by Dr Patrick Nolan, Chief Economist, Reform
Spending cuts is the only game in town. Both the OECD and the Governor of the Bank of England have (in their own ways) emphasised a need for a debate on reducing government expenditure and debt. In April this year Reform released a detailed plan for expenditure reductions of at least £30 billion from 2010-11. The proposals in the report were widely debated in the media and at a series of lunch seminars, which highlighted that restoring the government’s finances requires being honest with the electorate about what has to be done.
As politicians such as David Cameron and Vince Cable appear to have recognised, making so called ‘efficiency savings’ will not be enough. The fiscal situation requires bold measures like addressing middle class welfare, reducing pay and employment in the civil service, focusing defence procurement on the UK’s real military needs and controlling increasing health expenditure.
Yet there has been limited political appetite for outlining a clear programme of expenditure and deficit reductions. International examples, however, highlight that UK politicians may be unnecessarily cautious – many countries have undertaken major programmes of reform that have restored fiscal creditability and improved the quality of their services. To highlight possible lessons from governments that have successfully reduced deficits this article briefly looks at reforms in New Zealand and Canada in the 1990s. (Many other examples could be given from countries such as Australia, Chile and Sweden.)
New Zealand 1991 – Self Reliance and Private Enterprise
A centre-right government was elected in New Zealand in November 1990. The incoming government faced a larger than expected fiscal deficit (approaching 20 per cent), as the economy moved into recession and funds were required to stop the country’s largest bank from collapsing. In 1991 the Minister of Finance, Ruth Richardson, introduced a wide-ranging budget (which, evoking memories of the 1990-91 Gulf War, came to be known as ‘the mother of all Budgets’). Key initiatives contained in the Budget included:
• removing middle class welfare, such as replacing a universal child benefit with targeted family assistance. This reduced the degree of churn in the welfare system, where tax rates on higher income earners were used to fund transfers they receive with associated administrative and deadweight costs. David Cameron and Vince Cable have raised similar concerns regarding the need for tax credits in the UK to be more effectively targeted to families in need
• addressing the growing costs of pensions, through reforming the levels at which pensions are paid, adjusting the degree to which assets and incomes are taken into account in the assessment of entitlement, and raising the qualifying age
• reforming main welfare (e.g., benefits for people out of work) and supplementary assistance (e.g., housing assistance) to improve incentives for work
• restructuring the health system to separate funding from provision of services and introduce part-charging patients for in-hospital and outpatient services (and moving towards a defined list of core treatments the state would fund).
Some elements in the new government saw this budget as principally about bringing a runaway fiscal deficit into balance and being consistent with principles of self-reliance and private enterprise. Other elements viewed this budget as supporting an enterprise culture through encouraging a profound change of attitude and behaviour. This focus on an enterprise culture reflected the influence of the Chicago and Virginia schools of economic thought.
To ensure that the shift towards a more prudent fiscal policy achieved in the 1991 Budget became permanent, in 1994 a Fiscal Responsibility Act was introduced to improve fiscal policy by specifying principles of responsible fiscal management and strengthening reporting requirements. This Act highlighted the importance of transparency of fiscal plans and aggregates in ensuring ongoing political commitment to reducing public debt.
Canada 1994 – Nothing is Off Limits
Federal government net debt in Canada increased from the 1980s through the early 1990s as a result of lower economic growth, reaching 70 per cent of GDP by 1994. Debt servicing costs were rising and adding to the fiscal deficit, further increasing debt.
During the tenure of Paul Martin, Liberal Finance Minister from 1994 to 2002, Canada was the first G7 nation to return to budget balance after the recession in the 1990s, the debt-to-GDP ratio was reduced by 20 per cent (the largest decline among G7 nations) and unfunded pension liabilities were addressed.
As with New Zealand in the early 1990s, reductions in debt were achieved by taking a broad approach to reform. No areas of expenditure were off limits. Focus also went beyond merely limiting the growth of expenditure and making ‘efficiency measures’ (which may help reallocate expenditure but not reduce debt).
These reforms also highlighted the importance of looking beyond the short-term costs and benefits of cuts. Deficits increase the requirement to raise the taxes facing future generations of workers (or reduce the entitlements they will eventually receive), and represent transfers of wealth from the future to the present. A key lesson from these reforms was thus that providing assistance to the well-off through increasing burdens on future taxpayers cannot be seen as fair. When it comes to reform, being bold can and has worked.
