Fiscal policy for sustainable development: Achieving social and ecological goals

Introduction

The world is facing multiple challenges to sustainable development, exacerbated by deficits in care and ecological sustainability as well as intersecting income, wealth, gender, race, and regional inequalities. These challenges demand urgent action and require a big push in public spending for a universal care system (defined here to include health and social care¹ for the elderly and disabled, education, and childcare) and the green economy (defined to include renewable energy, public transport, insulation, industrial energy efficiency, upgrading of the grid, organic agriculture, reforestation, recycling, and repair) both of which constitute the locomotive of sustainable inclusive development. Public investment in high-quality, universal, free basic services for care (termed social infrastructure) tackles both caregiving deficits and inequalities by creating decent jobs and providing the much-needed services. Public investment in the green economy supports interrelated interventions that address the scale and timing of the investment required for a transition to a zero-carbon economy. The public good character of the green economy and a universal care system invite a large public spending program in these areas.

The brief is based on four technical papers exploring the impact of fiscal policies on growth, productivity, and the employment of men and women in both the short and long run.² The first part of this brief explains the theoretical framework used in these papers. The second part summarizes the empirical evidence from seven low- and middle-income economies, and one high-income economy.

Investments in universal care systems and the green economy are complementary; ecological sustainability and gender equality enhance each other. Investing in sustainable, high-quality, and affordable public transport would improve women’s lives, as women use public transport more and drive less than men.³ Renewable energy investment is key to reducing not only emissions but also the cost of living, and it thereby alleviates the challenges to women as primary carers, who struggle to make difficult decisions between heating and eating. Public investment in green social housing—as opposed to the current financialized housing market dominated by private investment funds that turn houses into speculative assets—improves the livelihoods of carers. Public support for organic agriculture and a plant-based diet supports women who carry the primary responsibility for shopping and cooking in many households.⁴ Similarly, changing how we eat, commute, heat, or live to achieve sustainability is expected to become easier when women who do most of the care work have more voice and income as a result of the new employment opportunities provided by public investments in care.⁵ As a whole, care services are low-carbon, and public investments in care services have a high potential for employment creation, given their labor intensity and low import content.⁶ Finally, creating new well-paid jobs in care sectors could facilitate phasing out fossil fuel sectors by creating new job opportunities not only for women but also for men and providing training (which is part of the education sector) for redeployment in alternative sectors to address skill mismatches.⁷

Achieving these complementary goals requires a paradigm shift toward a needs-based approach to macroeconomic policy and, in particular, fiscal policy. Such a paradigm shift is necessary to address both care and ecological deficits, while tackling inequalities and avoiding competition between social and ecological requirements. A needs-based approach to policy means starting with questions such as how many care workers will help meet the needs arising from changing population trends, and what is a decent rate of pay for their valuable work? Or how much investment in renewable energy, public transport, or housing is needed every year to achieve the transition to a zero-carbon economy by 2050? Then, the approach would consider all the tools in the economic policy tool kit that can be marshalled to finance these needs, rather than planning with a self-imposed artificial budget balance constraint or public debt targets. This requires state capacity and fiscal space for governments, as well as coordination of a range of policies, including not just fiscal but also monetary, industrial, social, and labor market policies.

Empirical findings

We estimate empirical macro-econometric models of the impact of public investment in universal care services and the green economy in both emerging markets (Chile, Colombia, India, Indonesia, Philippines, Turkey, South Africa, South Korea)⁸ and high-income economies (the U.K.).⁹ We find very strong effects on GDP and employment. This is due to high multiplier effects on both private investment and consumption and thereby national aggregate output and income, because economies are not operating at full capacity, and are demand-constrained due to excess capacity and involuntary unemployment. In the case of a stimulus to care provision,¹⁰ not just on the level but also changes in the composition of consumption of care services, more income in the hands of women leads to more household spending on goods and services that improve health, education, and nutrition outcomes in households, as care services tend to hire more women.¹¹

We also tested the impact of public spending on care and green infrastructure on labor productivity in both emerging market and high-income economies and found very strong effects.¹² On the supply side, spending on public care provision affects women’s labor supply. The time period of the effects, however, is different: e.g., childcare is expected to immediately affect women’s labor force participation and, via this channel, labor productivity, while also having a lagged positive effect on the development of human capabilities and productivity in the long run.¹³ Such substantial, albeit lagged, positive externality effects and benefits of public spending indicate that patient capital and long-term thinking should become the dominant approach to financing these investments in policymaking. Patient financing can be mobilized through national investment banks to fund public spending in social infrastructure, and stable tax revenues will ease potential pressure on fiscal balances and public indebtedness, as we discuss further below.

We find that the cumulative GDP multiplier in five years (in response to a one-off increase) in public spending on care services/infrastructure ranges between 1.6 in Turkey and South Africa to 2.8 in India, and 4.5 in South Korea.¹⁴ In response to increasing spending on care by one percentage point of GDP every year, at the end of five years, GDP increases on average across eight emerging economies by 11.0%, and employment increases on average by 6.3% with jobs created for both women and men, albeit at a faster rate for women.¹⁵ In response to increasing spending in the green economy (the sum of effects of stimulus to the sectors providing inputs to renewable energy, energy efficiency, and public transport) by one percentage point of GDP every year, at the end of five years, GDP increases on average by 10.0%, and total employment increases on average by 7.5%. In summary, public spending in care and green economies is a strong tool for both stimulating growth and generating employment.

For the U.K., we summarize below the results of a policy package simulation, using more detailed data and estimation methodology,¹⁶ including:

1. An annual increase in government spending on care services and public physical infrastructure by one percentage point of GDP. Public spending on care includes both hiring more nurses, social care workers, teachers, and increasing the wage rates, while at the same time closing gender wage gaps via upward convergence, in other words, by increasing the wages at the bottom of the pay scale at a higher rate and enforcing equal pay legislation. The policy simulation is based on the effects of an annual 2% increase in women’s hourly wages and 1% increase in men’s hourly wages in real terms.
2. An increase in the average tax rate on wealth by one percentage point (which corresponds to a doubling of the tax rate on wealth in the U.K.),¹⁷ and an increase in the progressivity of income taxation via an increase in the average effective tax rate on profit income by one percentage point and a decrease in the average tax rate on wage income by one percentage point.
3. Labor market policies targeting an increase in the hourly real wage rate of women in the private sector by 2% and that of men by 1%, again closing gender gaps via upward convergence in the rest of the economy.

In the case of the U.K., this policy mix leads in the medium-run to a 10.9% increase in GDP, an increase in the hours of paid employment of women by 9.6%, and that of men by 5.8% and a substantial improvement in public finance with a 10.3-percentage-point decline in public debt as a ratio to GDP.¹⁸

Financing public investment on care and the green economy

Public spending is partly (albeit not fully) self-financing, as it increases national income and, thereby, tax revenues even without an increase in the tax rate, given the high multiplier effects. Our econometric estimations indicate that the negative effect on the primary budget balance to GDP ratio (excluding interest payments, and comparing the growth of public spending and GDP based on multiplier effects) is less than one, based on the cumulative effects of a one percentage point one-off increase in public spending over five years (see Table 1 for the emerging economies).¹⁹ Spending on care has a slightly higher rate of self-financing due to higher multiplier effects, lower import dependency, and/or higher productivity effects. According to our econometric estimates, South Korea, among the eight emerging economies summarized in Table 1, and the U.K., based on our more detailed macroeconomic model,²⁰ have a higher capacity to self-finance public spending. We find that spending for public care services in the U.K. is fully self-financing, e.g., the public debt/GDP ratio does not increase even in the absence of any increases in tax rates, again due to very strong multiplier effects.

Eventually, however, the large-scale need for spending undeniably requires a combination of progressive taxation of both income and wealth. Our results for the U.K. show that an increase in the progressivity of income taxation by increasing the tax rate on profits and decreasing the tax rate on labor income increases output, men’s and women’s employment, and decreases in public debt/GDP.²¹ However, an increase in the tax rate on wealth has a much higher positive impact on output, and, thereby, employment and the budget. This is because it decreases wealth concentration, which in turn reduces the financialization of non-financial companies, market concentration, and barriers to entry, and thereby stimulates private investment. As such, taxation of wealth is a particularly effective policy to ease increasing pressure on fiscal deficit and public debt from care and green economy public spending, while tackling income, gender, and wealth inequalities.²²

Public borrowing to fund some of this spending can also be justified to some extent, given the effects on productivity and sustainability, or to put it negatively, the expected damage to the ecology, society, and economy if investment needs are not delivered on time. On a related matter, from a long-term perspective, it would be beneficial if fiscal sustainability did not narrowly focus on public borrowing or on public gross debt, but at least on net wealth (assets minus liabilities), as investing in both physical and social infrastructure creates assets that contribute to future productivity and sustainability of a society. Also, in the case of public spending on care, considering their long-term effects on productivity, such spending could be considered as public investment in social infrastructure rather than current expenditure, which justifies borrowing to fund spending if necessary. This requires a broadening of fiscal rules from a gendered perspective, acknowledging both demand and supply side effects of public spending on care. The statistical convention of national accounting systems treats public spending for the wages and salaries of care workers in the public care sector, e.g., salaries of teachers, nursery teachers, nurses, doctors, or social care workers, as current spending. Only spending on physical infrastructure, e.g., buildings such as schools or hospitals are considered capital spending, i.e., investment. This convention ignores the investment nature of the so-called “current” spending on care services related to both its public good character and its impact on productivity. Once the latter are acknowledged adequately, hiring more care workers and/or paying them a decent wage are investments in social infrastructure. This broad definition of infrastructure would allow a government to extend its area of maneuver to borrow to some extent for investment while still remaining within the limits of a fiscal credibility rule, if need be. This does not decrease the importance of progressive taxation of income and wealth but increases the options of a government to invest in both social and physical infrastructure.²³

To conclude, to achieve the multiple targets of social and ecological sustainability along with economic and financial sustainability, we need macroeconomic analysis and policies that adequately capture the dynamic effects of public spending on the demand, supply, and distribution sides, and the feedback effects among these three. A needs-based approach to macroeconomic policy reinvents fiscal policy credibility by defining long-term needs of the society and ecology and aims to create the state capacity and fiscal space by coordinating fiscal, monetary, industrial, social, and labor market policies.