The Political Fallout of Fiscal Adjustment

In a recent VOX column, Alberto Alesina argues that the conventional wisdom surrounding the political economy of fiscal adjustment — that governments that raise taxes and/or cut spending to get fiscal balances under control tend to be voted out of office — is wrong.  This is intended to be encouraging to European governments today, almost all of which face the need for immediate and sustained fiscal adjustment.  But I’m not sure how comforting Alesina’s analysis really is.

The table below shows Alesina’s data for the 10 significant fiscal adjustments undertaken in Western Europe over the past 25 years.  The fourth column shows the number of times a sitting government was upended, while the fifth shows cases where a government survived an election (or a new government was installed with a similar political orientation).  Alesina notes that there were a total of 13 government changes compared to 26 non-changes, meaning government changes made up 33% of the total.  In the full sample of these countries from 1975 to today government changes were 39% of the total, suggesting that governments that were pursuing fiscal adjustment were no more likely to be removed from office.

So far, so good.  However now look at the final column, which shows the average annual growth rate during that period (not included in Alesina’s table but added here using IMF data).  Not surprisingly, governments that ruled over periods of fiscal adjustment and economic growth were considerably more likely to survive.  Of the ten cases above, in those for which average growth was above 2 percent governments were removed from office less than 30 percent of the total.  But when growth was below 2 percent, governments were removed a full 50 percent of the time.

Fiscal adjustment during a period of growth is in some ways quite a different undertaking than during periods of low or no growth.  To begin with, when an economy is growing, fiscal adjustment can occur “naturally”: in raw terms tax receipts will increase, so simply holding the level of service provision constant will help bring the budget balance back in line.  Moreover, during eras of low or no growth fiscal adjustment means a pro-cyclical, anti-Keynesian reduction in aggregate demand just when it is needed most.  It appears voters can swallow higher taxes and/or lower services much more easily during periods of overall economic expansion.

Now, guess what the IMF forecast is for average annual growth in the Eurozone over the next five years? 1.6 percent.  (And this was estimated before the worst of the Greek crisis, so if anything is probably slightly lower today.)  Do you think governments should still be comforted by Alesina’s analysis?

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