Public expenditure growth is generally broken down into two components: the “trend”, sometimes referred to as “unchanged policy”, and the “measures” that are adopted in relation to it. This breakdown is important because it is used to characterize public finance policy choices. Their underlying principles must therefore be carefully explained, both conceptually and in terms of their empirical evaluation.
1/ Several notions of “unchanged policy” must be distinguished. They do not have the same meaning nor the same usage.
The concept of “unchanged policy” can first refer to the path that tends to keep stable the weight of expenditure in GDP. With this approach the trend growth of public expenditure is therefore equal to potential growth. Using this concept offers many advantages: it is well-established, simple, enshrined in organic law, and internationally recognized. By nature, it ensures a link between the effort made relative to the trend (the measures) and the evolution of the public-expenditure-to-GDP ratio. It is also the only approach where the effort made adequately reflects the actual stance of fiscal policy (expansionary, neutral, or restrictive).
A different notion of “unchanged policy” refers to the path that preserves past policy orientations and may be implemented by extrapolating past trends. This is what is referred to here as the “medium-term trend”. The “medium-term trend” differs from potential growth for two reasons. First, past average expenditure growth may differ from potential growth. Second, this approach may take on board medium-term changes, such as demographic factors, which inflect mere extrapolations of previous trends, either positively or negatively. The medium-term trend is useful when formulating a multiyear strategy, as it highlights the gap between a scenario in which measures and policies in place are maintained and a ‘target’ or programming scenario. The magnitude of this gap indicates the savings to be sought in a review of public spending to be implemented over several years.
Finally, a variation on the previous concept, referred to here as the “short-term path”, takes into account not only medium-term trends but also measures deemed to be already acquired in the context under consideration (“done deals”) and other more technical or “one-off” factors that affect short-term forecasts. In particular, this can be the latest expenditure forecast for the following year (N+1), ahead of the draft budget bill (“PLF”) and the draft social security financing bill (“PLFSS”). This approach is therefore context-specific and the short-term oriented. It gives insight on the quantum of additional measures to include into the budget bills, as well as on their breakdown, in order to achieve the expenditure target for year N+1. Beyond that time frame, the impact of “done deals” and other short-term evolutions fades out and the short-term path eventually coincides with the medium-term trend.
2/ Conceptually, these various notions of “unchanged policy evolution” do not have the same limitations either.
In the traditional approach based on potential growth, the limitation is that the expenditure effort does not correspond to the sum of the measures introduced in budget bills, even though this approach does correspond to a specific meaning of “unchanged policy” (stable public-expenditure-to-GDP ratio in terms of both total expenditure and expenditure per expenditure items).
In the other two approaches (medium-term trend or short-term path), the key limitation is that there is no correspondence between the amount of measures shown and the policy stance effectively pursued. Indeed, in the typical case where the estimated path is dynamic, it is possible that despite the adoption of austerity measures, the expenditure ratio continues to increase structurally.
This limitation applies to overall spending as well as to each category of spending, and points to a risk of misuse. It is incorrect to draw conclusions about the actual direction of policy and its distribution among public policies directly from reading the adjustment measures and their distribution. At most, the measures can be interpreted as an assessment of the change brought to the policy stance. Furthermore, the short-term path already includes additional savings or expenditure measures that have been implemented before the draft budget bills. The consolidation measures shown therefore correspond only to the additional measures presented in the draft budget bill/social security financing bill, or considered to be underlying them. The removal of a previously planned additional expenditure measure appears, for example, as a saving, even if this measure has not yet been implemented.
3/ Empirically speaking, assessing medium-term trend or short-term path requires numerous conventional choices, which are inherently debatable.
Two methods are commonly used to assess medium-term trend, leading to different results depending on how they are implemented: a retrospective method based on past developments, and a prospective method based on expenditure determinants or already established policy objectives. Conventional choices are required: the scope of action for each method, the selected time-periods for computations using the “retrospective method”, or even the assumptions made on the determinants of public expenditure for the “prospective method”.
In the case of the short-term path, other considerations also come into play. In particular, the short-term path may include a large number of short-term factors that are considered to be exogenous in regard to the PLF/PLFSS. These include growth in contributions to the European Union budget or “spontaneous” growth of local government expenditure. Since information and assumptions regarding these factors are bound to change, the short-term path is by nature variable. It fluctuates over time for a given year, or from one year to the next for a given point in time. A “counterfactual” scenario for the PLF/PLFSS is also required, which means that additional assumptions are made. These assumptions are necessarily conventional. The conventions chosen influence the intensity and distribution of the efforts shown.
Finally, interactions between the medium-term short-term paths and the economic scenario should be carefully clarified. On the one hand, the path is conditional on the inflation forecast and evolves with it, in value but also probably in volume, at least in the short term. On the other hand, the use of the path to assess the amount of adjustments required assumes that the economic effects of the adjustments, and thus their impact on public finances, have been anticipated in the economic assumptions underlying the path.
At a minimum, transparent documentation of the various assumptions is required. However, it should be borne in mind that even when well documented, the chosen valuation remains conventional, and the results are quite sensitive to such choices.