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Brussels, 14 October 2009

Sustainability of public finances: a challenge for the future and a condition for sustained recovery

Fiscal policymaking in the EU has, over the last year, been urgently and successfully focused on pulling the economy out of recession. Discretionary measures and in-built fiscal stimuli have cushioned the downturn in economic activity and have been a factor in the recent improvement. However, this has also led to a deterioration in government accounts which, coming on top of the projected demographic developments as populations age, makes the long-term sustainability of public finances an acute challenge, says a Commission communication on the ‘Long-term Sustainability of Public Finances for a Recovering Economy.’ Governments need to keep supporting the economy and avoid choking off the emerging recovery. But now is the time to start mapping their consolidation strategies and assess how the crisis has affected their sustainability conditions.

"Addressing the long term sustainability of our public finances is one of the key drivers of our exit strategy," says European Economic and Monetary Affairs Commissioner Joaquín Almunia . "We need to continue supporting the recovery but in a context of severely deteriorated public finances, measures to increase confidence and support demand can only be successful if they are perceived by markets and public opinion as temporary and consistent with long-term sustainability. By designing clear strategies for the aftermath of the crisis we will strengthen the effectiveness of the support measures in the short term and create the conditions for a sustained and balanced economic growth in the future".

Today's communication and accompanying ‘Sustainability Report 2009' assess the sustainability of public finances in the EU taking into account the impact of the crisis.

The long-term sustainability of public finances is a concern for all EU countries, although to a considerably varying degree across Member States. On the basis of a series of detailed indicators and sensitivity analyses, the communication and technical report make an overall assessment of the risks to sustainability the different Member States face. The sustainability gaps have widened in most countries as a consequence of the economic crisis, and several countries are now in a higher, long-term risk category.

EU governments have made progress in the last decade to address the challenge of an ageing population by adhering to the strategy mapped out at the 2001 Stockholm European Council. By 2007 they had achieved their best aggregate budgetary position in 30 years, with a deficit of 0.8% for the EU as a whole. This gave many Member States the necessary margin for manoeuvre to help their economies during the crisis. Employment levels increased and for some categories – notably older workers and women – reached the target set in the Lisbon Strategy. Pension reforms in a number of countries also contributed to preserving pension systems for future generations while making them more sustainable.

While the crisis has reversed part of that progress, the three-pronged strategy, which consists of deficit and debt reduction, increases in employment rates and reforms of social protection systems, remains valid. But while initially the different components were options from which countries could choose, all three are now indispensable for most EU members.

We must at all costs prevent unemployment from becoming entrenched. It is therefore vital to pursue the flexicurity and other structural reforms that helped raise employment rates in the past.

It is also necessary to increase effective retirement ages in line with gains in life expectancy. Several countries are contemplating steps to this end. People are living longer and in better health than ever before. If current policies are not changed, the average age at which people exit the labour market in the EU will only increase by one year – from 62 to 63 – by 2060 (see effective exit ages p60 of the report). Yet life expectancy at 62 is expected to increase by a full six years over the same period – from 20.2 years to 26.2.

The Commission communication also highlights the need to consider reforms in healthcare, while an increase in the quality of public finances is indispensable in order to reduce non-productive expenditure and shift resources to education and research and other policy objectives (social, environmental, health). Fiscal consolidation by raising additional revenue, when necessary, should take incentive effects, efficiency and competitiveness into account and focus on those measures with the least distortionary effects.

The communication shows that successful fiscal expansions to counter recession and longer-term sustainability are not incompatible.

Fiscal exit strategies aimed at achieving ambitious and realistic medium-term objectives need to be designed now, and implemented in a coordinated manner as soon as the recovery takes hold, taking into account the specific situations of individual countries. To support the required reforms and enhance the credibility of fiscal adjustment – which will inevitably extend over a number of years – Member States may also need to further develop their own budgetary frameworks. In terms of the Stability and Growth Pact, debt sustainability should get a very prominent and explicit role in surveillance procedures.

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