Keynes and the fiscal dividend of independence

Pol Antràs
3 min

In 1919 a brash young British economist attended the Paris Peace Conference representing the British Treasury. Frustrated with the terms agreed in the Treaty of Versailles —particularly with the enormous economic reparations that the Allied Powers demanded from the defeated side— he resigned and returned to Cambridge. In just two months, he wrote a book that had great international impact and was entitled "The Economic Consequences of the Peace". The legend that is John Maynard Keynes had begun.

During the 1920s, Keynes continued his crusade against the excessive reparations that were imposed on the Central Powers and studied the matter from a more analytical perspective. Keynes' writings on the "transfer problem" prompted an intense academic debate in which some of the most brilliant economists of the first half of the 20th century participated —including Pigou, Ohlin, Meade, Viner or Samuelson.

The debate on the transfer problem is centred on the calculation of the effective cost for a country (say Germany) of making a monetary transfer of a certain amount (say 15 billion Euros) to another country (say France). The answer to this question may seem trivial: the cost is ... 15 billion Euros! As with many economic issues, though, the trivial answer often ends up being inexact because it ignores certain key aspects of the problem.

When it comes to international transfers, a crucial question must be asked: where do the 15 billion Euros come from? To be able to finance this payment, the German economy must increase its exports or reduce its imports until it reaches an increase in its trade balance of exactly 15 billion Euros. This adjustment is necessary to equilibrate the German balance of payments. That said, we can't assume that the effect that the transfer will have on Germany's purchasing power will also be of 15 billion Euros. In fact, that would only be true if the French spent the 15 billion Euros in the same way —i.e. on the same goods— as the Germans would have spent them on.

Keynes argued that it is much more sensible to think that the French would lean towards increasing the consumption of goods produced in France far more than the Germans would have with the same amount of money. This bias towards the consumption of locally produced goods can be explained, in part, by differences in preferences (the French like Chardonnay wines whereas the Germans prefer Riesling wines) but also by the fact that it is costly to ship goods and services across countries.

The existence of a "home bias" in consumption means that international transfers cause changes in prices that tend to worsen the real exchange rate —i.e. the real purchasing power— of the country that makes the transfer. In our example, the transfer will tend to increase demand for French goods (Chardonnay) and reduce the demand for German goods (Riesling), so that Germany will not only need to increase its trade balance in the amount of the transfer, but it will be forced to do so by selling exports at less favourable prices than before the transfer. This last effect is what economists call the "secondary burden" of the transfer. It is not easy to assign a specific value to this secondary effect, but a recent study indicates that the increase of the burden could amount to somewhere between a quarter and a third of the nominal value of the transfer. Therefore, an international transfer of 15 billion Euros could end up reducing the issuing country's purchasing power by between 18.75 and 20 billion Euros.

In the national transition process that we are currently living, it is often stressed that independence would provide Catalonia with a yearly fiscal dividend of around 15 billion Euros, which is the amount that the central administration currently receives from Catalonia and that never find their way back to Catalonia. This net transfer of 15 billion Euros is conceptually equivalent to the transfer between Germany and France that I described earlier. Therefore, independence would result in an annual "transfer" of around 15 billion Euros in the opposite direction, from Spain to Catalonia. However, the fiscal dividend of independence would not be 15 billion Euros, as is often argued. Rather, it could possibly be as high as 20 billion Euros and, thus, over 10 per cent of Catalonia's GDP. Obviously, the fiscal dividend of independence is not the only factor to be taken into account when calculating the impact that independence would have on the Catalan economy as a whole. Nevertheless, it is a central part of the equation.