The Annual Growth (?) Survey



After the winter break, people usually come back to work full of New Year’s resolutions and expectations. We don’t know what the 2015 has in store for our readers but we do know what the EU has in store for 2015. This is in fact the objective of the Annual Growth Survey (AGS), a Communication that the Commission presents at the end of each year and that sets the scene for the next cycle of the European Semester, the economic policy coordination exercise.

The survey starts with the presentation of the growth results for the past year. As everybody should know by now, they were far from spectacular. Real GDP grew by a modest 1.3% in the EU as a whole and by 0.8% in Eurozone. Unemployment has reached almost 25 million people and in some countries the unemployment rate is as high as 25% (Spain 24.8% and Greece 26.8%). Inflation in the EU was instead as low as 0.6% in 2014.

These poor performances should not be a surprise to our readers. We have seen in previous articles how an uncoordinated approach to fiscal, monetary and structural policies has led to implement contractionary economic policies, especially in the Euro area. Governments implemented budgetary cuts simultaneously: some in the attempt to restore a positive balance of payments, others in observance of rigorous doctrines. Meanwhile the ongoing deleveraging in the private sector has depressed consumption and investment, without restoring banks’ solidity. And finally, institutional limitations impeded the proper functioning of monetary policies in the euro area, forcing Member States to undergo deep internal devaluation which further aggravated demand and investment dynamics.

The AGS then presents the Commission strategy for the 2015 cycle of the European Semester. With respect to previous years, two main novelties are worth underlying. The first is that alongside reform suggestions for the Member States, the Commission puts forward some proposals for reforms at EU level. These include a renewed commitment to the completion of the single market and the digital market; further development of the energy networks and markets to achieve a proper Energy Union and a fundamental rethinking of the EU regulatory framework to make it lighter and more supportive of investments.

The second novelty is the so-called “integrated approach” which should consist of (1) investments, (2) structural reforms and (3) “fiscal responsibility”.

Investments should be promoted through the activation of the new European Fund for Strategic Investments with which the Commission hopes to mobilise about 315 billion EUR of public and private capital. In fact, as many observers have already noted, the plan is composed only of an initial guarantee of EUR 21 billion, 8 of them coming from existing EU funds, 5 billion from the existing EIB capital (and the origin of the remaining EUR 8 billion is unspecified). Concretely speaking there is therefore no “new” money available and actually one may say that there is no money at all: the fund is supposed to provide a safety buffer for investors, bearing the risks for first losses. This should in turn mobilize private or public (ie. Member States) funds by a factor of 15 to reach the total headline figure of EUR 315 billion. Besides the technicalities of the Fund however, it is important to notice that the projects to be financed will need to have an identifiable cash flow from which to derive the returns necessary to pay back the private investments. This seems to be somewhat hard to combine with the description of the potentially eligible projects made by the Commission that puts emphasis on “socio-economic returns”. It will be interesting to observe how the EU will manage to attract private resources in projects with dubious returns through a Fund with no new money.

On structural reforms, the Commission maintains an essentially supply-side approach. It starts by suggesting further measures to increase labour market flexibility. There is in particular a suggestion to ensure that “wages move in line with productivity”: the Commission notes how in certain Member States there is still a need to complete the “correction” of wages outpacing productivity gains. Pension schemes and social protection systems need to be “modernized” and product and service markets should be further liberalized to remove obstacles to the free movement of goods and capital. Finally the business environment should be improved, favouring investments in R&D and simplifying administrative procedures.

The third pillar is “fiscal responsibility”. Here the Commission reiterates the importance of “sound public finances” but also writes that those Member States with fiscal space should use it to boost growth (the message is subtle enough but one might surmise that the addressees are those Member States which have been registering an excess of savings over investments). As far as fiscal consolidation is concerned the Commission points out that Governments’ revenues should be shifted away from labour to other sources “less detrimental to growth” such as “recurrent property, environment and consumption taxes”. Without entering in the otherwise interesting discussion about which type of tax is more detrimental to growth – the direct or the indirect one – it may be useful to put some context around the Commission’s recommendation. Reducing taxation on labour responds to the need to reduce production costs of firms which in turn may reduce their prices. The Commission is suggesting that Governments make up the revenue gap increasing consumption taxes (VAT). However – it won’t escape you – this will negatively impact domestic demand. One may ponder upon the astuteness of such a manoeuvre since it would appear that the two effects cancel each other out. In reality because the VAT is not paid on exported goods, the measure aims at making firms more competitive on foreign markets (“fiscal devaluation” in jargon). This in turn should enable countries to benefit from an export-led growth. In other words, in order to grow Member State will have to sacrifice their domestic demand and try to appropriate an ever larger share of external demand. Which if you turn the sentence around means that other countries will have to do the opposite, that is grow on domestic demand and increase their imports.

In conclusions, the AGS puts forward a sort of “three arrows” strategy. The first of which – investments – is based on a new Fund to which we give the benefit of the doubt. The second one – structural reforms – continues to be loaded with supply-side recommendations aimed at facilitating internal devaluation, ie. the compression of wages and costs to regain external competitiveness. The third one – fiscal responsibility – insists in rearranging taxation in order to favour exporting firms. If you followed us until here, you may guess by now that the success of such a strategy rests on the premise that someone does not follow it. It is pointless to “internally devaluate”, unless someone “revaluates”; it is useless to support exporting firms through fiscal devaluation unless someone expands its imports. An odd way to run a Union.

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