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Ineffective, Inconsistent and Dangerous: The OECD-backed fiscal consolidation plans to deal with the looming sovereign debt crisis

25 April 2011
by Guest author

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Today’s post is contributed by Pierre Habbard of the Trade Union Advisory Committee to the OECD (TUAC)

In 2010 in the wake of the recession, the policy consensus at the OECD – alongside the IMF, the European Commission and many G20 Finance Ministries – shifted away from support for stimulating global demand to near-term fiscal consolidation. Their priority became reducing sovereign debt through unprecedented budget austerity programmes, the costs of which will be borne almost entirely by workers and their families: cuts in public services and in social protection, regressive tax reforms, and downward wage flexibility. At the same time, the much needed re-regulation and downsizing of the financial sector, which triggered the crisis in the first place, was either scaled back or postponed until “better days”.

This policy response is ineffective, inconsistent, and ultimately dangerous.

It is ineffective because the fiscal consolidation programmes that are advocated ignore the causes of the crisis: the combination of rising inequality, excessive leveraging and de-regulation of the financial sector. To bring government debt back to pre-crisis levels, public budgets should contract by -9.5% on average in the near future, and remain in surplus afterwards.

Considering the enormity of the social crisis spreading across OECD economies, the cuts in public services and in social protection that are foreseen, as well as, concomitantly, the regressive tax reforms which the OECD is pushing for will hit households and the lower income people front on. The OECD concedes that the massive public expenditure cuts it is advocating “may have adverse consequences for equity outcomes” – but its response to this concern appears thin, to say the least, and this, in spite of its recent work in that field.

It is suggested that social protection and unemployment benefits be “revisited in terms of their effectiveness in reaching envisaged policy goals”. The OECD lives with the hope that while the inputs will effectively be cut down, the output levels (including quality of public services) could be maintained thanks to “efficiency gains”, better “targeted” services and restructuring: “doing more with less”, we are told. Trade union experience with public sector restructuring would rather point to the opposite effect: “doing much less with less”. Any restructuring involves substantial upfront costs. Importantly, the notion that social protection could be better targeted in times of social crisis appears rather illusory with unemployment at 10% and under-employment at 20%, rising poverty and social deprivation.

It is inconsistent because, as OECD experts are well aware, the most effective way to deal with the unsustainable rise in sovereign debt is to put an end to the unhealthy relationship between private sector finance and government balance sheets. If public budgets have become more vulnerable following the crisis, it certainly is not due to any badly managed or inefficient public services or social protection, or badly designed tax systems; rather, the fault lies with the unwillingness of policymakers to take decisive action on banking and broader financial regulation, which leads to growing exposure of governments to any future financial crises.

The key threat to sovereign debt sustainability in the short term lies not in fiscal policy, but in government exposure to contingent liabilities created by multiple guarantees on banks’ liabilities as a result of the crisis and by financial institutions that are too big to fail. The on-going debate on the possibility of a ‘hair cut’ or debt restructuring for the most crisis-hit countries exemplifies that dilemma. Governments must put an end to this intertwining without delay. The OECD experts know that and have been calling, as at least implicitly, for splitting the large banks to shield commercial and retail activities – that serve the real economy – from the volatile investment banking activities.

On revenue side, the obvious “under-taxation” of the financial sector barely appears in the main recommendations by the OECD. The generalisation of Financial Stability Contribution (FSC) type insurance mechanisms together with the creation of a Financial Transaction Tax and the IMF suggested Financial Activity Tax would help redress the current under-taxation of the financial sector. Here the OECD is lagging behind. On that it is no small irony to compare the OECD’s insistence on broadening VAT with its total silence on the massive VAT exemptions which benefit the financial sector across OECD countries. Together with the current G20–Financial Stability Board “action plan” (Basel III, consolidation of the supervisory framework, regulation of the derivatives markets), these measures could help reduce governments exposure to the private banking sector. But the needed speed of reform simply is not there. 

And it is dangerous because the fiscal consolidation packages currently being introduced threaten to have long-lasting consequences in terms of income and welfare distribution. Trade unions are well placed to know through their membership that social cohesion is breaking down across OECD societies; they are first-hand witnesses of rising populism within the working class. The political dimension of the crisis, the need to bring back some redistributive justice in the economy, is not factored in the OECD–IMF response. To the contrary, their response fuels the risk of weakening democratic institutions if key elements of fiscal policy are transferred away from democratically elected bodies through the constitutionalisation of fiscal rules and the empowerment of “independent” experts in the fiscal consolidation process.

Useful links

TUAC Discussion paper The International Policy Response to the Post-Crisis Rise in Sovereign Debt – A trade union critique, April 2010

OECD work on public debt management

One Response leave one →
  1. Baye Kambui permalink
    April 25, 2011


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