New Paradigm Knowledge Base – Update on the role of the state

What role should the state play in innovation policy? How can the infrastructure investments needed for climate protection be financed by the state? Does a socially acceptable implementation of the Green New Deal require the EU to relax its debt rules?




29. OCTOBER 2021


4 MIN.

The first session of our IX New Paradigm Workshop aimed at providing an update on new economic thinking in three areas: i) on the role of the state, ii) on a modern climate policy, and iii) on new fiscal rules.

RAINER KATTEL explained the emergence of a new way of thinking about innovation policy and the paradigm shift away from hands-off approach towards a greater role for governments. He highlighted two areas of particular concern for mission-oriented policies: greening of finance with the aim of decreasing climate-related risks and rethinking competition policy with the aim of stopping digital value extraction. Looking at the past, much of innovation policy was due to military and security needs and did not sufficiently address people’s everyday needs (“the moon and the ghetto paradox”). Going forward, innovation policy must be implemented in an inclusive manner by engaging with the wider public and with a holistic approach by factoring in the effects on all relevant sectors.

In his comments, PHILIPP STEINBERG (BMWI, BERLIN) agreed that a green transformation of the economy is needed and explained that his ministry is working on expanding green procurement and improving competition law. In his view, (neo)classical arguments can justify market intervention in case of market failure. Referring to the idea of an “entrepreneurial state”, he said that he would not go as far as that but rather to choose the term of a “transformative state” that implements certain mission-oriented policies with a common European interest.

According to TOM KREBS, the cornerstone of a modern climate policy should be increasing public (infrastructure) investment, especially in the fields of transport and energy as this will generate green growth and create jobs. Debt-financed public investment projects including in the railroad system, energy grid, hydrogen pipeline system could make economic sense due to their high (social) returns. He explained possible ways of financing public investments necessary to achieving net neutrality by 2045 which would be compatible to the German debt brake.

In her comments, KATHARINA BOHNENBERGER steered the conversation towards the scale of economic transformation necessary to get the world on track to the 1.5 target: a rapid fossil fuel phase out or “exnovation” of the brown energy sector, while at the same time tackling the issue of social inequality in general and energy inequality in particular.

During the pandemic, EU member states accumulated large public deficits, which is why some EU member states (especially the frugal four) are calling for a swift return to fiscal rules. Other are warning against repeating the mistakes from the EU sovereign debt crisis, namely cutting budgets too early in the recovery. CATHERINE MATHIEU presented the current academic discussion on alternatives for the existing and somewhat arbitrary fiscal rules at the EU level (60% debt/GDP, 3% deficit/GDP, 0.5% structural deficit/GDP). Most of the proposals center around an rule that limits public expenditure. Another approach proposed by Blanchard et al (2021) would be exchanging fiscal rules through fiscal standards, monitored by newly created independent fiscal institutions. However, these would have to make their decisions on the basis of stochastic estimates of the probability of sovereign insolvency, which is fundamentally associated with high uncertainty. Therefore, Mathieu and Sterdyniak (2021) suggest a new fiscal paradigm: members should be allowed to run a government balance consistent with their macroeconomic needs and agree to an open coordination in which they should target growth, full employment, and the ecological transition. This new paradigm should be based on trust between member states.

CHRISTIAN BREUER framed EU fiscal policy in terms of a cost benefit analysis. While the costs of prohibiting countries from pursuing stabilization policies are often overlooked, the low interest rate environment provides a good argument in favour of relaxing the fiscal rules. He brought up the question which role countries such as Germany could play in reducing their excessive current account surpluses.



For decades, there was a consensus that reducing the role of the state and cutting public debt would generate wealth. This contributed to a chronic underinvestment in education and public infrastructure. New research focuses on establishing when and how governments need to intervene to better contribute to long-term prosperity and to stabilize rather than aggravate economic fluctuations.