Why Europe must reform

23/05/2006 | Angela Merkel

The future of an enlarged and unified Europe will depend on renewed political will. Central to this effort, says Angela Merkel, are Germany’s ambitious reforms

The increasing pace of globalization and the relentless shift in Europe’s demographics are placing ever-increasing pressure on European economies. Shoring up Europe’s competitiveness is vital if the region is to safeguard its prosperity in the long run, while ensuring social harmony.

Germany’s new federal government has launched its reform efforts to strengthen growth and employment as well as to sort out the fiscal budget and social security systems.

The European Union (EU) as a whole has also indicated its ability to act. It has demonstrated, through the European Council resolutions on the 2007 to 2013 financial framework, that Europe can indeed solve the problems at hand. The 10 new member states that joined the EU in 2004, in particular, are now able to plan, and have the means to shape economic development in their countries. At the same time, the new framework allows for fiscal discipline while limiting the burden on the net payers.
The European Council had already agreed, at the interim review of the Lisbon Strategy last spring, to reorient this vital reform platform for greater growth and employment. This was a crucial precondition for strengthening Europe’s competitiveness globally. Now EU member states must renew their efforts towards this end.

Lagging behind
Europe still lags way behind the goals it has set itself. The discrepancy in growth between Europe and both China and the US has intensified in the past few years. The American economy grew by 4.2% in 2004 and the Chinese by 9.2%, but overall growth for the 15 states that were EU members before the 2004 enlargement was just 2.3%. One reason for this is the relative proportion of people in paid work: 65% in Europe is significantly lower than 71% in the US. Conversely, at 8.1%, the EU-15 have a much higher unemployment rate than the 5.5% figure for the US.
Take innovation, which is the basis for future competitiveness. Here, too, Europe must catch up. With its expenditure of 2% of GDP for research and development, the EU lags way behind the US, which spends 2.6%.
It is now more important than ever to coordinate national and European reform efforts and to gear the politics of the member states more closely towards the European growth and development goals envisaged by the Lisbon Strategy. This requires resolute reforms. In this context, continued adherence to the Stability and Growth Pact is particularly important, since this is the only way to prevent the impetus for reform from flagging because of growing debt burdens.
It is also clear, however, that comprehensive renewal processes cannot be implemented without the consent of Europe’s citizens. This was demonstrated by the failed referenda over the European Constitution in two member states, France and the Netherlands. The overriding task of politics must therefore be to build trust. Europe only has a future if the necessary reforms are not perceived as a threat by its citizens but are rather seen as an opportunity for prosperity and growth. That is why changes must be carried out with a sense of proportion and social balance. In view of their different histories and diverse starting points, each member state must develop its own strategy for this.

German reform
Germany, as Europe’s biggest economy, is striving to use the modernization programme passed by the new federal government as a pacemaker for the European growth strategy outlined above. We are doing this by concentrating on further expanding Germany’s strength in the areas of sustainable growth, investment and employment. Our modern and effective infrastructure, a pronounced culture of innovation and an efficient capital market are examples of this strength. Together with a low rate of inflation, a high degree of social harmony and environmental protection, as well as the fact that the rule of law permeates all levels of society, we have a sound basis for growth and employment.
We also see a considerable call for action in central policy areas. It is particularly important that we reduce the high structural fiscal deficit to reflect the economic situation. This is the starting point of the three-pronged strategy “retrench – reform – invest” that we have opted for as a key guideline for government action. To ensure that the state can act and to guarantee a fair distribution of resources between generations, the federal government has agreed to budgetary reforms aimed at cutting and redirecting expenditure and meeting the Maastricht criteria (chiefly a budget deficit below 3% of national income) again in 2007.

Six priorities
In order to implement the Lisbon Strategy on the national level, the new federal government has set itself six priorities. Besides the budgetary reforms, the focus is mainly on expanding the knowledge-based society as a fundamental precondition for any sustainable, modern society. In the central growth area of research and development (R&D), German spending of 2.5% of GDP already bears comparison with any other country, and places Germany among Europe’s top-flight economies. By 2010 we want to boost R&D spending to 3% of GDP. Moreover, we are introducing a bundle of measures to make sure that innovative ideas and research results can be converted faster into marketable products and processes. The education systems, too, are to be strengthened, for instance by increasing the number of schools that are open all day or by promoting excellence at research institutions and universities. The ability to innovate in the field of ecology should also be strengthened and used to provide a competitive advantage.
Competitive markets are crucial preconditions for growth and employment. This means making sure that the European Single Market is maintained and developed in an enlarged Europe. This also applies to the services sector, which comprises about 70% of value creation in Europe. In doing so it is important to rule out the risk of unfair competition or distortions of competition. To aid investment and the setting up of new business we want to create a more favourable climate for entrepreneurial activities.
We must consistently reduce bureaucratic obstacles to private initiatives, simplify planning regulations and get rid of unnecessary legislation – on the European level as well. In addition, we aim to reform corporate tax law so that it treats all enterprises equally, irrespective of their legal form by January 1, 2008 and implement internationally-competitive tax rates. For a limited transitional period we will make the rules for depreciation of capital equipment more favourable to create incentives for technology-intensive investments. Furthermore, we will lower the inheritance tax burden on small and medium-sized enterprises to ease the transfer of business.
The core task is to gear economic, financial and labour market policies towards greater employment. By continuing the labour market reforms that have already been launched, Foerdern und Fordern (“incentives and demands” – the principle that the unemployed will be supported on condition that they accept the jobs that are found for them), the German federal government is trying to reduce the relatively high number of long-term unemployed and to activate the low-income sector. In light of demographic shifts, moreover, the employment rate – especially of older workers – should be raised, for example through continuous education and by making professional and family life more compatible. From 2012, the legal retirement age is going to be raised gradually from today’s 65 years to 67 years.
European integration has made considerable progress in recent decades, despite many crises. We have created a European Single Market, introduced a single currency and successfully seen through EU enlargement to include central and eastern European countries. I am therefore confident that we will also master the tasks that are now at hand. In doing so, it must be clear in our minds that a unified Europe is going to be just one of several economic centres. But by successfully implementing the Lisbon Strategy, we have every chance of ensuring that the advantages and gains in wealth of an ever-increasing international division of labour will be felt in Europe too. What Germany can contribute to this, it will achieve with consistent reforms. I am sure that if we all chip in equally, the voice of our continent will still carry weight in the global economy of the future.

Related stories


Editor's Picks


In Focus

  1. BRAZIL: Rousseff running out of time to restore economic credibility

  2. FINANCING LATAM’S BANKS: Niche currencies lead the way for LatAm exposure

  3. US QE tapering a good sign but watch the short end…

  4. JIM O'NEILL: Latin America can learn from Mexico’s efforts

  5. LATIN AMERICA: Filling the infrastructure financing gap