Managing the government’s fiscal deficit need not mean cutting social expenditure.

An economic Austerian is someone who advocates cutting government spending, particularly social expenditures, in order to eliminate a government’s fiscal deficits. (The name is a portmanteau of ‘austerity' and ‘Austrian' from the neoliberal ‘Austrian School of Economics'.)

While Austerian policies are currently most evidently being applied in Mediterranean Europe, they are not new to New Zealand. In 1932 the National Expenditure Adjustment Commission made recommendations to cut government spending. Alan Fisher, professor of economics at the University of Otago, satirised the outcome as :

     'We object so strongly to having our own incomes further reduced by taxation that we think the incomes of pensioners should be reduced instead. ... In times of depression it is necessary to curtail the community's consumption of many goods and services. Already people with large or moderate incomes have diminished their expenditure on many of the pleasant but unnecessary things which formerly they enjoyed. Most of them are, however, still tolerably comfortable. A great deal of money is spent on motor cars and holidays, on racing and other amusements. But rather than curtail further expenditure of this kind, we think it will become necessary to reduce expenditure on education, in such a way as will definitely handicap the children of poor parents, and make it more difficult than it has been in the past for them to develop their natural capacities in the way which would be advantageous to the whole community.'

Again in the Rogernomics/Ruthanasia era, the government squeezed its spending while giving substantial tax cuts to those at the top which maintained their real incomes while the economy stagnated and everyone else suffered. (There was no similar response from any economics professor.)

Austerians are concerned about diminishing the role and the size of the state and seize upon a fiscal crisis to pursue their political ends, claiming that their ideologically based actions are the only possible response. They are not. You can be a fiscal conservative, as I am, without being an Austerian.

An alternative, as implied by Fisher, is a balanced reduction in public spending and an increase in taxation so that the burden of adjustment is shared in proportion to how comfortably off people are. (It must be acknowledged though, that the Mediterranean economies do not have as sound a tax system as New Zealand has, which inclines them towards cutting expenditure.)

A fiscal conservative remains wary of building up too much government debt. There are a number of reasons.

First, high debt limits the room for manoeuver in a financial crisis. This was well demonstrated in the response to the Global Fiscal Crisis when the prudence of earlier governments enabled the Key-English government to switch from a surplus to deficit (it did by tax cuts) without too much trouble borrowing (the challenge the Mediterraneans, with their high government debt, face).

But note that while our public debt is low, the private sector owes a lot offshore. There is a danger of private debt shifting onto the government books (as happened during the GFC with the finance company crashes and almost did with the trading banks) so we need low public debt. (It is not only financial crises we need to provide for but also major natural catastrophes such as earthquakes, volcanos, tsunamis, epidemics.)

Second, the debt arises from fiscal deficits contributes to a shortage of domestic savings. The savings deficit drives up the exchange rate, making it more difficult for exporting and import-competing businesses to produce profitably, so that in the long term we have less capacity to service the debt. Thus a fiscal surplus may be necessary to offset the private sector’s lack of savings, especially if the borrowing is being spent on consumption goods (which is broadly true during a speculative bubble such as the one we are having on housing).

Third, a fiscal deficit today is a charge on the future which has to service the debt; it enables us to increase our consumption at the expense of our grandchildren. You may think that is a damned good idea or you may have some moral qualms about burdening them.

The third reason provides some guidance to what the additional spending should be on when it is necessary to borrow (say for business cycle reasons). The obvious answer is infrastructure because the grandchildren will benefit from it while they are servicing the debt its funding incurred.

Not on health and education? Are they not social investments? I am very supportive of such social investment but the logic seems to be that it should be paid out of current taxation rather than by borrowing. Consider X for whom the state borrows to fund their health and education spending. If X subsequently leaves the country, the debt servicing is borne by those left behind. The difference with borrowing for infrastructure is that it cannot leave the country.

Curiously, the logic suggests that such borrowing applies to other spending which remains forever in the country. For instance, if we are serious about a predator-free New Zealand (are we?), then it might make sense to borrow for that rather than for another motorway.

What I have set out here is a general framework. There are lots of caveats, for the devil is always in the detail. The takeaway lessons are that you can be a fiscal conservative who supports more government spending without being an Austerian; that a fiscal conservative generally funds the spending from higher taxes; that a fiscal conservative does not favour increasing public debt in the long run (compared to the economy’s capacity to service the debt); that on those occasions when it is necessary to borrow, the additional spending should be directed to what benefits the later generations who will service the debt.

Comments (2)

by Katharine Moody on May 24, 2017
Katharine Moody

One of the things I have thought might be appropriately funded through government borrowing is some form of financial incentive to our ag sector to de-intensify... a sort subsidy to buy cows off the land that could only be applied/spent by the recipients on debt reduction. Effectively, a sort of transfer of private agricultural debt to government debt in the interests of a cleaner future freshwater environment.  This might allow many heavily indebted dairy farmers in particular to find meeting nutrient/water quality targets much easier.

Just a thought.

by Katharine Moody on May 24, 2017
Katharine Moody

And related to the above;

Another positive benefit of de-intensification.

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