Country-specific recommendations for economic policies under the 2018 European Semester

Prepared by João Capella-Ramos

Published as part of the ECB Economic Bulletin, Issue 5/2018.

Within the EU governance framework for the coordination of economic policies, the country-specific recommendations (CSRs) represent an integral part of the annual European Semester process. They provide guidance to individual EU Member States on how to address structural reform needs and macroeconomic imbalances in the following 12-18 months. CSRs are the instrument through which EU national economic policies are treated as a matter of common concern and coordinated within the Council of the European Union in accordance with Article 121 of the Treaty on the Functioning of the European Union. They therefore constitute a cornerstone of the EU’s macroeconomic imbalance procedure (MIP), whose aim is to prevent, detect and correct macroeconomic imbalances in individual countries, thereby containing risks to the smooth functioning of Economic and Monetary Union (EMU). Their timely and proper implementation is critical to reducing vulnerabilities and strengthening the economic resilience of the euro area and the EU as a whole, ultimately leading to higher growth potential in the long term.^[1] Against the background of the 2018 CSRs received by 27 EU Member States (i.e. all excluding Greece^[2]), this box examines the policy recommendations addressed to 18 euro area countries, with the exception of those that pertain strictly to the implementation of the EU’s Stability and Growth Pact.^[3]

CSRs are the culmination of a comprehensive process of economic monitoring and surveillance within the European Semester, starting in the autumn of the preceding year. First, on 22 November 2017, the European Commission released the Annual Growth Survey, the Alert Mechanism Report and proposed recommendations on the economic policy of the euro area. The Annual Growth Survey identifies the main economic policy priorities for the EU as a whole. The Alert Mechanism Report screens EU Member States for any build-up of or need to correct macroeconomic imbalances. The recommendations for the euro area set out the main areas for structural reforms for the euro area as a whole. On 7 March 2018, the Commission released the Country Reports for all EU Member States, which analyse progress made on implementing structural reforms and, for countries previously selected in the Alert Mechanism Report, identify the nature and severity of macroeconomic imbalances in the context of in-depth reviews under the MIP. Subsequently, on 23 May 2018, the Commission adopted its proposals for the 2018 CSRs. On 13 July 2018, following discussions in the relevant EU committees and endorsement by the European Council, the Economic and Financial Affairs (ECOFIN) Council issued the final 2018 CSRs.

The 2018 recommendations for the euro area as a whole call on Member States to take advantage of ongoing solid and broad-based economic growth, in a context of favourable financing conditions, to strengthen growth potential and economic resilience, and rebuild fiscal buffers. On 23 January 2018, the ECOFIN Council issued the 2018 recommendations on the economic policy of the euro area on the basis of the European Commission’s proposal. The recommendations urge Member States, in parallel to widening thin fiscal buffers, to pursue policies that support sustainable and inclusive growth and improve economic resilience, rebalancing and convergence. To that end, Member States are invited to address structural challenges that continue to exert a drag on the economy, prioritising reforms that increase productivity and growth potential, improving the institutional and business environment, removing bottlenecks to investment, fostering innovation, supporting the creation of quality jobs and reducing inequality. They are also encouraged to make swift progress on completing EMU, and especially the banking union through enhanced risk reduction and risk sharing.

Chart A

The 2018 CSRs for euro area countries by policy area and MIP classification

The 2018 CSRs broadly echo the emphasis of the 2018 recommendations for the euro area as a whole. Chart A shows a breakdown of the 2018 CSRs by policy area, with a focus on fiscal-structural policies, framework conditions, and labour and product markets. The 2018 CSRs on fiscal-structural policies include ensuring the long-term sustainability of pension systems, increasing the efficiency of public spending, reducing the tax wedge and curbing tax fraud and evasion. The 2018 CSRs on policies to enhance framework conditions include improving the business environment, strengthening the effectiveness of judicial systems and insolvency frameworks, streamlining bureaucratic processes and removing inefficient market regulations. Compared with last year, the 2018 CSRs place greater emphasis on forward-looking structural reforms that support research, innovation and education, which could help unleash and manage technological progress, as well as boost workers’ market-relevant skills, thus helping countries to cope with the challenges from digital transformation.

Chart B

The 2017 and 2018 CSRs for euro area countries by policy area

The 2018 CSRs give less priority to product market reforms and to labour market reforms aimed at ensuring the appropriateness of wages. Chart B shows that the number of CSRs on product market reforms remains limited and that of CSRs on labour market reforms, while remaining relatively sizeable, decreased compared with last year. However, both policy areas remain vital to promoting the reallocation of resources to their most productive uses and thereby reviving productivity growth and strengthening the economic resilience of EMU. Product and labour markets overall should be adaptable, open and competitive. In this regard, product market reforms, such as lifting barriers to market entry, would support the proliferation of innovative enterprises and dynamic entrepreneurs that are at the root of productivity gains. Labour market policies should be formulated in such a way as to ensure that wages appropriately reflect the underlying economic conditions, in line with productivity at the firm, sector and country level, and workers’ qualifications. Indeed, while wage rigidities may be less visible in an economic upswing, their negative impact may be sizeable when the economic cycle turns.

Chart C

CSR implementation over the period 2013-17 in euro area countries

Continued weak CSR implementation over recent years remains a challenge in view of still outstanding stock imbalances of a long-lasting nature.^[4] Chart C shows that most CSRs were, at best, only partly addressed by Member States over the period 2013-17. The disappointing track record on implementing structural reforms may be seen in the light of the cyclical upswing and the fact that the perception of policy challenges may have moderated in the favourable economic and financial environment. Similarly to the previous year, the European Commission concluded in February 2018 that the overwhelming majority (i.e. more than 90%) of the 2017 CSRs had been implemented to only “some” or a “limited” extent. Only one of close to 80 CSRs had been “substantially” implemented and none had been “fully” implemented. Moreover, countries with “excessive” macroeconomic imbalances do not seem to have taken decisive policy action to step up the implementation of their 2017 CSRs, even though this would have been commensurate with the rigidities and vulnerabilities remaining in those countries. Furthermore, some of the 2017 CSRs were not repeated this year, despite the fact that only “some” or even “limited” progress had been made on them, and their continued macro-critical relevance (i.e. their importance to the reduction of macroeconomic imbalances). This may risk sending unwarranted signals; efforts made in recent years to contain the number of CSRs, which have streamlined the process, are by no means a reflection of improved or strong structural reform momentum.

Chart D

Share of MIP-relevant 2018 CSRs for euro area countries by policy area

Refocusing the CSRs on macro-critical policies that facilitate a timely wind-down of macroeconomic imbalances could encourage compliance with the MIP. Chart D shows that most 2018 CSRs are deemed significant for compliance with the MIP; these are referred to as “MIP-relevant”. However, some have been made MIP-relevant even though they pertain to the realm of broad economic coordination and only indirectly address macroeconomic imbalances.^[5] Where the presence of excessive macroeconomic imbalances implies greater urgency, recommendations for a wide array of structural reforms may blur the focus and thus ultimately fail to induce effective policy action in the short term. Better prioritisation of CSRs according to their macro-critical relevance could encourage compliance with the MIP and also help incentivise countries to take firmer ownership of structural reforms.

The full and effective use of all instruments available under the MIP, including the excessive imbalance procedure (EIP), as its corrective arm, could help buttress recent cyclical improvements by means of structural measures that strengthen economic resilience and growth potential over the medium term.^[6] The EIP, which so far is yet to be activated, is in essence aimed at ensuring greater traction for the implementation of macro-critical policies in the most vulnerable countries. Since it has proven difficult to reinvigorate the pace of structural reform under the preventive arm of the MIP, there seems to be a strong case for applying the EIP for all countries with excessive macroeconomic imbalances. The application of the EIP would ensure the credibility and ultimate effectiveness of the MIP. In addition, if appropriately designed and implemented, other instruments and measures being considered with a view to creating the right incentives for structural reform implementation and national ownership could help improve the current lacklustre prospects for CSR implementation in the EU.

CSRs should serve as the key benchmark for sound economic policies at the country level, thereby ensuring consistency over time. The European Commission has gradually excluded from the CSRs certain policy areas which are covered by other monitoring mechanisms. These include economic aspects of the energy sector, moved to the Energy Union governance arrangements, and the monitoring and enforcement mechanisms related to the Single Market. Insofar as they matter for the overall economic performance of the Member States, the continued monitoring of these policy areas remains essential, not least to ensure that the economic policies implemented by individual Member States are assessed in an even more comprehensive and consistent manner across time and policy areas.