IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
UK might not get a single party government after next month’s election. Again. Moody’s are not worried about the consequences for government finances. They probably should be.
The United Kingdom will hold general election in early May. Pundits speculate about the outcome – whether any party will win a majority or whether there will be a hung parliament or another coalition government of sorts. Moody’s, in business of predicting whether governments would be able to pay their debts, has issued a statement that there is nothing to fear from an inconclusive election result.
Such optimism is unwarranted. Economic research suggests that political instability actually tends to increase government deficits and debt. There are plenty of ways through which hung parliaments, minority or coalition governments tend to deteriorate a country’s fiscal health through at least 6 possible mechanisms.
• 1) Pre-election bribery prolonged. Governments in power are known to “bribe” voters with unfunded spending increases before an election. Lack of a clear winner extends the campaign towards a new early election and more bribery.
• 2) Regional spending increases. In the UK, more than in most other countries, political parties have strong regional affiliation: most regions have been voting the same over decades. A coalition (or “compromise”) government would mean that in addition to general spending, there are now more parties and more regions to endow with particular “pork barrel”.
• 3) Inability to plan a cycle. Pre-election bribery often leads to a “political budget cycle” where pre-election debts are repaid after a clearly-won election (only to run up against repeated deficits at the end of the term). However, if the election is not clearly won, Pasten and Cover show that the repayment stage does not arrive. Uncertain elections therefore reduce also the probability of paying off previous pre-election deficits.
• 4) Lack of legitimacy for consolidation. Fiscal consolidations need a coordinated plan, executed by a strong government capable of withstanding attacks by interests currently benefiting from spending. Even if election manifesto includes consolidation, the mandate to stick to it is not there after an indecisive election.
• 5) Unclear laurels. It may seem that even if there is no clear winner, the parties might “at least” agree on reducing the deficit and debt since – as Moody’s themselves point out – “all parties are committed to fiscal consolidation”. However, each party will want to enter the history textbooks as the party that reduced the debt mountain (or at least stopped it from rising). Having to share such laurels during a minority or even another coalition government makes consolidation less likely.
• 6) Post-shock coalition games. In 1992 the Harvard economist Spolaore showed that single-party governments are better at reacting to a negative fiscal shock. While coalition parties may play a game with each other since they are unsure about whose constituency would be worse off from an ensuing tax increase, a single party government may in fact even overshoot – raise taxes more than necessary to offset the fiscal shock. (Largely because it can partially shield its own electorate.) If we call the post-2007 events a fiscal shock, any coalition government is now in the worst position to deal with its aftermath in a fiscally sustainable way.
There is much empirical evidence to show that political instability increases deficits and debts. Alesina and Perotti evaluated fiscal consolidations in OECD countries over three decades and found coalition governments to be the least capable of achieving success. Pasten and Cover investigated almost 200 years of data in Chile and found that political instability was the biggest culprit at increasing deficits. Lane showed on 40 years of OECD data that dispersed political power leads to pro-cyclical deficits. Bad news especially if the UK recovery is as strong as it seems (by EU standards): uncertain election would increase deficits.
Coalition and minority governments are very rare in UK politics. This lack of experience may make any such new government more susceptible to the danger of not reining in the debt.