When Governments Cut Spending

Steve Davies,

Release Date
September 28, 2011


Gov't Debt & 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.