Bound on our hands and feet? : global finance and domestic fiscal policy

This thesis is a study of one of the most pronounced relationships in the popular debate on globalisation: the relationship between the globalisation of finance and state autonomy in fiscal policy. Popular opinion as well as conventional academic wisdom has it that globalisation deprives nation states of (much of) their autonomy in key policies. The advocates of this view see a border-less world evolving, where nation states are unnatural units that are disregarded by global networks of capital flows. Others question this analysis, and point to the unchallenged domestic authority of nation states and their enduring dominance in international affairs. The main question is, thus, to what degree capital flows across borders lead to changes in domestic fiscal policy? Keynesian fiscal policies were formulated in a period of limited capital flows across borders. Economic theory has it that these policies will go through major changes in the face of financial internationalisation. I study this claim through four key policy areas; Capital taxation, public spending, government debt and public budget deficits. I argue that one can identify two distinctly different presumptions about the outcome on fiscal policies. The least comprehensive is convergence, meaning that states become less deviant from each other. The other is a policy race to the bottom. This process implies that states become engaged in a spiralling process of reduced income and spending, gradually leading to smaller public sectors in OECD-economies. The problem is studied by an analysis of 22 western OECD-countries. These countries share a history of Keynesian fiscal policies and the development of welfare states. The study confines itself to the period 1980-1999, with special attention to the period 1995-1999. The aim of the thesis is not to study in-depth processes in specific case, but to examine general tendencies in the relationship between capital flows and fiscal policy. A quantitative methodical framework is therefore applied. The empirical evidence did not support the theoretical prediction of a policy race to the bottom in fiscal policy. First, analyses showed that there was no general tendency of lower levels of income, spending or debt after 1980. Second, to the degree that changes in fiscal policy were observed after 1995, they were barely related to increased capital flows across borders. However, the theory of generally converging levels of fiscal policy did not find much support in the evidence either. With the exception of public budget deficits, there was no evidence of converging levels of fiscal policy from 1980 and onwards. Capital taxation, public spending and government debt were only marginally affected by capital flows across borders, while levels of public deficits were converging. My second question arose from the empirical evidence, and was analytical. Why are domestic policies less vulnerable to financial market pressure than initially expected? After examining several possible explanations to this, I introduced three suggestions about how fiscal policy changes may have other causes than the pressure from capital flows. First, ideas of good fiscal policy are diffused and lead to new perceptions among domestic policy makers. Second, domestic institutions filter external constraints and frequently adjust them or even initiate domestically driven change. Third, states are more than recipients of pressure; They rely heavily on the adaption and creation of new measures to fulfil their policy goals. The results of the empirical analysis contradicted the conventional wisdom and rather supported a notion of stability in domestic fiscal policies. To the degree that changes were occuring, they were more likely to be caused by other processes that the direct pressure from capital flows across borders. Several such processes have a better potential to explain fiscal policy changes