Annual Report of the European Commission: How did Austria do?

Published: March 11, 2018; 16:00 · (Vindobona)

The European Commission presented its annual reports on 27 EU member states. How did Austria do? Well, it kinda ended up with a black eye. The report took a pop at Vienna for a number of structural shortcomings, including tax burden on labour, pension and healthcare expenditures, house prices, restrictive regulation in the services markets, stagnating productivity and and not enough action on spreading digital technologies. That isn’t a particularly good report card for the previous coalition government of ÖVP und SPÖ. Let’s see if the new coalition government of ÖVP und FPÖ can make the grade the next time around.

Annual Report of the European Commission: How did Austria do? / Picture: © European Union and Austrian crossed flags by Vindobona

In the survey, the Commission calls on EU Member States to implement reforms to make the European economy more productive, resilient and inclusive.

In so doing, Member States should focus their efforts on the three elements of the virtuous triangle of economic policy - boosting investment, pursuing structural reforms and ensuring responsible fiscal policies.

The challenges for Austria’s economy are the following:

1. Austria’s fiscal framework provides only weak incentives to improve cost efficiency.
2. The overall tax burden on labour is comparatively large, while more growth-friendly sources of revenue are underused.
3. The projections for medium-and long-term pension and healthcare expenditures point to a challenge for fiscal sustainability.
4. Banking sector resilience continues to improve, but some pockets of vulnerability still warrant monitoring.
5. House prices have grown considerably in recent years but overall risks to financial stability seem contained.
6. Austria’s labour market performance is improving but challenges for specific groups remain.
7. Overall, social indicators reflect the good economic conditions, but vulnerabilities for certain groups still exist.
8. Learning outcomes of disadvantaged students have not improved.
9. Restrictive regulation in Austria’s services markets hampers productivity and discourages innovation and investment.
10. Stagnating productivity requires a strong focus on boosting innovation results and supporting innovative businesses.
11. Austria faces a challenge in spreading digital technologies including broadband and business models among small and medium-sized enterprises (SMEs).

Austria’s strong economic performance offers a window of opportunity to improve potential growth and address remaining challenges.
The sound economic outlook provides a supportive environment to further strengthen public finances, social outcomes, and innovation. Austria could also benefit from further measures to improve the sustainability of healthcare and pension expenditures and to enhance labour market and educational outcomes for specific groups where vulnerabilities still exist.
Together with additional efforts to reduce restrictive regulations, this could help to boost productivity and potential growth, making Austria more resilient to future challenges.

The Austrian economy is growing robustly, supported by strong private consumption and investment.
After several years of subdued progress, GDP growth accelerated to 1.5% in 2016 and is expected to have doubled to around 3% in 2017.
The 2016 tax reform triggered a pick-up in private consumption that also acted as a boost to investment, strengthening domestic demand in 2017.
On the back of improved developments in neighbouring countries and in world trade, investment also benefitted from markedly increasing exports, reversing in 2017 the trend of falling export market shares since the financial crisis in 2008.
At the same time, the strong private consumption and investment growth increased imports, leading to only a marginal contribution by the external sector to GDP growth.
For 2018 and 2019, the economic outlook remains favourable.
GDP growth is expected to be broadly unchanged, driven mainly by stable domestic demand despite a slightly decreasing contribution from investment.
The unemployment rate decreased from 6.0% in 2016 to 5.5% in 2017.
The upswing phase is also reflected in higher headline and core inflation, which remained above the euro area average in 2017.

Good economic conditions and the fade out of bank support costs are expected to benefit public finances in a no-policy-change scenario.

After widening in 2016 due to the tax relief, headline deficit is expected to improve progressively at unchanged policies, with revenues benefiting from strong employment and consumption growth.
Following the financial crisis Austria’s government debt increased significantly, peaking at 84.3% of GDP in 2015, due to the impact of support measures for the banking sector.
Government debt declined to 83.6% of GDP in 2016 and is expected to continue decreasing to below 74% of GDP in 2019, helped by the divestment of impaired assets from asset management companies.

Austria has made some progress in addressing the 2017 country-specific recommendations.

With regard to ensuring financial sustainability, some progress was made on healthcare but no progress was made on the pension system. Limited progress was made towards reforming fiscal relations between the various levels of government.
Austria has made some progress in improving the labour market participation of women, but childcare provision is still below the targets for the under 3 years old and regional differences persist.
Limited progress has been made in improving the educational achievements of disadvantaged young people.
Some progress was made in reducing investment barriers in the services sector
.
Regarding progress in reaching the national targets under the Europe 2020 strategy, Austria has already reached its targets on tertiary education attainment and limiting early school leaving.
It is on track to meet the employment and the renewable energy targets.
However, more effort is needed to raise research and development expenditure, cut greenhouse gas emissions, decrease energy consumption and reduce poverty and social exclusion.

Austria performs relatively well on the indicators of the Social Scoreboard supporting the European Pillar of Social Rights.
Austria has robust policies to facilitate labour market access and to ensure fair working conditions.
Policies to reduce poverty and social exclusion risks are generally effective.
Austria has well developed institutional social dialogue mechanisms.

Key structural issues analysed in this report, which point to particular challenges for Austria’s economy, are the following:

1. Austria’s fiscal framework provides only weak incentives to improve cost efficiency.
In 2016 the different levels of government agreed on several initiatives that could improve the quality of public spending at subnational level.
These include spending reviews, more task-oriented financing, benchmark systems, a reform of subnational competencies and discussions on increasing tax autonomy at subnational level.
While these initiatives are promising, their effectiveness depends on being implemented in full.
Currently, the spending powers of municipal and federal state governments remain far greater than their revenue-raising responsibilities, giving them little incentive to contain costs.

2. The overall tax burden on labour is comparatively large, while more growth-friendly sources of revenue are underused.
Despite the 2016 tax reform, the burden on labour remains high and is set to increase as tax brackets are not indexed to inflation.
This is especially true for low-income earners with adverse effects on labour supply incentives.
Social security contributions represent a relatively large share of the tax wedge.
Conversely, revenues from recurrent property taxes are significantly below the EU average due to the outdated tax base.

3. The projections for medium-and long-term pension and healthcare expenditures point to a challenge for fiscal sustainability.
Current pension expenditure is comparatively high and is expected to rise further as life expectancy increases while the statutory retirement age remains fixed.
Closing the gap between the effective and statutory retirement ages would reduce public spending, but the potential savings are lower than for measures affecting the statutory retirement age.
For the healthcare sector, the main driver of the high expenditure is an over-sized hospital sector, which is the result of a fragmented financial and organisational structure.
There are efficiency gains to be made both at the system level, by shifting services to the less costly outpatient sector, and within the hospital sector itself by improving the use of public procurement.
In this context, implementing the ongoing reform aimed at strengthening primary healthcare in full could contribute to reduce the size of the hospital sector.
Enforcing expenditure ceilings may also help containing the projected spending increase.

4. Banking sector resilience continues to improve, but some pockets of vulnerability still warrant monitoring.
The capitalisation of Austrian banks increased substantially in 2016 but profitability in the domestic market remains under pressure. Foreign-currency loans granted by banks on the local market have further declined but are still a matter of concern.
The asset quality and profitability of subsidiaries in central, eastern and south-eastern Europe continue to improve, whereas the exposure of Austrian banks to several markets has declined following the restructuring of UniCredit.
Despite several challenges over recent years, Austrian insurance companies have managed to adjust relatively well to the low interest rates.
The winding-down of the asset management companies is proceeding better than expected and overall risks are limited.

5. House prices have grown considerably in recent years but overall risks to financial stability seem contained.
Prices have risen particularly strongly in the Vienna region, where some overvaluation can be observed.
Housing investment has been subdued in recent years compared to the relatively strong population growth, but picked up in 2017.
Nevertheless, the price increases do not appear to be credit-driven as the level of household mortgages remains relatively low. Furthermore, the rental market and social housing play a strong role in Austria, so that the house price increase mainly affects wealthier households as well as tenants in the private urban rental market.
The macro-prudential toolkit has been strengthened and can be activated to contain potential risks from real estate.

6. Austria’s labour market performance is improving but challenges for specific groups remain.
Over several years, immigration and overall increasing labour market participation led to a rapid expansion of the labour force that outpaced strong employment growth, causing moderate increases in the unemployment rate.
In 2017 the unemployment rate started to fall on the back of a further acceleration in employment growth. Austria has reached a high employment rate of 75.3% in Q3 of 2017, thus meeting the Europe 2020 target.
Wage increases were moderate, improving Austria’s competitive position. The high proportion of women in part-time work and the high gender pay gap remain issues of concern.
This is partly due to the still comparatively scarce and uneven provision of childcare for children below 3 years.
The labour market integration of people with a migrant background including refugees is also a policy challenge. So is the digital transformation of the economy.

7. Overall, social indicators reflect the good economic conditions, but vulnerabilities for certain groups still exist.
The number of people at risk of poverty and social exclusion has continued to decline. By contrast, in-work poverty is rising, especially among foreign workers.
In addition, while benefit adequacy has been overall favourable, the cuts in means-tested minimum income implemented in several federal states may put larger families at risk of poverty.
The risk of poverty and social exclusion for women above 65 years is higher than for men, also due to a gender gap in pensions. Wealth inequality is particularly high.

8. Learning outcomes of disadvantaged students have not improved.
New reforms in education were introduced but their impact has yet to materialise.
The second package of the reform agenda has increased schools’ autonomy, the regional coordination of schools and the availability of all-day schools.
Nevertheless, recent national and international testing both point to a comparatively weak performance by Austrian students.
Students' educational outcomes also continue to depend heavily on their socio-economic background and on whether they have a migrant background.
At the same time, Austria’s tertiary education attainment rate has reached the national and Europe 2020 target.
Several policy initiatives have been launched to help integrate refugees and people with a migrant background into the education system, as well as to encourage adult learning and improve digital education.

9. Restrictive regulation in Austria’s services markets hampers productivity and discourages innovation and investment.
Austria has high access barriers and restrictive rules on the exercise of key trades and professions.
These include specific shareholding requirements, extensive reserved activities and interdisciplinary restrictions.
High regulatory burdens also bear on the retail and tourism sectors. These barriers, burdens and restrictions are limiting investment, job creation and innovation in the services sector itself. They also affect other parts of the economy for which competitive and innovative services are a crucial input.

10. Stagnating productivity requires a strong focus on boosting innovation results and supporting innovative businesses.
Austria is investing heavily in research and innovation but has not yet managed to overcome the stagnation in total factor productivity.
Strengthening science-business links and supporting knowledge-intensive sectors remain therefore important.
Austria’s eco-system for starting and, even more so, for scaling-up innovative businesses remains a policy challenge.
Apart from regulatory barriers, the lack of later stage funding options, such as venture capital, play a role, as well as skill shortages in some professions.

11. Austria faces a challenge in spreading digital technologies including broadband and business models among small and medium-sized enterprises (SMEs).
Austria is well-advanced in digitalising its public administrations and larger companies are well placed to exploit the opportunities of the digital economy.
SMEs, the backbone of the Austrian economy, and micro-enterprises, are lagging behind.
Austria has only started to address this issue with initiatives supporting digitalization of SMEs.
High-speed connectivity in rural areas is also an issue.
Austria’s national digitalization strategy still lacks monitoring and systematic performance review tools.

The full 60 page report can be downloaded here.