* Someone who chooses to receive the benefits of a “public good” or a positive “externality” without contributing to paying the costs of producing those benefits.

The world is facing the most severe financial and economic crisis in the post-war decades. International organisations, like the OECD and IMF, in their latest projections, anticipate that the contraction in economic activity will worsen during 2009 before a sort of a weak recovery takes place through 2010. There are two important factors that distinguish this crisis from previous ones:
a. The crisis is not only deep but also globally synchronised. The emerging economies, notably the BRICs (Brazil, Russia, China, India), are not “decoupled” with the economic cycle in the OECD countries as many believed before the collapse of Lehman Brothers in “9/15” 2008. Instead, they have proved “supercoupled”.
b. The OECD economies (both states and individuals) are heavily indebted (with few exemptions). This factor could prolong the duration of the downturn, inhibit the vigour of the subsequent recovery and influence the post-crisis financial and economic architecture.

Against this background, the macroeconomic, both monetary and fiscal, response was large, not so timely though. The conventional monetary policy is reaching its limit in most countries given that the Central Banks are bringing policy rates near zero, with the remarkable exemption of the European Central Bank, almost seven months after “9/15”. Given that and taking into account that the crisis is globally synchronised, there is scope for international cooperation and for a fair “burden-sharing” agreement. Thus, there is a growing pressure to large EU member-states for more ambitious than currently announced fiscal stimulus packages (by either cutting taxes or boosting spending). The USA, the UK and some APEC countries, in particular, asked from continental European countries to “do more” to address the consequences of the crisis. On their part, the USA has announced the biggest fiscal stimulus package (5,6% of GDP) among OECD countries following by Korea (4,9% of GDP), Australia (4,7% of GDP) and New Zealand (4,3% of GDP). On the other hand the net effect of the fiscal package in Germany is estimated by the OECD at 2,7% of GDP and in France at 0,6% of GDP, while Italy has not adopted fiscal stimulus package. Because fiscal stimulus has positive cross-border “spillover effects” it is possible that some countries will benefit (e.g. stronger growth, lower unemployment) from fiscal stimulus other countries undertake, without bearing a fair share of the necessary costs. Therefore, if one isolates the fiscal stimulus packages, it appears that the Europeans do contribute less and the burden-sharing principle is not fulfilled.

However, there are at least two important aspects that someone has to take also into account before gives his final verdict: The initial fiscal conditions and the size of automatic stabilisers in the OECD economies.

Initial Fiscal Conditions: The general government financial balance [surplus (+) or deficit (-) as per cent of nominal GDP)] according to OECD’s Economic Outlook No 84 (November 2008), as an average in the previous economic cycle (2002-2007), was -2,2% of GDP in the euroarea, -3,5% of GDP in the USA, +1,4% of GDP in Australia, +3,2% of GDP in Korea and +13,1% of GDP in Norway. In the same period, the general government’s gross financial liabilities, in national accounts basis, were 74,7% of GDP in the euroarea, 61,2% of GDP in the USA, 17,4% of GDP in Australia, 23,3% of GDP in Korea and 51,7% of GDP in Norway. Subsequently, in the same period, general government’s net debt interest payments were 2,7% of GDP in euroarea, 1,9% of GDP in the USA, 1,2% of GDP in Australia, while were -1,4% of GDP in Korea and -9,1% of GDP in Norway. Accordingly, and not surprisingly, there is a great deal of cross-country variation in the size, and even in direction, of fiscal measures aiming to address the consequences of the crisis. Countries with strong initial fiscal position like Norway or Korea have significant “fiscal space” in order to address the consequences of the crisis and they have already used it. Other countries, with public deficits and high public debt as percentage of their GDP, and thus with weaker initial fiscal conditions, like Japan, Italy and Greece, have very little fiscal room for manoeuvre. From this group of countries only Japan has provided noteworthy fiscal stimulus (1,7% of GDP). On the other hand, countries like Iceland, Ireland and Hungary which have faced the most severe impact of the crisis have moved to the opposite direction and they have tightened their fiscal stance (by lowering spending and increasing taxes). Thus, clearly enough, despite the fact that there are some voices asking for a 2% of GDP fiscal stimulus from virtually every country, there is no “one size fits all” solution. Moreover, in general, the higher the public debt, the higher are the interest rates one country has to pay in order to serve its debt. Indeed, the general government’s net debt interest payments in 2007 for Italy and Greece were 4,4% and 4,1% of their GDP respectively. Furthermore, due to the crisis and the “flight to quality” behaviour of the international markets it is more likely a rise in long-term interest rates which imply a significant increase in debt servicing costs. By way of proof, over the last two quarters in Greece we have experienced a sharp increase in the spreads between the yield on long-term German bonds and those issued by our own country. This overwhelming cost forces countries like Greece to concentrate their efforts on how to restore the long-term fiscal sustainability, rather than to provide short-term stimulus.

Automatic stabilisers**: According to a recent OECD paper,  the size of automatic stabilisers (both in terms of lower revenues and higher spending) is much bigger in EU countries than in the USA for example. This, again, is not surprising given that over the last three decades a “massive withdrawal of the state” took place in the USA, in particular from sectors like education, health and social security. Thus, one should expect that the size of discretionary fiscal stimulus packages varies inversely with the automatic stabilisers.

Indeed, the above mentioned OECD paper confirms that.  In particular, for countries with relatively “big governments” and high social spending as per cent of GDP, like France or Sweden, the size of automatic stabilisers is four to five times bigger than that of their initial fiscal stimulus packages. On the contrary, for Australia and the USA the size of fiscal stimulus packages is slightly bigger than the size of the automatic stabilisers. In addition, the size of the so-called “fiscal multipliers” in the USA and Australia is bigger than unity (1), due to its large market and economic geography respectively, while it is much smaller in small open economies mostly due to import leakages.

So, are the Europeans “free riders”? It seems that this is hardly the case. If one takes into account the initial fiscal conditions and combine the effects of the fiscal stimulus packages and automatic stabilisers would conclude that EU countries are not doing less than what the USA or Australia are doing. Only Germany has some small fiscal space yet to “do more”. On top of that, it is difficult to blame someone for “free riding” when he simultaneously is one of the victims of a deep recession caused, among others, by an unprecedented external regulatory and supervisory “fiasco”.

The analysis is solely represents the views of the author.

** Coefficient summarising the automatic change in the fiscal balance due to 1 percentage point change in the output gap.