Beyond the Fiscal Straightjacket: Redefining State Capacity for the 21st Century

By Mariana Mazzucato and Anna Hope Emerson
October 26, 2026

In the corridors of power from London to Washington, a familiar, debilitating narrative has taken hold: the idea that governments are effectively bankrupt, lacking the "fiscal space" to address the cascading crises of the modern era. As inequality widens and the cost of living erodes the stability of the middle class, policymakers frequently point to tight budgets and mounting deficits as reasons for inaction.

However, this supposed lack of room to maneuver is, in many instances, a self-imposed prison. By equating "fiscal responsibility" with the narrow, accounting-based pursuit of deficit reduction, governments are failing to distinguish between wasteful spending and vital public investment. True fiscal responsibility is not merely about balancing a ledger in the short term; it is about building an economy’s capacity to grow, innovate, withstand global shocks, and meet the long-term aspirations of its citizens.

The Fiscal Fallacy: Why Austerity Undermines Growth

The prevailing orthodoxy—which prioritizes the reduction of debt-to-GDP ratios above all else—often creates a perverse feedback loop. When governments slash public spending in a cooling economy, they frequently trigger a contraction in growth that exceeds the savings achieved by the cuts. The result is a paradox: the debt-to-GDP ratio often climbs higher because the denominator (the economy) shrinks faster than the numerator (the debt).

The Chronology of the Fiscal Squeeze

• Post-2008 Financial Crisis: Following the Great Recession, global fiscal policy shifted rapidly from stimulus to austerity. The era of "fiscal consolidation" saw public services slashed across the G7, leading to a decade of stagnant wage growth and crumbling infrastructure.
• 2020–2022 Pandemic Intervention: The COVID-19 pandemic forced a brief, necessary suspension of the fiscal-austerity dogma. Governments engaged in massive deficit spending to keep economies on life support.
• 2023–2025 Retrenchment: As inflation spiked, central banks raised interest rates and governments were pressured to return to "fiscal prudence." This move back to austerity has hampered the green transition and left public health and education systems in a state of chronic underfunding.
• Late 2026: The current moment reflects a growing consensus among institutional economists that current fiscal rules are outdated, ill-suited for the structural transformations required by climate change and the digital revolution.

Reframing State Capacity: Beyond Ownership

As more governments begin to recognize the necessity of regaining public control over economic outcomes, a critical debate has emerged: Does "control" mean state ownership of the means of production, or does it mean something more nuanced?

The answer lies in the concept of State Capacity. Ownership of industries—such as nationalizing energy grids or transport networks—is not a silver bullet. If the state lacks the bureaucratic, technical, and strategic capability to manage these assets effectively, ownership can become a bureaucratic burden rather than a public asset.

What ultimately matters is not the legal status of the assets, but the state’s ability to steer economic activity toward strategic objectives. Whether it is through mission-oriented industrial policy, public-private partnerships that ensure the public receives a fair return for its risk, or direct procurement, the state must act as an architect of markets, not just a bystander or a "market fixer."

Supporting Data: The Cost of Underinvestment

The evidence against the current "austerity-first" model is overwhelming. According to recent economic data from the OECD, countries that maintained higher levels of public investment as a percentage of GDP during the last three years have seen a faster recovery in labor productivity.

• Public Investment vs. Private Sector Growth: Studies indicate that for every $1 invested in public R&D, the private sector typically generates between $2 and $4 in follow-on innovation. When public investment is the "first thing cut" under fiscal pressure, the long-term innovation pipeline dries up.
• The Multiplier Effect: During periods of economic slack, the fiscal multiplier—the effect of government spending on GDP—is significantly greater than one. Cutting spending during these times is essentially choosing to impoverish the future to appease the bond markets of the present.
• Infrastructure Gaps: Estimates from the Global Infrastructure Hub suggest a global investment gap of over $15 trillion by 2040. This gap is not a result of a lack of global capital, but a failure of fiscal policy to channel that capital into productive, long-term public assets.

Official Responses and the Shifting Consensus

The skepticism toward traditional fiscal rules is no longer limited to radical economists; it is permeating the highest levels of international governance.

The International Monetary Fund (IMF), historically a bastion of fiscal conservatism, has increasingly signaled that "fiscal space" is a flexible concept. In recent policy papers, IMF officials have acknowledged that "growth-friendly" fiscal consolidation should protect public investment in education and green energy, arguing that these are not costs, but essential capital expenditures.

Similarly, within the European Union, the reform of the Stability and Growth Pact reflects a desire to move away from arbitrary debt ceilings. New frameworks allow for more "tailored" debt-reduction paths, provided that member states commit to strategic reforms and investments that enhance long-term growth potential.

However, resistance remains. Powerful financial lobbies and political factions wedded to the "household budget" analogy of national debt continue to exert pressure. They argue that any deviation from strict fiscal rules will lead to inflation and a loss of investor confidence. This argument fails to distinguish between debt incurred for consumption and debt incurred for investment in the productive capacity of the nation.

The Implications: A New Social Contract

If governments are to meet the challenges of the 21st century—decarbonization, the AI-driven labor transition, and the demographic pressures of an aging population—they must redefine their role in the economy.

1. Mission-Oriented Policy

Governments must stop acting as passive funders of last resort. Instead, they should adopt a mission-oriented approach, where the state sets clear, ambitious goals (e.g., carbon neutrality by 2040, or universal digital access) and coordinates the public and private sectors to achieve them. This requires a shift in how we measure success, moving away from GDP growth alone to include indicators of well-being, sustainability, and resilience.

2. Changing the Rules of the Game

Fiscal rules must be redesigned to treat public investment as an asset rather than a liability. This might involve "golden rules" for fiscal policy, which explicitly exempt public investment from deficit calculations. By insulating these investments from the volatility of the political cycle, governments can ensure continuity in long-term projects.

3. Institutional Capacity Building

The most significant challenge is administrative. Rebuilding the capacity of the state to execute complex projects is as important as the funding itself. This means investing in civil service expertise, ensuring that the state has the internal skills to negotiate with private entities, and fostering a culture of experimentation and iterative policy design.

4. Protecting the Common Good

Finally, the state must ensure that the risks and rewards of economic activity are shared. When the state takes the risks—such as through public R&D or providing guarantees for early-stage technologies—the public should participate in the rewards. This ensures that the fruits of innovation are not privatized while the losses are socialized.

Conclusion: The Choice Ahead

The narrative that "there is no money" is a political choice, not an economic reality. As we navigate the complex, interconnected crises of the coming decades, the state cannot afford to be a mere regulator or a provider of a social safety net. It must be the primary driver of sustainable and inclusive growth.

The path forward requires a fundamental shift in our economic vocabulary. We must stop viewing fiscal policy through the lens of short-term debt management and start viewing it through the lens of long-term value creation. By prioritizing the state’s capacity to steer the economy toward the common good, governments can break free from the fiscal straightjacket and build a future that is both resilient and equitable.

The question is not whether we can afford to invest in our future, but whether we can afford the cost of our current inaction. The era of passive governance must end; the era of the strategic, capable state must begin.