How policy-makers should best react to crises is a controversial issue both in public debate and in science. Should fiscal policy measures be taken in times of crisis, as John Maynard Keynes stipulated? And what measures are the right ones? The difficulties were clearly evident in the financial and economic crisis of the last two decades in the European single currency area, where strong economic and financial policy networking among states did not leave many options for countermeasures, especially in smaller countries.
A research group from the Alpen-Adria-Universität in Klagenfurt has now carried out model calculations for Slovenia’s economy in an international project co-financed by the Austrian Science Fund FWF. The team compared different strategies for combating crises, and it turned out that budget policy measures generally have only a small effect. The biggest impact – even in the short term – is generated by investments in research and development as well as in the further training of the country’s population. Under certain circumstances, investments in these areas may even reduce the country’s debt.
What expenditures should be raised, and what taxes should be reduced?
As the principal investigator Reinhard Neck explains, Slovenia is an interesting subject for this kind of investigation for several reasons: “Since Slovenia is in the eurozone, monetary policy variables cannot be changed by national instruments, since they are determined by the European Central Bank in Frankfurt. Consequently, the only possible adjustments involve budgetary policy by making changes on the revenue side or in government expenditure.” Slovenia is thus a model case for small countries in the eurozone. In the event of a crisis, government spending is usually increased and taxes are lowered. “In this way, people can consume more and the increase in government spending automatically generates demand,” says Neck. But what expenditures should be increased and what taxes should be lowered? “We looked at a total of eight areas, five on the expenditure side and three on the revenue side, and explored what could be done if a new crisis were to come,” notes the researcher.
Few budget policy options
According to Neck, the most important insight is that the impact of national instruments on Slovenia’s economy is extraordinarily small: “Budgetary policy has hardly any significant possibilities of steering the Slovenian economy if another crisis comes. This is because the Slovenian economy is very open, characterised by many international relations, imports and exports. In addition, there is no longer any independent monetary policy.”
On the other hand, the team also discovered that there some instruments work better than others. “On the expenditure side, it is investment into research and development that generates relatively strong multipliers and has virtually no negative side effects. On the contrary, the side effects can even be positive: Under certain circumstances, debt levels can drop despite increased spending,” says Neck. A similar, albeit weaker, effect can be achieved by expenditure related to “human capital”. If the state spends money so that a larger percentage of the population receives tertiary education, there are also positive effects.
As Neck explains, this is not basically a new insight: “We have known for a long time that investments in these two areas have a long-term positive effect. What is new is that of all budget policy measures, investments in research and development, as well as in education, also have the best short-term impact on production and income.”
Reduce taxes on income
The team also achieved important findings relating to measures on the revenue side. “It has proven favourable to reduce income tax and social security contributions,” said Neck. All these measures could be financed by an increase in value-added tax. “We have found that this increase has virtually no negative effect on employment,” explains the researcher.
The model used by Neck’s group is a system of 75 equations developed to simulate economic policy actions. The model by the name of “SLOPOL10” is a further development of a system on which the economist and his team have been working for a number of years and which was already used in earlier projects. “We have maintained and updated this model over and over again. In the course of this project, we made a complete relaunch,” explains Reinhard Neck.
Slovenia as a model
Slovenia is an interesting model case for other small states, says Neck. “Slovenia was the first of the former communist countries to join the European Union and also the first to adopt the euro. All this happened before the great economic and financial crisis.” This makes the country a model for countries that want to join the eurozone in the foreseeable future, such as Bosnia, Serbia, Montenegro and others. According to Neck, the case of Slovenia is also interesting for Austria. “In Austria, a considerable part of the debate is still at the level of 1936, turning on the assumption that higher government spending can save the economy,” explains Neck. “The smaller an economy is, the fewer possibilities there are for budget policy.” The international basic-research project was carried out in cooperation with research groups from Ljubljana and co-financing came from the Slovenian research agency ARRS.
Reinhard Neck is an economist at the Alpen-Adria-Universität in Klagenfurt where he heads the Department of Economics. He is interested in budgetary policy in Europe, macroeconomics, economic policy and philosophical questions relating to economics, politics and science.