Will Budget Cuts Doom Europe's Leaders? A New Paper Suggests No

... but by leaving out examples of past countries whose cuts only led to higher deficits, it tells only half the story

Reuters

Austerity, it appears, is ready to conquer Europe. Last week, the continent's leaders joined hands and agreed to pursue tighter integration on spending policy, including tough rules that would punish profligate governments. Meanwhile, new leaders in Greece and Italy are pushing budget reforms meant to win back the good graces of global investors.

How will all this new frugality play with voters? We have yet to see. But if Europe's heads of state are worried about their next election, they might take solace in a new study by Harvard economist Alberto Alesina.

The working paper, released this week, argues that governments that cut deficits by slashing spending or raising taxes don't necessarily suffer at the polls. Focusing on the years from 1975 through 2008, it looks at the electoral fortunes of governments in the 19 early members of the OECD. Those include rich European nations such as Britain, Germany, and Italy, as well as the United States and Japan. Despite the conventional wisdom that spending cuts and tax hikes are political poison, the study concludes that there is "no evidence that governments which reduce budget deficits even decisively are systemically voted out of office."

The core of the paper is contained in the graph below, which looks at governments that moved to cut deficits either one year, two years, or three years before the next election. It shows that political parties that use tax hikes and spending cuts to close budget gaps are no more likely to get booted from government than parties that spend more while in power. There are some differences. Parties that made large deficit-cutting moves three years before voters went to the polls seemed to do worse than parties that turned on the spending tap. But according to Alesina, the discrepancies aren't statistically significant.

Although he writes that governments can safely raise taxes or cut spending, Alesina suggests that budget cutting may be the better option. In another graph, he shows that governments that tightened their belts instead of raising revenue were a bit more likely to survive their next vote. That was especially the case with large deficit reduction packages.

All of this, of course, is music to a conservative's ear. Indeed, the study follows on a controversial paper Alesina wrote in 2009, which argued that rich nations could successfully spur growth by cutting spending. That work became a touchstone for right-wing wonks.

It also came under serious fire from the IMF, which picked apart its findings in a follow-up study. The IMF zeroed in on the way Alesina defined "deficit reduction" as adjustments leading to an improvement in a government's cyclically adjusted budget gap equal to 1.5% of GDP.* Alesina's study ignored times when austerity measures backfired. For example, Ireland tried budget-cutting in 2009, only to see their deficits deepen as the housing market crashed and revenue dried up. Those kinds of missteps weren't captured in the Alesina's data.

This newest study uses an identical definition of deficit reduction -- and suffers the same shortcoming. Alesina is only looking at what happened to political parties when their deficit reduction plans worked. He doesn't take stock of governments that accidentally torpedoed their own economies with budget cuts and, presumably, would have had to answer to some very angry voters. The bottom line is that Europe's leaders should pay as much attention to what's in this study as to what's not in it.
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*An earlier version of this article misstated the study's benchmark for deficit reduction.