Of wage expectations in an ageing society

Ülo Kaasik
Ülo Kaasik
Deputy Governor of Eesti Pank

The draft budget for the next year is on the way to the parliament. Since Estonia’s public finances are relatively sound, the main issues are related to the future rather than to the 2013 budget.

The government’s continuous commitment to reaching a budget surplus is commendable. The only drawback is that compared to the plans of 2011, the surplus has been postponed until 2014. This deserves criticism, because economic developments (that is, the receipt of budget revenues) have been even somewhat favourable than expected. One can only hope that the new target will be adhered to in drafting the budget for the next year.

A budget surplus is the essential goal, since sound and far-sighted fiscal policy (that is, accumulation of savings) increases the credibility of Estonia’s economic policy, which, in turn, improves the wellbeing of the people in the longer run.

In addition to the overall objective, a series of inescapable concerns needs to be considered as well. The population is ageing, which means that in the longer perspective, the number of the employed will decrease, but medical and pension costs will grow, whereas the pension system already needs state support and it makes no sense to increase the Unemployment Insurance Fund surplus any further. Contributions from the EU structural funds make up a significant share of state revenue and in the future they will only decrease. Such problems indicate the need to fundamentally reform budgetary expenditure and revenue, which will be far easier when the budget is in surplus.

With Estonia being a small and open economy, our economic growth will continue to be volatile also in the future, so we need to prepare for harder times. Therefore, the goal to restore and increase reserves established in the government’s budget documents is very important. That reserves are indispensable was also proved by the recent crisis experience, when reserves helped us somewhat cushion the slump. However, restoration of reserves can be seriously talked about only when the budget posts a surplus.

Among other things, budget deficit is justified by the need to alleviate the impact of hectic economic developments. When times are tough, the government spends more than it earns in order to boost demand, whereas expenditures are limited in better times to reduce aggregate demand. The government, citing similar reasons, has also started to put more value on structural budget balance. This is an indicator measuring the state of the budget without business cycle influences or one-off factors (for example, revenue from the sale of emission allowances). The structural budget balance indicator is a good landmark in solving the task of balancing the economy. By now, it should be clear to everyone that signs of a overheating and imbalances may occur very suddenly.

Though measuring structural budget balance does have its goal and place, it says nothing about actual cash flows. It is difficult to measure structural budget balance in real time and it also gives plenty of room for interpretation in justifying excessive expenditures, both statistically and theoretically. How often do we see a government that thinks good times have arrived? This is definitely one of the reasons why several countries are experiencing difficulties. Therefore, nominal budget balance continues to be the highest fiscal goal. Like in case of household budgets, it is actual cash flows that set limits on spending.

The Estonian economy has recuperated faster than expected. The first half of the year was relatively successful, allowing an upgrade in growth outlooks for 2013. This is why the Ministry of Finance's recent economic forecast may be interpreted as if the government has more tax revenue at their disposal when drafting the next year’s budget than expected in spring. However, the "extra funds" should be used to reduce the deficit, not to increase expenditure.

Risks to Estonia’s economic growth have disappeared nowhere. Some experts are of the opinion they have even grown recently. Global trade outlooks are still uncertain: the external environment has clearly deteriorated in recent months, and there are very few analysts who expect positive surprises from the external environment in the years to come. The European Central Bank's recent forecast also shows that risks to growth can only increase. Such uncertainty calls for caution rather than optimism. Estonia’s economy is like a patient who has recently suffered from a serious illness. Irrespective of the recovery, its health is still fragile and there is the threat of falling ill again if we are not careful.

At the same time, there are more and more various desires and expectations that are in no way consistent with the public revenue growth potential. It is a fact that budget expenditure can be increased only in line with revenue growth. Looking further ahead, it is important to bear in mind that the average economic growth rate will be much slower than in the past decade’s pre-crisis years. Even when the goal of a consolidated budget surplus is reached, government spending cannot be expected to grow more than 5-6% a year. And this is an optimistic view. In the coming years, rapid expenditure growth will be kept in check by the need of reaching a budget surplus and by some earlier promises. As a result, a steep increase in expenditure would take a toll on efficiency or something else. It is unrealistic to expect it to happen within a short time span.

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