Harvard Economist Gita Gopinath Offers a Euro Cure

Gita Gopinath offers a way to mimic a devaluation without a euro bust-up
Gopinath’s “remarkably simple” solution uses creative taxation Photograph by Kelvin Ma/Bloomberg

When French President François Hollande unveiled a plan in November for a business tax credit and higher sales taxes as a way to revive the economy, he was implementing an idea championed by economist Gita Gopinath. A 41-year-old professor at Harvard University, Gopinath has pushed for tax intervention as a way forward for euro-area countries that can’t devalue their exchange rates. This so-called fiscal devaluation is helping France turn the corner at a time of extreme budget constraints, former Airbus chief Louis Gallois said in a report on France’s business competitiveness commissioned by Hollande.

Gopinath’s understanding of the theory took shape through her years teaching at Harvard and the University of Chicago, and particularly as a Ph.D. student at Princeton under the guidance of economists Kenneth Rogoff, Pierre-Olivier Gourinchas, and Ben Bernanke, now chairman of the Federal Reserve. While her earlier work on current accounts and balance of payments garnered praise, it’s her recent focus on the 17 euro-zone nations that has national leaders paying attention. “Gita is already a major star, at the top of her cohort in international macroeconomics and still rapidly growing as a scholar,” Rogoff says in an e-mail. He calls her internal devaluation strategy for the euro region “very influential.”

Gopinath, the first Indian woman to receive tenure at Harvard, grew up in the South Indian city of Mysore. Like many Indian high school students, she sought her parents’ advice on what to study after graduation; the Gopinaths wanted their daughter to land a respectable job as a government official in the Indian Administrative Service. The best way to achieve that, friends told them, was a bachelor’s degree in economics from the University of Delhi. “It was purely accidental,” Gopinath says. “Luckily, I found out fairly quickly that I had more of an academic leaning and little aptitude for administration.”

Her bachelor’s degree in economics from the university’s Lady Shri Ram College for Women in 1992 was followed by two master’s degrees, and a doctorate from Princeton in 2001. She taught at the University of Chicago from 2001 to 2005 before moving to Harvard.

The idea of fiscal devaluation originates with John Maynard Keynes. Gopinath’s insight was to advocate fiscal devaluation for Europe’s beleaguered currency union in a 2011 paper she co-authored with her colleague Emmanuel Farhi and former student Oleg Itskhoki, now an assistant professor at Princeton. “Despite discussions in policy circles, there is little formal analysis of the equivalence between fiscal devaluations and exchange-rate devaluations,” they wrote. “This paper is intended to bridge this gap.”

The paper examines a “remarkably simple alternative” that doesn’t require countries to abandon the euro and devalue their currencies to revive growth through exports, Gopinath says. By increasing value-added taxes while cutting payroll taxes, a government can affect gross domestic product, consumption, employment, and inflation much as a currency devaluation would.

The higher VAT raises the price of imported goods as foreign companies pay the levy on the products and services they export to that country. The lower payroll tax helps offset the extra sales tax for domestic companies, reducing the need for them to raise prices. Since exports are VAT-exempt, the payroll cost saving allows producers to sell goods more cheaply overseas, simulating the effect of a weaker currency, according to the paper. The policy also can help on the fiscal front, as increased competitiveness can lead to higher tax revenue, Gopinath says.

As part of France’s fiscal devaluation, Hollande has offered French companies a €20 billion ($27 billion) tax cut on some salaries as he attempts to turn around an economy that has barely grown in more than a year. He’ll also lift the two highest VAT rates.

The plan was inspired partly by Gopinath’s paper, says Harvard professor Philippe Aghion, an informal campaign adviser to Hollande, who was elected president in May. Aghion co-wrote a column in Le Monde last October urging fiscal devaluation. Airbus’s Gallois then proposed the strategy to Hollande. “We contributed to the adoption of the policy by Hollande, and Gallois called to thank me,” Aghion says. “There is wider interest in the policy. Italy, Spain, Greece—they should all be interested. It’s an idea that would work.”

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