Structural reforms in the economy and fiscal sustainability

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Title: Structural reforms in the economy and fiscal sustainability
Author: Kinnunen, Helvi ; Mäki-Fränti, Petri ; Railavo, Jukka
Series: Bank of Finland bulletin. Economic outlook
Series volume: 87
Series number: 5
Year of publication: 2013
Pages: 67-77
Keywords: julkinen talous; uudistukset; Suomi; rakennemuutokset; vajeet; kunnallistalous; tulevaisuus; kestävyys; työurat
Abstract: In August 2013, the Finnish government published the general outlines of an extensive structural policy programme.1 The programme sets out the objectives for bringing the public finances onto a sustainable footing. The aim is to strengthen local government finances by scaling down municipal obligations and to look for measures that will enable improvements to the productivity of public service provision, lengthen working lives, reduce structural unemployment and boost the economy's potential output via other means. The structural reforms, if implemented as planned, would mean a considerable improvement in the state of the public finances. According to the Bank of Finland's calculations, the fiscal sustainability gap could be bridged if it were possible to implement the reforms in full and without delay. However, achievement of the targeted effects would require significant changes to the structures of the economy. The average employment rate would rise substantially. Employment structures would also change from what has been estimated previously, as the production of public services would require a much smaller work force than expected if the reduced level of local government services could be provided more efficiently. The present article examines the structural reforms from the perspective of fiscal sustainability.2 At the same time, we discuss the changes that the realisation of the objectives would necessitate in the labour market and other economic activity, among other factors. In addition, there is a projection of the position of the public finances a couple of decades ahead. The effects of the structural reforms will take several decades to feed through to the macroeconomy and the public finances. The key question is how high the general government debt ratio can rise before the structural reforms begin to exert an effect. The scenarios indicate that, even if local government consolidation measures materialise according to schedule and working lives lengthen as targeted, the debt ratio will rise to around 90% in the 2030s. If, in addition, public service productivity improves and potential output grows, the debt ratio will remain in the region of 70%. The examination of the structural reforms is extended by an analysis taking account of economic agents' reactions to both the structural reforms and the resultant change in the required fiscal consolidation. In the Bank of Finland's macroeconomic model, the public finances are modelled in a way that enables assessment of the macroeconomic implications of a higher retirement age, increased potential output and local government savings. 3 Model simulations show that reforms enabling reductions in taxes and other charges on labour boost both growth and employment.
Note: ISSN: 0784-6509 (painettu), ISSN: 1456-5870 (online)

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