By Mariana Mazzucato and Anna Hope Emerson
October 26, 2026
In the corridors of power from London to Washington, a familiar, stifling narrative has taken hold: the idea that governments are essentially out of options. As global inequality widens and the cost-of-living crisis erodes the standard of living for the middle and working classes, the prevailing orthodoxy remains unchanged. We are told repeatedly that "fiscal space is tight," that the ledger must be balanced, and that the state is an overstretched actor that must retreat to make room for private-sector dynamism.
Yet, this narrative of inevitable constraint is increasingly revealed as a self-imposed prison. By equating "fiscal responsibility" with the narrow, accounting-based logic of cutting deficits and debt, policymakers are failing to account for the true nature of economic health. True fiscal responsibility is not about shrinking the balance sheet; it is about building the capacity of an economy to grow, to absorb systemic shocks, and to fulfill the fundamental social contract.
As we look toward the remainder of the decade, the debate must shift. The question is no longer whether the state should intervene, but how it should intervene. It is time to move past the binary obsession with ownership and toward a sophisticated, mission-oriented model of state capacity.
Main Facts: The Myth of the Empty Purse
The central fallacy of contemporary economic policy is the belief that public investment is a cost to be minimized rather than an asset to be managed. When governments prioritize short-term deficit reduction during periods of economic fragility, they often trigger a "pro-cyclical" trap. By slashing public investment, they undermine the very drivers of long-term growth—innovation, infrastructure, and human capital—that are necessary to service debt in the future.
The empirical record is clear: when fiscal rules are applied blindly, public investment is invariably the first item on the chopping block. This is a strategic error of the highest order. Austerity, far from stabilizing debt-to-GDP ratios, often leaves them higher by choking off the economic expansion required to generate tax revenue.
Chronology of a Failed Paradigm
To understand our current malaise, one must look at the recent evolution of fiscal policy:
- 2008–2012 (The Post-Crash Austerity Wave): Following the global financial crisis, many advanced economies pivoted prematurely from stimulus to austerity. The result was a "lost decade" of sluggish growth, stagnant wages, and the degradation of public services.
- 2020–2022 (The Pandemic Interlude): The COVID-19 pandemic forced a brief, necessary suspension of fiscal orthodoxy. Governments deployed massive direct support, proving that fiscal capacity exists when the political will is present.
- 2023–2025 (The Return of the Rules): As inflation rose, central banks tightened monetary policy and fiscal hawks regained influence. The rhetoric returned to "fiscal consolidation," ignoring the structural requirements of the green transition and the digital shift.
- 2026 (The Current Crossroads): As we sit in late 2026, the failure of this return to austerity is becoming manifest. Debt-to-GDP ratios remain elevated, while the private sector—hampered by a lack of public investment in foundational technologies—remains hesitant to lead the charge on climate and industrial strategy.
Supporting Data: Why "Fiscal Space" is a Choice
The data suggests that the "tightness" of fiscal space is largely a matter of political architecture rather than economic reality.
1. The Multiplier Effect: Research consistently shows that public investment in R&D, green infrastructure, and public health carries a high fiscal multiplier. Every dollar of strategic public spending can generate several dollars of economic activity over the long term. Conversely, cutting public spending during a downturn acts as a drag on GDP that far outweighs the immediate savings.
2. Interest Rates vs. Investment Returns: Critics of public spending often point to rising debt-servicing costs. However, they ignore the productivity of the debt. If debt is used to finance a structural transformation—such as the transition to renewable energy—the long-term productivity gains and the avoidance of climate-related disaster costs far outweigh the interest rates paid on that debt.
3. The Inequality Feedback Loop: Stagnant public investment has contributed to a decade of wealth concentration. Without a proactive state to redistribute the benefits of growth or to provide high-quality public services, the gap between capital owners and wage earners has reached levels that threaten democratic stability.
Official Responses: A Divided Political Landscape
The response from international financial institutions (IFIs) and national treasuries has been varied, reflecting a deepening schism in economic thought.
- The Traditionalists: Many central banks and treasury officials continue to argue that "market credibility" is the primary constraint. They maintain that excessive deficit spending will trigger bond market volatility and crowd out private investment. Their focus remains on supply-side reforms and regulatory easing.
- The Reformers: A growing movement of economists and progressive political leaders is challenging this. They argue for a "Green New Deal" approach, where fiscal policy is explicitly tied to industrial strategy. They point to the successes of state-led investment in sectors like renewable energy and biotech as proof that the state can successfully steer the economy.
- The Skeptics: Critics from the private sector often express concern over "crowding out." However, when asked to provide evidence of where private capital is waiting to fill the void, they are often unable to point to productive, long-term ventures, citing "short-termism" and uncertainty as primary drivers for their own inaction.
Implications: Building State Capacity for the Future
If governments are to successfully navigate the coming years, they must reframe their approach to economic governance. This requires three distinct shifts:
1. From "Market Fixing" to "Market Shaping"
The state should stop viewing its role merely as a "fixer" of market failures—the "referee" that steps in only when things go wrong. Instead, it must become a "market shaper." This means setting ambitious, mission-oriented goals—such as decarbonizing the economy or ensuring universal digital access—and providing the stable, long-term investment needed to achieve them.
2. Redefining Ownership and Stewardship
As noted, the debate should not be about whether the state owns an asset, but whether it is a good steward of that asset. Public-private partnerships (PPPs) have often failed because the state took the risks while the private sector reaped the rewards. A new model of "value co-creation" is needed, where the state ensures that the public receives a fair return on the investments it makes in innovation and infrastructure.
3. Institutional Capacity Building
Fiscal rules must be redesigned. Rather than arbitrary caps on deficits, we need rules that distinguish between consumption spending (which should be balanced) and investment spending (which should be treated as capital expenditure). This would allow governments to borrow for the future without being penalized for building the foundations of a more resilient, sustainable economy.
Conclusion: The Path Ahead
The challenges of the late 2020s—inequality, climate change, and the erosion of the social contract—cannot be solved by the same fiscal frameworks that helped create them. The narrative of "no room to act" is a choice, not an economic law.
Governments must reclaim their agency. They must demonstrate that they have the capacity to identify strategic objectives, mobilize the necessary resources, and ensure that the fruits of economic progress are shared broadly. Ownership is a secondary concern; the primary task is to govern the economy in the service of the common good.
To achieve this, we need a new generation of policymakers who understand that the most expensive action a government can take is not spending money on the future—it is failing to do so. The "fiscal space" exists, provided we have the courage to use it for the right ends. The time for hesitant, rule-bound policy is over; the era of strategic state capacity must begin.
