The Santa Claus effect

The budgetary crisis afflicting many Western economies is in part a consequence of the democratic political process at work.

According to economist James Buchanan, politicians prefer spending to taxing.

This is because governments like to be popular by providing public services and welfare, rather than unpopular by levying taxes, fees and charges.

Throw in exotic theoretical rationales for spending, such as the Keynesian idea government spending should compensate for subdued market activity, and the incentive for governments to play the role of a perpetual Santa Claus becomes magnified.

To ensure voters receive the benefits of all this spending, governments need to hire public servants who manage and deliver public sector programs.

It is estimated 80 million people across developed countries directly worked for the government in this capacity during 2006.  In Australia, almost 1.7 million people worked for federal, state and local administrations.

This cohort of government workers represents an influential voting constituency dedicated to the growth of their employers, the central and subnational public sectors.

If the political dynamic of excessive spending is left unchecked the result is entrenched fiscal deficits and spiralling public sector debt.  These outcomes threaten to crowd out more efficient private sector activities and dampen future economic growth prospects.

According to the International Monetary Fund, advanced Group of 20 economies are expecting to face budget deficits averaging close to 5 per cent of gross domestic product in the next few years.  This compares with an average pre-financial crisis deficit of 1.2 per cent in 2007.

Despite the clear economic imperative to restore the health of their public finances, countries are becoming stuck in a quagmire of reform inertia as vested interests with voting rights actively resist the loss of entitlements and conditions associated with big-spending government.

Public sector unions, representing a significant proportion of government employees, have used two strategies to resist fiscal adjustments.

By disrupting the provision of essential public services, striking public sector employees seek to bring the community onside in putting pressure on governments to halt proposed spending cutbacks and thereby resume services.

For public servants, the potential pay-off from such a strategy is the retention of their taxpayer-funded salaries, pensions and other benefits.

Recently tens of thousands of Greek public servants took to the streets opposing fiscal austerity measures, brandishing various threatening slogans such as "No more illusions, war against the rich".

This was despite Greece's budget deficit hovering about 14 per cent of GDP and the recent downgrading of government bonds to junk status.

Similar scenes have been witnessed in Germany, Portugal, Romania, Britain and France, where public sector union strike action has long been elevated into an art form.

In Australia, public sector unions have succeeded during the past few years in seeking inflationary wage increases, placing pressure on state government budget bottom lines.

Victoria's teacher unions engaged in a 14-month campaign of pickets and stop-work periods to finally secure a new pay deal from the state government in 2008.

The success of Victorian teacher unions in attaining record wage increases at public expense sparked an interstate pay bidding war by teacher unions in other jurisdictions.

These actions, and successful strike actions enacted by nurses, police and other state government workers, contributed to the growth of public sector wage expenses averaging 9 per cent a year since about the peak of the previous economic cycle in 2005-06.

The second strategy employed by public sector workers and unions is to use their voice swaying public opinion against the need for fiscal consolidation.

In the US, public sector unions routinely use the airwaves and television screens to argue the case for more government spending and to oppose reforms such as tax and expenditure limitations to cap budgetary growth.

For example, unions were instrumental in the recent defeat of initiatives in the state of Maine to introduce a comprehensive fiscal cap similar to Colorado's taxpayer bill of rights.  Maine's TABOR model would have capped revenue growth to inflation and population growth, and ensured that most of the excess revenue collections would be directly rebated to taxpayers.

Unions representing teachers and municipal workers spent close to $US1 million ($1.1m) on TV advertisements alone opposing the measure to ensure that growth in that state's budget would be held in check.

Public sector unions in California have long flexed their muscles with significant implications for fiscal sustainability and the provision of efficient government services.

For example, the Service Employees International Union expended $US20m to help defeat initiatives to limit the growth of the state government and to limit union power in the education system.

In 2003 the same union pressured the board of California's public sector pension fund to stop investing in companies that participated in outsourcing government jobs.

The result of these and similar activities is a state with a $US20 billion fiscal gap, yet with continuing pension provisions allowing various public sector workers to retire at 50 with a pension equivalent to 90 per cent of their highest pay level.

In Queensland, public sector unions have been caught in a parallel universe of supporting Premier Anna Bligh's campaign to protect public sector jobs against an efficiency dividend proposed by the opposition during last year's election campaign, only to expend hundreds of thousands of dollars later protesting against planned sales of government assets.

Breaking the connection between the demands of those with a vested interest in a growing government, and changes in the scale of government itself, is an ongoing challenge in modern democracies.

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