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
1
I. A CONCEPTUAL FRAMEWORK
EUROPE SINCE WWII:
Three sub-periods
The Golden age :
1950-1973
The fall from heaven:
1973-1993
Maastricht stabilisation:
1993-2000-2004
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
Growth
3
_
~
An interpretation: the Musgravian triangle
Golden 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 reelection: benevolent government = political economy approach
4
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
5
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
6
II. THE PAST 30 YEARS
7
GDP growth
10
8
DE
6
FR
4
IT
2
UK
0
EUR-12
-2
-4
1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
8
Unemployment rate
14
12
DE
10
FR
8
IT
6
UK
4
EUR-12
2
0
1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
9
Inflation
30
25
DE
20
FR
15
IT
10
UK
5
EUR-12
0
-5
1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
10
Budget balance
6
% of GDP
4
2
0
DE
-2
-4
FR
-6
UK
-8
EUR-12
IT
-10
-12
-14
1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
11
Cyclically adjusted primary balance
8.0
6.0
DE
FR
IT
UK
EUR-12
% of GDP
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0
1970
1973
1976
1979
1982
1985
1988
1991
12
1994
1997
2000
2003
Public debt
140
% of GDP
120
100
DE
80
FR
IT
60
UK
40
EUR-12
20
0
1970
1973
1976
1979
1982
1985
1988
1991
13
1994
1997
2000
2003
Total expenditure
60
% of GDP
55
50
DE
45
FR
40
IT
35
UK
EUR-12
30
25
20
1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
14
Total revenue
60
% of GDP
50
DE
FR
40
IT
UK
EUR-12
30
20
1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
15
III. FUTURE PERSPECTIVES:
AGEING KICKS IN
16
Demographic changes
Old Age Dependency Ratio
2003
2025
2050
D
26
38
52
F
25
37
46
I
28
39
62
UK
24
33
45
25
37
53
EUR-12
17
LONG TERM BUDGETARY
PROJECTIONS
Non-age
related
exp.
Age related expenditure
Health care
Pensions
2008
2050
2008
2050
Education
2008
2050
TOTAL
Others
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
11,1
14
6,1
7,6
5
4,8
1,4
1,2
18,5
42,1
46,1
EUR-12
18
The “maximum sustainable” level
of debt is decreasing

b 
s (a)
r  y(a)
sM(a) ↓, y (a) ↓, r ?
a = ageing
19
IV. EMU’S FISCAL FRAMEWORK:
HELP OR HINDRANCE?
20
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-tobalance or in surplus”.
21
In the steady state
Sustainability
↓ public debt
Stabilisation
CTB + automatic stabilisers
Allocation
↓ public spending
… BUT WE NEVER GOT THERE
22
Lessons from the first 5 years of EMU
Economic assessment
• High structural deficits and debts
• Lack of consolidation in good times
• Somewhat better stabilisation (but largely in spite of the rules)
Political assessment
• Fading ‘ownership’
• Large countries/small countries divide
• Enlargement of the EU heightens the problems
23
SGP reform: motivation
• Sustainability
↓ public debt plus
reforms for ageing
• Stabilisation
CTB + automatic stabilisers
plus country differentiation
• Allocation
↓ public spending plus
expenditure quality
24
The reformed SGP
1.
•
•
•
•
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
25
THE OLD AND THE NEW STABILITY
PACT: two readings
Old SGP
New SGP:
collusion
1. Public visibility High but fading
New SGP:
genuine
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
26