Continuing a Deutsche Bank Research series on Eurozone competitiveness, it is argued that the focus should not be solely on prices and costs, but also on the value-added structure of the respective economies, their innovative capacity and degree of economic freedom. This non-price competitiveness is partly a result of historical developments and partly a result of good economic policy. Proper infrastructure, reliable institutions and efficient markets can create a sensible environment that is conducive to business success. The Eurozone economies also differ from one another in this regard - - and in some cases appreciably.
Economist Nicolaus Heinen says first of all, differences are to be found in value-added structures. In Germany, Austria, Slovakia, Finland and even Ireland, manufacturing, mining and energy generate a very large share of value-added (over 30%). Industry in these countries is competitive because international competition compels companies to offer high-quality production, structural flexibility and reliable delivery.
For countries featuring a strongly developed services sector, knowledge-intensive services are the key to greater competitiveness: such services increase the innovation potential of an economy, boosting its productivity in the long run. In the Eurozone, the shares of knowledge-intensive services vary: while Belgium, the Netherlands and France show employment in knowledge-intensive services at over 38%, Eurostat says Portugal and Greece have readings of less than 25%.
A further key to success is the innovative capacity of an economy and its business sector. A good indicator in this context is the level of public and private expenditure on research and development (R&D). Here, too, there are major differences between the EMU (European Monetary Union) members. Luxembourg, Germany and Austria are in the vanguard. These countries invest more than €700 per capita in research and development every year. Portugal, Greece and Slovakia bring up the rear with R&D spending of less than €120 per head.
Heinen says in order for value-added structures and innovative capacity to be able to develop their growth potential it is vital that a regulatory framework guarantees economic flexibility. With its uniform business legislation the single European market has already achieved this high degree of economic freedom. The national values of the Fraser Index of Economic Freedom (which measures the overall degree of freedom of individual countries on a scale of 0 to 10) vary for the EMU countries by 10% at most from their average value of 7.4.
As regards the flexibility of their labour markets, the EMU countries rank around the international average. On a scale of 0 to 6, the OECD’s Indicator of Employment Protection rates the flexible labour markets of Ireland, the Netherlands, Slovakia and Finland with scores of below 2.3. At the same time, the markets of Spain, Greece, France and Portugal still exhibit colossal catch-up potential with readings of over 2.9.
Besides the foregoing there are also other qualitative factors, such as institutional quality, infrastructure, macroeconomic stability and the efficiency of goods and financial markets. The Competitiveness Index of the World Economic Forum reflects these factors as a composite indicator. The chart shows Finland, Germany and the Netherlands at the head of the class. Portugal, Slovakia, Italy and Greece trail the field.
This plethora of parameters highlights that non-price competitiveness provides greater latitude for businesses and economic policy than price competitiveness. Nonetheless, the related implications for the EU are no less relevant.
Where can the politicians come in? Inconsistent targets and a lack of national commitment to reforms made the Lisbon Agenda, at best, only a partial success at the EU level. True, the Open Method of Coordination achieved a certain amount of success in raising labour participation rates. In other policy fields, however, this soft form of coordination failed to really get off the ground.
With the post-Lisbon strategy, Europe 2020, horizontal voting between member countries is meant to be supplemented by vertical elements.
- Already today, the Treaty of Lisbon enables the Commission to issue economic policy recommendations directly to individual member states (without having to go via the Council) and facilitates closer policy coordination among the EMU countries.
- Moreover, the recent proceedings of the Commission and the Council against Greece show that the Broad Economic Policy Guidelines and annual stability programmes, hitherto criticised for being non-binding, can be effectively linked with the sanctions horizon of the excessive deficit procedure.
- Furthermore, the smoke and mirrors tactics of several member countries have sensitised their peers in the Council of Ministers. Deviating from a common growth strategy is likely in future to be sanctioned politically, with individual countries being rapidly isolated. Intergovernmental pressure will be stepped up.
These options will be supplemented by the reactions of the capital markets. They will increasingly shift their attention away from government deficits per se towards their causes, and going forward they will even intensify their punishment of countries lacking a willingness to implement reforms. Structural reforms which raise competitiveness will become key signals for the capital markets. For many countries, the party is over.
Sustainability Gaps
In a separate commentary, Deutsche Bank economist, Jan-Philipp Heinemann, says the European Commission calculates scenarios on the long-term sustainability of public finances of the EU member states at regular intervals. For this purpose, it compares debt ratios and interest expenditures of member states to trend growth.
The chart plots the sustainabilty gap (% of GDP). This is the sum of two variables: first, the adjustment in fiscal policy required to achieve a budget balance on whose basis current debt levels (2009) can be kept stable in the long term. Second, the change in annual ageing-related expenditure to be borne by the state in the long-term care, health, education and social sectors.
A glance at the three large EU countries France, Germany and Italy and a comparison between the years 2006 and 2009 show the following:
Due to the rise in government debt in France between 2006 and 2009, the consolidation requirement of the current budget for a sustained debt stabilisation is now at 3.9% of GDP. The projected effects of age-related costs vs the comparison report have fallen to 1.9% of GDP. The reforms of the social-security system are obviously producing results. In particular, the projected increase in costs of old-age provision has weakened substantially.
In Germany, above all the sound fiscal policies of the years 2007 and 2008 led to a decline in the sustainability gap with regard to government debt to 1.1% from 1.6%. At the same time, the expected ageing-related cost increase accelerated, in particular in health expenditure and long-term care. Irrespective of the downward trend, old-age provisioning remains the strongest cost-pushing factor. The projected sustainability gap with regard to ageing-related expenditure rose to 2.9% of GDP from 2.8%.
Italymanaged to reduce its sustainability gap to 2.0% of GDP from 3.1%. This was due mainly to an improvement in the budget deficit. The main factor behind consolidation requirements is the impact of ageing-related expenditure which rose slightly to 2% of GDP. This is due to an increase in the projected cost development of long-term care, which, together with health expenditure, now drives ageing-related expenditure. In addition, the expected pension payments (% of GDP) continue to be very high. The forecasts for Italy already anticipate the full implementation of reforms which have been passed so far.
The analysis of the three euro area countries illustrates three aspects:
- A lack of political reform efforts automatically leads to a steady increase in tomorrow’s reform requirements
- Appropriate reforms can rapidly garner positive results with regard to a sustainable fiscal policy.
- The implicit challenge for government budgets from the ageing of society has so far not been taken seriously enough.
Heinemann says the chart depicting the sustainability gap shows the high importance of taking a long-term view of government budgets under consideration of population dynamics. However, the question of the long-term financing of government debt and the stabilisation of the debt ratio does not take the real level of the debt ratio of the individual member states and the urgency of its reduction into consideration: for Italy, the Commission projects a debt ratio of 116% of GDP for 2010, for France 82.5% and for Germany 76.7%. Not only do these debt levels exceed the 60% threshold fixed by the Treaty of Maastricht but they will continue to rise strongly. A debt reduction is advisable, for a high debt level - - thus high financing costs - - may severely curtail a country’s scope for action after interest-rate shocks or growth slumps.
Only in connection with total debt does the sustainability gap offer a sensible overview of the budget situation and provide valuable information on the need for action on the part of individual member states.
