Debt in a Time of Protests

IMF Blog, October 16, 2012

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Author: Nemat Shafik
Date: October 16, 2012
Context: Public protests against cuts in public spending designed to reduce government debt and deficits. The piece argues that debt reduction requires planning, fair burden-sharing, and time.

There is no silver bullet to debt reduction; it takes sustained efforts over many years.
Many countries have made significant headway in rolling back fiscal deficits.
With a sluggish recovery, controlling debt stocks is taking longer to yield results, particularly in advanced economies.

Governments must put together a credible medium-term plan and stick to it.
- Plans should be based on structural (not nominal) targets to allow flexibility in response to the economic cycle.
- For most countries this implies tackling entitlement reform.
Fiscal adjustment must be fair and transparent.
- Spending cuts and tax increases perceived as unfair are unlikely to be sustainable.

Adjustment should be gradual and steady; the pace should reflect adjustment needs, the state of the economy, and financing constraints.
As a general rule, an adjustment of about 1 percentage point of GDP per year seems an appropriate pace for advanced economies over the medium term.
Large advanced economies should take the lead in providing certainty:
- The United States should define a reasonable plan to reduce government debt and deficits to avoid the “fiscal cliff.”
- Japan needs a decisive debt reduction plan that includes both revenue and entitlement reform; the recently enacted consumption tax hike will slow debt accumulation, but not arrest it.
- In the euro area, implementing a robust fiscal governance framework that limits moral hazard and a credible roadmap toward a banking union and fiscal integration are essential.

Pension and health spending is projected to increase by over 4 percentage points of GDP in advanced economies by 2030, and by 3 percentage points in emerging markets.
Pension reforms have been widespread in recent years; health care reform has been more timid and remains the key long-term challenge for public finances in many countries.
The author expresses particular concern about controlling health care spending in countries with rapidly aging populations.
Pension reform, while politically difficult, is described as fairly straightforward—options include increasing the retirement age and adjusting contribution and benefit rates.

Income inequality tends to rise when governments cut debt and deficits, but this outcome can be mitigated.
Policies should be tailored to support social equity and long-term employment, including:
- A degree of progressivity in taxation and access to social benefits.
- Enhancement of social safety nets supported by greater means-testing and monitoring.
- Fighting tax evasion.
- Subsidy reform, particularly in low-income and emerging economies.
Reviving long-term growth and boosting competitiveness in many advanced economies may require addressing longstanding policies that do not suit a modern economy.
Strengthening fiscal institutions and governance can enhance the credibility of medium-term fiscal plans.

Results from current policy changes will take time to bear fruit, which is a source of frustration for those without the luxury of time.
Governments should make the case for reforms and be transparent about their impact across different population segments.
Young people should be involved and heard, as they will bear much of the burden of repaying consequences of past financial excesses.

Gross public debt is nearing 80 percent of GDP on average for advanced economies—over 100 percent in several of them—and we do not expect it to stabilize before 2014-15.
By the end of next year in more than half of the world’s advanced economies, and about the same share of emerging markets, we expect deficits —adjusted for the economic cycle—to be at the same level or lower than before the global economic crisis hit in 2008.
Pension and health spending is projected to increase by over 4 percentage points of GDP in advanced economies by 2030, and by 3 percentage points in emerging markets.
As a general rule, adjustment of about 1 percentage point of GDP per year seems an appropriate pace for advanced economies over the medium term.

Source: Nemat Shafik, "Debt in a Time of Protests", October 16, 2012.