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What Is Fiscal Squeeze and Why does It Matter?
By fiscal squeeze we mean a type of 'austerity' policy that takes the form of substantial effort and activity by governments to impose absolute or relative losses on at least some people by increasing revenue, restraining spending, or a mixture of the two.
The word 'substantial' is there to signify some threshold—hard to define, of course—that distinguishes the normal, everyday 'getting and spending' politics of the budgetary process from episodes when real effort is exerted to rein in government spending, raise revenue, or both. The point is that the normal politics of budgeting, as many scholars have noted, tends to involve a staged process of cutting down initial bids, ambit claims, or strategically pumped-up expectations, setting the rival claims of different groups and agencies for funding or tax relief against one another to test their relative political support, against some at least implicit budget constraint. For 'fiscal squeeze' to mean anything other than that normal process of disappointing or winnowing down initial bids to fit finite resources, it must denote some additional effort to raise revenue or restrain spending.
We discuss later what that threshold might be, but the point at which 'normal' budgetary politics ends and fiscal squeeze begins can never be clear-cut, because political pain thresholds can be subjective and context- dependent. For example, if voters have been promised lower taxes or higher spending, a squeeze that looks slight in recorded statistics might have more political effect than one that is statistically bigger but turns out to be lower than what has been widely expected or trailed by politicians trying to manage down expectations and so comes as a 'reprieve' (Rose (1980): 227-8). Similarly, efforts to reduce public spending or increase revenue in the depths of a recession are likely to be more painful to many individuals than they would be in the midst of an economic boom. Such contextual effects obviously matter.
Further, while we defined fiscal squeeze earlier as involving the imposition of losses on some individuals or groups, those losses may in some cases be accompanied by benefits to the same or other individuals or groups. For instance, in some of our cases government spending was reduced expressly to pay for tax cuts (as happened for instance in 1922, when expansionist policies of post-World War I reconstruction clashed with powerful middle- class demands for income tax reductions), and conversely, in other cases, taxes were raised to pay for higher spending on benefits or services (as happened, for instance, in 1974, which saw a major tax hike by a newly elected Labour Government to fund ambitious social and industrial policy plans). The politics of fiscal squeeze therefore centres on how such loss-imposition works, how losses and benefits play out, and what shapes who gets how much political blame or credit.
As we shall argue throughout this book, 'squeeze' defined as political effort or activity is not necessarily the same as the achievement of lower levels of budget deficit (broadly, the difference between public spending and revenue raised, relative to GDP) in subsequently reported financial data. The latter is what econometricians of fiscal consolidations understandably tend to focus on, but we will show in Chapters Two and Eleven how imperfect a measure it is of the political effort going into fiscal squeezes, the degree of pain experienced by voters and taxpayers, or of the timing of squeeze episodes.
For example, as we will describe in Chapter Four, the early 1930s saw substantial efforts to raise revenue and reduce spending, and in the process also witnessed major party splits, politicians putting their credit on the line, and real pain imposed on many voters, notably by cutting unemployment benefits in the depths of the Great Depression. But if we look at that episode only through the prism of deficit reductions, those efforts are reflected only as a one-year fall in primary budget deficit in 1932/3. Conversely, a government might exert less political effort to restrain spending or to raise taxes (as happened during a period of steady economic growth in the later 1980s and later 1990s), and see deficit fall substantially. Accordingly, to capture properly how much loss was imposed on voters and how much political cost and exertion was expended by politicians and the state machine, we have to look directly at what happened to spending and revenues. And to complement this quantitative analysis we have to look more qualitatively at each episode. We describe that exploration in section 1.3 below.
So why does fiscal squeeze matter? Analysing fiscal squeeze is important in its own right, as a central aspect of the politics of many states today. Just as sociologists find that disasters reveal where power lies in a society (Burns and Thomas 2015: 3), any fiscal squeeze is a 'stress test' of political power and priorities—probing anew the political support for every component of public spending and/or testing political tolerance of new or higher taxes. It is a form of political discovery analogous to the 'discovery' function classically attributed to markets by Friedrich Hayek (1949). Further, given that loss imposition is central to our definition of fiscal squeeze, every fiscal squeeze is also a key test of incumbents' capacity to manage political credit and blame. That is why we aim to look carefully and with hindsight at the aftermath of fiscal squeezes.
As for credit and blame, there is an extensive literature on the electoral politics of welfare state retrenchment, much of it inspired by the work of the Paul Pierson (1994 and 1996) in the 1990s. Starting from Kent Weaver's (1986) classic analysis of blame-avoidance imperatives in politics, Pierson argued that the political logic of welfare state retrenchment is different from that of welfare state expansion, mainly because many welfare programmes are not pure 'public goods' in the language of economics (creating services, such as defence, from which no one can be excluded) but rather tend to involve groups enjoying concentrated and direct benefits that can be mobilized to resist cutbacks. Consequently (echoing Weaver's ideas), Pierson claims, 'almost always, retrenchment is an exercise in blame avoidance rather than in credit claiming'. He argues that radical retrenchment was rarer under the Reagan and Thatcher regimes in the United States and UK than is suggested by popular narratives that portray those regimes as driven wholly by 'conviction politics', and that 'cutbacks in social programs usually raise the risk of electoral retribution'.
The idea that cutbacks in welfare state programmes run the risk of such retribution tends to rest on two main assumptions. First, it assumes malefici- aries of such retrenchment will typically be better organized and motivated to political action than beneficiaries (such as taxpayers or non-users) because welfare retrenchment tends to mean concentrated and direct losses to the former but only diffuse and indirect gains to the latter. Second, it assumes electoral choices typically involve a mixture of 'economic voting' (that is, voters normally cast their ballots mainly on the basis of 'pocketbook' issues affecting themselves), 'retrospective voting' (that is, voters choosing as much on perception of the past records of candidates and parties in office as on the promises those candidates and parties make about the future), and 'negativity bias' (that is, voters more disposed to punish incumbents for losses imposed than to reward them for any corresponding gains). It follows from those assumptions that efforts to impose losses on key voters or well-organized interest groups through welfare state retrenchment will tend to produce electoral losses or defeat for political incumbents, and that such efforts will be politically viable only if those incumbents find ways of shifting, sharing, or avoiding blame, for example by all-party national governments.
Like many successful social science ideas, this account of the electoral vulnerability of welfare state retrenchment is elegant, simple, and at first sight eminently plausible. But it is surprisingly hard to validate systematically, as numerous scholars have shown. Economic studies of the impact of austerity on electoral outcomes using data from before the 2008 crash have produced only mixed results. As for more recent studies, one study found austerity in the form of adverse economic indicators was associated with increased electoral volatility (Dassonneville and Hooghe 2015), while the work of Alberto Alesina, Dorian Carloni, and Giampaolo Lecce (2012) found no systematic relationship between fiscal austerity and electoral defeat for incumbents, and no evidence that governments which reduced budget deficits quickly were systematically voted out of office. And in an earlier study with other colleagues comparing nine different cases of fiscal squeeze crossnationally, we ourselves found numerous cases where fiscal squeeze did not result in notable electoral punishment and even seems to have, on occasion, acted as a credit-claiming opportunity for incumbents (Hood, Heald, and Himaz 2014). Our study here of a century of fiscal squeezes in the UK also shows variety, but we show later that on the measures used here, more severe squeezes seem to be more associated with electoral losses by incumbents.
There could be several reasons why electoral punishment does not invariably follow from fiscal squeeze. First, in circumstances such as those of 1931 (once-in-a-century global crisis), or after major wars, it may not make sense even in theory for voters to vote retrospectively rather than prospectively, especially given that the major tax hikes of both the twentieth-century world wars were imposed by war coalitions comprising all the major political parties and with ordinary electoral competition suspended (such that the only way for electors to punish the incumbents was to vote in by-elections for parties outside the war coalition, such as Sinn Fein or the Scottish National Party). Second, it may be that Pierson's original assessment that any electoral credit flowing from tax reductions would tend to be outweighed by blame resulting from spending restraint underestimated the credit-claiming opportunities for those types of fiscal squeeze that involve spending cuts to pay for tax cuts.
And third, it could be that blame avoidance can take more varied forms (in presentational, agency, and policy strategies) than was envisaged in Pierson's original study. For example, a blame-avoidance tactic not much discussed by that study comprises what William Riker termed 'heresthetic'—that is, structuring choices in a way that can shape electoral outcomes, notably by introducing issues such as protectionism that cut across the tax-and-spend dimension and thereby undermining the conventional assumption about 'pocketbook' voting that voters are strung out on a single right-left dimension.
This book focuses mainly on the political aftermath of fiscal squeezes, in terms of electoral outcomes, institutional or constitutional changes, and policy developments. But there is a huge literature in economics and economic history on the short- and medium-term effects of fiscal and monetary policy on output, employment, and growth. 'Keynesians' stress the importance of deficit financing in recessions by cutting taxes and raising government spending, while those of other schools, such as monetarist and other revisionist approaches, take a different or more nuanced view (Konzelmann 2014). The average effect of fiscal austerity on economic output is argued to be expansionary by some economists (for example, Giavazzi and Pagano 1990; Alesina and Ardagna 2010), while others claim it is contractionary (such as Guajardo etal. 2014).
What this book shows is that there were some recurring features in the way fiscal squeeze worked over the century but notable variation in the process by which squeeze decisions were made, in who the winners and losers were, and in the composition and time-pattern of squeezes. It also shows that over a hundred years fiscal squeezes rarely seemed to have dramatically reshaped the state or methods of delivery of public services, though in several cases they left deep political scars that shaped the way subsequent squeezes were handled.