Deficits

To Grow, a Country Must First Shrink?


The idea that cutting government spending can spark an immediate economic upswing lies at the heart of House Budget Committee Chairman Paul Ryan's new proposal. Conservatives credit the phenomenon known as "expansionary fiscal contraction" with revitalizing the economies of Sweden and Canada, among others. Here's how the evidence stacks up.

NEW ZEALAND, 1984
Pro: U.S. conservatives point to New Zealand's uncompromising cuts in government payrolls, down nearly 60 percent from 1984 to 1996, and the cross-party support for an ambitious program of reforms. Those included slashing personal and corporate tax rates, selling off state monopolies, and phasing out agricultural subsidies. The payoff: Public debt dwindled and growth accelerated to 4.7 percent in 1993.

Con: Reforms were less successful for workers: Unemployment averaged more than 8 percent in the '90s and was higher at the end of the decade than when the transformation began in 1984.

IRELAND, 1987
Pro: Hobbled by Third World levels of debt, 18 percent unemployment, and a debilitating brain drain, Ireland in 1987 embarked on a new course. It dramatically reduced its budget deficit and put foreign direct investment at the center of its economic strategy. The resulting growth spurt earned the country the moniker "Celtic Tiger." By 1997, the Irish boasted a higher per capita income than their former colonial masters in the U.K.

Con: Ireland's turnaround was aided by two currency devaluations that spurred exports. The fiscal improvement also lowered interest rates from double digits, providing a boost impossible to replicate today, when short-term rates are effectively zero. Ireland, before veering into a costly credit bubble, enjoyed something else the U.S. can't count on: robust demand for its exports.

CANADA, 1993
Pro: A new government slashed federal spending as a percentage of GDP from 22.3 percent to 17.9 percent in four years. Prime Minister Jean Chrétien reduced unemployment payments, abandoned the costly EH-101 helicopter program as part of a broader pullback in defense spending, and overhauled the national pension system. Economic growth surged and the federal budget moved from deficit to surplus.

Con: Like Ireland, Canada's economy got a major boost from a sharp currency devaluation. The weaker loonie caused annual exports to more than double by 2000. It's unlikely the U.S.'s trading partners would tolerate a similar plunge in the greenback, given that every major economy is trying to export its way back to prosperity. As part of its pension revamp, Canada hiked taxes on employers and employees, anathema to U.S. conservatives.

SWEDEN, 1994
Pro: The classic European welfare state seemed to have reached a dead end in the early 1990s. A housing bust and banking crisis had saddled it with debt and 11 percent unemployment. In 1994, Sweden began shrinking the government's share of the economy from 71 percent to less than 60 percent six years later. Growth averaged 3.5 percent annually from 1994 to 2000.

Con: Success of some of the changes is hard to assess because the early 1990s were a time of epic financial crisis. Sweden was one of the few countries in Europe to partially privatize its pension system. Yet the pioneering move looks less attractive after a dozen years of stocks treading water.

Lynch is a reporter for Bloomberg News in Washington.

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