Are European nations free-riders when it comes to fiscal policy?

I don't think so.  I think the truth — hard for some people to digest — is simply that these smart Social Democrats, rightly or wrongly, don't much believe in massive fiscal stimulus.  They're used to the idea that their economies have big structural problems that government spending cannot eliminate.

If fiscal policy can work for a large country such as the United States, it should work for the Netherlands (or Portugal) as well, even if it would work with less potency.

The benefits from the first round of spending would be captured almost completely within the Netherlands.  If unemployed resources can be well targeted, and without messing up incentives too badly, (big "ifs" in my view), that provides an almost automatic case for extra Dutch government spending.

It is a good question whether the Dutch already have too much government spending.  I will say yes but I don't much hear this from fiscal policy advocates.  Maybe they think the current Dutch balance is "just right" but again that means at the margin fiscal policy, targeted at unemployed resources, won't wreck the overall balance.

What about the second round of expenditures from the fiscal policy?  Well, if a big chunk of those newly employed workers increase their spending on food, shelter, and local transportation, lots of the second round is captured in the Netherlands as well.  Even buying a T-shirt from China will likely benefit a Dutch retailer to some extent.

You will hear the common tale that "everyone not crazy thinks fiscal policy is a good idea, but some countries are too selfish, or too cowardly, to do it."

That story is an easy out, but the truth is that not everyone is so enamored of massive fiscal policy stimulus.  If they were, they would be doing it.  But they're not.

Hong Kong, by the way, is preparing a relatively aggressive stimulus package.

Here is a relevant blog post on Germany.

Comments

Tyler. I'm sorry but sometimes it appears that you don't *really* know what you're talking about. I live in the Netherlands and let me tell you our government is not refraining from simulating the economy fiscally: our budget deficit will be in the order of magnitude of 5% of GDP in 2009 and 2010. We'll be paying it off until the late 2020's experts say. The point is that our automatic stabilizators (think unemployment benefits) are so potent that we don't need discretionary spending to simulate our economy.

A similar scenario holds for other western european countries. So no, our governments - which are not particularily 'social-democratic' - still believe in fiscal stimulus.

One of the big reasons that a lot of Asian countries are aggressively pursuing fiscal stimulus is that they do not have automatic stabilisers like unemployment insurance or benefits. Coupled with the huge downturn in exports, domestic consumption has to be stimulated or else there will be a huge social backlash leading to political turmoil. Thailand and Malaysia are already seeing quite a bit of this.

JSK, see Paul Krugman's post about how these "automatic stabilizers" don't come close to doing what he and other Keynesians would recommend. A lot of the growing European deficits are stemming from collapses in economic activity, also, not active fiscal stimulus.

Spot on post.

Isn't that also partly because bond investors in other countries think their governments, for lack of a better term, suck?

The funny thing about this, it seems to me, is that the global savings glut that facilitated the boom is financing our bust.

The foreigners and governments that didn't have anything smarter to do with their dollars than invest them here haven't come up with any better ideas.

They're used to the idea that their economies have big structural problems that government spending cannot eliminate.

Are we? News to me.

Look, all the economies and societies in the world are different. What works for one, won't work for others.

I found this article very offensive and inaccurate. Its like saying petrol works really well in a petrol engine, therefore putting petrol in a diesel engine will work too. Last time I tried, a diesel engine doesnt work too well if you try to run it in petrol.

There are several aspects of this that have not been mentioned.
One is the general fiscal agreement within the Eurozone countries
not to run deficits greater than 3% of GDP. That is being breached
now just because of automatic stabilizers in many countries. Given
that especially Germany, but also France, want to keep that pact
in place, partly to be able to enforce it on any would-be joiners
of the Eurozone (and there are now more of those than before), this
means not doing much in the way of further stimulus.

Another aspect is that some of the more ardent Social Democratic
countries, such as Sweden, traditionally followed a policy more
in line with what Keynes actually recommended for the UK. The UK
used to regularly run surpluses, so fiscal stimulus amounted to
lowering that surplus by running public works programs. That is
exactly how Sweden ran its fiscal policy for quite a few decades
after WW II.

Oh, and even though Hong Kong is going to run a stimulus, there
is that minor matter that such stimuli have less impact in smaller,
more open, economies. The US and China are clearly better candidates
for it, even if we are whining about the Europeans not going along.
Maybe if they really were a United States of Europe...

I lived in the Netherlands most of my life until moving to the US, which apparently gives me legitimacy to respond to JSK. I think Cowen is right, assuming as I do that 'fiscal stimulus' is meant to express an *extra* or *supplemental* stimulus over baseline. Consider that currently, at baseline, the percentage of government expenditures in the Netherlands is >50% of GNP, that the marginal income tax rate for an educated worker is >50%, that sales tax(BTW) is 20% for most expenditures, and substantially more for such luxury items as a car, and that someone who is unemployed and has never worked is entitled to social security >850euro (>$1100)/month for the rest of his/her life if he/she never works again. Given this situation of baseline saturation or overstabilization, it is difficult to see what the effect of an extra fiscal stimulus would be. In addition most of the money, except in the case of unemployment benefits as some rightfully commented, if not saved, would flow directly back to the government in the form of income and sales tax.

"If fiscal policy can work for a large country such as the United States, it should work for the Netherlands (or Portugal) as well, even if it would work with less potency."

Really this is the weak and baseless part of your argument. Why argue this? What about the Netherlands is similar to the US? Size? Population? Density? Industrial output? Import to export ratio? Government spending as a percent of GDP? I'm sorry, but very disappointing analysis.

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