A few weeks ago, a piece on Bloomberg looked at the question of whether government spending cuts hurt the economy. (Hat tip: Hot Air) First, the authors remind us that a large public debt saps economic growth:
In a paper released this year, economists Carmen M. Reinhart, Vincent R. Reinhart and Kenneth Rogoff said that periods of debt overhang — when accumulated gross [ed: public] debt exceeds 90 percent of a country’s total economic activity for five or more consecutive years — reduce annual economic growth by more than one percentage point for decades.
Over 20 years, the authors write, there can be a “massive cumulative output loss” that reduces gains by 25 percent or more. The U.S. went over the 90 percent threshold after the 2008 financial crisis…
To grow robustly, the U.S. must reduce that debt overhang. But that would mean genuine spending cuts: large enough to give us a budget surplus. And that would cause a recession, right? Maybe not:
In the 1990s, Canada, for instance, reduced debt-to-GDP ratios through an aggressive combination of actual, year-over- year spending cuts and higher taxes. The result wasn’t malaise but a burst in activity.
The same happened in the U.S. right after World War II. In 1944 and 1945, annual government spending (in 2005 dollars) averaged about $1 trillion and represented more than 40 percent of GDP. By 1947, it had plummeted to $345 billion in 2005 dollars and 14 percent of GDP. Even facing the demobilization of millions of soldiers, the economy soared and unemployment fell despite almost universal fears that the opposite would happen.
Such outcomes are not flukes. Research by economists Alberto F. Alesina and Silvia Ardagna underscored that fiscal adjustments achieved through spending cuts rather than tax increases are less likely to cause recessions, and, if they do, the slowdowns are mild and short-lived.
…[especially] when spending reductions are accompanied by policies such as the liberalization of trade and labor markets…
Read the whole thing; they cite more examples of countries who achieved growth through government-cutting measures, like Sweden, or the UK in the 1990s. There are still more examples, which they didn’t cite: the UK in the 1980s (where Thatcher’s spending cuts enabled an economic boom), the U.S. in the early 1920s (where Harding’s spending cuts did likewise), and more. (more…)