Category: Fiscal Policy

Macroeconomics of Public Sector Reform

Without knowing the details of today’s deal, it is still worth thinking about the macroeconomics of public sector reform.  I will take it that the deal delivers widespread productivity growth in the public sector.

All else equal, an improvement in the quality or output of public services should be valued by the population. It is desirable that this be reflected in the measurement of GDP and various countries are attempting to capture quality and output measures for public services to this end. (The alternative is to measure public sector output by the volume of inputs – but this cannot capture productivity growth.)  The value to the population of extended opening hours, for example, should be considerable.  It would be helpful if Ireland made efforts to improve the measurement of the public sector contribution to GDP.

Next, for given levels of output and quality, an improvement in productivity means that the public sector requires fewer workers.  This expands the supply of labour to the private sector.  This will benefit private-sector enterprises, including via the attendant downward pressure on wage levels.  A cautionary note:  the initial impact of technological progress can be contractionary, since rigidities in the labour market may mean that it takes time for private-sector employment to expand to absorb the extra supply of workers.

Next, the financial savings from the reduction in public sector numbers [and/or the elimination/reduction of premium payments for some types of overtime] can be allocated in several ways:  (a) reduce the deficit; (b) increase the provision of public services [equivalently, avoid service reductions] ; (c) reduce taxes [equivalently, avoid tax increases beyond what is inevitable]; or (d) increase public sector pay levels [equivalently, partial or full restoration of previous pay cuts].

It is currently unclear about the intended allocation of savings across (a) through (d).

I further note that uncertainty in the provision of public services is damaging for the population, such that the commitment to avoid strike action and other types of service interruption is very welcome.

Finally, as part of the overall package, a commitment to no further pay reductions is also welcome by providing certainty to public sector workers  – this should reduce the level of excess precautionary savings. (I made this point back in January 2009 in my paper “A New Fiscal Strategy for Ireland”  –  the ideal time profile for pay cuts is to make a significant initial cut but not to pursue a sequential process of gradual pay cuts.) Since there are likely still significant pay premia for many public sector occupations, it will be important to closely monitor future public pay dynamics by reference to labour market conditions across the economy.

Public Sector Deal

The main points are summarised in this IT article.

Reforming the Fiscal Process

The Fine Gael “New Politics” document includes a number of proposals to re-shape the fiscal process.

Some extracts:

In Government, Fine Gael will implement a Responsible Budgeting Initiative that will make the budgeting process much more transparent and give the Dáil a clear and meaningful role. In particular, it will allow both the Opposition and the wider public to examine in detail the key underlying financial assumptions on which Government is basing its actions before the budget is published.

and

Fine Gael will overhaul radically the entire budget process. We recognise that these new fiscal processes cannot by themselves buy international credibility or fiscal stability. However, we believe that a different budget process, such as we areproposing, might have limited the worst excesses of the last few years and will help avoid any recurrence.
• We will establish a Parliamentary Budget Office (PBO), supported by an Independent Advisory Council (IAC) to provide members generally, and the proposed Dáil Budget Committee in particular, with expert input and advice into:
o The underlying structural state of the public finances
o The desirable borrowing / savings target for Government in the Budget, taking into account the economic cycle and longer-term fiscal pressures;
o The long-term implications of specific spending and taxation policies, taking into account likely demographic and other social and economic changes;
o Opportunities for rationalisation and prioritisation of public spending; and
o Performance evaluation of spending programmes.
• We will overhaul the annual Government Budget Documentation to include:
o Presentation of high-level service delivery and outcome targets alongside proposed spending allocations for public services;
o Quantification of the cost of all major “tax expenditures” and “tax shelters”;
o Assessment of the Government’s financial and non-financial assets and its financial and contingent liabilities, including public sector pension liabilities, future liabilities under Public Private Partnerships and possible liabilities resulting from the National Asset Management Agency (NAMA).
• A new Parliamentary Budget Cycle will be established:
o September – Publication by the new Budget Office of its recommendation for the fiscal stance (borrowing target) in the Budget

o October – Government presentation to the Dáil of its Pre-Budget Outlook, including macro targets for spending, taxation and borrowing (saving) in the year ahead. The Government would have a “comply or explain” obligation with regard to the target set by the Budget Office.
o November – Government presentation to the Dáil of its draft Budget.
o March – Government presentation to the Dáil of a new Public Service Delivery Report, audited by the C&AG, showing compliance in the previous year with the levels of spending authorised by the Dáil, as well as a comparison of service delivery and outcome targets promised and actual
results achieved
o March – Oireachtas Estimate Approval, following consideration of the Public Service Delivery Report.
o April, July, September, December – Government presentation to the Dáil of Quarterly Exchequer Reports (an expanded Exchequer Return), which would require the Minister to report on deviations from strategy and on the need for correction, at Departmental and macro-level
• Government will develop a new Medium Term Expenditure Framework which will
include:
o Presentation of aggregate envelopes for expenditure and tax based on the appropriate fiscal stance, recognising the different constraints that should apply to:
Capital
Demand-led spending
Stable programme spending
o An explicit cabinet “rationalisation and prioritisation” mechanism to drive restructuring and to divide up the spending envelopes among broad departments and agencies. Cabinet would also retain a “strategic reserve” which could be applied to cross cutting activities and to Government priorities

o Within the broad allocations set by cabinet; units within Departments would be required to bid publicly for resources and offer a set of quantifiable service delivery and outcome commitments that they would deliver in return.  New evaluation mechanisms within Departments would be established to judge whether commitments are being hit and to create an accountability framework.

Effects of Fiscal Stimulus in Structural Models

This new IMF working paper provides interesting analytical insights into the determinants of fiscal multipliers.  Also striking is the set of co-authors: it represents a joint collaborative effort across the IMF, ECB, European Commission, Federal Reserve, OECD and Bank of Canada.

Inflation-Indexed Bonds

This FT story reports that Ireland may issues inflation-indexed bonds.  I have advocated such a move in  this paper;  an interesting dimension is whether such bonds would be indexed to euro area inflation or domestic inflation.