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Fiscal Policies and Growth: Constraints and Opportunities Carlo Cottarelli and Michael Keen “Ascent after Decline”: Workshop World Bank, November 19, 2010 1 THE MACROECONOMIC DIMENSION 2 The state of the world’s public finances 3 Advanced economies entered crisis with worst (non-war) fiscal outlook General Government Gross Debt for G-7 Economies, 1950-2007 (In percent of GDP) 90 80 70 60 50 40 30 Gross Debt 20 Net Debt 10 2005 2000 1995 1990 1985 1980 1975 1970 1965 1960 1955 1950 0 4 With pressures from aging on top of that Old Age Dependency Ratio 60 50 40 2009 2030 2050 • Pension reforms contain cost to 1 percent of GDP 30 • Health care costs increase by average 3.5 points by 2030 20 10 0 Emerging Advanced 5 Pre-crisis outlook for emerging economies better General Government Debt in Emerging Economies, 1998-2007 (In percent of GDP) 80 70 60 50 40 30 20 All Emerging Latin America Asia Europe 10 0 1998 2000 2002 2004 2006 6 Fiscal legacy of crisis most marked in advanced economies---reflecting lasting impact on GDP 1 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10 General Government Balance Advanced 2007 2009 2011 2013 Emerging 2015 120 General Government Debt 100 80 60 40 20 Advanced Emerging 0 2007 2009 2011 2013 2015 7 Deficits, debt and growth 8 In advanced economies, fiscal positions are unsustainable 10 Advanced Economies 8 6 4 CAPB 2 0 -2 -4 -6 -8 -10 0 50 100 150 200 250 Debt ratio 9 What debt target for stabilization? Higher public debt associated with: Higher real interest rates—perhaps 1.75 percentage points over 2008-15 for advanced economies Lower growth (through reduced investment and labor productivity)—perhaps 0.5 points per year 10 So need to do more than return to pre-crisis 6 4 2 0 Cyclically Adjusted Primary Balance -2 Primary Balance -4 -6 Overall Balance -8 -10 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2030 Required adjustment is roughly: • 8.5 percent GDP in advanced economies • 3 percent in emerging 11 Impact of fiscal adjustment on growth Prospects for expansionary contractions limited: • • Recent WEO work Low interest rates Evidence that adjustment on spending side is: • Associated with more durable consolidation Less contractionary • 12 THE MICROECONOMIC DIMENSION 13 Spending better 14 Welfare reform Pensions—Argue for raising retirement age by 2 years: stabilizes spending at 2010; best for growth Health care—supply and demand side measures ‘Better targeting’? • Incentive effects of means-testing Wage subsidies Tagging by correlates with participation responsiveness; increase UK workforce by 1 percent. • • 15 Infrastructure and innovation Literature gives good reason to suppose strong positive output effect from public capital.... ...but little guidance on specifics Institutions matter Likely needs: • Climate change—adaptation not costly in most advanced, but likely to be in some emerging Fundamental R&D—energy research, geoengineering? • 16 Eliminating wasteful subsidies Petroleum subsidies—cost around 0.3 percent global GDP in 2010 Exemptions and special treatment—importance of tax expenditure analysis Subsidies to renewables—don’t let spending substitute for proper carbon pricing 17 Taxing smarter 18 In search of immobile tax bases VAT: • Potential in Japan (and US?) Large scope in most advanced economies to eliminate exemptions and reduced rates—could raise £11 bn in UK even after compensation • Property tax 19 Green taxes Revenue potential is: • • Significant but not transformational in advanced—about $100 bn per year in U.S More in some emerging—If internationally traded But requires that permits not be given away Not much money in other environmental taxes • Though potential in congestion pricing • 20 Investment and finance Giving an allowance for notional cost of equity (an ‘ACE’) would Eliminate corporate-level disincentives to invest Reduce debt bias Financial sector • • Pre-financing resolution/Corrective tax ‘Financial Activities Tax’—a fix for the VAT Gains from enhanced international cooperation 21