In view of the Informal Ecofin on April 8-9 in Gödöll, the Hungarian Presidency organised a high-level economic policy seminar at the end of March around the topic “economic growth and fiscal consolidation”. Lead speakers (from Bruegel Institute, the World Bank and the EBRD; and a former Swedish member of the Economic and Financial Committee) addressed the challenges Europe is facing at a time when fiscal consolidation needs to be pursued with determination, while post-crisis growth needs to be safeguarded and strengthened. The main findings of the seminar are as follows.

Lessons from international experience.

Fiscal space is needed to accommodate eventual future shocks. In addition, low public debt is the greatest contribution of fiscal policy to growth. Empirics show that debt above 90% is associated with lower GDP growth. In the short and medium run a significant risk to fiscal sustainability lies in excessive private debt. In the long run, aging is the most significant contingent liability. Fiscal consolidations do not always have contractionary effects and can even promote growth through various channels. Comparison of pre-and post adjustment growth figures underestimate the welfare improvement associated with fiscal consolidation. The key to success lies in the composition of adjustment, accompanying structural reforms and fiscal/budgetary institutions. Even if fiscal consolidation is needed, the timing and the required magnitude is very much country-specific and depend on various factors. In cases where fiscal space and credibility remained and ongoing private sector deleveraging is significant, premature fiscal consolidation should be avoided. In any case, prudent policies based on conservative growth and interest rate assumptions are needed.

Growth-enhancing structural reforms.

Post-crisis economic growth in the EU-10 is likely to be lower than before the crisis. Structural reforms could accelerate growth. The main structural problems to be handled:

• Low employment rates in EU-10 countries, particularly among older and less-educated workers, women, and minority groups such as Roma;
• Low skill levels hampering growth, innovation, and social inclusion; and
• Inefficient R&D spending slowing economic growth in EU-10 countries. Thus, reforms should focus on: raising employment, improving skills, enhancing technology absorption and innovation, enhance the productivity and employability of older workers through focused training programs and private sector involvement, increase retirement age and decrease worker disincentives resulting from pre-retirement benefits, rationalise disability pensions, reduce tax wedge, encourage higher female labour force participation.

The long term view: raising potential growth and the relevance of EU2020.

It is of paramount importance to ensure a solid political commitment backed by social acceptance behind the consolidation plans. While the economics of budgetary consolidation is well understood, more in-depth knowledge of the political economy of fiscal adjustment and structural reforms might be needed. The following lessons may be drawn from the Swedish example and should be kept in mind with respect to structural reforms raising potential growth. Public understanding is vital, people should be taken on board to cooperate with policy-makers, a kind of social pact is key to success. Good communication and transparency are needed to this end. The reform strategy should be presented as a comprehensive package with a focus on burden sharing. Ad-hoc measures will only have a limited chance of success. A successful reform process needs credibility, in the eyes of the public and in the eyes of the financial markets. Clear and transparent, concrete goals are necessary. The new growth agenda should be pragmatic and politically feasible, and focus on: the completion of the Single Market, macroeconomic stability, structural reforms and financial sector reforms. As key responsibility is on Member States, the success crucially depends on political will and determination of national political elites.

Promoting the development of domestic capital markets.

The following factors can be considered among the causes of underdeveloped local capital markets: weak macroeconomic policy frameworks, underdeveloped local funding markets and abundant foreign financing. However, increased foreign exchange exposure carries systemic risks, such as increased vulnerability of the banking system and volatile capital flows. Thus, it is rational to develop local capital markets in order to address systemic risks, enhance the effectiveness of monetary policy. Sufficiently developed local capital market is a pre-requisite for sustainable growth and external stability. The EBRD’s Local Currency and Local Capital Markets Initiative serves these ends. As the case study of Hungary revealed, the availability of readily marketable instruments, indeed, could facilitate the maturity transformation, thus making funding costs cheaper, as well as contribute to the narrowing of the interest margin, since a more advanced domestic capital market would put competitive pressure on the banks on both the asset and the liability sides. Nonetheless, a more developed local capital market, at the present juncture, would only be a partial solution to the problem of indebtedness in foreign currency and that of currency mismatch. Macro-economic, fiscal and structural policies ensuring financial stability are indispensible components of the adequate response.

See:

• Seminar programme
• Presentations

(Ministry for National Economy)