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The Fiscal Dimension of the
European-Mediterranean Challenge
by Mustapha Nabli
Fiscal adjustment in the Mediterranean countries is one among the many dimensions of the overall adjustment policies that those counties need to pursue if the European-Mediterranean agreements are to succeed. This therefore calls for looking at fiscal adjustment issues from the perspective of the reform process as a whole.
On the fiscal side, the process of trade liberalization will normally have the effect of increasing public expenditures aimed at improving the country’s competitive position, particularly in areas such as subsidies in support of the adjustment costs associated with the private sector’s necessary restructuring as it faces increased competition; training and education to improve the quality of the labor force; and basic infrastructure supporting the private sector itself.
These necessary increased expenditures will usually be accompanied by reduced revenues resulting from a lowering of trade tariffs. This will make it essential for the government to pursue two related objectives: a) restructure its priorities with the objective of reducing overall expenditures; and b) review the role of the public sector in the economy in an effort to limit its activities and expand the privatization of state-owned enterprises. To succeed, this process must also be accompanied by economy-wide reforms aimed at accelerating growth, which will in turn ameliorate the cost of fiscal adjustment through increases in non-tariff revenues.
Beyond the specific costs associated with fiscal adjustment, the Euro-Med agreements will produce adjustment costs affecting the whole economy, as well as overall economic gains stemming from trade liberalization. The adjustment costs to the economy are likely to be substantial, and they represent a very important aspect of the politics of integration. As such, they are an integral part of policymakers’ overall approach to the process, which includes the expectation that the European Union will provide financial support to partially compensate for those costs.
Many studies have been undertaken to help countries in the region estimate the costs of adjustment — which are temporary and span over the ten to twelve year implementation period. These estimates however vary widely. For example, in terms of the extent of labor displacement, estimates range from 2 to 3 percent in Morocco to 9 percent in Tunisia. In addition, they originate from studies that are essentially based on computable general equilibrium models which are static in nature.
An alternative approach in trying to estimate adjustment costs is to examine other countries’ experiences with trade liberalization. The main difficulty with this approach is that there are hardly any examples of trade liberalization in the developing world over the last thirty-five to forty years, which equal the extent and scope of the changes that the Mediterranean countries will face. Bringing the tariff levels from an average of 30 to 40 percent in most countries in the region down to almost zero in a relatively short period of about ten to twelve years — as envisaged in the Euro-Med agreements — has no precedent. And while some developing countries outside the region did well adapting to somewhat similar but not as extensive agreements, the Mediterranean countries face far-reaching agreements entailing very significant adjustment costs.
In the final analysis, adjustment costs will ultimately depend on the economies’ structural factors and on the policies that are undertaken to deal with them. In this connection, three factors play a major role.
Flexibility of the labor market. The more rigid the labor market, the higher the adjustment costs. Inflexible labor markets will prevent a smooth and quick re-allocation of resources.
Size of the public enterprise sector. With a large public enterprise sector, adjustment is likely to be longer and more costly.
Level and quality of labor skills. The higher the skill levels, the easier and less costly the adjustment process.
In sum, the adjustment costs will crucially depend on the overall environment in which firms undertake the adjustment process. The most critical point is that significant structural reforms will have to be carried out in order to minimize the adjustment costs of Euro-Med agreements. Policy reforms are also needed to fully reap the gains that are potentially available.
As in the case of costs, the various available estimates of the size of the economic gains stemming from the Euro-Med agreements are based on static models and, as a result, tend to be relatively modest — such as, typically, a two percentage points increase in the GDP growth rate. Because of their static nature, these calculations typically underestimate significant potential gains from trade liberalization which stem from its dynamic effects, as experienced by many countries in the recent past. For example, in addition to gains from static effects, some countries experience long-term dynamic gains of up to two percentage points in their growth rates.
These gains however do not accrue automatically and independently of the policies in place. In fact, the actual level of gains from trade liberalization — which in some cases have added up to 5 percentage points to the GDP growth rate — is very closely linked to the policies adopted by the country. And the overall success of the adjustment process will depend on the type of reforms that governments will undertake to accompany trade liberalization. Without getting into details, the thrust of these reforms must be directed to promoting a competitive and efficient economy and an increased GDP growth rate. In this connection, the private sector should have minimum constraints affecting the way it adjusts, it produces, its exports and it innovates.
Perhaps the most important priority to ensure the success of the Euro-Med partnership is the promotion of innovation, information exchange and access to knowledge. In the final analysis, these themes should be the main focus around which reforms gravitate.
