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

(July 2023, revised December 2024)

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 use a two-region endogenous growth model of the world economy with local and global public goods to study strategic interactions between national policymakers. Distortionary taxes are used to finance infrastructure investment at home and generate resources for vaccine production by a global fund. While the global public good is non-excludable, it is partially rival. Optimal tax rates under cooperation and non-cooperation are solved analytically, under both financial autarky and openness, and numerical experiments are performed to evaluate the welfare gain from cooperation.

Findings

First, there is a trade-off between growth, welfare and the provision of the global public good. On 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, whether optimal levies are higher or lower under cooperation, as well as the magnitude of welfare gains, depend on the degree of integration of capital markets, the existence of a direct trade-off between expenditure components and the nature of the tax base. Third, when the health levy takes the form of a capital or wealth tax, cooperation is welfare-improving under both autarky and financial openness, but enforcement and collection costs may narrow the scope of taxation under all policy regimes.

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