The Politics of Fiscal Austerity: Can Democracies Act With Foresight? Paul Posner George Mason University

The Politics of Fiscal Austerity: Can Democracies Act With Foresight? Paul Posner George Mason University

Fiscal Crisis Affects Nations Differently Group 1: Fiscal foresight includes Australia, Canada, Korea, New Zealand, Sweden and Finland. Group 2: Fiscal crisis victims including Greece, Iceland, Ireland, Portugal, Italy and Spain. Group 3: other euro area countries escaping fiscal crises including Austria, Belgium, Estonia, France, Germany, Luxembourg, the Netherlands, Slovenia. Group 4: debt market immune nations including Japan, Switzerland, the United Kingdom and the United States.

Gross Debt (% of GDP) IMF Gross Debt Averages 140.00 120.00 100.00 80.00 60.00 Group 1 Group 2 Group 3 Group 4 40.00 20.00 0.00 2006 2007 2008 2009 2010 2011 2012 2013 Year

Deficit Reduction Needed to Stabilize Debt

GAO Long Term Model for Current Policy Alternative

Need for early action Stein s law Advantages of early action Avoid the pain of a fiscal shock Intercept vicious cycle of interest costs Improve economic growth Secure smoother transition to program reform Promote political stability

Erosion of faith Advanced democracies are incapable of Acting with foresight Instituting fiscal sacrifice Nordhaus A perfect democracy with retrospective evaluation will make decisions biased against future generations. Political leaders face electoral retribution not reward from fiscal consolidation Ambivalence of credit markets

The costs of crisis driven change It is said that democracies can only act during a crisis Yet a crisis precipitates Bad economics with austerity at the worst possible economic time Bad politics with precipitous changes foisted on unprepared publics Bad economics and bad politics reinforce each other Waiting for a crisis is the highest risk strategy both economically and politically

Political Fallout of Nine European Nations

Implications of Austerity for Political Trust

Fiscal Swings for Major Consolidations OECD Nation Period Fiscal Swing as %GDP Australia 1992-2000 7.5 Canada 1992-2000 11.1 Finland 1992-2000 12.3 New Zealand 2000-2006 5.9 Sweden 1993-2000 14.9 United Kingdom 1993-2000 11.7 United States 1992-2000 7.4

OECD History of Consolidations.++ 85 episodes from 1974-2004 Median improvement in deficit 2.8% of GDP Median duration - two years

Deficit/Surplus as a Percentage of GDP (2000-2010)

Major Policy Reforms and Crisis: Reforms without crisis 1982-2010 Reforms with crisis Uncertain 1982 TEFRA 2002 DHS 1983 Soc Security 1986 Tax Reform 2002 Sarbanes Oxley 1988 Medicare Catastrophic 1990 Clean Air 1993 Deficit Reduction 1994 NAFTA 1996 TANF 1996 Farm Reform 1997 Bal Budget Act 2010 Health Reform 2010 Financial Market Reform 1990 OBRA

Fiscal Consolidation Triggers for Case Study Nations Country: Triggers Market Crisis Economic Pressures Political Blame Avoidance Canada (1993-97) 1 3 2 Australia (1994-98) 1 2 3 Sweden (1994-97) 3 2 1 United States (1990-98) 1 2 3 New Zealand (1984-93) 3 2 1 1= least important 3 =most important

Economic Growth rates and Consolidation

Political Institutions Political timing is critical honeymoon after election Transparent campaign focused on deficit Many political regimes can be effective. --Strong ruling parties effective --Coalitions can be effective in blame avoidance --Particular leverage enjoyed by parties taking counterintuitive actions No single party or ideology most successful

Political Systems Presidential Unified Presidential Divided Parliamentary Single Party Parliamentary Coalition Australia (1994-98) X X Canada (1993-97) X New Zealand (1984-93) X X Sweden (1994-97) X United States (1990-98) X X

Multiparty Strategies to Reform Pensions The political cohesion of governments is important Strong majoritarian parties are important but. Multiparty coalitions are often necessary --Canada reform of the Canada Pension Plan was adopted after two-thirds of the provinces supported the arrangement. --Spain the 1996 Toledo Pact is an all party agreement ratified by unions and employers association for reform of the Spanish old age security system. --Sweden the 1998 reform was developed through an allparty agreement resulting in incentives to prolong work and create notional accounts. United States 1983 commission developed a bipartisan pension reform extending retirement age and raising taxes.

Imposing Losses: Strategies Shared Sacrifice Compensation of Losers Phasing in Cuts/Backloading Broad Sweeping Changes Long-term Reforms

Cold Shower vs. Gradual Consolidations

Fiscal rules Expenditure ceilings and balanced budget rules are both important Fiscal rules are associated with successful consolidations Difficult to unwind cause and effect Reinforce but don t create political will

Electoral Success of Surplus vs. Deficit Nations Country # of times surplus was achieved (2000-2008) # of times governing party changed (2000-2008) Election after GFC Elections Surplus Nations Change in Government Australia 9 3 1 Incumbent won Canada 6 4 1 Incumbent won Denmark 8 2 0 Opposition won Finland 9 2 2 Opposition won Korea 9 5 3 No election held yet Luxemburg 8 1 0 Incumbent won New Zealand 9 3 1 Incumbent won Norway 9 2 0 Incumbent won Sweden 7 2 1 Incumbent won Deficit Nations Greece 0 2 1 Incumbent won/lost Portugal 0 2 0 Opposition won Spain 3 2 1 Opposition won Italy 0 2 3 Opposition won Hungary 0 2 1 Opposition won

The Politics of Austerity: What are the Incentives? Political incentives Retrospective voting and the economy Market pressures Bond markets and interest rates Long term time horizons of elites Elected officials Interest groups Norms of fiscal performance

The Politics of Fiscal Austerity: How Can Leaders Overcome Opposition Public ambivalence about fiscal consolidation Cyclical public views on importance of deficits Leaders can reframe what the debate is about Shifting focus from one area of public consensus to another Public both wants benefits protected and strong economy

The U.S. Fiscal Prospects in Comparison? Fiscal Strengths Strongest economy Low revenues Lower defense profile Growing population Fiscal Weaknesses Strongest economy Highest health care Polarized politics

Prospects for Grand Bargains: Party leaders anxious tor deal High interest rates 1990 vs. 2013 1990 2013 x x Threat of sequester x x Fiscal opportunity x x Divided govt x x International threat x