Elections cloud eurozone economic reform outlook

It looks like a crunch year for economic overhaul in "old Europe" as voters feel the pinch from cuts in public welfare provision and elections creep onto the radar screen in Germany, Italy and France.

Changes unpopular with many voters are judged essential by governments under pressure to cut costs, enhance competitiveness, reduce joblessness and meet the mounting bill for caring for ageing populations.

Without them, many politicians and economists say, countries with higher wages and more protective social security systems and labour laws will lose out to lower-cost, less regulated rivals.

However, painful reforms have already sparked protests and strikes, and leaders in the three biggest euro zone economies will soon be worrying more about popularity ratings - with elections in 2006 in Germany and Italy and 2007 in France.

While the ball is in their court policy-wise, business is increasingly taking things into its own hands, and experts say the euro's strength versus the dollar may add to pressure for structural changes at corporate level, such as relocation of manufacturing and routine services to low-cost countries.

In Germany, Siemens wants more of its 170,000 staff to follow those at its mobile phone assembly plants who agreed to work 40 hours rather than 35 a week for no extra pay for fear of the business going to Hungary.

Luxembourg-based steel giant Arcelor, facing rising Chinese demand and Asian competition, is trying to move the same way in France, where over a third of its 100,000 employees are based, union sources say.

Perhaps the most dramatic policy change is in Germany, where as of January 1 state unemployment benefit is being reduced for a million people and others face similar treatment if they refuse job offers.

The so-called Hartz IV reform is the latest of a string of basic policy changes on pensions, healthcare and labour rights under Social Democrat Chancellor Gerhard Schroeder, now in the last full year of his second term.

Labour market changes devised by Volkswagen personnel chief Peter Hartz are designed to make it easier to hire and fire. They reduce the scale and duration of benefit payments to make unemployed people less choosy about job offers.

While few economists question the thrust, the timing is delicate because Germany's economic growth is the slowest in the euro zone, largely because gloomy consumers refuse to spend.

The main independent research institutes predict that growth will fall well short of government predictions of 1.7 per cent in 2005 and marginally more in 2004, after -0.1 per cent in 2003.

Germans are also being asked to pay for dentures, on top of the introduction last year of a 10 euros per quarter fee for visits to doctors.

All that, experts say, may be good for government finances and ultimately for the country, but in the short term it is not great for consumer morale, just what is lacking in Germany.

France is also revamping its public healthcare system, perhaps less ambitiously, raising a health tax for pensioners and bringing in a one euro charge for visits to the doctor.

Even government insiders admit the repair-job on French healthcare finances is far from certain to succeed.

Another big policy change the government is considering is to water down the 35-hour week brought in by the previous Socialist-led government.

The centre-right governent has declared its intention to raise overtime limits, which would allow companies to make more flexible staffing arrangements at a price.

Some experts point out that France is ahead of Germany on another less visible front, the reduction of social welfare levies on low-wage earners and their employers. President Jacques Chirac pledged to go further on this front.

Italy, which with Germany and France accounts for some three-quarters of euro zone economic output, is also known for protective traditions that make it harder to face up to global competition.

The attempts of Prime Minister Silvio Berlusconi, a self-styled liberal reformer, to make the labour market more flexible have triggered stiff union resistance and strikes and not gone very far.

Rule changes in 2003 made it easier to hire temporary staff but strict rules remain on hiring and firing, and experts say stiff union resistance will prevent any move on that front ahead of 2006 elections.

Mr Berlusconi, an admirer of US President George W. Bush, is instead banking for now on plans for some €6 billion of tax cuts which kick in this year.

But in all the Big Three countries, the window is closing and prospects dimming as a result for attaining the ambitious goal of the Lisbon Agenda in which the EU stated in 2000 its ambition to become more competitive than the United States by 2010.

For the wave of elections in 2006 and 2007 is unlikely to raise the reformist fervour of Mr Schroeder, Mr Berlusconi or Mr Chirac.

"A solid reason to act boldly in 2005," says Eric Chaney, chief European economist at Morgan Stanley bank.