The Contribution of Public Finances to the European Growth Strategy

Abstract

The objective of the paper is to point out the impact of public finances in the context of the Lisbon growth strategy. Official communications from the Commission and ECOFIN Council note that public finances can contribute to achieving the goal of higher growth and employment via three mechanisms: supporting a stable macro-economic environment, making tax and benefit systems more employment friendly, and redirecting public expenditures towards productive areas. This paper surveys the literature to investigate these channels, to quantify their impact and to identify conditions for their effectiveness. Based on empirical results in the literature, we conclude that there is substantial evidence to suggest that public finances can be considered a source of endogenous growth, but there remains considerable uncertainty regarding the size of their impact. This uncertainty emerges, among other factors, because the effectiveness of fiscal policies hinges on external conditions, such as the state of development. In addition, the link between these policy mechanisms and economic growth seems to have a non-linear functional form in the short and in the long-run.