11 Apr 2018 13:56

Spring budget – more campaign kick-off than actual policy

A booming economy and solid central government finances have created room for an expansionary election budget; the “krona-by-krona” principle has been replaced by a splurge mentality. These stimulus measures will arrive rather late in the economic cycle, but given the many urgent needs in Swedish society and the Riksbank’s leading role in coordinating stabilisation policy, an aggressive fiscal policy is reasonable. After eight years of weak minority governments, however, it is becoming increasing vital to adopt fresh approaches in such areas as labour market, immigrant integration, housing and taxation policies. Yet given the prevailing public opinion situation, it is difficult to see how a strong and decisive government can take over after the September 2018 election. The election campaign is likely to be dominated by confrontation and tactical positioning, thus providing little guidance on how to manage Sweden’s structural challenges.

The spring budget as a reluctant campaign kick-off
The Spring Fiscal Policy Bill is the natural starting point for shaping 2019 economic policies, but election years are a bit different − among other things because the Social-Democratic-Green Party (S-MP) government does not know if it will remain in power after the election. The spring budget can be used as one element of the campaign, but meanwhile April is a bit early to play important cards. Party election strategists often want to steer the process and choose later dates for the most crucial campaign announcements. This means that concrete proposals in the Bill will probably be less extensive than normal and mainly occur in areas where the government is trying to deprive the opposition of arguments ahead of the upcoming election debates. The government’s recent announcements that it is abandoning its plans for an emigration (exit) tax on capital income and that it gradually wants to trim corporation tax to 20.6 per cent by 2021 are examples of such a strategy. The Social Democrats (S) thus want to show that they care about entrepreneurship and are prepared to cut strategic taxes. The government has also announced new funding for police, customs and related agencies to show that it takes law and order seriously. Compensation to local governments for extra burdens connected to refugee resettlement is also uncontroversial. The spring budget only mentions concrete, aggressive proposals in classical S areas such as jobs, health and social services in general terms – thereby saving detailed proposals until the campaign to achieve a greater impact.

From krona-by-krona to expansionary election budget
After a chaotic start to its four-year term, when a decision by the right-wing populist Sweden Democrats (SD) to defeat the S-MP budget led to the “December Agreement” (in which the opposition centre-right Alliance parties agreed not to vote down future budgets), the government chose to prioritise fiscal responsibility. Finance Minister Magdalena Andersson embraced the principle of the previous Alliance government and its Finance Minister, Anders Borg, that reforms should be funded by tax hikes or cost-cutting (krona-by-krona). Largely due to the strong economy, her budget outcomes have repeatedly triggered upside surprises, despite heavier spending in the wake of the massive 2015-2016 refugee influx. In the end, the government could not resist the temptation to propose an expansionary election budget for 2018, including broad commitments aimed at reaching as many voters as possible. The Finance Ministry’s calculations show that actual new spending represents a yearly stimulus dose equal to 0.5 per cent of GDP in 2018-2020, following a largely neutral 2015-2017. Like Donald Trump’s tax cuts in the United States, the timing is not so optimal: it would have been better if these stimulus measures had come earlier in the economic cycle, when resource utilisation was not as tight.

Cyclically bloated public sector finances? 
The question of how suitable this fiscal strategy is will likely be a controversial issue during the election campaign. In recent years, the structure of GDP growth has been especially favourable to public sector finances, with relatively heavily-taxed elements of economic demand – such as construction and private consumption − as dominant drivers. In addition, tax revenues have benefited from rapid job growth, and capital tax revenues have been high. The strong economy has also lowered spending in many areas, offsetting high expenditures related to record-sized refugee resettlement and other prioritised programmes. Looking ahead, the economic tailwind will weaken a bit. GDP growth looks set to decelerate, while its mix will be less tax-intensive as home construction falls while exports and industrial production become more important drivers. As labour shortages increase, job growth is also likely to slow. GDP growth will become more productivity-driven, also dampening tax revenues. The budget surplus is also arguably bloated to some extent by the strong economy. Both the government and the Institute of Economic Research (NIER) estimate that the output gap – which is hard to interpret, see below – is now closed and that the economy is even overheating by 1-2 per cent of GDP. The structural surplus is thus lower than the actual surplus. Both we and the government forecast a budget surplus of around 1 per cent of GDP, while the structural surplus is a bit below the current official target of 1 per cent.

Continued manoeuvring room for fiscal policymakers 
Overall, however, most indications are that there is room for a continued rather aggressive fiscal policy during the next couple of years as well. Under a 2016 agreement between the government and the Alliance parties, the official budget surplus target will be lowered in 2019 from 1.0 to 0.33 per cent of GDP, giving the next government more manoeuvring room. Central government finances may also conceivably be so strong that we will soon need to reassess the agreed targets. Aside from the surplus target, the agreement stipulates a general government debt “anchor” equivalent to 35 per cent of GDP. Given the debt ratio’s current 40-year low, meeting the surplus target will soon push general government debt below 35 per cent, unless the government initiates some new kind of reserve fund system. The emerging goal conflict between the budget surplus and government debt targets may be perceived as a luxury problem, but liquidity shortages in the Swedish fixed income market will become increasingly apparent. This will be especially true as long as the Riksbank (central bank) retains large government bond holdings (now above 45 per cent of outstanding debt issues). Purely fiscal justifications for tighter fiscal policy are thus not especially strong.

Unclear resource situation and weaker Phillips curve 
So how weighty are the stabilisation policy arguments for a more cautious fiscal policy? It would have been better if fiscal policy had been more expansionary at an earlier stage, when resource utilisation was not as tight. But on the other hand, it is quite common for a finance minister to face conflicting roles: one as a “national household manager” who must allocate the resources generated by a strong economy, and another as a practitioner of “Keynesian” stabilisation policy who should instead spend money when the economy is weak and requires stimulus. Since Sweden’s prevailing economic policy framework, with its inflation target and floating exchange rates, assigns chief responsibility for stabilisation policy to the Riksbank, the finance minister should mainly focus on meeting budget surplus and government debt targets. If overall economic policies become too loose, it is mainly the Riksbank that must tighten them. If the government and finance minister took over that role, it might be interpreted as a signal that they do not really trust the Riksbank’s judgement. The situation becomes even more pointed when the Riksbank declares that it might conceivably overshoot its inflation target, thus helping squeeze unemployment further.

Nor is it so easy to answer the question of how much slack actually exists in the Swedish economy. In a northern European perspective, Swedish unemployment is high. Over the past 10 years, it has been 1.5-2.0 percentage points above the (unweighted) average of the countries shown in the above chart. This is partly due to large-scale immigration. Another factor is that impressive labour force mobilisation has enabled Sweden’s participation rate to top the international charts. But this does not keep the government’s target of achieving the European Union’s lowest unemployment by 2020 from starting to look increasingly unrealistic. A more relevant policy challenge should be to devise a strategy that would enable Sweden to avoid being a negative outlier in our part of Europe.

The percentage of companies complaining of recruitment difficulties is close to historical peaks. This is quite compatible with the government’s and NIER assessment that some overheating already exists in the Swedish economy. Public sector labour shortages are also record-high. But estimates of the output gap are generally very unclear. The current situation − with large-scale immigration and a weakened relationship between the resource situation and price and wage formation (the Phillips curve) − makes things especially uncertain. In such countries as the US and Germany, unemployment has fallen to levels we have not seen for several decades, without prices and wages soaring at the same time. In the US, this has caused the Federal Reserve to initiate a discussion as to whether equilibrium unemployment may have fallen significantly. A similar reassessment of the size of the output gap in Sweden is thus not unreasonable. In any event, it is too early to reject the possibility of pushing down unemployment as long as wage and price pressures are so low.

Increasingly clear need for structural policy measures
Although one can argue about the details and timing, our overall view is that fiscal policy has been fairly well-balanced in the past decade. The 2006-2014 Alliance government successfully supported the economy during the most acute phase of the financial crisis, without letting public sector deficits grow so large as to generate credibility problems. The current government (2014-2018) has established stable surpluses and pushed down public debt, despite its recent stimulus measures. Both Magdalena Andersson’s claim that she had to take over an “empty treasury” from the Alliance and today’s arguments, mainly by the Moderates (the dominant Alliance party), that the government should build up even bigger buffers seem a bit rhetorically exaggerated. Of course it is good to have a long-term perspective that takes responsibility for the future, but cutting expenditures or raising taxes is hardly the most suitable strategy at present. Many spending commitments are urgently needed relatively soon, among other things to ease tensions connected to the challenges of immigrant integration and eroding social contracts.

The combination of strong central government finances, both in a historical and international perspective, and relatively high unemployment clearly suggests that structural policy measures now need to be given priority. After almost eight years of minority governments, the lack of decisive action in this field is increasingly evident. It has been possible to reach agreements between the blocs in areas like defence and energy policies, but in more ideologically inflamed areas such as labour market, housing and taxation policies there has been an obvious paralysis in decision-making. Today it is not difficult to detect a state of confusion in both the red-green and Alliance blocs. Because of large-scale immigration from outside Europe, many job seekers have a very low level of skills. Traditional Social Democratic labour market policy − with training programmes as the main solution − is hardly sufficient. If the target of achieving the lowest unemployment in the EU is to be taken seriously, broader reforms are likely to be needed, but there is great opposition in large sections of the labour movement against opening the way for low-wage jobs. For their part, the Alliance parties seem unsure how extensive a systemic change they want to advocate in the election campaign. They also face difficult trade-offs regarding how vigorously they should defend some of their earlier privatisation and deregulation measures, for example in social services, since public opinion both in Sweden and elsewhere is sceptical about the chances of resolving built-in goal conflicts via improved oversight alone.

In housing and taxation policies, various often-interrelated issues need to be resolved. One example is the need to reform tenancy rights and thereby enable increased mobility in the housing market, while maintaining an acceptable level of rental unit construction. A 2018 report from the Centre for Business and Policy Studies (SNS), a think tank, notes that the overall level of Swedish taxation on capital is generally very low in an international perspective. The report concludes that in the long term, it will be difficult to diverge so much from the international average without being forced to impose unsustainably high income taxes. Yet reintroducing the real estate tax or curbing deductions on interest payments would be politically hard to stomach. Given the likelihood of falling home prices, the timing is not especially suitable during the next couple of years.

No strong, decisive government in sight 
Given today’s public opinion situation, with both the red-green and Alliance blocs showing stable voter support of around 40 per cent, it is difficult to see how a strong, decisive government can be formed after this autumn’s election. With the Liberals (L), Green Party (MP) and Christian Democrats (KD) all hovering close to the 4 per cent minimum of votes needed to win any seats, their presence or non-presence in the next Parliament may determine which bloc ends up being larger. Historically, however, tactical voting by “Comrade 4 Per Cent” has made it unusual for parties to be pushed out of Parliament: only three times during the post-war period (the Left Party in 1968, the Greens in 1991 and the right-wing populist New Democracy in 1994) have parties had to leave Parliament completely.

The campaign is unlikely to make it much clearer whether structural policy breakthroughs can be achieved after the election. Various surveys show that voters are now according such issues as immigrant integration and law and order higher priority than before. Traditional social welfare issues such as health care and the schools remain high priorities, but together with jobs and the Swedish economy, they have fallen in the rankings since the 2014 election. Economists may argue that structural reforms are required to eventually resolve these issues, but the parties have hardly prepared voters for the necessary systemic changes and are unlikely to do so in the near future. The Social Democrats (S) and Moderates (M) also have an interest in keeping the left-right conflict alive in the campaign, in order to slow the growth of the Sweden Democrats (SD). Heated polemics could make it harder to reach broad post-election agreements. Meanwhile it is not unusual for parties to shift positions rapidly if they are really eager to resolve thorny issues. The 1990 tax reform is one example. In the 1988 election campaign, S ruled out major cuts in marginal taxes, but only a few months later the party accepted a commission report to this effect, which was largely implemented. 

Even match between blocs ahead of 2018 election
An ambition to broaden their voter base will cause the parties in each respective bloc to “glide apart”, making it even harder to forecast future policies. In the Alliance, for example, M will continue to focus on regaining lost voters from SD (in competition with S) by concentrating on “hard issues”. C’s task will instead be to keep those voters who mainly left MP in disappointment over its compromises in government on such issues as refugee policy. In their battle for this voter category, it will be important for both C and L to reject all contacts with SD. This will make the Alliance seem more divided and less suitable to govern: a price the parties are certainly willing to pay. The current governing parties (S and MP) find it even easier to demonstrate internal divisions, since they do not seem so eager to govern as a minority under circumstances similar to those of today.

The issue of who should govern will certainly dominate the campaign, but mainly because the parties will declare what constellations they will not consider. Unless the public opinion situation changes drastically, our main scenario is that some kind of M-led minority government will take over after the election, especially since the alternatives seem even more unlikely. For various reasons, it is difficult to foresee a grand coalition including both M and S. C’s suggestion that S should act as a supporting party for the Alliance is hardly realistic. The first choice of S – an S-led coalition including C and L − is also unlikely. The political risks to the two “middle parties” from splitting the Alliance and paving the way for S to continue dominating the government seem unreasonably large. If the red-green bloc ends up being larger in Parliament than the Alliance, it is also unlikely that the Alliance parties can accept the “December Agreement light” that has prevailed in practice over the past few years, after the formal 2014 agreement broke down. Only if an M-led minority government fails to manage the difficult balancing acts that it will face, especially in relation to SD, do we believe that cross-bloc governing coalitions will be considered. But even if decision-making power in Swedish politics remains weak, it is difficult to see that this would lead to any major financial market turbulence. After all, public sector finances are in very good shape by international standards, and compared to the lengthy government crises that have paralysed political life in many European countries, the problems surrounding the formation of a Swedish government are not especially severe.