The Economic Role of the State Before and After the Current Crisis*

Transcription

1 The Economic Role of the State Before and * by Vito Tanzi** *For presentation at the ECB Public Finance Workshop, Frankfurt, 29 January, **Honorary President of the IIPF. Former Director, Fiscal Affairs Department of the IMF.

2 The economic role of the state is not fixed in time or in place. There is no objectively optimal role. (a) Economists have developed theories about it; (b) The most popular is the theory based on market failure (i.e., the so-called normative theory); (c) There are various kinds of market failure, some natural, some correctable; (d) Market failures relate mainly to allocation of resources.

3 Keynesian economics added to allocation the role of stabilization of the economy. Deficient aggregate demand, due to excessive saving on the part of individuals or due to little investment, was seen as a special kind of market failure that needed to be corrected. This gave the stabilization role.

4 There has been much ambiguity about the government role in income distribution. Is an uneven income distribution (example: a high Gini coefficient) evidence of market failure? Does it require governmental intervention? If yes, how much? To reduce the Gini coefficient? Or to assist the poor? Is income redistribution the same objective as protection against risks that have economic consequences? These risks are old age, illnesses, disabilities, illiteracy, unemployment, etc. They can create economic difficulties.

5 The rigorous application of the normative theory, based only on market failures, would require a low share of public spending into GDP. However, G/GDP increased a lot, in many countries, during the 20 th century-- from very low levels at the beginning of the century. Governments assumed new responsibilities and monopolized some functions that had been private ones. For example, government programs crowded out the actions of civil societies in assisting people in difficulties. The new government role was aided by fiscal illusion: the assumption among citizens of getting free services.

6 New spending by governments aimed at: (a) correcting for genuine market failures (public goods, externalities, etc.); (b) helping to stabilize the economy; (c) improving the income distribution; and (d) protecting citizens against risks with negative economic consequences; The growth of G/GDP over the years moved several countries towards mature welfare states.

7 The new economic role: (a) required high tax levels; (b) extended public assistance from the truly deserving poor toward progressively broader groups of beneficiaries (assisted from the cradle to the grave); (c) lowered the bar to qualify for public assistance for various groups; (d) created property rights against society, while weakening those against personal property; and (e) it generally did little to make the market operate more efficiently.this was not an important objective.

8 Some basic assumptions were behind this expansion of government role: (a) that citizens are myopic; (b) that private markets are inherently inefficient; and (c) that policymakers are not affected by myopia or by government failures.

9 Some important issues: (a) fiscal illusion on the part of many citizens; (b) horizontal inequities in the use of government services; (c) gaming of public programs by some; (d) hazardous welfare-state dynamics a la Lindbeck; (e) reduction of individual freedom because of high taxes; weakening of property rights? (f) reduction of degrees of freedom in policy actions for governments, due to path dependency of policies.

10 Other problems and major issues: (a) the impact of high taxes on incentives and on rates of growth; (b) the efficiency of public sector programs; (c) the impact of public spending on socioeconomic indicators; and (d) citizens myopia compared with policymakers myopia.

11 The Economic Role of the State Before and Is a different role of the state possible? There is clearly a lot of variation among countries in that role. (a) role of social norms; (b) role of civil society; (c) crowding out and crowding in of civil society; (d) impact of large tax reductions on individuals incomes and incentives; (e) greater effort by government to improve the working of private markets, rather than to replace them with government programs, because of market failure ; (f) market enhancing versus market replacing role.

12 The Economic Role of the State Before and What would a government do in the new role? Three major choices: (a) to wash its hands (a la Nozick) and let individuals do whatever they want; a minimalist or service state role, similar to that that existed during the laissez-faire period?; (b) choose a paternalistic, but less expensive, options that would rely more on regulations and less on public spending?; (c ) libertarian paternalism, from behavioral economics?

13 The Economic Role of the State Before and Problems with first alternative (Nozick s). Second alternative. Various examples of regulation -based paternalistic alternatives already exists. In this new role the state: (a) would be much more forceful in its regulatory function; (b) would play a more forceful role in creating a betterworking private sector; (c) would be more focused on the deserving poor and less on universal programs. Libertarian paternalism? Pipe dream? Limits to it.

14 The paternalistic alternative (a) is more difficult politically; (b) is more difficult administratively;but,it (c) requires less public spending and less taxes; (d) is easier to operate in a world with fiscal termites. The role of the state would change but would remain important. It could be made more directly pro-poor. Note that there is no positive relation between levels of public spending and several indicators of welfare.

15 The poor fiscal conditions that existed in many countries (high public debts, high fiscal deficits, high levels of taxation) before the arrival of the current crisis had already made these countries incapable of facing the future implications of demographic changes. The clouds of fiscal crises were already looming. Add to the above the growing threat from fiscal termites.

16 The current crisis has been attributed by many to widespread market failure. They have been calling for less market and more government. To stabilize their economies, several governments are using extraordinary monetary and fiscal tools. Central banks have become off-budget funds. They have provided huge amounts of money to banks and other financial institutions. This is the role they used to play in Latin America a few decades ago. The result was always high inflation. Will it be different this time? Let us hope so.

17 Forecasts of the impact of the crisis on the fiscal accounts, made by the IMF and others, are truly worrisome. Between 2007 and 2010, there will be huge increases in public spending, in fiscal deficits, and in public debts, as percentages of the countries GDPs. The deterioration of the fiscal accounts is especially large in the United States, Japan, the United Kingdom, Spain and some other countries. The forecasts assume an end of the crisis by What if the crisis continues beyond 2010? What if countries go many years without much growth? Will they repeat the Japanese experience of the 1990s?

18 There are also long-run estimates of the fiscal cost of the ageing of the population. For several countries these costs are very large (Spain, Netherlands, United States, United Kingdom, Germany). Under current policies, the costs imposed by demographic developments seemed unsustainable before the crisis, for many of these countries. When added to the fiscal costs of the crisis, they create a nightmare scenario. We risk of going directly from a financial to a fiscal crisis. And fiscal crisis are much more difficult to deal with than financial crises.

19 In view of the above scenario, how can countries have more government and less market? Is it true that it was the market that failed? A strong case can be made that it was the government that failed in not controlling the financial markets and macroeconomic developments. What are the exit strategies for fiscal crises? In the past they have been (a) high inflation, combined with low interest rates on debts with long-term maturity; or (b) high economic growth.

20 High economic growth is not likely to materialize in the next several years because of the major distortions and the low investments due to the crisis. Additionally, the uncertainty created by the fiscal situation and by the high public debts will not help. High inflation remains a possibility but hopefully it will be prevented. This leaves the change in the role of the state as the most rational but a difficult policy. Rather than less market and more state countries shall need less government spending and better regulated markets as an exit strategy.

21 As mentioned, before the current crisis the fiscal accounts of many countries were already significantly out of balance in spite of the high tax burdens. They had significant fiscal deficits and were facing demographic changes with significant fiscal consequences. Some economists had considered those accounts unsustainable. The crisis will make them much more so. Add to that the possibility of growing fiscal termites, due to globalization and ongoing technological developments. Thus more government and less market, if it means more government spending, could take countries quickly over the cliff.

22 The realistic future economic role for the state will have to depend more on the private market for social programs and for protection against economic risks. It will require more public intervention to make markets more efficient. Real markets have been working satisfactorily, by and large. Financial markets have not. Market fundamentalism has proven to be a dangerous illusion. As Adam Smith already knew two centuries ago, markets are not self-correcting. They need government monitoring and supervision.

23 Supervision means intelligent and effective regulation. Innovation is essential for all markets. Without innovation, there would be little growth. Thus regulation should not be oppressive but adequate and effective. Better regulated markets can make possible an economic role of the state that requires less public spending and less taxes. If achievable that would be a genuine change and a sustainable exit strategy. If this strategy is politically not possible, countries will face the real consequences of fiscal hurricanes.