THE STATE MUST LIVE WITHIN ITS MEANS?
By Louis-Philippe Rochon
How many times have we heard politicians say ‘the government cannot afford it’ or ‘the government cannot live beyond its means’? These statements have become the foundation of austerity policies around the world, as they are used to justify fiscal restraint, under the assumption that less government spending somehow contributes to higher economic growth. This notion is known as fiscal consolidation or more generally ‘sound finance’ or fiscal responsibility.
Moreover, these warnings are usually accompanied by dire consequences: failure to follow these austerity policies, it is argued, will result in economic catastrophe. For instance, if governments spend too much and increase fiscal deficits and debt, the inevitable result, we are told, is that inflation will soar, interest rates will increase, economic activity will slow and unemployment will increase. Worse, governments may have to default on their debt, being unable to meet financial commitments. Worst of all, there are intergenerational consequences: by spending too much today and living beyond our means now, it will be up to our children and grandchildren to pay back our debt. Hence, we will enslave our children and grandchildren, who will end up paying for our sins today.
At this point, governments begin cutting expenditures, the burden of which is usually asymmetrical—it is not shared by all equally. Governments usually begin by cutting social programs that serve the poor and less fortunate, that protect minorities and minority rights. Austerity also disproportionality affects women. If this is correct, then it suggests austerity is a class-based policy aimed at shifting the burden of fiscal consolidation on to those who depend on the generosity of the state (compare the 11th chapter on the two worlds of austerity).
What makes matters worse is the fact that there are very few credible studies supporting the idea that government spending leads to such economic problems. The most famous was that by Reinhart and Rogoff, Growth in a Time of Debt, in which the authors claimed that a debt-to-GDP ratio of over 90 percent would lead to slow or even negative growth. It was highly influential in persuading many governments in 2010 to revert back to austerity, having in 2009 initially embraced Keynesian stimulus policies, which were proving to be working. That infamous study was famously debunked by a doctoral student at the University of Massachusetts Amherst (compare the chapter on Mickey Mouse numbers in economic history). So where do these ideas come from? Essentially, they emanate from two sources—one theoretical, one ideological.
On the theoretical side, the notion that governments cannot live beyond their means comes from an analysis which reduces the actions of the state to those of the individual worker or even of firms: since you and I cannot live beyond our means, then neither should the government. This confuses micro-economics and macro-economics and is a fallacy of composition—assuming that what is good for an individual (micro-economics) must also be good for the government or the whole economy (macro-economics). For instance, an individual may benefit from reducing his or her expenditures and saving for a rainy day: increased savings will undoubtedly make one more financially secure. But imagine what would happen if everyone started to save money—the economy would necessarily suffer.
Moreover, proponents of this myth suggest the same logic must apply to the state: it too would greatly benefit from reducing its spending (compare the chapter on Swabian-housewife economics). The analogy is quite misleading. An individual needs to live within his or her means largely because his or her income is fixed: workers cannot unilaterally raise their income. But government can increase its revenues, by raising various income or consumption taxes. These policies may not prove popular with voters, but the government can always raise revenues—it is not constrained in the same way the public are. Moreover, if a worker has a deficit, he or she has no choice but to reduce spending. In the case of the state, it has the ability not only to raise revenues but can also find ways of financing a deficit, over many decades.
Also it is not entirely true to say that individuals cannot live beyond their means. While we cannot be overburdened with debt and ‘live beyond our means’ for an extended period, we nevertheless accept debt over the short run: we borrow to invest in our education, we borrow to buy a car or a house—these are good or productive debts. Students often will struggle to pay back their debt but, ultimately, they prosper: by borrowing to go to university, they are essentially investing in themselves, which will hopefully allow them to have a better job and a higher salary, which in turn will benefit society as a whole.
The same applies to the government: borrowing to build new bridges, roads or schools will improve our infrastructure, not only today but for our children. In other words, if used properly, government debt can benefit society for generations. In fact, the idea that debt is a burden on our children is not only wrong but deceptive. By not investing in our infrastructure today, we are in fact bequeathing to our children an economy deprived of the tools required to grow and prosper. It is by not spending today that we cripple our children’s and grandchildren’s wellbeing.
The ideological reasoning is perhaps more problematic, if not outwardly dangerous. Those who advocate austerity or claim governments cannot live beyond their means mask a desire to see smaller governments—for them it is the size of government that is problematic. The state is seen as a beast which impinges on our wealth, rights and freedoms and, as such, cannot be trusted to manage the economy, which is best left to market forces. Capitalism is seen as a stable and self-reinforcing system—governments are the source of our economic problems.
This is a problem of vision. For many, the state is a generous institution capable of dealing with the shortcomings and uncertainties of capitalism, by protecting those who need it most, and by addressing the weaknesses of capitalism, which is seen as inherently unstable and tending towards periods of great instability. The state can mitigate the peaks and troughs by managing aggregate demand in a just and generous way.
In this light, austerity and associated reduction in public expenditure has a more sinister objective: to shrink the size of government and de facto the influence it has on markets, economic activity and individual wealth—if one believes in ‘free-market’ ideology, it makes sense to want to reduce the size of the state. Advocates propose lower taxes, claiming this will be stimulative. But lower taxes imply less government revenue, which, coupled with the austerian desire to balance budgets, must lead to less expenditure.
Indeed, there is an enormous amount of literature which shows, convincingly, that government spending stimulates economic activity. Social programs serve not only social objectives but an economic one as well: providing daycare allows more women to enter the workforce; providing health care makes for a healthier workforce and can generate more efficiencies and productivity gains. Higher wages increase productivity and support aggregate demand. In general, fiscal stimulus can lead to more private-sector activity.
In the end, the myth of comparing the actions of the state with those of an individual worker is misplaced. And the consequences, to paraphrase John Maynard Keynes, can be ‘misleading and disastrous’.