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December 19, 2014

The Politics of Fiscal Squeeze: Book Review

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Posted by Richard Allen[1]

The politics of cutting government spending or raising taxes (or both) has dominated public debate in many countries in recent years. A new era of conflict has developed, with old political alignments being tested and new battles emerging over whose expectations are to be disappointed and who should be blamed for fiscal squeeze. Do parties who cut spending always get defeated in the following election? Are there “good practice” cases that every government should follow when it has to cut spending or raise taxes to balance its public finances? Such issues have typically been analyzed from an economic or financial perspective, with a particular focus on the recent financial crisis.

An interesting recent volume of papers focuses on the politics of fiscal squeeze and takes a longer view.[2] In this respect, the commonly held assumption that the financial crash of 2008 and the dramatic policy changes that followed were unique in the history of the world is mistaken. David Heald and Christopher Hood note, for example, that the fiscal travails of the early United States in the 1840s, or the Ottoman Empire after it defaulted on its loan repayments to foreign creditors in 1875, goes beyond anything witnessed in the Eurozone countries in the 2010s.

The volume analyzes case studies ranging from the United States in the 1840s  (when half of the states then in the union defaulted) to the squeeze following the 2011 default in Argentina. It assesses who were the winners and losers, who got the blame, and what were the longer-term effects on politics and government. It argues that “how to do it” approaches to fiscal squeeze in democracies based on apparently successful cases often fail to take into account profound differences in circumstances. Among the nine case studies, those by Alisdair Roberts (on the U.S. crisis of 1836-1842), Christopher Hood and Rozana Himaz (on the UK’s so-called “Geddes axe” of the 1920s), Niamh Hardiman (comparing the two squeezes in Ireland in the late 1980s and post-2008), Anders Lindbom (on the Swedish squeeze of 1990-97), and Donald Savoie (on the “perfect storm in reverse”, Canada’s program review of 1994-97) are especially illuminating. The remaining case studies cover Argentina, Germany, the Netherlands, and New Zealand.

The authors define fiscal squeeze as the amount of political effort that is put into reining in public expenditure and/or raising taxes. This differentiates the term from the idea “fiscal adjustment” which is often used in practice by the IMF and others as a euphemism for higher taxes and/or spending cuts, and often means attempts to change public spending relative to GDP. Fiscal adjustment is a measure of financial outcome rather than political effort. It follows that fiscal squeeze is harder to measure since political effort is not captured by economic or financial outcome indicators. To assist the measurement of fiscal squeeze, the editors adopt the following definitions of the various forms of squeeze:

  • “soft” expenditure squeezes, when either (a) government spending falls relative to GDP, but such expenditure does not fall in constant-price terms, or (b) expenditure falls in constant-price terms but not relative to GDP;
  • “hard” expenditure squeezes, when government spending falls both relative to GDP and in constant-price terms;
  • “soft” revenue squeezes, when either (a) tax revenues rise relative to GDP but such revenues do not rise in constant-price terms, or (b) tax revenues rise in constant-price terms but not relative to GDP; and
  • “hard” revenue squeezes, when tax revenues rise both relative to GDP and in constant-price terms.

Rozana Himaz and Christopher Hood apply this methodology to the data from each of the case studies to assess what form the various squeezes took, and their degree of severity. The authors’ application of statistical techniques to the analysis of complex and sometimes chaotic political events is thought provoking and breaks new ground.  

The book sets out to test three basic hypotheses which, at first sight seem plausible, but for which the data presented suggest mixed results. The authors use the analogy that it is only necessary for one black swan to be identified to disprove the hypothesis that all swans are white. One hypothesis is that there is something essentially different about the politics of fiscal squeeze, as something especially challenging and difficult for the political leadership in modern democracies. The second hypothesis is that fiscal squeeze presents incumbent political parties and leaders with high blame risks, particularly when squeezes are “hard” and more or less endogenous (that is, imposed by domestic politicians rather than brought about by external events or the intervention of outside agencies such as the EU or the IMF). The third hypothesis is that fiscal squeezes are high-consequence, never-to-be-repeated events that lead a long shadow as a result of the changes they bring about.

None of these hypotheses survives the authors’ empirical analysis without an associated black swan. As a general rule, fiscal squeezes can be expected to be electorally toxic, and tax-led adjustments are more toxic than expenditure-led ones. Nevertheless, the editors of the volume conclude that the overall picture “suggests black or at least grayish swans for the idea that fiscal squeeze is clearly and invariably a high-consequentiality affair, in terms of irreversibility of tax and spending changes; for long-term political impact, in terms of major party-system upsets or constitutional change; and for lasting social effects of a broader kind.”

Another interesting finding is that squeezes sometimes (or perhaps usually) reverse themselves. Donald Savoie, for example notes that, following the program review of 1994-97 in Canada: “the moment the prime minister, the minister of finance and the guardians in the central agencies took their eyes off the ball, the machinery of government went back to its old ways, with the spenders quickly gaining the upper hand. Pressure to increase spending came from all policy sectors, all departments and agencies, and all provincial governments.” By the early 2000s, both spending and public service employment in Canada, cut by one-fifth during the crisis, had risen back to their pre-crisis level. 

While the book comes to few definitive conclusions and policy recommendations, it raises many interesting issues where further research would be profitable, for example to adjust the statistical analysis for the impact of the economic cycle. It also notes that future policymakers grappling with the next round of fiscal squeezes are likely to be making decisions whose consequences they may not be able to foresee. The 2008 crisis, for example, which some commentators had expected to mark the end of neo-liberalism, might alternatively lead to its intensification. While not all fiscal squeezes appear to have high long-term consequences, some certainly do, such as the changes in the US constitution resulting from the state defaults of the 1830s. Similarly, New Zealand’s introduction of electoral reform in 1996 seems to have been motivated in part by a reaction against the imposition by a previous government in the 1980s, without serious challenge, of a fiscal squeeze combined with a radical restructuring of the country’s public institutions.  

To summarize, this well-structured and carefully edited volume is strongly recommended for students of public finance, political science, and contemporary history, as well as to the more general reader with an interest in world events and their political and electoral repercussions.



[1] The author is an economist and a consultant with the IMF in Washington DC, as well as a Senior Research Associate of the Overseas Development Institute. He is the co-editor of the IMF’s PFM Blog and of The International Handbook of Public Financial Management, published in 2013 by Palgrave Macmillan. The present article is a slightly adapted version of a review that will be published in Governance in early 2015.

[2] Christopher Hood, David Heald and Rozana Himaz (eds.), 2014. When the Party’s Over: the Politics of Fiscal Squeeze in Perspective. Oxford, England: Oxford University Press. The papers in this volume were written by a group of eminent economists and political scientists and delivered at a conference organized by the British Academy in London in July 2013.

 

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

Comments

Good information; I guess Fiscal Responsibility legislations will do better if at least the budgets are prevented from being 'electoral toxic'!

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