How spending cuts affect election results

Six years ago, a study by Alberto Alesina, Dorian Carloni, and Giampaolo Lecce was published entitled “Electoral Consequences of Large Fiscal Adjustments”. In it, the authors challenge the thesis that large reductions in budget deficits (for which the term “fiscal adjustments” is used) lead to worse electoral results for the political parties that govern during their implementation. After a thorough review of data for 19 OECD countries in the period 1975-2008, they conclude that there is no empirical evidence that governments that implement such fiscal adjustments tend to have a stronger than expected (due to the very fact that they are already in power, the expected result of the parties in the next election decreases) deterioration in electoral results. Moreover, some of the data support the thesis that governments that do not take action to address their fiscal problems lose elections more often than the average for the population considered in the study.

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The authors define “ completion” as a situation in which elections were held during the fiscal adjustment period or within two years of its end. When reviewing the ten largest fiscal adjustments, it is concluded that out of 19 “completions” 7 (i.e. 37%) were followed by a change in government (the number of “completions” is greater than the number of fiscal adjustments considered, since in some cases the period of fiscal adjustments was accompanied by elections more than once). When reviewing only the five largest adjustments, there was a change in government in only 1 out of 10 cases. For comparison, when reviewing all fiscal adjustments, the “completions” that ended with a change in government were 40%. The conclusion is that large fiscal adjustments do not carry an increased risk of loss of power positions for the politicians implementing them.

Econometric analysis of the data leads to similar conclusions. In addition, it is concluded that fiscal adjustments achieved by reducing government spending lead to a lower probability of electoral loss compared to those based on tax increases. According to the authors, the reason for the difficulties in reducing budget deficits is not so much due to political uncertainty about the effect of these actions on electoral results, but to two other factors: the actions of various interest groups (trade unions, lobbyists), as well as the desire of politicians to postpone reforms in order to avoid internal conflicts between individual ministries and agencies in the distribution of reduced budgets.

The study also examines four examples of implementing fiscal adjustment.

Canada

In Canada, in 1992, government spending exceeded 50% of GDP, the budget deficit reached 9.1% of GDP, and the public debt exceeded 100% of GDP. The deterioration of these indicators was due to both the increasing deficit of the provinces and the high cost of labor and low productivity growth. In 1993, a period of fiscal adjustment began, based on three principles: low and stable inflation, structural reforms, and reduction of government spending. As a result, by 1997 the budget was balanced (90% of the fiscal adjustment was the result of reduced government spending, which shrank by more than 11% of GDP). The reduction of the deficit was accompanied by reductions in certain taxes, privatization, and increased flexibility in the labor market. As a result, the ruling Liberal Party was re-elected in the 1997 elections (albeit with a lower result), but fully recovered its performance from the 1993 elections in those held in 2000.

Finland

As a result of the banking crisis of 1991, as well as the loss of markets after the collapse of the USSR, Finland fell into recession in the period 1991–1993, with real GDP falling by 14%. Government spending reached 65% of GDP, and the budget deficit – 7% of GDP. In the period 1993–1998, the level of public debt fell by 6.2% of GDP, and government spending was reduced by 15% of GDP. Social benefits, capital expenditure and unemployment benefits were reduced, and payments for health care and education made by users of these services were increased. Inflation targeting was also introduced for inflation of 2% per year. As a result, the Center Party, which had initiated the fiscal adjustment, lost the 1995 elections, but its successor, the Social Democratic Party (ruling in a broad coalition), continued to implement the measures, managing to win the 1999 elections.

Sweden

In 1991, government spending in Sweden reached 73% of GDP, and government debt represented over 70% of GDP. The budget deficit was 11.2% of GDP, and unemployment reached 7.5%. As a result of the reforms initiated by the government (fiscal adjustment of 8.4% of GDP), in 2000 the budget surplus was 3% of GDP. About 70% of the fiscal adjustment was the result of spending cuts. A ceiling was imposed on government spending in 1996. All transfers from the government to citizens were significantly reduced, including pensions, housing subsidies, unemployment benefits and social assistance. Some taxes were also increased. Since 1995, a scheme of privatization, pension reform and reduction of labor market regulations has been implemented. As a result of the measures implemented, the Social Democratic Party won both the 1994 and 1998 elections, although it lost 7% of the vote. It managed to win a majority again in 2002.

United Kingdom

After the UK left ERM-1 in 1992, a period of fiscal adjustment followed, accompanied by GDP growth (mainly due to consumption growth), low inflation and a decline in unemployment. In the period 1994-1999, the deficit decreased by 6.7% of GDP, mainly due to the reduction of government spending, the reduction of the number of employees in the public sector, the reduction of transfers, as well as an increase in indirect taxes and some customs duties. In addition, tax reform was carried out and the independence of the central bank was affirmed. The Conservative Party lost the 1997 election, but the loss of positions compared to the results of 1992 was not great.

*The text is a summary of a study by Alberto Alesina, Dorian Carloni and Giampaolo Lecce entitled “Electoral Consequences of Large Fiscal Adjustments”, which is available   here . The resume is by Petar Penev, an intern at the Institute for Market Economics.
A link to the original translation of the IME can be found here

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