12 March 2012

Lars Calmfors: What can Europe learn from Sweden? Four lessons for fiscal discipline

This column argues that Sweden provides an example that fiscal transparency and a high-quality economic policy debate may be more important for budget discipline than formally-binding rules and automatic correction mechanisms, as being envisaged in the European fiscal compact.

Several eurozone countries are currently struggling with acute fiscal crises. At the same time, the new fiscal compact is an attempt to beef up fiscal frameworks for the future. In order to judge both the fiscal consolidation efforts and the reforms, comparisons with economies that have in the past carried through such processes successfully are helpful.

A prominent example is Sweden, which stands out among the EU countries for its strong public finances. At the trough of the recession in 2009, Sweden had a fiscal deficit of only 0.9 per cent of GDP. In 2011, it even showed a small surplus. This is a stark contrast to the fiscal crisis that Sweden experienced in the 1990s. The lessons from Sweden are diverse. They show that a determined policy can indeed turn around the fiscal situation. But they also highlight that fiscal consolidation will be very painful in the eurozone crisis countries and that the fiscal reforms underway may not be the optimal ones.

The four lessons (here abridged):

• Lesson one: A deep fiscal crisis can create a consensus on fiscal discipline.
• Lesson two: Comprehensive fiscal reforms increase the chances of success.
• Lesson three: Fiscal transparency may be more important than formal enforcement.
• Lesson four: Output growth is crucial.

Sweden shows that a deep fiscal crisis can forge a political consensus on the need for budget discipline and trigger comprehensive reforms of the fiscal framework. This may provide cause for some optimism regarding the eurozone. But the Swedish experiences also suggest that transparency and a high-quality policy debate may be more important for fiscal discipline than the German-type binding rules and automatic correction mechanisms that the eurozone seems now to be heading for. Most importantly, Sweden illustrates the importance of swift real exchange rate depreciation for fiscal consolidation. Without it, fiscal retrenchment is bound to hurt growth and the consolidation process to be long and painful. In this sense, the Swedish experiences do not offer any consolation for the crisis countries in the eurozone, which with the common currency have no instrument for a fast real exchange rate depreciation.

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