Eric Crampton: Ratcheting up Govt in a crisis goes just one way

It’s funny how times change.

In 2019, Labour announced its first ‘wellbeing’ budget. It was hardly austere.

Over the prior decade, core government spending, as a fraction of overall economic activity, had retrenched considerably. Core Crown expenses peaked at 34.1 percent of GDP in 2011 – the year of the most substantial Christchurch earthquake, as well as continued government response to the Great Financial Crisis.

From 2012 onward, the economy grew and the government’s share of overall economic activity declined. By 2017, core government expenses were less than 28% of GDP. That fraction did not increase in the first year after Labour’s election. While Labour decided on its overall policy agenda and where it might get the most value for each dollar spent, core government expenses dropped to 27.3% of GDP in 2018.

Come Budget 2019, Labour had decided on its agenda. The size of government would increase as Labour aimed to tackle child poverty and housing, with a ‘wellbeing’ focus.

Governments change. Labour-led governments tend to prefer government to take a larger role in the economy; National-led ones tend to prefer that government take a smaller role.

But Labour’s Budget 2019 promised that while Core Crown expenses would rise by more than a percentage point, relative to the size of the economy, those expenses would remain below 30% of GDP. Spending more than that was reserved for crises, like the response to the GFC and Christchurch earthquake.

Core Crown expenses were projected to rise to 29.6% of GDP in 2021 before stabilising below 29% from 2023. Projections from the standard Treasury models would have Core Crown expenses rise above 29% of GDP in the 2030s as an aging population’s higher health and superannuation costs came to the fore.

But at least over the nearer future, Labour’s agenda in the First Wellbeing Budget promised to hold the Crown Expenditures line well below 30% of GDP.

This is the number to keep in mind when assessing the National led-government’s fiscal agenda. Labour’s expansive first wellbeing budget promised that government spending would, in 2023, be 28.8% of GDP. Because it’s a fraction of GDP, population growth and inflation are already factored in.

In December, Treasury released its Half-Year Fiscal Update. Covid support and expenditure has largely ended. No recession came to accompany Covid; labour markets remain reasonably strong. Nevertheless, Core Crown expenditures, as a fraction of GDP, were projected to slowly decline from 33.4% of GDP in 2024 to 31.4% by 2028.

When Labour took office in 2017, Core Crown tax revenue was 27.5% of GDP. It is forecast to hit 29.1% of GDP in 2024 and 30% by 2028.

These are also numbers to keep in mind when assessing the case for tax cuts, or at least the case for inflation-indexing the tax thresholds. The National-led government could deliver a spending programme comparable to the Wellbeing Budget’s promise in 2019, as a fraction of GDP, while still cutting taxes from where they are now.

But if Luxon today announced a 2024 budget identical to Ardern’s 2019 budget, relative to the size of the economy, he would be criticised for austerity – even though Ardern’s budget was hardly austere.

Covid did not just increase government spending to deal with the pandemic. It also seems to have ratcheted in a very substantial increase in the overall size of government. In December, Treasury forecasted government spending, as a fraction of overall economic activity, to be more than two and a half percentage points above Labour’s longer-term promise in 2019.

Getting government spending back down to the longer-term proportions of GDP that Prime Minister Ardern’s wellbeing agenda had promised in 2019 hardly seems radical or austere. It would simply be a getting-back-to-normal after a crisis.

Getting core government spending down from Ardern’s promised 28.8% of GDP to the 27.7% of GDP that Bill English’s National-led government bequeathed to the incoming Labour government would not be radical either. It would be the normal partisan shifts in the relative size of government that come with changes in government.

Keeping these things straight matters.

When Covid intervened, the Labour-led government achieved remarkable cross-party agreement on substantial government assistance to see us through. The wage subsidy scheme provided support in preventing layoffs during lockdown, helping to enable a faster re-start from May 2020 onward. But a speedy programme was not going to be a cheap one. And vaccines needed to be purchased along with treatments.

Bipartisan agreement on emergency spending funded by emergency debt was straightforward. Everyone expected that it was a crisis response that would be scaled back after the crisis.

But decades ago, economist Robert Higgs warned that post-crisis retrenchments may be wishful thinking.

Professor Higgs looked at American government spending over the Twentieth Century and found a worrying pattern. Every crisis brought a sharp increase in government spending to deal with the crisis. But, after the crisis, spending would only partially retrench before expanding even further during the next crisis.

And so, a one-way ratchet effect meant a continued increase in the size of government. A lot of ground can be covered over decades of two steps forward and one step back.

If fiscal conservatives expect it to be impossible to unwind emergency spending and that New Zealand sits in Robert Higgs’s world, agreement on spending necessary during crises will become a lot more difficult.

Getting post-Covid spending back to what Prime Minister Ardern had promised in the first Wellbeing Budget is hardly austerity. It should be the least that fiscal conservatives should expect.

Dr Eric Crampton is Chief Economist at the New Zealand Initiative. This article was first published HERE