What should the state do, and what should the market do?

In this time of crisis, the role of the state in the economy is growing – and you can see that in the development of language. New abbreviations and words are introduced. ‘TEK’ is the Allowance for Energy Costs, the Dutch subsidy for energy-intensive, medium-sized and small companies. ‘EKDP’ is German energy cost containment program (company energy cost reduction program). ‘TCF’ stands for it temporary crisis framework (temporary crisis framework), with which the European Commission allows member states to give more state aid to companies than usual.

Governments sometimes come up with visual terms to tell their citizens: we protect you against skyrocketing energy prices. A defensive screen (defense screen) the German government calls the entire package of measures to protect households and companies from poverty and bankruptcies. Tariff shield (tariff shield) is the French variant thereof.

This wave of government support – grants, subsidies, scattered nationalizations – costs money. Germany set aside 264 billion euros (almost 9 percent of its GDP) this year, the Netherlands 45 billion (more than 5 percent of GDP), the United Kingdom almost 100 billion (3.5 percent) and France 71 billion (just under 3 percent). according to the Brussels economist think tank Bruegel. These tens of billions come on top of the massive support that governments provided during the corona crisis, which also spawned its official support acronyms: NOW, TVL, Tozo.

Two major, costly state interventions in the economy in a short period of time – that raises the question of how much flexibility there is left in government budgets. Another question also arises: what should the state actually do in this era of ‘polycrisis’, in which several crises reinforce each other? Every euro with which the government casts safety nets for households or entrepreneurs does not go towards tackling longer-term crises that are difficult to tackle without government funding. Think of the energy transition, think of the shortages in defense.

The longer the energy crisis lasts, the greater the pressure on the government to help all kinds of groups and sectors. The bakery around the corner can no longer afford the sky-high energy prices. Business organizations and politicians are calling for an active ‘industrial policy’ to preserve heavy industry for Europe.

The acute needs of the day do not make the more deeply rooted problems – climate change and Europe’s threatened security – any less urgent or costly. Moreover, a government that looks ahead also takes aging into account. That means rising costs for healthcare and pensions. Weekly magazine The Economist recently mapped out how the costs of CO2reduction, defense and aging will push up government spending considerably. They will increase in Europe in the coming years and by the year 2030 should be 2 to 3 percent higher than now. From a financial point of view, this is “manageable”, but also “painful”, the magazine writes.

Budget space eroded

The accumulation of costly short- and long-term expenditures means that governments must – perhaps more than usual – think about priorities. Not coincidentally, the recent report on government budgets by the International Monetary Fund, the Fiscal Monitor, exactly about this. “Fiscal choices are increasingly difficult to make, especially for highly indebted countries where the response to the Covid-19 pandemic has eroded fiscal space,” the IMF writes. In the eurozone as a whole, public debt increased from 84 percent of GDP in 2019 to 95 percent in 2021, in the G7 countries (US, UK, Germany, France, Italy, Japan, Canada) from 118 to 135 percent.

Every euro with which the government now casts safety nets for households does not go towards tackling long-term crises

Those debts should be seen in relation to another current crisis: peak inflation. Inflation has advantages and disadvantages for public finances. Because the nominal GDP of countries automatically increases due to inflation (everything becomes more expensive, so GDP in euros rises), the national debt as a percentage of GDP decreases. In the IMF forecast, government debt ratios will therefore fall slightly this year and next year. Another advantage for the government is that it receives more VAT due to the increased consumer prices. On the other hand, the government incurs higher costs: personnel and purchasing are becoming more expensive – and interest costs in particular are increasing. The interest that European governments pay on the bond market has risen rapidly because central banks fight inflation with sharp interest rate hikes. The era of ‘free money’, with which governments can easily finance new spending, is well and truly over.

Gambling that ever higher inflation will automatically bring down government debt is therefore “not a realistic strategy”, the IMF warns governments. “Reducing” budget deficits is “necessary”, it believes. Not only to keep debts in check, but also to contain inflation. Because the more budget deficits increase, the more government money ends up in the economy on balance. The government then spends more money than it receives. This only fuels price increases. The central banks – which are now fighting inflation hard – have also been pointing out this link between government spending and inflation.

In addition to these admonitions from the monetary authorities, governments recently received a clear warning from the field. The financial and political turmoil in the United Kingdom showed how investors react when the government completely abandons fiscal discipline. The previous British government was mercilessly punished by bond investors for uncovered tax cuts: interest rates on government debt shot up. It led to the fall of Prime Minister Truss’ government. The UK is now talking about austerity (austerity), rather than support for citizens or investment.

Choices are therefore necessary. And priorities. But which? The debate on this touches on the role that the state should play in the economy. In times of polycrisis, should the state cover all risks of citizens and companies? What should the market do, what should the government do? Short-term interests often collide with long-term interests.

Entrepreneurial risk

Calls from the IMF and central banks to keep the current crisis support ‘focused’ – tailored to those who really need it – appear politically and technically barely feasible. And so many European countries nevertheless received broad energy price ceilings, which also benefit high and middle incomes. It weakens the incentive to save energy – much needed for the climate and against the threat of Putin. For example, the reflex of the government to operate as an outpatient crisis relief worker, just like in the corona crisis, has disruptive effects in the longer term. Especially if price ceilings remain in force for a longer period of time.

Disruptive effects also pose a threat to support for entrepreneurs. The entrepreneurial risk here is transferred to the state. That is understandable, given the serious problems that some entrepreneurs face. Twenty bakery companies in the Netherlands have already closed their doors due to rising energy costs. It is also risky: companies that were already not viable (‘zombie companies’) can be kept alive with taxpayers’ money.

In February this year, Minister Ernst Kuipers (Public Health, D66) wrote in a letter to the House of Representatives that the cabinet wanted to return to a “regular economic dynamic in which corona largely becomes part of the normal entrepreneurial risk”.

A few months later, the government, like other European governments, concluded that the shock of the rapidly rising energy and raw material costs does not constitute a regular business risk. This is how the TEK scheme was created for medium-sized and small companies with energy costs that amount to at least 7 percent of their turnover.

Germany goes even further and reactivated it during the corona crisis Economic Stabilization Fund (Economic Stabilization Fund, WSF). From a pot of 200 billion euros, not only households and small and medium-sized enterprises, but also large companies can receive (millions of) support. This has led to resentment elsewhere in Europe, because not every government can or wants to keep its own companies afloat with so much money. Imbalances within Europe are increasing.

It’s all possible thanks to the partial suspension of EU state aid rules during two successive crises. The last relaxations of these rules, from the corona era, will run until the end of 2023, thus overlapping the new relaxations of state aid rules due to the energy crisis. That second easing was recently extended, from December 2022 to March 2023.

For the time being, we will have to wait for that ‘regular economic dynamic’. Without hard rules for state aid, the boundary between market and state becomes increasingly blurred. And: the existing is saved, with euros that can also be invested in new things.

Without hard rules for state aid, the boundary between market and state becomes increasingly blurred

Not so long ago, during the corona crisis, the debate was about public investments that should make the economy stronger and greener in the future: the European recovery fund, the National Growth Fund in the Netherlands, the France 2030 investment program in France. The billions from these programs are now flowing. But the danger is that new investments will come under pressure with rising interest rates, especially if cutbacks have to be made as abruptly as in the UK. As recently in the financial-political newsletter Eurointelligence was: if cutbacks have to be made, investments are the first to die. Because voters don’t immediately feel the effect of that. In the past, investments in defense equipment often failed. Now that there is war in Europe, this is less obvious, to say the least.

Read also: The scorching summer showed: global warming is paying off

Costly global warming

With the difficult budgetary choices that are now being made, the IMF urges countries to keep an eye on the long term. The fund advocates investments in ‘resilience’: strengthening healthcare systems to better cope with pandemics (that crisis will not just end) and strengthening infrastructure against damage caused by extreme weather as a result of climate change. In other studies, the IMF points to the need for extra public investment in CO reduction2emissions, which should prevent global warming from escalating to such an extent that the social and economic damage (natural disasters, drought, loss of productivity) skyrockets. The business community will have to cough up a lot of money for those climate investments, but everyone is looking to the government for the rapid expansion of hydrogen networks, for example.

For example, several major crises have taken up Father State as guardian angel. Disruptive climate change, an unpredictable virus, geopolitical shocks: they threaten to overburden and overburden the government in the coming years.

What the state should do and what the market should do is a classic question – and it will (have to) be asked often as the era of free money comes to an end. Because protecting everyone against all crises will be difficult. Especially when future generations also ask for protection.

Correction (November 17, 2022): An earlier version stated that the TEK scheme applies to SMEs whose energy costs amount to at least 12.5 percent of turnover. On November 9, this threshold was lowered to 7 percent. This has been corrected above.

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