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

certain types of structural reforms are able to boost productivity, potential growth and, therefore,
alleviate fiscal pressures (see, for example, Nicoletti and Scarpetta, 2003).

This paper contributes new insights to the existing literature in the following respects: First, it
clarifies conceptual issues how to disentangle typical fiscal features of reform periods on their
outset on the one hand and over the course of the reform cycle on the other hand. Second, it
analyzes the mutual link between budgetary policy and structural reforms by looking not only at
the budgetary balance but also at specific developments on both sides of the budget. This
refinement is important to make a better empirical distinction between different possible
mechanisms ranging from compensating reform losers up to demand management considerations.
Third, it also studies expectation effects of structural reforms which so far have largely been
neglected although they can be of major importance for government budgets. The empirical basis
is given by reform indicators depicting structural change of tax system and product, financial and
labour market for 20 OECD countries between 1975 and 1998/2002 depending on the policy field.

Overall, the results do not point towards a general short-run trade-off between Maastricht and
Lisbon since the link between budgetary phenomena and structural reforms is not very close.
However, the results show that the reform-budget-link differs significantly among reform fields.
While Maastricht and Lisbon tend to be mutually reinforcing for the liberalization of financial and
product markets, there may be some short-term conflicts for tax and labour market reforms. The
challenge of tax reforms is the inherent deterioration of the budgetary balance, which, fortunately,
is dampened by significant positive growth effects. Labour market reforms appear to suffer from
negative expectation effects. For all reform fields, the results indicate that expectation effects may
be a more important part of the link between reforms and the budget compared to other often
debated dimensions such as compensation issues.

The next section combines a conceptual clarification of the reform cycle with a survey on the
existing literature on the short-run mutual link between reforms and budgetary development.
Section 3 presents a detailed analysis of the situation on the eve of reforms and the evolution of
fiscal and economic variables over the reform cycle. Section 4 presents estimation results for a
model of reform processes based on lagged adjustments towards a given target level. Section 5
presents some insights on direct expectation effects of reforms. Section 6 concludes.

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