Overview publications

A recession is now inevitable, says Daniel Gros (CEPS, EconPol Europe), but it can be followed by a vigorous recovery. The memory of the financial crisis of 2008/9 is fresh enough to ensure the combined efforts of central bankers and governments can keep financial markets working and prevent mass bankruptcies. Policymakers at every level are using every lever at their disposal to avoid a repeat of the freezing of financial markets, which was so damaging ten years ago. The lesson was learned and is now being applied at a vast scale throughout Europe and the US. Containing the virus and protecting public health is where Western societies have to learn and adapt quickly.

Existing literature suggests that firm R&D support policies stimulate private R&D within a country and that in most cases, the positive impact of government support is stronger on smaller firms. Recent evidence also indicates that some of the policy instruments, such as patent box policies, are tools that multinationals use to lower their total tax bill through profit shifting. In this policy report, İrem Güçeri (EconPol Europe, Oxford University), Marko Köthenbürger (EconPol Europe, ETH Zurich) and Martin Simmler (EconPol Europe, Oxford University) find that the most prevalent support policies are effective in fostering private enterprise sector R&D and small and young firms seem to benefit the most from both public R&D and R&D tax incentives.

EconPol Speaker Clemens Fuest has called for the UK Government to abandon its plan to complete the Brexit transition by the end of 2020. Prof Fuest describes the UK’s decision to rule out a customs union and pursue its own trade policy as ‘regrettable’, highlights fears from both the UK and EU over the potential lack of a “level playing field”, calls tax policy “a minefield of disagreement” and says climate policy “poses a further challenge to the free trade agreement.”

In the 1930s, countries fought destructive trade conflicts – now we have a similar situation, but the conflicts are taking place in the tax system. These conflicts arise out of the twin impacts of globalization and digitalization. Once upon a time, there was an implicit understanding of fairness in taxation, meaning how countries tax within their borders and how the tax burden is distributed. More specifically, companies and individuals were taxed based on their residence and consumption in the destination country. Such an approach worked while these events were mostly perceived as national. However, the world has changed, and in an increasingly globalized, digitalized, and mobile world, these understandings no longer appear to work smoothly, efficiently, and uncontentiously.

An expanding body of research finds a sharp increase in the average markups in the US and Europe, driven by firms located at the top of the markup distribution; other studies find that markups in the US and Europe have increased only moderately or even remained stable. These differing results have triggered a discussion on methodology, a key issue being the choice of the free input in the production function approach. Authors Gerrit Hugo van Heuvelen, Leon Bettendor and Gerdien Meijerink (EconPol Europe, CPB Netherlands Bureau for Economic Policy Analysis) show that the choice of the free input is crucial, and may explain at least some of the discrepancies in the findings in the recent literature. They illustrate this with the case of the Netherlands, which has a large share of flexible work arrangements and temporary labor contracts as well as fixed contracts.

This paper from Štěpán Mikula (Masaryk University) and Mariola Pytliková (EconPol Europe, CERGE-EI) examines causal effects of air pollution on migration by exploiting a unique natural experiment of desulfurization of power plants in the region of North Bohemia in the Czech Republic after the fall of communism in 1989. They find that anti-emigration policies had no impact on emigration decisions, but the effect of air pollution on emigration tended to be stronger in municipalities with weaker social capital and in municipalities less equipped with man-made amenities. These results suggest that strengthening social capital, investing into better facilities in the area of education, health and social care, and promoting sport and cultural activities can partially mitigate the migratory response to air pollution.

There is a clear consensus that stimulating firm R&D is welfare-increasing due to positive externalities and uncertainty, but the question about the most efficient way to do so is still open to debate. This paper from Leonie Koch ( Ludwig Maximilian University of Munich) and Martin Simmler (EconPol Europe, Oxford University Centre for Business Taxation) analyzes the magnitude of local knowledge spillovers of public R&D in Germany and its determinants using patent application data. They find that firms file more patent applications when collaborating with (local) public institutions, that firms file more patent applications when citing a public patent, and that local public R&D seems to increase the number of patent applications by local firms. The authors conclude there is evidence for substantial local spillovers and that these are driven by non-specific knowledge spillovers.

Tech giants such as Google and Facebook generate significant amounts of advertising income, which is mainly reported in low-tax countries. This has created a policy discussion of how to re-align the location of value creation and taxation, says author Marko Köthenbürger (EconPol Europe, ETH Zurich). The success of the business model of these digital platforms relies on the existence of indirect network effects, which are the prime reason why platforms exist and generate advertising income. To account for these effects, conventional tax policy needs to be adjusted. This includes an adjusted concept of nexus that should rely on the location of users, which generate the relevant indirect network effects. The recent EU proposal of a digital service tax goes in this direction and constitutes a policy option for other countries.

The ‘Green Deal’ in its objective is highly ambitious and will absorb substantive financial resources, and it is not surprising that the potential role of higher public debt is being discussed. The European Central Bank is increasingly requested to provide green finance through its asset purchase programmes and similar suggestions are being made in national debates. But does an ambitious climate policy really provide compelling arguments for higher public debt? Friedrich Heinemann (EconPol Europe, ZEW Mannheim) argues that fighting climate change is not a convincing justification to open new loopholes in European debt rules and fiscal or monetary institutions.

In this working paper, António Afonso (EconPol Europe; ISEG – School of Economics and Management, Universidade de Lisboa; REM – Research in Economics and Mathematics, UECE) and Nuno Verdial (ISEG – School of Economics and Management, Universidade de Lisboa) analyze the events of the 2007/2008 financial crisis and European sovereign debt crisis with a focus on Portugal and Spain. They find that that the pricing of sovereign risk changed with the crisis and the “whatever it takes” speech of Mario Draghi. Specifically, market pricing of the Eurozone credit risk, liquidity risk and the risk appetite increased after the crisis and relaxed afterwards. However, there is no evidence of specific pricing regime changes after the speech in the case of Portugal and Spain.