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Several eurozone countries are facing what appears to be the conflicting challenges of reducing public sector debt to GDP while boosting productivity. That's not an easy task, but Sweden's success, in the late 1990s, could provide a blueprint for a solution based on the application of new budgetary rules and the efficient allocation of private savings.
Chart 2
What's Happening
France, Italy, and Belgium face the dual challenge of consolidating their public finances while boosting productivity. The task isn't easy and can seem contradictory: a recovery in productivity would contribute to fiscal consolidation, but the reverse is not necessarily true.
With financial markets and the European Commission both looking for bold plans, the trio might want to look to the example of another developed economy with abundant private savings that rose to exactly that challenge. Sweden halved its public debt to 37.5% of GDP in 2007, from 69% in 1996, without abandoning its social model or killing growth. On the contrary, average annual growth was maintained at over 3% during those 10 years, didn't fall into recession in any single year, and increased hourly labor productivity and capital intensity by 30%.
Why It Matters
European countries can't rely on the cyclical economic recovery to repair public finances and restore productivity. Failure to make structural changes could leave domestic and foreign investors no longer willing to overlook risks associated with onerous sovereign debts, rendering them unable (or at least less willing) to invest. That would consign the countries to widening sovereign debt spreads and could force the European Central Bank (ECB) to resume its sovereign debt purchasing program.
Europe has ample private savings which could be more efficiently allocated in support of innovative small businesses, resulting in productivity growth that would help the region remain at the technological frontier. Without action, key European economies could continue to lose market share, undermining global trade that has been an important source of their growth for the last thirty years.
What Comes Next
We'll be keeping a close eye on this autumn's national budget debates, especially in countries that the European Commission has flagged for excessive deficit procedures. And we will be watching for improved application of new European fiscal rules.
At the same time we will want to see a more efficient allocation of private savings across Europe, notably with regards to progress on the use of long-term pension products--within or without the framework for a capital markets union.
The Swedish Recipe For Fiscal Consolidation And More Capital
Sweden's economic reforms were born out of necessity following the bursting of a property bubble, that led to a state to bail out the banking system between 1990 and 1994, and a recession over 1991 and 1992, which left unemployment at 12%, up from 6%. The recovery, which began in 1993, was supported by the country's central bank, the Riksbank, which cut interest rates by almost 600 basis points (bps) between 1993 and 1997, and by Sweden's accession to the European single market, in 1995. Yet the foundations for that turnaround were laid with the ambitious reform of Sweden's public finances and its pension system.
Key among the measures to improve public finances was 1997's introduction of a three-year ceiling on nominal central government expenditure, which was complemented, from 2000, by a budget surplus target--initially set at 2% of GDP (2000 to 2007) and since lowered. The resulting Swedish model arguably inspired the overhaul of Europe's fiscal rules. But good rules count for little without effective application and it is the dedication to the rules, notably at the national government level, that has been the foundation for Sweden's success. Three national agencies are responsible for monitoring application, and informing parliament in the event of non-compliance, in which case the government has four months to amend its roadmap (see "The Swedish Fiscal Policy framework," Government offices of Sweden, Ministry of Finance, April 12, 2018). The result has been budget surpluses in good years (often above 1% of GDP) that have compensated for weaker performance in bad times.
With regards to pensions, Sweden benefitted from reform in the 1990s, which led to the creation of strong pension funds. In 1998, the country's universal contribution, which provides two-thirds of pension benefits, was reformed so that of the 18.5% of contributions from pensionable income a total 16% goes to a notional pay-as-you-go account and the remaining 2.5% per cent to pension funds The pension funds' investment policy favors business development. It accounts for over 30% of the country's private equity (PE) investment, according to InvestEurope, a European PE trade association. That investment in PE is eight times higher than the amount Swedish banks invest in domestic PE. Swedish pension funds are particularly active in funding PE acquisitions, which focus on development of acquired companies. Pension fund investment activity has contributed to an increase in private sector investment equivalent to 4 points of Swedish GDP since 1998 (see chart), while the capital intensity of the Swedish economy has risen by 30%.
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| Chief EMEA economist: | Sylvain Broyer, Frankfurt + 49 693 399 9156; sylvain.broyer@spglobal.com |
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