Euro-zone Economy

Part of the debate – in the House of Lords at 2:20 pm on 12 October 2006.

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Photo of Lord McKenzie of Luton Lord McKenzie of Luton Government Whip, Government Whip 2:20, 12 October 2006

My Lords, this has been an interesting and useful debate, and I thank the noble Lord, Lord Dykes, for initiating it, and all noble Lords who have spoken this afternoon. There has been a spread of views—not an identity of view—on this issue, which is not surprising.

At the heart of our debate must be the assessment that despite Europe's and the euro area's current cyclical recovery, structural problems persist. Europe's low growth in the past five years—2001-2005—coupled with a persistent lack of resilience highlight continuing structural policy weaknesses. To be fair, that is a different picture from that painted by the noble Lords, Lord Dykes and Lord Newby, and, to a certain extent, my noble friend Lord Harrison. If anything, the current recovery must be seen as a rare window of opportunity for Europe and the euro-zone to exploit the upswing and commit to making Europe a dynamic and knowledge-based economy capable of sustainable economic growth and creating employment.

The right policy response—to which several noble Lords referred—is therefore the continued pursuit of structural reform to raise labour participation, boost productivity and increase flexibility in labour, product and capital markets. Economic and monetary union puts a premium on structural economic flexibility, as to be successful in monetary union countries need additional flexibility to adjust to change and to unexpected economic events.

Alongside EMU, the challenges of globalisation and demographic change place additional emphasis on the importance of rising to the reform challenge. We are part of a rapidly changing global economy that brings significant economic challenges in terms of a changing balance of economic activity, increasing global integration and intensifying global competition. Declining birth rates and rising life expectancies are interacting to produce a dramatic change in the size and age structure of Europe's population. If unaddressed this will markedly increase the dependency ratio in countries, with serious negative implications for trend growth and pronounced increases in public spending. To address this challenge Europe needs to review its pension, long-term care and health systems and aim to raise labour utilisation underpinned by an adequate and transparent macro-economic framework as well as sound public finances.

To improve its economic performance relative to the US and consistently match the recent growth rates of other successful developed economies, Europe must take urgent action to promote employment and boost productivity. The Lisbon programme of economic reform has recently been refocused by EU leaders on promoting growth and employment. They are the areas in which Europe most needs to succeed in order to compete in a global economy that puts a premium on skills, innovation and flexibility.

With regard to Europe's current economic performance, which was the subject of a number of contributions, although it is currently undergoing a cyclical recovery and the majority of member states are performing relatively well, with strong out-turns, particularly in the first half of this year, Europe still needs to make up much ground in comparison with key developed economies, while unemployment remains relatively high and persistent. As the noble Baroness said, we cannot look at this in total; we have to unpick and see what is happening in individual countries.

The current recovery is still not sustainably entrenched, with greater uncertainty beyond 2006, while the recent economic stagnation highlights remaining structural problems. On the issue of growth, since 1996 annual average growth in GDP in the euro area has averaged about 1.2 per cent less than in the US. Indeed, in 2005, real GDP growth in the euro area was less than half that in the US.

Stronger growth in non-euro area countries, such as Sweden, the UK and also the new member states, boosted growth for the EU25 as a whole to about 1.75 per cent in 2005, compared to 3.25 per cent in the US. Europe's growth rate still lags behind those of its main competitors. As a result, the gap in living standards between the US and the EU15 has widened back above 30 per cent.

Analysis suggests that Europe's labour market performance explains about two-thirds of Europe's gap in living standards with the US; the remaining third can be attributed to Europe's lower productivity levels. Despite recent efforts to boost employment and marked success in some member states, particularly in raising female employment, inactivity rates remain high, with more than 90 million inactive people of working age across the EU25.

The employment rate of older workers remains especially low and well below that of major competitors like the USA and Japan. Moreover, at around 8 per cent, Europe's unemployment rate is considerably higher than that in the US and Japan—and the UK—leaving 17.5 million people unemployed.

Raising productivity levels will also be crucial for Europe to improve its long-term economic performance and living standards. The euro-zone underperforms against the US in terms of both output per hour and output per worker, and the gap has been widening since the mid-1990s, reversing the trend of catch-up with US productivity levels during the three decades following the war.

Recent analysis suggests that the underlying causes are largely structural, reflecting in particular a failure to boost services productivity. The relatively small size of the EU's "knowledge services" and ICT-producing as well as high-productivity ICT-using manufacturing sectors particularly present challenges. This points to a clear need for further action to promote the key drivers of productivity, increasing product market competition, enhancing the EU's frameworks for innovation and enterprise, and upgrading the skills of both existing workers and new entrants to the labour market so that they can exploit the opportunities of new technology.

The advent of EMU is itself a driver for pursuing structural reform and enhancing economic flexibility, especially in the euro area. To be successful in monetary union, countries need even more flexibility to adjust to change and to unexpected economic events once the ability of countries to vary their interest rates and exchange rates has gone and the euro and the single European interest rate are in place. EMU membership therefore puts an additional premium on ongoing reform of EU labour, product and capital markets.

In this context, the Government continue to argue that employability, flexibility and stronger competition policies must be a top priority, so that EMU can be a sustained success. Enhancing the flexibility and dynamism of the European economy and building on the achievements to date are important if the full benefits of EMU are to be realised. This is particularly important as EMU expands to take in the new members that joined the EU in 2004.

Several questions were posed and I shall try to deal with them all. Perhaps I may start by reaffirming the Government's policy. The Government's policy on membership of the single currency is unchanged. It remains as set out in the Chancellor's Statement in the House of Commons in October 1997, and again in the Chancellor's Statement on the five tests assessment in June 2003. The Chancellor announced in Budget 2006 that the Government do not propose a euro assessment to be initiated at the time of this Budget and the Treasury will again review the situation at Budget time next year, as required by the Chancellor's 2003 Statement.

In principle, we are in favour of UK membership of EMU, but in practice the economic conditions must be right. A decision on the membership of the single currency will be based on whether it is in the national interest to join and whether the case is clear and unambiguous. Overall, the Treasury assessment is that since 1997 the UK has made real progress towards meeting the five-year economic test, but on balance until the potential benefits of increased investment and trade, a boost to financial services, growth and jobs are clear, which addresses the point made by my noble friend Lord Harrison, we cannot at this point conclude that there is sustainable and durable convergence, or sufficient flexibility to cope with any potential difficulties within the euro area. Despite the risks and costs, which clearly exist, of delaying the benefits of joining, a clear and unambiguous case for UK membership of EMU has not yet been made and a decision to join now would not be in the national economic interest.

My noble friend Lord Harrison asked about the EPU. It maintains a network of experts with stakeholders as part of the regular programme of activities on EU preparations. The meeting with local authorities took place on 21 September and discussed European preparation issues of relevance to local authorities. There was a question about the separate budget for the Euro Preparations Unit. The costs of the euro preparations in the Treasury are met from within Treasury department expenditure limits.

An update on the national changeover plan was asked for. The third outlying national changeover plan was published in June 2003 and sets out the possible timetable for changeover, its management and the impact on consumers, business, financial services, and the voluntary and public sectors. Since then, the EPU has worked with stakeholders from across the economy to develop a suite of supporting planning documents, including a draft management transition plan and a draft consumer protection framework. Details of these can be found on the website.

On banks, the UK is committed to encouraging competition in both the UK and EU markets. EU competition authorities are currently looking at the state of competition in retail banking markets, and will be reporting shortly.

The noble Baroness, Lady Noakes, posed some questions about the Government's position on the euro, and I think I have set that out. She referred to the Chancellor continuing to be wise, and I can confirm that I am sure he will. I have dealt with when the next assessment is due. No assessment has been made in relation to the last Budget, and the matter will be reviewed at the next. The position on the referendum remains unchanged: we would not go into the euro without one.

The noble Lord, Lord Harrison, raised issues about public finances. UK public finances are fully consistent with a prudent interpretation of the stability and growth pact, which takes into account the economic cycle, long-term sustainability of public finances and the role of public investment. Both the Treasury and Commission projections show that the UK deficit will reach the reference value of 3 per cent in 2006-07, and fall thereafter.

I am reminded that time is up, so I shall briefly summarise. Although Europe is currently bouncing back, enjoying a cyclical recovery and, encouragingly, some of the major European economies are seen to be turning a corner, many problems remain. Europe continues to lose ground in comparison with key developed economies. Structural problems persist. Unemployment remains high, particularly long-term and youth unemployment, while productivity and innovation is low. Europe's recent growth record and its marked lack of resilience to shocks are worrying. The underlying factors contributing to Europe's slow growth and economic performance stem from structural policy weaknesses. The right policy response is therefore the pursuit of structural reform to promote employment, raise productivity and increase flexibility in labour, product and capital markets.