Budgetary Balances in Europe
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European nations face many challenges in maintaining strong budgetary positions. Though maintaining strong budgetary positions is important and challenging for any individual country, members of a monetary union must also be concerned and aware of each other’s budgetary positions. Weakness in one member’s budgetary position could cause problems for other members through its effects on the common currency. In addition, the possibility of weak budgetary positions in a monetary union is greater because of the risk of moral hazard in the budgetary process.
Outlined below are budgetary problems that European governments have inherited, as well as some looming budgetary problems. Some of the efforts to overcome these difficulties are also presented.
- Existing high levels of debt. These high debt levels are the result of deficit bias budgets which come from the strong welfare state in Europe, as well as an insufficient system of tax collection.
- In order to overcome the deficit bias evident in Europe since the mid-1970s and to promote stability across the union, deficit and debt restrictions were implemented in the run up to the formation of the EMU. Under the Maastricht treaty, each potential member of the EMU had to bring their deficit to GDP ratio under 3 percent and their debt to GDP ratio under 60 percent before they could join.
- The deficit restrictions were maintained in the Stability and Growth Pact after the formation of the EMU. Each member was still obligated to maintain a deficit to GDP ratio of at least 3 percent.
- It is expected that the restrictions would lead to structural changes in order to insure that under normal circumstances, a government’s spending obligations would equal its revenue.
- Every current member for the EMU (or Euro zone) brought their deficit to GDP ratio within 3 percent before joining the union in 1999.
- Some of the improvement can be attributed to structural changes to budgets. For example:
- France changed its tax code so that more people paid taxes (broadened the base), while the high rates of those that did pay taxes were reduced (to encourage more work effort and less tax evasion).
- Italy increased the age at which a person became eligible for retirement benefits as well as adjusted payments to more closely match contributions to the social security system.
- Spain cut back the amount of unemployment benefits paid as well as shortened the duration a person could receive unemployment benefits.
- Germany created laws to contain healthcare costs by making the public healthcare system more efficient.
- Not all improvements to the budget were structural; many temporary adjustments were made to ensure the budget met the deficit restriction. For example:
- Italy imposed a temporary one-year tax in 1999 to temporarily raise government receipts.
- Greece employed accounting tricks, which masked its true budgetary position.
- All government investment contracts signed in Spain in 1997 were not to be paid for until they were completed (most projects took longer than two years to complete).
- France froze government spending in 1997, prohibiting any new spending items from being introduced that year.
- Once the temporary fixes wore off, it was evident that the structural changes undertaken were not sufficient for many countries to maintain their strong budgetary positions.
- Germany, France, Italy, Netherlands, Portugal, and Greece all violated the Stability and Growth Pact 3 percent deficit to GDP restriction by 2004.
- Pressure from these countries led to a revised Stability and Growth Pact in 2005.
- Structural change has continued and budget positions have in general improved.
- Since 2005 each country, with the exception of Greece, that was in violation of the SGP has been successful in bringing deficit to GDP ratios within 3 percent.
- No longer do we see deficits as high as they were in the 1980s.
- In as much as these restrictions are adhered to, Europe has made progress in overcoming its deficit bias. Continued adherence to the deficit restrictions will force European countries to address the looming problems facing budgetary positions before they become too unmanageable.
Even as the structure of budgets has improved across Europe, there are areas of the budget that have the potential to cause large deficits in the future if not addressed. The areas of greatest concern are
- Social security and the public pension system.
- Social security and public pension systems in Europe as a whole are generous. Changes to eligibility requirements (such as the retirement age at which you can receive benefits) as well as a reduction in benefits have helped, but there are major problems on the horizon.
- The number of people who will be eligible for benefits, no matter what the age, will increase across Europe as the current working population retires.
- There are fewer people in the rising generation, a result of low birth rates across Europe.
- This is a problem in a pay-as-you-go social security system, such as those in Europe. Those on social security are paid with taxes collected from those who are working. As more people age into the social security program and less people are born to take their place in the work force and pay taxes, the system will eventually go bankrupt.
- This problem is summarized by the old age dependency ratio (OADR): OADR = (# of people age 65+) / (# of people age 15 - 64).
- So an OADR of 0.25 says that for every person over the age of 65 there are 4 people of working age (15-64).
- In 2000 the average OADR in Europe was 0.25, by 2050 it is projected to be 0.5. (click here for a chart provided by Amy Medearis of the European Commission)
- Rising costs of healthcare
- Healthcare costs across the world are rising. This is damaging to government budgets because of the extensive public healthcare system provided by a majority of European countries. As the costs of healthcare rise, so will the portion of government spending dedicated to providing health services. Without increases in revenue for healthcare expenses the public healthcare system will go bankrupt.
- Structural unemployment remains high in Europe.
- This is a problem for budgetary positions because those who are unemployed receive welfare payments from the government.
- In addition, had those who are unemployed been working, they would have paid taxes. There is lost potential revenue as a result of the high structural unemployment rates.