Chapter

6 Summary and Conclusions

Author(s):
International Monetary Fund
Published Date:
March 1986
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The two oil crises and persistent global recessionary conditions had far-reaching repercussions on budgets and in many ways shaped fiscal policy in the smaller industrial countries over the period covered. Although policy priorities differed among these countries, there was one overriding similarity in fiscal policy response to these external impulses, namely, a defensive stance intended to cushion their adverse impact on the national economy, especially on employment and economic activity and on living standards in general. The intensity of policy responses varied from one country to another for various reasons. Thus, the action required differed according to the size of the external sector, or openness of the economies, and also because domestic energy production varied substantially among the countries. Also, political ideologies with regard to the proper role of the state and the reliance on the market mechanism differed among these countries and sometimes changed within individual countries with changes of government. Moreover, the likely duration of the recession following the first oil crisis was perceived differently and, consequently, so was the appropriate degree of fiscal stimulus.

The policy response to the first oil crisis and the ensuing world recession was generally to shift the stance of fiscal policy in a highly expansionary direction. Although initially intended to be temporary, the persistence of recessionary conditions caused a prolongation of this posture, which entailed, with a few exceptions, sharp increases in government expenditure in relation to total output, mounting tax burdens, and widening fiscal deficits. During the latter half of the period, policy was increasingly directed at the containment or reduction of these imbalances, as the large-scale absorption of resources by the public sector was widely seen as having an adverse long-term impact on economic performance. However, the problem of achieving the needed adjustment was exacerbated by rigidities in the fiscal systems that had grown over the period and severely limited the scope for fiscal action. In countries experiencing the largest deterioration in the fiscal position, the public finances had assumed imbalances of a structural character. Deficits and debt accumulation threatened to become self-perpetuating, and fiscal adjustment became an objective per se.

Despite growing efforts, limited success has been achieved in reducing fiscal imbalances. Obstacles to fiscal improvement are diverse and include elements of both an economic and a political nature. The period thus witnessed a strengthening of automatic fiscal stabilizers that tended simultaneously to trigger increased spending, notably in the social security area, and retard revenue growth. Demographic developments produced increasing claims on budgetary resources. The scope for fiscal action was narrowed by a growing tendency for future expenditure commitments to be determined by specific legislation whose budgetary burden was frequently aggravated by indexation mechanisms. Persistent fiscal deficits implied debt accumulation whose servicing requirement increasingly pre-empted budget resources. All these elements introduced growing rigidities into fiscal systems. Furthermore, there are indications that overoptimistic assumptions about the growth potential of the economy led to the setting of overambitious goals of fiscal policy, with adverse implications for the fiscal position. Lastly, the smaller industrial countries all have a system of political democracy which is often characterized by frequent changes of government. This political environment has not proved conducive to the formulation and pursuit of consistent long-term policies with clearly defined objectives, and the stance of policy tended to change frequently. There is ample evidence of inconsistent policy actions over the period that caused the impact of restrictive fiscal measures to be outweighed by subsequent measures of stimulus to promote employment and social welfare objectives. Such changes run the risk of impairing confidence in the firmness of the policy stance, with adverse repercussions on economic performance. The political element in fiscal policy thus contributed to difficulties in achieving targeted fiscal adjustment.

While the foregoing comments are fairly representative of the general situation, fiscal performance nonetheless varied markedly among individual countries. This variety applies to the expansion of the government sector, as measured by the ratio of government expenditure to GDP, and of tax burdens as well as the size of fiscal deficits and the debt accumulation they generated. While all countries experienced tendencies toward a rapid expansion of the government sector after the first oil crisis, some reacted quickly and were successful in curbing expenditure growth, for example, Australia, Finland, Iceland, and Norway. Consequently, these countries had less need to raise revenue, and the tax burden was not a cause for particular concern by the end of the period. Other countries, including Belgium, Ireland, the Netherlands, and Sweden experienced an explosive expansion of the government sector, and tax burdens also rose steeply in these countries, especially in Belgium and Ireland. However, revenue growth did not match that of expenditure, except in Norway, which implied growing fiscal deficits elsewhere. Over the whole period, the largest government deficits were incurred by Ireland, Belgium, New Zealand, and Sweden; Luxembourg had the distinction of maintaining a surplus for the major part of the period. Ireland and Belgium had the highest government debt/GDP ratios and mounting debt-servicing burden by the end of the period; this ratio was lowest in Luxembourg and Finland.

These fiscal developments and policies had far-reaching economic implications. Analyzing their impact on the economy in any precise manner is a complicated task, however; a major problem is the issue of causation, as factors outside the realm of public finance influence economic performance and their impact is not separable from that of fiscal factors. But in many instances the direction of the impact is fairly clear. On the expenditure side, while analysis at the aggregate level does not lead to conclusive findings, there is strong evidence that separate expenditure schemes in many instances increased to an extent that exerted a harmful impact on economic performance. Thus, it was a fairly general experience that employment-creating schemes contributed to a slowdown of labor mobility and thus retarded structural adjustment and efficient resource use. Various forms of industrial support designed to protect the exposed sector of the economy against adverse external impulses and to preserve regional balance had a similar effect. An explosive growth of social security expenditure was a major cause of fiscal imbalances. The generosity of pension and unemployment compensation schemes, in particular, in some instances reached a level that caused concern over the adverse repercussions on work incentives. Also, while incomes policy in a few countries, including Austria and Finland, contributed to economic stabilization, this was not the general experience, and the fiscal contribution to incomes policy invariably entailed a substantial deterioration in fiscal positions and added to demand pressures.

While revenue in most countries increased at a slower pace than expenditure, some experienced a substantial increase in the tax burden. Personal income taxes and their progressivity affected work effort and initiative adversely in countries where this tax was highest, such as Belgium, New Zealand, Norway, and Sweden. In some of these countries, the high personal income taxes encouraged tax avoidance and evasion, contributed to wage-push pressures, and discouraged savings. Social security contributions, a significant revenue source in countries like the Netherlands, Spain, and Sweden, increased rapidly over the period and added significantly to labor costs. This led to a distortion of factor costs against labor and aggravated the cost position in a depressed enterprise sector.

Finally, the large and persistent fiscal deficits implied debt accumulation whose servicing constituted increasing claims on present and future budgetary resources. There is evidence also that in countries like Australia, Belgium, the Netherlands, and Sweden, where financial markets are well developed, fiscal deficits exerted upward pressure on interest rates, with an adverse impact on business investment and economic growth. Such financial crowding-out effects were doubtless experienced in varying degrees in other countries in the group, although the imperfection of financial markets and external influences on interest rate determination make analysis of the crowding-out effects of fiscal deficits in these cases inconclusive.

One lesson that emerges from the different experiences in the fiscal field is that the degree of expenditure restraint would appear to be a significant determinant of overall fiscal performance (see Table 6.1). The rate of expansion of the government sector thus tended to be positively correlated with the rate at which deficits widened, debt ratios expanded, and debt-servicing burdens increased. Also, with a few exceptions, notably Norway and Spain, countries with the smallest government sector at the beginning of the period tended to experience the smallest expansion of that sector over the period in terms of percentage points of GDP. On the other hand, the relation between government sector expansion and growth of the tax burden exhibited, to some extent implicitly, a highly irregular pattern.

Table 6.1.Smaller Industrial Countries: Selected Fiscal Indicators(Central Government, Percentages of GDP)
Government

Sector

Expansion

1972–82

(Percentage

Points)
Deficit

in

1982
Annual

Average

Deficit

1972–82
Interest

Payments

1982
Debt

Ratio

1982
Government

Sector Size

1982
Tax

Burden

1982
Norway2.40.8–2.82.426.541.842.6
Australia3.7–0.3–2.21.922.728.328.0
Luxembourg3.70.51.10.74.735.834.7
Finland5.1–2.1–0.80.912.330.628.6
Iceland5.4–2.9–3.02.431.435.932.9
Austria9.8–4.4–3.12.230.039.935.5
New Zealand11.2–7.4–5.94.658.242.234.8
Spain11.81–7.12–2.410.6219.4232.3225.32
Netherlands12.83–7.6–3.533.239.458.851.3
Denmark13.2–8.3–1.44.659.245.236.9
Sweden13.5–9.8–4.74.645.448.939.0
Belgium17.1–12.2–6.67.773.956.944.7
Ireland21.1–15.2–11.29.1108.757.842.6

1972–81.

1981.

1973–82.

1972–81.

1981.

1973–82.

The scope for exercising expenditure restraint depends on a variety of factors and the most important ones are probably not economic in nature. Among countries that were most successful in restraining expenditure growth, it appears that certain attitudes, which had evolved through long and complicated historical processes, had an important bearing on the pursuit of fiscal policy. In some instances, these attitudes generated national cohesion that ensured sufficient acceptance of short-term material sacrifices against longer-term gains, and in other instances, fiscal prudence was equated with national security. There is also evidence that ideological persuasion concerning the proper role of the state caused a reversal of an ongoing process of increased government sector absorption of resources. While the nature and strength of such attitudes varied among the countries concerned, they generated in each case the required fiscal discipline to keep government sector size to more manageable proportions.

Finally, it should be reiterated that the main objective of this study has been to provide information and analysis that could enhance knowledge and understanding of public finances and the conduct of fiscal policy in this group of countries. For this reason, the scope of issues addressed has been fairly broad. It is hoped, however, that the study will provoke thought and will direct attention to separate issues that deserve more thorough research and analysis.

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