Global public goods, fiscal policy coordination, and welfare in the world economy

Summary

Focus

The Covid-19 pandemic made it clear that, in today's globalised world, national borders cannot stop the propagation of viruses and communicable diseases. Compelling evidence also suggests that the rate of emergence of new diseases is accelerating, and that their adverse effects may increase significantly in the future. Observers have therefore advocated the implementation of a global strategy to address these potential risks.

Contribution

We develop a two-region, endogenous growth model of the world economy in which a global health fund produces a public good (vaccines) based on contributions by national governments. Resources transferred to the fund are productive because health improves productivity everywhere. A local public good is also provided. The analysis considers both separate budgets and tax rates for the financing of each type of public goods, and an integrated budget. As a result, direct trade-offs in spending allocation between local and global public goods can be studied as well. Distortionary tax rates are chosen to maximise welfare. Both the non-cooperative equilibrium and the cooperative equilibrium between national fiscal authorities are derived.

Findings

First, there is a trade-off between growth, welfare and the provision of the global public good. On the one hand, raising revenues to transfer to the global fund reduces savings and capital accumulation at home; on the other, greater access to the global public good improves health and productivity. This trade-off is internalised by optimally choosing the health-specific tax rate. Second, under financial autarchy, the non-cooperative equilibrium is inefficient. Cooperation improves welfare and may lead to a smaller share of spending on health. Third, under financial openness, the non-cooperative equilibrium remains inefficient, because it fails to internalise the cross-border leakage associated with capital flows. When the health levy takes the form of a wealth tax, cooperation also generates superior outcomes. These results are illustrated with simple numerical experiments.

Abstract

A two-region endogenous growth model of the world economy with local and global public goods is used to study strategic interactions between national fiscal authorities. Distortionary levies are used to finance infrastructure investment at home and to generate resources that are transferred to a global public fund for the production of vaccines, which contribute to individual health in both regions. While the global public good is nonexcludable, it is partially rival - its distribution in each region is subject to congestion. Under financial autarky, the cooperative equilibrium is efficient because the benefits of vaccines are fully internalized. Under financial openness, the cooperative equilibrium is also efficient because it preserves the tax base by internalizing the cross-border leakages associated with capital flows. Similar results hold when the health levy takes the form of a wealth tax. However, optimal tax rates are not necessarily higher under cooperation---an important consideration from a policy perspective. Simple numerical experiments are performed to calculate the optimal rates and the gain from cooperation under alternative regimes.

JEL classification: F43, H51, H87

Keywords: global public goods, endogenous growth, fiscal policy coordination, optimal taxation