A silver lining in the ideological storm clouds?

In the AFR yesterday my CIS colleagues Gaurav Sodhi and Jeremy Sammut see a rare silver lining in the ideological storm clouds of the financial market meltdown. The driver of bloated government – the easy money flowing into Treasury’s coffers during a long boom – is about to slow. And

[as] government revenues [] fall, [] there won’t be the same scope for irresponsible spending promises. This is no bad thing. More straitened times give governments an excellent opportunity to implement unpopular measures, strike down bad policy, and enact new reforms.

History suggests that real cuts in spending are very rare, occurring only at the tail end of long periods of severe deficits. Dire fiscal necessity can let politicians get away with truly tough decisions; it is not enough that money is tight or spending programs are a waste of money. The largely petty savings in the first Rudd Budget, despite the big talk about spending constraint and the start of a new government being politically the most favourable time to make cuts, suggest how hard governments find tackling the areas that drive big-dollar spending: welfare, health, education and defence.

Though I have not seen an analysis of the number of new Budget expenditure measures over time, I would expect that the main fiscal benefits in times of budgetary constraint come from avoiding new spending programs rather than slashing old programs. While in business recessions flush out bad firms and replace them with better firms, in government it is more likely that mild recessions will just stop new programs starting, even though these may be preferable to earlier programs.

While I am less optimistic than Gaurav and Jeremy that good will come of a downturn, their op-ed is a useful reminder that in the real world policies do not go together the way they do in ideological discussions. Ideologically, the free market and small government go together, but in practice that is rarely the case. Successful free markets fuel the tax revenues that drive big government, and create the desire among voters for that money to be spent on them. And a failed market (whatever the precise cause) will push down the revenues that inflate the size of government and, if my theories about tax-and-spend opinion are correct, also create more popular support for lower taxation.

4 thoughts on “A silver lining in the ideological storm clouds?

  1. Charles, that’s exactly what happens. Andrew’s thesis is simply wrong; government spending rises sharply in recessions everywhere, on good Keynesian grounds.

    And it is not ratcheted back in recoveries. That’s the way the long-run trend to ever higher government spending works (as I’ve said elsewhere, there are good economic reasons for that long run trend, around differential rates of productivity growth).

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  2. DD – My thesis wasn’t that spending drops in recessions; clearly not. It drops in recoveries when there are massive deficits. The issue that interests me is whether wasteful new entitlements are more common in good times or bad times. The Howard era was striking for the cost of these, and the hypothesis is that these happened because there was more money coming in than they knew what to do with and therefore did not need to make difficult decisions. In tighter times such largesse is less likely; the increase in spending during recessions will be driven by the entitlement programs automatically expanding and once-only measures more than by new or increased entitlements. But I don’t recall seeing any empirical work on this. The budgetary situation during the later Howard years was so unusual that it may be hard to find similar circumstances with which to compare it.

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  3. I thought Sinclair Davidson or Des Moore demolished this myth that ‘starving the beast’ works in an edition of Policy or IPA Review?

    While it would be nice if governments eased up on wasteful spending when the budget goes into deficit, the reality is that they do not. Governments can still borrow money, raise taxes or finance it through the printing press. The US example – they have a budget deficit in the billions – is particularly instructive.

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