2.2. Do numerical rules for deficits discourage structural reforms?
In the policy debate, it is sometimes claimed that carrying out economic reforms could go at the
expense of the respect of budgetary objectives, and criticisms have been moved to the Stability and
Growth Pact for not taking properly in consideration this trade-off (e.g., Eichengreen and Wyplosz
(1998)). In particular, it has been argued that an excessive focus on short-term budgetary discipline
could act as a constraint on the pursuit of reforms that could improve public finances in the long
term. This could occur if reforms worsen the budgetary position in the short to medium-term while
gains appear mainly after some time, so that a choice has to be made in the short-term between
implementing the reform and keeping deficits unchanged.
There are several arguments that could provide a justification for the claim that structural reforms
could worsen the budget in the short-run in spite of an improvement in the medium/long-term in
public finances.
The first argument is that reforms may temporarily worsen budget balances. This may be due to
the presence of direct budgetary costs associated with the reform. A notable example is that of
systemic pension reforms implying that the social contributions previously collected by the
government are diverted to a new pillar, which may be privately run or classified outside the
government. This type of reforms help to contain the impact of ageing on the dynamics of
government expenditure related to the payment of pensions. However, they will also normally
entail a reduction of government revenues not immediately compensated by reduced pension
payments.
The above argument has been formalized in several recent theoretical papers. Razin and and Sadka
(2002) develop a political economy model providing a rationalisation of the trade-off between the
budgetary objectives of the Stability Pact and the implementation of social security reforms. In this
model, an ageing population has a double effect on the political balance of interests for what
concerns the implementation of pension system reforms from PAYG to funding. On the one hand,
it reduces the expected returns from PAYG schemes, thus raising the incentive to reform the
where pension benefits are earnings-related, and by a 0.6-3 GDP points in systems where pensions are paid on a flat
rate. Moreover, increasing by one year the effective retirement rate would lead to a reduction of pension
expenditures in 2050 in the order of 0.6 to 1 % of GDP. Estimates of the long-term budgetary impact of various
types of pension reforms have also been provided by EU countries in their updated stability and convergence
programmes submitted to the European Commission. All programmes report long-term budgetary improvements
associated with the reforms, which range between 0.6 to almost 2 % of GDP (stability and convergence programmes
are available at: http://europa.eu.int/comm/economy_finance/about/activities/sgp/scplist_en.htm).
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