Monday, November 23, 2009

Yes We Can

Do we really need to go through all that again?

Tyler has lost count of the times he's heard supposedly well informed people say something like "no government has ever succeeded in cutting public expenditure" (eg see here). Of course, it's completely untrue - even UK governments have sometimes managed it. But the myth persists.

Unfortunately, it's a myth that could prove highly damaging to us over the next few years. Because by suggesting we can't expect to correct our huge fiscal deficit through spending cuts, it nudges our politicos even further towards the perceived easier option of tax rises. Which is precisely what M Portillo suggested over the weekend (although see this excellent riposte from Andrew Lilico).

Now PolicyExchange has published an extremely timely paper looking in detail at twelve historic examples where governments have tackled big fiscal deficits. Written by Andrew Lilico, Ed Holmes, and Hiba Sameen, it stresses that each case has its own particular features. But the succesful programmes do share some important common themes.

It's well worth reading the paper for yourself, but the points that jumped out at Tyler are:
  • Fiscal consolidations can promote growth and recovery – particularly by enabling a looser monetary policy than would otherwise have been the case. Provided that spending cuts dominate over tax rises, tightening appears to be more likely to promote recovery than impede it (partly through lower bond yields - eg Sweden and Finland in the 1990s)
  • Fiscal correction should be biased towards spending cuts. Successful consolidations have typically placed around 80% of the burden on spending cuts; 20% on tax rises (cf Labour's fiscal tightening following the 1967 devaluation which loaded too much on tax rises and proved unsustainable)
  • Persistance: initial failure does not mean it can't be done (eg Canada had three failed attempts before succeeding)
It is an extraordinarily thorough paper, and just for future reference, here is the summary table listing the twelve cases examined, and showing how much spending was cut in each one (click on image to enlarge):

As we can see, all 12 involved real spending reductions, disproving the assertion we began with. The 1920s Geddes Axe (see this blog) was by far the most severe, but the 1976 IMF 4% cut was also pretty chunky.

The bottom line is that substantial spending cuts are always possible. Never easy, but always possible. And in terms of going for growth they are infinitely preferable to tax rises.

But what is needed more than anything else is will - the will to do it. And that's where right now we still seem to be some way off the pace.

The historic experience surveyed in this paper reminds us that the politicians rarely lead the public in this respect. There needs to be a palpable sense of crisis, of the the kind we oldies can recall from the 1970s. It was the emergency summons to the IMF that forced the policy action, but the sense of crisis had been brewing for much longer.

And for those who don't remember, the PolicyExchange paper helpfully provides a series of splendid quotes from the time:
  • ‘Good-bye Great Britain. It was nice knowing you.’  Headline of Wall Street Journal article advising readers to withdraw from sterling investments, 29th April 1975.
  • ‘England ist kein entwickeltes Land mehr.’ [‘England is no longer a developed country’] West German Chancellor Helmut Schmidt.
  • ‘RIGSBY:This country gets more like the boiler room of the Titanic every day: confused orders from the bridge, water swirling around our ankles. The only difference is they had a band.’  Eric Chappell, Rising Damp, popular TV sitcom, 1977 (pic).

Those who forget the lessons of history are of course condemned to repeat them. But do we really have to sit through the entire back catalogue of 1970s sitcoms before we act?

PS This paper has a lot of nice charts - well worth a persusal. One of my favourites is this one which neatly summarises something we've blogged many times on BOM - the inverse relationship between longterm GDP growth and the share of public spending in GDP:

Now, what could be clearer than that?


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