Three Reasons Why Lithuanian Public Sector Adapts to Worsening Economic Conditions with Great Difficulty

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Lithuania’s 2015 budget bill rests on the assumption that the country’s GDP will grow by 3.4 %. Compared to other institutions’ forecasts, the Ministry’s projections of economic growth seem relatively bold. The International Monetary Fund (IMF) predicts that Lithuania’s GDP will grow by 3.3 % in 2015, and the European Commission gives the figure of 3.1 %. Respondents to the Survey of the Lithuanian Economy (LFMI) expect the country’s economy to rise by 2.8 %. 

The use of optimistic projections would pose no problems if budget expenditures were trimmed, automatically, in lockstep with shrinking budget revenue. Sadly, this is not the case.

The Lithuanian public sector finds it difficult to adjust to a deteriorating economic situation for a number of reasons.

Firstly, when politicians curtail spending—namely, public-sector pay, pensions and various social benefits—this invariably dwarfs their popularity among the ranks of public-sector employees and the recipients of social benefits involved.

In 2014, Lithuania paid old-age pensions to 600,000 retirees (from the State Social Insurance Fund (“Sodra”) budget), work incapacity pensions to about 210,000 citizens, and various other social allowances to hundreds of thousands of Lithuanians. At the same time, the country’s public sector was employing 362,000 civil servants, comprising 31.6 % of the total hired labour force in Lithuania. Because cuts in public-sector salaries and entitlements affect more than a half of the country’s electorate, such moves are always highly unpopular, meaning politicians usually attempt to give them a wide berth or at least to postpone them.

Secondly, the Lithuanian Constitutional Court has ruled that salaries and pensions that were reduced during the latest economic crisis must be restored. Consequently, there is always some likelihood that the Court may issue similar unfavourable decisions in the future, too. This uncertainty is diminishing politicians’ abilities to make an adequate response to the economic situation and trim the budget.

The Constitutional Court’s ruling also states that the decreased old-age pensions must be compensated for when the extreme economic conditions are over. But, when such time comes, the national budget may lack a source of funds for this purpose. Thus, a fraction of politicians might be reluctant to enact cuts in the “Sodra” budget entirely because they will be obligated to offset them, one way or another, at some time in the future. As mentioned previously, the probability of similar decisions by the Constitutional Court in the future lessens politicians’ abilities to react flexibly to changes in the economic situation. As the Constitutional Court has ruled, salaries and pensions may be reduced temporarily at times of economic-financial hardship. But the problem is that decision makers do not know in advance whether a specific method of these reductions will not be acknowledged as running counter to the Constitution.

For example, in the year 2009 salaries of civil servants were cut progressively, i.e. the most sizeable reductions of salary rates were applied to the highest-paid servants. At that time it was believed that this was the most appropriate way for cutting down public-sector pay. But in 2013 the Constitutional Court issued a ruling, establishing that the uneven reduction of civil servants’ salaries conflicted with the Constitution. The upshot of this ruling is the following: politicians cannot be certain that the next time they cut the public sector’s wage bill, pensions or other welfare payments, their decision is not ruled, in process of time, to be violating the Constitution, and they are not bound legally to compensate for the anti-constitutional reductions.

Finally, budget expenditure is never prioritized, so there is no way of knowing beforehand which areas of spending are more/less important than others. As a result, when the need for budget cuts arises, it invariably becomes a difficult task to trim spending according to priorities.

As already stated, when revenue collection misses the planned target, spending is not slimmed down, automatically and accordingly. The country’s budget bill does not contain a ‘Plan B’ which would specify smaller budget allocations and be followed when budget revenue sinks. As Lithuania’s experience indicates, trimming the state budget without having spending priorities at hand turns into an unpredictable, chaotic process. This problem could be resolved by means of instituting the principle of conditional budgeting. This means that at the stage of endorsing budgetary programmes, specific levels of priority must be attached to each programme, indicating, say, ‘highly important,’ ‘important,’ ‘less important,’ or numbers from 1 to 3 (or higher). When the state budget fails to collect the planned income, the ‘less important’ programmes should be automatically frozen.

It must be admitted that if the economy contracts, the public sector is much less prepared for cutting spending at present than it was in 2008 and 2009. Like in the year 2009, spending programmes have not been prioritized but, unlike in 2009, the costs of interest on state debt have more than doubled in size. Moreover, the budget is now under pressure to reimburse the earlier cuts in the public-sector pay and old-age pensions. And on top of that, politicians are likely to be less willing to shave off spending, fearing the new cuts might be ruled as being out of tune with the Constitution.