Proceedings from the ECFIN Workshop "The budgetary implications of structural reforms" - Brussels, 2 December 2005

1 Introduction

In a number of EU countries, governments are facing a double economic-policy challenge: Not
only that many features of labour markets, social security and tax systems are in need of an
overhaul given the constraints of an ageing population and increasing global competition. In
addition, significant consolidation steps are necessary in order to guarantee long-run sustainability
of budgetary policies.

Defining an adequate strategy which successfully copes with these twin tasks requires a thorough
understanding of possible conflicts or complementarities between both fields. If budgetary
consolidation and structural reforms are of an instantaneously mutually reinforcing nature there
would be a strong case of a “big bang” approach combining measures on both policy fields. If,
however, there are - at least in the short-run - conflicts it can become necessary to define reform
and consolidation sequences carefully.

For the EU, the possible conflicts between budgetary objectives and required structural reforms
have a specific framing represented by the fiscal constraints of the Stability and Growth Pact
(SGP) on the one and the Lisbon strategy’s growth objective on the other hand. If there is a
conflict between budgetary prudence and measures to increase the flexibility of markets and the
viability of social security systems, it may be hard to reconcile “Lisbon” with “Maastricht”. The
recent reform of the SGP (European Commission, 2005) reflects this potential problem as it has
allowed taking account of major structural reforms in the so called “preventive part” of the Pact.
Specifically, reforms may now justify a temporary deviation from the given medium term fiscal
objectives. Obviously, the Pact’s reformers are convinced that fiscal consolidation and structural
reforms are not always complementary undertakings.

The SGP’s contentious reform underlines the need for a more thorough understanding of the link
between fiscal prudence and structural reforms. The SGP’s guardian, the Commission, has to
decide in future which reform episodes may have an exculpating character for a temporary
deterioration of the fiscal position.

Given these policy challenges, this study is to contribute to a better understanding of the link
between fiscal prudence and structural reforms. It adds to the limited literature which is surveyed
in the next section. This study explicitly does not treat the long-run link between structural
reforms and budgetary performance. In regard to the long-run, it is hardly controversial that

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