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Thanks are due to Albert Jaeger, Eric LeBorgne, Marcos Ribeiro, participants of the Workshop on “Fiscal Aspects of the EMU” (European University Institute, Florence, 4 and 5 April 2003) and seminar participants at the University of Amsterdam for helpful comments.
Department of Economics, University of Amsterdam.
“Commission calls for stronger budgetary policy coordination”, press release IP/02/1742, available at http://europa.eu.int/rapid/start/cgi/guesten.ksh.
In particular, “countries with underlying deficits exceeding the ‘close to balance or in surplus’ requirement would be required to achieve an annual improvement in the underlying budget position of 0.5% of GDP each year until the ‘close-to-balance or in surplus’ requirement of the SGP has been reached. This rate of improvement in the underlying budget position should be higher in countries with high deficits or debt.”
As illustrated in Section II, this consideration goes well beyond the mere composition of public spending (i.e. the usual split between current and capital expenditure). For instance, in our view, a temporary increase in the coverage of unemployment benefits to compensate the public for a drastic reduction in employment protection is qualitatively an “investment” in the broad sense defined above.
Rodrik (1996) provides a detailed survey of economic arguments pertaining to reforms in developing and transition economies. Many of his arguments naturally apply to industrial countries. However, the greater consideration given to redistribution issues in the latter (especially in Europe) suggests that short-term costs and the necessity to compensate those who are negatively affected by reforms may play a bigger role than in developing countries.
European Commission, Press release IP/02/1742, November 2002.
Numerous studies have shown that labor reforms would indeed result in lower unemployment; see for instance Nickell and Layard (1999), Belot and van Ours (2000), Blanchard and Wolfers (2000), Nickell et al. (2002), OECD (2002), European Commission (2002) and IMF (2003).
This is reminiscent of Alesina and Drazen (1991) who show that desirable policy measures (in their case fiscal stabilization) are delayed because a “war of attrition” takes place among social groups about the sharing of the adjustment burden. In the model we propose later, the reluctance to implement structural reforms stems from the need to divert public resources away from the provision of public goods to finance transfers compensating the adjustment burden borne by citizens.
Detailed background information on the fiscal impact of job-rich growth in France is provided by IMF (2002).
Calmfors (2001) arrives at a similar conclusion. However, he shows that in the absence of an inflation bias, monetary unification may push governments to do more reforms because the induced price and wage flexibility would ease adjustment to country-specific disturbances.
The real interest rate is exogenous and can be assumed to be determined in the world market (which is large relative to the union), reflecting perfect capital mobility.
Grüner (2002) analyzes the role of compensations in a political model of labor-market reforms. The same article provides additional references to the relevant literature.
Beyond its technical appeal, decreasing returns to scale is an intuitively plausible assumption. For example, assume that employment is inefficiently low due to the market power of workers (e.g. because of strict employment protection or the institutional role of trade unions in wage bargaining). Initial labor market reforms will “easily” drive down wage premia, boosting job creation. However, it will become increasingly difficult to create new jobs through additional reforms as wages converge towards their competitive levels.
In Rogoff (1990) for instance, temporary information asymmetries about the policymakers’ competence suffice to bias equilibrium fiscal policy toward public consumption, producing a political cycle in the budget. By contrast to Rogoff, our model is purely “partisan”.
This means that public goods are only differentiated according to the political affiliation of the provider, a characteristic that admittedly matters only to the latter, and is consequently irrelevant for the private agent, for whom these goods are perfect substitutes. For instance, a consumer does not care about who provides public security but about the amount provided. Hence, our setup is formally identical to allowing for only one type of public good, while a party benefits from its provision only when it is in government.
The procedure unfolds as follows. First, the European Commission prepares recommendations on the basis of countries’ macroeconomic and budgetary data. Second, the ECOFIN decides whether to follow the recommendation or not. Third, sanctions may be decided if the country fails to comply with the injunction to correct its fiscal trajectory. However, the formal activation of the Excessive Deficit Procedure and the subsequent imposition of sanctions are subject to qualified majority voting by the ECOFIN and thereby exposed to political bargaining. Strauch and von Hagen (2001) provide a detailed analysis of the SGP in the light of effectiveness criteria of fiscal rules.
Formally, a greater chance that sanctions will indeed be imposed when
Earlier computations allowing for second-period sanctions in response to a first-period excessive deficit are available upon request.
We assume that
The Appendix containing detailed calculations and proofs is available at the following web page: http://wwwl.fee.uva.nl/toe/content/people/beetsma.shtm.
It is straightforward to check this numerically in a linear-quadratic version of the model. See the Appendix for details.
See the Appendix for details.
By continuity of all the functions involved, if a solution γ > 0 exists for k = 0, there also exists one for k > 0, but not too large.
The proof can be found in the Appendix.
The arrangement analyzed here is based on relaxing the deficit threshold, rather than the “underlying budgetary position” (presumably the Commission’s jargon to express budget figures corrected for cyclical influences). Nevertheless, both arrangements should have similar effects on the incentives for structural reforms, because they reduce the adverse consequences (such as public rebukes or financial penalties) of a resulting deterioration of the public budget in the short run.
Details of the calculations are in the Appendix.
If for k = 0,