Trust and Economic Policy

OECD Workshop „Joint Learning for an

OECD Trust Strategy”

Dóra Győrffy

Associate Professor, Péter Pázmány Catholic University, Hungary

Structure of the presentation

Definitions of trust

Trust and the time-horizon of decision-making

Trust and economic policy:

1. Satisfaction with democracy and fiscal

performance

2. Choosing a method of fiscal consolidation

3. Public vs private sector indebtedness

Trust in government vs systemic trust

Definitions Definition of trust:

1. “A psychological state comprising the intention to accept vulnerability based

upon positive expectations of the intentions or behavior of another”

(Rousseau et a 1998).

2. “A trusts B to do X” (Levi 1998).

Trust in government: perception that the government is committed to serve the

public good and is capable to do so (Rosanvallon 2008).

Institutional trust: institutions fulfill a legitimate function and operate in the

interest of the public good.(Offe 1999).

Sources of institutional trust:

Gilley (2009): main determinants of legitimacy /trust/: general governance,

income level, gender equality, welfare level and economic governance

Rothstein and Teorell (2008): theory of impartial institutions to assess quality

of governance. Impartiality: a norm on the output side of the political process,

“when implementing laws and policies government officials shall not take into

consideration anything about the citizen / case that is not beforehand

stipulated in policy or the law.”

Trust and the time-horizon of decision-

making

Perceptions on success in Hungary (2009)

0

10

20

30

40

50

60

70

80

90

In this country it isimpossible to get rich

through honestmeans

Certain rules have tobe broken if

somebody wants toget ahead

Those, who workhard, reach their

goals

In this countryeveryone has anequal chance for

success

Consequences for economic policy

Given their need for gathering votes politicians cannot ignore the

dominant time-horizon in society

In the absence of strong external pressure, the short-term orientation

in society is paralleled by short-term orientation in policy, which have

various forms:

1. Ignoring the breaking of the rules to ensure social peace

2. Increasing expenditure without corresponding revenues

3. Decreasing taxes without matching expenditure cuts

4. Soft financial regulations to increase access to credit

In such an environment reforms are extremely difficult since long-

term promises are not credible and the pain of adjustment is seen

not as a sacrifice for tomorrow but rather as a loss today.

Consequences: growing indebtedness, macroeconomic volatility and

periodic crisis.

Satisfaction with democracy and fiscal

outcomes in the EMU 1998-2007

The success of fiscal consolidation

General finding from the 1990s: the superiority of expenditure-

based consolidations over revenue-based ones (Alesina and

Ardagna 2004, 2010)

Why?

1. Cutting politically sensitive expenditures signals commitment

increases credibility lowers interest rates

2. Lower expenditures expectations about lower future taxes

increases investment

3. Restraints on government wages restraint on private

sector wages

4. Decreases in social spending incentive to search

employment

Hypothesis: expenditure-based adjustments are more likely in

high-trust regimes.

Sources of consolidation in the EU-15

during the Maastricht process

Case studies: Sweden vs Hungary

-12

-10

-8

-6

-4

-2

0

2

4

6

1990 1994 1998 2002 2006 2010

Fis

cal

bal

ance

% o

f G

DP

Sweden

Hungary

Different responses to fiscal imbalances Sweden Hungary

Source of imbalances Credit boom following the

deregulation of financial

markets in the 1980s

Growing debt due to

inheritance and

transformational recession

Method of adjustment Devaluation, banking

resolution, expenditures-

based fiscal consolidation,

structural reforms,

strengthening fiscal

institutions

Procrastination followed by a

surprise package: devaluation

aiming at surprise inflation,

new exchange rate regime,

import surcharge, some cuts

in welfare provisions. Later

privatization, and pension

reform

Outcome Regular surplus, steady

growth

Acceleration of growth,

defeat of government in the

next elections fear of

consolidation for a decade

The role of trust

Method of decision-making: political consensus vs

secret planning and increased polarization

Choice of method: international best practices vs

navigating among political constraints

Sustainability: presence or absence of election

cycles reflecting the planning horizont of policy-

makers

Satisfaction with democracy in the CEE-10

(2002-2007)

Sources of fiscal consolidation

Public and private indebtedness in the CEE-10

(2002-2008)

0

10

20

30

40

50

60

70

80

90

100

Public debt 2002 Public debt 2007 Private credit 2002 Private credit 2008

Public and private debt in the CEE-8 in

2007/2008

Popularity of government vs trust

In a democratic regime where the possibilities for

using force to induce compliance are limited,

governments need the voluntary compliance of the

citizens to be able to govern effectively

Popularity caused by short-term populist measures

should not be confused with trust

Latest trend in Hungary: given the constraints on

both public and private indebtedness redistribution of

existing wealth takes place, which is rather

popular…

Difference between specific and systemic support

(Easton 1965)

The influence of crisis on systemic

legitimacy in Greece and Ireland

Assessment of national

economic situation

Trends in systemic

support

Conclusions

In a low-trust environment the time-horizon of

decision-making shortens given the prevalence of

uncertainty

The manifestation of short-term measures can vary

greatly depending on the constraints presented by

the international financial markets

In a low-trust environment building trust in the

government might come into conflict with economic

rationality

Building systemic trust is unavoidable in order to

lenghten the time-horizon in society, which in turn

allows governments to plan for the long-term

Thank you for your attention!