“lisbon ii and the new pact: prioritising structural reform over fiscal prudence?”

Workshop on“Policy learning and experimentation in EU

economic governance : Laboratory federalism in practice?”

European Institute (LSE)London, 31 March 2006

“Lisbon II and the new Pact: prioritising structural reform over fiscal prudence?”

Fabienne Ilzkovitz and Lucio Pench

Directorate General Economic and Financial AffairsEuropean Commission

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DG ECFIN

Contents1. Trade-off between structural reforms and

budgetary discipline?

2. The renewed Lisbon strategy : prioritisation structural reforms over fiscal prudence?

3. The EU budgetary framework and the new Pact

4. The first year of implementation of the new Pact

5. The way forward

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Trade-off between structural reforms and budgetary discipline?

Two questions :

1. Do reforms necessarily entail significant budgetary costs?

Reforms Budget

2. Does budgetary consolidation slow down structural reforms?

Budget Reforms

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Reforms Budget Direct budgetary implications of reforms:1. Reforms reinforcing fiscal discipline

efficiency of public expenditures instead of public expenditures

– Better control of public subsidies2. Reforms neutral regarding fiscal discipline

in administrative burden – Improve links between universities and business

3. Reforms in conflict with fiscal discipline– Uncompensated tax cuts in public R&D, in education

Depends on the package of reforms

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Reforms Budget

Indirect budgetary implications : Temporary deterioration in economic activity

(reallocation of resources across sectors and restructuring of firms)

Reforms are difficult to implement because of identifiable short-term adjustment costs and long-term and more uncertain benefits

Compensatory packages consisting of targeted expenditures or tax cuts

Expansionary fiscal policy (but time inconsistency problem)

May increase the political support for reforms

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Budget Reforms

Does budgetary consolidation slow down structural reforms? Expansionary fiscal policy may raise the “political capital” available to governments for carrying out reforms

BUT A sound budgetary position could facilitate

the implementation of reforms A credible commitment towards budgetary discipline could also reduce resistance against reforms

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Empirical evidence:

1. Debrun X., IMF (2005): “Fostering structural reforms in industrial countries”

– Trade-off between fiscal consolidation and labour and tax reforms

– It can be difficult to undertake fiscal adjustment and structural reforms simultaneously

– Structural reforms associated positively with favourable fiscal position

2. OECD (2006): “Political economy of structural reform” – A healthy fiscal position tends to be associated with higher

overall reform activity – Fiscal consolidation negatively associated with LMR

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Empirical evidence:

3. Heinemann, ZEW (2005): “How Distant is Lisbon from Maastricht?”

– No general short-term trade-off between Maastricht and Lisbon– Possible short-term conflicts for tax and LMR

4. Deroose and Turrini, EC (2005): “Short-term impact of structural reforms”

– No evidence that reforms are less frequent when budgetary consolidation takes place

– Slight deterioration of budget balances (about 0.2 to 0.3 pp of GDP)

– Trade-off cannot be easily dismissed but it depends on the specific reform considered (more likely for LMR)

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Empirical evidence not conclusive:Reforms Budget

1. No general trade-off between fiscal discipline and structural reforms

2. Only for LMR, such a trade-off might existBudget Reforms

1. Some support for a negative association between structural reforms (LMR and tax reforms) and budgetary consolidation

2. Some support for a positive association between structural reforms and a healthy fiscal position

Results depend on the type and design of reforms

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DG ECFINThe renewed Lisbon strategy : prioritisation structural reforms over

fiscal prudence?

Conclusions of the mid-term review of the Lisbon strategy :

Too many priorities and problem of governance Refocus the strategy on growth and jobs Improvement of the governance

Streamlining Increased ownership (NRPs)

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Increase national ownership

National reform programmes presented in Autumn 2005: a major novelty of the re-launched Lisbon strategy

Transfer policy-making initiatives to the MS Identifying main challenges and specific

measures to be taken over the 3 next years (possibility to amend every year)

Subject to a broad political debate at the national level (Parliament, social partners, …)

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The renewed Lisbon strategy : prioritisation structural reforms over fiscal prudence?

Issue of trade-off not really addressed in the Commission WP “Next steps in implementing the revised Lisbon strategy”:

“Macroeconomic priorities identified in the NRPs are discussed in more details in the SCP…”

“The NRP would cover … where relevant, a description of budgetary resources available…to implement the referred measures together with a link to the SCP”

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The renewed Lisbon strategy : prioritisation structural reforms over fiscal prudence?

Integrated guidelinesGuideline 1: Fiscal prudence In line with the SGP, MS should respect their medium-term budgetary objectives. As long as this objective has not yet been achieved, they should take all the necessary corrective measures…

Guideline 2: Quality and efficiency of public finance…MS should, without prejudice to the G on economic stability and sustainability, re-direct the composition of public expenditure towards growth-enhancing categories in line with the Lisbon strategy…BUT

Guideline 7 : Increase and improve investment in R&D… through more effective and efficient public expenditure on R&D….and developing and making better use of incentives to leverage private R&D

Guideline 23 : Expand and improve investment in human capital

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What can be learnt from the NRPs?

Few concrete measuresBudgetary implications of these

measures largely missingQuestion to be investigated :

Do MS in EDP have a different strategy of reforms than other MS?

Work in progress

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What can be learnt from the NRPs (challenges)?

Key challenges identified by MS All MS MS in EDP Other MS

R&D, innovation 24 11 13

Utilisation of labour 23 10 13

Business environment 22 12 10

Sustainability of public finance 20 11 9

Education & skills 20 11 9

Sustainable dev. 18 9 9

Competition 14 8 6

Infrastructure 13 6 7

ICT 11 7 4

Efficiency of public administration 8 6 2

Short-term budgetary sustainability

5 2 3

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What can be learnt from the NRPs (challenges)?

Key challenges identified by MS All MS

%

MS in EDP

%

Other MS %

R&D, innovation 96 92 100

Utilisation of labour 92 83 100

Business environment 88 100 77

Sustainability of public finance 80 85 75

Education & skills 80 85 75

Sustainable dev. 72 69 75

Competition 56 61 50

Infrastructure 52 46 54

ICT 44 55 33

Efficiency of public administration 32 46 17

Short-term budgetary sustainability 20 15 25

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What can be learnt from the NRPs (Challenges)?

For all the MS :

1. Budgetary discipline is generally formulated in terms of public finance sustainability and less so in terms of budgetary short-term stability

2. All the MS seem reluctant to make choices between different priorities : no perceived trade-off?

For the MS in EDP :

1. MS in EDP seem to attach a greater importance to the business environment and competition and to the sustainability and efficiency of public finance

2. Only 2 MS in EDP identify short term budgetary stability as a challenge

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What can be learnt from the NRPs?Product market reforms

PMR All MS MS in EDP Other MS

in AB and other regulation for business

16

(64%)

11

(92%)

5

(38%)

Measures to assist SMEs

16 (64%)

11

(92%)

5

(38%)

in competition 14

(56%)

8

(67%)

6

(46%)

Tax reforms 7

(28%)

4

(33%)

3

(23%)

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What can be learnt from the NRPs: measures (1)

Product market reforms : Improving business climateCountries in EDP tend to focus more than other MS on :

– Reduction of administrative burden and other costs to set-up a new business

– Measures to assist SMEs– Framework conditions for competition

In most cases, these measures have no significant budgetary implications

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What can be learnt from the NRPs?R&D policies

R&D and innovation All MS MS in EDP

Other MS

in public spending on R&D

25 (100%)

12

(100%)

13 (100%)

Tax incentives 13 (52%)

7

(58%)

6

(46%)

links between universities and businesses

18 (72%)

7

(58%)

11

(85%)

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What can be learnt from the NRPs? Measures (2)

R&D and innovation– All MS target a significant increase in overall domestic

R&D spending by 2010– The most common measure is an increase in the

public spending on R&D (25 MS)– Tax credits for private R&D expenditures are also

used (13 MS) MS in EDP do not seem to focus less on measures

to stimulate R&D having potentially a negative impact on budgetary stability

However, improvement in quality of public finances can counterbalance this negative impact (to be investigated)

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What can be learnt from the NRPs? Measures (3)

Labour market reforms : – Reforms of the benefit systems – Reforms of the tax systems– Modernising public employment services– Active Labour Market policies

Budgetary impact of these reforms is more uncertain

MS in EDP seem to focus more on ALMP and modernising public employment services (to be investigated further)

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Measures in the NRPs: recognition of the trade-off? MS in EDP tend to have a relatively larger business

environment/competition agenda and a relatively smaller labour market agenda

MS in EDP MS do not seem to focus less on measures to stimulate R&D having potentially a negative impact on budgetary stability

But 1/2 MS under EDP envisage to improve the quality of public finances

At this stage, difficult to conclude whether the trade-off was really addressed

More information to be obtained in autumn when the MS will provide more details on measures taken to address their challenges

Structural reform and the EU budgetary framework

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The EU budgetary framework

Set of legally-based fiscal rules aiming at contrasting deficit bias and ensuring sustainability of government finances. ‘Corrective arm’ (EDP): 3% of GDP deficit threshold; graduated enforcement mechanism; possibility of sanctions.‘Preventive arm’ (SCPs): medium-term budgetary objectives and programmes; multilateral surveillance mechanism; possibility of warning.

Strategic complementarity of the two arms.

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The reform of the SGP

Introduction of restrained state-contingency in fiscal rules:Corrective arm (EDP): (limited) extension of ‘exceptions’ and ‘relevant factors’; (limited) modulation of enforcement (effort vs. outcome).Preventive arm (SCPs): (limited) cross-country differentiation of MTOs; (limited) modulation of adjustment to cyclical conditions and quality of policies (structural vs. nominal; good/bad times; allowance for reforms).Quality of monitoring and enforcement critical.

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The new Pact and structural reform: EDP

Structural reforms (‘Lisbon agenda’) to be included in ‘relevant factors’ for deciding on existence of excessive deficit and in subsequent steps of EDP (except abrogation) – limit: deficit to be ‘close’ (to 3% of GDP) and ‘temporary’.

Pension reforms introducing funded second pillar to be considered in all steps of EDP - specifically, 'net cost of reform to the publicly managed pillar' to be deducted from deficit on 'linear degressive scale' - limit: deficit to be ‘close’ and ‘declining’.

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The new SGP and structural reform: SCPs

‘Major structural reforms' (e.g. ‘major health, pension and labour market reforms’) with ‘verifiable [positive] impact on long-term sustainability of public finances' to allow deviation from MTO or adjustment path toward it .

Special attention to be given to pension reforms introducing funded second pillar, with deviation reflecting 'net cost of reform to the publicly managed pillar' .

Limit: deviation ‘temporary’ and ‘safety margin’ kept

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The new SGP and structural reform: the 2005-06 experience

Integration between ‘Lisbon’ and the SGP: Re-launch of Lisbon strategy not elaborating on

division of labour between ‘Lisbon’ programmes (NRPs) and ‘SGP’ programmes (SCPs).

Assessment of consistency between NRPs and SCPs possible in terms :

– public finance strategy

– ‘concreteness’ of actions

– ‘budgetary implications’

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Assessment of consistency between NRPs and SCPs made problematic by: Timing of the Lisbon and SCPs exercises. Lack of institutional detail and quantitative information in Lisbon programmes. Different focus of the two exercises: overall reform (Lisbon); public finances (SCPs)

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Broad consistency in assessments of fiscal strategy

NRP

assessment SCP

assessment BE YES NO

CZ YES YES

DK NO YES

EL YES YES

ES NO NO

FR YES YES

IE NO NO

IT YES YES

CY YES YES

LV NO NO

LT NO NO

LU NO NO

NRP

assessment SCP

assessment HU YES YES

MT NO NO

NL NO YES

AT NO NO

PL NO YES

PT YES YES

SI YES YES

SK YES YES

FI YES YES

SE NO NO

UK YES YES

EE NO NO

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Assessment of ‘concreteness’ of action sometimes different fort NRPs and SCPs

NRP assessment of 'concreteness' of reform strategy

SCP assessment of 'concreteness' of reform strategy

CZ 'concrete… only in certain areas' 'broadly in line [with standards]'

MT 'concrete measures… except in the macro-area'

'broadly in line [with standards]'

LU 'measures in planning stages' 'in line [with standards]'

PL 'measures not detailed' 'broadly in line [with standards]'

UK 'series of measures' 'broadly in line [with standards]'

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Budgetary implications of reform strategy sometimes assessed differently across NRPs

and SCPs NRP assessment of 'budgetary

implications' of reform strategy SCP assessment of 'concreteness'

of reform strategy

CZ 'not clearly spelled out' 'concrete measures reflected'

ES 'limited' 'sufficiently reflected'

HU 'not clear' 'reflected'

AT 'not provided' 'broadly reflected'

SK 'insufficient' 'fully reflected'

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Deviation clause of new SGP on ‘major structural reforms’ effectively NOT invoked by MS:Strictness of the limits of permissible deviation (‘temporary’ and ‘safety margin’)Unwillingness/inability to provide ‘detailed quantitative cost-benefit analysis of short-term costs and long-term benefits from the budgetary point of view’Clause on pension reforms introducing funded second pillar possibly easier to invoke (LT)

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Tentative conclusions

Structural reform is NOT being prioritised over fiscal discipline:

– SGP clearly prioritising fiscal discipline.

– Lisbon strategy implicitly considering trade-off not problematic.

Consistency between SGP and Lisbon NOT elaborated and hampered by information deficiencies of Lisbon programmes

EU consensus deeply averse to taking risks with stability for the sake of growth

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Ways forward

Improve the consistency between Lisbon and the SGP:Specify ‘division of labour’ between NRPs and SCPs:– NRPs could detail the overall reform strategy including on ‘quality’ of public finances– SCPs could provide itemised budgetary information on ex ante costs of the reform strategyFill information gap in Lisbon programmes to allow for tentative quantitative assessment of impact of structural reform.