As the election season reaches full swing, the inevitable claims of who did what and when, and what this means in the future intensifies. One oft-repeated tale beginning to reemerge is that an expansion in public spending during the 2000s is a, or perhaps the leading cause of the subsequent financial and debt crisis. After all, as seen below, the crisis manifested itself in an explosion of the public deficit and overall debt, which eventually culminated in an inability of the government to borrow from financial markets in 2010. While the topic has been much-discussed, it’s worth going over this again as there are several misunderstandings, and some questions which I think elements of the left have had difficulty answering too.
Notes: The Fiscal Balance and Adjusted Balance are shown on the left-hand side, Expenditure and Debt are shown on the right-hand side. Adjusted Balance taken from IMF’s World Economic Outlook. All others are taken from Eurostat.
The most obvious counter to the argument that bloated public spending was at the centre of the crisis is to point out the actual trajectory of fiscal policy in the 2000s. As shown above, Ireland actually ran a surplus (blue line) in all but one year of the 2000s pre-crisis, and also had one of the lowest debt-to-GDP ratios in the developed world. As a proportion of national income, spending increased, but quite modestly considering the low base. Thus, if anything, it was a model of fiscal prudency.
The counter to this is that, yes, the headline deficit was actually a surplus, but this masks underlying structural weaknesses. As we all know by now, the surpluses arose because of transient taxes such as stamp duty and other bubble-related windfalls. There was an expansion in public spending and the headline surplus was in reality a deficit (or as economists would say there was a structural public deficit). This was hidden by a basket-case economy, which delayed the inevitable collapse. In reality, the state was spending money it didn’t have – government profligacy in the form of excess spending has been a root cause of our woes. This can be seen clearly by the evolution of the cyclically-adjusted government balance, which clearly shows a large deficit from 2001 on.
A not inconsiderable portion of the left have difficulty answering this, and as a result it weakens the case for greater public investment in services, infrastructure, and so on. One response is to point to the costs of the bank bailout. Another is to repeat the point that the public finances were in surpluses. Another criticism is that it is in practice impossible to measure a structural deficit: that is, one cannot disentangle structural versus cyclical components of the deficit. I think all of these answers are somewhat weak, and leave open the charge of denial.