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July 16, 2020, 8:26 a.m. EDT

We deserve an economy that provides jobs, public health and a sustainable environment

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LONDON ( Project Syndicate )—The COVID-19 pandemic has had an immense, unpredictable, and lasting impact on economies around the world. As a result, governments have been given an opportunity—and an imperative—to rethink the role and purpose of fiscal policy.

A new approach is long overdue. Since the era of British Prime Minister Margaret Thatcher and U.S. President Ronald Reagan, the prevailing economic orthodoxy has effectively denied the state’s potential investment function and made balancing the budget an end in itself.

This indifference to both the direction and level of economic activity rendered the 2008-09 crash all but inevitable, and the subsequent rush to austerity weakened the recovery. Now, the simultaneous collapse of supply and demand following the arrival of COVID-19 has made neoliberal orthodoxy doubly untenable.

There is, however, little evidence that any new fiscal thinking is under way. Yes, emergency financing is being deployed. But unless this spending is structured, the post-2008 outcome will be repeated, with the liquidity driving up asset prices in financial markets but doing little to help the real economy.

In the United Kingdom, Prime Minister Boris Johnson may aspire to the mantle of President Franklin D. Roosevelt. But his touted “new deal” comes nowhere close to the scale or ambition of FDR’s original. None of the government spending announced so far goes beyond “ambulance work.”

What the emergency response has highlighted is the immense fiscal power of the state, which, when circumstances demand, is perfectly capable of keeping households provisioned through a monthslong standstill of private enterprise. Accordingly, the goal in the months and years ahead should not be to jettison the subsidy economy as quickly as possible, but rather to transform it into a new lasting partnership between the state, private enterprise, and workers.

A New Baseline

Just as the path out of the Great Depression and World War II required political collaboration and the adoption of ideas that in the 1920s and 1930s had been considered radical and “antibusiness,” so must the post-pandemic recovery go beyond mere crisis management. It is time to embrace the state’s unique and profound capacity for steering economic life in the interest of the common good.

After all, there is no shortage of long-run challenges that will require proactive political leadership and mission-driven public investment.

In the face of a historic  Arctic heat wave , the need to reorient the economy toward clean, sustainable growth has never been more urgent or more obvious. And while calls for a “Green New Deal” on the scale of the WWII-era socioeconomic transformation had already gained traction, the COVID-19 crisis has shown that “business as usual” is unfit for purpose. When push comes to shove, states—not private companies—are the primary economic actors.

The socioeconomic and climate dimensions of the current crisis are  closely related . The legacy of  laissez-faire  policies had left key sectors and large swaths of the labor force chronically underemployed and  undervalued .

As the U.K. Committee on Climate Change has  shown , the current economic downturn is thus the perfect time to accelerate “the transition to a cleaner, net-zero emissions economy and strengthen the country’s resilience to the impacts of climate change.”

But any modernized version of the New Deal must include a new fiscal constitution. Otherwise, there will be no guarantee against a resumption of financial orthodoxy when the current emergency is deemed to be over.

The state must be given a permanent, continuing role in guiding, stabilizing, and—if need be—transforming economic life. Intervening only in bad times to fix the system guarantees another crisis.

On the supply side, there should be more attention on steering production toward long-term development needs—toward a more sustainable, innovative, and inclusive economy. And on the demand side, it is time to reaffirm the Keynesian commitment to full employment, by establishing a job-guarantee scheme to ensure that human capital is neither wasted nor eroded during the coming economic transformation.

More to the point, a modernized New Deal means paying as much attention to the  direction  of growth as to its rate. It means actively tilting the playing field in a greener direction, which calls not only for “shovel-ready” projects in clean infrastructure, renewable energy, and other forms of decarbonization, but also for a vision of how to design and coordinate such projects as part of a new sustainable growth path.

New incentives to drive private investment in the right direction are also needed. Taxes, regulations, and other public policies must be aligned to foster long-term planning and reduce greenhouse-gas (GHG) emissions across the entire economy.

Such a mission-oriented approach to economic management would yield a bigger bang for the public’s buck, both decreasing the negative multiplier of any business downturn and increasing the positive multiplier of any business upturn.

The Hollow State

As John Maynard Keynes  observed  in the mid-1930s, “The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

Today, the key failure of the prevailing economic model—particularly in the United States and the U.K.—has been its neglect of public goods. While these are essential to the proper functioning of the economy, the private sector lacks any incentive to supply them.

That is why Adam Smith argued in   that the state bears the duty of furnishing the infrastructure upon which the market economy relies. And as the list of public goods expands to include access to data and digital technologies, we need to become more ambitious about supplying what citizens need to prosper.

The contemporary orthodoxy, however, subordinates this duty to that of balancing the government’s budget. The responsibility of developing the economy’s real resources is simply abandoned in the name of a financial imperative that, in truth, applies only to households.

While households need to balance budgets over time, governments should be creating budgets to balance the economy, ensuring full capacity utilization. Crucially, to resurrect the notion of public goods, we must ensure that they are not merely “corrections” for market failures, but rather central elements in the interplay between government and private enterprise.

A narrow market-maintenance logic must give way to a more proactive  market-creating and market-shaping logic .

The prevailing orthodoxy rests on two supposedly axiomatic assumptions: that public investment is a form of waste and should therefore be minimized; and that market economies have a spontaneous tendency to achieve full employment (defined as the “natural” rate of unemployment). From these axioms it follows that only when markets cannot allocate resources efficiently should public investment be used to smooth out “frictions.”

The 2008-09 financial crisis already exposed the weakness of this model. Between 1975 and 2000, gross public investment as a share of GDP in the U.K.  fell from 8.9% to 1.7%.  As a result, more investment spending shifted toward speculation, where it was not only wasted but destabilizing, contributing to a sequence of financial crises.

The COVID-19 crisis has made the orthodox model’s flaws even more obvious, not least by highlighting the severe  deficiency of public goods , from basic health infrastructure to personal protective equipment. Orthodoxy had prescribed privatization, patent protection, and the outsourcing of critical government functions across almost every relevant domain, from research and development in medicine and technology to transportation, health care, and education.

After years of spending cuts, many Western governments were completely unprepared to manage a shock such as the one that struck this year.

As soon as COVID-19 emerged, so, too, did the signs of rot, from gaps in critical supply chains to  inadequate state capacity . Across the Western world, governments have mustered everything they have in responding to the pandemic, but it has been too little, too late. Building up sufficient state capacity takes years of patient investment, not just helicopter money dumped on the economy in response to an emergency.

Moreover, this undersupply is a product of under-demand. Economies have operated well below full capacity ever since the 2008 crisis. In 2018, the U.K. may have had a “headline” unemployment rate of 4.2%, but its underemployment rate—which includes those working part-time and unable to secure full-time jobs—was  closer to 8%  (and that figure excludes those who have been forced to work below their skill level).

Lessons Learned?

Because governments remained beholden to financial rather than real resource accounting during the Great Recession, they missed an opportunity to start shifting economic activity in a more sustainable, inclusive direction. Worse, many abandoned stimulus measures for growth-inhibiting fiscal consolidation.

In the U.K.’s case, Simon Wren-Lewis of the University of Oxford estimates that austerity  delayed  the economy’s recovery for up to three years, exactly as elementary Keynesianism would have predicted. And though monetary policy remained expansive, it did not offset the country’s contractionary fiscal policy.

To be sure, the Bank of England claimed that the situation would have been even worse had it not been priming the pump. And yet, by pursuing asset purchases, policy makers were simply putting “new” money into the hands of existing asset holders, who were least likely to spend it. Unless money creation is linked to  opportunity creation  in the real economy, most of the liquidity provided by the central bank will end up back in the financial sector—exactly as happened after 2008.

The lessons from the last crisis are clear: the marginalization of the state’s investment function deprived policy makers of the tools needed to deal with an unexpected event or to stabilize the economy, let alone position it for sustained growth.

Public investment is essential not just to “fix” market failures, but also to drive the high-risk, capital-intensive spending that is necessary for innovation—and thus for capital development itself. It can be leveraged both on the supply side—through investments in transformative projects with risks too large for a private firm to bear—and on the demand side, through public-procurement policies.

Under the neoliberal Washington Consensus, it was these state functions that were largely “outsourced” to markets—voluntarily in the case of developed countries, and as a condition of financial support in developing countries (which were then relabeled “emerging markets”).

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