The public finance situation in Italy and to a lesser extent France has brought the long-simmering issue of the European Union’s fiscal rules, their enforcement, and even their ultimate rationale, back to the front burner of euro-area governance. In all the heated polemic, however, a vital piece of the jigsaw has gone missing. The debate and the tortuous negotiations between the European Commission and the Italian government over the latter’s 2019 budget plans focused solely on numerical targets, and, concretely, on decimal points of the nominal and structural deficit ratios to GDP, on the progress (or lack thereof) toward the Fiscal Compact’s medium-term objective, on whether public debt reduction was set to proceed at the stipulated pace, and on the applicability of complex “flexibility clauses” and other provisions set out in the 220 pages of the Vade Mecum on the Stability and Growth Pact 2018 Edition.
While justified by concerns about the sustainability of public finance, this focus loses sight of a key dimension which is itself essential to that very sustainability: namely, the quality of the measures underlying the public balance outcome. This outcome – whether it is a deficit of 1.6%, 2.0% or 2.4% of GDP (or, remaining within the Italian case, the manifestly absurd two-decimal point precision of 2.04% of GDP) – is a tiny number when compared to its two determinants: total revenues and total expenditures, ranging respectively around 46% and 48% of GDP. It is of course intuitive that what has the greater impact on a country’s macroeconomic performance and the inclusiveness of its growth is the composition of the two larger magnitudes, each approaching some 50% of GDP, rather than the comparatively minuscule difference between the two. Put simply, composition – i.e., the underlying quality of a country’s public finances – matters more for growth than the deficit. What, then, is the “quality” of public finance? And how do we assess it?
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