The Economic Crisis: Facts and implications for public policy Higher Education at a Time of Crisis – Challenges and Opportunities, Copenhagen, June 2009 Sven Blondal Macroeconomic Policy Divison Economics Department OECD

Organisation of presentation The economic crisis: driving forces and key features. The OECD Economic Outlook projections. The implications of the crisis for budget policies in the medium term. Budget policies and public spending in the medium term. 2

The driving force in the downturn Abrupt shift towards risk aversion: –Collapse in asset prices –Increased cost of capital –Credit rationing The consequences: –Financial institutions left with bad loans and assets; lack of confidence in counter parties –Businesses cut capital spending as financial conditions tighten and uncertainty mounts –Households reduce consumption in response to falling wealth 3

The negative feedback loop The weakness of the economy is making it difficult for households and businesses to service and repay their debt … …creating more bad debts for banks and undermining their balance sheet … … which in turn weakens the real economy even further. 4

The crisis: key features The deepest post-war recession in the OECD area. The most synchronised recession on record. Manufacturing has been particularly hard hit. Employment has fallen and unemployment has risen. Inflation is falling but is positive in most countries. 5

The recession: Depth and synchronicity 6

Output declines in the 4 th quarter of 2008 and the 1 st quarter of

Industrial production has plunged Index, January 2000 = 100 8

Unemployment has risen significantly in many countries 9

Inflation is falling 10

The policy responses –Monetary policy has been eased significantly, with interest rates close to zero in many countries and central banks have used other unconventional measures to support demand. –Fiscal stimulus packages have been introduced in most OECD countries to increase aggregate demand. –Financial market policies have aimed at repairing the financial system and increase confidence. 11

Policy rates are very close to zero in most major OECD economies 12

Discretionary fiscal stimulus programmes in most OECD countries ( net effect on fiscal balance, % of 2008 GDP) 13

OECD Economic Outlook 85 projections to end-2010: summary 14

OECD Economic Outlook 85 projections to end-2010: United States Relatively early exit from the recession. The recession bottoms out in 3 rd quarter and a recovery starts in 4 th quarter thanks to massive policy effort. The recovery is weaker than consensus projections for Unemployment rate to reach 10% in end 2009 and stay at that level in Inflation falls to low levels but remains positive. 15 GDP growth (s.a.a.r.)

Very high budget deficits in most OECD countries in 2010 High budget deficits due to: –Fiscal packages introduced to support the economy. –Budgets no longer benefitting from revenues related to booming asset markets. –“Automatic stabilisers”: revenues fall and spending increases when the economy is weak. 16

General government net lending in 2010 (% of GDP) 17

The inevitable consolidation of public finances in the medium term Consolidation will have to take place in the medium term and governments have to prepare credible medium-term consolidation plans now. Absence of credible consolidation plans risks triggering adverse reactions of financial markets, which in turn would risk the economic recovery. 18

Consolidation requirements will differ across OECD countries –Remove stimulus measures only: Most Nordic countries, Korea, Switzerland. –Remove stimulus measures and cumulative tightening of 3 per cent of GDP: Japan, Germany, France, Italy, Canada, etc. –Remove stimulus measures and cumulative tightening of 7 per cent of GDP: United States, United Kingdom, Spain, Ireland. 19

Consolidation requirements (% of general government outlays) 20

Consolidation based on tax increases? Historical experience suggests that tax-based consolidation is rarely successful. Tax increases would undermine economic performance. If unavoidable, tax increases should be concentrated on taxes that have the least harmful effects on economic performance, e.g. increase taxes on fixed property and indirect taxes rather than taxes on labour or corporate profits. 21

Consolidation based on public spending cuts On unchanged policies, public spending is set to increase rather than fall due to the ageing of the population: –Old-age pension spending is set to increase. –Health care spending will increase. Consolidation needs may trigger long overdue reforms in these key areas. 22

Increase in ageing-related public spending 23

Education spending in a time of budget consolidation Education spending will come under close scrutiny in the search for budgetary saving as the size of young cohorts diminishes. Cuts in education output could undermine economic performance in the long term. Scope for efficiency increases in the delivery of education services? 24

Tertiary education in a time of budget consolidation: the scope for efficiency gains and new ways of financing What scope is there for efficiency gains in delivery of higher education? Will consolidation lead to, for example, institutional rationalisation to exploit economies of scale? Restriction on numbers in high cost programmes? Growth in distance education? Higher education graduates appropriate most of the gains of university education: A case for raising tuition fees for university education combined with government- sponsored income-contingent study loans? 25