Mitchell: Do crises produce liberalization or more statism?

Daniel J. Mitchell

When I give speeches about modern welfare states, I’ll often cite grim data from the IMF, BIS, and OECD about the depressing fiscal consequences of ever-expanding government.

And if I really want to worry an audience, I’ll augment those numbers by talking about the erosion of societal capital and the difficulty of adopting necessary reforms once work ethic and self-reliance have been replaced by a culture of dependency and entitlement.

I basically warn people that many western nations (including the United States) are doomed to suffer Greek-style fiscal collapse. Depending on the type of speech, this is where I sometimes share a slide suggesting there are two possible outcomes once an economic crisis occurs: Does a crisis caused by bad government lead to even more bad government, which is the pessimistic hypothesis in Robert Higgs’ classic, Crisis and Leviathan? Or does an economic crisis force politicians to scale back the size and scope of government, which is the hypothesis in Naomi Klein’s The Rise of Disaster Capitalism.

I’ve generally sided with Higgs, though there obviously are cases – such as Chile – where bad statist policies were followed by sweeping economic liberalization. But, based on new research from the International Monetary Fund, Klein may have a stronger argument (which would be a depressing outcome for her, since she favors bigger government).

The authors wanted to find out whether bad economic news (as captured by data on “GDP growth, deep recession, unemployment, crisis”) leads to pro-market reforms.

The answer is yes. The authors write, “Our main result supports some form of the crisis-induces-reform hypothesis across all four reform areas. High unemployment, recession and/or an open economic crisis tend to be associated with a greater likelihood of reform. The effect is economically significant. For example, an increase of 10 percentage points in unemployment (as seen in several European economies in the aftermath of the Great Recession) is associated with an increase in the probability to undertake a major EPL reform for regular contract of about 5 percentage points – that is, about twice the average probability in the sample.”

Keep in mind, by the way, that some nations (such as Austria) may not have reformed because they never adopted bad policies in the first place.

Kudos to Denmark for implementing so much reform. And Greece wins a Booby Prize for failing to adopt desperately needed reforms.

I was also happy to see some results that bolster my argument in favor of jurisdictional competition as a tool to encourage better policy, as the researchers found evidence that outside pressure can increase the likelihood of reform. Interestingly, it does not appear that ideology plays a major role.

My two cents is that ideology can play a role (think Reagan and Thatcher, for instance), but that there are plenty of instances of putative right-of-center politicians making government bigger (Nixon and Bush, to cite US examples) and several instances of supposed left-of-center politicians overseeing pro-market reforms (Bill Clinton being the obvious example from America).

I’ll close with a very important caveat. The IMF study looked at regulatory policy. There are no lessons to be learned from this research about whether crises produce better fiscal policy.

For what it’s worth, based on all the post-financial-crisis tax increases that were imposed in Europe, I suspect that the Higgs hypothesis is still very relevant.

Daniel J. Mitchell, chairman of the Center for Freedom and Prosperity, is on the Editorial Board of the Cayman Financial Review.