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



1. Introduction

Structural reforms are at the centre of the EU agenda. Reforms in the functioning of markets and
the government sector are perceived as a necessary ingredient for re-launching the growth
potential for the union, in accordance with priorities set in the Lisbon agenda. In addition, growing
focus is placed on the link between structural reforms and public finances in implementing the EU
framework for fiscal policy. It is often claimed (e.g., Eichengreen and Wyplosz (1998)) that the
Stability and Growth Pact neglects a possible trade-off between short-term budgetary objectives
and the implementation of reforms that could improve public finances durably in a medium-to-
long term perspective. The idea of a possible trade-off between the implementation of structural
reforms and the pursuit of budgetary objectives was reflected in the 2005 reform of the Stability
and Growth Pact, which permits, under certain conditions, to take into account structural reforms
in the implementation of both the preventive arm and the corrective arm of the EU fiscal
framework. In future years, the evaluation of budgetary impact of reforms is likely to acquire
greater relevance in the implementation of the SGP. Better knowledge on the implication of
structural reforms for public finances will be required in EU fiscal surveillance.

A first reason for why there could be a trade-off between reforms and budgetary objectives is that
reforms may have a temporary negative effect on budget balances. There can be direct budgetary
costs associated with reforms. This is for instance the case of pension reforms introducing a
funded pillar classified outside the government sector. In the case of this particular type of
reforms, budgets would normally undergo a temporary deterioration (due to lost social security
contributions by the government) offset by long-term improvements (associated with saved
pension payments by the government). Alternatively, higher deficits could be the result of policy
action aimed at overcoming resistance to reforms in the political arena via tax cuts or targeted
government expenditure programmes. Moreover, to the extent that fiscal expansions are expected
to produce a positive short-run impact on economic activity and employment, keeping an
accommodating fiscal stance could help to ease to the political cost of reforms. Finally, the
budgetary deterioration could also be associated with short-term output losses stemming from
corporate restructuring and temporary increases in unemployment due to higher job destruction.

Some papers have analysed the trade-off between budgetary objectives and structural reforms
mainly from a theoretical perspective (e.g., Razin and and Sadka (2002), Beetsma and Debrun

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