Fiscal austerity: sectors in the line of fire

Véronique Riches-Flores

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THAT WILL BE FOLLOWED BY MAJOR CHANGES IN THOSE COUNTRIES’ FISCAL POLICIES Already in 2006.we have no chance to see our future income improving substantially in the long run . S&P was arguing that ageing populations would cause most OECD countries to lose their investment grade status by 2040 Abstract from our report “After the central banks who will buy our government bonds?” June 09 S&P 2006 long-term baseline scenario – sovereign debt ratings Australia Canada AAA AAA AAA AAA France AAA A Non-IG Non-IG Germany AAA AAA A Non-IG Italy AA A Non-IG Non-IG Japan AA Non-IG Non-IG Non-IG S.e.with weak potential GDP. WHY? » OUR ECONOMIES ARE MATURE .WE ARE ALL GREEKS! NO ONE CAN CLAIM TO BE IMMUNE FROM A GREEK-STYLE SPIRAL. especially post the financial crisis » WE ARE AGEING . FAILURE OF AN OECD STATE – IS AN ELECTROSHOCK FOR THE COMMUNITY OF INDUSTRIALISED NATIONS. SG Cross Asset Research 25/10/2011 2 . Korea A A Non-IG Non-IG Spain AAA AAA BBB Non-IG Sweden AAA AAA A Non-IG UK AAA AAA A Non-IG USA AAA BBB Non-IG Non-IG 2005 2020 2030 2040 AAA AA BBB Non-IG Source: S&P 2006. our savings capacities are shrinking and our health and pensions spending is increasing THE REAL-LIFE STRESS TEST OF GREECE – i.

00 20.00 30.THE LONG ROAD TOWARDS FISCAL CONSOLIDATION THE BILL IS HUGE. IT WOULD STILL REQUIRE THREE YEARS TO STABILISE THE DEBT RATIO » THE FISCAL CONSOLIDATION REQUIRED – RETURNING TO 60% OF GDP WOULD TAKE A MINIMUM OF 10 YEARS ACCORDING TO THE OECD.00 Consolidation required to stabilize debt at 2010 levels Consolidation needed to bring government debt to 60% of GDP by 2026 Source : OECD.00 15.00 25. 20 YEARS ACCORDING TO THE IMF… Effort required on primary balance to stabilise or return to debt level of 60% of GDP by 2026. THE LEVEL OF PUBLIC DEBT IS UNSUSTAINABLE » AT 100% OF OECD’S GDP. according to the OECD. EVEN IF THE PRIMARY DEFICIT DISAPPEARED AS OF TODAY.00 10. % of potential GDP 35.00 0. SG Cross Asset Research 25/10/2011 3 . BUT THAT IS NOT THE ISSUE. AND THERE IS A SIGNIFICANT RISK THAT EFFORTS WILL ULTIMATELY BE ABSORBED BY LASTING WEAK ECONOMIC AND INFLATION GROWTH.00 5.

Over these 107 periods .5 percentage points. Authors identified 107 episodes of fiscal adjustmen ts between 1970 and 2007 (91 episodes of stimuli ). SG Cro ss Asset Research Alesina and Ardagna define fiscal adjustment episodes as the years during which the cyclically adjusted primary balance (public balance exc. 35% Expansionary episodes Contractionary episodes Exp. 25/10/2011 4 .5 % of GDP. 4 lasted three years but one only lasted over four consecutive years (Denmark from 1983 to 1986). An episode of fiscal adjustment is qu alified as “expansionary” if the average growth rate of GDP gap with the G7 in the first year of adjustment and the two following years significantly exceeds the same variable in all episodes of fiscal adjustment. 135% Revenue 66% Exp. 2009. SUCH AN ADJUSTMENT WOULD BE MADE BY EFFORTS TO REDUCE SPENDING » OF THE 107 EPISODES OF FISCAL ADJUSTMENTS OBSERVED IN THE PAST 40 YEARS THE MOST EFFICIENT IN TERMS OF FISCAL RESULTS AND LEAST COSTLY IN TERMS OF GROWTH HAVE BEEN THE ONES BASED ON SPENDING DRAG RATHER THAN TAX INCREASES Typolog y and efficiency of fiscal consol idation episodes between 1970 and 2007 in OECD countries Repartition of the 107 episodes of fiscal adjustment by d uration Contribution of expenditure and revenue items to fiscal adjustment and impact on growth 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 3 4 Duration (years) Contribution of expenditure and revenue items to fiscal adjustment and impact on primary deficit 160 140 120 100 80 60 40 20 0 -20 -40 -60 70 60 50 40 30 20 10 0 Number of episodes by duration Revenue 14 Revenue 65% Exp. 34% Revenue -35% Successes Failures 1 2 Source: Alesina et Ardagna.WHAT’S NEXT? “IDEALLY”. interests) improves by at least 1. They are qualified as “successful” when th e cumulative reduction of the debt to GDP ratio three years after the beginning of the fiscal adjustment is greater than 4. 65 lasted only one year. 86% Exp. 13 lasted two years.

SG Cross Asset Research 25/10/2011 5 . none of them dealt with as many economies as are involved today The success of a fiscal adjustment is much more uncertain over the long haul (when it repeatedly affects a growing number of economic agents and causes a reassessment of the role of public authorities) Austerity measures may find differing levels of acceptance among population Their impact on the behaviour of agents is largely unpredictable and may notably cancel out much of the effects initially targeted (see Greece) SPENDING CUTS THAT HAVE LARGELY CHARACTERISED BUDGETARY POLICY IN 2010 WILL BE DIFFICULT TO CONTINUE IN THE LONG TERM Expenditure versus revenue-based measures in fiscal consolidation plans of 2010 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Expenditure Revenue Source : OECD. HOWEVER Fiscal austerity efforts are more accessible when they are carried out in isolation (their depressive effects can be offset by growth in the rest of the world) 60% of the past episodes of adjustment lasted less than one year.THE CURRENT SITUATION IS FAR MORE COMPLEX.

096*u-0.657+0.53*g R2=0. exp/GDP ratio .OECD d=1.789 Actual d= one year change in public spending/GDP ratio -1 -2 2 0 -2 Residuals u= one year change in the unemployment rate g= one year change in reral GDP growth 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 6 7 8 9 10 Source : SG Cross Asset Research 25/10/2011 6 .GROWTH CONSTRAINTS THE CURRENT CONTEXT OF SLOW GROWTH AND A STUBBORNLY HIGH UNEMPLOYMENT RATE CONSIDERABLY REDUCES THE PROBABILITY OF A SUBSTANTIAL CUT IN PUBLIC SPENDING 80% OF THE CHANGE IN THE RATIO OF PUBLIC SPENDING/GDP HAS RESULTED FROM THE COMBINATION OF GDP GROWTH AND UNEMPLOYMENT RATE OVER THE LAST 40 YEARS! 4 3 2 1 0 Fitted Implicit imp of pact SG economi c forecasts Change in pub.

Those that offer the least protection may be faced with the need to increase their social action.BEWARE THE SOCIAL/POLITICAL CONSTRAINTS… THE SOCIAL COST OF THE ONGOING CRISIS WILL LIMIT THE SCOPE OF PUBLIC SPENDING CUTS Average replacement rate of revenue during initial phase of unemployment based on six family types – level 1 of earnings (from 67% to 150% of national average wages) Countries with the highest protection level will have very limited room for manoeuvre to reduce their spending. 90 80 70 OECD average 60 50 40 AUS NZL KOR GBR TUR USA POL IRL JPN EST SWE GRC AUT FIN HUN ITA BEL ESP CAN SVK NOR CZE DNK DEU NLD SVN FRA ICE CHE PRT LUX 20 Gap to average 10 0 -10 -20 AUS NZL KOR GBR TUR USA POL IRL JPN EST SWE GRC AUT FIN HUN ITA BEL ESP CAN SVK NOR CZE DNK DEU NLD SVN FRA ICE CHE PRT LUX Source: From OECD. SG Cross Asset Research 25/10/2011 7 . Tax-Benefit Models.

0 25.0 30. public sector investment is likely to bear the brunt of the spending cuts Easier to cut or postpone than other forms of expenditures.PUBLIC INVESTMENT IN THE FIRING LINE Eventually.0 15.0 35.0 20.0 5. SG Cross Asset Research 25/10/2011 8 . 2009 45. in the end.0 As a % of total investment As a % of total public expenditure Source: OECD. less political/social conflict A substantial part of public spending (10% of OCDE public spending) Sometimes poor economic efficiency BUT A LONG-TERM ECONOMIC COST Public investment account for 1/5th of total investment in OECD countries Lasting underinvestment in the public sector has always come at a cost in terms of infrastructure efficiency and.0 40.0 10.0 0. productivity (see UK or German experiences) Weight of public investment among OECD members.

80000 1981 France 70000 60000 50000 40000 Income level. nat. cur. SG Cross Asset Research 80000 Marginal tax rate. 1981 at 2010 prices 2010 USA 30000 20000 10000 0 400000 350000 300000 250000 200000 1981 1981 at 2010 prices 2010 0 10 20 Greece 30 40 50 60 Marginal tax rate. % Income level. nat. 150000 100000 100000 120000 1981 1981 at 2010 prices 2010 50000 0 0 20 40 60 80 60000 40000 20000 0 0 Source: OECD. nat. cur.HIGHER TAX AND MORE PROGRESSIVITY AHEAD Income level. cur. % 25/10/2011 9 . % 10 20 30 40 50 60 70 Marginal tax rate.

$PPP 20000 25000 30000 35000 40000 45000 50000 25000 0 15000 Public expenditure/cap.) GDP/cap.-) 25000 Public revenues/cap. 2009.. 2011. 20000 FIN FRA ITA OECD GBR GRC 10000 POL 5000 PRT KOR JAP ESP DNK SWE OE BEL DEU CAN IRE AUS NDL CHE USA 15000 The preservation of nationally preferred models may be hit by the fiscal consolidation Tax revenues/capita relative to GDP/capita for main OECD countries and probable trend (..SG Cross Asset Research GDP/cap. PPP 20000 25000 30000 35000 40000 45000 50000 25/10/2011 10 . DIFFERENT OUTCOME Public spending per capita relative to GDP per capita for the main OECD countries and probable trend (.....SAME PROBLEMS. 20000 SWE DNK OE NDL BEL IRE FRA GBR CAN ITA GER OECD AUS SP FIN JAP PRT POL 5000 KOR 15000 GRC 10000 USA CHE 0 15000 Source: OECD “Governments at a glance”. 2009. $.

0 -37. % change from 2009 30.0 -10.300.0 -20.0 Source: OECD. within OECD average.0 30. 20.INCREASING INCOME TAX OR REDUCING EXPENDITURE? 40.0 12. % change from 2009 25. the US would actually have to increase government revenues by 33% (or $4.) France would have to decrease both its revenues and expenditure by PPP $ 2.0 -10.5 -50.) and to p increase public expenditure by 10% (or $1.0 Restriction 20. SG Cross Asset Research 25/10/2011 11 .0 Restriction needed to bring gvt expenditure/cap.700/cap.5 -25. % change from 2009 Restriction To bring its fiscal situation in line with the OECD average.100/cap.0 -30.280/cap.0 Restriction Overall restriction per capita. within OECD average.5 0.0 10.0 Restriction needed to bring gvt revenue/cap.0 0.0 -20.0 10.2.0 0.0 -12.0 -30.

CORPORATE TAXATION: POTENTIALLY VERY DIFFERENT SITUATIONS IN THE US AND EUROPE Corporate income tax rate. % 60 THE US IS POTENTIALLY MORE EXPOSED TO AN INCREASE IN SOCIAL CONTRIBUTIONS THAN EUROPE (potentially negative for US labour-intensive industries) BUT IT IS IN EUROPE THAT THE RISK OF HIGHER INCOME TAX SEEMS THE MOST ELEVATED (the US corporate income tax is among the highest in the OECD) Adjusted top statutary tax rate on corporate income 55 50 45 JAP 40 USA 35 FRA ITA 30 DEU ESP 25 GBR 20 1995 1997 1999 2001 2003 2005 2007 2009 2011 Source: EUROSTAT. SG Cross Asset Research 25/10/2011 12 .

CROWDING-OUT EFFECTS DRAIN ON REVENUES/weaker economic growth Higher risk premium UNSTABLE TAX AND REGULATORY ENVIRONMENT /negative for investment Structural decline in P/E CONSUMER TAXATION Negative on consumption outlook CORPORATE TAXATION Negative on investment and corporate performance WHICH ARE THE MOST EXPOSED SECTORS? 25/10/2011 13 .

0 -2.0 0.0 3.0 -2.0 5.0 -3.0 0.0 1.MULTI-CRITERIA* EXPOSURE OF THE VARIOUS EUROPEAN SECTORS TO AN INCREASE IN TAXATION Tobacco Utilities Overall exposure Most profitable sectors are highly exposed Telecommunication Services Semiconductors & Semiconductor Equipment Pharmaceuticals Beverages Real Estate Media Low taxed Cies are highly exposed Oil & gaz extraction Food Products Metals & Mining Textiles.retail Hotels Restaurants & Leisure IT Services Commercial Services & Supplies Labour intensive Cies may be relatively protected Source: SG Cross Asset Research.0 -4.0 25/10/2011 14 .0 4. Apparel & Luxury Goods Energy Equipment & Services Chemicals Electrical Equipment Construction Materials Labour intensity EBIT margins Payout ratio Effective tax rate Aerospace & Defence Machinery Software Automobiles & Components Specialty Retail . *All indicators are normalised and rebased to zero.0 2.0 -1.0 6. -4.0 2.0 4.

THE EUROPEAN FISCAL HIT LIST Exposure of the various sectors to tougher fiscal conditions for companies in Europe The most exposed sectors Tobacco Utilities Telecoms Semiconductors S i d t Pharmaceuticals Real estate Media Beverages Oil & Gas Neutral sectors Agrifood Metals & Mining Textiles. apparel & Luxury goods Energy equipment & S i E i t Services Chemicals Electrical equipment Construction & Materials The most protected sectors Commercial services Hotels. restaurants & leisure Specialised distribution Automobile & E i A t bil Equipment makers t k Software & IT services Machinery Aerospace & Defence Source: SG Cross Asset Research 25/10/2011 15 .

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