When Governments Cut Spending
Do governments ever cut spending? According to Dr. Stephen Davies, there are historical examples of government spending cuts in Canada, New Zealand, Sweden, and America. In these cases, despite popular belief, the government spending cuts did not cause economic stagnation. In fact, the spending cuts often accelerated economic growth by freeing up resources for the private sector.
When Governments Cut Spending
What history, and both recent history and the most distant past history tells us is that bringing your spending under control through budget cuts and stringency bears big dividends in the short term and the medium term. Obvious case is Canada. Canada’s public finances in the 1990s were in a truly terrible mess. They took drastic action. They imposed across the board 10 percent cuts when Paul Martin was the finance minister in Canada under the Liberal Party government at that time. The result is that now Canada has been very lightly touched by the current financial crisis, and the Canadian public finances are in extremely good shape.
Another example is Sweden, where various steps were taken by both the nonsocialist and socialist government during the 1990s to address the then-perilous state of the Swedish public finances. The result again is that now Sweden has a large amount of money available. If it wants to spend money, it does not face a prospect of either significant spending cuts or of major tax increases. On the contrary, they’re looking to reduce taxes. They have room to maneuver. They can reduce taxes and alleviate the burden on all new taxpayers. By contrast, countries and governments that persist in excessive spending find themselves in the situation where they have absolutely no room to maneuver, and they have loaded an enormous burden of debt repayment onto future generations.
There’s no historical credence to this very popular idea, that cutting spending now will actually slow down the economy and actually lead to a double-dip recession or an increase in economic stagnation. The U.S. after World War II is a very good counter example. It’s hard to realize now, but there was widespread expectations in the United States in 1945-46 that once the war ended and the military spending came to an end there would be a return to recession or even the Great Depression. There was a general expectation that all this government spending would simply lead to a collapse in economic activity once it was withdrawn. In fact, as we know, exactly the opposite happened. As the defense spending of the war years was wound down and government was pulled back in other ways as well under the Truman and then the Eisenhower administrations, the result was an enormous period of sustained growth in the United States and, indeed, in other countries, which also went through a similar process.
The evidence of countries that have made major reductions in public spending, such as Canada, New Zealand, and a number of other countries, is that in fact economic growth accelerates after major reductions in public spending. And in some ways this is quite obvious, and it’s easy to see why this should be the case. It’s because the money that would have been lent to the government or taken by the government in taxation is now available for other purposes, productive purposes.
There’s also the fact that people are more confident about the future because they no longer fear future tax rises in order to pay for the debt that’s currently being accumulated. And as such they’re more confident to make productive investments and undertake activity that’s going to create more wealth.
So there is no evidence at all, I would say, that reductions in government spending are going to bring about the kind of effects that many people argue for. And a lot of evidence, in fact, to the contrary.
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Comments
Referring to Clinton's surpluses is an excellent indication that you have no idea what you are talking about.
"The private sector is equal, if not worse, than Gov in wastefulness."
You have got to be kidding. The private sector, although imperfect, is bound by its failures, by its wastefulness. In order to profit it must trim the fat. Government is composed almost entirely of fat. If private sector decisions are flawed, they need to be rectified or the business suffers, unless subsidized by government so we can all share the misfortune. The government is by no means bound by the same awareness. The government has a history of throwing good money after bad. By its very nature government spends wastefully. A centralized system cannot know who needs what or where or how many at the precise time or place it is needed with more certainty than the one who needs it. That's exactly why the free market exists. It is the natural state of economics, the efficient use of scarce resources.
"it was not the gov that built McMansions, and bought 2nd, 3rd and 4th homes"
Who purchased McMansions and 2nd and 3rd homes? Private individuals. How? By government creating a bubble that seemingly made them affordable. The owners were then foreclosed upon when the reality of ballooning and unsustainable mortgage payments hit home, and the banks then owned the homes. Too many foreclosed upon homes and no buyers hit the banks hard. The potential of banks too big to fail were bailed out by the government. And so, essentially, the government bought all those McMansions and 2nd and 3rd homes. And now they spend millions annually on mowing lawns instead of selling them at a bargain.
"That is no different than removing every street light and stop sign and sending the traffic cops home and thinking the drivers will just figure it out."
But they DO figure it out! Have you ever driven in an area where the traffic lights were not functioning? Did you ever come to an intersection with no stop signs? Did you panic? Of course not. More likely you applied a reasoned civilized mind and waited your turn. Why? Because your life was at stake, not just a ticket.
@hangemhi:
Speculative bubbles do not occur in sufficiently decentralized economies, which we don't have anymore due to such institutions as central banks which effectively monopolize interest rates, and due to legislation that affects everyone in a certain way across the board, instigating individual action that is ultimately unsustainable as it is being driven by improper signals. You're blaming gravity for a plane crash. It is centralized motives that distort markets; not the fundamentals of human nature that exist in both stable and unstable economies.
Whenever recession occurs it is only the necessary aggregate result of the economy as a whole reacting to bad information. Recession is a kind of "detox" through which capital is reoriented toward its most optimal uses as people re-evaluate what has the greatest utility in their own lives. For government to prevent recession by borrowing or inflating the currency only perpetuates the distortion of signals and thus creates new bubbles which must themselves detox. There are at least 6 different bubbles brewing in the American (and global) economy due to the federal government's attempts to "stimulate" it. These will bust and it will be bad. The best thing a government can do after it causes a recession is to just stop interfering and allow the economy to decentralize again.
What this "economist" apparently doesn't realize is that there are two sources of money - private sector debt and gov "debt". The ONLY times when economies didn't suffer major cuts to Gov spending is when a) the private sector took on debt like Clinton's surpluses when private debt started to skyrocket, or b) saved money was spent - as in the case of soldiers coming home, or c) money re-directed from unproductive to productive uses (from tanks to cars, from war planes to well, anything at home). Meanwhile, the UK is proving right now that a Gov cutting spending when none of the above 3 things are happening leads to recession/depression.
As for AnOasis' comment, this "free market" monetarist idea that Gov always spends wastefully - it was not the gov that built McMansions, and bought 2nd, 3rd and 4th homes, and speculated to high heaven in both the 20's and the 00's. The private sector is equal, if not worse, than Gov in wastefulness. Gov didn't create dirivitives, that was Wall St. Both can do great good, and both can do great harm. Placing all the blame on Gov spending is idealogy, not economics. Understanding that the Gov and Private Sector are like two parents who must work together should be obvious, but ever since Reagan/Thacher we've come to believe that the private sector should do everything and Gov should just get out of the way. That is no different than removing every street light and stop sign and sending the traffic cops home and thinking the drivers will just figure it out.
The simple analogy is that governments do not spend wisely. They do not have the ability to do so, history tell us this and yet we do not learn from history. All bad governments do is to create bubbles, bubbles which when they explode cause problems.