Prof. Joseph E. Stiglitz – The Future of Fiscal Policy Post-COVID
Three Key Takeaways:
- Prof. Stiglitz argued that the EU’s fiscal rules are not fit for purpose, as they do not distinguish between consumption and investment, they are pro-cyclical, and have promoted divergence rather than convergence amongst EU Member States.
- In reforming the fiscal rules, Prof. Stiglitz stated that the EU should consider the introduction of a ‘green golden rule’ to exempt investment in the green transition from the debt and deficit calculations that form part of the EU’s current fiscal rules. In addition, he proposed that the EU should consider a greater role for automatic stabilisers which would be triggered in times of economic downturn and would allow the EU to focus on idiosyncratic aspects of economic crises.
- Prof. Stiglitz welcomed the EU’s decision to agree on common debt issuance to fund the response to the pandemic within its NextGenerationEU COVID-19 recovery fund and also praised NextGenerationEU’s technical design. However, he argued that, at approximately €750 billion, the fund was not large enough, and raised concerns regarding the impact of potential conditionality requirements imposed by the European Commission. Further, Prof. Stiglitz criticised the lack of agreement on an EU-wide taxation framework to repay the Union’s borrowings. In addition, the stronger post-pandemic economic recovery in the US can at least partly be explained by higher levels of government spending compared to the EU.
Introduction
On Tuesday, 15 February 2022, Nobel Laureate economist and University Professor at Columbia University, Prof. Joseph E. Stiglitz delivered a major address to the IIEA on the subject of The Future of Fiscal Policy Post-COVID. Prof. Stiglitz’s address coincided with an important debate regarding the future of the EU’s fiscal policy, with divergent perspectives existing amongst Member States regarding the future of the EU’s fiscal framework.[1]
Within his address, Prof. Stiglitz strongly criticised the economic rationale and effectiveness of the EU’s Stability and Growth Pact, provided reflections on the NextGenerationEU COVID-19 recovery fund, and compared the fiscal responses to the pandemic in both the EU and the United States.
‘The Instability and Non-Growth Pact’
Prof. Stiglitz opened his address by outlining what he views as three central flaws that exist within the EU’s Stability and Growth Pact. The Stability and Growth Pact was introduced in 1997 and formalised a framework which requires Member States to pursue budgetary positions which keep governments’ debt-to-GDP ratios below 60% of GDP and annual deficit-to-GDP ratios below 3% of GDP.[2]
Firstly, Prof. Stiglitz identified the failure of the Stability and Growth Pact to distinguish between consumption and investment expenditure as a fundamental flaw of the EU’s fiscal rules. According to Prof. Stiglitz, the rules fail to make the distinction between consumption expenditure in the present and growth-enhancing investment expenditures which improve a country’s economic potential in the future. These investments include government borrowing to address the challenges relating to climate change and environmental degradation. Prof. Stiglitz remarked that the absence of a distinction between consumption and investment expenditure hampered the EU’s economic growth. As such, he argued for the introduction of a ‘green golden rule’ within the EU’s fiscal rules which would deduct investment expenditures in the green transition from the debt and deficit calculations in the Stability and Growth Pact.
Secondly, Prof. Stiglitz described the current fiscal rules as de facto pro-cyclical. During an economic downturn, it is inevitable, according to Prof. Stiglitz, that tax receipts will fall. When countries reach the 3% deficit-to-GDP limit, they are forced to contract spending which further weakens the economy. Prof. Stiglitz noted that this was witnessed clearly during the Eurozone sovereign debt crisis from 2010 to 2012, where the Troika of the European Commission, European Central Bank and the IMF forced countries in economic crisis to reduce spending. In his address to the IIEA, Prof. Stiglitz emphasised that this decision deepened the economic downturn, did not improve countries’ fiscal balances and that it took years for some of the countries to recover.
Finally, Prof. Stiglitz viewed the fiscal rules as resulting in divergence rather than convergence amongst EU Member States. He noted that, in his view, it was recognised that the EU was not an optimal currency area, which is a geographical region where the adoption of a single currency would be of greatest benefit to the region economically. While he argued that it was hoped there would be greater economic convergence amongst Member States after the euro was introduced, the EU fiscal rules had promoted divergence rather than convergence amongst Member States’ economies. Countries which were worst affected by the Eurozone sovereign debt crisis were forced to implement austerity measures and were obliged to reduce growth-enhancing expenditures whereas countries such as Germany, which were least affected, continued to grow. Prof. Stiglitz argued that this divergence in economic growth within the EU made the future of the euro currency less prosperous and less stable.
How to Fix the EU Fiscal Rules
Prof. Stiglitz outlined a number of proposals to make the EU’s fiscal policy more fit for purpose with respect to current economic circumstances.
To address the lack of distinction between consumption and investment expenditure, he argued at the very least for the introduction of a ‘green golden rule’ which would deduct investment expenditures in the green transition from the debt and deficit calculations in the Stability and Growth Pact.
Prof. Stiglitz also referenced a paper[3] published by the Peterson Institute of International Economics (PIIE) that he co-authored with Robert Rubin, former US Secretary of the Treasury in the Clinton Administration and Peter R. Orszag, former Director of the Office of Management and Budget in the Obama Administration. One of the paper’s central recommendations is for governments to make greater use of automatic stabilisers. Countercyclical government programmes, such as automatic unemployment insurance would kick-in during periods of economic downturn to increase the growth rate of the economy in exchange for reducing economic growth during economic booms. Prof. Stiglitz argued that implementing more automatic stabilisers would free up governments to focus on the idiosyncratic aspects of specific economic crises.
For example, in the case of the COVID-19 pandemic, Prof. Stiglitz stated that policymakers should not have spent time debating whether unemployment insurance would be extended. Instead, the presence of unemployment insurance as an automatic stabiliser would have allowed policymakers to focus on the distinctive aspects of the economic crisis that had been induced by the pandemic, such as its impact on the services sector. Prof. Stiglitz viewed this as a far better approach than implementing the rules of the Stability and Growth Pact, which he described as overly rigid.
NextGenerationEU and the Recovery from the Pandemic
Prof. Stiglitz also provided his perspective on the EU’s NextGenerationEU COVID-19 recovery fund and compared the fiscal response to the pandemic in the EU and the United States.
He welcomed the agreement on the NextGenerationEU recovery fund, saying that he believed that common borrowing at an EU level was essential. Prof. Stiglitz also commended the design of the recovery fund, stating that spending during a recovery should serve multiple purposes due to the limited availability of funds. Specifically, he proposed that the EU funding should support the economic recovery and should seek to achieve other objectives such as addressing climate change and reducing inequality. In this respect, Prof. Stiglitz welcomed the fact that NextGenerationEU is intended to help fund the green and digital transitions and argued that perhaps even a greater share of the funding should have been allocated to serve these twin objectives.
Nonetheless, Prof. Stiglitz outlined a number of criticisms of the NextGenerationEU recovery fund. Firstly, he argued that the package was too small, and highlighted that €750 billion was a small fraction of the EU’s GDP.
Secondly, he was concerned that as the fund’s tranches of disbursements are spread out over several years, conditionalities would be imposed by the European Commission which would not allow the funds to serve their intended purposes.
Finally, Prof. Stiglitz argued that there also should have been an agreement with regard to how the commonly borrowed funds would be repaid. He suggested that a central flaw in the design of the Eurozone is that it does not have an adequate framework for taxation and generation of own resources.
Prof. Stiglitz outlined three potential EU-wide taxes that could be implemented by Member States to raise revenues to fund its common borrowings. Firstly, he advocated for the introduction of a European wealth tax. In addition to raising revenue, for Prof. Stiglitz, an EU-wide levy would help to negate concerns regarding capital flight – something which is typically associated with the introduction of domestic wealth taxes.
Furthermore, Prof. Stiglitz advocated for a European corporate tax to be introduced to circumvent what he perceives to be tax arbitrage practices from a number of European countries as well as a European digital tax.
In comparing the responses of the EU and the United States to the pandemic, Prof. Stiglitz highlighted that the slower recovery of the EU compared to the United States can be rationalised by the fact that the combined fiscal response at the national and EU levels in the Union was weaker than that of the United States. However, he qualified this by stating that the EU’s automatic stabilisers and pandemic recovery programmes were better designed than in the US and, as such, EU economies did not require as much discretionary government spending as the United States did.
In response to a question regarding whether the United States had overstimulated its economy and induced higher levels of inflation than the EU as a result of its large fiscal response, Prof. Stiglitz believed that very little of the recent increase in US inflation could be explained by the US’ fiscal stimulus packages. He also identified issues with respect to the measurement of used car prices in the US and the EU as a way to explain the US’ higher rate of measured inflation.
To view the full recording of the IIEA’s event with Prof. Joseph Stiglitz, please click here.
[2] https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:31997Y0802(01)&from=EN
[3] https://www.piie.com/sites/default/files/documents/pb21-2.pdf