Fiscal austerity and the trade-off between public investment and social spending

Abstract

This article makes two claims: first, it argues that the impact of fiscal austerity varies across different types of public spending. In particular, we show that discretionary spending (public investment) is hit harder by fiscal austerity than entitlement spending (public spending on pensions and unemployment) because of different institutional and political constraints. Second, we find that electoral institutions affect how governments solve this trade-off. Discretionary spending is cut back more severely in countries with an electoral system based on proportional representation than in a majoritarian system. Our empirical analysis relies on a methodological approach (composite data analysis) that takes into account interdependencies between budgetary categories. Using data for 21 Organisation for Economic Co-operation and Development countries from 1979 to 2003, we find strong evidence for the varying impact of fiscal stress on the budget shares of discretionary and entitlement spending as well as strong interactive effect between fiscal austerity and electoral institutions.