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Smart Fiscal Policy Will Help Jobs

Unemployment remains unacceptably high in many countries. It increased dramatically during the Great Recession. Global unemployment currently exceeds 200 million people. An additional 13 million people are expected to be unemployed by 2018.

The most worrisome is youth unemployment. There are examples of advanced economies in Europe where youth unemployment surged above 50 percent. In several developing economies, job creation does not absorb the large number of young workers entering the labor force every year.

FM Chart

This puts unemployment at the top of the global policy agenda.

Working together: Fiscal and Structural

Faced with this immense challenge, we asked ourselves: “Can fiscal policy do more for jobs?” This is the theme of the October 2014 Fiscal Monitor, released today.

Support to employment and economic growth requires action on multiple fronts. In some countries, particularly in Europe, reform of labor markets may be necessary to remove persistent rigidities.

Fiscal policy cannot substitute for such reforms. But fiscal policy can work in tandem with broader structural reform efforts to support job creation.

The Fiscal Monitor highlights three possibilities.

First, fiscal policy can foster macroeconomic conditions that are supportive of economic activity and labor markets. For example, deficit reduction can be designed and timed to minimize negative effects on employment. Clearly, the adequate policy mix for each country needs to be tailored to its specific circumstances.

Second, fiscal policy can facilitate structural reforms in the labor market. How? Fiscal policy can offset the potential short term economic costs of reform. It can also help build political consensus on reform, for instance, by compensating groups that may be adversely affected by change. This allows me to make a point of general importance: going forward it is very important to improve the understanding of the political dimension of economic policy.

Effective fiscal policy in support of structural reform must meet certain conditions: it should not raise debt sustainability risks; the costs and benefits of the reform need to be well identified; the costs need to be constrained in size and duration; and there needs to be sufficient certainty that reforms will be carried fully to their end.

And third, fiscal policy can be part of the overall design of structural policy measures.

Let me give a couple of examples.

In advanced economies, we find that a carefully designed reduction in employer social security contributions on young workers can improve youth employment.

In emerging market and developing economies, we find that removing tax barriers, providing basic public services, and offering greater access to finance and training can help address challenges related to informality and low growth in labor productivity.

Current fiscal environment

In the last six months, interest rates have been low and volatility in bond markets has been subdued. This has helped ease immediate pressures on public finances in most countries. However, we are at a difficult juncture. Underlying fiscal vulnerabilities and fiscal risks continue to accumulate.

In advanced economies, debt levels are stabilizing but remain elevated. In some cases, debt exceeds 100 percent of GDP. So it is important to bring government debt down to safer levels. But it is also important to be mindful of the uneven economic recovery and the risk of persistent low inflation in some countries, especially in the euro area.

In emerging economies, deficits and debt ratios are generally moderate, but still remain above pre-crisis levels. In some cases, there are risks to debt sustainability from off-budget transactions and government guarantees. Many of these economies share the need to raise potential growth while rebuilding the fiscal buffers used during the crisis.

In low-income developing countries, fiscal risks are generally modest. Here, efforts should focus on mobilizing revenue, better budget prioritization, and higher efficiency of public spending. Some countries also need to strengthen fiscal governance.

Smart fiscal policy

Overall, the challenges I have pointed to throughout my presentation call for smart fiscal policy. This is no time for complacency.

Smart fiscal policy is imperative for countries facing the difficult juncture of an anemic recovery, weak potential growth, and very low inflation.

Smart fiscal policy is one that supports jobs and growth while bringing public debt to safer levels.

Smart fiscal policy is one that values efficient public investment and facilitates structural reform.