![Spending While Liberalizing: Boosting Reforms Through Fiscal Stimulus Spending While Liberalizing: Boosting Reforms Through Fiscal Stimulus](https://strategie-prod-renew.ext.ssl-gouv.fr/sites/strategie.gouv.fr/files/thumbnails/image/167454627_7.jpg)
The energy crisis of the 1970s and the subsequent stagflation and recession that hit Western economies at the end of the decade and in the early 1980s laid the Keynesian view low. Policy makers began to see government spending as ineffective and even counterproductive when it came to boosting flagging output. They maintained the solution lay in just the opposite – unfettered markets. In other words, they advocated limited government, privatization, deregulation of markets, free trade and fiscal austerity.
The government to the rescue
Though it can be argued that many policy makers today are still in thrall to this way of thinking, the financial crisis of 2008-09 and the economic turmoil that has followed in its wake have called this neoliberal paradigm into question.
So while in the face of persistent anaemic growth there is still a consensus on the need for liberalizing labour markets and product markets (i.e. the marketplace for goods and services), many policy makers have come round to the Keynesian idea that fiscal stimulus is also needed during a downturn.
Nevertheless, with government debt-to-GDP ratios at all-time highs across the developed world, it remains an issue fraught with difficulty. And not surprisingly, fiscal austerity continues to be a priority for many governments.
The question then is can fiscal stimulus help offset the short-term costs of reforms to both labour markets and product markets without increasing debt in the medium term.
France Stratégie invited IMF advisor Romain Duval to explore this pressing and topical macroeconomic issue and present a recently published note he authored with a group of colleagues.[1] They start by asking whether such reforms strengthen governments’ fiscal hand and if so to what extent they do so. They also look at whether fiscal incentives can be used to make implementing labour and product market reforms easier.
The debt issue
But the key question the authors grapple with is whether governments can support reforms with fiscal measures while at the same time reduce public debt in the medium term.
The state of the economy weighs heavily on the effects of both reforms and any spending measures. For example, labour tax cuts and labour market spending that are financed by debt are more effective and have a stronger positive impact on public finances through growth when the economy is in a downturn.
Along similar lines, up-front temporary fiscal stimulus can enhance the impact of reforms such as reducing unemployment benefits, leading to increased output and higher tax revenues in the medium term. Moreover, Duval pointed out that fiscal incentives have in several cases facilitated such reforms by lessening transition and social costs.
“Fiscal stimulus improves economic conditions, making companies more likely to hire and less likely to fire when labour reforms are undertaken,” he explained.
As for a government that lacks the fiscal room to manoeuvre, the authors explain that provided a country is committed to comprehensive reforms and sustainable fiscal policies, temporary up-front fiscal support can still mitigate the short-term economic or social costs of reforms and deliver a medium-term fiscal gain.
However, Duval and his colleagues stress that if there is a lack of commitment, “fiscal support is not warranted even when cyclical conditions are weak.” In such a case, product market reforms should be prioritized. If the government undertakes labour market reforms, short-term costs can be minimized. An example they give is a reform lowering employment protection that is implemented over time, reducing short-term costs by immediately boosting hiring. They write, “Fiscal incentives could be considered, but as part of broader growth-friendly fiscal rebalancing. However, offsetting their cost by cutting public investment would be highly counterproductive.”
As Xavier Ragot, president, the French Economic Observatory (OFCE), put it, the underlying message is that when carrying out reforms, “don’t be afraid of issuing short-term debt as it can bolster demand and have a wider economic impact, even positive medium-term fiscal gains.”
Keeping the goal in sight
However, he also pointed out that whether it’s reducing unemployment, increasing productivity or, perhaps most importantly, enhancing well-being, the goals of labour and product markets reforms are paramount and must be taken into account.
Another fundamental question, he highlighted, is what does it mean to have fiscal room to manoeuvre. France, which had a debt-to-GDP ratio of 97.6% at the end of the third quarter in 2016, does have fiscal leeway, he maintained.
For EU countries like France, Spain and Italy, reducing employment – and in particular youth joblessness – justifies using public debt as a fiscal stimulus.
Nevertheless, he stressed that a case by case approach should be taken, determining what the country’s specific goal is at the outset. For example, whether a government wishes to increase labour productivity or whether it aims to increase low-wage employment, which could impact adversely on productivity, conditions the use of fiscal stimulus.
[1] Duval R. et al. (2017), “Labor and Product Market Reforms in Advanced Economies: Fiscal Costs, Gains, and Support”, IMF Discussion Note, International Monetary Fund, Washington, DC.