment as such can hardly be regarded as a maximand, both because there are many good reasons why someone might not be economically active and because the quality of jobs is also a consideration. In fact, repeated criticisms of the functioning of the EES did eventually compel the Commission to pay more attention to job quality. To these overall targets there were added targets first for women (EU employment rate of 60 per cent by 2010) and then for older workers (50 per cent by 2010). It was always hopelessly unrealistic to expect such targets to be achieved by the supply-side measures of the EES. In fact, considerable progress towards the targets was made in the early years between 1997 and 2001. The Commission was unwise enough to attribute this progress to structural reforms of the European labour market. This raises the question of how to explain the subsequent rise in EU unemployment from a low of 8.4 per cent in 2001 up to 9 per cent in 2004 (for

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the EU as a whole; the figures for the EU15, those countries involved in the EES since its inception, are 7.2 per cent and 8.1 per cent). Have the structural improvements been rapidly reversed? Or are we dealing with a conjunctural downturn? If the latter, why are macroeconomic instruments not being deployed? (See Table 5.1.) The form of the EES is a cycle of policy proposals and policy assessments for each country. The Council of Ministers prepares each year Employment Policy Guidelines, for the EU as a whole and for individual member states. These are translated by the member state governments into “national reform programmes” (originally “national action plans”) for developments in their labour market policies. These measures are then assessed in a Joint Employment Report which feeds into the next cycle. In principle, the open method of coordination involves a lot more than this simple interaction between each member state and the centre: comparative studies and peer review of policy are intended to help build a transnational policy community and to make for more informed and successful policy formation in each country. However, this multinational policy debate is only developing slowly and the essence of the EES process at present remains a series of dialogues between national governments and the centre, in practice, the Commission. Even this dialogue does not necessarily have a very big impact on national labour market policies – some governments clearly take the Luxembourg process very seriously; for others it is a question of tweaking some details and making some presentational changes.22 Recent reforms of the EES tried to streamline procedures and to stabilise recommendations so that the process would be less burdensome for

Table 5.1 EU–15 EES targets and outcomes (per cent) Employment rate Target 1997 1998 1999 2000 2001 2002 2003 2004

70.0 60.7 61.4 62.6 63.4 64.0 64.2 64.3 64.7

Source: Employment in Europe (2005).

Female employment rate 60.0 50.8 51.6 53.0 54.1 55.0 55.6 56.0 56.8

Older workers employment rate 50.0 36.4 36.6 37.1 37.8 38.8 40.2 41.7 42.5

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member state governments. Here, as with labour market legislation, we can see the new EU minimalism at work. 5.2. Content of the EES The Directorate-General for Employment and Social Affairs protests that the EES is concerned with more than active employment measures. This is indeed the case. Every aspect of labour market policy is covered: training systems, the working of government employment agencies, regional policies in so far as these bear on employment issues and so on. Nevertheless, active employment measures have been at the centre of the EES so far and the success and failure of the EES has depended on the potential of such measures to increase employment. In fact additional targets have been formulated for such interventions – for instance, that every young unemployed worker should be offered some kind of placement with a specified period of time. Now the general expression, “active employment measures” is deeply ambiguous. The term active is used to signal that something more is being done than indemnify an individual’s unemployment (the payment of indemnities is a so-called “passive” measure presumably because of the passivity of the individual in question). But what that more is requires close examination. Contrast the following polar cases. Firstly, “active” employment measures can be thought of as solidaristic interventions in favour of disadvantaged groups. Although macroeconomic policies are the most potent measure to deal with unemployment, it is never exactly true that a rising tide lifts all boats. Some localities – where for example an important employer has gone out of business – and some groups – perhaps ethnic minorities – will be left behind. When unemployment is particularly high because of the closure of a major company or the rapid run-down of an industry there will be an “island” of unemployment which will stand out even when the general level of demand is rising. The tradition of the Nordic social models has been to use both job creation measures and relocation/retraining in such circumstances; although there are certainly disciplinary aspects to active measures even in the Nordic countries, their overall impact is to widen the possibilities open to the members of disadvantaged groups. It should be noted that this kind of intervention is bound to be to some extent ad hoc and contingent, because the need for active measures is cyclical. In practice, such programmes are initiated in downturns and dismantled in booms. This is very logical and turns the increased expenditure, which active measures require, into a stabilising force.

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On the other hand, there are active employment measures which are best understood as instruments of social discipline or even social punishment. The training or work experience “opportunities” which are offered to the unemployed are seen as testing the authenticity of their claims as well as reinserting them into employment. In the 1990s, reforms of the social security system in the US dissolved the main federal welfare programme, Aid to Families with Dependent Children, and transferred responsibility for poverty relief to the states, some of which proceeded to introduce extremely harsh “workfare” regimes (FAIM – families achieving independence in Montana, or WW – Wisconsin works). One aspect of these disciplinary programmes is that they are often designed not just to move people off welfare benefits and into employment, but also to encourage people to cease claiming relief even when they do not find work. From the beginnings of the EES in the Luxembourg summit of 1997, official statements of the strategy have deliberately maintained a measure of ambiguity about its underlying social logic. For example, member states are enjoined to “improve the incentives to accept work”, which might mean increasing minimum wage rates, but which could equally mean reducing unemployment indemnities.23 It seems clear that the political motives behind the EES were mixed. An important consideration was to legitimise the process of European construction, at that time focussed on painful preparations for monetary union, by doing something to address the central social problem of unemployment. On the other hand, certain governments represented at Luxembourg, notably that of Britain, were already committed to methods of employment intervention which drew heavily on the US experience and which marked a break with traditional social-democratic approaches to social security. 5.3. Active employment measures A key criterion in the assessment of “active measures” is their impact on the liberty of the individual. Do the measures widen the opportunities available to an unemployed individual and relax the constraints which he or she confronts? Or do they, on the other hand, tighten these constraints and attempt to induce decisions previously rejected by that individual?24 In the latter case, we are faced with what Standing (2002) calls “the new paternalism” – an authoritarian reinforcement of market disciplines. Standing analyses in some detail the attempt to give an ethical veneer to such initiatives, by appealing to “reciprocity”, “balance between rights and responsibilities”, “the work ethic” and so on and so

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forth. There is, at the least, a certain tension between such pronouncements and the simultaneous celebration of market processes not characterised by any clear conformity to the values invoked. It is not possible to survey all the policies adopted by member states under the rubric of “activation” but the huge substantive variations can be illustrated by contrasting the approach in Britain with that in Denmark. The main British policy associated with the EES is certainly the “New Deal” initiative, aimed initially at the activation of the young unemployed. The Labour government elected in 1997 certainly intended to introduce a more generous and humane regime than those used from time to time to control youth unemployment by its Conservative predecessors. Nevertheless the “New Deal” had a clear economic logic: to increase employment while intensifying competition among (in practice, lower-paid) workers and thus to reduce the non-accelerating inflation rate of unemployment (NAIRU) (see Layard,1997, for a clear account of this reasoning).25 In this regard, it was to be seen as a success of the intervention, if a young person, confronted by a distasteful activation experience, chose instead to renounce their unemployment indemnities and either to take a job or to find some other means of subsistence. The British report on its EES policies (ECOTEC, 2002) shows that the main consequence of the “New Deal” was indeed to drive young people off the unemployment register, without their having benefited from the “opportunities” offered to them, which “opportunities” indeed most of them refused. Of 166,000 young people reaching the point of activation between January 1998 and July 2001, only 39 per cent in fact accepted one of the training or job experience options; 26 per cent are known to have taken employment outside the scheme, often perhaps, employment they would otherwise have refused; 8 per cent transferred from unemployment indemnities to other social security benefits; the destiny of 17 per cent is unknown. As a mechanism of social discipline, the New Deal is an obvious success; as a contribution to the well-being of those affected by it, it is much harder to assess. By contrast, the Danish exercise in activation is usually interpreted as following a completely different social and economic logic – one that rejects the recasting of the welfare state along Anglo-American lines. Thus Bredgaard (2001) writes: A more generous welfare state does not seem to corrode work motivation or job search flexibility. Labour market marginalisation is in general better understood in relation to mismatch between the structure of jobs and the distribution of skills combined with the

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institutional mechanisms of job allocation. . . . The universal and expensive welfare state has not been retrenched or dismantled but rather consolidated and in some areas partly improved, corporatist institutions have been reinforced, and Keynesian inspired fiscal policy (initially) adopted successfully (p. 10). Gilbert (2000) offers a similar assessment. The Danish strategy, which has certainly achieved a substantial reduction in unemployment, involved macro-economic measures and a wage policy as well as labour market policies. The latter certainly involved some tightening of the rules and constraints which apply to the unemployed, but these were minor. They focussed above all on vocational education with programmes tailored to the needs of the individual concerned. It is not intended here to recommend the universal adoption of Danish practices. Rather, the point of the contrast between British and Danish policies is to pose the question: What does it mean to assert that these two opposed approaches to labour market reform are both legitimate components of a unified European strategy? If the two approaches both lead to a higher volume of employment, is it the same kind of employment? 5.4. Review and reformulation of the EES The EES has always involved contestation and debate around the types of intervention which it proposes. There are, of course, different points of view among the participating governments but the main frictions are probably between the social partners. In the dialogue around the EES, trade union representatives have argued for a more generous treatment of the unemployed, for a more “Nordic” approach to unemployment and so on. However, they have not had a great deal of influence on the implementation of the EES. Indeed, the procedures of the EES reinforce a narrow and restrictive approach to labour market policy. Although the Employment Policy Guidelines are prepared each year in the DirectorateGeneral for Employment and Social Affairs, they are given their definitive form by the D-G for Economic and Financial Affairs. This means that employment policy recommendations are subordinated to the annual “Broad Economic Policy Guidelines”, which never fail to prioritise fiscal consolidation, reduced labour costs and market-led integration.26 The obvious way to make employment policies compatible with the unchanging agenda of the Economic Policy Guidelines is to reduce expenditure, deregulate labour markets and promote competition between the unemployed and those in insecure employment in order to achieve further labour cost reductions. Thus the last word in the annual

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policy round is always given to the most conservative voice.27 From 2005, Economic and Employment Guidelines are published together as an “integrated” document, but this integration seems only to confirm the subordination of the latter to the former. However, repeated criticism, backed up by evidence, does seem to have called some of the original presuppositions of the EES into question. One issue is the quality of employment – more recent formulations of the strategy are less likely to make the level of employment a simple maximand, independently of the quality of the job. Similar considerations are also now more likely to be invoked as regards the quality of active measures. One should not exclude, from this somewhat negative account, the generally helpful approach adopted within the EES to the employment problems of immigrant workers. Nor is it possible to object to the emphasis on gender inequalities, although of course their correction implies a lot more than rising female participation rates. In the course of 2003, as part of a comprehensive review of the Lisbon agenda, the EES was subject to a basic review which, while reaffirming its main content, reformulated its objectives (for a full assessment, Watt, 2005). Instead of the four “pillars” the strategy was now expressed as three “overarching and interrelated objectives’ – full employment, quality and productivity at work and social cohesion and inclusion. Then ten guidelines, “the ten commandments” are derived from these overarching goals. These are: 1. Active and preventive measures for the unemployed and inactive 2. Job creation and entrepreneurship 3. Address change and promote adaptability and mobility in the labour market 4. Promote development of human capital and lifelong learning 5. Increase labour supply and promote active ageing 6. Gender equality 7. Promote the integration of and combat the discrimination against people at a disadvantage in the labour market 8. Make work pay through incentives to enhance work attractiveness 9. Transform undeclared work into regular employment 10. Address regional employment disparities. The guidelines for individual member states, on which national action plans are based, are laid out in terms of these “commandments.” In general they are close to the four pillars but items 7, 8 and 10 may

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signal a certain shift in policy thinking. The review of the strategy also attempted to simplify the open coordination process by making major changes to the national action plans less frequent. From year to year the main concern will be the implementation of existing guidelines with qualitative changes made at longer intervals. This is intended to reduce the administrative burden on member state governments – but it too may be a sign of the new minimalism. A recent change in the guidelines for Britain reinforces the impression of a certain shift in priorities. As usual, Britain is congratulated on the rise in employment and on the working of such schemes as the “New Deal”. However three other issues are raised which the British government might find less to their taste. They are enjoined to give more consideration to the quality of jobs – which might be a difficult task given that many of the new jobs in Britain have been part-time jobs at low rates of pay. Secondly, the Commission expresses concern about the productivity of the new jobs in Britain. This may be a coded expression; it should be remembered that the EU can say nothing about wages, even within the open coordination process, because the Social Chapter explicitly bars it from doing so. To speak of productivity, that is, the main determinant of wages may be a way of making the critical point that many of the jobs being created in Britain are very low-paid. Finally, a point is made about social dialogue – the British are encouraged to develop the role of the social partners within the EES. Since most British workers are no longer represented by trade unions this recommendation might lead to a little embarrassment in Whitehall. These changes in the Guidelines for Britain suggest a certain welcome modification in the priorities of the EES. Another change that should be signalled is in the approach taken by D-G Employment and Social Affairs to “atypical” contracts. The standard position in the past was that these are absolutely necessary to deal with the “adjustment gap”. However, extensive empirical studies indicated that at least in one case, short-term contracts, these “flexible” forms of employment add nothing to total employment but do make employment much more volatile.28 This should mean, but perhaps will not, that the drive for “flexibility” in this form will be abandoned. One further change, at least in the presentation of the EES, is the now frequent reference to “flexicurity” or, as the latest Guidelines have it, what is to be promoted is “flexibility combined with employment security”. Nordic models seem to be behind this notion: it is a challenging one for most advocates of the “flexibility” agenda because what makes atypical contracts so attractive to employers is exactly the insecurity to

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which they give rise and the consequent readiness to settle for lower rewards and less satisfactory conditions.29 The interpretation of “employment security” which will be made is suggested by the EU’s own account of this guideline, which calls for “support for transitions in occupational status, including training, self-employment, business creation and geographic mobility” (European Commission, 2005a). 5.5. Overview of the EES It has to be recognised, then, that the EES is a contested domain, that criticism, above all from employees’ representatives, backed up with strong evidence on the effects of some labour market policies has modified at least the language of the EES and led to a certain enrichment of its objectives. The changes, however, are minor: the basic logic of the strategy is to bring about higher employment by intensifying supplyside competition in the labour market. The social consequences of such an approach will tend to be negative because those most affected by the strategy will be the more vulnerable parts of the population (the young unemployed, for instance). The economic benefits are justified more by the doctrine of “flexibility” than by strong evidence.30 In any case, the impact of the EES on member state policy is probably very limited. The open method of coordination is a promising approach to policy formation but it is still in its early stages. Reference to European comparisons and to European policy communities is perhaps becoming more important in many countries but at present they do not have much impact on policy decisions. The European Commission (2005b) argues that the structural rate of unemployment has been reduced by the EES, or at least during the five years after 2000 when the EES was fully functional. (This claim applies to EU15, not to the new member states, in many of which the “NAIRU” is said to have risen.) However, the Commission has to recognise that unemployment as such has increased and that this is a demand effect: In the period 2001–2004, the average annual GDP growth rate for the EU-15 turned out to be around half of what had been initially anticipated. Obviously, given the strong relationship between economic growth and labour market performance, this had a negative impact on employment creation. Moreover, the weakness of domestic demand in some EU Member States, especially in Germany since 2000, is worrying not only in itself, but also because of the potential knock-on effects in the rest of Europe . . ., which represents a major downward risk to the current economic recovery in Europe in general, and job creation

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in particular. Given the low levels of economic confidence, firms might not want to expand in the present circumstances (early on in the upswing), fearing a possible “double-dip” economic downturn. Employment in Europe, 2005, p. 75 It is immediately added that ongoing labour market “reforms” in Germany will reverse this situation but that is perhaps the triumph of hope over experience. The claims still put forward for a “structural” improvement do not seem to be very soundly based. The actual technique used by the Commission to separate structural from cyclical unemployment is purely statistical, that is, unemployment is treated as cyclical if it does not persist, structural if it does. This begs a lot of questions about the persistence of demand shocks.

6. The macroeconomic dialogue For the sake of completeness, a third component of EU labour market policies can be mentioned; this is the macroeconomic dialogue, which brings together the ETUC, UNICE and CEEP as representing the social partners with the European Central Bank (ECB), the Commission and the Council of Ministers in two forms (economics ministers (Ecofin) as well as ministers of employment and social affairs). The structure was designed by Oskar Lafontaine during his brief tenure as German Finance Minister and was agreed at the Cologne Council (Dufresne, 2002). Lafontaine had in mind a neo-Keynesian process through which income formation, in the hands of the social partners, would be loosely coordinated with monetary policy (the ECB) and fiscal policies (member state governments, as represented by the ministers referred to). Of course, even if this kind of neo-Keynesian process were accepted, it would not permit any precise macroeconomic strategy. The actual economic structures of the EU, apart from monetary policy, are much too decentralised for that. But dialogue could develop general guidelines which might reduce inconsistencies among the three components of the macroeconomic mix and reduce the probability of negative sum games between the central bank and the other actors. It would not be a question of an optimal policy mix but of seeking to avoid very inefficient outcomes. In practice, however, not even this limited form of coordination has been possible, because the institutional structure of the EU rules it out. The ECB formulates monetary policy in perfect independence and would certainly not involve either the member states or the social partners in its

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deliberations. The governments of those member states which use the euro, although they are the victims of the ECB’s first mover advantages, mostly seek to enjoy the same advantages as against the social partners in their own countries (although there are exceptions to this rule in some of the smaller states which are experimenting with social pacts). Thus the social partners are pre-empted twice, by both monetary and fiscal authorities. As for the Commission – it is hardly acting as a neutral referee in these discussions – rather it pursues its agenda of fiscal stabilisation together with the kind of labour market “reform” which was discussed in the previous section. Thus, in practice, the macroeconomic dialogue has never amounted to more than a rather sterile “exchange of views”. As with the other aspects of labour market policy which have been discussed – regulation and intervention – one can envisage changes which would give the macroeconomic dialogue a different and more positive significance. But at present, it cannot be regarded as a serious attempt to affect macroeconomic circumstances in the EU.

7. Conclusion The two main forms of labour market policy at EU level are, firstly, labour market legislation and secondly, the “open” coordination of member state labour market interventions, through the EES. The various programmes of legislation, going back almost to the beginning of European integration, are by far the more important of the two forms. Their immediate effect is to establish minimum labour standards in several fields, including equal opportunities, health and safety, the use of “atypical” contracts, the information and consultation of employees and “work-life” balance. This legislation can be criticised on several grounds: inadequate attention to enforcement; a lack of ambition which means that convergence on the highest standards in the EU is too slow; in some cases, the danger of doing more to legitimise “flexible” employment practices than to regulate them. However, the general impact of these directives is positive – it works to raise both actual standards and aspirations in many member states where standards in the past are too low. The main problem is that new legislation may be avoided or weakened, and existing legislation also perhaps weakened, in an attempt to placate business interests by a war on “red tape”. The second aspect of EU consists of the coordinated interventions of the EES. Although they have a more constructive side, these have been influenced by a regressive and inegalitarian view of the labour market which regards it as possible and desirable to achieve higher levels of employment

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by intensifying competition among the weakest and most vulnerable sections of the population. As such, the EES is a manifest failure. This, however, does not mean that the open method of cooperation as such is a failure. On the contrary, it is a promising and imaginative approach to public policy. Labour market interventions will never lead to full employment – that requires expansionary macroeconomic measures. But the interventions proposed in the EES could become very useful if they were clearly developed as forms of social solidarity rather than social discipline. The EU today is basically a set of economic arrangements designed to liberalise market exchange within the member states, and involving a macroeconomic regime which seeks to use restrictive policies to constrain member state expenditure and contain labour costs. The social aspects of the EU are secondary, often little more than cosmetic, and completely subordinated to its economic content. Initiatives in the EU focus on further market creation, today for example, the creation of big integrated financial markets, rather than market correction on social or environmental grounds. This situation is not an accident, nor is it a simple expression of a neoliberal Zeitgeist, although ideological factors are important. The democratic and social policy deficits of the EU reflect, firstly, the structural predominance of large corporations in the international economy, as well as the failure of countervailing forces to integrate and aggregate their own interests at the European level. A second cause is the refusal of member states to part with their autonomy in social policy, which autonomy is seen as all the more valuable just because they have lost so many of their economic powers. However, this narrow and socially regressive model of European integration has led to an impasse, as is shown by the failure of the European constitution. If the priorities and strategies which predominate in the EU today are not changed then the EU itself will stagnate and the existing structures may start to erode. More positive developments, based on an expansion of the demand for labour and on reinforced social policies, are possible. Such developments could draw much from the experience of EU labour market policies.

References Bredgaard, T. (2001), “The quest for the Holy Grail: The Danish labour market strategy of the 1990s”, Centre for Labour Market Research, Aalborg University, Aalborg, Denmark. Cremers, J. and Donders, P. (eds) (2004), The free movement of workers in the European Union, CLR-Studies 4, The Hague.

John Grahl 199 Dufresne, A. (2002), “Oskar Lafontaine’s dream: An opportunity for economic policy co-ordination?”, in Degryse C. Pochet P.(ed.), Social Developments in the European Union, Brussels: ETUI/OSE, pp. 85–113. ECOTEC (2002), UK Contribution to the Evaluation of the European Employment Strategy, ECOTEC, Birmingham. Esping-Andersen, G. (1990), The Three Worlds of Welfare Capitalism, Polity, Cambridge. European Commission (2005a), Integrated Guidelines for Growth and Jobs (20052008) COM(2005), 141 final, Brussels. European Commission (2005b), Employment in Europe, EU, Brussels. Falkner, G. (2000), “The Council or the social partners? EC social policy between diplomacy and collective bargaining”. Journal of European Public Policy, 7(5), pp. 705—724. Falkner, G. and Treib, O. (2004), “The First EU Social Partner Agreement in practice: Parental leave in the 15 Member States”, Institute for Advanced Studies, Political Science Series, 96, Vienna. Ferner, A. and Hyman, R. (eds) (1998), Changing Industrial Relations in Europe, Blackwell, Oxford. Foden, D. and Magnusson, L. (eds) (2003), Five Years’ Experience of the Luxembourg Employment Strategy, ETUI, Brussels. Gilbert, G. (2000), “Aktive Arbeitsmarkt- und Sozialpolitik in Denmark” in Deppe, F. and Tidow, S. (eds) Europäische Beschäftigungspolitik, FEG, University of Marburg, Marburg, Germany. Grahl, J. and Teague, P. (2004), “The German model in danger”, Industrial Relations Journal, 35(6), 557—573. Harvey, M. (2001), Undermining Construction: The Corrosive Effects of False SelfEmployment, Institute of Employment Rights, London. Hendy, J. and James, P. (2001), “The Development of Employer’s Liability Law”, Chapter 1 of J. Hendy and M. Ford (eds) Munkmanon Employer’s Liability, 13th edition, Butterworth, London. Hodson, D. and Maher, I. (2001), “The open method as a new mode of governance: The case of soft economic policy co-ordination”, Journal of Common Market Studies, 39(4), pp. 719–745. James, P. (2003), “Well being at Work: an issue whose legislative time has come?”, Policy and Practice in Health and Safety, 1(2), pp. 1–15. Layard, R. (1997), “Preventing long-term Unemployment: an economic analysis” in Snower, D. and De La Dehesa, G. (eds) Unemployment Policy: Government Options for the Labour Market, CUP, Cambridge. Milward, A. (2000), The European Rescue of the Nation-State, 2nd edition, Routledge, London. National Engineering Construction Committee (2004), Social Dumping: A Crisis in the UK Engineering Construction Industry, Amicus, Bromley. Raveaud, G. (2003) “La stratégie européenne de l’emploi: une première évaluation” in Euzeby C., Carluer F., Chapon S., Euzeby A., Mansanti D., Offredi C., (eds), Mondialisation et régulation sociale, L’ Harmattan, tome 1, pp. 159–173. Scharpf, F.(1999), Governing in Europe: Effective and Democratic?, OUP, Oxford. Serrano Pascual, A. (2003a), “A contribution to evaluation of the European employment strategy: what lessons from the first five years of implementation of the EES?” in E. Gabaglio and R. Hoffmann (eds) European Trade Union Yearbook 2002, ETUI, Brussels.

200 Alternative Perspectives on Economic Policies in the European Union Serrano Pascual, A. (2003b), ‘Towards convergence of European activation policies?’, in Foden and Magnusson (2003). Standing, G. (1999), Beyond the New Paternalism: Basic Security as Equality, Verso, London. Standing, G. (2002), Beyond the New Paternalism: Basic Security as Equality, Verso, London. Streeck, W. (1997), “Industrial citizenship under regime competition: The case of the European works councils”, Journal of European Public Policy, 4(4), pp. 643–664. Watt, A. (2005), “Reform of the European employment strategy after five years: A change of course or merely of presentation?”, European Journal of Industrial Relations, 10(2), pp. 117—137. Woolfson, C. (2005), “Health and safety at work after enlargement”, Policy and Practice in Health and Safety, 3(2), pp. 69—88.

Notes 1. Official EU documents usually refer to “employment policy” rather than labour market policy but this is a misnomer in that the policies referred to do not include the macroeconomic measures central to the generation and maintenance of high levels of employment. The policies dealt with here on the other hand concern the regulation of the labour market and of the employment relation, and such interventions in the labour market as “active employment programmes.” The general term, “labour market policy” has therefore been preferred. 2. Even in the 1950s a move away from social policy can be detected in that the social provisions of the Treaty of Rome were already weaker than those of the Treaty of Paris (1951) which established the ECSC. 3. Social Fund expenditure was planned to be 62.5 billion euro over the period 2000–2006. The annual average of about 10 billion should of course be related to the 450 million inhabitants of EU member states. 4. Welfare economics does not allow us to say that a reform represents an improvement (or even, in strict logic, an efficiency gain) unless it is accompanied by full compensation of the losers. This result is usually forgotten by neoliberals, unless the probable losers are rich and powerful. 5. For an amusing discussion of this terminology see the introduction to the second edition of Ferner and Hyman (1998). 6. Esping-Andersen (1990) for the seminal discussion. 7. In Britain, some key moves against gender discrimination (Equal Pay Act, 1970; Equal Opportunities Commission, 1975) were taken on a British basis prior to, or independent of, Britain’s accession to the EEC; however, European legislation is usually seen as helping to reinforce the movement for gender equality, although the movement is still a long way from its goals. 8. For an overview of the actual legislation and its impact in Britain see Hendy and James (2001), pp. 17–24, “The European Revolution”. 9. Recent press reports suggest that the British government may agree to the elimination of individual derogations from the Directive. 10. This case illustrates how far populist British complaints about the imposition of rules by Brussels are from reality. British ministers are in fact almost never

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11. 12. 13. 14.

15. 16. 17.

18. 19.

20. 21.

22.

23.

24.

put into a minority in the Council. What would need to be explained is rather why other member state governments are so reluctant to challenge British positions. See Harvey (2001) on the mass illegality of the British construction industry. This terminology, more accurate than the distinction between negative and positive integration, is taken from Scharpf (1999). For critical assessments of this legislation from a labour movement perspective see the publications of the Institute of Employment Rights, www.ier.org.uk See Cremers and Donders (2004). Increasing concern has been expressed by British unions about the use of the Posted Worker Directive to circumvent national labour market regulation or national collective agreements (National Engineering Construction Committee, 2004). For a discussion of these debates in Germany, Grahl and Teague (2004). For the opposition, see www.stopbolkestein.org Currently Article 136 of the Treaty Establishing the European Community: “The Community and the Member States, having in mind fundamental social rights such as those set out in the European Social Charter signed at Turin on 18 October 1961 and in the 1989 Community Charter of the Fundamental Social Rights of Workers, shall have as their objectives the promotion of employment, improved living and working conditions, so as to make possible their harmonisation while the improvement is being maintained, proper social protection, dialogue between management and labour, the development of human resources with a view to lasting high employment and the combating of exclusion.” See James (2003) Parts of this section draw on a joint report on the EES prepared in 2003 for the Euromemorandum group and available on http://www.epoc.uni-bremen.de/publications/pup2003/files/Brussels_Grahl_2003.PDF. The other authors were Frank Brouwer, Anne Dufresne, Mahmoud Messkoub, Ingo Schmidt and Andrew Watt. None of them is responsible for the views expressed here. On OMC, see, for example, Hodson and Mayer (2001). A necessary complement would have been the output gap, in the usual sense of an aggregate demand for goods and services below the productive potential of the economy. This last gap, however, was never mentioned. A year or two ago a colleague told me that she had had some difficulty finding a single official in the British Department for Work and Pensions who had any knowledge of the EES. See, for example, Serrano Pascual (2003a and 2003b). Of course it can be argued that a certain degree of ambiguity is a political necessity if any progress is to be made in European construction. The view taken here is that to apply the same term to interventions which reduce and those which expand the personal autonomy of disadvantaged groups such as the unemployed can only increase cynicism about European policies. An interesting topical example is the case of the “intermittent” workers in France, often in the performing arts, who have benefited until now from a relatively generous regime of unemployment indemnities. This might be seen as an “active” policy which extends the autonomy of the individuals concerned.

202 Alternative Perspectives on Economic Policies in the European Union 25. Although it can be noted that there is a certain drift in official rationale for disciplinary labour market interventions – away from the battle against inflation and towards the promotion of a low-wage service sector as a necessary aspect of global competitiveness. 26. For detailed critical analysis of the Economic Guidelines see the annual memoranda published by the Euromemorandum group (European Economists for an Alternative Policy) available on www.memo-europe.unibremen.de 27. Sometimes the results of these procedures are simply absurd. For example, the Employment Guidelines addressed to Sweden, after congratulating that country on its success in more than meeting all its EES targets, suggested that even more employment could be achieved with lower taxes. Anyone familiar with the Swedish labour market is aware that its very high employment levels are based on high taxation in order to support public service employment. See Raveaud (2004) who comments that “this calls the nature of the Commission’s recommendations into question. Are they really positive, aiming at improved efficiency or do they defend, of course without saying so explicitly, a certain theoretical (and normative) conception of how an ideal labour market should function, a conception which they maintain despite the empirical results obtained in this field by the Nordic countries, above all by Sweden.” 28. See Employment in Europe, 2002 edition, p. 57: “The ‘bonus’ provided by flexible forms of contractual arrangements is somewhat reduced when countries are ‘over-exploiting’ the possibilities of temporary contracts and use them as a substitute for permanent employment.” 29. For the link between “flexibility” and insecurity see Standing (1999). 30. The rationale for “flexibility” measures has shifted: in the 1980s, the main issue was inflation and “flexibility” was seen as necessary to reduce the NAIRU. Today this rationale persists but is less convincing in a low inflation environment. A new rationale, based on globalisation and competition from low-wage countries is today often advanced instead or as well. The recommended policies, however, have hardly changed.

Index active employment measures, 190–2 agricultural prices, volatility, 144–5 agricultural, rural development and fisheries interventions, 91 Amsterdam Treaty, 177 Anglo-Saxon terminology, 182 atypical contracts, 178–9 Austria, 51 ‘Averting the Old Age Crisis’, 51 Bank for International Settlements (BIS), 39 Basle 1 framework, 69 Basle 2 conception, 63–4, 69 Bayh-Dole Act, 1980, 140 boom, bust and stagnation, in EU financial integration, 46–50 the boom, 46–7 the crisis, 48 unstable recovery, 48–50 Brazil, 147–50 Cancun summit, 150 Capital Adequacy Directives (CAD), 57, 63 capital controls, 71 capital gains tax, 71 capital requirements, 69–70 ‘caveat venditor’ rule, 77 cohesion policy, reform of, and Member States perspectives, 106–24 eligibility criteria, 120–3 financial debate, 106–14 re-nationalisation debate, 114–20, see also separate entry Common Agricultural Policy (CAP) and research and innovation policy, 79, 87, 129–67, see also under European structural policies CAP’s re-nationalisation, 148 commission reforming, 148–9

continued regional policy in context of Eastern enlargement, 164–6 control of anti-competitive agreements and concentration supervision, 134–5 control of national aids, 135 in Eastern enlargement, 149 European trade policy, 137–44 foundations of, 144–5 from the treaty of Rome to the Single Market, 130–2 from the Treaty of Rome to the WTO, 137–9 guaranteed prices system with individual quotas, 162–4 negotiations within GATS, 143 problems raised by, 145–8 reform proposals, 148–50 reforms needed for, 144–50 rural development policy, 164 strategic trade policy and North–North relations, 139–40 trade policy towards Southern countries, 140–3 consumer country control, 78 consumer protection, 66–7, 76–9 corporate profits, taxation of, 73–4 corporate tax base,73 credibility, 9 credit credit controls, 23 and financial services channel, access to, 65–6 cross-border co-operation, 97 currency speculation, 71 Currency Transaction Tax (CTT), 71 current account and capital account, distinction, 17 Czech Republic, 108, 123 deflationary policy, 27 Dispute Settlement Body’s (DSB) framework, 138 203

204 Index DIW Berlin study, 117 DMark, 28 Doha Declaration, 141 Dutch government, 116 Eastern enlargement, continued regional policy in context of, 164–6 ECOFIN, 19–21, 26 Economic and Monetary Union (EMU), 6–7, 11, 19–20, 23, 26, 29–32 EMU model, 8–10 economic environment, long-term decline and financial turbulence, 39–50 economic policies, ECB stance on, 12–14 empirical analyses, 91 employee voice systems, 179–80 employment targets, 187–9 EU cohesion policy, 89–102 challenges for future, 94–5 convergence, 95–6 and EU constitution, 102–6 European Commission proposals for, 94–100 European territorial co-operation, 97–8 financing, European Commission proposals for, 100–2 and Member States perspectives, 106–24, see also separate entry new system of state aids, 99–100 for the period 2007–2013, 95–8, 103 policy strategy, 92–3 reform of delivery system, 98–9 reform of, and Member States perspectives, 106–24, see also separate entry regional competitiveness and employment, 96–7 regional disparities in, 90 strategy, 92–3 structural fund management, effectiveness, 93–4 third cohesion report, 95 EU Constitution and reform of cohesion policy, 102–6

EU financial integration, constraints and alternatives, 37–82 alternatives, taming European finance, 67–81 boom, bust and stagnation, 46–50, see also separate entry capital requirements, 69–70 corporate profits, taxation of, 73–4 economic efficiency, 73–5 economic environment, long-term decline and financial turbulence, 39–50 efficient economic development, 67 EU financial integration policy, 55–61 European economic development, pattern, 39 financial stability, 67–72 inclusion, 75–81, see also separate entry macroeconomic supervision and emergency plans, 68–9 National consolidation and tighter European co-operation in financial supervision, 72 shift in the driving forces of financial markets, 39–44 social inclusion, 67 structures, trends and policy, 50–67, see also separate entry tax policy, 73–4 weak growth, high unemployment, redistribution from bottom to top, 39–46 EU financial integration, structures, trends and policy, 50–67 actual state of, 54 adjusting to international standards of prudential regulation, 63–4 EU co-ordinating committees, 62 EU supervisory framework, 62–3 implications of policy for stability and inclusion, 61–7 National supervisory structures, 62 overall framework, 50–2 social inclusion, 65–7 stability, 62–5 synthetic view, 55

Index 205 EU labour market legislation, 175–87 active employment measures, 190–2 atypical contracts, 178–9 employee voice, 179–80 employment targets, 187–9 health and safety and working time, 175–7 important forms of flexibility, 180–1 Luxembourg process and EES, 186–9 retreat from employment regulation?, 184–5 social chapter, 177–8 social partnership and the European social model, 182–4 working life and the family, 181 EUREKA programme, 132 euro, exchange rates, 28–31 Euro–Mediterranean agreements, 147, 156, 163 European Central Bank (ECB), 1–2, 4, 7–13, 19–27, 29–30, 52, 63 democratising, 21–27 ECB’s economic activity level, assessment by, 25 on economic policies, 12–14 new consensus macroeconomics model, 10–12 objectives and mode of operation of, 23 European citizenship, 100 European Commission proposals, for cohesion policy, 88–102 European competition policy, pragmatic use, 156–8 anti-competitive agreements, control of, 156–7 more flexible interpretation of the rules on concentration, 157 national aids and Community interventions, improved links between, 157–8 preserving and reinforcing the public sector, 158–9 European constitution and macroeconomic policy, 1–33 neo-liberal agenda of, 5 European consumer protection, 78

European control of anti-competitive agreements, 134–5 European economy European economic development, pattern, 39 recovery of, 48 European Employment Strategy (EES), 170 content of, 189–90 form of, 188 and Luxembourg process, 186–9 overview, 195–6 review and reformulation of, 192–5 European financial sector, constellation for, 48 European financial supervision centralisation of, 72 institutional implementation of, 72 European Fund for Regional Development (EFRED), 131 European Grouping of Cross-Border Cooperation (EGCC), 97 European industrial policy, progressive elaboration, 154–156 European Investment Bank (EIB), 31–32, 59 European Investment Fund (EIF), 59 European policies on economic and social cohesion, impact, 90 European Reconstruction Development Bank (ERDB), 165 European Regional Development Fund (ERDF), 96 European regional policy, reform of, see EU cohesion policy European Securities Committee (ESC), 72 European Social Model (ESM), 67, 170 European structural policies, proposals for alternatives, 152–67 assessment and alternative proposals on, 129–67, see also under Common Agricultural Policy community procedures aimed at encouraging research, rationalisation, 153–4

206 Index European structural policies, proposals for alternatives – continued competition policy, pre-eminence, 134–7 comprehensive innovation and industrial policy, 153–9 dynamic research and innovation policy, 153–4 European competition policy, pragmatic use, 156–8, see also separate entry innovation and industrial policies, 132–4 new means implementation, 154 policy of standards and patent, 156 promotion of cooperation and the renewal of sectoral interventions, 155–6 public services to competition, opening, 136–7 regional policies and planned reduction, 150–2 regulatory instruments, implementation, 155 trade policy, new design for, 159–62, see also separate entry European System of Central Banks (ESCB), 38 European territorial co-operation, 97–8 European trade policy, 137–144 European Union (EU), 1–2, 4–7, 12–15, 18–19, 25–6, 30–31, 52–5, see also individual entries current state of financial integration in, 52–5 Eastern enlargement of, 152 EU cohesion policy, reform of, 88–102, see also separate entry EU labour market legislation, 175–87, see also separate entry financial integration, 37–82, see also separate entry financial integration, structures, trends and policy, 50–67, see also separate entry labour market policies in, 169–98, see also under labour market policies regional agreements, 142 regional policy, 86–124, see also under EU cohesion policy

Farm Act, 1996, 149 financial bubble burst and economy, 48 financial crisis of 2000 to 2002, 48 financial institutions, privatisation, 51 Financial Services Action Plan (FSAP), 57–8 Financial services policy 2005–2010, 60–61 financial speculation, specific measures against, 70–71 Finland, 108 FIN-NET network, 66 FIN-USE, 66 fiscal policies, co-ordination, 14–17 considerations in, 18 defects, 22–3 mechanisms for, 15 reasons for supporting, 15 France, 51 full employment, achieving, 30–32 ‘functional finance’ approach, 17 General Agreement on Trade in Services (GATS), 79, 143 negotiations, constraints on, 79 renegotiating, 161–2 Geneva Agreement, 2003, 141 Geneva deal, 150 Germany, 51, 72, 152 Great Britain, 72 Greece, 51, 152 ‘Green Paper on Financial Services Policy’, 61 group-specific risk weights,70 Guaranteed prices systems, 162–4 ‘harmonisation’, concept, 50 IBO working group, 115 inclusion, 75–81 consumer protection, 76–9 universal access to basic financial services, 75–6 ‘industrial competitiveness policy’, 133, 153 inflation in fiscal policy, 22 inflation targeting, 9, 27

Index 207 Innovation and use of Communication Technologies(ICT), 88 interest rates changes in fiscal policy, 22 Investment Services Directive (ISD), 57 Ireland, 108 Italy, 51, 108, 152 labour market ‘reforms’, 13 labour market policies in European Union, 169–98 EU labour market legislation, 175–87 EU labour market policies, 174–5 imbalance, 173–4 Single Act, 172 social policy, 172–3 Lamfalussy process, 59–60 Lisbon Agenda, 88, 100 Lisbon and Gothenburg strategies, 95 Lisbon strategy, 51–2 Lithuania, 123 Luxembourg compromise, 171–2 Luxembourg process and EES, 186–9 Maastricht Treaty, 45, 177–8, 182 macroeconomic dialogue, 196–7 macroeconomic policy and EMU, 8 and European constitution, 1–33, see also under European constitution objectives, 5–6 macroeconomic supervision and emergency plans, 68–9 ‘market-creating’ integration, 77 Marrakech agreements, 138, 140 Member States, 122 perspectives, and cohesion policy, 106–24 monetary policy, 8, 22–3, 26 effectiveness, 27 reservations, 26 transmission mechanism of, 26 Multilateral Investment Agreement (MIA), 141 ‘mutual recognition’, principle, 50 National consolidation and tighter European co-operation in financial supervision, 72

neo-liberal agenda, of the European Constitution, 5–14 New Consensus Macroeconomics (NCM), 7–8, 10–12 three relationships in, 11 New Member States (NMS), 53–4, 122–3 banking sector of, 54 non-accelerating inflation rate of unemployment (NAIRU), 8, 10, 191, 195 non-accelerating wage rate of unemployment (NAWRU), 30 ‘Nordic’ approach, 192 ‘one programme one fund’ principle, 99 Open Method of Co-ordination (OMC), 51 Organization for Economic Cooperation and Development (OECD), 13–14, 30, 45, 52 Portugal, 51, 152 public banks, 75 quasi-privatisation of supervision, 64–5 RD Framework Programme (RDFP), 132–3 regional unemployment levels, 31 re-nationalisation debate, 114–20 retail services, standardisation, 78 Risk Capital Action Plan (RCAP), 57 1999–2003, 59 equity financing model adopted by, 59 risk weights, 70 Say’s Law, 10 Seattle Conference, 1999, 142 Second Banking Directive of 1989, 57 Second Cohesion Report, 106 second flexible rate, 71 securities transaction tax, 70 self-regulation, 77 ‘Singapore issues’, 141, 160 Single Act, 1986, 131, 172

208 Index single currency and a federal Europe, 14–21 Single European Act, 57, 171 Single Market, 131–40 Single Market programme of 1985, 50 Slovak Republic, 123 ‘social deficit’, 171–4 social partnership and the European social model, 182–4 ‘sound finance’, 5 Spain, 152 Stability and Growth Pact (SGP), 2–4, 7, 15–21, 26 criticisms of, 15 of 1997, 45 statistical effect and transition arrangements, 122 strategic trade policy and North–North relations, 139–40 structural and agricultural policies moderate reform of, 116 substantial reform of, 116 structural fund management, effectiveness, 93–4

Trade Act, 1988, 137 trade policy another conception of the WTO, 159–60 new design for, 159–62 towards Southern countries, 140–3 unstable recovery, 48–50 Vredeling proposals, 180 weak growth, high unemployment, redistribution from bottom to top, 39–46 workers protection, 79–81 remedies against harmful consequences for, 80 working life and the family, 181 World Trade Organisation (WTO), 159–160 democratisation of, 159 functioning of, 159 new orientations for, 160–1