By Jan Strupczewski
BRUSSELS (Reuters) - After three years of deep spending cuts, the European Union confirmed a shift in policy on Wednesday, telling countries they must focus on structural economic reforms to boost growth, while not abandoning budget discipline.
In a long-flagged move reflecting growing frustration among euro zone governments and voters over the hardships of austerity, the European Commission announced that several countries would have more time to meet deficit targets.
The change of emphasis comes as the euro zone struggles to escape a second consecutive year of recession and record high unemployment that has provoked concerns about social unrest.
The EU's executive said budget cuts would still have to be made, but since financial markets have calmed after three years of crisis, there was now more "breathing space", time that should be used to make long-needed reforms.
"The social emergency in many parts of Europe and the increasing level of inequalities in some regions add to the pressing need for reforms," European Commission President Jose Manuel Barroso said as he presented the Commission's recommendations for 23 of the EU's 27 member states.
"The fact that more than 120 million people are now at risk of poverty or social exclusion in Europe is a real worry," he said. "We need to reform, and reform now. The cost of inaction will be very high," he said.
France, Spain, Slovenia and Poland were all given two more years to bring their deficits below 3 percent of GDP, while the Netherlands, Portugal and Belgium got one more year. At the same time, Hungary and Italy were removed from a list of countries on "budget watch", along with Romania, Latvia and Lithuania.
Perhaps the most closely watched recommendations were those made to France, the euro zone's largest economy after Germany, and to Spain, the fourth largest, with both in recession and afflicted with high unemployment
French joblessness is above 10 percent and set to grow while in Spain it is 27 percent, with more than half of young people without jobs, giving rise to fears of a lost generation.
Showing just how far the 17-nation euro zone is from returning to health, the Organisation for Economic Co-operation and Development said on Wednesday that the currency bloc would shrink 0.6 percent this year.
Because debt-laden governments cannot afford to jump-start growth through public spending, they must reform the way their economies are run, largely by tackling inefficiencies in labor markets, pension systems and public services.
The Commission emphasized the need for labor markets to be made more flexible and on the opening up of product and services markets. It also called for Germany to push wages up in line with productivity so that domestic demand is increased.
Much of its attention was focused on France, which it said must carry out labor and pension reforms to regain the country's lost business dynamism while cutting public spending to address its swollen budget.
It must also simplify its tax system to help companies compete and make its pensions system sustainable by 2020.
French labor laws make it difficult to fire someone on a permanent contract, which makes employers more reluctant to hire. The minimum wage in France, which at 1,430 euros ($1,850) a month is among the highest in Europe, hinders employment and makes French products less competitive globally.
Barroso said Paris should use the extra two years granted by the Commission to reform.
"This extra time should be used wisely to address France's failing competitiveness, as France's enterprises have suffered a worrying loss of competitiveness in the last decade, indeed we can say in last 20 years," he said.
The commissioner for economic affairs, Olli Rehn, hammered home that message.
"It is now of paramount importance that this breathing space created by the slower pace of consolidation is used by member states for implementing those economic reforms that are necessary to unleash our growth potential and improve our capacity to create jobs," he said.
The recommendations, once approved by EU leaders at a summit in late June, will become binding and are expected to influence how national budgets are drafted for 2014 and onwards.
(Additional reporting by Paul Taylor in Paris, John O'Donnell, Robin Emmott, Martin Santa and Luke Baker in Brussels; editing by Mike Peacock and Giles Elgood)