World Economy Needs Smart Fiscal Policies
October 8, 2014
- Smart fiscal policy could support jobs, bring public debt to safer levels
- Fiscal policy can help achieve needed structural reforms
- Targeted fiscal steps can tackle youth unemployment, labor market problems
Fiscal policies can help support job creation, though designing the right policies will depend on conditions in individual countries.
Job creation sits atop the policy agenda globally. High and persistent levels of unemployment call for a broad policy response, generally encompassing structural reform and other economic policies. While fiscal policy cannot substitute for comprehensive reforms, it can support job creation in a number of ways, according to the IMF’s latest Fiscal Monitor.
According to the International Labor Organization, global unemployment exceeds 200 million people, and an additional 13 million people are expected to be unemployed by 2018. In order to address the high and persistent levels of unemployment, the IMF is calling for a multipronged policy response, where fiscal policy works in tandem with broader structural reform efforts to support job creation.
“Under certain conditions, the fiscal decisions taken by countries can help promote labor market reforms,” said Vitor Gaspar, Director of the IMF’s Fiscal Affairs Department. “Labor market reforms can have sizeable costs. A higher deficit or slower pace of deficit reduction can absorb these costs and offset the adverse short-term impact of reforms on output and employment. It can also facilitate political consensus on reform, for instance, by compensating groups that may be adversely affected by the change. Smart fiscal policy also values public investment.”
Policymakers can use targeted measures—cuts in employers’ social contributions or reform of pension systems—as part of an arsenal of policies designed to help fix some of the current weaknesses in labor markets, such as high youth unemployment and low participation in the labor force by women and older workers. Measures targeted to specific labor market trouble spots are more cost effective than blanket ones.
The IMF Fiscal Monitor is published twice a year to track public finance developments around the world.
Advanced economies’ efforts on track
In advanced economies, a slowing pace of deficit reduction should provide support to economic activity. Fiscal efforts over the past five years in many of these countries have helped to stabilize debt-to-GDP ratios, though the average debt-to-GDP ratio across all advanced economies is expected to exceed 100 percent of GDP at the end of the decade. Hesitant recovery and risks of lowflation and reform fatigue call for fiscal policies that carefully balance support for growth and job creation with fiscal sustainability.
With continued uncertainties regarding the strength of the recovery, fiscal policies now often include measures aimed at increasing competitiveness, employment, and long-term growth. The challenge, according the Fiscal Monitor, is how to absorb the costs associated with these measures in such a way so as to keep overall budget deficit in check. This could be achieved by cutting spending in other areas or shifting to other forms of taxation.
Emerging markets on guard
Although budget deficits and debt ratios remain moderate on average, fiscal positions and risks vary widely across emerging market and middle-income economies. While immediate pressures on public finances have eased, the IMF sees lower potential growth, prospects of tighter financing conditions, and rising contingent liabilities as looming risks.
In emerging market and middle-income economies, debt ratios and deficits remain generally moderate, although on average above precrisis levels. The prospect of increasing risks calls for rebuilding the policy room for maneuver that was used during the last few years.
Geopolitical conflicts in Ukraine and the Middle East could also raise fiscal risks, but the report acknowledges these are difficult to measure at this point in time.
Developing countries on uneven ground
As for low-income developing countries, with a few exceptions, immediate fiscal risks are generally moderate. A key policy challenge in low-income developing countries is to scale up the provision of social public services and growth-enhancing infrastructure, health, and education.
Looking forward, efforts should focus on improving fiscal outcomes through revenue mobilization, budget prioritization, and greater efficiency of public spending. Another important policy challenge is strengthening fiscal governance, especially for the growing number of low-income developing countries that are gaining access to global financial markets.