The current sovereign debt crisis is mainly a crisis of confidence. It requires both further integration in the European Union (EU) and a strong fiscal union to restore confidence in the euro. Reinstating trust by investors as well as citizens is needed in order to safeguard the system. The combined market and state failure questions even the very adequateness and sustainability of our European social market economy. Sustainability of public finance plays a key role in this regard.
Five elements are necessary in order to re-establish confidence in the ability of policy-makers and our social free market economy at large.
1. Transparency and long-term planning is a necessity.
2. Soundness of statistical data by improving the quality of data is necessary to ensure comparability and adequateness.
3. Implicit liabilities have to be included in government budgets.
4. Household consolidation needs to remain an over-arching policy goal.
5. Sustainability in the long run is the only means to success.
At the core of confidence is trust and dependability, which is established through high levels of transparency. Reliable financial statistics on public finances are indispensable to the assessment of a country’s debt and stability. This will enable both the public and policy-makers to act responsibly, but the basis for this is sound data and statistics.
The past has shown that sovereignty of national Member States in statistical matters has led to poor quality data and in exceptional cases even the falsification of such data. Statistical data needs to follow the principles of independence, reliability, timeliness and transparency.
The ability to assess the sustainability of pensions systems and the relating fiscal policy choices are essential to establish more transparency.
Therefore, it is indispensable that governments move to accruals-based accounting to match outstanding future liabilities (such as pensions) with the necessary assets and savings.
The recent adoption of the framework for strengthened economic governance in the EU is a step in the right direction. It forces Member States to use actuarial recording of public pension liabilities for the medium-term budgetary objectives and surveillance of the stability programmes. This provides a structure for including outstanding/implicit liabilities relating especially to ageing and a changing demographic in debt and deficit targets.
Responsible financial planning requires that contingent liabilities are identified and preparatory work undertaken to match future requirements. The assessment of public debt (eg, in the form of credit ratings) should reflect implicit liabilities and potential future funding mismatches. Putting the house in order requires a long-term perspective, particularly as the real challenges still lie ahead.
A study from Stiftung Marktwirtschaft1 shows that implicit contingent liabilities, including the costs of an ageing population, represent possibly 27% to 1,000% of GDP in the EURO12-States. This means – for most Member States – that further consolidation is inevitable due to the financing gap growing bigger in the years to come.
Confidence in the common currency and the capability of governments will largely depend upon sound public finances. The measures discussed above are a necessary prerequisite to assessing and achieving this goal.
To return to trust, sustainability should be the major goal of European Member States, now more than ever.
Dr Wolf Klinz has been a member of the European Parliament since 2004. He chaired the European Parliamentary Special Committee on the Financial, Economic and Social Crisis from 2009 to 2011
This article was originally published in Sustainable Public Finances: Global Views. Previous articles include Carlo Cottarelli, IMF director of fiscal affairs, Ian Ball, chief executive officer at IFAC, Ken Beeton, former Treasury director, and Philipp Rother, head of the fiscal policies division at the European Central Bank.