EUROPEAN COMMISSION

Brussels, 23.11.2011

COM(2011) 815 final

VOL. 1/5

COMMUNICATION FROM THE COMMISSION

Annual Growth Survey 2012

Introduction

The Autumn forecasts for 2011-2013 published by the Commission on 10 November 2011 show that economic recovery has come to a standstill and that low levels of confidence are adversely affecting investment and consumption. This lack of confidence is due to the negative feedback between the sovereign debt crisis and the situation in the financial sector together with a slowdown in the global economy. The impact has been particularly acute in the Euro area. As a result, GDP is likely to stagnate in the coming year and overall growth in the EU is forecast to be as low as 0.6% for 2012. Unemployment levels are likely to remain high at around 10% in 2012 and into 2013, exacerbating the social impact of the crisis.

Without a convincing response to the crisis in the Euro area the economic outlook for the whole of the EU will deteriorate rapidly. The growth prospects of all Member States, whether they are currently in the Euro area or not, depend on dealing decisively with the sovereign debt crisis and demonstrating that the Euro is a stable and strong currency whose members are determined and capable of implementing sound economic policies. Given the risk aversion in financial markets, these issues are not yet settled. This prolonged period of uncertainty needs to come to an end. As the decisions of the European Council and the Euro area Summits have repeatedly shown, and most recently on 26/27 October 2011, EU leaders are prepared to do whatever it takes to resolve the current crisis – even to the point of considering the need for further Treaty change. While understandable and necessary, too much political time and energy is being spent on emergency measures and not enough time is being devoted to implementing the policy changes that will bring our economies back to higher growth levels.

The upcoming European semester will be the first to be implemented as part of the recently strengthened economic governance of the Euro area and the wider EU. 2 The "six pack" of legislation will significantly strengthen the Stability and Growth Pact and extend fiscal surveillance. For the first time there will be a procedure for monitoring and correcting macroeconomic imbalances: the Excessive Imbalance Procedure. The Commission has just tabled new proposals 3 designed to strengthen further the surveillance of Euro area Member State budgetary policies, in particular for those Euro area Member States with serious difficulties with regard to financial stability or subject to an excessive deficit procedure. The new governance framework will deliver stronger integration and discipline.

This year's Annual Growth Survey puts a strong emphasis on the need for implementation. Now that agreement has been reached on a new way of doing economic governance, further recognising the interdependence between Member State economies, the top priority must be to implement what has already been agreed with a clear emphasis on growth enhancing actions. The sequence and coherence of action – also across the EU – is crucial to success as is the capacity to exert leadership in the conduct of change and to demonstrate the fairness of what is being done.

In spite of the urgency of the situation, progress by Member States in implementing the guidance of the 2011 Annual Growth Survey is below expectations. There is not yet full ownership, at national level, of the radical changes which have been decided in terms of future economic governance. There is sometimes a disconnection between what is decided at EU level and the length of time it takes to come through in national policy decisions. To remedy this, a sense of urgency needs to accompany the next European semester, with rapid and demonstrable follow through by Member States of EU level guidance. An implementation gap also exists at EU level, where decisions already agreed are not fully or well implemented by Member States, even in areas of core importance like the Internal Market, and where proposals with an important growth impact are still awaiting co-decision, or where funds available to Member States under the EU structural funds are not used.

The focus needs to be simultaneously on reform measures having a short term growth effect, and on the right growth model in the medium-term. Financial markets are assessing the sustainability of Member States' government debt on the basis of long-term growth prospects, on their ability to take far reaching decisions on structural reform and their commitment to improve competitiveness.

For 2012, the Commission considers that efforts at national and EU level should concentrate on the following five priorities:

1.Pursuing differentiated growth-friendly fiscal consolidation

Determined fiscal consolidation is a means to an end: it is essential to restoring macro-financial stability as a basis for growth and to securing the future of the European social model. Government debt levels have increased markedly – by 20 percentage points on average over 2007-2010 as a result of the crisis – and are expected to reach 85% of GDP in the EU and 90% in the Euro area by 2012.

In line with the agreed EU approach, significant steps have been taken to consolidate public finances, and, based on unchanged policies, public deficits are set to decline to just above 3% of GDP on average in the EU in 2013. The pace of consolidation is thus globally commensurate with the efforts required, provided commitments are followed through.

Member States are not all in the same situation so differentiated strategies should be pursued within the common framework, taking account of country-specific fiscal and macro-financial risks. In particular:

Member States benefitting from financial assistance programmes and those under close market scrutiny should continue to meet agreed budgetary targets in spite of possibly changing macro-economic conditions.

Member States with a significant adjustment gap under excessive deficit procedure, or a high deficit should step up their consolidation efforts. Possible limited downwards revisions of the main macro-economic scenario should not result in delays in the correction of excessive deficits.

In Member States which do not have an excessive deficit, and that are on an appropriate adjustment path towards their medium-term objectives, budgetary policy can play its counter-cyclical and stabilising role, as long as medium-term fiscal sustainability is not put at risk.

While there is good progress on the overall objective of fiscal consolidation, the distributional impact of the reforms requires closer monitoring to avoid the risk of neglecting certain growth items and of compounding existing social difficulties.

On the expenditure side, Member States should keep public expenditure growth below the rate of medium-term trend GDP growth. The Commission considers that Member States should give particular attention to the following:

Prioritising growth-friendly expenditure, such as education, research, innovation and energy which are an investment in future growth, and ensuring the efficiency of such spending. First evidence shows very different patterns across Member States. Particular attention should also be paid to maintaining or reinforcing the coverage and effectiveness of employment services and active labour market policies such as training schemes for unemployed persons.

Pursuing the reform and modernisation of pension systems, respecting national traditions of social dialogue to ensure the financial sustainability and adequacy of pensions, by aligning the retirement age with increasing life expectancy, restricting access to early retirement schemes, supporting longer working lives, equalising the pensionable age between men and women and supporting the development of complementary private savings to enhance retirement incomes. This modernisation should be coupled with a reform of health systems aiming at cost-efficiency and sustainability.

To take better account of the need to integrate tax policy this year's Annual Growth Survey contains a new annex on growth-friendly tax policies in Member States and better tax coordination in the EU 4 which is also of particular relevance to the Euro Plus Pact. In order to improve the contribution of the revenue side to fiscal consolidation, more attention is needed in the design and structure of the tax systems to make them more effective, efficient and fairer, while also taking into account that Member States may need to increase taxes. Tax reforms are already taking place in many Member States. They should take account of the following: 

There is scope for broadening the tax base of certain taxes and thus increasing revenue or reducing distortively high tax rates. For instance, deductions and exemptions from the standard tax base often create economic distortions and lower the efficiency of the tax system. This is particularly the case for VAT exemptions and reduced rates but it is also relevant for corporate and personal income tax. Phasing out some hidden tax subsidies could help to widen the tax base. In particular, environmentally harmful subsidies should be eliminated.

Greater efforts should be made to shift taxation away from labour towards taxation which is less detrimental to growth: for example, increasing consumption, environmental, wealth (for example, high value property) taxation can help to alleviate the tax burden on labour thus making hiring more attractive. Particular attention should be paid to the needs of the most vulnerable groups in any tax shifts.

In several Member States, improving the efficiency of tax collection and tackling tax evasion can increase government revenue. A more effective application of tax rules in all areas of taxation will help in this respect. Measures to encourage moves from informal or undeclared work to regular employment should be reinforced.

New sources of national revenues such as the auctioning of CO2 emission allowances and spectrum auctioning will start to become available and could be used to support expenditure in growth-friendly areas 5 including green growth, given the commitment to devote a substantial share of these new resources to combating climate change.

In order to maximise the impact of their tax reforms, Member States should co-ordinate their efforts through enhanced dialogue at EU level. Progress should be made on the proposals announced by the Commission in its last Annual Growth Survey – for a common consolidated corporate tax base, for a financial transaction tax and for energy taxation – which are now on the table of the European legislator.

2.Restoring normal lending to the economy

A healthy financial system and, in particular, a robust banking sector support growth. The bank excesses leading up to the crisis have resulted in a widespread fragility in the sector and now risk acting as a brake on economic recovery. Restoring investor confidence will require a strengthening of banks capital positions and measures to support banks access to funding, and will help to sever the link between the sovereign crisis and the financial sector.

A major overhaul of regulation and supervision of the financial sector is underway and many of the new decisions are already being implemented. The objective is to address the weakness in the current regulatory and supervisory framework and enable more normal lending patterns to business and to private households, without the excessive risk taking of the pre-crisis period.

In a short-term perspective, the Commission considers that priority should be given to:

Strengthening of the capital positions of systemic banks where required in order to reflect heightened risks in the sovereign debt markets. Measures in this regard will be based on the proposal of the European Banking Authority. It will be critical to ensure that banks strengthen their capital ratios primarily by increasing their capital positions, and not by unduly restricting lending to the real economy. In addition, banks should respect agreed rules on bonuses and pay.

Facilitating bank access to term funding by implementing temporary measures (e.g. public guarantees) so as to limit the impact of banking sector reform on the flow of credit to the real economy, avoiding the risk of further tightening credit conditions. Both capitalisation (in cases where this can only be achieved through public resources) and the provision of public guarantees should be done in a way that is fully consistent with state aid rules.

Creating a specific regime adapted for SME growth markets allowing them to be more visible to investors and subjecting SMEs to proportionate listing requirements. Prudential rules should also be reviewed to ensure that they do not unduly penalise lending to SMEs.

Working with the European Investment Bank to maintain and increase its SME loan activity at a sustained pace, while developing synergies with the European Investment Fund through risk-sharing operations, and the establishment of a fund-of-funds 6 to provide capital to funds that targets investments in more than one Member State.

Developing a new European venture capital regime that will enable EU venture capital funds to market their funds and raise capital on a pan-European basis across the Single Market. Passporting rights will be granted on the basis of a single registration in the home Member State, and conditioned on the respect of simplified reporting obligations and adapted organisation and conduct of business rules.

Completing the implementation of a new regulatory framework for EU financial markets in accordance with G20 commitments and strengthening the new EU-level arrangements for financial supervision.

3.Promoting growth and competitiveness for today and tomorrow

Fiscal consolidation and financial repair are needed but are not sufficient in themselves to deliver growth. Given the need for fiscal consolidation, structural reforms must play a key role in enhancing the overall efficiency and adjustment capacity of the EU economy. While the growth enhancing effects of structural reforms deliver their results gradually over time, creating a perspective of improved growth can have a positive short term effect on growth by improving confidence and help all Member States, in particular those under market pressure.

Most of the growth levers are in the hands of the Member States, as highlighted in the recommendations made under the European semester. For instance, national reforms in the areas of services, network industries and the public sector should be accelerated to increase the EU's growth potential. An emphasis on resource efficiency, for example in areas such as energy efficiency and reducing waste, can improve competitiveness, create new jobs and help our environment. Reforms which improve the business environment and competitiveness should also be a priority.

Long before the current crisis overall EU performance has been weaker than key competitors. In spite of some progress in terms of employment, the EU has been lagging behind notably in terms of productivity, and this productivity gap is widening. There are many factors to explain such a gap. But there are two specific obstacles for the EU in comparison to a number of other major competitors: first, the Europe-wide market is still too fragmented and does not allow firms to grow and enjoy the same economies of scale; second, several framework conditions – from access to finance to innovation capacities or regulatory obstacles – are less conducive for firms to create and invest.

Without the necessary structural reforms, medium term projections point to the EU remaining stuck in slow growth. Specific priority areas for reform in each Member State have been identified in the EU country-specific recommendations. The EU level can support and complement national actions, for example, through the Single Market Act proposed by the Commission and endorsed by the European Parliament and the European Council. A number of growth levers could deliver rapid results during 2012, if pursued both individually by each Member State and as part of EU wide action.

Three examples of growth potential

The EU digital single market can be built by:

–Developing an EU market for secure mobile and on-line payment systems, while improving data protection rules and promoting the use of public sector information.

–Making more radio spectrum available, in particular to the fast-growing mobile data market. At the same time, investments need to be encouraged in high-speed broadband connections.

–Reducing the costs and improving the quality of delivery of goods and services bought online including through delivering a sufficient level of consumer protection.

–Eliminating sales restrictions based on nationality or residence. The Commission will contribute to this by issuing guidelines on the implementation of Article 20 of the Service Directive.

–Developing on-line dispute resolution systems to provide fast and reliable arbitration to consumers and businesses in case of dispute.

–Using the power of ICT to deliver smart energy and transport systems linking all corners of the EU. Smart electricity grids, high levels of energy efficiency and widespread use of renewable energy made possible through sophisticated use of ICTs and world-class logistics servicing the Internal Market are essential components of a modern, competitive economy and crucial for EU development in the coming years.

A real internal market for services

–In many Member States, awareness of economic operators about the possibilities offered by the Services Directive is limited. The "points of single contact", which help businesses to obtain relevant information and complete formalities, do not yet exist in some. The Commission is taking measures to ensure enforcement by those Member States which have not yet transposed the Directive. Sectoral performance tests will be conducted, and follow-up measures will be adopted by the end of 2012 to ensure full implementation.

–Enhancing competition and competitiveness in the retail sector, reducing barriers for the entry and exit of firms, and eliminating unjustified restrictions for business and professional services, legal professions, accounting or technical advice, health and social sectors.

–Removing technical, administrative and societal barriers to innovative technologies and production processes, including in the take up of key enabling technologies.

The external growth dimension:

–Tapping into the potential of external trade: 90% of global growth in the coming years will come from outside the EU. A lot can be done to help EU firms, in particular SMEs 7 , tap into this growth. Already during the crisis, trade helped cushion the shock: one quarter of EU growth in 2010 came through trade with non-EU partners. Recently concluded trade agreements with Neighbourhood countries, and the recent free-trade agreement with South Korea offer many potential benefits that can come from exploiting the new opportunities it offers, and these should be adequately publicised to businesses.

Mobilising the EU budget for growth and competitiveness

In current circumstances of fiscal restraint the room for a fiscal stimulus is severely limited. However, it is possible to use existing resources to produce a stronger impact on growth and competitiveness. For the period 2007-2013, a budget of € 347 billion is available for investments in the Member States under cohesion policy. In some, EU funds can represent as much as 4% of GDP. After a slow start, both commitments and payments are now picking up – but unevenly across the EU. Using the potential of the EU structural Funds can and must be part of a new growth focus:

–There is still considerable room for using or re-programming available funds to boost growth and competitiveness and to implement the country specific recommendations of the first European semester. There are many examples of successful schemes – for instance schemes to support apprenticeships for young people with the help of the European Social Fund or energy efficiency investment programmes for households and firms – which have an immediate impact. Such programmes are a very effective and smart way to create local jobs, especially now the construction sector is struggling.

–For Member States receiving financial assistance programmes, the Commission has proposed to increase the co-financing rates in order to make sure that necessary investments take place now despite severely constrained national budgets. The Commission urges the European Parliament and the Council to adopt these proposals by the end of 2011.

–To help build the necessary infrastructure in terms of transport, energy and ICT, the Commission has also proposed the use of project bonds to stimulate private financing of key infrastructure projects which can generate income flows. A pilot phase of project bonds has been tabled to make a link between the current and future budgets of the EU and to bring forward in time the financing of some of these key projects.

A targeted programme to fast track growth

To support these efforts, the Commission has identified a series of EU-level decisions which, if taken quickly, could give an immediate boost to growth 8 . These involve:

Getting more out of what has already been agreed at EU level.

Accelerating adoption of what is pending before the European Parliament and the Council.

Fast tracking certain future proposals that the Commission will make in the coming months.

Details are set out in the attached annex and the Commission looks forward to discussing a fast tracked growth package with the European Parliament and the Council in the near future.

4.Tackling unemployment and the social consequences of the crisis

The social impact of the crisis is far-reaching. While the EU was able to create millions of jobs and increase the number of people in work since the mid-1990s, progress has stopped since 2008. Unemployment has increased significantly as a result, with 23 million people unemployed in the EU today.

The crisis is precipitating major shifts across the economy, with business undergoing fast restructuring, many persons moving in and out of employment and working conditions being adjusted to changing environments. With job prospects deteriorating, a significant share of the population may not manage such transitions. The share of long-term unemployed has increased, with risks of falling permanently outside the labour force. The implementation of balanced flexicurity policies can help workers to move across jobs and labour market situations. At the same time, the effect of demographic ageing is now accelerating the withdrawal of experienced workers from the labour market and the prospect of a stagnating/diminishing working age population is imminent in several Member States.

The scope and pace of these changes create the risk of a structural mismatch between the supply and demand for labour which will hinder recovery and long-term growth. While unemployment has been reaching high levels, the number of unfilled vacancies has also been increasing since mid-2009. This situation results from inadequate wage conditions, lack of adequate skills or limited geographic mobility.

Already before the crisis, performance of Member States in terms of participation of all age groups in employment, as well as in terms of education, training and lifelong learning, varied widely and the overall EU average was falling behind in international comparison.

Mobilising labour for growth:

To create jobs and ensure a job-rich recovery, the Commission considers that Member States should give particular priority to the following:

Moving forward with the agreed recommendations on revising wage-setting mechanisms, in conformity with national social dialogue practices, to better reflect productivity developments, and adapting unemployment benefits further, combined with more effective activation and appropriate training and support schemes, to facilitate the return to work.

Enhancing labour mobility by removing remaining legal obstacles, by facilitating the recognition of professional qualifications and experience, by strengthening cooperation between public employment services, and by reviewing the functioning of housing markets and the provision of transport infrastructure.

Restricting access to early retirement schemes and other early exit pathways while supporting longer working lives by providing better access to life-long learning, adapting work places to a more diverse workforce, and developing employment opportunities for older workers, including through incentives.

Promoting business creation and self-employment, including social entrepreneurship, by improving the quality of support systems, and promoting entrepreneurial skills.

Developing initiatives that facilitate the development of sectors with the highest employment potential, including in the low-carbon, resource-efficient economy ("green jobs"), health and social sectors ("white jobs") and in the digital economy.

Supporting employment especially of young people:

A particular focus is needed on young people. Between 2008 and 2010, the total number of young (under 25) unemployed in the EU increased by one million – making it one of the groups that have been worst affected by the crisis. EU-wide unemployment rate has increased to over 20%, with peaks of more than 40% in some Member States. This group also faces other structural challenges, hindering their integration into the labour market. For instance, 40% of young employed persons work on temporary contracts. Moreover, one out of seven (14.4%) currently leaves the education system with no more than lower secondary education and participates in no further education and training.

In these circumstances, the Commission considers that Member States should give priority to:

Identifying the most urgent needs and proposing concrete actions, targeting in particular young people who are not in employment, education or training, as well as commitments to promote quality apprenticeships and traineeship contracts and entrepreneurial skills. Particular attention should be paid to a vocational training dimension in tertiary education systems and getting work experience.

Engaging with social partners to implement commitments to promote quality apprenticeships and traineeship contracts, especially in sectors with bottlenecks in filling vacancies, so that young people gain real work experience and quickly enter the job market.

Reforming employment protection legislation in consultation with social partners, reducing the excessive rigidities of permanent contracts and providing protection and easier access to the labour market to those left outside, in particular young people.

Further adapting education and training systems to reflect labour market conditions and skills demand, while reinforcing their efficiency and quality, and focusing on sectors and occupations that experience the most pronounced skills or labour shortages – for instance, the number of IT graduates has not increased since 2008 and if this persists, the EU may lack 700 000 IT professionals by 2015.

Reviewing the quality and funding of the universities and considering measures such as the introduction of tuition fees for tertiary education, accompanied by student loan and scholarship schemes, or alternative sources of funding, including the use of public funds to leverage private investment.

Protecting the vulnerable:

In addition to economic realities, the social tissue of the EU is being put to the test. The crisis has disproportionately hit those who were already vulnerable and has created new categories of people at risk of poverty. There are also clear signs of increases in the number of people at risk of income poverty, notably child poverty, and social exclusion, with acute health problems and homelessness in the most extreme cases. People with no or limited links to the labour market – such as pensioners or vulnerable people dependent on social benefits, for instance single parents – are also exposed to changes affecting the calculation and eligibility of their source of income.

The Commission considers that Member States should give priority to:

Further improving the effectiveness of social protection systems and making sure that social automatic stabilisers can play their role as appropriate, avoiding precipitate withdrawals of past extensions of coverage and eligibility until jobs growth substantially resume.

The implementation of active inclusion strategies encompassing labour market activation measures, and adequate and affordable social services to prevent marginalisation of vulnerable groups.

Ensuring access to services supporting integration in the labour market and in society, including by ensuring access to a basic payment account, electricity supply to vulnerable customers and access to affordable housing.

5.    Modernising public administration

The quality of public administration at EU, national, regional and local level is a determining element of competitiveness, and an important productivity factor. The on-going pressure on public finances is driving major changes and restructuring of the public sector. What is a challenge must be turned into an opportunity. Although public sector reform cannot be achieved overnight there is a need to give it a new impetus under current circumstances.

The interdependence and complexity of administering the EU's multilevel governance structures has shown, particularly under the pressure of the crisis, that there is room for improvement. Member States need well-performing administrations to be able to play their full role in the EU, to meet their obligations and to ensure that their citizens can benefit fully from the advantages of EU membership. The successful implementation of EU policies in important areas from customs control to the quality of statistics relies on the capacity of each Member State to deliver agreed results. The persistent implementation gap in the application of EU legislation, or in the use of structural funds, is in many cases the result of a poor administrative capacity.

In many Member States, there is scope for increasing the efficiency in the delivery of public services as well as the transparency and quality of public administration and the judiciary. In particular, there is a need to enhance the performance of the civil justice system so that claims can be settled in a reasonable time frame – undue delay is costly for businesses and often means they are unable to take advantage of new business opportunities. In this context the Commission has indicated its intention to propose to improve the effectiveness of cross border insolvency rules. Another area where different policy objectives need to be reconciled is the issuance of planning permits – here the Commission has recently proposed a new Regulation on Guidelines for Trans-European Energy Infrastructure 9 . These are just a few examples – it is clear that addressing these and other existing problems would allow reconciling the aims of fiscal consolidation and improving competitiveness and growth prospects.

The Commission has been promoting a smart regulation agenda, designed to ensure that the EU has high quality regulation where it needs it, and only takes action where the EU level delivers better results than at national level in full respect of the subsidiarity principle. An integral part of this agenda is the drive to simplify existing EU legislation and to keep it under constant review so that it is always up to date and fit for purpose. Equally important is the Commission's programme to reduce administrative burden and red tape – the Commission has already surpassed the 25% reduction target by delivering proposals to reduce administrative burden by 31% if the co legislator adopts its proposals. The Commission has just proposed 10 a new regime for micro and small enterprises, basically exempting them from new EU regulations unless a convincing case can be made for including them. Even where SMEs are covered by new regulation the possibility of lighter regimes will be explored. The constant improvement in consultation of stakeholders, evidence-based impact assessments and a focus on implementation on the ground of EU legislation will continue to be central to the Commission's agenda.

The Commission considers that Member States should give priority to:

Improving their business environments by minimising administrative burdens, including by avoiding "gold plating" when transposing EU legislation and by reducing unnecessary regulations and permits, and introducing simpler and quicker procedures, in particular in their judicial systems. In its proposal on exempting micro enterprises from new regulations, the Commission has announced it will keep a scoreboard of its proposals to reduce administrative burden as they go through co-decision and national transposition so that it can highlight cases where the legislator adds burdens during the process.

Ensuring that exchanges between administrations and enterprises as well as citizens can be done digitally, in order to increase administrative efficiency, transparency and the quality of service. Online public services can be particularly beneficial for SMEs and should be adapted to their needs.

Facilitating the creation of new businesses by implementing the commitment in the Small Business Act to reduce the time for starting up of a company to 3 days. The twenty five Member States that have not already done so should make the changes needed to meet this target by the end of 2012.

Where absorption rates of EU structural funds is low, building administrative capacity, including the necessary expertise and continuity of management, to ensure speedier disbursement of unused funds on growth-enhancing projects and using available technical assistance for this purpose.

6.Conclusion

The EU economy is now going through the most challenging times in its history. The focus of the 2012 Annual Growth Survey is on implementation of the priorities agreed as part of the new economic governance and the Europe 2020 strategy. It takes account of the need to adjust the level of ambition and priorities to a worsening economic context. The Commission invites:

The European Council to take note of this Annual Growth Survey and to task Council formations to consider it and report to the Spring European Council so that the March European Council can adopt appropriate guidance for the 2012 European semester.

The Member States to reflect the guidance agreed by the Spring European Council in their next Stability and Convergence Programmes and their National Reform Programmes in the spring 2012. These will be examined by the Commission when it issues new or updated country-specific recommendations next year, taking into account the degree of implementation of the 2011 recommendations, including the commitments made under the Euro Plus Pact.

The Member States to step up implementation of their Stability and Convergence Programmes, their National Reform Programmes and the 2011 country-specific recommendations.

The European Parliament and the European Council to agree to fast track the list of proposals attached to this Communication with a view to adopting them by the end of 2012.

I.Getting more out of what has already been agreed at EU level

Full implementation of the Services directive

ACTION REQUIRED:

All Member States to transpose by end 2011 (implementation report by end of 2011/early 2012)

All single points of contact to be in place by end 2011

Ongoing performance check of the directive to be published in Q2 2012 and follow up measures to be adopted before the end of 2012

Commission to propose implementing guidelines based on art. 20 of the directive to eliminate sales restrictions based on nationality or residence in first semester 2012

Completion of the integrated market for energy which would give consumers choice between suppliers and make markets fully accessible for energy providers.

ACTION REQUIRED:

All Member States to transpose second and third energy package without delay (the transposition deadline was mid-2011)

Council and Parliament to swiftly adopt the Regulation on guidelines for trans-European energy infrastructure

Commission to propose first set of implementation guidelines and network codes in 2012 (announced by the third package) with a view to completing work by 2014

Implementation of the late payments directive should be advanced from March 2013 to March 2012, in order to help SMEs

ACTION REQUIRED: all Member States to anticipate the date, de facto if not de jure

Full implementation of the Free Trade Agreement with Korea

ACTION REQUIRED:

Campaigns in each Member State to advertise the opportunities opening up in Korea during 2012

Monitoring by the Commission of implementation and report on improved market access by end 2012

II.Accelerating adoption of what is pending before the Council and European Parliament

The proposed unitary European patent protection valid in 25 Member States would lead to an estimated 80% reduction in costs for companies (SMA proposal).

ACTION REQUIRED:

Political agreement on the unitary patent by Ministers of 25 Member States by end 2011

Adoption of the implementing regulations and agreement at political level/signature of the UPC Agreement following the European Parliament vote in February 2012.

Agreement on the revision of the Roaming regulation, which will create more opportunities for businesses and lower prices for consumers 

ACTION REQUIRED: Council and EP to agree Commission proposal (COM (2011) 402) in first semester 2012 (current regulation expires on 30 June 2012)

The pending revisions of the directives on annual accounts would simplify reporting requirements in particular through exemptions for micro enterprises and burden reduction for small enterprises

ACTION REQUIRED:

Political agreement on Commission proposal on Accounting of micro-entities (COM (2009)35 COD) by end of 2011

Adoption of the proposal on the revision of the Accounting directives (COM (2011) 684) by the end of 2012 (SMA proposal)

Increasing co-financing rates for Structural Funds in programme countries as proposed would enable the rapid mobilisation of EU funds in support of growth.

ACTION REQUIRED: adoption of Commission proposal (COM (2011) 482) by end 2011

The proposed energy savings directive would promote more efficient use of energy

ACTION REQUIRED:

Adoption of the Directive by Council and European Parliament during the first semester 2012

All Member States to set their efficiency targets and submit first reports by end 2012 (after adoption of the directive)

Concluding the further trade agreements which are underway with key strategic partners

ACTION REQUIRED:

Subject to the position of partners, aim to conclude negotiations with India and Ukraine by the time of the next Summits with these countries

Subject to the position of partners, aim to conclude negotiations with Canada, Singapore and Malaysia during 2012 at the latest

Finalise formally in early 2012 the agreements with Peru and Colombia, on which negotiations have already concluded

Revision of the legislation on the European standardisation system (ICTs and services) (SMA proposal)

ACTION REQUIRED: Council and EP to agree Commission proposal (COM (2011) 315) by the end of 2012

Agreement on the proposals on savings tax

ACTION REQUIRED: conclude the already advanced discussion in Council on the Savings tax proposal (COM (2008) 727) before the end of 2011.

Giving the Commission the mandate to negotiate targeted tax agreements for the whole EU with third countries to effectively fight tax evasion whilst avoiding double taxation

ACTION REQUIRED:

Agree negotiating directives by March 2012

Agree anti fraud agreement with Lichtenstein by end 2011

Proposal from the Commission to tackle tax heavens by end 2012

Adopting the optional Common European Sales Law

ACTION REQUIRED: Council and EP to agree Commission proposal (COM (2011) 636) by end 2012

III.Fast-track future proposals that the Commission will propose in the coming months, including:

The twelve proposals of the Single Market Act, notably: 

Facilitating access to venture capital across Europe through an EU passport – Commission proposal on 30 Nov 2011, agreement by Council and EP by end 2012

Providing a common legal base for mutual recognition of e- authentication and electronic signature across borders – Commission proposal 2nd Qt 2012, agreement by Council and EP by end 2012

Revising the public procurement framework to provide simpler rules and more efficient procedures – Commission proposal on 13 Dec 2011, agreement by Council and EP by end 2012

Legislation modernising the system for recognising professional qualifications

ACTION REQUIRED: Council and European Parliament to adopt by end 2012

Other proposals:

A Youth Opportunities initiative to boost youth employment, in particular access to a first job, apprenticeships and internships

ACTION REQUIRED: Commission proposal by end 2011, agreement by Council and EP by end June 2012

Collective rights management – to enable the emergence of a single market for online music and to modernize the management of copyright in the EU

ACTION REQUIRED: Commission proposal first quarter 2012, agreement by Council and EP by end 2012

Proposal on on-line payments to improve trust and competition, two issues of concern today

ACTION REQUIRED: Commission to present concrete proposals in 2012 to address the issues identified in the Green paper (planned for adoption end 2011)

(1) A more detailed assessment of the economic situation and of the employment situation is contained in annexes to this Communication.

(2) See also COM (2011) 669 of 12 October 2011 – A roadmap to stability and growth.

(3) COM (2011) 821/2 and COM(2011)819 of 23.11.11.

(4) This report responds to the invitation of the European Council on 24 June 2011 to the Commission to report on progress made in the structured discussions on tax policy in the context of the Euro Plus Pact.

(5) The annual revenue from auctioning ETS allowances is estimated to be at least €11 billion from 2013.

(6) This would consist of a collective investment vehicle at European level managed by the EIB to invest in other funds at national level rather than investing in shares, bonds, etc.

(7) See COM (2011) 702 Small business, big world – a new partnership to help small business seize global opportunities

(8) These include the 12 actions of the Single Market Act which the European Parliament and the Council have already agreed to fast track

(9) COM (2011) 658 of 19.10.2011

(10) COM (2011) 803 of 23.11.2011

EUROPEAN COMMISSION

Brussels, 23.11.2011

COM(2011) 815 final

VOL. 2/5 - ANNEX I

ANNEX

PROGRESS REPORT ON THE EUROPE 2020 STRATEGY

to the

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF REGIONS

Annual Growth Survey 2012

1.Introduction

In 2010, the European Council agreed on a comprehensive response to the challenges that Europe is currently facing: the Europe 2020 strategy. In the current climate, this strategy has become more relevant than ever. GDP in the EU grew in the first quarter of 2011, but has slowed down substantially since then. Economic growth is now expected to come to a virtual standstill towards the end of the year. 1  In the euro area, this is exacerbated by the continuing sovereign debt crisis and remaining fragilities in the banking sector. In this situation, households and businesses lack confidence and therefore hold back on consumption and investments. In addition, with strained public finances, there is very limited room for further expansionary fiscal policy to boost growth.

This situation weighs heavily on future growth prospects, having wide-spread negative effects on business operations, on the labour market – with the young and low-skilled being particularly hit, and on government finances - both on the revenue and expenditure side. At the same time, the global environment is becoming ever more competitive, with emerging economies climbing up the technology ladder.

In the face of its deepest economic crisis since its inception, the EU must redouble its efforts to accelerate growth, productivity and job creation. There is no longer a distinction to be made between the short and the long-term as longer-term economic prospects have an immediate short-term impact on countries' borrowing costs. Longer-term reforms have to be pursued in parallel to shorter-term measures.

The Europe 2020 strategy rightly puts an emphasis on the need for a new growth path that can lead to a smart, sustainable and inclusive economy, a path that can overcome the structural weaknesses in Europe's economy, improve its competitiveness and productivity and underpin a sustainable social market economy.

The strategy defines where the EU wants to be by 2020 through five headline targets: 75% of the EU population aged 20-64 should be employed; 3% of the EU's GDP should be invested in R&D; the "20/20/20" climate/energy targets should be met. The share of early school leavers should be under 10% and at least 40% of the younger generation should have a tertiary l education attainment or equivalent. At least 20 million people should be lifted out of poverty and social exclusion. These targets are interrelated and critical to our overall success and require concerted efforts across Member States, supported by EU-level actions.

The Europe 2020 strategy is part of the European semester. This process of enhanced economic coordination was launched in the beginning of 2011. Based on the National Reform and Stability and Convergence Programmes, the Council concluded the first semester in July by agreeing on a set of country-specific recommendations, highlighting areas where Member States needed to take further action 2 . They reflected the need to step up structural reforms in a number of areas in order to release Europe's growth potential, while putting a particular focus on the opening up of services markets, improving the regulatory environment, ensuring access to finance and promoting energy efficiency. 3  The implementation of these country-specific recommendations should now be a priority.

2.Progress on the Europe 2020 headline targets

Reaching the Europe 2020 targets can enhance Member States' growth potential significantly. However, at this point in time, commitments set out by Member States in their Spring 2011 National Reform Programmes are insufficient to meet most of the EU-level targets, in particular for energy efficiency 4 . Moreover, on the basis of the latest statistics available, some progress towards achieving the targets has so far only been made at EU level in the area education.

Education target: The global EU target of early school leaving will not be reached on the basis of current national commitments. The national targets suggest that a rate of 10.5% early school leavers would be achieved by 2020, thus missing the common European target of 10%. Early school leaving still averaged 14.1% across the EU in 2010 compared to 14.4% in 2009. However, the figure hides considerable differences between and within countries. On tertiary education attainment (among 30-34 year olds), the cumulative effect of achieving the existing national targets set by Member States would on its own only lead to an attainment level of around 37% in 2020. However, the EU tertiary attainment rate has increased from 32.3% in 2009 to 33.6% in 2010 and current trends suggest that the headline target of 40% could in fact be met for the 30-34 year old age group.

Employment target: If all Member States achieved their national target, the EU as a whole would still fall short of the 75 % target by 1.0-1.3 percentage points. In the course of 2011 there has been no substantial progress. With the recovery stalling and only marginal overall employment growth during the first half of the year, the EU-27 employment rate for 2011 is likely to be only slightly above the 2010 level of 68.6% and to remain well below its pre-crisis high of 70.3%. The challenge remains to bring an additional 17.6 million people into employment between now and 2020.

Research and development target: Based on the national targets, the EU would still fall short of the 3% target by approximately 0.3 percentage points. The R&D investment rate stood at 2.01% in 2009, with little progress foreseen in 2011.

Poverty reduction target: The EU target of lifting at least 20 million people out of poverty and social exclusion by 2020 will not be reached based on current national targets. According to a first preliminary estimation of the cumulative ambition around 12 million people would be lifted out of poverty and social exclusion by 2020. If spillover effects of strategies focusing on, for example, combating child poverty or reducing long-term unemployment are taken into account, this number can be increased by 25%. However, this would still fall short by at least 5 million or 25% of the EU headline target.

20/20/20 target: Concerning the 20/20/20 targets, recent emission reduction projections 5 suggest that the EU as a whole would meet its 20% greenhouse gas emission reduction target, while for a number of Member States, additional policies will be necessary to achieve their binding national targets. As far as energy efficiency is concerned, work is ongoing on the overall analysis of Member States' national targets. A report should be ready in early 2012. However, the 20% renewable energy target based on the legally binding national targets should be met by 2020 if Member States fully implement their renewable action plans. At EU level, the share increased from 10.34% in 2008 to 11.6% 6 in 2009.

The purpose of the targets is to generate momentum with each Member State committing to stretch itself to make measurable progress in the key areas which are summarised by the five headline targets. While the current difficult economic context and ongoing fiscal consolidation are constraining the level of ambition, further efforts will be needed over the next years to make sure that the objectives set at the EU level are reached by 2020.

3.Releasing Europe's growth potential

The Europe 2020 flagship initiatives and EU levers need to be fully mobilised to boost growth. With all seven flagships in place 7 , focus has now shifted to implementation. Overall, progress has been satisfactory. In each flagship, a number of key actions have already been completed throughout 2010 and 2011. However, a large number of actions are still at the proposal stage and will need to be adopted by the Council and European Parliament. Given the urgency of the situation, the Commission has identified a number of priority proposals with a substantial growth potential whose adoption should be accelerated in order to kick-start growth 8 . 

3.1.Europe 2020 Flagship: Innovation Union

Europe's research and innovation performance has not progressed satisfactorily in recent years, broadening an already important innovation gap vis-à-vis the US and Japan. A number of other important competitors, including China and Brazil are now catching up with the EU's innovation performance 9 . The EU-wide situation masks a wide range of performance amongst Member States, with some (notably Sweden, Denmark, Finland and Germany) performing well by global standards.

A number of reasons have been put forward to explain Europe's innovation deficit. These include the fact that European firms are to a large extent present in more traditional, less R&D intensive sectors ("path dependency"); that investment in more innovation-based growth sectors (e.g. bio-tech, internet) are held back by an incomplete Single Market, including in services, by lower market prospects for innovative products, and by the growing shortage of human resources with the right mix of skills; that access to finance is more difficult, the weak exploitation of framework and demand-side policies in favour of innovation;; and that linkages between the "knowledge-triangle" are relatively poor across the EU.

The Innovation Union flagship aims to tackle these challenges through 34 specific commitments within clearly defined timescales. Overall, good progress has been made and actions are fully on track for 30 out of the 34 commitments. Concrete initiatives and pilot schemes have been launched. By the end of 2011, based on wide ranging discussions with stakeholders, the Commission will have put forward the six legislative proposals announced in the flagship initiative (unitary patent protection, standardisation package, Horizon 2020, new Cohesion policy, modernisation of public procurement legal framework and a European passport for venture capital funds).

Europe needs faster and modernised standard-setting, more affordable patents, more public procurement of innovative products and services, better access to capital and a genuine European knowledge market. The Commission has already tabled proposals for the creation of unitary patent protection to reduce the complexity and costs of patenting. The Commission calls for a political agreement on these proposals as well as on the Unified Patent Court agreement before end 2011. It has also presented a standardisation package to modernise and speed-up standard setting by 50%.

Key actions taken in 2011 include the launch of the pilot European Innovation Partnership on 'Active and Healthy Aging', which aims to contribute to a two year increase in healthy life years, and consequent increases in employability and reduction in losses to the labour market through mobilisation of actors across the innovation cycle and across sectors to speed up innovative solutions to address societal challenges. The European Innovation Partnership on Agriculture and Rural Development has been put forward within the framework of the CAP Reform proposals. It is expected to fill in a substantial gap that currently exists between research and improvement of farming practices. Progress has also been made towards the establishment of the 48 priority European research infrastructures identified in the 2010 roadmap of the European Strategy Forum on Research Infrastructures. 10 are already underway and development could start for another16 in 2012.

With an estimated 19.9% of EU GDP in 2009, public procurement has an immense potential to pull EU innovations to the market. The Commission is working with Member States towards a better use of this potential. The Commission will present a proposal to simplify the public procurement framework and make procedures more efficient and greener before the end of 2011. This proposal will include a new specific procurement procedure for the development and subsequent purchase of new, innovative products, works and services.

Furthermore, options are being explored to improve the exploitation of intellectual property by companies. The Commission has investigated a set of options for enhancing the value of intellectual property rights at European level. The Commission plans to launch a debate with Member States in 2012 to shape further actions. To enhance the linkages between scientific researchers and businesses, the European Institute of Innovation and Technology (EIT) was set up in 2008. It aims to bring together higher education institutions, research organisations and businesses in new types of partnerships – Knowledge Innovation Communities (KICs). Such Communities have so far been set up in three areas: sustainable energy, climate change and ICT, with positive results so far. The Commission will continue to monitor and evaluate the performance of the EIT KICs that are up and running and come forward with proposals under Horizon 2020 for an expansion of the EIT from 2014.

The Commission will also support business-academia collaborations through the creation of "Knowledge Alliances" between education and business to develop new interdisciplinary curricula addressing innovation skills gaps and entrepreneurship. A pilot project was launched to this end in 2011. In 2012, the Commission will propose a European Research Area framework and supporting measures to remove obstacles to mobility and cross-border cooperation, aiming for them to be implemented by end 2014. The Commission will also launch the "U-Multirank" in 2012: a performance-based ranking and information tool for profiling universities, with first results in 2013.

Two Member States received country specific recommendations to improve their research and innovation systems, in particular their framework for private research and innovation. First indications on implementation show that some progress has been made in this area, albeit still limited.

3.2.Europe 2020 Flagship: A digital agenda for Europe

ICTs are a major growth driver, explaining half of the productivity growth of modern economies. However, compared to its main competitors, Europe is lagging behind in ICT investment as well as in the roll-out of high-speed broadband and is not fully exploiting the growth and jobs potential of what should be booming sectors.

Progress on the Digital agenda flagship as measured by the digital agenda scoreboard 10  is ongoing, but efforts need to be stepped up if the related targets are to be achieved. Out of the 101 actions planned under the 7 pillars of the digital agenda, 14 actions have already been completed in 2010 and 2011 and another 50 actions are on track to be completed in the next 12 months. Lowering barriers to fast internet take up and building trust in the online environment could help kick start GDP growth, enhance Europe's competitive edge and create new jobs and businesses. In the Digital Agenda, the most urgent actions are to create a Digital Single Market, which could deliver 4% extra GDP growth over the next ten years 11 .

World demand for bandwidth has been growing by 50-60% per year. Today, more than 50% of broadband lines in Japan and 40% in Korea are fibre, delivering high-capacity connections, while fibre accounts for only around 5% in Europe. A 10 percentage-point increase in the broadband penetration rate is expected to result in a 0.9-1.5 percentage-point increase of GDP. Investments in broadband should therefore become a core part of the EU's growth strategy, in particular by using available national and regional funds, adopting appropriate town planning rules to reduce deployment costs and focusing on exploiting synergies with energy infrastructure to accelerate the delivery of smart grids. In 2010, the Commission issued a Communication 12 outlining common rules within which EU and national policies should be developed to meet the broadband targets. This measure is aimed at accelerating the development of very fast internet. The Communication was adopted along a Recommendation on Next Generation Access Networks to encourage investment through clear and effective regulatory measures. 

The rise in mobile internet traffic calls for greater availability of spectrum bands. This is evidenced by the generalisation of smartphones (that could reach 100% of the population globally by 2020) and the explosion of the use of tablets (projection of 62 million units in 2011 13 ). The increased use of video, which accounts already for two thirds of all mobile traffic, requires greater capacity. Services which rely on radio spectrum represent 2% - 2.5 % of EU GDP (about €250bn) and the European wireless electronic communications industry supports 3.5m jobs, generates around €130bn annually in tax revenues and contributes €140bn directly to European GDP. The 5-year Radio Spectrum Policy programme, which has been agreed in principle between the institutions, should be adopted as soon as possible by the European Parliament and Council in early 2012.

The growth potential of e-commerce is still largely untapped in the EU. It plays an important role for business to business (B2B), as 27% of enterprises purchase online and 13% sell online. Nonetheless, it is currently limited to 3.4% of retail commerce. While 40.4% of citizens purchased online in 2010, only 9% did so cross border (Eurostat). Recent evidence suggests that the current consumer welfare gains from e-commerce in goods alone in terms of lower online prices and wider choice are estimated to be around €11.7 billion, an amount equivalent to 0.12% of EU GDP. If e-commerce were to grow to 15% of the total retail sector and Single Market barriers were eliminated, total consumer welfare gains are estimated to be around €204 billion, an amount equivalent with 1.7% of EU GDP. 14  The difference with the US in buying music and books on-line is striking. In 2010, digital music sales accounted for 19% of the market for recorded music in the EU compared with 49% in the US. Two online music service providers are available in all 27 Member States, but most online music services are available in only one or a few Member States. In the US, e-books outsold mass market paperback books in the first quarter of 2011 whilst the EU e-book market is anaemic. 

In 2011, the Commission proposed legislation to improve alternative dispute resolution between consumers and businesses in the Union, comprising a specific proposal on an EU-wide online redress tool to resolve effectively dispute arising from cross-border e-commerce. The Commission will announce in 2012 proposals to facilitate e-commerce inter alia through the mutual recognition of e-authentication and electronic signature across borders, rules to stimulate cross-border trade of digital content modernising Europe's copyright regime. The Commission will also consider measures supporting market integration at EU level for card, internet and mobile payments on the basis of a Green Paper consultation. It will also propose new legislation for increased protection of personal data and actions in the areas of enforcement and information provision to increase consumers' confidence in e-commerce.

There is also scope for significant efficiency gains through the full implementation of electronic procurement (e-procurement) procedures throughout the EU: some estimates indicate that these untapped savings could as high as €50 to €70 billion per year. The Commission estimates that only about 5% of procedures were conducted by electronic means in 2009. Its proposal to modernise the public procurement directives, scheduled in December 2011, will therefore set out measures to make the use of electronic procedures the rule rather than the exception.

To support advanced digital devices, a European approach to cloud computing is necessary to provide the legal certainty for European companies and administrations to offer and use cloud-enabled services, which are fast becoming key enablers for efficiency and entrepreneurship in today's digital economy. The average contribution of cloud computing to GDP is estimated in the range of 0.1% in the short run and 0.4% in the medium run, with the initial creation of about 300,000 additional jobs in Europe 15 . The Commission will propose a European approach to cloud computing by 2013 to provide the necessary legal certainty for European providers and users.

Bold action is also needed to reinforce the security of the internet and counter the costs of the mounting number of the attacks against what is an essential infrastructure for the single market. The Commission plans to propose an ambitious EU Internet Security Strategy in 2012.

3.3.Europe 2020 Flagship: Resource efficient Europe

Europe can benefit economically from tackling the energy/climate and resource challenges. The Union's energy efficiency target of saving 20% of energy by 2020 could cut consumers’ bills by up to €1000 per household a year and improve Europe’s industrial competitiveness creating up to 2 million new jobs by 2020. In a broader resource-efficiency perspective, according to preliminary modelling results for the Commission, a reduction of the Total Material Requirements (TMR) of the economy by 15% can boost GDP by up to 3.6% and employment in the EU by around 2 and a half million. Each percentage point reduction of TMR would be worth around €25 billion to business and up to 150,000 new jobs 16 . Business could achieve important savings (around € 25 billion per year in the UK only) from resource efficiency measures that are either no or low cost, using raw materials more efficiently and generating less waste. The sectors with the greatest potential identified were chemicals, minerals, metal manufacturing, power, utilities, construction and waste management 17 . In spite of the CO2 emission reductions due to the economic crisis, projections suggest that additional policies will be necessary in a number of Member States to achieve their national 2020 emission reduction targets. Equally, effective measures will be needed to achieve the remaining renewable energy and energy efficiency targets. In this context a substantial increase of investment in energy infrastructure, energy transmission networks, renewable energies and energy efficiency of buildings will be needed.

The Commission has delivered 14 out of the 20 planned strategic initiatives under the flagship. To further guide the implementation of the Resource Efficiency Flagship the Commission published a roadmap that lists concrete actions to follow and identifies the economic sectors that consume the most resources and have the dominant environmental impacts, and suggests tools and indicators to help guide action in Europe and internationally. In particular, a legislative proposal for a Directive on energy efficiency has been presented, specifying a range of energy efficiency measures to be implemented to achieve further energy saving. A communication on security of energy supply and international cooperation has also been adopted, setting out a comprehensive strategy for the EU's external relations in energy. The Commission launched a Roadmap for moving to a competitive low carbon economy indicating intermediate milestones to deliver cost-effective emission reductions in line with the -80 to 95% objective by 2050. The gradual transition to a low-carbon economy would improve energy security and reduce EU's average fuel costs by between €175 and €320 billion per year. Other benefits include better air quality and public health, which would cut costs by up to €27 billion per year in 2030. The Commission also presented a new Transport White Paper for a competitive and resource efficient transport system. It sets ambitious targets to decarbonise transport, achieve a genuine Single European Transport Area and to reduce oil dependency.

The Commission approved in 2011 a package of legislative proposals for the reform of the Common Agricultural Policy which include a strong commitment to substantially improving the management of natural resources. Changes proposed to both the first and second pillars of the CAP aim at better integrating environmental and climate challenges at farm level and incentivise the sustainable economic development of rural areas.

Finalising the internal energy market is a precondition for realising the full savings potential which a truly integrated pan-European market for gas and electricity can yield due to enhanced liquidity and competition. Market integration will also enhance energy security and facilitate the integration of new generation sources from renewable energies thanks to larger balancing areas. More cross border trading of electricity and gas can smooth out price peaks and facilitate entry of new market players, thereby stimulating innovation and competition.

For the proper functioning of the internal energy market, it is crucial to have a more coherent approach in national policies on issues that affect neighbouring countries. When legislating at national level, and providing incentives for investments, including on prices and taxation, interactions between different instruments should be carefully assessed to ensure a stable investment framework for European industries and service providers. For instance, in the renewable energy sector, drastic policy changes, including with retroactive effect, should be avoided to prevent unnecessary regulatory risks that undermine the viability of renewable power generation. The current support schemes for renewable energies should become more cost-effective. The challenge is to support large-scale production, enabling market actors to bring down costs, reduce subsidies and integrate renewable energies in a truly European market.

Under any future energy scenario, energy infrastructures will play a vital role in balancing demand and supply across the entire Union. To this end, Europe's electricity and gas networks must be modernised and expanded urgently. The Commission's proposal for a new energy infrastructure regulation replacing the current TEN-E framework was presented recently 18 . The objective of the new framework is to ensure that strategic energy networks and storage facilities are completed by 2020 in the different regions of the Union. With respect to EU financing, the € 9.1 billion foreseen in the Commission's proposal for a Connecting Europe Facility will allow the full realisation of € 200 billion worth of investments needed for infrastructure projects of European relevance between now and 2020. This investment will have a significant positive overall effect on GDP and employment, with a cumulative effect of up to about +0.4% of GDP and 400,000 additional jobs over the period 2011-2020.

According to studies regarding energy and resource efficiency, better construction and use of buildings in the EU would influence 42% of final energy consumption 19 , about 35% of greenhouse gas emissions 20 and more than 50% of all extracted materials 21 ; it could also help save up to 30% water 22 . The building sector employs 8% of Europe's workforce. Around 230,000 people are involved in the manufacturing and installation of insulation. As energy efficiency investments are partly financed by energy savings, public measures to remove barriers, such as access to capital and information can have a strong leverage effect. In this context, rapid adoption of the proposed directive on energy efficiency would help close the gap towards the Europe 2020 target, create the necessary framework conditions 23 and allow the Member States to set their efficiency targets and submit first reports by end 2012.

There is also scope for better use of EU structural funding in energy efficiency as well as renewable energies. Investments in sustainable energy can be further triggered by the EU support mechanisms ELENA (European Local Energy Assistance) and EEE-F (European Energy Efficiency Facility). Finally, the upfront investment costs for building refurbishment or for the promotion of energy efficiency in the public sector can be met or leveraged by involving energy service providers (ESCOs).

Phasing out of environmentally harmful subsidies enhances resource efficiency and fosters economic growth. Inefficient subsidies lock in obsolete technologies and business structures, and hinder investment in clean energy and other green technologies. Removing inefficient subsidies could also be an important element of fiscal consolidation. For instance, direct revenue losses may approach 0.5% of EU GDP (€60 billion) and welfare losses from distortions of consumer choice are substantial, estimated at 0.1 to 0.3 percent of GDP (€12 billion to €37 billion). The Commission has asked the Member States to identify the most significant environmentally-harmful subsidies in 2012 and to prepare plans to phase them out 24 .

There is large scope for advancing on green taxation to help facing today’s and tomorrow’s challenges related to climate change, water scarcity, energy security and general resource limits. When carried out in a budgetary-neutral way, green taxation combined with a tax shift away from labour improves resource allocation while boosting employment 25 . Adoption of the Commission's 2011 proposal for a revision of the Energy Taxation Directive 26 will facilitate this shift. Moreover, getting prices right would also help stimulate new industries and investments in green technologies.

In the 2011 European semester, a number of country specific recommendations referred to issues related to sustainable growth, such as functioning of the energy markets and competition, network interconnectors and resource efficiency. So far, the first indications on implementation show that in most Member States there is some progress on addressing the recommendations.

3.4.Europe 2020 Flagship: An industrial policy for the globalisation era

Manufacturing industry led the recovery from the economic crisis: output has increased some 15% over its trough in early 2009. Nevertheless, the economic recovery in EU industry has stalled in recent months, whilst business confidence has fallen back to its historical average. Uncertainties about the prospects of the European economy and the turmoil related to the debt crisis in the euro area have taken their toll on industrial confidence. High energy prices and persisting difficulties in access to finance are also adversely affecting the dynamics of the recovery. Nevertheless, EU industry is now in better shape to face a slowdown, with lower inventories and higher productivity than in 2008.

The flagship initiative on An Integrated Industrial Policy for the Globalisation Era contains 70 key actions many of which are already being implemented by the Commission. For instance, the Commission ensures an in-depth assessment of the impacts on competitiveness and on SMEs of its new policy proposals with significant impacts. This has been the case for proposals such as the ETS allowances to address the risk of carbon leakage and the Capital Requirements Directive IV.

The Commission will also propose concrete actions to minimise the regulatory burdens on SMEs, in particular micro enterprises. The envisaged actions include possible exemptions for micro and small enterprises from the existing acquis; improved involvement of smaller enterprises in the shaping of proposals for EU regulation; introduction of a micro-entities dimension to the existing SME test and; a scoreboard on exemptions and lighter regimes for SMEs and micro companies in proposals made by the Commission for new EU regulation, their adoption by the EU legislator and their implementation by Member States.

The Small Business Act for Europe was reviewed in February 2011 27  putting emphasis on improved access to finance, more favourable regulation environment and helping SMEs facing globalisation challenges. The latter aspect was further developed in related follow-up actions, like the new strategy to support the internationalisation of SMEs that was adopted in November 2011 28 . The review also recalled the need for Member States to prioritise the business environment through smart regulation, reducing unnecessary regulations and permits, introducing simpler procedures through e-government, and reducing the set-up time for a new business to 3 working days.

The Commission will present an Action Plan to improve access to finance for SMEs before the end of 2011. It will be accompanied by a proposal to facilitate access to venture capital across Europe through an EU passport that will allow venture capital funds to raise capital in all 27 member States on the basis of a single registration. It is expected that, if successful, this initiative could create up to 315,000 additional jobs and € 100 billion additional GDP. The Commission will endeavour to eliminate any tax treatment that disadvantages cross-border venture capital investments and to reduce the administrative burden.

Enhancing competition across the economy requires not only horizontal, sector-specific product and service market reforms, as well as effective enforcement of competition rules but also an overall institutional set up conducive to competition at all levels (EU, national, regional and local) at a limited cost for Member States. This includes an effective role for competition authorities, sectoral regulators and judicial authorities entrusted with the protection and promotion of competition. A well functioning civil justice system is a vital link in any institutional framework conducive to competition and growth.

In the area of industrial innovation, the High-Level Group on Key Enabling Technologies presented its final report in June 2011 with concrete recommendations on development and deployment of these technologies 29 . These technologies have enormous market potential with annual growth rates between 5% and 16% per year up to 2020 and also provide crucial spill-over effects to key downstream industry sectors in terms of innovation and growth. The Commission also proposed in June a major modernisation of the European standardisation system 30 by, amongst others, including standards on services in the European system and giving more recognition to ICT industrial specifications.

The Commission has put forward some sector-specific initiatives, such as adoption of a strategy for space policy 31 aiming at strengthening of the European space sector or re-launching of the CARS 21 process 32 which will serve as an input to the EU's strategy for clean and energy efficient vehicles. The deployment of electric vehicles has a major market potential growing from 100.000 today to 1 million hybrid vehicles by 2020, whilst the fully-electric vehicle market is expected to reach 750,000 units by 2020. The Commission also continues its efforts to address the concerns of energy-intensive industries, in particular through initiating the Sustainable Industry Low Carbon Scheme (SILC), and by promoting ultra-low carbon production technologies and through developing a private-public partnership to stimulate innovation in the energy-intensive process industries.

Based on first indications, Member States' efforts to implement the country-specific recommendations in this area appear to have been mixed. The implementation of recommendations as regards access to finance to SMEs is rather poor. The picture is slightly better regarding measures to improve the business environment, such as the reduction of administrative burden, improving administrative capacity or the efficiency of the judicial system. Six of the ten Member States which received a recommendation to improve the business environment took some actions, but these remain partial in most of the cases.

3.5.Europe 2020 Flagship: An agenda for new skills and jobs

Increasing employment levels and enhancing labour productivity are two key sources of growth together with capital investment and innovation. Currently, there are 23 million unemployed people in the EU, corresponding to 10% of the working age population.

The slight improvement in the EU's unemployment rate since 2010 has come to a halt. The share of the long term unemployed in the total stock of those looking for work exceeds 40% and is up one third compared to the level of 30% registered two years ago. An increased share of people live in households with very low work intensity in 12 out of the 15 Member States for which data is available.

A jobless recovery has not only important economic and social costs but also signals structural deficiencies in the labour market that weakens growth potential in the medium to long-term. In particular, skills mismatches and shortages hinder economic recovery. Unfilled vacancies started to increase as of mid-2009, while unemployment is not showing signs of improvement. This fact points to labour market mismatches, such as inadequate skills or limited mobility, at least in certain sectors and regions.

Life-long learning policies are essential to equip people with the right skills for the labour market. In 2000, 22% of employed people had high level qualifications in the EU while 29% had low qualifications. In 2010, it was the reverse. By 2020, 35% of jobs will require high qualifications and the demand for low skills will drop by 12 million jobs. However, educational attainment currently falls short of this growing skill-intensity of available jobs. One out of seven (14.41%) young persons aged 18 to 24 in the EU currently leaves the education system with no more than lower secondary education and participates in no further education and training (early school leavers) and many have qualifications that do not match with labour market requirements. Moreover, more than one fifth of all children do not meet basic standards of literacy and numeracy (measured at age 15).

Policy actions to address these challenges are being developed under the flagship an Agenda for new skills and jobs. Work is progressing well on the 13 key measures such as the EU Skills panorama aimed at improving transparency for jobseekers, workers, companies and/or public institutions by providing updated forecasting of skills supply and labour market needs up to 2020 planned for October 2012, as well as on sectoral initiatives foreseen under the flagship such as the Action Plan on Health workforce.

The legislative proposals on the review of the EU labour law are under preparation. Social partners have agreed to negotiate on the revision of the Working Time Directive. The adoption of the package of two legislative proposals concerning the Posting of Workers is foreseen in the coming weeks. A Council Recommendation to promote the validation of non-formal and informal learning is expected by the first half of 2012 and a practical tool to help citizens record their skills acquired through work and other experiences will be operational online by October 2012. A wider reflection on addressing the skills challenge in Europe will be the object of a Commission Communication in the second half of 2012.

3.6.Europe 2020 Flagship: Youth on the move

The current labour market situation is particularly critical for young people who face an unemployment rate of over 20%, twice as high as that of the overall population. Furthermore, the decrease in permanent jobs as a result of the crisis has hit young people disproportionally and even though over-represented in temporary contracts, the recent net growth in the latter has not benefited young people in any significant way.

Work has started on all the policy actions planned under the flagship initiative Youth on the Move. Some key actions have already been launched to fight youth unemployment, such as Youth@work, an awareness-raising campaign to build contacts between young people and small businesses (SMEs) or the European Vacancy Monitor, which gather up-to-date information on job vacancies, which can also serve as an early-warning tool for bottlenecks and mismatches on the labour market.

Regarding education, a Council Recommendation on policies against early leaving from education and training was adopted on 7 June 2011 setting out a framework to Member States for coherent, comprehensive and evidence based policies against early school leaving. Now it should be implemented.

Moreover, in October 2011, the Commission adopted a Communication on the modernisation of higher education systems which includes a proposal for the Erasmus Masters student loan guarantee facility, aimed at improving mobility of Master's students across Europe.

The aim of the European framework for youth employment is to ensure robust policy coordination at European level within the common principles for flexicurity. The framework is built upon four pillars: 1) Help to get a first job and start a career; 2) Support youth at risk; 3) Provide adequate social safety nets for young people; 4) Support young entrepreneurs and self-employment. As part of the framework, the Commission has proposed the following specific areas for action in Member States: Youth Guarantees to ensure that all young people are in jobs, further education or activation measures within four months of leaving; open-ended "single" contracts to reduce labour market segmentation; unemployment and social assistance to young people in a mutual obligations approach. In the context of the future Youth Opportunities Initiative, which the Commission will present before the end of the year, further action will be needed to support transition into the labour market, provide more traineeships and encourage mobility.

3.7.Europe 2020 Flagship: European platform against poverty

Apart from being valuable objectives in their own-right, fostering inclusive labour markets and societies have an impact on growth through improved labour market outcomes, enhanced aggregate demand and strengthened confidence. These three areas are also three important bottlenecks that hinder a robust recovery.

In the few countries for which income data reflecting the economic crisis is already available, household disposable income has fallen significantly 33 . Moreover, there is some evidence that both income-poverty, especially child poverty, and severe material deprivation represents an increasing challenge in several Member States. As long term unemployment shares rise and unemployment benefits run out, there is a risk of seeing a significant decline of disposable income affecting low income earners.

The consumption propensity of low-income people tends to be high, since they have to spend most of what they earn in essential goods and services. For this reason, any further reductions at the bottom of the income distribution may have a lasting impact on domestic demand and hence on growth 34 . Hence also the importance of consumer empowerment, allowing consumers to make optimal consumption choices and thus maximise their welfare. 

Work is ongoing on the 10 key actions of the Platform against poverty and social exclusion flagship initiative. Some have already been launched this year such as the New European Agenda on Integration to support efforts of Member States promoting third country nationals to participate actively in our societies or the EU Framework for national Roma Integration Strategies.

The Social Business Initiative was adopted in October 2011, and its key actions will be rolled out in the coming months, starting with the new framework on social investment funds, the new investment priority for social enterprises in the proposed structural funds, or the future draft Regulation on a statute for European Foundations.

A White Paper on pensions addressing sustainability and adequacy of pensions in the post-crisis context is scheduled for adoption in the coming months.

To fight poverty and social exclusion, the modernisation of social protection systems should be pursued along the lines of the active inclusion common principles. In particular, public services are an essential element to support labour market integration and social inclusion. Furthermore, access to effective and affordable services plays a key role in reducing private expenditure and hence raising disposable income, mitigating income poverty and inequality 35 . According to an OECD study on publicly provided services, imputing public services in household income reduces poverty estimates to a considerable amount. At-risk-of poverty rates fall substantially, by almost 40% when a floating poverty line is used and even by close to 80% when a fixed poverty line is used. Consequently, in-kind benefits taken together would have the potential to reduce the poverty gap by 80% on average.

Among the 30 million Europeans over 18 that do not have a bank account, it is estimated that about 6.4 million are actually deprived of or afraid to ask for a bank account. 36 The situation in the EU regarding lack of a bank account is very diverse and in Romania and Bulgaria around half of the respondents do not have a bank account. Unbanked consumers are likely to face problems in relation to employment, renting property and receiving wages or benefits and they face higher transaction costs. The Commission Recommendation on access to a basic payment account 37 provides the details on the actions needed to fight financial exclusion.

The cost and quality of housing are a key determinant of living standards and well-being, especially for the most vulnerable people. This is clearly shown by the EU indicators on housing cost and housing deprivation 38 . In 2010, 38% of people at-risk of poverty spend more than 40% of their disposable income on housing – more than six times for the rest of the population (6%) 39 . At the same time, the share of housing costs in total disposable income reached 32% and more for half of the people at risk of poverty against 16% for the rest of the population. If housing costs are analysed more in detail, it emerges that rents and interest paid on mortgage make up only around 30% of total gross housing costs, while other elements – repairs, maintenance, fuel and others costs of various kind – make up some 70% 40 . According to the Commission's Household Budget Survey, housing, water, electricity, gas and other fuels is the single most important item in household's expenditure corresponding to 27.7% of household consumption.

The consequences of housing costs, and in particular utilities, on poverty rates is very significant: if disposable income is defined after deducting housing costs, the proportion of people with income below 60% of the (new) median was increased in 2007 from 16% to 22% in the EU as a whole. 41  This points to the importance of a full implementation of Directive 2009/72/EC concerning common rules for the Internal Market in electricity, including Article 3(8) on the need to address energy poverty.

3.8.Addressing missing links and bottlenecks

3.8.1.Getting more out of the Single Market

During the past two decades, the creation of an internal market and the opening of borders have been two of the main driving forces behind European growth. The estimated effect of internal market integration in the EU in the period 1992-2006 has been the creation of 2.75 million additional jobs and an extra 2.1% of GDP growth. Today, intra-European trade accounts for 17% and 28% if world trade in goods and services respectively. For every €1000 of wealth created in a Member State, it is estimated that about €200 end up benefitting other EU Member States through trade.

The Single Market Act of April 2011 set out twelve levers to further complete and deepen the internal market in the areas of access to finance, citizen mobility, public procurement, professional qualifications, intellectual property rights, consumer rights, services, networks, the digital single market, taxation, the regulatory environment for businesses, social entrepreneurship and social cohesion. The Commission has already presented several of the 12 key legislative proposals of the Single Market Act, and will put forward the remaining ones by the end of the year (except for proposed legislation on eSignatures, eIdentity and eAuthentication). These proposals should all be agreed by the European Parliament and the Council before the end of 2012, so that their practical benefits can be rapidly felt across the EU.

The implementation of the Single Market Act is of key importance to create a favourable environment for European businesses, in particular SMEs, and to restore and reinforce trust in consumers and workers so that they confidently take up the opportunities the Single Market has on offer. The Commission's annual Consumer Markets Scoreboard monitors markets across the economy and contributes to identify those which do not function for consumers. There is already a significant EU trade in services: it accounts for more than half of the global services trade and more than half of this represents trade within the single market. However, the Single Market for services is not yet delivering to its full potential. Despite that services account for over two-thirds of EU GDP and employment, services still represent only around one-fifth of total intra-EU trade. Barriers to the Single Market for services are partly accountable for low competition intensity, which in turns affects productivity.

There is therefore still a large potential for the internal market to deliver additional growth and jobs. In the 2011 European semester, the largest amount of country-specific recommendations for structural policies concerned the services sector, including calls to step up the full implementation of the Services Directive 42 , to remove unjustified barriers to entry and further opening professional services. The Services Directive covers a wide range of economic activities representing around 45% of the EU economy, including large sectors such as retail, construction, business services, tourism and most regulated professions. According to conservative estimates it could deliver growth of up to +1.5% of EU GDP. Progress so far in Member States seems mixed, ranging from some reform efforts to no progress at all depending on the recommendations.

To exploit the Directive's full potential, there is now a need to shift from a compliance perspective to a competitiveness driven focus. The Commission will continue the analysis of the quality of implementation and, where necessary, take formal enforcement measures. The Commission will also put forward in 2012 additional actions to deepen the Single Market for services.

Beyond the current scope of the services directive, there are other sectors with an important growth potential. For example, the health and social sector created 4.2 million jobs over 2000-2009, more than a quarter of total job creation in that period. It accounts for 10% of all jobs in countries like Denmark, Finland, Netherlands and Sweden and represent around 5% of the total economic output. Ageing will increase demand for such services and their development should therefore be facilitated. Issues that need to be addressed include a lack of qualified personnel in the sector in a number of Member States, a limited freedom of establishment due to various unjustified or disproportionate restrictions, and difficulties in recognising professional qualification cross-border, which affects these and other sectors, including education, construction, manufacturing and business services.

Rising unemployment in Member States will drive professionals to seek job opportunities in other Member States 43 , changing patterns of mobility in the European Union. The upcoming modernisation of EU legislation facilitating the recognition of professional qualifications 44 will respond to needs of Member States facing an increasing shortage of skilled workforce while easing the unemployment pressure.

Finally, confidence in the Single Market will be enhanced for all stakeholders through the policies that safeguard the legal framework for the operation of services of general interest (State aid and public procurement) and that guarantee that competitiveness and liberalisation go hand in hand with the respect for social rights of workers and citizens.

3.8.2.Maximising the impact of EU funds

In the current economic climate the Commission stresses the need to use existing EU budgetary resources to the maximum and to put in place a reformed Multi-annual financial framework that will more thoroughly support Europe 2020 objectives 49 .

Existing budget lines have a strong potential to provide a significant boost to growth in the EU. Different large scale investments through the Cohesion Fund and European Regional Development Fund (CF and ERDF), in particular to improve the environment, transport infrastructure, energy and broadband connections, can have a direct impact on growth and jobs. Alongside these direct investments, the ERDF provides valuable support for entrepreneurship, investment in enterprises, innovation and Research, and ICT for business. The European Social Fund (ESF) works under four priority areas: employment, with special emphasis on the employment of disadvantaged groups and the young, skills and lifelong learning, improving the adaptability of the labour market and promoting social inclusion. In many cases this support is tailored towards the recommendations given to the Member States in the context of the Europe 2020 strategy.

To improve the potential to generate growth offered by the Structural Funds, Member States should ensure the (re-)prioritisation of funding to direct support towards country-specific recommendations or areas that have a high growth potential using the flexibility available in their programmes. In some cases, reprogramming may be necessary when a more intensive and upfront use of EU funding could be beneficial to support sources of growth. Actions to support growth include:

–Improving the liquidity of SMEs in a financially constrained banking environment by more intensive use of JEREMIE financial instruments (loans, guarantees and venture capital);

–Investing more in the energy efficiency of buildings (as has been done in France). This would also help secure jobs in the building and construction sector, a sector severely hit by the crisis and which has sizable underutilised capacity;

–Reinforcing resource efficiency, by investing in eco-innovation, renewable energies and environmental technologies;

–Accelerating major projects in convergence regions (as has been done in Greece);

–Developing a fast-track list of priority projects, which are both ready to be implemented and can directly contribute to growth, to replace programmes performing significantly below potential. The Commission is ready to offer its help in this process, as it is already doing to Greece and Romania;

–Accelerating the use of available funds by reprioritising programmes on fewer priorities with the aim of improving the conditions for growth and reducing the regional divide as recently agreed with Italy in the framework of the Action Plan for Cohesion.

In any event all Member States should report by end 2012 50 on outputs and results and the progress in achieving the objectives of cohesion policy and of its contribution to Europe 2020.

To support the disbursement of unused funds in times of fiscal constraints, the Commission proposed on 1 August 2011 to increase the co-financing rates to get some of the EU's most troubled economies back on track. Under the proposal, higher rates of EU co-financing would be made available for Greece, Ireland, Portugal, Romania, Latvia and Hungary to take forward growth and competitiveness-enhancing projects in each of these countries. In total, the maximum expected impact would amount to € 2,884 million. The Council and the European Parliament are invited to adopt this proposal urgently, before the end of the year.

The Commission is making good progress in detailing its blueprint for a future EU budget geared to driving growth and job creation in line with the Europe 2020 strategy. Detailed proposals have been adopted in relation to the Connecting Europe Facility and Cohesion Policy, the Common Agriculture Policy and Rural Development, with further proposals close to adoption, i.e. on Horizon 2020. These legislative bases will also be accompanied with policy frameworks such as the revised Trans European Transport and Energy guidelines, and proposals in early 2012 for two Community Strategic Frameworks, one for shared management funds 51 and a second for research and innovation. These frameworks will prioritise the areas for EU support and better coordinate different EU funding programmes.

A key element of the Multi-annual Financial Framework (MFF) proposals is the need to ensure effective, growth enhancing investment from the EU budget. Key elements of the cohesion policy proposals that respond to these objectives are the mechanisms for thematic focus in Europe 2020 priorities, concentration of resources and the new conditionality provisions that will ensure that EU funding is focussed on results and creates strong incentives for Member States to ensure the effective delivery of the Europe 2020 growth and jobs objectives. Partnership contracts will be concluded with each Member State to ensure mutual reinforcement of national and EU funding.

In anticipation of the Connecting Europe facility under the next Multiannual Financial Framework, the Commission proposed a Europe 2020 Project Bond Initiative pilot phase in October, amounting to € 230 million. This Initiative seeks to mobilise investment in areas that will stimulate growth and create jobs. The large and urgent infrastructure investment needs combined with the long lead times for project preparation, call for immediate action to address the scarcity of funding. At a time of tight public budgets, innovative solutions are urgently required to mobilise a greater share of private savings and to improve the range of financial instruments available for energy, transport and ICT projects. Reduced possibilities to access finance by infrastructure projects calls for alternative sources of debt financing. The norm for infrastructure projects with commercial potential should be to combine EU funds in partnerships with the capital market and banking sectors, particularly via the European Investment Bank (EIB) as the EU financial body established by the Treaty.

3.8.3.Exploiting the potential of the global market

The core of the EU's economy remains the Single Market, but the share of trade in growth generation has never been as high as now – in 2010 roughly 25%of EU growth came from international trade. In the short-term, the bulk of economic growth will happen outside of Europe. In fact by 2015, 90% of future economic growth will be generated outside of Europe. The EU's growth potential will depend on the ability to reap the benefits of that growth. Yet, the fastest-growing markets are less open than the EU.

Europe's external economic relations are well established. The EU will continue to pursue them with all partners, especially developing countries, and adapt them to changing circumstances. The US and China are the EU's biggest trading partners. The EU has developed new and broad instruments with strategic partners (with the US: TEC as example on electric vehicle cooperation; with China: HED as example in the area of innovation). The Asian region is home to the fastest growing economies in the world. Its regional economic integration is moving at a fast pace and the EU wants to tap into this potential and seize opportunities. A FTA with India is a key plank of the EU's strategy. Asia is not only a crucial export market; it is also key element in the EU's supply chains.With respect to Russia, the EU's interest lies in anchoring Russia in the global economic system and in a potential FTA, and with Mercosur and Japan FTAs are being explored. The trade agenda with the near neighbourhood goes beyond growth and jobs, implying also security and solidarity. Nevertheless the neighbourhood region is an economic factor as the EU's fifth largest trading partner. With respect to the Southern Mediterranean: the EU concentrated on FTAs and short-term initiatives. The EU also engages with Ukraine (DCFTA) and other Eastern Partnership countries.

An initiative on commodities and raw materials 52 proposed actions to secure access to raw materials for the European industry on world markets and to improve transparency of financial and commodity markets.

More trade and investment with the world are key to a stable and sustainable economic recovery, growth and jobs in Europe. To achieve this the EU's immediate priority is to conclude those trade agreements which are underway: (1) subject to the position of partners, the EU aims to conclude negotiations with India and Ukraine by the time of the next Summits with these countries; (2) subject to the position of partners, the EU aims to conclude negotiations with Canada, Singapore and Malaysia during 2012 at the latest and (3) finalise formally in early 2012 agreements with Peru and Colombia, on which negotiations have already concluded.

Note (1): For Ireland, Latvia, Greece, Portugal and Romania, the only recommendation is to implement existing commitments under EU/IMF financial assistance programmes

Note (2): The number of crosses do not necessarily correspond to the number of CSR for each Member State as CSRs often cover more than one area.

Europe 2020 targets 53

*Countries that have expressed their national target in relation to an indicator different than the EU headline target indicator

(1) http://ec.europa.eu/economy_finance/eu/forecasts/2011_autumn_forecast_en.htm

(2) COM(2011)400 of 7.6.2011.

(3) Overview table in Annex 1.

(4) Overview table in Annex 2.

(5) COM(2011) 1151 of 7.10.2011.

(6) Provisional data.

(7) Digital Agenda for Europe (COM(2010) 245 final/2, 19.5.2010), Youth on the Move (COM(2010) 477, 15.9.2010), Innovation Union (COM(2010) 456, 6.10.2010), An industrial policy for the globalisation era (COM(2010) 614, 27.10.2010) An agenda for new skills and jobs. A European Contribution towards full employment (COM(2010) 682, 23.11.2010), A European Platform against Poverty and Social Exclusion: A European Framework for Social and Territorial Cohesion (COM(2010) 758, 15.12.2010), Resource Efficient Europe (COM(2011) 21, 26.1.2011).

(8) Annex on EU-level specific proposals, Annual Growth Survey 2012.

(9) http://ec.europa.eu/research/innovation-union/pdf/iu-scoreboard-2010_en.pdf

(10) http://ec.europa.eu/information_society/digital-agenda/scoreboard/index_en.htm

(11) http://ec.europa.eu/bepa/pdf/monti_report_final_10_05_2010_en.pdf

(12) COM(2010) 472 final of 20.9.2010.

(13) IDC Report, Sept. 2011.

(14) Civic Consulting (2011) "Consumer market study on the functioning of e-commerce".

(15) F. Etro (2010), "The economic impact of cloud computing" Review of Business and Economics.

(16) The TMR indicator comprises the cumulative volume of primary materials which are extracted from nature for the economic activities of a country. TMR indicates the material basis of an economy. It includes extraction from the domestic territory as well as the resource requirements associated with imports.

(17) "Further Benefits of Business Resource Efficiency", Oakdene Hollins, 2011.

(18) COM(2011) 658 of 19.10.2011.

(19) COM(2007) 860 final of 21.12.2007.

(20) COM(2007) 860 final of 21.12.2007.

(21) COM(2007) 860 final of 21.12.2007.

(22) COM(2007) 414 final of 18.7.2007.

(23) COM(2011) 370 of 22.06.2011.

(24) COM(2011) 571 of 20.9.2011.

(25) For example, a permanent one-percentage point reduction of the average tax burden on labour is estimated to increase the employment rate by about 0.4 percentage points in the typical country over the long run; OECD (2006), OECD Employment Outlook 2006 – Boosting Jobs and Incomes: Policy Lessons from Reassessing the OECD Job Strategy, Paris.

(26) COM (2011) 169 of 13.4.2011.

(27) COM(2011) 78 of 23.02.2011.

(28) http://ec.europa.eu/enterprise/policies/sme/market-access/internationalisation/index_en.htm

(29) http://ec.europa.eu/enterprise/sectors/ict/key_technologies/kets_high_level_group_en.htm 

(30) COM(2011) 311 and COM(2011) 315 of 1.6.2011.

(31) COM(2011) 152 of 4.4.2011.

(32) First meeting of the relaunched High Level Group on 10 November 2010.

(33) For instance by more than 15% in the middle of the distribution in Lithuania and Latvia, by 8% in Estonia and by 2-4% in Spain, Ireland and the UK.

(34) IMF (2011): World Economic Outlook Report 2011, Global Prospects and Policies, Washington.

(35) See OECD (2011) The impact of publicly provided services on the distribution of resources; Report for the European Commission.

(36) European Financial Integration Report 2008, SEC(2009) 19 final of 19.1.2009.

(37) C(2011) 4977 of 18.7.2011.

(38) For a more detailed analysis, see the supporting document to the 2010 Joint Report on Social Protection and Social Inclusion, section 5.2.

(39) The Indicators Sub-Group of the Social Protection Committee agreed on the 40% threshold has an indication of unsustainable housing costs overburden.

(40) See the Social Situation in the EU 2009 report section 3.2.1.

(41) See the Social Situation in the EU 2009 report, fig. 69, p. 138.

(42) Directive 2006/123/EC of the European Parliament and of the Council of 12 December 2006 on services in the Internal Market.

(43) 28% of EU citizens consider working abroad according to recent Eurobarometer surveys.

(44) Directive 2005/36/EC.

(45) IP/11/1283 of 27.10.2011.

(46) Meetings have taken place with Bulgaria, Cyprus, Latvia, Lithuania,Portugal and Greece.

(47) Austria, Czech Republic, Denmark, Estonia, Luxembourg, the Netherlands, Spain, Sweden and the United Kingdom.

(48) Cyprus, Finland, France, Germany, Greece, Hungary, Lithuania, Latvia, Poland.

(49)  See also the opinion of the Committee of Regions of 12 October 2011 on the role of regional and local authorities in achieving the objectives of the Europe 2020 strategy.

(50) National Strategic Reports are required under existing rules.

(51) ERDF, ESF, Cohesion Fund, Fisheries fund and Rural Development.

(52) COM(2011) 25 of 2.2.2011.

(53) The final national targets were set out in the National Reform Programmes in April 2011.

(54) The national emissions reduction targets defined in Decision 2009/406/EC (or "Effort Sharing Decision") concerns the emissions not covered by the Emissions Trading System. The emissions covered by the Emissions Trading System will be reduced by 21% compared to 2005 levels. The corresponding overall emission reduction will be -20% compared to 1990 levels.

(55) It should be noted that the national projections also vary as to the base year(s) against which savings are estimated.

(56) Calculation doesn't include ISCED 4 (Germany, Austria) , result with ISCED 4: 39.9 -40.4%

EUROPEAN COMMISSION

Brussels, 23.11.2011

COM(2011) 815 final

VOL. 4/5 - ANNEX III

ANNEX

DRAFT JOINT EMPLOYMENT REPORT

to the

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF REGIONS

Annual Growth Survey 2012

This year's Joint Employment Report, mandated by Article 148 TFEU, is part of the Commission package to launch the 2012 European Semester. As key input to strengthened economic guidance, the JER underpins and expands on key employment messages contained in the Annual Growth Survey. The analysis and messages it contains are based on the employment and social situation in Europe, the implementation of the Employment Guidelines 1 as well as on the results of country examination of the National Reform Programmes that led to the country-specific recommendations adopted by the Council in July 2011 and of their implementation so far.

1.Labour market and social trends

Slowing growth hampers the already weak employment recovery and prevents an improvement of the employment rate

Overall employment recovery has been slow and hesitant with employment growth remaining negative over most of 2010 for the EU-27 (-0.5%), and only turning slightly positive towards the end of the year. Employment gains of 1.5 million recorded by mid-2011 did little to offset massive job losses during the crisis, when 6 million jobs were shed. The weak and lagging response of employment to GDP growth was partly due to labour hoarding and the related slowdown of productivity used as adjustment mechanisms. Since GDP growth has decelerated during 2011 the prospects for employment are uncertain.

The EU employment rate declined by 1.8 pp during the 2008-2010 period with only few notable exceptions of Member States where employment rates increased (PL, DE, LU and MT). Underlying changes in employment rates were uneven between the various segments of the labour market. The most affected employment rates up to 2010 have been those of males in manufacturing and construction, low-skilled and notably young people where the negative trend has continued into 2011. The rate for women has been more gradually affected by the crisis. On the contrary, the employment rate of older people improved.

The increase in employment has mainly been within temporary contracts and part time jobs…..

The recent increases in employment levels have been mainly driven by increases in temporary contracts, unlike before the crisis when the increase was mainly in permanent contracts. Furthermore, employment increases in 2011 are also largely due to an increase in part-time jobs, whereas before the crisis employment mainly increased due to an increase in full-time jobs. This reflects companies' need to adapt to weak and uncertain economic conditions and outlooks.

The number of older workers on permanent contracts has continued to rise and increased by 4.7% in 2010 compared with the year before and by 7.9% (1.4 million more workers) compared with two years earlier. At the same time, the decrease in prime age workers on permanent contracts came to a halt in the first quarter of 2011 while the number of young people on permanent contracts continues to decrease.

Figure 1: Change in permanent jobs by age groups

The rebound of temporary and part time jobs is also benefiting mainly prime-age and to some extent older workers. Young people in particular are also left out from the increase of part-time jobs. Women are slightly over-represented compared to men in temporary work while the share of part-time workers is by far higher for women than for men.

Figure 2: Change in temporary jobs by age groups

…while the situation of young people has worsened

The youth unemployment rate rose from 15.5% to 20.9% between 2008 and 2010, while the inactivity rate rose from 55.6% to 56.9%. The increased inactivity of young people can be partly due to the fact that more young people returned to education or training in response to diminished work prospects. This would not be negative per se, in particular as long as education and training could improve their future labour market opportunities. However, the share of 15 to 24 year olds neither in education, employment or training (NEET) rose by 2 percentage points over the period 2008–2010. High youth unemployment and inactivity combined with ever more difficult school-to-work transitions in a period of persisting uncertainty for the young inevitably creates long-term risks of detachment from the labour market and of losses in human capital in the longer-term.

Figure 3: Change in the NEET as a % of population aged 15-24

Source: Eurostat, EU Labour Force Survey

Long-term and low-skilled unemployment are increasing across the Union…

The EU unemployment rate peaked at 9.7% during mid-2010 and after a small drop during the first half of 2011, it reached again 9.7%. Women have been facing higher unemployment rates than males the whole period, with a 9.9% unemployment rate in September (male unemployment rate was 9.5%). The situation is very diverse across the EU. Some Member States now record unemployment levels that are lower than before the crisis, whilst others are still at levels higher than 12%. For the period 2007-2010 almost three quarters of the increase in the number of unemployed in the EU can be attributed to just four Member States: Spain, UK, Italy and France. However, other MS also saw dramatic increases in the rates of unemployment, such as the Baltic countries, IE, EL, PT, SK and BG. Conversely, during the same period the unemployment rates have remained low in AT, NL and LU and in DE the unemployment rate has decreased.

After having temporarily fallen at the early stages of the recession, long-term unemployment (persons in unemployment spells of 12 months or longer) has started increasing in most Member States, reaching 43% of total unemployment in the second quarter of 2011. This indicates that the outflow from unemployment is getting slower.

The unemployment rate of low-skilled increased from 11,6% in 2008 to 16,6% on average in the first half of 2011. This indicates that low-skilled individuals face constantly decreasing labour demand. This is on the one hand due to the sectoral change towards higher technology and knowledge-intensive activities that is taking place in the economies. Nevertheless, it is coupled with the aftermath of the crisis, and the fact, that at lower rate of job creation, the competition is higher, and lower skilled individuals get substituted by higher skilled individuals.

These developments add substantially to the structural problems in the EU labour market and intensify social risks, notably by making vulnerable groups particularly prone to poverty and social exclusion as they are facing increasing marginalisation or difficulties to have a proper start in adult and working life.

… putting social safety nets under stress…

Large unemployment shocks have lead to a significant increase in the number of people having to rely either on unemployment benefits or social assistance. Between June 2010 and June 2011 the pressure on social assistance schemes has increased in many countries as workers dismissed at the height of the crisis exhaust their unemployment benefit entitlements. The persistence of high rates of long-term unemployment is likely to aggravate this trend further. In most European Countries, automatic stabilisers and the stimulus packages adopted at the beginning of the crisis have contributed to sustain households' disposable incomes overall. However, the disposable income of middle class households started to fall significantly in half of the countries for which data is available for 2009, with a risk of affecting aggregate demand. This is to some extent the result of the increase in polarisation in the labour market that started before the crisis and was intensified during 2008-2009, when jobs losses particularly affected middle wage levels in manufacturing and construction. In addition, the educational and skills profile in the new jobs structure tends to become more demanding, thus compromising the chances of reemployment and access to a well paid job for the low-skilled.

The revenues for pension schemes have dropped considerably as a consequence of increases in unemployment and part-time work and the stagnation of wages contribution. Moreover, the persistence of gender inequalities in the labour market represents a genuine obstacle hindering women from contributing to their pension. This has lead to a greater need for cross subsidy from general revenue and pointing to the danger of longer lasting deficits in contributory social security pension schemes. Efforts are therefore being made to adjust the timeframe for and the scale of the contribution from funded pensions to future pension adequacy or by reviewing the cost of tax concession to stimulate 2nd and 3rd pillar supplementary pensions as part of fiscal consolidation measures. In both cases this is likely to lower and delay the extent to which supplementary pensions in the future will be able to alleviate the pressures on public pensions.

…and accompanied by new risks of long-term exclusion

The crisis has led to increased risks of long-term exclusion from the labour market and society. Between 2009 and 2010 the share of children and adults living in jobless households (households with zero or very low work intensity) increased from 9% to 9.9% in the EU overall. The situation has significantly worsened with an increase of 1 pp or more in about half of the Member States . In 2010 the share of people living in jobless households exceeded 10% in seven Member States. Among such jobless households lone parents, mainly women, and their children are particularly at risk of long-term exclusion.

In most countries, social transfers have until recently allowed the protection of people at the lower end of the income distribution from the fall in incomes. However, available data for 2009-2010 show signs of rising poverty and deprivation in several countries. In 2010, the overall risk of poverty or exclusion, based on the three underpinning indicators of relative poverty, material deprivation and jobless households has started to increase again after several years of decline. In 2010, the at-risk-of poverty rate has increased by more than 0.5 percentage point in three Member States . Between 2008 and 2010, severe material deprivation has increased by 3 percentage point or more in four Member States and by 1 percentage point or more in two Member States. Increasing difficulties in facing necessary expenses are also reported by the population in general.

Some groups among those most affected by the crisis face increased marginalisation (migrants, the homeless, Roma). These groups will continue to be most vulnerable in the coming years. With the continuation of the crisis and the risks of increasing long-term unemployment with the predictable impacts on material deprivation and poverty, there will be continued demand for the use of social automatic stabilisers. However these systems are under increasing stress themselves in the context of fiscal consolidation programmes.

Participation rates remained largely unaffected…

The sluggish labour market has not in general led to a drop in participation rates and most of those becoming unemployed maintain links to the labour market. Nevertheless, the overall stability in participation rates hides diverging developments for women and men and across different age groups. Women have been increasing their participation, mostly due to the "added worker" effect (women stepping in to the labour market as a consequence that their partners lost their jobs) whilst the participation rate for men has been decreasing. The participation of older workers (both men and women) increased, reflecting the effects of increases in retirement age and the phasing-out of early retirement schemes, while the activity rates of young people have been constantly decreasing.

….but weak labour market functioning may further delay job creation…

The so-called Beveridge curve (which relates unemployment rates to job vacancies as indicated through labour shortage indicator in figure 4) shows that the increase in vacancies during 2010 and 2011 does not have an effect on unemployment and thus indicates that increasing labour and skills mismatches might have been taking place. The reduced capacities to match jobseekers to vacancies and to create jobs, shows the limits to the efficiency of European labour markets especially in a situation of increased need for smooth resource reallocation and rapid adjustment in response to major external shocks as those engendered by the economic and financial crisis. It indirectly points to the existence of inadequate ALMPs, skills profiles and mobility incentives possibly leading to increasing structural unemployment.

Figure 4: Beveridge curve for the EU showing the relation between job vacancies and unemployment

….and educational outcomes are inadequate to meet labour market needs 

Education policies are essential to equip people with the right skills for the labour market. In 2000, 22% of employed people had high qualifications in the EU while 29% had low qualifications. In 2010, it was the reverse. By 2020, 35% of jobs will require high qualifications and only 15% will require low qualifications. However, educational outcomes fall short of this growing skill-intensity of available jobs. In 2010 one out of seven (14.1%) young persons aged 18 to 24 in the EU left the education system with no more than lower secondary education and participates in no further education and training (early school leavers) and many have qualifications that do not match with labour market requirements. Their unemployment rate in 2010 was at 53%; twice as high as the average unemployment rate of young people. Moreover, more than one fifth of all children do not fulfil basic standards of literacy and numeracy (measured at age 15).

Nominal unit labour costs broadly restrained…...

After having grown modestly in 2009, nominal labour costs growth 2 remained slightly positive in most Member States also in 2010. Notable exceptions to this trend were the Baltic States, IE and HU which recorded negative growth rates in both 2009 and 2010, and a few new Member States where wages grew strongly as the economy is still catching-up. By mid-2011 nominal labour cost started to list increasing growth rates also in some other Member States, especially in DE, while they continued to grow at a low pace in many other Member States. If sustained, such asymmetric developments in unit labour cost between "surplus" and "deficit" Member States may be pointing towards reduced macroeconomic imbalances at EU level.

The almost general negative productivity growth of 2009, which largely reflected the economic slowdown and short-time working arrangements (that resulted in a larger drop in GDP than in employment), came to a halt in 2010. Last year annual labour productivity per person employed recorded a growth in all Member States, except in the case of EL (-2,4%) . Notable was the outcome in DE, where year-on-year labour productivity growth increased from -5.2% in 2009 to +3.2% in 2010.. Though productivity growth remained robust for all Member States (with the exception of EL, where productivity still decreased) in the first quarter of 2011, it started to slow down in most Member States in the second quarter of 2011, reflecting a weakening economy.

As a result of these developments, in 2010 the euro area as a whole recorded a decline in the nominal unit labour cost for the first time since 2001. Most noticeable was the drop recorded for DE, down from a 5.5% growth in 2009 to 1.1% decline in 2010 - primarily reflecting a sharp increase in its labour productivity. Similar pattern is to be found in DK and NL, while in EL the decrease in 2010 reflects a sharper drop in compensation then in productivity. Other notable decreases are to be found in IE, LV and LT, reinforcing the downward trend that they commenced in 2009. Nevertheless, due to the slowing productivity growth in the second quarter of 2011, second quarter nominal unit labour cost growth (+1,2%) exceeded the first quarter (+0,2%) in the euro area.

In 2010 the real unit labour cost, which measures the real wage relative to labour productivity (i.e. the labour income share), regained its negative growth momentum (namely, a decrease in the labour share of income), which had been briefly interrupted during the economic downturn when productivity fell sharply. In the first half of 2011 this downward trend in the wage share was maintained in most Member States. Notable exceptions to these developments are to be found in CZ and PL where real wage growth outstripped productivity growth.

…while non-wage labour costs remain job- hampering

The burden of non-wage labour costs on economic activity hampers job creation, particularly in the low wage segments of the labour market in some Member States although they vary considerably across the EU. These costs represent high barriers and obstacles for economic activity as they are seen as vital elements in the job creation with negative effects on especially low-skilled workers employment prospects. Moreover, the high tax-wedge and its interaction with the benefit system contribute to deterioration in the willingness to work among these groups.

Figure 5 Components of tax wedge at 67% of average wage in 2010

Source: OECD data for BG, EE, LT, LV, MT, RO, are for 2009

…and undeclared work continues to be present

Despite the difficulties in the formal economy, undeclared work continues to persist (and may even be more prevalent) and is estimated to represent more than 20% of the economy in certain Member States. The attendant loss of tax revenues is of course especially unwelcome in time of serious public deficits, but undeclared work is also implicated in general labour market segmentation, loss of workers' rights and the possibility of social exclusion.

2.Implementing structural labour market policies

The European Council of 24-25 March 2011 set out the policy guidance for Member States to submit their national reform programmes containing their plans for labour market reforms to achieve the EU headline targets set in the employment guidelines.

Based on proposals of the Commission, the Council adopted country-specific recommendations underlining areas in which Member States should undertake policy reforms in a number of areas within the overall framework of the guidelines for Employment Policies. These include: making work more attractive, helping get unemployed back to work, combating poverty and promote social inclusion, investing in education and training, enhancing the balance between flexibility and security, reforming pension systems, and improving educational outcomes and active inclusion of vulnerable groups.

2.1.Make work more attractive (Guideline 7)

Several Member States addressed challenges in their tax and benefit systems in order to make these systems more employment enhancing, albeit the limited fiscal room for manoeuvre may have put some limitations on the reform efforts. For benefits, the measures taken generally addressed the rationalization of systems; with taxation the burden on labour was reduced in some Member States.

Eight Member States received a country specific recommendation on either reducing the tax wedge on low/medium wage earners or shifting taxation away from labour with in order to boost employment. The few measures taken concern the removal of fiscal disincentives for the employment of particular groups in a targeted manner (BE) as well as initiatives to prolong the compensation for the gradual reduction of the tax credit for employees with low salaries in 2012 (HU). A small group of Member States have already adopted or made commitments towards shifting taxes away from labour in a general manner (DK, EE). Further efforts should be made to shift the tax burden away from labour, especially for vulnerable groups, low-skilled workers and/or second earners, towards less detrimental types of taxes or by re-profiling labour taxation.

Seven Member States received a country specific recommendation linked to wages. The majority of these concerned reforms of wage bargaining in order to ensure that wages evolve in line with productivity developments. Some concerned the more specific issue of wage indexation systems. Policy measures taken include commitments to decentralise wage bargaining (IT, ES) while other measures include commitments to review the wage indexation mechanism (MT, CY) coupled with a temporary and partial suspension of the mechanism (CY).

A recommendation to fight undeclared work has triggered new policy responses in the form of legal acts to combat illegal work contracts (IT). Other Member States have taken enforcement measures by increasing the focus on inspections (PL, CZ, BG) while one Member State has used ESF resources to fight illegal employment. Other Member States have taken own initiatives and focused on the regularisation of undeclared through fiscal rebates on housing renovations (ES). More efforts are needed to support a move from informal or undeclared work to regular employment, including initiatives to reinforce the detection of undeclared work and initiatives to reduce the financial incentives to informal work.

Fiscal pressures and the need to increase labour market attachment and prevent people from falling into benefit dependency resulted in increased rationalization of benefits in several Member States. Measures include governments' intentions to make benefits conditional on recipients' agreeing to participate in public works (CZ, HU). Other measures include plans for better targeting of social benefits (CY, SI). Yet other welfare reforms are aiming at incentivising work and ensuring that work pays (UK) by a lower withdrawal rate of social benefits and higher earning disregards (UK).

Some Member States have taken steps to cut unemployment benefits (HU, LT) while others have announced budget cuts to the childcare facilities subsidies (NL). There is still a need to reinforce the structure, efficiency and consistency of unemployment and social assistance benefit systems through better targeting and linkages to activation measures.

Eight Member States received a country specific recommendation on promoting gender equality or fostering better work life balance. The majority of these concerned the provision of adequate and affordable care services while as second group concerned improving fiscal treatment of second earners.

The policy response include announcements to improve or reform the provision of childcare (UK, PL, AT, CZ, NL) and all-day school places (AT) aiming at encouraging inactive and lone parents to work or at providing part-time working parents with the possibility of working longer hours. Other measures include initiatives to raise awareness regarding the equal treatment of women and men, for example by introducing an income calculator or a gender index (AT).

Two Member States have taken measures towards improving fiscal treatment of second earners for example by linking government's contribution towards childcare to the working hours of the less working partner (NL) or by introducing a state contribution to the cost of childcare to help decreasing the fiscal disincentives for second earners. Further efforts should be made to tackle the financial disincentives and the combined effect of tax and benefit systems, long parental leaves and insufficient or non-affordable care facilities.

2.2.Help the unemployed get back to work (guideline 7)

The targeting of active labour market measures needs to be stepped up to avoid unemployment to become structural and social exclusion to increase. Twelve Member States received a country specific recommendation on the implementation and scope of active labour market policies. The main part of these concerned reforms that would increase the effectiveness of the ALMPs including the targeting of particular groups. A smaller group concerned the improvement of the capacity of Public Employment Services in order to provide a better and more coherent service.

In line with the above some Member States are planning to reform ALMP-s as set out in the government's work programme (FI, PT, DE). Others have taken measures towards targeting actions on young people by proposing a so-called social guarantee for young people offering work, traineeship or training (FI) or through large-scale youth internship programmes (BG), by reforming the contractual arrangements for the training of young workers (ES) or by introducing new financial incentives for employers in order to increase the number of apprenticeships (LU).

Others have taken steps to address the situation of long-term unemployed (SK, EE, ES) by exploring the better use of ESF financed projects (EE, EL, PL) or resources from abolished exemptions of unemployment insurance contributions of older workers (AT). In some Member States long term unemployment is planned to be addressed through the creation of intermediate labour markets (SK).

Some Member States have opened up employment intermediation services to private employment services (ES) while others are set for a tripartite renegotiation of the functioning and services of their PES and others again are introducing training "vouchers" that would allow job seekers to choose training providers (LT).

As to combating youth unemployment and improving young people's access to the labour market, a number of Member States have favoured a further development of alternating traineeships for young people.

2.3Combat poverty and promote social inclusion (guideline 10)

Member States have put in place monitoring tools to assess the social impact of the crisis and specific measures have been put in place to contain the negative effect thereof for example by a simplification of social welfare and assistance systems and the adaptation of benefit and/or eligibility conditions of social assistance. Also specific reform measures to prevent the negative impact of fiscal consolidation measures in different countries often based on ex-ante social impact assessments of these measures have been very valuable. Some MS also looked at how other policy areas (energy, housing, transport etc) could be mobilised to alleviate the impact of the crisis. There is a need to extend this to health care services in order to guarantee affordable access for low income and vulnerable groups, especially with regards to primary care, as well as chronic diseases and mental health-related services taken due account of the impact which budgetary measures in public health might have on poverty rates. Attention should also be paid to responsible crediting practices, in particular for vulnerable groups.

Measures to increase the labour market participation of specific vulnerable target groups including youth, immigrants and ethnic minorities were put in place in several Member States so as to prevent their long term exclusion from the labour market. Nine Member States received a country specific recommendation on combating poverty and promoting social inclusion. The majority of these concerned the question of integrating special groups better on the labour market while a smaller group directly addressed the magnitude of poverty or risk-of poverty. In this context specific attention to improving the situation of the working poor in Europe (8.4% of the EU population) has to be given in particular through active inclusion policies that facilitate adaptation to change and safeguard worker skills and productivity

Policy responses include proposals to increase the employer subsidies granted in the framework 'Win Win' plan to specific target groups (BE). Some Member States have launched integrated operations (ESF and ERDF) for a transition from institutional to community-based care for children and for developing new social housing options for Roma (BG).

Other Member States have taken steps to address the situation of immigrants through improvements to the reformed introduction system to the labour marked for newly arrived immigrants notably as regards language training (SE). Others have taken actions aimed at facilitating the recognition of degrees, offering second-chance schooling for young adults and setting up mentoring and training programmes for women (AT).

2.4Invest in education and training (guidelines 8 and 9)

General measures to reform education and training have been taken in a number of Member States targeted notably at young people, the unemployed and immigrants. Other reforms seek to anticipate skills needs or to increase the quality and access to vocational training. In view of the current challenge represented by youth unemployment, it is imperative to modernise education and training systems to ensure that they effectively equip young people with relevant skills and competences. A number of countries need to ensure that their secondary education and training systems effectively create the conditions for students to access successfully tertiary education or provide the specialised skills that permit a direct access to the job market. University governance should reward incentives for the students and the teaching and research staff, ensure a good adaptation of curricula to changing labour market needs and provide the basis for a stronger link between research and the business environment

This requires also better anticipating future skills needs and strengthening cooperation between educational institutions, businesses and employment services, drawing on the work of sectoral skills councils at national and EU levels. As part of smart fiscal consolidation, investments in education and skills should be given priority, while reinforcing the efficiency and effectiveness of education and training systems and ensuring that reforms increase the labour market relevance of education.

To fight early-school-leaving, some Member States have stepped up preventive measures, by introducing a compulsory pre-school year (AT, BG, CY, DK, EL, HU, PL, RO) while a large majority took intervention measures aiming at supporting individuals for example through mentoring or tutoring. In line with the 2011 Council Recommendations on policies to reduce early school leaving, such measures have to complement compensation measures such as second chance education for those who left education and training early.

Many Member States seek to increase tertiary educational attainment through a broad range of measures often focusing on widening access to currently under-represented groups. Measures include direct financial support, guidance and counselling or preparatory courses with many countries offering targeted support to low-income groups (BE, FR, PL, CY, RO) or students with a migrant background (BG, BE, NL, DK, EE, FI, GR). Some Member States have taken specific measures to increase completion rates, e.g. by helping students at risk of dropping out by guidance and counselling (FR, LU, NL, SE, SI). Reforms have to address the two-fold challenge of increasing the number of successful graduates, while maintaining and enhancing the quality of education and research.

A few countries have launched reforms in the area of Vocational Educational and Training (PL, SK, CY, EE) by making their education and training systems more responsive to existing and forecasted skills needs (BE, FR, EL, ES, FR, HU, IE, IT, RO, SK, SI, UK). A stronger labour market orientation in the vocational streams is needed together with the creation of sufficient vocational training pathways especially apprenticeships, in cooperation with social partners.

A number of policy initiatives have been taken to respond to the country- specific recommendations given to 16 Member States concerning investment and reforms in education and training

Among the Member States for which early school leaving was highlighted the initiatives taken include to prevent school drop-outs by for example initiating Youth Coaching projects (AT), further expanding the New Middle School (AT) or by supporting people who left school early to catch up and obtain necessary certificates (AT, BG). Measures were also proposed to channel students at risk of early school leaving towards interesting career paths through vocational education training and the diversification of the offer of schools and programmes (MT). Others have proposed social clauses for public procurement contracts in order to guarantee apprenticeships for youth in the vocational education system (DK).

However, there is scope to stepping up preventive and early-intervention policies, targeted at those at risk of dropping-out of school, including by boosting the capacity and quality of early childhood education and care facilities, providing more individualised learning approaches, better targeted support for pupils at risk of dropping out, early warning systems and extra curricular activities to broaden opportunities for learning and personal development. . Also, enhanced attention is required to the labour market relevance of the educational outcomes of migrant children.

Another area for policy responses is reform in higher education to align provision better with labour market needs. Measures include for example a higher education reform programme "Partnership for knowledge" (PL) or the introduction of a "university technical colleges (UTCs)" in collaboration with employers and universities (UK). Other Member States have adopted measures in order to facilitate access to vocational education (ES).

New strategies on lifelong learning were presented in some states (AT, PL, SK) and renewed in others (EE), while others have started a national dialogue and prepared a white book (LU). It is important to continue promoting up-skilling and lifelong learning, with particular emphasis on unemployed young people and adults with low or obsolete skills, and to involve enterprises and local authorities in partnerships to ensure that up-skilling addresses local labour market specifics.

2.5Balance security and flexibility (guideline 7)

General measures to address the balance between security and flexibility were taken in a number of Member States notably as to review unemployment and social benefits, combat labour market segmentation and reform existing legislation on minimum wages or strengthen compliance with minimum wage provisions and undeclared work. Improving the implementation of flexicurity in a comprehensive way remains a priority for most Member States' labour markets.

Five Member States received a country specific recommendation on the functioning of the labour market and on combating segmentation. The focus of the recommendations varied considerably with reform of the EPL to reduce segmentation between people on temporary contracts and open ended contracts being the main thrust.

Two Member States have provided a policy response including legislative reforms aimed at reducing labour market duality, strengthening internal flexibility and improving employment opportunities for the unemployed (ES) or a law on "Employment Support Measures" to strengthen the second level of bargaining (IT).

Other countries have adopted the legal basis regulating the functioning of Temporary Employment Agencies (LT) or increased flexibility of their labour market through reforming their Labour Code (SK). It is necessary to ensure that people on temporary and part-time employment contracts have adequate social protection coverage, notably by allowing them to acquire decent pension entitlements and that the framework conditions are set to enable them to progress in the labour market, including through the possibility to revert to full-time work, to make a career and to have access to training.

2.6Reform pension systems (guideline 10)

General pension reforms have taken place or are under preparation in a number of Member States (CZ, DK, CY, LT, NL) while reforms related to cross-boarder pensions have taken place in others (MT, PL). A number of Member States have taken steps to limit or discourage early retirement (CZ, LT, PT).

19 Member States received at least one recommendation related to pension systems. In most cases the recommendations were about either increasing the effective retirement age or about increasing the statutory retirement age and linking it with life expectancy. About half of these have so far provided a policy response or a commitment to address these.

Some countries have proposed, decided or implemented reforms that will limit access to early retirement for people with a long insurance period (AT, ES). Others have taken steps to improve the fiscal sustainability by increasing the statutory retirement age (LT, CZ) or by raising the incentives for labour market participation (ES).

One Member State has taken important steps to reform the early retirement scheme (DK). Member States have taken steps towards implementation of planned pension reforms including restructuring public pensions and measures to increase contributions by public sector employees (CY). Others have proposed a partial transfer of contributions to private funds (CZ), or initiatives to increase gradually the pension eligibility requirement related to years spent working (BG) or to link the retirement age to life expectancy and to raise the state pension age to 66 (NL). Further actions are needed to develop frameworks of incentives and opportunities for longer working lives for women and men to accompanying the rising of the retirement age, while ensuring adequate minimum income provisions to avoid and mitigate the risk of poverty and material deprivation to vulnerable older people.

3.Structural labour market reforms to support growth

The analysis of the previous sections suggests that, while the 2011 priorities and measures remain broadly valid and implementation of the corresponding reforms is far from finished, it is necessary to deploy additional efforts in certain areas.

Job creation capacity has to be stepped up to ensure a job-intense recovery that underpins economic growth and the reduction of unemployment. Although in a long-term perspective new jobs opportunities are first and foremost a consequence of strong economic growth and suitable macro-economic policies, job-friendly business and supportive labour market policies following the principles of flexicurity can also contribute to stimulate growth in the short term. Improving the quality of business and financial support systems, including to social enterpreneurship, is essential. Measures to move from informal or undeclared work to regular employment should be reinforced. Supporting geographical and occupational mobility and increased cooperation between employers and employment services can avoid that job openings remain unfilled due to labour shortages and skills mismatches. Properly designed social protection systems, including adequate coverage for all employment contracts and self-employment can minimise precariousness and make activity more attractive.

The difficult situation of young people risk creating unrecoverable damage to the labour market and calls for implementation of comprehensive frameworks in line with the Youth guarantee. The youth unemployment rate has risen sharply between 2008 and 2010, at a time when also the share of young neither in education, employment or training have soared. There is a real risk that EU might lose the competencies of a whole generation of young people with the consequent negative impact on employability. In line with the Youth Guarantees 3 approach, comprehensive policy frameworks are needed to secure the transitions from education to work, encompassing skills building, apprenticeships and internships, targeted job-search assistance and career-guidance. In this current juncture the greatest attention should therefore be given to establishing partnerships between education and labour market institutions, social partners and businesses in particular at the regional and local level, where relevant supported by EU funds.

High unemployment rates and dim employment prospects call for effective active labour market policies mutually supported by adequate benefit systems to maintain employability and help people get back to work. The large number of people in long-term unemployment deserves the highest attention since long periods of non-work may lead to discouragement and a depreciation and obsolescence of the skills, with negative implications for individual earnings prospects and potential growth. Retraining and work experiences targeted to long-term unemployed can help sustain their employability. Efficient and effective Employment Services, supported by local partnerships, need to provide more personalised activation and job search support, effective job matching and ensure coordination with social assistance support.

The social situation has deteriorated throughout recent months calling for additional measures. There is a need to ensure that the most vulnerable groups and those most hardly hit by the crisis are protected against the redistributive effects of the economic crisis and the fiscal consolidation plans. The spiral of unemployment and degradation of social conditions should be prevented by all means. The efficiency of social protection systems should be enhanced to guarantee that they continue acting as buffers against poverty and social exclusion. Active inclusion strategies encompassing labour market activation measures, adequate social services and income support are essential to prevent marginalisation of low income and vulnerable groups. Smart consolidation should give priority to maintain minimum pension levels and guarantee health care access for the most vulnerable groups.

Increasing skills mismatches and shortages hinder economic activity in the short run while investing in education and training will raise productivity and income levels in the long run. Skills and competences are a prerequisite for growth through innovation, productivity and high employment. In particular, it is essential to increase the number and quality of science, technology, engineering and maths graduates, as well as to promote additional skills and competences e.g. entrepreneurial, creative and innovation skills. The current budgetary context calls for prioritising investments in education and skills that modernise education and training systems to reinforce their efficiency and effectiveness. Preventive and early-intervention policies, targeted at those at risk of dropping-out of school, and increased labour market relevance of education help reduce unemployment and social exclusion and improve labour market outcomes. Sectoral skills councils at national and EU levels can strengthen cooperation between educational institutions, businesses and employment services to better anticipate skills change and provision.

(1) Official Journal L308/46, 24.11.2010, “Council Decision of 21 October 2010 on guidelines for the employment policies of the Member States (2010/707/EU)”

(2) Measured as changes in compensation per employee.

(3) As proposed in the Youth on the move initiative:.

EUROPEAN COMMISSION

Brussels, 23.11.2011

COM(2011) 815 final

VOL. 5/5 - ANNEX IV

ANNEX

GROWTH-FRIENDLY TAX POLICIES IN MEMBER STATES AND BETTER TAX COORDINATION IN THE EU

to the

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF REGIONS

Annual Growth Survey 2012

For the first time this report on "Growth friendly tax policies in Member States and better tax coordination" forms part of the Commission package to launch the European Semester 2012. The present report also follows-up on the European Council conclusions of 24 June 2011 which asked the Commission to report back by December 2011 on progress made in the structured discussions on tax policy issues in the context of the 'Euro Plus Pact' ( 1 ), notably to ensure the "exchanges of best practices, avoidance of harmful practices, and proposals to fight fraud and tax evasion." As a key input to the strengthened economic guidance, it should further pave the way for tax cooperation to develop more efficient tax systems in order to emerge from the crisis in a better and faster way. Elaborating the essential messages contained in the Annual Growth Survey, the report should also support the Member States to deepen their structured discussions on tax policy coordination, in a consistent and efficient way, in coherence with the recommendations defined or to be defined in the context of the European Semester ( 2 ) and the objectives of the Europe 2020 strategy.

1.Context

Taxation is particularly important in the current economic context in which Member States need to speed up their consolidation efforts. Member States have to consider revenue-raising measures, while at the same time preserve a still fragile European economic growth. Better tax coordination at the EU-level has a role to play in this context as it can be beneficial both for addressing common challenges and achieving national policy goals.

Enhancing the quality of taxation in the context of the European Semester of economic policy coordination will help them to achieve the balance between revenue raising and growth. The Country Specific Recommendations adopted by the Council on 12 July 2011 and closing the first European Semester highlight the importance of further tax reforms that give priority to growth-friendly sources of taxation while preserving overall tax revenues. Lowering taxes on labour to make work pay is singled out as a potentially important issue. The exchange of best practices and an enhanced dialogue between the Commission and Member States could be particularly helpful in this context. The need to improve the quality of taxation has further increased in the meantime hand in hand with the need to pay attention to the overall quality of fiscal consolidation and its impact on growth.

The European Semester process considers tax policy reforms at the level of Member States with a view to supporting economic growth and fiscal sustainability. At the same time, the exchange of best practices would strengthen the European Semester in the area of tax policies, benefit all Member States and provide helpful guidance on how to take common steps towards more sustainable, growth and jobs friendly tax systems, while meeting the need for substantial fiscal consolidation, removing distortions which contribute to macroeconomic imbalances and keeping their (re)distributional abilities.

Tax coordination is particularly needed in cases that involve cross-border issues. It can help to improve the efficiency of the Internal Market, given that some of the most important obstacles remaining in the internal market currently stem from uncoordinated tax policies of Member States. The integration of the EU single market, and the mobility of certain factors, mean that taxation influences economic agents' cross-border decisions. Mismatches between national tax provisions may act as barriers and prevent citizens and businesses from fully reaping the benefits of the integrated market. ( 3 ) Moreover, coordination can also help supporting the implementation of national growth-friendly tax policy strategies, for instance when it leads to the elimination of harmful tax practices and the prevention of fraud and tax evasion. Joint effort in fighting tax fraud and evasion can secure Member State's tax bases and help raising revenues without increases of the tax burden.

2.Tax Policy challenges in Member States to be adressed in the European Semester

EU Member States are currently facing two overarching challenges in the area of tax policy. The first challenge is combating tax fraud and evasion, reducing tax gaps and improving the efficiency of tax collection which can play an important role in raising additional revenues. The second challenge is improving the growth-friendliness of the overall structure of taxation which is an important element of the universal challenge to enhance the growth potential of the EU economies. While this is a goal per se, it is also a condition for making public finance sustainable. In addition, many Member States need to improve the design of individual types of taxes, inter alia through broadening tax bases, and to enhance tax compliance and administration. Where successfully tackling these challenges still leaves the need for extra revenue, increases in tax rates might be necessary to consolidate public finances.

This section draws on the findings of the recently published Commission report 'Tax reforms in EU Member States 2011'. ( 4 ) It employs a horizontal screening based on macroeconomic indicators, to tentatively identify the above-stated tax policy challenges in individual Member States. With a view to delivering feasible policy advice tailored to the needs of individual Member States, this preliminary assessment of national tax policies needs to be complemented by relevant country-specific evidence of more microeconomic or qualitative nature.

2.1.Contribution of higher tax revenues to consolidation

The consequences of the financial and economic crisis are, and will be, deeply reflected in Member States' government revenues. Having implemented a wide range of tax stimulus measures over the period 2008-10, the focus of tax policy has now clearly shifted towards a much needed consolidation of public finances. Some Member States could consider increasing tax revenues – as a complement to expenditure control – to consolidate their public finances. This is particularly relevant for countries that show unsustainable budgetary situations but, at the same time, have room for potential tax revenue increases. Research shows that revenue-based consolidation is more likely to be successful when the initial tax-to-GDP ratio is low. As a first priority, the need to increase tax revenues might be addressed by improving tax compliance and administration rather than by discretionary tax hikes. Where tax compliance is already high and/or revenue raising needs cannot be met by enhancing tax compliance alone, increasing the efficiency of taxation through base broadening measures such as reviewing tax breaks and reduced VAT rates should be considered (see section 2.3). As a last option, raising tax rates or introducing new taxes might be unavoidable in some cases. In gauging the appropriateness of tax-based consolidation, the availability of 'tax space' needs to be examined alongside the analysis of i) whether revenue raising measures have already been utilised extensively in the recent past and ii) whether there is scope for increasing revenues from tax categories least detrimental to growth. In selecting priorities for tax-based consolidation, Member States will most likely want to set their choices as a function of their available fiscal room for manoeuvre, their business cycle position and other microeconomic or institutional factors.

2.2.More growth-friendly tax structure

Potential for tax shift

A high tax burden on labour, especially on vulnerable groups, combined with low indirect and consumption taxation may indicate a need for rethinking the structure of a tax system. Economic literature points to the importance that tax composition plays for economic growth and suggests a ranking of the main categories of taxes with regards to growth, with taxes on immovable property being the least distortive to growth, followed by consumption taxes (including environmentally-related taxes) and, finally, income taxes (on personal and corporate income) being the most harmful.

As already stated by the 2011 AGS, shifting taxes away from labour should be a priority for most Member States in order to stimulate demand for labour and create jobs. In particular, the participation rates for low-income workers and second earners are worryingly low, reflecting the need to make work pay for these vulnerable groups. Reforms of tax and benefit systems are also called for in order to facilitate the participation of second earners in the labour market and to reduce undeclared work and benefit dependency.

The analysis in the 'Tax reforms in EU Member States 2011' report ( 5 ) of the potential to make the tax structure more growth-friendly suggests that some Member States might enhance economic growth by shifting their tax structure away from labour (personal income tax and social security contributions). Some Member States have recently shifted to some extent the tax burden towards consumption taxation, mainly by increasing VAT rates and excise duties. However, in a number of Member States, a high tax burden on labour is still matched by a relatively low share of revenues from consumption and other indirect taxes. Increasing consumption, environmental and/or housing taxation could be a way to alleviate the high tax burden on labour, while enhancing the growth-potential of the economy. Any reduction in the tax burden on labour should be focused on low-skilled workers and/or second earners, given that these groups often face particularly high disincentives to work while displaying a rather high elasticity of labour supply with respect to labour earnings.

A re-profiling of labour taxation across income levels could also be considered. To enhance labour mobility and the efficient allocation of the housing stock, rebalancing housing taxation away from transaction towards recurrent taxes might be warranted. Increasing environmental taxes could also be considered, as they can contribute to fiscal consolidation through their medium term effects on growth, income, productivity and tax receipts ( 6 ) without losing sight of the fact that their tax base remains in general fairly modest and their primary goal is to correct environmental distortions.

Given that empirical studies tend to show that corporate taxes are the most detrimental to economic growth in general, Member States with a relatively high tax burden on corporate income should try to avoid increasing corporate tax rates at the current juncture. By changing the risk-return profile of entrepreneurial decisions, taxes on business profits may distort the capital accumulation and depress investment.

2.3.Broadening tax bases

In addition to the broad macroeconomic challenges for sustainability and growth discussed above, a number of more specific challenges related to the design of individual taxes deserve particular attention with a view to increasing the efficiency of taxation. This applies in particular in cases where tax bases have been eroded by unjustified tax breaks and wide use of reduced tax rates. As mentioned above, rather than increasing tax rates (further), broadening tax bases should be high on the agenda to meet revenue-based consolidation needs.

Re-examining and reducing tax expenditure in direct taxation

The level of tax expenditures in direct taxation is an indication of the broadness of the tax base. Tax expenditures, which are de facto subsidies, are deductions, exemptions and deviations from a broadly-defined tax base. While they can be justified by equity and redistribution purposes, to correct externalities or to create positive or negative incentives, they often constitute unjustified preferential regimes that create economic distortions and lower the efficiency of the tax system. Cutting tax expenditures in personal and/or corporate income taxation broaden the tax base and reduce the complexity of the tax system. This could allow for raising additional revenues at constant (or even lower) tax rates. In addition, the reduction of compliance burden deriving from taxation could greatly improve the business environment. This implies increasing transparency and reducing complexities of tax codes and compliance regulations, simplifying payment procedures, including through the use of e-government, and ensuring the stability of taxation legislation.

Raising VAT efficiency

VAT accounts for the majority of consumption taxation. Limiting VAT exemptions and the application of reduced rates, in respect of the VAT directive (2006/112/EC), will be instrumental in broadening the tax base and increasing overall tax efficiency ( 7 ). In many Member States, actual VAT receipts are far below the level that could theoretically be collected if a uniform consumption tax was established (see Graph 2 for average EU / EA values). In practice, the existing VAT system is far from uniform, mainly reflecting social policy objectives, which could be achieved more efficiently by other policy instruments. Member States apply widely differing VAT rates, thereby creating a highly diversified and complex VAT system.

Relatively low VAT revenues could also be due to tax fraud and evasion, the so-called 'compliance gap' which is particularly relevant for some Member States. Increasing VAT efficiency and compliance, through the removal of reduced rates as well as fighting tax evasion and fraud could substantially improve revenue collection and reduce economic distortions in many Member States.

2.4.Better design of individual taxes

The 'Tax reforms in EU Member States 2011' report identified two other specific issues relevant for increasing economic efficiency in many Member States.

Reducing debt-bias in corporate and housing taxation

Corporate income tax systems and the taxation of housing investments in Member States lead to a 'debt bias' in the financing of investment.

The debt bias in corporate taxation mirrors the fact that interest payments on corporate debt are deductible from taxable profit, while the return on equity is not. The welfare costs related to this debt bias might not be negligible. More importantly, excessive debt levels increase the probability of default and the recent financial crisis has proved that the costs of adjustment can be substantial.

The debt bias in housing is also due to the tax deductibility of mortgage interest payments (or even capital payments) in the personal income tax that provides incentives for building up debt and overinvestment in housing, i.e. a misallocation of resources at the expense of (more) productive investment. This type of tax relief is considered to have contributed to the increase in housing prices and debt leverage, and thereby to the housing market bubble. There is evidence that countries that favour homeownership through a favourable tax treatment of mortgage debt financing also have higher ratios of mortgage debt to GDP.

Both debt biases lead to households' and businesses' financial decisions in favour of increased leverage being driven by tax incentives and not based on economic grounds. These distortions increase risk and volatility in the economy and can accentuate negative economic outcomes in cases where such risks materialise.

Developing environmentally friendly taxation

Given the context of austerity measures and budget consolidation, it seems extremely difficult to undertake environmental policy measures on the expenditure side of the budget. Thus, it is important to utilise the taxation framework as efficiently as possible in environmental policy. Environmentally harmful tax subsidies should therefore be phased out, while environmental taxes need to be properly designed. Of particular concern are subsidies to energy consumption via reduced VAT rates, tax favourable treatment of companies' cars ( 8 ) and inconsistent prices for CO2 emissions (e.g. reducing the implicit subsidies for diesel). The existence of these in many Member States ( 9 ) calls for rethinking the structure of environmental taxation in order to ensure proper incentives for environmental protection and better reflect the corresponding welfare losses. Moreover, to achieve a socially optimal level of environmental taxation, to benefit from the experiences of those Member States that have made intensive use of environmental taxes and to contribute to a level playing field for EU businesses, EU wide and international coordination should be enhanced.

2.5.The role of the European Semester and the exchange of best practices

An enhanced dialogue between the Commission and EU Member States can help support the quality of policy guidance in the context of the European Semester and can also help Member States to apply the policy guidance in an appropriate manner, taking due account of country specificities. Such an enhanced dialogue could take place in different fora:

In the context of the High Level Working Party on Taxation, the Member States should share their views both on process and substance so that timely and forward-looking draft reports can be produced, which can serve as roadmaps for future work in the field of tax policy coordination.

In the context of the Taxation Policy Group the Commission has had discussions with Member States on growth friendly design and assessment of taxes. It has also discussed some best practices, focusing in particular on the experience in shifts towards environmental taxes. More such exchanges should take place and could focus inter alia on tax administration issues to help Member States ensure better collection of their taxes.

In the context of the ECOFIN Council, in particular in the Economic Policy Committee (EPC) attached to it ( 10 ), technical discussions should take place on the horizontal principles of growth-friendly and sustainability-oriented policies and on the basis of country experience to further strengthen the methodological and analytical underpinning of tax policy guidance.

Good and reliable data will also have a key supportive role. It is required in order to analyse, evaluate and compare past and future tax reforms, as well as to facilitate an exchange of good practices. The work on exchange of best practices could be strengthened by (i) the further development of the European Commission's web portal ( 11 ) on the main features of national tax reforms, including the assessment of their effectiveness; and (ii) the identification of indicative targets when relevant.

3.Tax Coordination and EU legislation

Tax coordination within the EU or EU legislation, whose adoption can be considered expedient in areas particularly relevant for the good functioning of the internal market, can support the effort of Member States to make their tax system more growth friendly and improve the efficiency of tax collection.

Tax coordination and EU legislation are particularly relevant to address three different types of issues. First, tax coordination can contribute to removing obstacles to the Single Market and thereby creating a level playing field for businesses and individuals. Thus, coordinated tax measures can tackle double taxation as well as other tax measures which constitute cross-border obstacles on the Internal Market and for investment in the EU. Secondly, tax coordination can also play an important role in limiting and preventing non-taxation and abuse since such activities endanger the fairness and the efficient interaction between Member States' tax systems. This could lead to enhanced tax compliance and much needed additional revenue for national budgets. Finally, coordination can help prevent harmful tax competition and the ensuing "race to the bottom", reducing the capacity of Member States to tax mobile bases and forcing them to raise revenues from least mobile base, such as labour and especially low-skilled labour. This is likely to engender important distortions in terms of disincentives to work and higher labour costs for employers. Coordination could give back to Member States some useful room for achieving a better design of their tax policies.

The Commission has put forward several legislative proposals (see Box 1 below) that would, if implemented, improve the Single Market as well as the Member States' tax systems.

3.1.Harmful Tax practices and sound business environment

Harmful tax competition can only be addressed through international cooperation within as well as beyond the EU. The Code of Conduct on business taxation, a soft law instrument which does not provide a legally enforceable set of rules, has been instrumental in removing many harmful tax measures.

Recently, the Code of Conduct Group has started to discuss more horizontal issues. One example is the promotion of the Code principles towards third countries. Last year, upon an invitation by the Council, the Commission started discussions with Switzerland and Liechtenstein about the application of the Code principles and criteria in these two countries. Another issue aiming at limiting tax avoidance and evasion concerns the co-ordination of anti-abuse measures.

Moreover, the Commission believes that tax planning at firm level has become increasingly sophisticated in the past 15 years: instead of simply benefitting from preferential tax regimes of one country, some businesses engage in complex tax engineering whereby tax benefits are achieved through the imperfect alignment of tax systems of two or more countries. These developments have triggered a debate about the current and future role of the Code of Conduct Group. The effectiveness of the Code of Conduct Group would benefit significantly from a new impetus and from a reinforcement of its mandate. Priority should be given to reinforcing common work on harmful tax practices. In particular, the work of the Code of Conduct Group should be expanded, in particular to ensure that mismatches between tax systems do not lead to harmful results for tax administrations or business. In particular mismatches can create situations of double non-taxation which can be exploited to reduce Member States tax revenues and to provide unjustified advantages to certain businesses. In the current difficult times such loopholes, which also undermine the spirit of the Single Market, must be tackled. If results cannot be achieved by the end of 2012, the Commission will look to its right of initiative as a means of addressing these important matters.

In addition to fighting harmful tax practices, tax cooperation is geared towards removing the existing tax obstacles that still continue to prevent economic operators from reaping the benefits that the Single Market can offer. Double taxation has been singled out as one of the most damaging remaining impediments on the Single Market. Double taxation has many different facets and work to address elements of the problem is ongoing. For example, the Commission has set up a Forum of experts to find solutions to transfer pricing problems. In addition, it is examining the extent of problems of double taxation faced by venture capital funds with a view to finding solutions for these funds which can be a valuable source of finance for SMEs. Determined to tackle the remaining problems, the Commission has adopted a Communication on Double Taxation that highlights where the main double taxation problems lie within the EU, and which outlines concrete measures that the Commission will take to address them. In doing so, the Commission seeks to remove real obstacles to a more competitive economy and make the EU easier to invest and do business in. ( 12 ) One of the options being explored is a possible binding dispute resolution scheme to remove double taxation within the EU in a comprehensive manner 

Deeper market integration and elimination of distortions in the EU can also be achieved by finalising initiatives such as the proposal for a common consolidated base for corporate taxation. This scheme would offer the undertakings concerned the opportunity to opt for a common system, thereby avoiding important tax obstacles to cross-border activities. In addition, the adoption of the Energy Taxation Directive, which addresses shortcomings in the current directive would not only contribute to a true level playing field in the EU, but also facilitate a shift towards more growth friendly taxation. 

3.2.Anti-fraud and tax evasion 

A number of Member States faces the challenge of undertaking incentive-oriented policy measures to reduce tax gaps, by improving the efficiency of their tax collection and better preventing tax evasion. Firstly, the quality of administrative governance and a better understanding of taxpayers' behaviour are of key importance for optimizing the overall performance of the tax system and reducing tax administration costs. Secondly, the effectiveness of the enforcement activities will depend on the actual (staff and IT) resources put into detecting breaches of the rules, the penalties associated with violating rules and the control of the effectiveness of the enforcement process. The issue of good governance in the tax area has been discussed in the Taxation Policy Group and in the Council's High Level Working Party on taxation. A particular focus of the discussions was on how to improve transparency, exchange of information and fair tax competition.

Much work is being done at EU level, notably through the use of administrative cooperation provisions covering all areas of taxation. In the EU, the Member States should make the best use of existing tools to fight against tax fraud. In practical terms these activities can be supported by the Fiscalis programme ( 13 ) notably through joint actions to support cooperation between Member States. 

Moreover, within the EU, Member States are currently considering the revision of the Savings Directive so as to extend its scope and better ensure the taxation of interest payments which are channelled through intermediate tax-exempted structures. They are also considering the possibility of renegotiating the existing savings arrangements with third countries in line with the amendments to the Directive. The Council should now complete its work on the Savings Tax Directive and should quickly approve the negotiating mandates allowing the Commission to open discussions with third countries in this field.

Beyond the EU, the negotiations of EU agreements with third countries, such as Partnership and Cooperation Agreements (PCA) and Economic Partnership Agreements (EPA), should be an opportunity to ensure that third countries commit to the principles of good governance in tax matters. Initiatives to protect Member States against non-cooperative jurisdictions must also be part of the overall approach. Further work on good governance in tax matters in international fora such as the OECD and G-20 has been started. In order to retain the credibility of pressure on uncooperative jurisdictions the degree of coordination of the Member States' approaches should be strengthened. This could include a common application of countermeasures against those jurisdictions. This alignment of measures and greater coordination of Member States positions in international fora are essential in combating tax fraud.

In its recent Communication "Towards an EU Criminal Policy: Ensuring the effective implementation of EU policies through criminal law" the Commission has emphasised the importance of criminal law to ensure the effective implementation of EU policies. The Commission believes that working within this framework could be a step forward in tackling tax fraud, and in particular its cross border dimension. Hence, the Commission will examine how the framework established in its recent initiative in criminal law can be used to target strengthened measures against tax fraud.

4.Conclusions

Tax coordination and exchange of best practices are vital for growth and consolidation efforts, in particular in the current economic context where quality of revenue matters and where several Member States may need to consider revenue-raising measures. Many growth-enhancing tax reforms can be implemented individually by Member States. Enhanced dialogue between EU Member States can, however, prove beneficial in the implementation of national tax policy strategies, for instance when it leads to the exchange of best practices or the elimination of mismatches between national systems. In addition, some reforms benefit from coordination between Member States and EU legislation since cross-border spill-over effects may constrain the taxing capacity of an individual Member State.

The European Semester alongside various EU fora, allows for considering tax policy reforms in Member States with a view to supporting economic growth and fiscal sustainability, while establishing integrated economic policy coordination within the EU. An enhanced dialogue between Member States and with the Commission, including the exchange of best practices, could support the analytical quality of policy advice in the context of the European Semester, while taking due account of country specificities. It could and should take place in the existing EU fora, including the Council's High Level Working Party on taxation, the Taxation Policy Group and the ECOFIN network, in particular the Economic Policy Committee.

Coordinated actions at the EU-level and EU legal initiatives should make different tax systems more compatible with the Single Market and limit the negative spill-overs of national tax policies. They support the effort of Member States to make their tax systems more growth friendly, and contribute to removing substantial obstacles to the Single Market. EU legislative initiatives have been taken in areas particularly relevant for the good functioning of the Single Market, such as taxation of savings, energy and corporate income. In order to contribute to economic efficiency and deepen the Single Market, the Council is invited to finalise these proposals rapidly. Moreover, the future of VAT system deserves particular attention given its importance for the proper functioning of the Single Market. Fighting against tax haven and double taxation remain other key challenges, which require mobilising both existing and new instruments.

(1) ()The Pact for the Euro, later called Euro Plus Pact, to include non-euro-area members on a voluntary basis, was established by the Euro area heads of state and government on 11 March 2011 and endorsed by the European Council on 24/25 March 2011. The Pact stipulates that: "Pragmatic coordination of tax policies is a necessary element of a stronger economic policy coordination in the Euro area to support fiscal consolidation and economic growth. In this context, Member States commit to engage in structured discussions on tax policy issues, notably to ensure the exchange of best practices, avoidance of harmful practices and proposals to fight against fraud and tax evasion."

(2) ()A need for strengthening the European Semester of economic policy coordination to intensify surveillance of economic and fiscal policies and including the Euro Plus Pact into its procedures was identified in the Communication from the Commission on a roadmap to stability and growth, COM(2011) 669 final.

(3) ()Monti, M. (2010), A new Strategy for the Single Market.

(4) ()European Economy 5/2011 and Taxation Papers No. 28.

(5) ()ibid.

(6) ()Following the economic crisis, a number of countries have used higher environmentally related taxes as part of their fiscal consolidation strategies. Ireland is a clear case where higher fuel taxes, the introduction of a CO2 tax of EUR 15 per tonne (set to double to EUR 30 per tonne by 2014), and charges for water use comprise key elements in recent budgets.

(7) ()Unlike reduced VAT rates, most exemptions are not optional for Member States and laid down in the VAT Directive.

(8) ()According to estimations made for the Commission, favourable tax treatment of company cars leads to direct revenue losses close to 0.5% of EU GDP (€ 54 billion) and significant welfare losses of 0.1 to 0.3% of EU GDP (€ 12 to € 37 billion).

(9) ()European Commission 2011, Tax reforms in EU Member States 2011.

(10) ()The Committee was set up by a Council decision in 1974 to provide advice and to contribute to the work of the ECOFIN Council and the Commission. The core business of the Committee is structured around the following two interacting pillars: i) An economic policy pillar, which essentially refers to the Europe 2020 Strategy ii) A public finance pillar, where the EPC has particular responsibilities regarding quality and sustainability. Given the current economic situation, the EPC focus is on growth and jobs, in particular those reforms supporting competitiveness and adjustment capacity, as well as ensuring the sustainability of public finances.

(11) ()Tax reforms database.

(12) ()European Commission (2011), COM(2011) 712

(13) ()The Programme Fiscalis substantially supports tax coordination between Member States by providing a framework for cooperation between national tax administrations and further enhancing coordination between existing national tax systems. The proposed FISCUS 2020 programme aims at making national tax administrations more effective and efficient when dealing with cross-border transactions. Thus, they will be enabled to more successfully fight tax fraud and increase tax returns. 

EUROPEAN COMMISSION

Brussels, 23.11.2011

COM(2011) 815 final

VOL. 3/5 - ANNEX II

ANNEX

MACRO-ECONOMIC REPORT

to the

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF REGIONS

Annual Growth Survey 2012

Introduction

EU economic growth is faltering. In the euro area, this is exacerbated by the sovereign debt crisis and fragilities in the banking sector. These have created a dangerous feedback loop. The lack of confidence of the financial market has created volatility and undermined confidence in wider markets therefore weighing heavily on future economic prospects. After several years of crisis, there is very little further room for macroeconomic policies to boost growth. In particular, fiscal policy has been constrained in many countries by the high costs - or even the loss - of access to market financing.

In this context, measures to strengthen growth have become central. Growth-friendly fiscal consolidation is necessary in view of market pressure and policy challenges related to ageing. Robust banking sector and stronger financial backstops for the sovereigns are key to contain financial turbulence and hence for growth to resume. Structural reforms are critically important to enhance the EU economy's overall efficiency and speed up its capacity to adjust. In a positive feedback loop an improved growth outlook will support other objectives by enhancing confidence and boosting employment, contributing to fiscal consolidation and to the stability in the banking sector, as well as easing the situation in vulnerable countries.

1.economic situation and outlook: new headwinds

In the aftermath of the global financial and economic crisis the EU economy started to pick up. Growth was subdued, as is usually the case after financial crises, but the differences between Member States were significant. In particular, Member States with large accumulated imbalances embarked on a painful, but necessary adjustment, which weighed on growth. At the same time Member States free from major imbalances took advantage of the more resilient external environment and registered robust growth rates (Graph 1). These differences have been mirrored or even amplified in unemployment developments. In aggregate, however, the recovery has entailed only slow employment growth. While this partly reflects labour hoarding during the recession, employment growth has not been strong enough to reduce persistently high unemployment markedly.

These growth differences helped to significantly narrow the macroeconomic imbalances, in particular current account deficits, but the stock of accumulated debt remains large. Largely due to reductions in domestic consumption, the most significant corrections were recorded in Member States where external imbalances were the largest prior to the crisis (Graph 2). However, some structurally high current-account surpluses also appear to be coming down gradually, reflecting stronger domestic demand and dynamic imports. Nevertheless, further adjustment is needed in some Member States as the overall level of indebtedness continues to be high and progress in recovering cost/price competitiveness has been slow in some (notably euro area) Member States.

Fiscal imbalances continued to persist. Fiscal consolidation has started in 2011, as agreed among Member States in October 2009: the aggregate EU fiscal deficit improved by almost 2 percentage points from 6.6% in 2010 to 4.7% of GDP in 2011. Nevertheless, the debt challenge remains daunting. The debt-to-GDP ratio in the EU jumped by over 20 percentage points since 2007 and exceeded 82% in 2011 – the highest level on record. It is forecast to further increase to almost 85% of GDP in 2012 before stabilising at this level.

Financial tensions have deepened. Doubts about the sustainability of government debt in some euro area Member States has increasingly sapped investors' confidence since the early summer. This triggered bouts of heightened volatility on financial markets and a further strong rise in sovereign bond spreads of vulnerable euro area Member States relative to the benchmark (Graph 3). More recently, tensions have spread further to other Member States and yields of some triple-A rated sovereigns started to increase. The tensions spread to the banking sector, as European banks are the main holder of European government bonds. Finally, uncertainty related to policy choices in the euro area and in the US in the summer triggered a sharp correction on global financial markets, leaving them very tense ever since (Graph 4).

The recovery has now stalled in the EU. Financial turbulence and prospects of a global slowdown seriously undermined confidence in the whole economy weighing on consumption and investment. The necessary fiscal consolidation is putting a drag on growth. While resolute policy action to solve the debt crisis in the euro area should rekindle confidence, growth is not expected to pick up swiftly. Financing conditions are expected to be challenging going forward weighing on investment. The need to adjust the imbalances and deleverage both the private and the public sector will hold growth back for some time. Growth in the EU economy is expected to stall at the beginning of the 2012 and record only a meagre 0.6% in the year as a whole (Graph 5). Employment growth is expected to grind to a halt in 2012 and remain meagre in 2013. With weak job prospects the duration of unemployment has increased and there is the risk that unemployment becomes entrenched, with adverse effects on the contribution of labour to potential growth.

The current slowdown in growth adds to the long-term weaknesses in European growth. While there has been substantial convergence of income levels within Europe, the EU has ceased to catch up with the US over the past quarter-century. The moderate growth potential of the EU has been further weakened by the financial crisis. The Commission estimates show that the EU and the euro area in particular can be expected to lose further ground relative to the US in terms of growth and productivity in the coming decade. Over the next 10 years average annual growth rate in the EU is expected to be 1 percentage point lower than in the last decade and reach 1 ¼% only (Graph 6).

The gravity of the world economy is shifting towards very dynamic economies, which will make the global environment even more competitive. The role of emerging economies in the global economy has been increasing rapidly and is forecast to continue to do so. Although some of the open emerging economies have been also severely affected by the crisis, they have been recovering fast (Graph 7). Their development models are currently skewed heavily towards export sectors, and although this model cannot be sustained indefinitely and some gradual rebalancing can be expected in the long term, in the foreseeable future the intensity of competition in the world economy will continue to increase. In particular the export baskets of emerging markets have been climbing up the technology ladder, in some cases venturing successfully into sectors where Europe has traditionally held competitive advantage. Altogether, with the forecast slowdown in the global economy, this implies that the external environment will become increasingly challenging both in the short-term and the long-term unless the EU increases its competitiveness.

Dangerous negative feedback loops have developed in the European economy. First, investors' concerns about the sustainability of the sovereign debt burden in Europe have triggered the sovereign debt crisis and led to rising tensions in the banking sector, which holds large amounts of sovereign debt. In turn, the strains in the banking sector add to the sovereign risk as investors perceive Member States as an ultimate backstop for vulnerable financial institutions. Second, these tensions and existing imbalances in some of the Member States prompt both private and public sector to de-lever, which puts a drag on growth, while lower growth prospects further undermine debt sustainability. Finally, the tensions in the markets raise the interest rates for government borrowing, further undermining the sustainability of public finances.

All the elements of the negative feedback loop have to be tackled together, but growth plays a prominent role. A comprehensive reform strategy was agreed at the European Council on 26 October 2011 to ensure fiscal sustainability and rebuild trust in the European banking sector. Growth is a vital component of this strategy, having the potential to alleviate all the other challenges without creating side costs. More economic growth will create better conditions for the repayment of debt in the future. Expectations of higher growth will contribute to restoring confidence and stability on financial markets. With improved prospects, business will start to invest again. Finally, growth is an indispensable element of the European social model, which was created in the "golden years" of European growth. Preserving the current level of social protection will not be possible if growth remains on the current trend.

2.growth-friendly fiscal consolidation, public expenditure and revenues 

Public finances played a key stabilising role during the global crisis, but the price is higher debt. Since the onset of the crisis in 2007, government debt levels across the EU have increased from 59% of GDP in 2007 to an estimate of 82.5% of GDP in 2011. This increase is the result of a number of factors. First, the slump in economic activity during the crisis, led to an increase in general government deficits as automatic stabilisers were allowed to cushion the impact of the recession. Additionally, the unprecedented depth of the crisis triggered the European Economy Recovery Plan – a coordinated plan of fiscal measures to support the economy, launched by the European Commission in December 2008. Finally, some Member States were forced to grant targeted support to financial institutions to secure the viability of the financial system.

The projected increase in debt is not without precedent either in historical terms or among peers. Financial crises have proved to be fiscally costly in the past: they have led to large and persistent increases in the debt ratio. Moreover, while the current crisis has also led to a sharp increase in public debt in Europe, the increase and the level of debt has been even higher in other advanced economies, such as US and Japan than in the EU (Graph 8).

However, there are several aggravating factors at the current juncture, which put pressure on debt sustainability in the EU.

First, debt levels are currently higher than in the past, and particularly so in several Member States (Graph 9). In 2007, debt stood at above 60% of GDP for nine EU countries and exceeded 100% of GDP in the cases of Greece and Italy. Moreover, while the average foreseen increase of debt-to-GDP ratios projected between 2007 and 2013 is around 25 percentage points of GDP, there is wide cross-country variation, with increases in excess of 96 percentage points in Ireland, 90 percentage points in Greece and 40 percentage points in Spain, Portugal and the United Kingdom.

Second, the fiscal costs of ageing populations will be an increasing burden for public finances. Based on current policies, age-related public expenditure is projected to increase by about 4¾ percentage points of GDP over the next fifty years on average in the EU – especially through pension, healthcare and long-term care spending. However, again, the situation differs considerably across Member States, both in terms of demographic prospects, growth potential, design of pension and welfare systems, but also in terms of constraints related to the fiscal situation and external competitiveness.

Third, market pressure has reached unprecedented intensity. In view of the subdued growth prospects financial markets have had serious doubts about sustainability of the fiscal position of some euro-area Member States. This led to increases in interest for government borrowing and further to all the negative spillovers and feedback loops, described in the previous section.

Therefore, there is currently no viable option but to implement a comprehensive and credible fiscal exit strategy. Principles of such a strategy have been agreed by the ECOFIN Council and stipulate that consolidation should be coordinated across EU countries taking into account the specificities of country situations. It was agreed that consolidation in all EU Member States should start in 2011 at the latest, with a number of countries having to start consolidating earlier. As importantly, it was agreed that EU Member States would strengthen national budgetary frameworks and take structural measures that would lift potential output growth and thus support long-term fiscal sustainability.

The agreed exit strategy is delivering: the consolidation is underway. Budgetary plans presented by the Member States in the 2011 updates of the Stability and Convergence Programmes envisaged that the general government deficit would fall to below 3% of GDP in the EU in 2013. Implementation of budgetary plans is under way. Government finances in the EU started to improve somewhat already in 2010 on the back of both strengthening economic growth and first consolidation measures. A more noticeable improvement is being recorded in 2011 due to a broad-based consolidation effort in essentially all EU Member States. Further progress is expected in 2012 and – based on unchanged policies – in 2013, although at a somewhat slower pace. However, aggregate trends mask significant differences across countries. At present, 23 Member States are in the EDP, of which five are benefiting from a financial assistance programme. 1 Some Member States are making good progress towards a timely and sustainable correction of excessive deficits, while others exhibit adjustment gaps and need to step up their efforts to achieve the fiscal targets (Graph 9, Table 1).

Ensuring sustainability is currently the key factor affecting economic stability. Until mid-2011 the implementation of the fiscal exit took place against the backgroud of recovering economic activity. Growth, however, is forecast to come to a standstill next year. Nevertheless, the severe turbulences in the sovereign bond market imply that most Member States have no scope to allow higher deficits as fiscal sustainability has become priority. This is particularly the case for Member States being subject to close market scrutiny and those suffering from large fiscal macroeconomic imbalances (Graph 10). Insufficient consolidation risks causing higher risk premia, which would in turn be very damaging to economic prospects.

Therefore, consolidation should be differentiated across countries. Recognising the different situation across Member States, on 4 October 2011, the ECOFIN reiterated the principle that the speed of fiscal adjustment should be differentiated according to country specific fiscal and macro-financial risks. In particular:

Member States benefitting from financial assistance programmes and those under close market scrutiny should continue to meet agreed budgetary targets in spite of possibly changing macro-economic conditions.

Member States with a significant adjustment gap under the excessive deficit procedure or a high deficit, should step up their consolidation efforts. Possible limited downwards revisions of the main macro-economic scenario should not result in delays in the correction of excessive deficits.

In Member States which do not have an excessive deficit and that are on an appropriate adjustment path towards their medium-term objectives, budgetary policy can play its counter-cyclical and stabilizing role fully, as long as medium-term fiscal sustainability is not put at stake.

It is vital in the current economic context to ensure that the consolidation plans on both the expenditure and the revenue sides are designed to limit the negative short-term effects on growth.

Evidence shows that expenditure-based consolidations have a better chance of success, but the composition and quality of expenditure matters:

cuts in productive spending, notably capital investment, should nonetheless give priority to projects with the highest return in order to minimise the impact on growth potential.

efficiency of public spending in a given category of expenditure differs a lot across Member States, but also within the same country. This gives potential room for improvement: bringing the least efficient units up to higher standards could deliver large savings for the same volume of public services.

the need to prioritise expenditure and increase the efficiency of spending on all levels of government calls for developing appropriate supporting institutional tools within the budget, such as spending reviews, programme budgeting or performance budgeting. Equity considerations should be taken into account to ensure a fair distribution of the budgetary adjustment burden.

At the same time, the structure and design of taxation should be developed to better spur growth. Tax reforms can serve two aims: first, they can support the consolidation of public finances in those Member States where there is room for potential tax revenue increases and as a complement to expenditure control; secondly, they can support growth via changes in the structure of taxation or a better design of individual types of tax, which e.g. improve the incentives to work, produce, invest or raise resource efficiency. With regard to the structure of taxation:

Member States with heavy taxation on labour, especially for vulnerable groups, such as low-skilled workers and second earners, should shift taxation towards taxes which are less detrimental to growth, such as consumption, real estate or environmental taxes. A re-profiling of labour taxation across income levels could also be considered;

Member States with high corporate income taxation should avoid increasing tax rates further, especially in current times when investment performance is lacklustre;

To enhance labour mobility and the efficient allocation of the housing stock, rebalancing of housing taxation away from transaction towards recurrent taxes might be warranted;

Cutting tax expenditures in personal and corporate income taxation and limiting VAT exemptions and reduced rates, in respect of the VAT directive, will broaden the tax base, allowing for higher revenues and/or lower tax rates with a positive growth impact;

The incentives in many Member States for building private debt should be reduced in corporate taxation and the treatment of housing in personal income taxation.

Taxation can be made more environmentally-friendly in a majority of Member States by phasing out hidden tax subsidies.

Member States with weak tax compliance should improve the efficiency of their tax collecting administration and better prevent tax evasion.

Reduction of the compliance burden deriving from taxation can improve the business environment. This implies increasing transparency, reducing the complexity of tax codes and compliance regulations, and simplifying payment procedures.

Member States are encouraged to take full advantage of the instruments that facilitate cooperation between tax administrations to ensure the identification and sharing of best practices within the EU, the improvement in revenue collection and the reduction of compliance costs.

Urgent reforms are needed to address the challenges to public finances stemming from population ageing. There has been considerable progress in the last decade in terms of implementing reforms of welfare systems (pensions, but also health care), but a lot more needs to be done. The last Annual Growth Survey highlighted pension reform as an area for immediate policy action. For several countries where the pension reform process has not been set in motion and where large increase in pension expenditure is projected in the future, there is a need to align the 'pension promise' with what the rest of the economy can be expected to support. There is also a need to make health systems more cost-efficient, sustainable and prevention oriented to curb estimated cost increases due to ageing.

Raising pension ages to link them to life expectancy is of particular relevance. Increasing pension age would make up for some of the earlier longevity growth which has not yet been factored in pensions systems. Linking it then to life expectancy would help stabilising the balance between working years and years in retirement. In order to enable and encourage people to work longer, reforms in pension systems need to be underpinned by policies ensuring the effective integration of older workers in the labour market and policies to support active and healthy ageing and complemented with tax and benefit policies giving incentives to stay longer at work.

Implementation of country-specific recommendations is under way to improve long-term fiscal sustainability, albeit with varying speed and determination. Of the 17 Member States that received recommendations in this area, 12 have taken some action, including through reforming the pension system and through raising incentives for older workers to stay in the labour market. Raising the statutory retirement age and linking it to life expectancy based on an agreement between social partners and government has been an important step forward, although such agreements—on the agenda in a number of countries—have so far only been finalised in very few Member States. Action to monitor access to invalidity pension schemes and reform long-term care insurance has been limited.

Credible fiscal frameworks and effective surveillance mechanisms will strengthen long-term fiscal sustainability. The current dilemma between short-term stabilisation role for public finances and the investors' fears about debt sustainability in some Member States could be alleviated if credible commitments to fiscal sustainability are in place. If markets' expectations are firmly anchored in a credible medium-term path, investors will be less sensitive to the short-term fluctuation of fiscal aggregates, leaving more room for stabilisation policies. To anchor the expectations the role of national fiscal frameworks and EU fiscal surveillance is crucial in this respect.

Sweeping changes to the Stability and Growth Pact will increase the effectiveness of fiscal surveillance. In order to strengthen economic surveillance, a package of six legislative proposals on economic governance, proposed by the Commission in September 2010, will enter into force by the end of the year thus ensuring a reinforced legal framework for the EU economic surveillance and coordination framework as of 2012. The legislation will be a step-change in the way economic surveillance is conducted in the EU. But swift and rigorous implementation of the package is necessary to anchor market expectations, unwind fiscal and macroeconomic imbalances and lay the ground for sustainable economic growth (Box 1). 

A new Directive on minimum requirements for domestic budgetary frameworks has a potential to improve the budgetary processes on national level. The quality of the institutional and procedural arrangements governing domestically fiscal policy making, such as national fiscal rules, multi-annual fiscal frameworks and independent institutions, may significantly improve budgetary outcomes. In this respect, reforms spurred by the Directive have the potential to improve the conduct of fiscal policy at national level while promoting the respect of the SGP provisions. Member States should press ahead with its implementation by adopting the appropriate reforms in the areas covered by this Directive. Euro area Member States have a particular interest to speed up the transposition of the Directive into the national legislation and the October agreement in the euro area summit to go beyond these minimum requirements is welcome. In this connection, the domestic fiscal rules recently enshrined in the Constitutions of some euro area Member States go further than the provisions contained in the Directive (e.g. Spain).

Implementation of country-specific recommendations to improve fiscal frameworks is so far mixed. Eleven Member States had received a country-specific recommendation in this area. Recommendations spanned a broad range of issues, including the efficiency of the tax administration and revenue collection, the introduction of multi-annual budgetary rules and expenditure ceilings, the operationalisation of debt brakes, the role of independent fiscal councils as well as issues relating to budgetary data and transparency more broadly. At this stage only five out of the ten Member States have made clear progress. Actions taken concern introducing balanced-budget- or debt brake rules with constitutional status, strengthening the powers of central fiscal authorities to improve the predictability of budgetary planning, and the establishment or strengthening of independent fiscal councils. Where implementation is under way, it is still at an early stage of the legislative process but goes in the right direction.

Coordination of economic policies will have to be strengthened further, particularly in the euro area. The European Semester and the "six-pack" already provide a strong governance framework. Nevertheless, there is still need and room to strengthen the governance framework further, including its Community dimension. There should be a stronger euro-area dimension in the planning, implementation and ex-post assessment of Member States policies to ensure stronger economic policy co-ordination, based on surveillance procedures that become increasingly tighter (i.e. imply greater constraints on national budges and economic policies), whenever a member state deviates from the agreed prudential policy line. In this context the Commission has further reinforced of the role of the commissioner responsible for economic and monetary affairs, who has become the Vice-President of the Commission for economic and monetary affairs and the euro. A single, coherent framework for better economic governance on the basis of the Community method is necessary.

Box 1. "The six-pack": legislation to improve economic governance in the EU

Policy priorities

In order to address the challenges outlined above, action is needed particularly in the following areas in 2012-2013:

Fiscal consolidation should continue with a differentiated speed of fiscal adjustment.

Growth-friendliness of fiscal adjustment should be a key consideration. While expenditure-based adjustments should be favoured in general, growth-enhancing expenditure should be prioritised. Overall improvement in quality of expenditure should be aimed at.

The impact of tax structures on growth should be reflected.

Pension reforms have to be set in motion or implemented fully, if already started. Rising of pension age could be a promising short-term priority.

The adopted "six-pack" legislation should be implemented quickly and rigorously, including the requirements of the fiscal frameworks Directive. Euro area Member States should build on this without delay and honour their agreement to go beyond the requirements of the Directive. Commission proposals on further strengthening of euro area governance have to be swiftly implemented.

3.financial sector: breaking the vicious circle

The negative feedback loop between the banking sector and the sovereign has been the main stress-amplifier in the current crisis. As outlined in Section 1, the negative feedback loop between the banking sector and the sovereign debt markets has fed investors' doubts about sovereigns' and banks' ability to service their debt. This led in consequence to high costs of borrowing for both sovereigns and financial institutions, unsustainable if prolonged beyond the short term (Graph 11). Together with the measures discussed in the previous section, simultaneous strengthening of the banking sector and creating a credible and potent backstop for banks and sovereigns is indispensable to break this vicious circle.

Healthy financial system and a robust banking sector are vital to support the recovery and to finance the long-term growth. The financial excesses that led to the global crisis have undermined the credibility of the financial sector and its role in the economy. The financial sector was hard hit during the crisis and a collapse was avoided only at the expense of public support. However, the financial sector plays a crucial role in the market economy, matching the needs of savers and borrowers across time and across space and facilitating the financing of the real economy. In Europe, the banking sector plays a crucial role in this regard providing credit to enterprises and households. It is therefore essential to complete the ongoing financial repair and banking sector restructuring in order to safeguard the conditions of sustained recovery.

Numerous measures have been taken by the public and the private sector to restore the viability of the financial sector in the EU. Public support, in full compliance with the EU state aid framework, took mainly the form of capital injections, to cover past losses and improve the resilience of the banks to adverse conditions. Also guarantees were provided to restore confidence across the sector and to revive the wholesale funding market for banks. The availability of the necessary public support, on terms compatible with the internal market, was facilitated by the special crisis rules for state aid to financial institutions introduced by the Commission in 2008-09. While some progress was observed as a result of these policy measures, the situation remained fragile, and confidence was never fully restored. Three consecutive EU-wide stress tests since 2009 have failed to convince investors about the quality of EU bank balance sheets, even though in anticipation or as a response to the tests banks have considerably improved the quantity of capital and its quality. In view of the ongoing fragility of the banking sector, the Commission intends to extend the applicability of the crisis state aid rules beyond 2011.

Financial regulation and supervision has been strengthened and should play an important role in restoring the confidence in financial market. Since the beginning of 2011 three new European Supervisory Authorities have been in place to foster supervisory convergence in the supervision of banks, markets, insurances and pensions. They are cooperating closely with the new European Systemic Risk Board responsible for macro-prudential supervision. Furthermore, on 20 July 2011, the Commission adopted a legislative package to strengthen the regulation of the banking sector. The proposal transposes into EU legislation the Basel III agreement, which is the international standard on bank capital agreed at the G20 level. It will require banks to hold more and better capital to resist future shocks. The proposal also includes a Single Rule Book for banking supervision, which will improve both transparency and enforcement of prudential rules. Looking forward, a proper EU-wide crisis management framework for financial institutions will be needed to reinforce banks' resilience and better prevent failures.

Recently, the European Council endorsed a 'banking package' of measures to further strengthen the banking sector. The package, building on a proposal by the European Banking Authority is an integral part of a comprehensive plan to restore the confidence in the markets and address the sovereign debt crisis in the euro area. The agreed package comprises two parts: (i) an EU coordinated term funding guarantee scheme to support banks' access to term funding; and (ii) measures to strengthen banks' capital positions to provide a further capital buffer for the EU banking system. National supervisors were asked to cooperate with banks and to devise recapitalisation strategies that would not endanger credit growth to the economy. New capital should be sought from private sources in the first instance and if those are not available, public resources should be provided – first from national sources and if those are not available – from the EFSF as a last resort. It is of utmost importance that the package is implemented within the agreed timeframe. High-degree of coordination at the EU level among supervisors and governments is indispensable for the plan to work.

The strengthened EFSF will limit contagion in the sovereign and the financial sector. The last few years have clearly shown that purely national approaches to deal with the crisis are not effective and not compatible with the high degree of financial and economic integration in the EU, even more so in the euro area. Therefore, while strengthening sovereigns' and banks' accounts is the first line of defence, EU-level instruments are necessary to backstop financial institutions and sovereigns. With this in mind, on 21 July 2011 euro area Heads of State or Government agreed to improve the effectiveness of the EFSF, and later of the ESM by equipping it with new instruments allowing them to: (i) act on the basis of a precautionary programme; (ii) finance recapitalisation of financial institutions through loans to governments including in non programme countries and; (iii) intervene in the primary and secondary sovereign bond markets. Further, on 26 October 2011, the European Council decided to extend the capacity of the EFSF by leveraging its resources, indicating two non-excluding options: (i) providing credit enhancement to new sovereign debt and, (ii) combining resources from private and public financial institutions and investors.

Swift implementation and good cooperation between authorities is key for the success of the strategy. The measures agreed with regard to the EFSF and the ESM are bold, but it is now crucial to implemented them without delay to make the new tools operational without delay. At the same time, efforts should be made to reach an agreement to establish the ESM as quickly as possible since its more robust structure based on capital would alleviate some of the shortfalls of the EFSF. Moreover, a high degree of coordination between Member States and a good cooperation between fiscal authorities and the monetary authority in formulating the strategies to address the current crisis would strengthen confidence in EU's ability to regain stability. Coherent communication is crucial in this respect.

Significant progress is being made regarding the implementation of country-specific recommendations on the financial sector, but not across the board. Eight Member States had received country-specific recommendations in this area. Action is being taken in several countries to strengthen further the prudential supervision framework, make progress with on-going bank restructuring, enhance competition in the sector, and to support access to venture capital financing. In a few cases, the ambition of announced policy plans is insufficient and implementation is partial. Against the background of the risks and uncertainties outlined above, more determined action appears warranted, especially where spill over effects can be expected to be large.

Policy priorities:

The main strategic objective of any financial policy initiative is to sever the link between the sovereign crisis and the financial sector.

The capacity of the EFSF and of the ESM should be maximised by devising an appropriate mechanism of leverage, while respecting the Treaty provisions.

As some Member States do not have the fiscal space necessary to provide support to their financial sectors, mechanisms should be designed to support Member States and increase EU coordination of these interventions.

The capital requirement legislation should be adopted and implemented rapidly, while an EU crisis management framework for financial institutions is being developed. Attention should be given to limiting the impact of banking-sector reform on the flow of credit to the real economy.

4.structural reforms to support growth and correct imbalances

Growth enhancing structural reforms must come to the forefront of the policy agenda. Europe's long-term growth potential has been lagging behind its peers and has been further weakened by the financial crisis (Graph 12). Also, the short-term growth prospects are subdued, but macroeconomic tools to support growth, especially fiscal policy, have been largely exhausted and must now focus on ensuring stability, as explained in the previous sections. An ambitious programme of bold structural reforms can transform this outlook into a more positive one by increasing growth potential, tackling competitiveness divergences and facilitating adjustment. Member States need to put structural reforms in place and so does the EU overall (detail on the latter is to be found in Annex I on progress on Europe2020).

Structural reforms have the capacity to increase growth potential and tackle macroeconomic imbalances. Structural reforms improve the efficiency of the economy, includign resource efficiency, thereby expanding the level of output which the economy could produce at full employment as well as accelerating its growth rate. Reforms can also increase adjustment capacity of economies, as they facilitate the necessary reallocation of labour and capital across sectors. Structural reforms play a key role in addressing macroeconomic imbalances. Despite the recorded reductions in imbalances, significant adjustments are still necessary in some Member States. Structural problems e.g. in terms of competitiveness or demand sustainability, underlied the build up of imbalances before the crisis. Structural reforms to tackle these underlying problems are crucial to secure orderly adjustment and prevent rebuilding of imbalances in the future and to allow growth to pick up.

Reforms promoting a sustained rise in employment rates are necessary in view of the prevailing demographic prospects in the EU. The share of the working-age population in the EU has been on a declining trend and is projected to remain so (Graph 13). The Europe2020 Strategy aims at increasing the rate of employment from 69% currently to 75% in 2020, to partially counterbalance that trend. Moreover, the crisis has led to sharp increases in unemployment, which risks becoming entrenched. In this context reforms boosting job creation, tackling unemployment and keeping participation rates should feature high on policy agenda. There is room to learn from the successful labour market reforms in some Member States and to share good practices which had resulted in increased employment and a fall in unemployment before the crisis.

Productivity growth should be given priority due to its positive impact on output growth and adjustment. The current demographic trends imply that, productivity growth will be the main source of growth per capita in the coming decades. At the same time, comparing productivity trends across Member States it seems that there is ample room for improvement in a number of countries (Graph 14). Importantly, among available sources of growth, capital deepening or job creation have only temporary effects on output. Productivity gains, on the other hand, can be sustained over time if coming from innovation and technological improvement. ICTs are a major growth driver, explaining half of the productivity growth of modern economies. In such cases, productivity growth is compatible with employment growth.

Productivity growth can help reduce current account imbalances in a sustained way. In particular, productivity improvements in the non-tradable sector, such as most services, reduce domestic price pressures, including on domestic inputs to the export sector, and hence improve its competitiveness. Moreover, improved productivity in services gives room for a transfer of resources to the export sector, which is necessary for a durable adjustment. These adjustment channels are particularly important for countries with external deficits. At the same time, higher productivity growth boosts domestic demand to the extent it is constrained by market and policy failures. This is particularly relevant for surplus counties with weak domestic demand.

The scale of the productivity challenge differs across countries (Graph 14). Whilst the need to increase productivity spans across the whole EU, for some Member States it is particularly pressing. This is chiefly the case for Member States suffering from large external imbalances. For them increases in productivity bring additional value in facilitating rebalancing, as explained above, but they also seem to be lagging behind the other Member States.

An efficient adjustment of labour costs is crucial to reduce imbalances and address the high rise in unemployment. This is of particular importance in the euro area since costs and price adjustment is the only way of nomianl adjustment in a monetary union. Such adjustment has already started, but needs to continue to reduce internal imbalances (high and persistent unemployment, structural impediments to private domestic demand) as well as external ones (progressive competitiveness deterioration leading to current account imbalances). It is important that wage setting mechanims take these objectives into account.

In the current macroeconomic context, a careful and selective approach to structural measures is necessary. Due to slowing growth and financial tensions, priority has to be given to reforms which can deliver a positive impact on growth already in the near term and which incur the lowest budgetary costs. Regulatory reforms and opening up of sheltered sectors largely fulfil these conditions.

Equity considerations should be factored into reform plans. After years of subdued growth and difficult adjustment in some countries, the waning recovery inevitably puts a strain on jobs and the social fabric of Europe. Certain population groups – including the young and low-skilled – are hit particularly hard. Therefore reforms also need to take into account equity considerations. In this respect, there is a need to ensure the adequate financing and efficient design of social safety nets, especially in those countries where social exclusion is becoming a serious issue.

Enhancing the quality of public institutions will bring significant gains. In many Member States there is scope for increasing the efficiency in the delivery of public services as well as the transparency and quality of public administration, for example through enhanced eGovernment. Addressing existing problems would allow reconciling the aims of fiscal consolidation and improving competitiveness and growth prospects. In particular, tax collection systems are a stumbling block to fiscal adjustment in some Member States, but improving the efficiency of tax collection would contribute to a fairer sharing of the consolidation burden also in others. Also, to create a business friendly environment conducive to improving the economy's competitiveness efficient functioning of competition authorities, market regulators and judicial authorities is necessary.

The size of the economic challenges looming ahead means that a true structural change is necessary in the EU economy. For that to happen, resources need to be allowed to move from slow-growing to dynamic firms and sectors, within and across borders. Resource reallocation is particularly important for countries with large imbalances, where resources have to be shifted from non-tradable to tradable sector. This implies that some activities in some countries would have to be phased out to make space for new, higher-productivity enterprises. In this context particular attention has to be paid to labour mobility across companies and sectors but also regions and countries. Adequate price signals would facilitate mobility and hence wage-setting mechanisms need to ensure that wage growth adequately reflects local and sector-level productivity developments. Also, the education and vocational training system need to be able to provide the necessary re-skilling and re-training for easier mobility.

Implementation of country specific recommendations to strengthen competition in services markets and network industries is so far overall rather poor. This is disappointing both in view of the importance of competition for bolstering productivity, competitiveness, and growth and of the large gains that could be expected from forceful reforms in these areas. Of the 12 Member States which received recommendations on competition issues, seven have taken some action. However this action remains generally rather partial and so far clearly insufficient to reach the objectives. The recommendations of June 2011 had inter alia called for enhancing competition in retail services, removing unjustified restrictions in certain regulated professions and crafts, to reform regulatory frameworks, improve competition in network industries, and strengthening the administrative capacity of the competition authority. Among the actions taken by a number of Member States are additional powers to agencies monitoring price developments in energy networks, reports issued by relevant agencies, and political agreements that may form the basis for future legislative action.

Reform action to ensure that wage growth better reflects developments in labour productivity should be continued. Among the action taken in some Member States are agreements between social partners on new wage bargaining frameworks to facilitate the use and flexibility of firm-level contracts and legislation to contain the public sector wage bill, including through the introduction of pension contributions of civil servants. So far there has been little progress on reforming wage indexation systems and on minimum wages. Steps have been taken in the area of contractual arrangements and employment protection legislation but it is to early to draw conclusions on their ability to attain the intended objectives of removing labour market segmentation.

Policy priorities

In order to address the challenges outlined above, action is needed in particular in the following areas in 2012-2013:

Structural reforms have to be prioritised according to their potential to lift growth in the short term without incurring large budgetary costs.

Priority should be given to reforms promoting productivity growth due to their positive impact on output growth and adjustment capacacity as well as due to shrinking labour resources. These reforms have particular relevance for Member States suffering from macroeconomic imbalances.

Reforms on labour markets and in particular to wage setting mechanisms need to ensure efficient adjustment of labour costs in order to facilitate absorbtion of macroeconomic imbalances and to reduce unemployment. Reforms of the tax and benefit systems and policy actions that address rigidities in employment protection legislation should be also given priority with a view to boost job creation and reducing segmentation, while supporting adjustment.

Improving the efficiency of public institutions, in particular in the fiscal, market regulatory and judicial areas, can be an easy way to support fiscal consolidation and improving competitiveness at the same time.

Policies facilitating resource reallocation across firms, sectors, regions and countries need to be implemented to support structural change towards dynamic sectors and high-productivity activities. At the national level, policies promoting labour mobility and human capital formation are important, while strict implementation of competition policies at both EU and national level would contribute to this effect.

Annex. Selected macro-economic indicators [including Euro Plus Pact indicators]

(1) Greece, Ireland, Portugal, Latvia (EU's Balance of Payment assistance programme is set to expire in January 2012) and Romania (which has a precautionary programme).