It looks like some social democratic parties are starting to debate whether they should adopt fiscal conservatism; at least Policy Network released a discussion paper on the matter. David Lizoain criticised the idea heavily and I agree with what he says. Fiscal conservatism in the paper sounds to me like cutting just for the sake of it because there is an underlying believe that this is necessary:
Labour should commit to a process of ‘zero-budgeting’ across the whole of Whitehall, questioning every line of public spending, with nothing off the table but based on a clear focus on shifting funds towards jobs and growth. In addition to tough prioritisation, the other consequence of fiscal conservatism is to acknowledge that social justice is advanced far better by bold reform and well-targeted investment than public spending: this applies to the public sector as well as the private. Ultimately, this will force the left to articulate a different conception of the state.
If the authors have something like a German-style debt break in mind, there is a basic national accounting identities problem. And social justice would be best promoted by seriously reforming the distribution of wealth and income in society – I didn’t read anything about this in the paper.
But there also seems to be a widespread confusion about spending, investment, consumption, sustainable debt and unsustainable debt. Let me try to clarify this for the sake of debate. Public spending consists of public consumption and public investment. This distinction is not always clear-cut as educational expenses are normally accounted for as consumption, even though they have a clear investment side as well, but let’s leave this aside for the time being.
In general, public consumption should be financed through revenues and not debt. If you subsidise your consumption with debt or by shrinking assets this is unsustainable. The story, however, is different for investment. The definition of a worthwhile investment is that the expected return is higher than the cost of the capital you need for this investment. In other words, the investment pays for itself and makes a profit. No matter how big your debt burden is, you should pursue every single opportunity for which the above is true. Investors will not lose confidence in this case as your investment portfolio creates higher returns than you have to pay in interest so the debt is easily serviceable. In this case you create more assets than liabilities in your balance sheet.
From this follows that many countries ought to use the record low yields offered by the markets – in some cases even negative real interest rates! – to invest. Investment will create jobs, which will create tax revenues and lower current expenditure, etc – you know the story. So on this basis it is just wrong to bedevil all kinds of debt. There is good debt and there is bad debt and the distinction is crucial.
Nobody seriously denies the need for sound fiscal policies and the need to reduce debt levels. But the debt burden is so high because there was so much bad debt in the private sector that triggered the financial crisis; not because governments generally spent too much (only in some cases). How you go about fiscal consolidation is crucial and crude fiscal conservatism is the wrong way.
P.S. Of course financing consumption with revenue is a general task rather than something you should try to achieve each and every year. Crises will trigger consumption deficits that should be balanced out in boom times. Unfortunately this normally doesn’t happen because liberal and conservative parties then always start crying out for tax cuts (see Germany last year!) and later blame their political opponents of reckless spending. This is something that needs to change!
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