European Commission Recommends More of the Same

Countries are given longer to reduce their deficits but must press on with economic reforms.

Much was made of President José Manuel Barroso’s admission last month that austerity had “reached its limits” yet his European Commission on Wednesday recommended more of it for high debt countries in the continent’s periphery, if at a slower pace.

France and Spain both failed to meet their deficit targets last year, when they posted shortfalls equivalent to 4.8 and 7.1 percent of economic output, respectively. The European Commission recommends that they are given extensions until 2015 and 2016 to bring their deficits under the 3 percent treaty limit. But there has been no substantial change in the structural economic reforms that Southern European countries are advised to enact.

France should cut labor costs, according to the European Commission, particularly by reducing social security contributions for employers and lift the regulatory burden on businesses to enable them to become more competitive.

France’s hourly labor costs, at €34, far exceed the European average of €23 while its 34.4 percent corporate tax is more than twice as high as Germany’s 15.8 percent rate.

The European Commission also urges France to reform its pension system, for instance by raising the retirement age — something socialist president François Hollande explicitly campaigned against but hinted he might yet do — and change unemployment insurance so it “provides adequate incentives to return to work.”

France, Italy and Spain are all advised to open up closed professions and liberalize the services industry in particular.

Wages in Italy should better reflect productivity, which tends to be low, and property taxes should be aligned with market values. The tax burden altogether should shift “from labor and capital to consumption, property and the environment in a budgetary neutral manner.”

Italy managed to reduce its shortfall to 3 percent of gross domestic product last year but the repeal of a housing tax, proposed by the ruling conservative party, could yet blow an €8 billion hole in the budget.

Both Italy and Spain should strengthen labor market reforms to remove “rigidities.” The latter is advised to expand job retraining programs to enable workers to find employment outside construction, an industry that boomed in the years preceding the downturn, contributing to a “skills mismatch.”

Italy is also urged to streamline its regulatory framework and shorten judicial proceedings. Its justice system is among the most bloated in the world. Italy employs some 211.000 lawyers compared to 155.000 in Germany which has twenty million more citizens. Trials take up to 1,000 days on average and can be susceptible to political interference, forcing companies to often settle out of court.

In sum, the European Commission may have succumbed to political pressure to give countries more time to meet their budget targets but the other components of “austerity” — liberalizing labor markets and industries, reducing regulations to improve competitiveness, modernizing welfare programs and shrinking the state apparatus and making it work more efficiently — are still in place.