Michael de Laine

by Michael de Laine, The Copenhagen Voice, 3 June 2010

The Danish Economic Council sees the current expansive financial policy as supporting Denmark’s economy in 2010, but the prospect is for slow growth in the future. But financial policy must be tightened in 2011 to maintain credibility of the economic policy. Low GDP growth in the future implies tighter control over public spending, while the prospect of permanent improvement in the public debt of DKK 12-13 billion every year from 2011 implies a new plan for the period to 2020.

In its latest report on the Danish economy, the Danish Economic Council (the economic “wise men”) sees the current expansive financial policy as supporting Denmark’s economy in 2010, but the prospect is for slow growth in the future.

“Almost all European countries need to reduce their public deficits to maintain or regain finance policy credibility,” the wise men say. Tightening of both foreign and domestic finance policy will contribute to reducing growth in the coming years. It is expected that monetary policy will be normalised, resulting in higher interest rates.

“Together with a continued need for consolidation in the banking sector and in households, this will also tend towards lower growth,” the wise men add.

Turbulence on the financial markets as a result of too large public deficits in certain countries is a factor that can contribute to hampering a growing boom.

Financial policy was very expansive in 2009 and 2010, and the level this year equals the recommendations of the Danish Economic Council in its 2009 reports, which, however, recommended that a larger part of the expansion should come from public investments rather than public expenditure.

“Our recommendations for broad reforms – including of the early retirement scheme – have not been followed sufficiently,” the wise men say. “At the same time there are signs of some economic growth and rather lower unemployment than expected previously, so a tightening of financial policy in 2011 is now the prime recommendation.”

Control of public spending has been poor in the past decade, the wise men say, and on average the real growth in public consumption was twice as high as expected.

The Danish Economic Council expects considerably lower growth in gross domestic product (GDP) in the period to 2020 than the government used in calculating its convergence programme 2009.

“Reducing the share of GDP of public consumption will therefore be very difficult,” the wise men say. “Reaching the convergence programme target of public consumption of 27% of GDP in 2020 requires zero growth in the real public consumption in the whole period from 2011 to 2020.”

Hans Jørgen Whitta-Jacobsen, who chairs the Danish Economic Council, says the prospect of low GDP growth in the future implies tighter control over public spending. “Even if we use the same assumptions about the development of the real public consumption as the government, we expect considerably higher public deficits,” he says. “We therefore see that the need for cuts is greater than the government sees.”

If the government’s recent restoration plan for the economy is carried out in full, the wise men see Denmark having a finance policy sustainability problem that will entail a need for a permanent improvement in the public debt of DKK 12-13 billion every year from 2011. Even if the deficit is improved by this amount, the deficit will never turn into a surplus, but will exceed the 3% limit stipulated by the EU’s Stability and Growth Pact in the period 2030-2060, the wise men say.

Against the background of its assessments, the Danish Economic Council recommends that a new plan should be prepared for the period to 2020, with the following elements to improve the public deficit:

• A reform of the early retirement system that reduces the maximum period with post-employment wage to three years starting in 2012.

• A labour market reform reducing the length of entitlement to unemployment benefit so much that the structural level of unemployment is reduced by 0.5 percentage point.

• An abolition of the nominal principle of the tax freeze from 2012.

• A tight fiscal policy with a milestone for reducing the public consumption’s share to a maximum of 27% of GDP in 2020.

The wise men warn that, even when all four elements of the plan have been introduced, their calculations nevertheless show that there will be a considerable deficit n the budget for the next 50 years. In the short term the budget is expected to approach balance, but even when the budget is at its lowest structural level it is expected to reach 1-2% of GDP. This underlines the fact that there may be a need for improving the budget even more within 5-10 years, the wise men say.

Commenting on the government’s recent restoration plan for the economy, the Danish Economic Council says the plan in itself is not sufficient to ensure the credibility nor the sustainability of the financial policy. The plan will reduce the sustainability element from 1.4% of GDP to 0.7%. The public deficit will worsen gradually from 2015and will exceed 4% of GDP from the end of the 2020s – and such large deficits are not economically credible.

“There will soon be a need for further reforms that can contribute to a considerable improvement in the public deficit both towards 2020 and, in the longer term, towards 2050,” says Hans Jørgen Whitta-Jacobsen.