CONTRIBUTION ISSUE 2015/04 MARCH 2015 POOR AND UNDER · Unemployment and the share of people living in jobless households can have a direct impact on poverty. Moreover, the longer

ISSUE 2015/04MARCH 2015 POOR AND UNDER

PRESSURE: THESOCIAL IMPACT OFEUROPE’S FISCALCONSOLIDATION

ZSOLT DARVAS AND OLGA TSCHEKASSIN

Highlights• Europe faces major challenges related to poverty, unemployment and polarisation

between the south and the north, which impact adversely the current living conditionsof many citizens, and also negatively impact medium- and long-term economic growth.

• Fiscal consolidation exaggerated social hardship. In vulnerable countries there was noalternative to fiscal consolidation, but in most EU countries and at aggregate EU level,consolidation was premature when the cyclical position of the economy was deteriorating.

• Spending on social protection was shielded relative to other spending categories, butpublic bank rescue costs were high. While the changes in the tax mix favoured job crea-tion, the overall tax burden become more regressive.

• There is an increasing generational divide between the elderly and the young in termsof social indicators. Social spending on elderly people was favoured relative to spen-ding on families, children and education. There is now a serious danger that a lost gene-ration might develop in several member states.

• Forceful policies should include bold structural reforms, better use of the Europeaneconomic governance framework, more demand promotion, and a revision of nationaltax/benefit systems for fair burden sharing between the wealthy and poor.

Zsolt Darvas ([email protected]) is a Senior Fellow at Bruegel. Olga Tschekassin([email protected]) is a former Bruegel research assistant. This PolicyContribution is based on a research paper commissioned by the European Parliament(http://bit.ly/1yvRRm5), the copyright of which belongs to the European Union. Theopinions expressed are those of the authors alone and do not represent the EuropeanParliament's official position. The authors thank Anna Iara, Alessandro Turrini, ShahinVallee, Guntram Wolff and a European Parliament administrator who wished to stayanonymous for comments.

Telephone+32 2 227 4210 [email protected]

www.bruegel.org

BRU EGE LPOLICYCONTRIBUTION

POOR AND UNDER PRESSURE: THE SOCIALIMPACT OF EUROPE’S FISCAL CONSOLIDATION

ZSOLT DARVAS AND OLGA TSCHEKASSIN, MARCH 2015

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BR U EGE LPOLICYCONTRIBUTION

1. The nine items are: 1)(arrears on) mortgage or

rent payments, utility bills,hire purchase instalmentsor other loan payments; 2)one week’s annual holiday

away from home; 3) a mealwith meat, chicken, fish (or

vegetarian equivalent)every second day; 4) unex-pected financial expenses;

5) a telephone (includingmobile phone); 6) a colourTV; 7) a washing machine;8) a car and 9) heating to

keep the home adequatelywarm.

ARTICLE 3 of the Treaty on European Union (TEU)lays down the main objectives of the EU. Theseinclude, inter alia, promoting the well-being of itspeoples, a highly competitive social marketeconomy, aiming at full employment and socialprogress, social cohesion, social justice andcombating social exclusion. In the wake of theglobal and euro-area financial and economiccrisis, soaring unemployment in most EUcountries and the weak economic outlook raisesthe spectre of poverty and social exclusion in anumber of member states, and threatens gravepolarisation within the EU.

According to Eurobarometer (2012), which is thesixth and most recent wave of monitoring of publicperceptions on the social impact of the crisis, 80percent of respondents think that poverty hasincreased in their country over the past 12months, while 67 percent say it has increased inthe EU. The survey also suggests a growing senseof hopelessness and insecurity in a number of EUcountries.

One reason for increasing social hardship mightbe fiscal consolidation: the soaring budget deficitsand public debt levels that followed on from theglobal and euro-area financial and economiccrises led EU member states to embark on a seriesof fiscal retrenchment strategies to stabilise theirpublic finances. Fiscal consolidation, which oftenconsists of a combination of lay-offs in the publicsector, cuts in various headline expenditures andincreases in taxes and other contributions, canhave a direct negative impact on the poorest seg-ments of society. This can be particularly the caseif the enacted fiscal measures weaken publicsocial protection systems, or laid-off public ser-vants fall directly into poverty. Indirectly, fiscalconsolidation also holds back economic activity,which can negatively influence employment andthus adversely impact household incomes.

POOR AND UNDER PRESSURE Zsolt Darvas and Olga Tschekassin

However, there are major complications in estab-lishing a link between fiscal consolidation andpoverty. These relate to the complexities in iso-lating the impact of fiscal consolidation from otherfactors influencing social conditions, the reasonswhy fiscal consolidation was needed in the firstplace and the choices made about the speed andcomposition of fiscal adjustment.

Against this background, this Policy Contributionevaluates social indicators that can have a bear-ing on poverty, looks at the fiscal consolidationstrategies of EU member states and assesses thepossible links between fiscal consolidation andsocial developments.

SOCIAL DEVELOPMENTS IN THE EU

The social situation in the EU is alarming. To sum-marise developments related to poverty, we tooka closer look at four social indicators: the severematerial deprivation rate, the unemployment rate,the NEET rate (persons not in education, employ-ment or training) and children in jobless house-holds, for the EU as a whole and for some majorcountry groups. We do not analyse the at-risk-of-poverty rate, one of the three indicators adoptedby the EPSCO (Employment, Social Policy, Healthand Consumer Affairs) Council in the context of theEurope 2020 Strategy, because it is a measure ofincome inequality and not a measure of poverty(see Box 1 on page 5). High levels of incomeinequality can be identified as having adverseimplications for society, as we argued in Darvasand Wolff (2014), but should not be confused withpoverty.

The most suitable indicator of poverty is thesevere material deprivation rate, which representsthe proportion of people who cannot afford at leastfour of nine basic items, including utility bills,warm food, adequate heating or a car1. The leftpanel of Figure 1 on the next page shows that the

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BR U EGE LPOLICYCONTRIBUTIONZsolt Darvas and Olga Tschekassin POOR AND UNDER PRESSURE

favourable pre-crisis trend of a decline in materialdeprivation in the EU was reversed with the crisis,with some minor improvements observed in2013. There is an emerging generational divide:the gap between young and old has widened.While the fall in severely materially deprived eld-erly people is a highly welcome development,more children were severely materially deprivedeven in 2013 than in 2007, which is worrying.

There are also major differences between countriesin material deprivation terms, as indicated forcountry groups by the right panel of Figure 1.Before the crisis, material deprivation was veryhigh but declining in the member states that joinedin the EU in 2004-07. During the crisis, there weremajor increases in the Baltic states after 2008, andafter 2010 in the three euro-area programme coun-tries (Greece, Portugal, Ireland) and in Italy andSpain. In the other EU15 countries there was onlya minor increase and even a slight decline in cen-tral and eastern European countries, though from ahigher level. These developments suggest that theeast-west divide has narrowed, while the north-south divide has widened with the crisis.

The country aggregates also mask someheterogeneity. Poverty in Europe is the mostsevere in Bulgaria, Romania and Hungary wheremore than one-quarter of the population is

severely materially deprived. The trend has beendeclining in Bulgaria and Romania but increasingin Hungary. On the other hand, in Slovenia and theCzech Republic, the poverty rate was below 7percent in 2013, well below the EU average.Among the other 10 EU15 countries poverty washighest in the United Kingdom with a rate of 8.3percent in 2013, and lowest in Sweden andLuxembourg with rates below 2 percent.

Unemployment and the share of people living injobless households can have a direct impact onpoverty. Moreover, the longer unemployment per-sists, the more work-related skills are lost and themore difficult reintegration into the active labourmarket becomes. Figure 2 on the next page showsthat while the unemployment rate in the UnitedStates started to decline already in late 2009, inEurope it continued to increase up to early 2013.The recent decline in the EU unemployment rateis welcome, but it started too late, declined toolittle and there are still about 24 million unem-ployed in Europe, which is very alarming. There isagain major cross-country heterogeneity, as theright panel of Figure 2 shows: unemployment inthe euro-area periphery is very high, while it ismoderate in the other older EU member states.There is therefore clear evidence of a wide south-north divide within the EU, while more recently theeast-west divide has narrowed.

Source: Bruegel based on Eurostat. Note. 10 other EU15: Austria, Belgium, Denmark, Finland, France, Germany, Luxembourg,Netherlands, Sweden and United Kingdom; Baltic states: Latvia, Lithuania, Estonia; 9 other central and east European states:Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovenia, Slovakia, Cyprus and Malta. Country group values are calculatedby the total number of materially deprived people in the country group divided by the total population of the group. 2013 datafor Ireland is not available: for calculating the 2013 average of Greece, Ireland and Portugal, we assumed that the number ofseverely materially deprived persons in Ireland remained unchanged at the 2012 level of 451,000, while we used the actualdata for Greece (increase from 2.141 million in 2012 to 2.223 million in 2013) and for Portugal (increase from 910,000 in 2012to 1.148 million in 2013).

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EU27, different age groups Country groups, total population

Figure 1: Severe material deprivation rate (% population), 2005-13

2. We do not report theyouth unemployment rate(which typically considers

the 15-24-year age cohort),because it is a very impre-

cise measure of forcedinactivity of young people.

Most 15-year olds are incompulsory education and

very few are looking forwork, but also among, eg

24-year olds, education orother training activities

occupy a significant share.The NEET indicator takesthis into account educa-

tion/training activities.

3. Between 2007-13, theNEET rate remained stable

in Luxembourg and Swedenand decreased in Austria,

Germany and Malta.

4. For example, by studyingmore than 140 million US

birth records for the period1975-2010, Currie and

Schwandt (2014) foundthat a one percentage point

increase in the averageunemployment rate experi-enced between the ages of

20 and 24 reduces theshort-run fertility of womenin this age range by six con-

ceptions per 1,000 womenand to an to an overall lossof 14.2 conceptions by the

time these women reachthe age of 40.

A long period of unemployment after graduation,when a worker should acquire the first skills in theworkplace, can undermine whole careers – creat-ing a lost generation and also having trickle-downeffects on fertility rates and child support. Empir-ical research has confirmed a negative causalimpact of unemployment on fertility (Currie andSchwandt, 2014; Kreyenfeld and Andersson,2014)4, possibly due to increased income uncer-tainty related to unemployment.

When children grow up in families in which parentsdo not work for long periods or work irregularly,their current living conditions are curtailed, butalso their opportunities compared to childrenwhose parents work are affected. This is becausea jobless household might be unable to make anadequate investment in quality education andtraining and therefore a child’s opportunities toparticipate in the labour market in the future arelikely to be adversely affected. The empiricalresearch presented in OECD (2012) found thathigher levels of economic, social and culturalstatus of parents are associated with higher edu-cational attainments for their children.

Figure 4 shows a continuous increase in the shareof children under 18 living in jobless householdsbetween 2008 and 2013, with especially starkincreases in euro-area periphery countries, wherethe rates more than doubled. After a dramaticincrease between 2006 and 2010, the Balticcountries again show a positive developmentmore recently, though even the most recent 2013value remains well above pre-crisis levels.

POOR AND UNDER PRESSURE Zsolt Darvas and Olga TschekassinBR U EGE LPOLICYCONTRIBUTION

04

Unemployment among young people, which isvery high in a number of EU countries, is espe-cially alarming. Figure 3 shows that young NEETs2

have become substantially more numerous in theeuro-area periphery, but also in central and east-ern European countries. The only good news isthat after a major increase in the Baltics up to2010, there is a clear declining trend in thesecountries. Among the 28 EU member states, theproportion of NEETs increased from 2007 to 2013in 23 countries3, underlining that this is a generalEU problem and not just a problem for the euro-area periphery.

Source: Bruegel based on Eurostat. Note: country groups as described in Figure 1 (10 other central and east European coun-tries also includes Croatia). January 2015 data is not available for Estonia, Latvia, Hungary, Greece or the United Kingdom: weapproximated the missing data for these five countries by assuming that the number of unemployed remained unchangedfrom December 2014.

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Source: Bruegel based on Eurostat.

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Figure 3: People not in employment, educationor training (NEETs), 15-29 age group, 2004-13

Zsolt Darvas and Olga Tschekassin POOR AND UNDER PRESSUREBR U EGE LPOLICYCONTRIBUTION

05

5. http://go.worldbank.org/0C60K5UK40.

6. http://ec.europa.eu/eurostat/statistics-

explained/index.php/Glossary:At-risk-of-poverty_rate.

BOX 1: WHAT IS POVERTY AND WHAT DOES THE AT-RISK-OF-POVERTY INDICATOR MEASURE?

The World Bank defines poverty as whether households or individuals have sufficient resources or abili-ties to meet their daily needs5 and highlights non-monetary aspects, such as health, education and sub-jective perceptions.

However, the most widely used EU indicator including the word ‘poverty’, the at-risk-of-poverty rate, is nota measure of poorness. It measures the share of people with net income after social transfers below 60percent of national median equivalised disposable income. As Eurostat’s glossary also notes, “this indi-cator does not measure wealth or poverty, but low income in comparison to other residents in that coun-try, which does not necessarily imply a low standard of living”6. As Figure 5 highlights, there is a verystrong association between the at-risk-of-poverty rate and the Gini-coefficient of income inequality: thecorrelation coefficient is 0.90. The at-risk-of-poverty rate is therefore a measure of income inequality.

Furthermore, the differences between the national thresholds (which are used to calculate the at-risk-of-poverty-rate) are so huge that they further underline the inappropriateness of this indicator for assess-ing poverty trends in Europe. After correcting for the differences in price levels, in Romania, a disposableincome of €2,106 a year (after taxes and social transfers) is considered to be the threshold, while in Lux-embourg the price-level adjusted threshold is €15,996. This means that if a person’s net income aftersocial transfers is at the threshold in Luxembourg, she or he can consume 7.5 times more goods and serv-ices in Luxembourg than a Romanian person at the national threshold in Romania. This is an enormous dif-ference. But even the difference between two less extreme countries, Austria and the Czech Republic, issubstantial: after taking prices into account, someone at the national threshold in Austria can consumetwice as much in goods and services as someone at the national threshold in the Czech Republic. Theanchored version of this indicator, which uses the real value of the 2008 thresholds in later years, doesnot address these drawbacks and the inappropriateness of the indicator to measure poverty trends.

Source: Bruegel calculation using data from Eurostat. Note: bothindicators are averaged over 2007-13. The correlation coefficientsbetween the two indicators in each year between 2007 and 2013are: 0.92, 0.90, 0.88, 0.90, 0.85, 0.84 and 0.87. The correlationcoefficient between the 2007-13 time averages of the two indicatorsis 0.90. The at-risk-of-poverty indicator is ‘At risk of poverty rate (cut-off point: 60% of median equivalised income after social transfers)’,while the Gini coefficient is the ‘Gini coefficient of equivaliseddisposable income’.

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Gini coefficient of income inequality

Figure 5: The correlation between the Gini-coefficient of income inequality and the at-risk-of-poverty indicator

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Baltic states

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Figure 4: Children under 18 in jobless households (% of children), 2004-13

Source: Eurostat. Note: Jobless households are householdswhere no member is in employment. Country groups asdescribed in Figure 1; 10 other central & east European coun-tries also includes Croatia. Data for Sweden is missing before2009: for this period the indicator is assumed to evolve in linewith the 9 other EU15 countries.

7. Using the examples offiscal adjustment in Den-

mark and Ireland in the1980s, in their seminal

paper Giavazzi and Pagano(1990) introduced the

notion of ‘expansionaryfiscal consolidations’,

whereby fiscal consolida-tion could increase output.Guajardo et al (2011) chal-

lenged this notion andfound, using a better indica-tor of fiscal adjustment and

an empirical strategyapplied to a larger set of

countries that fiscal consol-idation has contractionary

effects on private domesticdemand and GDP.

8. We call fiscal consolida-tion premature when it is

conducted in an economyin which the cyclical condi-tions deteriorate, providedthat markets do not give a

clear signal that public debthas increased to such a

high level which threatenspublic debt sustainability.

POOR AND UNDER PRESSURE Zsolt Darvas and Olga TschekassinBR U EGE LPOLICYCONTRIBUTION

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Overall, social developments in the EU are alarm-ing and suggest polarisation between the youngand old, between the European south and north,while the trend in terms of the east-west divide ismore mixed, with some gaps narrowing whileothers have widened

THE SPEED AND COMPOSITION OF FISCALCONSOLIDATION IN THE EU

There are certain budget consolidation measuresthat can have a direct impact on the poorest seg-ments of society. Social spending cuts can reducethe benefits people receive and limit the ability ofsocial protection systems to support the poor.Public sector lay-offs lead to unemployment ifthere are no job opportunities in the private sector.Cuts in public sector wages reduce the disposableincome of public servants, which can deepenpoverty, if some public servants already belongedto the poorest segment of society. An increase inconsumption taxes, such as value added tax, hasmore adverse impacts on poorer people, becausethey spend a larger fraction of their income onconsumption than the people at the upper end ofthe income distribution scale.

Beyond these direct impacts, fiscal consolidationmeasures can also have an indirect impact onpoverty. Various spending cuts and revenueincreases depress the economy at least in theshort and medium terms7. Recent research con-cluded that fiscal consolidation has a more signif-icant negative impact on the economy during arecession than during expansions, ie the so-calledfiscal multiplier is higher; see for example litera-ture surveys and own estimates in Baum et al(2012), Auerbach and Gorodnichenko (2012) andDell’Erba et al (2014). It is also established, as wewill demonstrate, that economic contractions arestrongly associated with a fall in employment inalmost all EU countries, and therefore fiscal con-solidation can adversely impact social conditions,including poverty.

Consequently, beyond fiscal measures that canpotentially directly impact poverty, the overallfiscal consolidation strategies of EU memberstates should also be assessed. Policy choices,such as the actual speed and composition of fiscaladjustment, can have major impact.

Speed of fiscal adjustment

The EU’s fiscal strategy was based on the convic-tion that fiscal consolidation was needed torestore the trust of financial markets, to limit theincrease in public debt levels, and thereby to laythe foundations for sustainable growth. Undoubt-edly, low public debt levels come with great ben-efits. However, premature8 fiscal consolidation atthe EU level likely had significant side effects,such as the worsening of the cyclical situation ofthe EU economy (Figure 6), and the need for fiscalconsolidation at the country level varies.

Fiscal consolidation needs – from an economicperspective – were different in different EU coun-tries. Fiscal consolidation was clearly necessary(at least to some extent) in those member statesin which budget deficits had increased to veryhigh levels at a time when there was a supposedlypermanent fall in output resulting from the burst-

Source: Bruegel using AMECO and European Commission(2013). Note: the blue line shows the cumulative change instructural primary balance (SPB), as revealed by AMECO. Thered line shows the cumulative discretionary fiscal effort (DFE)as implied by European Commission (2013). We calculatedthe EU27 SPB as the weighted average of the euro area 17and the 10 other EU countries, for which we derived theweights from the average GDP during 2000-13. We calculatedthe DFE for the EU27 the same way, after calculating the euroarea 17 DFE for 2012-13 by weighting the values of the first17 members of the euro area, because DFE for the euro areaas whole was available in European Commission only for2007-11. A source of non-comparability between the twolines is that we use the February 2014 version of AMECO,while European Commission (2013) calculated DFE using anearlier vintage of the structural balance.

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Figure 6: The output gap and two indicators of dis-cretionary fiscal measures in the EU (% of GDP)

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ing of unsustainable pre-crisis bubbles. Greece,for example, had a 16 percent of GDP budgetdeficit in 2009, when public debt was 130 percentof GDP. Under such circumstances, there was noalternative to fiscal consolidation: the questionwas the speed and composition. The speed wasprobably too fast and Greece entered a viciouscircle with falling output, lower tax revenue andlarger budget deficits, accompanied by the con-sequent increased consolidation needs, whichexaggerated the output fall. Entering such avicious circle was a major flaw of the Greek assis-tance programme (Sapir et al, 2014), though thepublic finance trajectory had to be rectified.

However, from an economic perspective, at theaggregate EU level as well as in most EU countries,budget deficits and public debts did not warrant aharsh consolidation strategy at a time when thecyclical position of the EU economy had deterio-rated considerably. In countries with strongerfiscal fundamentals more expansive fiscal poli-cies better aligned to their negative output gaps,and the needs of the EU aggregate would have notled to concerns about debt sustainability. Ger-many has even outperformed both the nationaland European fiscal targets (Barbiero and Darvas,2014). As a comparison, the US and Japan con-tinue to borrow at low interest rates despite theirmuch higher public debts and deficits. Therefore,the issue is not a return to ‘failed old debt-makingpolicies’ in highly indebted countries, but toensure fiscal stabilisation at the EU level as longas private demand is weak.

Buti and Carnot (2013) challenge some criticismsof the EU’s fiscal strategy and essentially con-clude that fiscal consolidation was necessary insouthern Europe, a conclusion that we agree with.But they are silent on developments in the aggre-gate fiscal stance of the euro area, which wasstrongly influenced by the major fiscal consolida-tion in Germany and other euro-area memberstates with strong fiscal fundamentals. They onlynote that the fiscal stance of Germany is nowbroadly neutral: this assessment does not con-sider the implications of the earlier German fiscaltightening for the aggregate euro-area fiscalstance at a time when the cyclical position of theeuro area was very weak.

In an elegant model, Merler and Piani-Ferry (2012)demonstrated that in a monetary union which con-sists of a competitive, moderately leveraged Northand an uncompetitive, over-indebted South, theSouth needs to tighten fiscal policy more than theNorth. Consequently, when fiscal consolidation istoo fast in the North, it has to be even faster in theSouth, which depresses output and inflation morein the South, making it more difficult to progresswith debt deleveraging.

The premature aggregate EU and euro-area fiscalconsolidation is hindering the deleveraging of theprivate sector and making it more difficult forsouthern euro-area member states to implementtheir necessary fiscal consolidations. It is pushinginflation close to zero, making it more difficult toachieve a symmetric correction in intra-euro areacurrent-account imbalances. It is also pushing theeuro area and the EU into a strong current accountsurplus. This last effect worsens globalimbalances9.

Composition of fiscal adjustment

Beyond the speed, the composition of fiscalconsolidation is also crucial for influencing socialconditions.

Large-scale support to the financial sector drainedthe resources of many EU governments and trig-gered or reinforced fiscal consolidation efforts,which in turn depressed the economy withadverse consequences for the poor. Data from theEuropean Commission's State Aid Scoreboard,which is reported in Table 5 of Darvas et al (2014),shows that in the EU as a whole, recapitalisationmeasures and asset-relief interventionsamounted to almost €600 billion in the EU from2008-12, which is equivalent to 4.6 percent of EUGDP, a very large amount. In addition, govern-ments provided various guarantees and liquiditysupport measures, which amounted to €906 bil-lion (7.7 percent of GDP) in 2009, of which €535billion (4.1 percent of GDP) was still outstandingin 2012.

Financial-sector support was very high in Ireland,Greece, Belgium, Cyprus and Spain. However, ineight EU countries (Bulgaria, Czech Republic, Esto-nia, Lithuania, Malta, Poland, Romania and Slovakia),

9. Darvas (2010) warnedthat premature fiscal con-

solidation at the euro-arealevel would likely lead to

these side effects.

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BR U EGE LPOLICYCONTRIBUTION POOR AND UNDER PRESSURE Zsolt Darvas and Olga Tschekassin

area programme countries. While the aggregatesocial payment amounts are in themselves notinformative on the effectiveness of social protec-tion, and inflation has eroded the real value ofsocial expenditures (see the last line in Table 1),this development suggests that governmentsmight have tried to cushion the negative impact ofthe crisis on society, which applies also to thosecountries that implemented the sharpest fiscaladjustments. Indeed, Figure 7 on the next pageclearly indicates that there is no systematic rela-tionship between fiscal adjustments and socialexpenditures; that is, countries that implementedlarger fiscal adjustments did not cut social expen-ditures more. This is a benign development. Theonly exception is Greece.

However, within social expenditures, pensionerswere the main beneficiaries of fiscal adjustments,as old-age related expenditure increased morethan other social protection expenditure in everycountry group (Table 2 on the next page). Sick-ness and disability expenditure suffered cuts inthe hardest-hit countries (vulnerable euro-areamembers and the Baltic states), but increased inother EU15 and central and eastern Europeancountries. Family and child support declined sub-stantially, by 19 percent in the three euro-areaprogramme countries, 14 percent in the Balticstates and 10 percent in Italy and Spain, whilethere was only a marginal increase in other EU15and central and eastern European countries. Infla-tion eroded further the real value of family and

10. In the central and east-ern EU members, foreign

banks dominate domesticbanking systems and for-

eign parent banks providedthe necessary capital to

their subsidiaries andbranches established in

other countries. This wascertainly helpful for publicfinances in host countries,

yet foreign-owned banksreduced their activities inhost countries, which canhave adverse effects (seeFigures 1 and 2 of Darvas

and Wolff, 2013).

11. Ireland: Anglo Irish Bank(2009), Germany: Hypo

Real Estate (2009), Den-mark: Amagerbanken(2010, 2008), Spain:

Bankia/BFA (2012,2010/11), France/Belgium:

Dexia (2012, 2008),Netherlands: SNS Reaal

(2013), Cyprus: Laiki Bank(2013, 2012), Greece:

Alpha Bank (2013).

12. The substan-tial public support to banks

was the main reason for theshift in bank rescue policies

to more bail-ins, leading tothe Bank Recovery and Res-

olution Directive (BRRD)and the Single Resolution

Mechanism (SRM).

no support was provided, while support was tiny inFinland and small in Hungary, Sweden and Italy10.

At the height of the crisis, public support was moti-vated by financial stability concerns. However, byanalysing eight bank restructurings between2008 and 2013 in different countries11, Dübel(2013) concluded that in all cases significantpotential for creditor participation was wasted, tothe detriment of taxpayers, even if there has beenmore emphasis in more recent restructurings onthe depth of creditor participation. These eightcases underline that even given the financial sta-bility motive of financial-sector support, bankrestructuring could and should have been imple-mented in a less costly way for taxpayers, whichwould have provided more fiscal space for gov-ernments for other purposes12.

By considering the main public expenditure cate-gories beyond bank support, Table 1 shows thatfor the EU as a whole and all country groups, publicinvestment was the major victim of fiscal adjust-ments. Barbiero and Darvas (2014) argue thatsince the fiscal multiplier of public investment isthe largest among the main expenditure and rev-enue categories of the government, the significantcut-backs in public investment exaggerated theoutput fall.

On the other hand, social payments increasedmore than other primary expenditures, or fell lessthan other primary expenditures in the three euro-

Source: Bruegel using AMECO data. Notes: Country groups as described in Figure 1. For the Baltics the 2008-13 period is shown,because fiscal consolidation started earlier in these countries. The aggregates involving countries with different currencieswere calculated using constant exchange rates (the average of 2009-13) and therefore exchange rate fluctuations do notaffect the values shown.

Table 1: Main public expenditure categories net of bank recapitalisation by the public sector, %change from 2009-13 (in current prices and constant exchange rates)

Share Percent change in current prices, 2009-13

EU28 EU28Greece,Ireland,Portugal

Italy,Spain

10 otherEU15

Baltics 310 other

CEE

Total expenditure 100 6 -15 -2 9 1 9Interest expenditure 5 20 10 31 15 167 25Primary expenditure 95 5 -17 -4 9 -1 8

Social expenditures 43 10 -8 8 12 14 13Compensation of employees 22 2 -21 -6 7 -8 3Other current primary expenditure 22 3 -24 -9 7 -6 12Capital expenditure 8 -13 -31 -41 -1 -13 -8Memorandum: inflation 10 6 9 9 13 12

09


child benefits. Unemployment benefits wereincreased significantly where it was needed themost, in the euro-area periphery and the Balticstates, while they declined in the rest of the EU.

Therefore, intentionally or not, there was redistri-bution from families and children towards pen-sioners, while unemployment benefit expendituremight have helped to mitigate the adverse impactof unemployment in those countries in which theunemployment rate has increased the most.Spending on education was also significantlyreduced in the most vulnerable countries, whichcan also affect adversely the young generation.

Fiscal consolidation might also have an impact onpoverty rates by reducing expenditure on publicsector employees. Figure 8 on the next pageshows that countries that implemented largerfiscal adjustments reduced more their spendingon public sector workers.

Reducing public sector labour compensation cantake two main forms: reducing wages and laying

Share Percent change in current prices, 2009-12

EU28 EU28Greece,Ireland,Portugal

Italy,Spain

10 otherEU15

Baltics 310 other

CEE

Total general govt. expenditure 100 4 -12 1 6 -3 7Interest payments 5 23 14 32 19 164 22Broad services 17 -2 -12 -11 2 -15 -1Economic affairs 9 -5 -45 5 -6 -20 -4Environment protection 2 -5 -26 -8 -4 -6 21Health, recreation 17 4 -20 -7 8 -6 12Education 11 2 -14 -10 5 -7 8Old age 20 10 0 8 10 15 13Family and children 4 0 -19 -10 3 -14 1Housing 1 12 -30 6 13 23 20Unemployment 4 0 11 14 -5 13 -11Sickness and disability 6 7 -7 -1 9 -5 12Other social protection 5 7 -11 5 9 26 8Memorandum: inflation 8 6 8 7 12 10

Table 2: General government expenditure by function, % change 2009-12 (in current prices andconstant exchange rates)

Source: Bruegel using Eurostat’s ‘General government expenditure by function’ (COFOG) database. Note: Belgium, Croatia, Slo-vakia and Romania are not included because of lack of data; we report data for the aggregate of the remaining 24 countries ofthe EU (EU24). Country groups as described in Figure 1. For the Baltic states the 2008-12 period is shown, because fiscal con-solidation started earlier in these countries. The aggregates for countries with different currencies were calculated using con-stant exchange rates (the average of 2009-13) and therefore exchange rate fluctuations do not affect the values shown.Broad services include: general public services except interest payments, defence, public order and safety and communityamenities.

Source: Bruegel using data from Eurostat and European Com-mission (2013). Note: for each country, we checked the startdate of fiscal consolidation and calculated the change in theindicators from that date till 2013. Social expenditures in thesum of ‘Social benefits other than social transfers in kind: gen-eral government’ and ‘Social transfers in kind supplied tohouseholds via market producers: general government’.Fiscal consolidation is measured by the discretionary fiscaleffort (DFE) indicator of European Commission (2013). Miss-ing DFE values for Greece (2007-10), Hungary (2007-09) andLuxembourg (2007-11) completed with the change in struc-tural primary balance.

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Figure 7: Fiscal adjustment vs social expendituresduring fiscal consolidations

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off public sector workers. EU countries adopteddifferent mixes of these methods: in Ireland,Romania and Spain, most of the reduction in totallabour compensation resulted from cutting hourlywages, while in Latvia about half of the reductionwas the result of wage cuts and lay-offs. Wageswere cut the most in Greece (by 20 percent), butalso employment was reduced by 10 percent,while those who remained employed work morehours per week now than in 2008 (see Figure 4 inDarvas et al, 2014).

The cut in the public sector bill might have notimpacted the poorest segments of the society,because wages in the public sector tend be muchhigher than wages in the private sector in thosecountries that implemented the largest fiscaladjustments (see Figure 5 in Darvas et al, 2014).Also, in some countries public sector wage cutswere highly progressive. For example in Greece,where wages were cut by 20 percent on average,public servants with monthly salaries of less than€1000 faced only a 2 percent cut, while higherearners faced larger cuts with the highest earnercategory (over €4000) facing a 35 percent cut. Yetif lay-offs lead to long-term unemployment, then itcertainly has an impact on poverty too.

The analysis of the revenue side of budgets sug-gests that in the EU as a whole, effective labour

13. Unfortunately, there isno comprehensive datasetof tax rates and the compli-

cated tax laws, includingthe definition of tax bases

and exemptions, making itrather difficult, if not impos-

sible, to compare tax ratesand the changes to them.

We therefore compareimplicit tax rates (ITRs),

which measure the effec-tive average tax burden on

different types of economicincome or activities (labour,

consumption and capital),as the ratio between rev-

enue from the tax typeunder consideration and its(maximum possible) base.

For example, the ITR on con-sumption is the ratio

between the revenue fromall consumption taxes and

the final consumptionexpenditure of households.

‘While social expenditures were generally preserved relative to other spending categories, there

was redistribution from families, children and education towards pensioners, which may have

contributed to the widening poverty gap between the young and the old.’

taxes fell slightly, effective consumption taxesincreased slightly, while effective capital taxeswere reduced significantly (Table 6 of Darvas et al,2014)13. But there are diverse developmentswithin the EU. Labour taxes tended to decrease inthose countries in which they were the highestbefore the crisis, while labour taxes increased incountries with low tax rates. The correlation coef-ficient between 2008 tax rates and their changefrom 2008 to 2011 is -0.57. A similar relationshipcan be observed with consumption taxes, thoughthe correlation coefficient between 2008 con-sumption tax rates and their subsequent changesis smaller, -0.31. However, for capital taxes, thecorrelation coefficient is close to zero (-0.03), sug-gesting that the level of the pre-crisis tax rates didnot influence the direction of changes in the taxrate during the crisis.

Labour taxes are generally structured in a way thatis progressive to some degree, though there areabout ten central and eastern EU members thathave adopted flat personal income tax rates.Among the most severely hit countries, labourtaxes increased in Ireland, Latvia, Portugal andSpain, which might have negatively impactedsocial conditions, though the effective tax rates inthese countries remained well below the EU aver-age even after the increase. In Greece, effectivelabour taxes declined by 2 percentage points,which was the third largest decline in the EU.

In the various editions of the Annual GrowthSurvey, the European Commission suggestedmoving the tax burden away from labour towardconsumption, on the basis that this should boostlabour productivity and promote employment. Inthe 2008-11 period, 14 out of the 27 EU countriesfollowed this advice (of which eight cut labourtaxes and increased consumption taxes, while theother six countries cut labour taxes more thanconsumption taxes). Additionally, two other coun-tries cut both taxes, but cut labour taxes morethan consumption taxes. Therefore, the directionof tax changes was in line with the Commissionsuggestion in many EU countries. Yet the eco-Source and notes: see Figure 7.

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Figure 8: Fiscal adjustment vs public sectorlabour compensation during fiscal consolidations

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nomics literature has shown how indirect (and inparticular consumption) taxes tend to be regres-sive, so an increase in consumption taxes bur-dens more the poorest segments of society.

Finally, during 2008-11, the effective tax rate oncapital was reduced in 17 countries and increasedin only three countries (France, Sweden and Ger-many). It needs to be seen to what extent thesecuts in effective capital taxes are part of a broadertaxing strategy to attract (or at least maintain)investment and capital inflows, or if they are aspecific and temporary reaction by the govern-ments to the crisis, during which corporate profitsplummeted.

THE RELATIONSHIP BETWEEN FISCALCONSOLIDATION AND DETERIORATING SOCIALCONDITIONS

Academic research on poverty, inequality andfiscal adjustments

Poverty has various micro and macro determi-nants, as detailed by, among others, Jäntti andBradbury (2003), Valletta (2004) and Zaidi(2009). Factors such as educational attainment,age, employment status, family structure, gen-erosity of social benefits (and especially of familybenefits) and pension generosity are proved tohave a significant negative effect on the odds ofpoverty. Macro factors, such as the regional unem-ployment rate and regional GDP, have also beenfound to affect the individual at-risk-of-povertystatus. The key question is thus the interactionbetween fiscal austerity and these micro andmacro determinants of poverty.

The literature has also concluded that fiscalconsolidation typically increases incomeinequality. If an increase in income inequalityincreases poverty too, then one may easilyassociate the increase in poverty indicators withfiscal consolidation.

For example, Ball et al (2013) analysed the distri-butional impacts of 173 fiscal consolidationepisodes in 17 OECD countries from 1978-2009.They found that fiscal consolidation typically hadsignificant distributional effects by increasinginequality, decreasing wage income shares and

increasing long-term unemployment. On the com-position of fiscal adjustment, they found thatspending-based adjustments had, on average,greater distributional effects than tax-basedadjustments.

Woo et al (2013) largely corroborate these find-ings and also present further results demonstrat-ing why the composition of austerity measuresmatters. They find that progressive taxation andtargeted social benefits and subsidies introducedin the context of a broader decline in spending canhelp offset some of the adverse distributionalimpact of consolidation. In addition, they concludethat fiscal policy can favourably influence long-term trends in both inequality and growth by pro-moting education and training among low- andmiddle-income workers.

On the other hand, various structural reform meas-ures adopted in parallel to fiscal austerity meas-ures could alleviate the negative impact of fiscalconsolidation on poverty. OECD (2011) finds thatregulatory and institutional changes exerted a sig-nificant impact on the employment rate, andthereby on poverty. Yet, most policy and institu-tional reforms also contributed to widening wagedisparities, as more low-paid people enteredemployment and the highly skilled reaped greaterbenefits from a more dynamic economy resultingfrom the reforms.

By analysing data up to 2010, OECD (2013) findsthat taxes and benefits effectively compensatedfor part of the overall increases in market incomeinequality and poverty. But their impact varied fordifferent population groups. On average, relativeincome poverty increased among children, youthand adults, but it fell among the elderly.

Therefore, fiscal austerity and poverty trends haveto be put into the broader context of the determi-nants of poverty and the other measures, such asstructural reforms, as the mere coincidencebetween various fiscal indicators and an increasein poverty does not necessarily imply causality.But even if there is causality (and we argue belowthat there is), conclusions for policy should bedrawn very carefully.

12


Co-movements between relevant indicators

Establishing causal links between austerity meas-ures and poverty is extremely complicated, as wehave discussed, and is beyond the scope of thispaper. We do, however, assess the co-movementsof various indicators, which might shed light onthe impact of fiscal consolidation and adversesocial conditions.

Figure 9 assesses the coincidence between thefiscal adjustment and the change in the severematerial deprivation rates in two sub-periods:Panel A shows the expansionary fiscal policyperiod while Panel B shows the fiscal consolida-tion period. For each country we checked the startof the fiscal consolidation period and therefore setthe exact timing of the variables shown on the twopanels. During the first phase of the crisis, whenmost countries implemented fiscal stimuli (ie the

discretionary fiscal effort was negative), there waspractically no relationship (Panel A). However, therelationship is more pronounced in the period offiscal consolidation (Panel B), suggesting thatmore fiscal consolidation is associated withgreater increases in poverty.

The relationship between fiscal consolidation andunemployment is similarly ambiguous in theperiod of fiscal expansion (Figure 10, panel A). Inthe period of fiscal consolidation, however, there isa strong relationship: more consolidation isstrongly associated with greater increases inunemployment, indicated by Panel B of Figure 10.

Furthermore, there is also a strong negative rela-tionship between fiscal consolidation and GDPgrowth, as shown by Panel B of Figure 11; this rela-tionship is corroborated by a more comprehensiveempirical study by Blanchard and Leigh (2013).

Source: Bruegel using data from European Commission (2013) and Eurostat. Note: missing DFE values for Greece (2007-10),Hungary (2007-09) and Luxembourg (2007-11) completed with the change in structural primary balance. Last year with anexpansionary DFE: 2008: Bulgaria, Estonia, Ireland, Lithuania, Latvia, Romania; 2009: Belgium, Czech Republic, Germany,Greece, Spain, France, Italy, Netherlands, Slovakia, Great Britain; 2010: Austria, Cyprus, Denmark, Poland, Portugal, Slovenia;2011: Finland.

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Figure 9: Discretionary fiscal effort and severe material deprivation

Source: Bruegel using data from Eurostat and European Commission (2013). Note: see notes on DFE under Figure 9.

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Figure 10: Discretionary fiscal effort and the unemployment rate

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Unsurprisingly, GDP and unemployment develop-ments moved strongly together, as labour condi-tions are well known to be intrinsically related tothe business cycle. This relationship holds bothbefore and after 2009, as indicated by Figure 12.

Consequently, to the extent that fiscal consolida-tion measures weakened GDP growth andincreased unemployment, and if unemploymentis a main determinant of poverty, one can con-clude that fiscal consolidation has led to anincrease in poverty. Gallie, Paugam and Jacobs(2003) and Matsaganis (2013) also established alink between long-term unemployment andpoverty. Using a panel regression, Duiella and Tur-rini (2014) found that long-term unemploymentappears the most significant and robust explana-tory factor for relative and absolute poverty,stronger than income-per-capita variables. Theyalso found that social protection expenditure hasa significant impact.

Source: Bruegel using data from Eurostat and European Commission (2013). Note: see notes on DFE under Figure 9.

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Figure 11: Discretionary Fiscal Effort and GDP growth

Source: Bruegel using data from Eurostat and AMECO database (February 2014).

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Figure 12: GDP growth and unemployment rate

CONCLUDING REMARKS

Europe faces major social challenges: the share ofseverely materially deprived people, unemploy-ment and the share of children living in joblesshouseholds is high, and European citizens per-ceive that poverty has increased. Within Europe,the degree of polarisation between the south andthe north in terms of social indicators haswidened, while the east-west gap, which was gen-erally wide before the crisis, is narrowing accord-ing to some indicators but widening according toothers. Whatever the reasons behind adversesocial developments, the sad conclusion is thatEU membership was not enough to guaranteesocial protection for many citizens.

Poverty and unemployment have a negativeimpact on the current living conditions of a largesegment of society, and also have major negativeimpacts on medium- and long-term economicgrowth. Long spells of unemployment erode skillsand discourage labour market participation,

14


thereby undermining a country’s long-term growthpotential. Youth unemployment is especiallyalarming because a long period of unemploymentafter graduation, when a worker should acquirethe first skills in the workplace, can underminewhole careers – creating a lost generation andalso having trickle-down effects on fertility ratesand child support. Unemployment-related incomeuncertainty reduces fertility and when childrengrow up in families in which parents do not workfor long periods or work irregularly, their opportu-nities are curtailed compared to children whoseparents work.

One reason for the increased social hardship isfiscal consolidation. The high budget deficits andrising public debt levels that followed the globaland euro-area financial and economic crises ledmost EU states to embark on a series of fiscalretrenchment strategies to stabilise their publicfinances. However, it is not easy to derive a con-clusion for policy from this observation. EU coun-tries should be divided into two major groups andconclusions for policy are different for each group.

• In one group, in which budget deficits wereexceptionally high and public debts started toincrease at a very rapid pace, there was noalternative to fiscal consolidation: the questionwas its speed and composition.

• In the other group, which includes most of theEU, the fiscal situation was within reasonablelimits and macroeconomic stabilisation wouldhave called for fiscal support at a time when thecyclical position of the European economy wasdeteriorating. In these countries fiscal consoli-dation, which started around 2009 and 2010,was premature.

The aggregate of country-specific fiscal strategiesresulted in an overly tight fiscal stance for the EUas a whole. Since there is no fiscal authority at theEU or at least euro-area level to manage the aggre-gate fiscal stance, it is unlikely that the fiscalbehaviour of the EU aggregate will be more con-ducive to cyclical stabilisation in the future.

When looking at the composition of fiscal adjust-ment, we found that spending on social protectionwas shielded relative to other spending cate-gories, which suggests that governments have

tried to cushion the social impact of the crisis. Thisis good news. But we also concluded that bankrescue was very expensive for taxpayers. Bankrescue limited the fiscal resources available forother purposes and resulted in greater fiscal con-solidation needs, with a negative impact on theeconomy and social conditions in Europe. Thechanges in taxes broadly followed the advice ofthe European Commission by moving the taxburden away from labour toward consumption,but since labour taxes are typically progressive(except in a number of central European memberstates), while the impact of consumption taxes isregressive (the poor consume a larger share oftheir income than the rich), such tax changesmight have adversely impacted the poorest seg-ments of the society.

Last but not least, the crisis has brought to the forean increasing generational divide. Within socialspending, elderly people were protected mostduring the crisis, possibly due to pension rules ortheir better ability to assert their interests. Socialindicators for the elderly showed little deteriora-tion and in fact the severe material deprivationrate for elderly people has declined during thepast five years, which is certainly a benign devel-opment. However, social spending on families andchildren was preserved less than spending on theelderly, and social indicators suggest that theyounger generation has suffered seriously: chil-dren who live now in households in which theirparents no longer work and young people who arenot in work or education. Spending on educationwas also cut substantially in the more vulnerablecountries, which can have adverse impacts on theyoung. There is now a serious danger that a lostgeneration might develop in several memberstates, which would undermine medium- andlong-term growth prospects for the whole conti-nent, adding to social and human costs.

Forceful policies are needed, well beyond whathas been announced so far, to improve social con-ditions in Europe and limit polarisation. Theseshould include bold structural reforms, better useof the European economic governance framework,more demand promotion, and a revision ofnational tax/benefit systems for improved effi-ciency, intergenerational equity and fair burdensharing between the wealthy and poor14.

14. Our policy proposals aredetailed in Darvas and Wolff

(2014a and 2014b).

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Documents

CONTRIBUTION ISSUE 2015/04 MARCH 2015 POOR AND UNDER · Unemployment and the share of people living in jobless households can have a direct impact on poverty. Moreover, the longer