Austerity and Social Spending: Estimating the Long-Run Effects of Fiscal Adjustment

Abstract

Ageing populations and slower growth have compelled governments in mature welfare states to implement fiscal adjustments, but uncertainty persists about whether these measures have successfully curtailed the size of the welfare state. This letter documents that fiscal adjustments reduce social spending more effectively than previously thought. Using data from sixteen advanced economies between 1978 and 2018 and the narrative identification of adjustment plans, I estimate cumulative multipliers with local projections. I find that fiscal adjustments persistently lower social spending, including key components of social consumption and social investment. To explain why austerity does not shelter the welfare state, I present stylized facts about the timing and composition of adjustment plans. First, while public investment cuts concentrate at the beginning of the adjustment period, social consumption cuts accumulate over time. Second, large budget deficits and financial crises are frequent antecedents of the most ambitious fiscal reforms.