1

Marco Buti (European Commission)

and André Sapir

(Université Libre de Bruxelles, Bruegel and CEPR)

Fiscal Policy in Europe : A Long View

Second annual Berkeley-Vienna conference:The US and European Economies in Comparative Perspective

Berkeley, September 12-13 2005

I. A CONCEPTUAL FRAMEWORK

3

EUROPE SINCE WWII: Three sub-periods

The Golden age : 1950-1973

The fall from heaven: 1973-1993

Maastricht stabilisation: 1993-2000-2004

Growth 4,5 2,5 1,5

Unemployment 2 8 8

Inflation 4 8 2

Public deficit <2 0 => 6 6 => 1,5 => 3

Government spending <35 37 => 51 51 => 46 => 44

4

An interpretation: the Musgravian triangleGolden age

Redistribution Stabilisation

Allocation

• No trade offs: setting up of the welfare state allows improvement of allocation (correct market failures in unemployment and social insurance), redistribution (via the same programmes) and stabilisation (tax and welfare systems as automatic stabilisers)

• Social welfare maximisation increases the chances of re-election: benevolent government = political economy approach

+

+ +

_~

5

Fall from heaven

Redistribution Stabilisation

Allocation

• Trade offs emerge: between allocation and redistribution/ stabilisation (work incentives hampered)

• Social welfare maximisation ≠ politically motivated behaviour

• Sustainability becomes a problem

- -

6

Maastricht consolidation

Redistribution Stabilisation

Consolidation

Allocation

• Primary focus: discipline/sustainability

• Maastricht consolidation: higher taxes, lower spending impact on Musgrave, in the short and longer run

• Beyond a critical level, reducing taxes may improve allocation and stabilisation

--

--/+

-/+

7

II. THE PAST 30 YEARS

8

GDP growth

-4

-2

0

2

4

6

8

10

1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

DE

FR

IT

UK

EUR-12

9

Unemployment rate

0

2

4

6

8

10

12

14

1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002

DE

FR

IT

UK

EUR-12

10

Inflation

-5

0

5

10

15

20

25

30

1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

DE

FR

IT

UK

EUR-12

11

Budget balance

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

% o

f GD

P

DE

FR

IT

UK

EUR-12

12

Cyclically adjusted primary balance

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

% o

f GD

P

DE

FR

IT

UK

EUR-12

13

Public debt

0

20

40

60

80

100

120

140

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

% o

f GD

P

DE

FR

IT

UK

EUR-12

14

Total expenditure

20

25

30

35

40

45

50

55

60

1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002

% o

f GD

P

DE

FR

IT

UK

EUR-12

15

Total revenue

20

30

40

50

60

1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

% o

f GD

P

DE

FR

IT

UK

EUR-12

16

III. FUTURE PERSPECTIVES: AGEING KICKS IN

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Demographic changes

2003 2025 2050

D 26 38 52

F 25 37 46

I 28 39 62

UK 24 33 45

EUR-1225 37 53

Old Age Dependency Ratio

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LONG TERM BUDGETARY PROJECTIONS

Non-age related

exp.

2008 2050 2008 2050 2008 2050 2008 2050 Constant 2008 2050

D 11 14,9 5,9 7,1 5,3 5,5 0,9 0,7 18,3 41,4 46,5

F 12,7 14,5 6,4 7,4 5,9 5,5 1 0,7 22,8 48,8 50,9

I 14 14,1 6,4 8,1 4,6 4,2 0,4 0,3 13,4 38,8 40,1

UK 5,1 5,3 7,7 9,7 5,4 5,4 1,4 1,5 20,4 40 42,3

EUR-12 11,1 14 6,1 7,6 5 4,8 1,4 1,2 18,5 42,1 46,1

TOTALAge related expenditure

Pensions Health care Education Others

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The “maximum sustainable” level of debt is decreasing

)()(

ayrasb

sM(a) ↓, y (a) ↓, r ?

a = ageing

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IV. EMU’S FISCAL FRAMEWORK:HELP OR HINDRANCE?

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SGP spirit

The approach chosen by the framers of the SGP was two-pronged:

• The 3% of GDP reference value should be treated as much as possible a ‘hard ceiling’.

• Member States should commit themselves to a “medium-term budgetary objective” of “close-to-balance or in surplus”.

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In the steady state

Sustainability ↓ public debt

Stabilisation CTB + automatic stabilisers

Allocation ↓ public spending

… BUT WE NEVER GOT THERE

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Lessons from the first 5 years of EMU

• High structural deficits and debts

• Lack of consolidation in good times

• Somewhat better stabilisation (but largely in spite of the rules)

Political assessment

Economic assessment

• Fading ‘ownership’

• Large countries/small countries divide

• Enlargement of the EU heightens the problems

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SGP reform: motivation

• Sustainability ↓ public debt plus

reforms for ageing

• Stabilisation CTB + automatic stabilisers

plus country differentiation

• Allocation ↓ public spending plus

expenditure quality

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The reformed SGP1. Economic governance• Stability programme for the legislature• Involvement of national parliaments• Reliable forecasts• Better statistical governance

2. Preventive arm• Diversified MTOs• At least 0.5% structural adjustment

3. Corrective arm• Exceptional circumstances• ‘All ORFs’, but only if d>3% is ‘close and temporary’• Debt and sustainability• Repeatability of EDP steps

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THE OLD AND THE NEW STABILITY PACT: two readings

Old SGP New SGP: collusion

New SGP: genuine

1. Public visibility High but fading Lower

2. Clear incentives

Less clear Easier to get away with

Better rationale

3. Political ownership

Small MS High deficit MS: D+F+I

All MS

4. Constraining calendar

CTB in the medium term

MTO de facto never

MTO in the medium term

5. Collegial culture

Acrimony prevailed

From collegiality to collusion

New collegiality based on trust