Is a need for fiscal stimulus a symptom of a poorly-designed social safety net?

In the debates on the need for a fiscal stimulus, both sides generally agreed that this particular policy instrument is one of the clumsiest available to policy makers. The dangers are well-known and well-documented: getting the timing wrong, getting the targets wrong, political interference, the risk of seeing a temporary spending program turn into a permanent one, et cetera. Those who advocated stimulus accepted all this, but argued than once monetary policy hit the zero interest rate bound (ZIRB), it was the only counter-cyclical measure available to us.

(I'm going to interpret "us" fairly broadly here. Ex post, it's not clear that Canada really needed much in the way of fiscal stimulus; monetary policy seems to be working. Ex ante, we didn't have the luxury of a lengthy discussion on this topic; the ZIRB was coming up fast, and we needed to think about what would happen if we hit it. In the US, of course, things have turned out much less well.)

But here's a question: Why was a discretionary fiscal policy necessary? Why weren't the automatic stabilisers enough?

This question is promoted by the following passage:

The Nordics in the global crisis: [T]he Nordic model itself contributes to resilience. The comprehensive safety net, one of the attributes of the Nordic model, has proved to be robust also in times of crisis. The entitlements are not tied to the fate of individual companies or particular markets, and risks are widely shared in the society. While forest plants are shutting down in Finland and car manufacturing is sharply contracting in Sweden, the governments are firmly rejecting requests for support of ailing industries. Still, there are no crowds protesting in the streets, largely because flexible work arrangements, based both on general and company-specific agreements between businesses and labour, alleviate a rise in unemployment. Structural change is enhanced by the employment protection legislation, which is more liberal than in most other EU countries. A well-educated labour force, another of the attributes of the Nordic model, facilitates adjustment by making it easier to upgrade skills through additional training.

Why doesn't our fiscal stimulus look like this? Wouldn't these sorts of programs be a better use of public money than setting up photo opportunities with oversized cheques?

Comments

[David]

Yeah, of course these sorts of programs would be a better use of public money. But imagine if Stephen Harper had said, "We're going to do nothing about the financial crisis. EI and welfare are enough to fill in the gaps." Joe the Plumber wouldn't be too happy.

Good policy isn't always good politics.

[JenCT]

David,

Why can't Steven Harper tell "Joe the Plumber" to suck it up, and get a better marketing campaign? Are we so closely allied with the American psyche that this wouldn't be possible?

I think we have much to learn here.

[tyronen]

The political right and its supporters in the media have long since brought the public over to their side. Canada has spent the past quarter century cutting welfare and EI benefits, not enhancing them.

Canada would be a much better place if it had a Nordic-style welfare state. But the only international comparison Canadians seem to take seriously is the United States.

[Frances Woolley]

The employment insurance program is, I think, required to balance its budget over a fairly short time period. Which means premiums were cut substantially during the long boom. In many ways a good thing, because employment insurance premiums hit low income people relatively hard. Even with the premium cuts, there was still a surplus, so employment insurance was used to deliver parental leaves and other good things the public wants.

But what all this means is that there's no serious money around in the employment insurance fund to do the kind of automatic stabilization that Steve is talking about.

Why do we have legislation that requires the EI fund to balance? Because - rightly or wrongly - we don't trust politicians to decide when running a deficit in the fund is justified.

Anyone have any suggestions for correcting this 'political failure' so that we can trust our politicians to do the right thing?

[Christopher Hylarides]

Tyronen,
Nordic-style means cutting corporate taxes to the bone, having high income & (what the left considers regressive) consumption taxes, and opening up to free trade. The economic left in Canada hasn't "modernized" to these ideas, yet. Part of the problem may be that they have little practical experience in power. The provinces where the NDP has had long-term success(Saskatewan and Manitoba), they've acted in this direction.

However, even if we were to do such a thing, we don't have the cultural and linguistic barriers that tend to keep people in one country the way Europe does. It's not a shock for a rich Canadian to leave for the United States or to a lesser extent the UK, Australia, or even New Zealand. The nordic countries are also small and relatively homogeneous in their populations and cultural traditions. Canada is big and our people are spread out. Alberta won't put up with more redistribution and Ontario, which is where traditionally where it came from, is in no position to provide it.

The Nordic countries also have large problems with structural unemployment (the graph started to go down when they started cutting what were even more generous programs). There's little incentive to find work when your benefits are just as good as any job you'd have is.

To add what I think is the answer to Gordon's questions: Why was a discretionary fiscal policy necessary? Why weren't the automatic stabilizers enough?
Politics. Automatic monetary stabilizers don't make it look like the government is in direct control over the economy, which is a myth that exists in the average voters head and politicians have to campaign on it. However, as people here have probably figured out, I'm skeptical of aggregate demand theories. I think recovery will come when consumer debt is lessened and/or inventories and excess capacities are cleared out.

[Christopher Hylarides]

Frances, EI is a percentage of your income capped at a certain amount a year, it's effect on lower incomes is minimized that way. Low income people also benefit disproportionately, as it's very hard for self-employed and many types of professionals to get benefits, even though they pay in.

During the 1990s, the government used surplus EI funds in general revenue so there's no law in practice that says it has to be balanced. The recent ruling against this was that this was done without a proper act of parliament, not the act of doing it itself. Also, EI payouts have been used as a form of regional redistribution, as access to it becomes easier and longer in areas of high unemployment (particularly eastern Canada). Unfortunately this has led to encouraging seasonal work, but alas it's the way it is.

EI, if you recall, was also a very messy, very unbalanced affair when politicians ran it more directly.

[Andrew F]

As automatic stabilizers go, negative income tax would probably work better. Less distorted incentives than with EI, and a negative income tax would allow us to replace EI with genuine income insurance. The main issue would be how quickly it kicks in. I suppose individuals, in the event of losing their job, could inform the government of their loss of income, and could begin receiving negative income tax, possibly through their former employer. This would help with cashflow, even though the result would likely be that the individual would have a tax liability at the end of the year.

I can see how Alberta might take issue with this. But if it allows us to eliminate some of the quasi-equalization payments like EI and perhaps even scale back some of the formal equalization payments, it could be sold. The problem for Alberta (and they hate hearing this) is that they have gobs of money just waiting to be shovelled out of the ground. Any reasonable welfare policy is likely to result in some transfer of wealth in that circumstance.

[Ralph Musgrave]

Is a need for fiscal stimulus a symptom of a poorly-designed social safety net?

Answer: the larger the brute size of the automatic stabilisers, the less the need for fiscal stimuli. But that does not make brute size a merit. A small well designed social safety net (i.e. stabilisers) which needed a helping hand from fiscal stimuli might be better.

[Mike Moffatt]

"but argued than once monetary policy hit the zero interest rate bound (ZIRB), it was the only counter-cyclical measure available to us."

It's a bit of an aside, but does anyone anywhere seriously buy this argument? Particularly in the Canadian context? For instance, why can't the BoC simply start buying greenbacks thereby both increasing the money supply *and* driving down the loonie?

[bob]

good post.

The authors of the original article also have an entire book-length report available that goes into detail:

Nordics in Global Crisis – Vulnerability and Resilience
http://www.etla.fi/files/2427_nordics_in_global_crisis_(kannet).pdf

I haven't read the whole thing, but so far it is very good.

[David]

JenCT: My hunch is that if Harper tried to sell a no-stimulus-is-needed approach to the public (even with a good marketing campaign), people would freak out and there'd be a high political price to pay. It would have looked like a leader did nothing — was paralyzed — in the face of a crisis.

But that's just my hunch, so maybe I'm wrong.

[Doc Merlin]

I don't really believe that fiscal stimulus actually works. I've read papers that argue that increasing G decreases I+C, this suggests to me that increasing G is just gaming GDP but doesn't actually help.

[westslope]

Excellent post. There are also some excellent contributions, particularly those by Christopher Hylarides.

Would quibble with the ZIRB issue as posing a "problem"; it does not in the light of the potential for balance sheet adjustments.

[Justin Donelle]

Christopher couldn't have said it better!

Mike, a high Canadian dollar isn't a bad thing, it encourages higher productivity and efficiency, and it helps with trade. The US prints enough money; do we really want to follow them down the drain sooner?

David, recent surveys actually have been showing that Canadians favour by priority: 1. cutting government spending 2. Cutting taxes 3. Reducing the deficit. There are also some surveys, one from Nanos, which showed that many Canadians aren't too key on public-run pensions and the 'Cadillac' pensions plan of public employees, many believed that we needed to cut public servants pensions down to more reasonable levels. I think Harper could have followed with a plan of doing nothing, however, he would have sent Canadians to an election, and he’ll probably sell it as running a small deficit to stop the coalition of big spending Liberals and New Democrats. They will be adding up all of the Liberal and NDP promises, those constant McGuinty calls of "We would have quadrupled the investment in green technologies" and other statements will cost the Liberals. I do find it sad that Harper didn't follow through with doing nothing.