Translation

Aleksander Wojciechowski

introduction, chapter 1, 2, 3, 6, 9

Amelia Wydra

chapter 7, 8, 12

Michał Płonka

chapter 11

Cover and title pages

Małgorzata Smogorzewska

Publisher

Dorota Siudowska-Mieszkowska

Editorial coordinator

Renata Ziółkowska

Editor

Robert Mitoraj

Production coordinator

Mariola Iwona Keppel

Reviewer

Prof. dr hab. Sławomir Bukowski

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Warszawa 2018

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Table of Contents

Introduction

Chapter 1. Practical dimension of research on public finances

1. Premises for disciplining public finances in the European Union

2. Measures undertaken by the European Union to discipline public finances

3. Research thesis

4. Verification methods

4.1. A qualitative and quantitative approach

4.2. Fiscal consolidation as the basic tool for disciplining public finances

4.3. Budget balance and types of fiscal policy

4.4. Methods of examining the relationship between budget balance and macroeconomic variables

4.5. The matter of non-Keynesian effects of fiscal policy during the crisis

4.6. Method for testing the economic potential of EU countries

4.7. Convergence or economic divergence in Europe

5. Time scope of the study

6. Country selection criteria – case studies

Chapter 2. Concepts of fiscal consolidation

1. Definitional difficulties

2. Controversies over the concept of fiscal consolidation

2.1. Problem of the starting point of consolidation

2.2. Choice of consolidation strategy and macroeconomic effects

2.3. Measuring consolidation

2.4. Criteria for assessing the effects of consolidation

3. Dilemma regarding the choice of consolidation instruments

4. Assessing the sustainability of fiscal consolidation in selected EU countries

5. Summary

Chapter 3. Fiscal supervision as an element of new economic governance in the European Union

1. Treaty bases for coordination of the Member States’ economic and budgetary policies

2. Evolution of fiscal supervision 1992–2005

3. Fiscal supervision as an element of new economic governance

3.1. General concept of change

3.2. New requirements for budgetary frameworks of member states

3.3. Action undertaken to strengthen the surveillance of budgetary positions and the surveillance and coordination of economic policies

3.4. Action to speed up and clarify the excessive deficit procedure

3.5. Enforcement of budgetary surveillance in the euro area

3.6. Mechanism for preventing and correcting macroeconomic imbalances

3.7. Enforcement of correction of excessive macroeconomic imbalances in the euro area

4. Further attempts to strengthen fiscal supervision

4.1. The Fiscal Compact

4.2. ‘The two-pack’

5. Assessment of the reform of the economic governance in the EU

6. Conclusion

Chapter 4. Austerity as a tool of fiscal consolidation – theoretical and empirical perspective

1. Introduction

2. Historical debate

3. Neoliberalism and financialization

4. Macroeconomic performance

5. The justification for austerity

6. Economic crisis and fiscal policy

7. The ideological foundations of supply side economics

8. Brexit and its implications for the UK

9. Conclusion

Chapter 5. Efforts of fiscal consolidation in the United Kingdom

1. Introduction – background of the study

1.1. The sovereign debt crisis and financial stability

1.2. The United Kingdom’s Fiscal Stability Code

1.3. The Maastricht Treaty and fiscal rules

2. The pre-crisis overview

2.1. Macroeconomic imbalances in the UK

2.2. State of public finances before the crisis

2.3. Budgetary forecast before the crisis

3. Analysis of the financial crisis period

3.1. Public sector net debt

3.2. Relative projections and economic performances

3.3. Output gap and real GDP

3.4. The structural deficit

4. Efforts of fiscal consolidation

4.1. Policy implementation under Labour government

4.2. Policy changes under coalition government

4.3. Policy effects on the UK economy

4.4. The UK’s public finances and Brexit

4.4.1. The mechanical effect

4.4.2. The national income effect

5. The policy decision and summary

Chapter 6. Fiscal consolidation in the Federal Republic of Germany

1. Characteristics of fiscal policy in the Federal Republic of Germany 1999–2007

2. Reforms in the public expenditure system

3. Changes in the public revenue system in the years 1999–2007

4. Characteristics of fiscal policy in the Federal Republic of Germany 2008–2015

4.1. State interventionism in response to the crisis: 2008–2010

4.2. Savings policy implemented by the Federal Republic of Germany in 2011–2015

5. German fiscal policy and the business cycle

6. The problem of common monetary policy

7. Socio-economic effects of the fiscal policy of the Federal Republic of Germany

8. Summary

Chapter 7. Fiscal consolidation strategies in Hungary

1. Introduction

2. Excessive deficit in Hungary and scenarios for its correction

3. Medium-term budgetary objective

4. Public debt in Hungary

5. Instruments for disciplining public finances on the expenditure side

6. Scenarios of expenditure adjustments and their implementation

7. Instruments for disciplining public finances on the revenue side

8. Scenarios of revenue adjustments and their implementation

9. Institutional changes favouring fiscal consolidation

10. Evaluation of fiscal consolidation

11. Economic effects of fiscal consolidation

12. Macroeconomic imbalances in Hungary in the period of fiscal consolidation attempts

12.1. Internal imbalances

12.2. External imbalances

13. Conclusions

Chapter 8. Strategies of fiscal consolidation in Poland

1. Introduction

2. Fiscal consolidation in Poland in 2003–2008

2.1. Adaptation measures to the nominal fiscal convergence criterion

2.2. Changes on the revenue side of government institutions sector and local government

2.3. Actions to reduce public spending

3. Impact of 1999 pension reform on the condition of public finances in the period 2004–2015

4. Fiscal policy in Poland in response to the global financial and economic crisis

4.1. New solutions adopted in the Public Finance Act of 2009

4.2. Disciplining public finances in Poland after launching the excessive deficit procedure in 2009

5. Summary

Chapter 9. Testing the dynamic relationships between the public financial sector deficit and the macroeconomic variables in selected EU countries

1. Description of the testing procedure

2. Dynamic modelling results in selected EU economies

2.1. Poland

2.2. The United Kingdom

2.3. Hungary

2.4. Germany

2.5. France

2.6. Sweden

3. Analysis of the impulse response function

4. The results of Granger causality test

5. Summary

Annex

Chapter 10. The impact of the financial crisis on the distribution of total power across the member states of the European Union

1. Introduction

2. The measurement of power and its distribution in the European Union

2.1. The applicability of the power model and its core components

2.2. The distribution of power in the European Union

2.3. Total power and stability at the onset of the recession in the EU

3. Shifts in the stability of total power

3.1. The position during the recession

3.2. The position after the recession

3.3. Economic potential and public spending in the Baltic states

4. The impact of the crisis on the Baltic states and their fiscal responses

4.1. Changes in GDP output from 2006 to 2014

4.2. Changes in the structure of total power and its causes – Poland and the Baltic states

4.3. Drivers of growth and debt compared

5. Conclusion

Chapter 11. Process of economic convergence of European countries

1. Initial remarks

2. Models for cross-section and time-series variables configuration

3. Methods for stratified analysis

4. Initial analysis of GDP per capita ratios variation in European countries in 1950–2015

5. Analysis of moveable dynamics indexes for GDP per capita ratios in European countries

6. Analysis of the ranking of European countries by GDP per capita ratios in selected years

7. Summary

Chapter 12. Options for disciplining public finances – synthesis

1. Condition of public finances as a result of various factors

2. Assessment of the impact of fiscal stimulus on public finances in the European Union countries

3. Convergence or divergence – research results

4. Case study on the assessment of disciplining public finances in the surveyed countries

5. Evaluation of fiscal consolidations

6. Evaluation of the role of new public governance in disciplining public finances

7. Variants for achieving public finance discipline – conclusions for Poland

Annex

Bibliography

Footnotes

Introduction

Public finances are the subject of ongoing studies by various centres and research teams. They are also of interest to politicians. This interest is fully justified, as public finances fulfil important economic and social functions, playing a major role in redistribution and allocation of gross domestic product, varying from 30% to 60%, depending on the country and period.

Public finances are a tool for achieving socially and economically useful goals, and as such are an attribute of power. The use of public finances is closely related to the socioeconomic programmes of political parties and their doctrines. Importantly, these doctrines affect the scope and method of using public finances in practice.

A significant impetus in research on public finances and practical solutions in this area gave rise to the European Union in 1992 and its gradual expansion, from 12 countries in the year of its creation to 28 countries in 2011.

With the creation of the EU, a new quality appeared in public finance, in particular due to restrictions on fiscal policy (tax and expenditure) imposed on member states. In the initial phase, these constraints were relatively small, as they concerned the reference value of the budget deficit (3% of GDP) and public debt (60% of GDP), which was included in the Maastricht Treaty. With the course of time, the expansion of the European Union and the clear determination of its authorities for rapid economic and social integration of economies and societies, the freedom in shaping public finances by national authorities has been limited. This was also accompanied by the imposition of many obligations on the member states in the sphere of public finances put down in the Stability and Growth Pact (1997). They consist of, among others, the need to systematically submit convergence and stability programmes to the European Commission. In relation to public finances, the authorities of the European Union obtained an important instrument, which is the excessive deficit procedure. Its imposition limited the scope of freedom in national fiscal policy, in which the fiscal criteria contained in the Maastricht Treaty and the principles set out in the Stability and Growth Pact had to be taken into account. This new instrument complicated the actions of the national fiscal authorities on the expenditure and revenue side or both sides simultaneously.

The second important event in the last dozen or so years that strongly influenced the direction of public finance research was the financial crisis, which began in the United States in 2007 and relatively quickly spread to many countries, including all EU member states, although with different strength. The scale and depth of the financial crisis represented a serious threat to the stability of the European Union and the euro area. The Community faced the prospect of disintegration. The governments of many countries had to take extraordinary measures to rescue commercial banks, insurance companies and other financial institutions. The financial crisis has had negative effects on the real economy, which is reflected in a decrease in production, an increase in unemployment, a decline in the investment rate, etc.

The governments of many countries were forced to develop and implement packages stimulating the real economy. There were four negative processes involved in shaping public finances in numerous countries during the last crisis: 1) a decline in public revenues as a result of the collapse of the real economy; 2) an increase in public expenditure related to the need to rescue commercial banks and other financial institutions; 3) an increase in public spending in connection with the stimulus packages used; 4) a decrease in public revenues due to implemented stimulus packages consisting in lowering taxes. The combination of these factors negatively influenced public finances and caused serious disruptions in the socioeconomic mechanism in many countries, threatening the governments with illiquidity, loss of creditworthiness and basic social and economic dysfunction of the state. In some countries, the situation was so critical that it required the cooperation of national governments with external financial and economic institutions (European Commission, European Central Bank, International Monetary Fund, or the so-called troika). This applies to countries such as Portugal, Italy, Ireland, Greece and Spain (PIIGS).

Negative impact of the financial crisis on the European Union countries and the related risks for public finances have forced the EU authorities to take a new look at the institutional basis of the economic and financial system of the community, which as a whole proved not to be immune to crises. For some countries, the apparent immunity turned out to be even less effective and more insidious. It is not surprising that the authorities of the European Union were forced to react to these threats by reviewing and revising the pre-crisis institutional order. As a result, it was recognized that security buffers and stability conditions based exclusively on synthetic fiscal criteria (deficit, public debt) are not sufficient to minimize the risk of another economic and financial crisis. It proved necessary to take a broader look at macroeconomic imbalances, instead of focusing solely on their fiscal aspect, to monitor and alleviate systemic risk and create integrated supervision over financial markets.

In systemic terms, after the financial crisis, the concept of new economic governance (2011) appeared as a more comprehensive approach to the economy and finance, including public finances, of the entire community and individual countries. In the new approach, when macroeconomic imbalances occur, appropriate measures are taken and the systemic risks are reduced. Additionally, in the new economic paradigm fiscal situation of a country is analysed in relation to other important economic processes, in particular the real economy and the financial sector.

As part of the new economic governance public finances were also set in a different light. The European Union authorities had to adopt more radical measures to minimize the risk of another crisis in the wake of deep fiscal imbalances and rapidly growing public debt. The idea was to introduce a number of institutions that would discipline public finances much more effectively than the ones functioning before the crisis. The actions of the EU authorities were focused on the adoption of six legal acts (Six-Pack) in 2011, then the Fiscal Compact in 2012, and finally, in 2013, two more legal acts (Two-Pack). The basic goal of all these legal acts is to discipline the public finances of countries that flagrantly breach the budget balance, especially those in the euro area. As part of eliminating the institutional gaps, the role of the medium-term budgetary objective (MTO) has been strengthened, the significance of the European Semester has increased, the budgetary stability criteria for the euro countries and the public debt criterion have been tightened. A rule determining the desired rate of debt reduction, the obligation to create independent fiscal councils and the EU expenditure rule were also introduced. Moreover, the period of long-term budgetary planning was extended and closer connection of financial planning with programmes in the real sphere and in the social sphere was established. Other EU measures of equal importance for the situation of public finances included: establishment of macro-prudential supervision institutions, institutions monitoring systemic risk, integrated system of supervision over financial markets of European Union countries, creation of the Banking Union, introduction of stress-tests for systemically important commercial banks and tightening of capital requirements for banks and insurance companies.

The aforementioned changes support the thesis that after the financial crisis in the European Union a new institutional quality has emerged. Moreover, the adopted solutions had a significant impact on the functioning of domestic institutions shaping processes in the area of public finances, not only on tax policy, but also on expenditure policy, an example of which is the obligation to respect the EU expenditure rule.

Symptoms of the crisis, its severe economic and social consequences seen in many countries, radical systemic changes, prompted the authors of this work to undertake in-depth research on the course of the financial and economic crisis in the European Union as a whole and in selected member countries. The research covered 28 countries in the years 2003–2015. The choice of such a period of observation results from the fact that it is all about capturing the most important features of the public finances of the surveyed countries before the crisis, then identifying measures taken by individual countries to manage the crisis, and finally – assessing the effects of fiscal consolidation on the real sphere in post-crisis years. The analysis of post-crisis period was aimed at preliminary assessment of new solutions adopted systematically from 2011.

The authors assume that effective disciplining of public finances, executed by appropriate attitude in fiscal policy, may bring expected results, provided that tools based on both the revenue and expenditure sides are applied. The studied literature on the subject and the results of the research challenge the thesis that austerity is the only legitimate policy leading to the so-called non-Keynesian effects and ensuring the return of the economy to the path of growth and then to the balance of public finances. While accepting the otherwise obvious paradigm that public finance is a tool for achieving social and economic goals, the authors of the research tried to indicate that disciplining public finances cannot be just an exogenous goal, and the criterion of their balance cannot be considered as absolutely binding for every country and period. This excludes, in the understanding of the authors, the possibility of forceful balancing the state budget or a radical reduction in the level of public debt, because such an approach could lead to deepening the recession and cause negative effects in the social sphere. The likelihood of this outcome is increased by questionable criteria, such as (unobservable) potential output and cyclical and structural balances, used by the EU in its corrective programmes that are imposed on the member states and their public finances. The authors of the study sought to determine how far the individual countries’ approaches in the analysed sub-periods were an expression of pragmatism dictated by the state of the economy and the condition of the social sphere, and to what extent the governments simply followed fiscal policy of disciplining public finances according to the new institutional order.

The research was conducted by a relatively large team. The authors may discuss their topics differently but their primary focus is on the issues determined by the title of the project. They all share the view that fiscal policy measures as a tool for disciplining public finances cannot be limited to quantitative analyses, although such analyses have also been undertaken. Evaluation of methods of disciplining public finances required more detailed analysis by a qualitative approach in which it was all about capturing the impact of systemic changes on the state of public finances. Conducting qualitative research for all 28 countries exceeded, of course, the team’s capabilities. For this reason, 4 out of 28 countries were selected for qualitative analyses: Germany, the United Kingdom, Hungary and Poland. The underlying principle for choosing these particular countries has also been clarified.

The work consists of 12 chapters. Chapter 1 defines the research objective, formulates the theses of the project and describes its methods. Chapter 2 presents various fiscal consolidation concepts that can be used in disciplining public finances. Chapter 3 scrutinizes the new economic governance as the main concept of the European Union, aimed at making the whole group as well as individual member states more resistant to the risk of possible economic and social crises, including the crisis of public finances. The paper carries out a detailed analysis and preliminary assessment of new institutional solutions aimed at disciplining public finances. Chapter 4 presents the theoretical aspects of the approach to crisis phenomena and the experience of various countries in coping with them, with special attention paid to the policy of austerity. In chapters 5–8 an in-depth analysis of the discipline of public finances in the selected countries was performed. In Chapter 9, using the econometric model, an attempt was made to capture the relationship between the development of the public finance balance and selected macroeconomic variables, especially in the face of shock changes in the budget balance. In Chapter 10, the analytical database was significantly extended by including other macroeconomic and macro-social variables in order to identify changes in the economic potential of EU member states over a longer period of time. The research tries to answer the question about the economic and social integration or disintegration of EU countries. Similarly, in Chapter 11 GDP per capita is assumed as the main criterion for assessing convergence and divergence.

The work ends with a chapter in which conditions for disciplining public finances in the entire European Union and in selected countries are characterized, in synthetic terms, using the case study method. Moreover, assessments of the experience of the countries studied and conclusions for disciplining public finances in Poland have been presented.

The authors hope that this work will contribute to a better understanding of the possibilities of running sovereign national fiscal policies under the conditions of new economic governance.

Stanisław Owsiak