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Politics of Fiscal Consolidation

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(Originally published 29 March 2010)
 
How best to implement fiscal consolidation? The technical aspects of the question are absorbing. But they are of secondary importance, because fiscal consolidation is first and foremost a matter of politics. Governments do not initiate – let alone successfully implement – serious fiscal consolidation unless they believe it to be a political winner. And the only way this happens is if the electorate becomes convinced that there is a fiscal crisis which threatens the society as a whole.  Only then are voters prepared to accept the bitter medicine of spending cuts and tax rises which consolidation necessarily entails.

If a country reaches the point Greece is in now, it is the financial markets which deliver the message of crisis to the voters. But no country wants to find itself in that position. Far better to take the matter in hand and achieve an internally-driven fiscal consolidation. But for this to happen, the political leadership itself has to persuade the electorate of the seriousness of the position.
 
This is why successful internally-driven fiscal consolidations usually follow a change of government. Incumbent governments can’t deliberately set out to scare voters that the country is standing on the brink of a financial abyss. To do so would be, in effect, to confess to voters that they have disastrously mismanaged public finances. It is only the political opposition which can gain political advantage by telling voters how disastrous things are – and maybe, for good measure, exaggerating the position.
 
Politics are also the reason why the real tough work required for a successful fiscal consolidation usually takes within the first two budgets after a change of government. If this doesn’t happen, the sense of urgency amongst voters dissipates. Political support for consolidation falls away rapidly, with the electorate falling prey to what the London-based Institute for Government calls – in its interesting recent report Undertaking a Fiscal Consolidation – “consolidation fatigue”.

I am convinced that “fiscal culture” is all-important. In countries with conservative fiscal cultures, community attitudes towards government debt and deficits make it relatively easy to stir voter fears about the state of public finances. Germany and Australia are prime examples. In this type of countries, it can be the case that the most naively conservative notions of public finance – for example, that all debt is wrong and represents an unfair burden on future generations – are widespread, and provide a launching pad for fiscal consolidation.

At the other end of the spectrum are cultures where there is little tradition of concern about these issues, and where even amongst intellectuals it is fashionable to dismiss any concern about fiscal sustainability as reactionary. I fear that, apart from the usual southern European suspects, France also falls in this category. In such countries, it is extremely difficult to convince the community that there is a problem. There is then a high probability that the country will fail to deal with fundamental imbalances in public finances internally, prior to the point at which an external funding crisis arises.

It is politics which make fiscal policy in the wake of the crisis so difficult. Good economics  demands a “nuanced” fiscal policy. Consolidation should not be so quick or radical as to threaten the recovery, but should not be avoided as recovery gains strengthen. But good economics is not good politics, and there is not much room in the political debate for nuance. In countries with a culture of fiscal conservatism, fiscal consolidation is likely to take place too quickly and too savagely. And in countries without such a culture, the danger is that action will be postponed until it is too late to avoid a full-blown external crisis.
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