FISCAL CONSOLIDATION AND DECENTRALISATION: A TALE OF TWO TIERS

4.2 Analysis of the composition of consolidation attempts

The existing literature has concluded that a consolidation attempt is most likely to succeed if
it is focussed on cuts in expenditure, and in particular, on cuts in the government wage bill
and transfer payments. In contrast consolidations based upon tax hikes and cuts in public
sector investment seem more likely to represent short-lived effort and to end in failure. In
principle this distinction is unsurprising. Consolidations based upon a tightening of current
expenditures have been shown on a number of occasions to generate a negative (‘non-
keynesian’) fiscal multiplier (for example, Ireland 1987-89 and Denmark 1984-86 see
Giavazzi and Pagano [1990]). Clearly, debt to GDP ratios are more likely to fall in periods of
positive economic growth, ceteris paribus. Further, cuts to expenditure tend to be politically
more difficult than raising revenue, take for example decisions to alter welfare benefit criteria,
cut public sector wage bills etc. Such action can send a clear signal to the private sector that
the government is serious about improving their financial position and in turn lead to
increases in private sector consumption. Moreover, such cuts tend to be more permanent (it
takes a long-time to pass legislation which alters welfare benefit payments etc) and sustained
cuts are more likely to lead to falling debt-to GDP ratios¹⁶.

Here, for the first time, we present results of a compositional analysis of consolidation
attempts using data disaggregated by tier of government as well as by function.

Table 4: Expenditure and revenue changes during general govt. consolidation attempts
(each shown as % of GDP)

¹⁶ For a summary of these issues, see Alesina and Perotti [1994] & [1995].

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