The last couple of days has seen a lot of attention being given to the predictions of the Danish public deficit in 2010. The good news is that the deficit turned out to be lower than predicted in relation to the European Commission’s review of the fiscal policies of member countries. But apparently this is bad news for the government which may sound weird at first glance.
There are many issues at stake here. One of them is if the Growth and Stability Pact of the EMU – which the Danish fiscal policy is measured against even if Denmark is not a full member of the EMU – has problematic short and long-term effects on the economy. The US economist Paul Krugman has come out as a strong critic of the EMU and the ECB, favouring a more expansive economic policy which would lead to lower levels of unemployment, even at the cost of higher inflation. So the demands of the European Commission based on the GSP for member states to pass austerity measures may have been premature, or led to what economists call a sub-optimal outcome, even if the German economy has shown stronger growth than anyone had expected.
The second issue is that the Danish economy faces some short-term and some long-term challenges and the long-term challenges are pretty nasty: Denmark will lose income from the North-Sea oil and the demographic outlook is problematic. So, all things being equal, Denmark is looking at long-term deficits on the trade balance and the public budget.
Dealing with long-term problems in politics is difficult for two reasons: First, they are … long-term, and obviously people (i.e. voters) care more about tomorrow than next year. Or, as somebody once said, in the long run we are all dead. Creating the political support for solutions to long-term problems is very hard. Second, it is very difficult to predict the future with any measure of precision. The demography looks bleak? Well, maybe the Danes will suddenly start having babies in high numbers. This was what happened in the 1940s following two decades of low birth-rates.
The short-term challenges are linked to the economic cycles in general and the fall-out from the 2008-2009 fiscal crisis in particular – basically rising unemployment means lower public income and higher public spending. Which is where the GSP kicks in.
Now the question is when and how a government should act against long- and short-term deficits. The government’s range of actions are limited by the demands and expectations of voters, and if they believe that everything is OK in the economy, budget cuts equal political suicide. Obviously, the demands from the EU that Denmark should tighten its fiscal policy was in many ways a god-send to the Danish government: It is always good when you can explain unpopular (but not necessarily wrong) policies by the intervention of external powers. In a way, the EU and the projection of the 2010 public deficit created a long-wanted window of opportunity for the government. If a government can link cuts in the unemployment insurance (which was and is a solution to some of the long-term problems in the economy) to the demands of the European Commission, it are less likely to be blamed by voters at the next election.
But cunning plans may come back at you: If you’ve given the wrong motivation (even if there may be good motives) once, it may be harder to win support for policies that are unpopular in the short run the next time. Like, say, a reform of the Early Retirement Benefit. Which is a nightmare for a government facing an election in a couple of months time.