Great Powers: Maintain sound public finances

Democracies with weak and/or fragmented party systems seem to produce sub-optimal public policies, including heavy government debt burdens.  From Israel to India, Italy to Japan, Brazil to Belgium, governing coalitions held together by paying off key constituencies have yielded chronic deficits and high debt.  By contrast, countries with a small number of strong political parties – usually ideologically-based — that can form stable governments have tended to mind the public purse better (e.g. the U.S., U.K., Germany, and Mexico are examples). 

Some countries with fragmented multi-party systems have been moving in the direction of two or three ideological groupings in recent years, which could be a positive development.  This has been the case in India, Italy and Japan, with some promising signs in Brazil.  This year the financial crisis will continue to unfold, and elections are taking place in such Rising Powers as India and Indonesia.  The conclusion that weak coalition governments produce fiscal irresponsibility will no doubt be tested. 

Recent debt/GDP ratios of selected countries:

India                77%

Brazil               65%

Indonesia        32%

Mexico            31%

Japan              180%

Israel               76%

Italy                103%

Belgium           88%

U.S.                  62%

U.K.                  50%

Germany         64%

Note: Debt/GDP ratios are not strictly comparable, as wealthier countries have a higher “debt tolerance.”

Weimar Germany was the poster child of a weak democratic system.  Electoral and legislative rules hindered the formation of stable governments, and therefore the public had little faith in democratic government.  To avoid the errors of the past, the architects of Germany’s postwar constitution, the 1949 Basic Law, erected a system that balanced fairness with effectiveness.  It was a mixed proportional representation/first-past-the-post system that excluded parties garnering less than 5% of the popular vote from the legislature and produced two large, ideologically-opposed parties of the right and the left.  Stable governing coalitions alternated in power. 

Konrad Adenauer, postwar Germany’s first chancellor

 

Konrad Adenauer, one of postwar Germany’s architects, and his Christian Democratic Union were able to govern West Germany democratically and effectively from 1949 till 1963, two years longer than his totalitarian predecessor.  His center-right CDU/CSU and the center-left SPD have largely governed Germany ever since.  Currently, these two strong parties cooperate (to some extent) in a grand coalition, but will head back to the polls this fall to see if they can oust their opponents from power.  Germany’s constitution has worked so well that democratic reformers the world over consider adopting portions of it.

The logic of the two-party, or nearly two-party, system is that if one party mucks up the economy while in power, the voters will “throw the rascals out.” Hence, the incentive to mind the public purse.  On the other hand, if a party’s survival in power is based less on success at the polls and more on maintaining complex coalitions, then the dominant coalition partner will be more interested in using the public purse to buy off smaller parties than in maintaining fiscal prudence. 

This is exactly how the State of Israel functions.  In its February 2009 election, the largest party, Kadima, only garnered 22.5% of the vote.  With twelve parties in the Israeli legislature, the six smallest obtained only 2.5%-3.4% of the popular vote apiece.  The German constitution (and by the way, newly reformed Italian electoral rules) wouldn’t even seat these parties.  It can be argued that Israel’s system is fairer, giving voice to the country’s diversity, but it is not very effective.  Only during Ariel Sharon’s popular rule beginning in 2001, when his party reached close to 30% of the popular vote (quite high in Israel), was his strong finance minister, Benjamin Netanyahu, able to implement reforms to public finances that reduced the deficit and got the debt/GDP ratio on a downward trajectory.

Italy functioned in much the same way until the reforms of the mid-1990s.  Belgium, Brazil and India have functioned this way as well, with public debt levels rising as a result.  Although Japanese politics has long been dominated by one party, the center-right LDP has for all intents and purposes engaged in coalition politics and a consequent public spending spree. The LDP is a collection of personality-based factions, interest groups, local constituencies, and patron-client relationships.  As a result, by opening up the public spigot, the LDP holds together these factions, keeping itself in power. 

Interestingly, the U.S. is embarking on a very large increase in its public debt, and this will occur in a two-party system with one party now overwhelmingly dominating two branches of government.  This must be seen as an aberration, however, an exception to the rule, given the size of the fiscal stimulus required to prevent a collapse of the financial system and to support sagging demand.  This unprecedented increase in public outlays is not being implemented in order to keep a coalition together.  Nevertheless, should the Democrats not act quickly, once the economy rebounds, to re-establish fiscal rectitude, an adjustment that will be very painful, then the government’s credibility will suffer, foreign investment will slow, the dollar will fall, interest rates will rise, and American voters will “throw the rascals out.”

As for India’s election, as spelled out by my colleague, David Kampf, the world’s largest democracy is in the midst of a month-long national election that will be tallied on May 16.  Some commentators believe that the two large parties, the center-left Congress Party and the center-right BJP Party, will lose ground to smaller and regional parties.  This will put pressure on the coalition leaders to spend their way into power.  Rulers of Rising Powers be forewarned: history shows that a sustained mismanagement of public finances often precedes the decline of nations.

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