Fiscal rules and structural reforms

Rana Sajedi,Armin Steinbach

doi:10.1016/j.irle.2018.12.008

Rana Sajedi, Armin Steinbach

Open Access

https://doi.org/10.1016/j.irle.2018.12.008

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Abstract

Implementation of fiscal surveillance rules relies heavily on the proper interpretation of legal terms, creating a need to infuse economic insight into legal analysis. Rigid legal application of fiscal deficit rules may curtail structural reforms, as reforms can go against fiscal consolidation in the short run. However, if reforms are expected to improve public finances in the long run, they should not be viewed as incompatible with the legal framework. Focussing on the case of EU fiscal surveillance, this paper identifies the circumstances under which the positive budgetary long-term effect of structural reforms materialize in such a way that the legal rules should be applied with a degree of leniency, allowing for a short-term deterioration of the fiscal position. To that end, we quantify the short-run fiscal costs and long-run fiscal benefits of reforms, and investigate how the design of reforms can affect this trade-off. Results suggest that as short run output losses of reforms are alleviated by fiscal stimulus, long run output gains from the reforms imply that fiscal viability can be reached within a reasonable period of time. Product market reforms are generally preferable over labour market reforms, as they have a larger impact on fiscal revenues. These insights inform the legal analysis in several regards. First, the economic analysis is in line with teleological interpretation of legal rules aimed at ensuring long-term fiscal stability, while allowing short-term fiscal leniency. Second, the economic analysis can give contours to vague legal terms, such as “prompt” positive budgetary effects and the legal requirement of “major” structural reforms, showing that the type of reform matters as much as the size of the reform, and that while larger reforms have larger long run budgetary effects, they also require greater leniency in the short run. More generally, our analysis calls for the design and interpretation of legal fiscal regimes with reference to the interdependency between fiscal policy and structural economic policies.

Highlights

Application of fiscal rules is often considered in clinical disciplinary isolation
Imperfect competition in product markets leads to a mark-up of prices over marginal costs, and imperfect competition in labour markets leads to a mark-up of wages over the marginal disutility of labour
We will label a reduction in price mark-ups as “Product Market Reform” (PMR), and a reduction in wage mark-ups as “Labour Market Reform” (LMR)

Summary

Introduction

Application of fiscal rules is often considered in clinical disciplinary isolation. While lawyers tend to care about dogmatic consistency and uniform application of rules, economists are concerned about the effects of the specific design of fiscal rules. Even though the rules have not always been applied consistently due to political reasons (Fatás and Mihov 2010), there is a strong conviction in legal scholarship (Borger 2016, Palmstorfer 2012) and economic scholarship towards strict enforcement of fiscal rules This stance has been subject to criticism pointing, inter alia, at other elements promoting growth and positive long-term budgetary effects, such as structural reforms. On the basis of its discretion, the Commission found that structural reforms can be recognized provided they have a long-term positive budgetary effect where this effect can have direct budgetary savings from reforms (e.g., pension reform) or through increased revenues (e.g., as a result of increased employment) This interpretation of the fiscal rules can be explored by economic methods and forms part of the analysis below. According to the legal requirement, structural reforms must account for the main purpose of the corrective arm of the SGP, which is to ensure the “prompt” correction of excessive deficits. This criterion corresponds to the dynamic adjustment occurring between the implementation of structural reforms and the new post-reform fiscal steady state and can be determined through economic modelling

Article

Results

Conclusions