Three key questions for the future of public finance

In the wake of the great recession, public finance remains high on the global policy agenda, with fiscal crises, structural unemployment and severe income disparities all posing serious threats. This poses a twin problem.  Without the resolution of fiscal crises, two risks emerge: either the system cracks, or at best, growth is too slow for the structural changes required. But without a sense of resolving structural and long term unemployment, the social consensus to address the fiscal problem can’t be created.

This is the politically charged context in which the Global Agenda Council on Public Finances and Social Protection Systems will work in 2014-16. We join our brains and hearts to provide answers on how to ensure sustainable public finances and adequate social security in the post-recession, low-growth economic environment that some regard as the “new normal”.

This leads our work towards three critical questions focusing, respectively, on economic growth, public finance and social security. My starting point is that one cannot really discuss public finance without discussing growth – sustainable growth. Stronger and sustained GDP growth is essential for sustainable public finances and social security systems. These factors are intimately intertwined and affect each other, which is why they make up the key elements in the equation that defines our economic and social success.

What’s the right policy mix?

The first question we must ask is: what kind of policy mix of monetary policy, fiscal policy and structural reforms can support stronger and more sustainable growth? This is related to the recent debate on “secular stagnation”, where competing theories exist to explain the sclerotic performance of advanced economies. Many underline demand-side weaknesses and the constraints low inflation creates for monetary policy to keep activity close to its potential. Others refer to supply-side barriers, due to demographics and the weakening impact of technological change on total factor productivity.

While Europe was the epicentre of the crises in 2010-13, we should avoid being euro-centric and rather take a global perspective. The emerging market economies, particularly China, India and Brazil, were able to grow throughout the crisis, which was for the most part a crisis of the advanced economies of Europe and the United States. What can we learn from the policy choices of emerging markets? What can we learn from the experience of the Asian financial crisis in the late 1990s, especially on how the majority of Asian countries put their fiscal houses in order and maintained solid growth rates during the recent crisis?

Moreover, how about the policy mix in the US and United Kingdom compared to the Eurozone? Did the US combination of early financial repair, expansive monetary policy and a relatively neutral fiscal stance after the initial substantial fiscal expansion bring better results than the half-hearted monetary stimulus and a more consolidation-oriented fiscal policy of the Eurozone? What lessons are there to be learnt from comparing Europe and the United States in the current debate on sustainable growth? Did the UK policy mix of expansive monetary policy and rigorous fiscal policy defy the critics and bring the economy back to growth better than they expected?

How can budgets support growth?

Our second question focuses on the quality of public finances, which has been an underrated subject in crisis economics, perhaps because it is politically so difficult and sensitive. Too often, fiscal consolidation has been done only or largely through tax increases and cuts in capital expenditure, which before long will start to damage or even suffocate growth. Take France and Italy, which suffer from the combination of sluggish growth and high public debt: instead of further tax increases, one should seek more growth-friendly ways of pursuing the necessary consolidation of public finances.

So how do we protect budget lines that support growth in the medium-to-long-term, such as public investment to modern infrastructure and competitive innovation, while maintaining a decent level of social protection? And how do we make social protection and tax systems more supportive to work and enterprise through better-designed incentives?

How to safeguard the safety net?

Our third question is: how to ensure the adequacy and sustainability of social protection systems while making them more supportive to growth? As the crisis has already hit public finances and populations are aging, European societies in particular are currently facing a true stress test of their pension and social systems. To illustrate the policy urgency, there is a wave of reforms going on: in 23 out of the EU’s 28 member states, significant pension reforms that link the retirement age to life expectancy have been decided in recent years.

It seems inevitable that structural reforms in social protection systems are needed to ensure their adequacy and sustainability in the medium to long term. Economics and other social sciences suggest some general principles for reforms. However, designing effective reforms is far from easy in practice due to both technical and political reasons. Learning from the experience of countries that have implemented significant reforms could be very important to overcome these hurdles. While for example the OECD and the EU have tried to make systematic use of country comparisons, I believe there is much more that we could do in this regard to help pursue true evidence-based policies.

In the pursuit of reform we should think outside the box of economics proper: for instance, how can we better capitalise on information technology to enhance productivity, provide improved social and healthcare services and reduce the budgetary costs of their provision? Digital technology has revolutionised the service economy in the private sector, but the public sector is still clearly behind in using ICTs and developing e-government and e-services. Cloud computing will only accelerate the trend. We need to be more innovative and also more effective in how we provide services.

Through the work of our Global Agenda Council, I am looking forward to listening to fresh insights on these three intertwined sets of issues. I don’t think there is a single policy prescription – a silver bullet – one can recommend to all countries around the globe. Our level of ambition should be more modest but yet, perhaps paradoxically, more relevant: to provide analytically sound and politically realistic policy advice for reformers all over the world, in order to underpin a sustained recovery, secure sound public finances and provide adequate social protection systems.

Author: Olli Rehn is the Vice-President and Member of the European Parliament.

Image: Foreign tourists play on Kuta beach in Bali October 11, 2004. REUTERS/Beawiharta