The Road to Stable Public Finances: The Importance of Being Prudent – Sweden’s Fiscal Approach

The Road to Stable Public Finances: The Importance of Being Prudent – Sweden’s Fiscal Approach Swedish Minister for Finance Anders Borg April 18, 2011

Agenda • The state of public finances • The Swedish experience of fiscal consolidation • Lessons and policy suggestions

Most OECD countries are struggling with large deficitsUnderlying budget balance in 2012, % of GDP. OECD Economic Outlook, November 2010

…and growing debtsAccumulated debt, % of GDP. OECD Economic Outlook, November 2010.

The European debt crisis has led to high bond spreads…

Public finances are also threatened by underfunded pension systemsChange in the Public Pension/GDP over 2007-60 (in percentage points) Source: Joint report on pensions

A repeat of the fiscal catastrophe of the early 1990s has been avoidedSwedish net lending, % of GDP

Billions, SEK % of GDP 1600 90 80 1400 70 1200 Debt 60 1000 50 800 40 600 30 400 20 % of GDP 200 10 0 0 90 92 94 96 98 00 02 04 06 08 10 12 14 The Swedish debt level has declined continuously since the mid-1990s

Successful recovery from financial crisis • Large surplus going into crisis • Allowed expansionary fiscal policy without jeopardizing public finances • Relatively good labor market outcomes driven by • Income tax cuts (EITC), focusing on low- and middle income earners • Pro-work benefit reforms • Active labor market policy

Reduced marginal tax wedge on laborMarginal tax wedge on labor, as percentage of total labor compensation, at 100% of average worker earnings, single person without children. OECD Going for Growth 2011.

Swedish reforms to disability and sick benefits have paid offNumber of weeks lost due to sick leave. OECD Going for Growth 2011.

Swedish reforms to unemployment benefitsNet income replacement rates for unemployment (first year), % of earnings. OECD Going for Growth, 2011.

Relatively strong labor market in part due to labor market reforms Employment, percentage change since 2008Q4 Average -3,4%. Data until 2010Q4, for Belgium, UK, Germany, Italy, Greece, Slovenia, Ireland and Estonia up to and including 2010Q3 and for the Netherlands until 2010Q2. EU-countries which have not had a recession and are not members of the OECD are excluded. Source: OECD Unemployment, change in percentage points since 2008Q4(Nov) Average 3,0%. Data up to and including Feb. 2011, for UK, Greece and Estonia until September 2010. Countries which have not had a recession are excluded. Source: Eurostat

Key lessons from the Swedish experience of fiscal consolidation in the 1990s • Increase taxes • Cut expenditure • Establish credibility • Strengthen fiscal institutions • Maintain social cohesion

Raising taxes • Target items with negative external effects, such as carbondioxide, alcohol, and tobacco • Taxes on immobile property, and to a lesser degree, consumption taxes, appear to have the least impact on growth • Balance between the aims of efficiency, equity, simplicity, legitimacy, and revenue raising

Cutting expenditure • Preserve spending that enhances growth and employment prospects, such as education and training, • Spending decisions should boost incentives to work and join the labor force, • Social welfare programs and pension systems should be designed to encourage people to work more, start working at an earlier age, retire later, and stay in the work force. • Poverty traps, which arise when effective marginal tax rates of moving from unemployment to employment are too high, must be avoided. • Swedish expenditure cuts in the 1990s • Focus on government transfers, such as pensions, early retirement benefits, housing subsidies, and social and unemployment insurance

Establish credibility • Credibility central to any successful consolidation process • Credibility with markets, investors, analysts, and the public • Country must be seen as trustworthy and committed • Non-credible fiscal policy has major costs • Credibility depends on • Transparency and honesty • Delivering realistic and accurate forecasts • Exceeding, or at least living up to expectations • Building a reputation of competence and consistent performance

Strengthening fiscal policy frameworks • Fiscal policy institutions bring stability and credibility to the fiscal policy-making process • Countries with stronger fiscal institutions tend to achieve better fiscal outcomes, in terms of lower deficit and debt • Households and firms will adjust consumption and investment if they lose confidence in fiscal policy

Four cornerstones of the Swedish framework • A surplus target for total government sector • An expenditure ceiling for central government • A balance requirement on local governments • A stringent budget process controlled by a strong Ministry of Finance

Maintaining social cohesion • Fiscal consolidation should not harm the poorest members of society • Burden must be shared by all, in an equitable fashion • The richer should take on a larger burden, in proportion to their greater wealth • Sweden’s consolidation • The two richest deciles accounted for 43 percent of the savings • Other deciles each contributed about five to ten percent (with the poorest deciles accounting for the least).

The Road to Stable Public Finances: The Importance of Being Prudent – Sweden’s Fiscal Approach