GDP growth in the euro area rebounded to 0.7% in the third quarter of 2007, broadly in line with the growth projected in the Commission's autumn 2007 forecasts. Growth continued to be driven by domestic demand with a pick up in investment, after a pause in the second quarter, while private consumption maintained the moderate 1.5% growth path. Looking ahead, economic activity is expected to moderate as the conditions in international financial markets have deteriorated significantly and remain fragile. Whilst the effects of the turmoil have, so far, been largely confined to the financial sector, there are some signs that also they may have been impacting the rest of the economy. Banks have tightened their credit conditions to both non-financial corporations and households and business and consumer confidence have weakened significantly since the summer.
In November, inflation rose sharply to 3.1%, a six and a half year high. It is hoped that this is a temporary blip caused by soaring oil and agricultural commodity prices as well as base effects that turned unfavourable since September. This should not mask that, historically, inflation has never been so low and stable than since the advent of the euro, as the report highlights. While in the 1970s, average inflation in the euro-area members more than doubled to over 9% following the two oil price shocks, it has since declined to 2% in the current decade. This is despite a series of important adverse shocks, including the price of oil which more than trebled since 2003 in dollar terms. This better record appears to be due to an improved monetary policy and a better understanding of the importance of inflation expectations.
Structural reforms where they are most needed
Looking at labour market reforms, the report shows that they were particularly important in the early years of this decade, especially in those countries that need them most, such as Greece, Italy and Spain. The reforms generally made labour markets more adaptable through a better mix of flexibility and security – the flexicuritity concept successfully embraced by other EU countries before. In particular, stricter eligibility criteria for unemployment benefits and activation policies were among the measures that increased work attractiveness and made work pay. The positive impact of these reforms can be seen in the lower level of unemployment at the euro-area level, which decreased from a peak of almost 11% in 1994, to just above 7% at present.
The focus of this edition of the QREA analyses euro-area productivity trends from an industry perspective. It shows that the relative weakness of productivity can be traced back to developments in total factor productivity (TFP) and can be attributed to a small group of industries. On a more encouraging note, it highlights that in the network industry, the euro area has outperformed the US in TFP terms over the recent years. The analysis of the causes of the productivity slowdown shows that there is a need to re-focus policies and institutions towards an innovation-based economic model, with less emphasis on the imitation of available leading-edge technologies and a more intensive use of R&D and high-skilled human capital.
