Fiscal devaluation and economic activity in the EU

In the aftermath of the global financial crisis, a fiscal devaluation (hereafter: FD), understood as a shift in taxation from labor to consumption, has been debated as a possible tool of restoring competitiveness in peripheral countries of the Euro area. We contribute to this debate. Based on a set of panel and spatial panel models for the EU 27 over the period 1995 – 2014, we find that FD increases value added in exports, improves net exports, accelerates GDP and employment growth, and decelerates labour costs growth. These effects are nonlinear: stronger in the members of the Euro area and weaker in countries with either more coordinated or more centralised wage bargaining process, or more generous unemployment benefits. Most importantly, FD turns out not to be a beggar thy neighbour policy, at least in the EU. In our sample ‘cooperative effect’ of unilateral FD, which is beneficial for neighbouring countries, dominates by far ‘competitive effect’, which goes at the expense of other countries’ competitiveness. Admittedly, FD implemented in one country can benefit other countries, provided that they are strongly integrated in global value chains. These findings are robust to changes in the estimation methods, the sample composition, the set of explanatory variables and the selection of a spatial weight matrix.