In economic crises, a small country in the eurozone has hardly any room for maneuver when it comes to taking countermeasures. Economists at the University of Klagenfurt calculated various budgetary strategies with a view to finding the most effective ones.

How politics should react to economic crises is controversial even within the scientific community. Recently a team of economists has been working on this question. Researchers led by Reinhard Neck at the University of Klagenfurt compared eight strategies in order to determine the best budgetary policy measure aimed at cushioning the effects of an economic crisis in a small-sized country in the euro area. The model case for small countries in the euro area was Slovenia – formerly the first communist country to join the European Union (2004) and also the first to adopt the euro. In addition, as a eurozone country, Slovenia has already had experiences with the economic and financial crisis since 2009.

Budgetary policy measures

In the euro zone, monetary policy parameters are determined by the European Central Bank in Frankfurt. Countries cannot change this, explains project leader Neck. Quote: “Subsequently, there can only be budgetary policy adjustments, either via changes on the revenue side or via changes in government spending”. Typically during crises spending is increased and taxes lowered. The increase in government spending automatically creates demand and the population is able to spend more.

Low impact of national measures

The team around Neck calculated eight models to find out which expenditure should be increased and which taxes should be lowered. The most important finding was that national measures had an exceptionally low impact on Slovenia’s economy. Neck attributes the reason for this to the degree of openness inherent in Slovenia’s economy, which is characterized by numerous international links as well as imports and exports. There is also no longer an independent monetary policy. Nevertheless, there are some measures that work better than others.

Increase spending on education and research

Expenditure on research and development is a relatively strong determinant and has virtually no adverse effects. On the contrary, side effects can be positive. “Under certain circumstances, the level of debt can decrease despite increased expenditure,” explains Neck. A similar, albeit somewhat weaker effect can be seen in expenditure on education. When a greater proportion of the population gains access to tertiary education, the effects are also positive.

“It has been known for some time that investments in research and education have positive long-term effects. What is new is that these investments also have the best short-term effect on both productivity and income of all budget policy measures.” Reinhard Neck

Lower wage and income taxes

On the revenue side, there was a positive effect from the lowering of wage and income tax and a reduction in social security contributions. Measures that can be counter-financed by a higher value-added tax. According to the researcher, this increase has virtually no negative effects on employment.

Simulation of economic policy actions

The calculation method used by the team is called SLOPOL10 and was developed with te aim of simulating economic policy measures. Neck has already used this model in previous projects. Subsequent to past maintenance and updates, it was subjected to a total relaunch as part of the current project.

Model for future accession countries

Slovenia is a model for countries that intend to join the eurozone in the foreseeable future, such as Bosnia, Serbia, Montenegro and others.

Slovenia’s participation is also interesting for Austria. Discussion here on this is still at the level of 1936, when it was assumed that the economy could be saved with higher government spending. However, this was the case only to a limited extent, as the researcher notes. Quote: “The smaller an economy is, the fewer possibilities there are for budget policy.”

The project was carried out in cooperation with research groups from Ljubljana. The funding was provided in part by the Slovenian Research Agency (ARRS) and in part by the Austrian Science Fund (FWF).

About Reinhard Neck

Richard Neck has been a university lecturer in economics at the University of Klagenfurt since 1997, where he is a board member of the Institute of Economics. Most recently he was a visiting professor and research fellow at the University of Ljubljana, Stanford University and the University of California in Berkeley. He has published forty books and three hundred articles. His research interests include economic policy, finance, and business ethics.

Publications and articles

Blueschke, K. Weyerstraß, R. Neck, B. Majcen, A. Srakar und M. Verbič: Budget Consolidation in a Small Open Economy: A Case Study for Slovenia, in: Post-Communist Economies 31:3, 2019
Weyerstraß, R. Neck, D. Blüschke, B. Majcen, A. Srakar und M. Verbič: SLOPOL10: A Macroeconometric Model for Slovenia, in: Economic and Business Review 20, 2018 (pdf)
Neck, K. Weyerstraß, D. Blüschke, B. Majcen, A. Srakar, M. Verbič: How to Achieve the Take-off into Sustained Growth? A Case Study for Slovenia, in: International Advances in Economic Research 24, 2018

 

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