Emil Lobe Suenson, Peter Nedergaard and Peter Munk Christiansen

Emil Lobe Suenson, Peter Nedergaard and Peter Munk Christiansen

Why do you want tolash yourself to the mast? The case of the Danish “Budget Law”

Abstract: The article examines the conditions that led to the adoption of the Danish 2012 “Budget Law”. The law added important new features to the institutional setup governing Danish public expenditures, the most important being budget ceilings, economic sanctions, and the requirement of structural budget balance.

By testing three hypotheses drawn from different branches of public choice theory, the analysis seeks to isolate the drivers of institutional change which led to the adoption of the budget law.

Each hypothesis is tested separately,and three main conclusions are reached:

• The Budget Law can be seen as an attempt to address two cost driving dynamics: continuous problems related to cost control especially in Danish municipalities, and asymmetrical preferences concerning public expenditures.
• The Budget Law can be interpreted as a credible commitment initiative established to ensure that public expenditures can be controlled even when economic conditions improve and public expenditure preferences rise.
• An empirical test of the median voter model reveals that Danish voters, due to the economic crisis, preferred significantly lower public expenditures in 2011 than in 2007. This shift in voter preferences most likely made it easier for the majority in the Danish Parliament to pass the Budget Law without encountering massive resistance from voters and interest groups.

Overall, the sudden and radical institutional change caused by the adoption of the Budget Law is a result of the above factors coinciding.

Key words: Public expenditures, Public Choice, Denmark, Budget Law.

1Introduction

In 2012, the Danish Parliament adoptedprobably the most seminal public spending actever – the so-called Budget Law.[1] Behind the enactment lies a complex story about the relationship between public spending growth and cost overruns, the economic crisis and resulting crisis awareness, the desire to minimize the expense policy scope, and implementation of expenditure policy management systems across both national and international levels of government. The lawwas adopted to ensure that public budgets are respected. Over the last 35 years, this has not been the case, and the public sector had massive cost overruns, which resulted in comparatively high public spending growth (JørgensenandMouritzen 2005: 19).

Denmark was hit hard by the economic crisis after 2008 (Goul Andersen 2013).This gave rise to major crisis awareness among voters, interest groups and politicians, and to a political paradigm shift in which cost overruns were no longer acceptable. From December 2011, the intergovernmental agreement, the European Fiscal Compact, requiredsignature countries to ensure public finances balance. The Budget Law represents the Danish implementation of the Fiscal Compact.

Theories of public expenditures traditionally point in two important and conflicting directions:They emphasize (1) that political institutions seldom change and (2) that concerning public expenditures, politicians focus on the short term andtherefore are reluctant to commit to long-term objectives (Mueller 2003: 114-127). The Budget Law is an expression of the exact opposite. Flexible, but dissolute economic management has been replaced by strict legislation limiting politicians’ current and future spending policy options and flexibility. Yet,a large majority in the Danish Parliament adopted the law. The article asks how it was possible to adopt the Budget Law.

The Budget Law contains the following elements:

• A requirement that public expenditures must be in balance or surplus.[2]
• An automatic correction mechanism is triggered when public finances differ from the above balance requirements.
• Budget ceilings for the state, municipalities, and regions.
• Financial penalties to ensure compliance with the ceilings in the state, municipalities, and regions.
• The Economic Council[3] continually assesses whether fiscal and expenditure policies comply with the above requirements.

These five main elements are designed to ensure long-term balance in public finances and that elected politicians conduct fiscal policy within the requirement of structural budget balance. The Fiscal Compact imposes identical requirements on Denmark. However, the Budget Law hadalreadybeen prepared when the Fiscal Compact was adopted (Ministry of Finance 2011a: 8-10).

By all accounts, Denmark has introduced an economic government institution that represents a paradigm shift compared to previous expenditure management. This article asks under which conditions such a significant institutional change can take place. In general, rationalist theoreticalfoundation(see below) is suitable for answering why so few policy changes occur (why so much stability? – as Dennis Mueller (2003:114) asked) and rationalist theories are less suitablefor explaining political paradigm shifts (LynggaardandNedergaard 2009).The article exposes the theoretical foundation to a hard test and proceeds as follows: theoretical foundation; method; analysis; and, finally, conclusion.

2Theory

The article is based on rationalist theories of the political system and politicians’behaviour, which derive their assumptions about actors’ preferences from neoclassical economic theory. Theyassign the actors exogenously determined preferences, and their actions are seen as the consequence of the players’ cost-benefit analyses, where the alternative with the highest net benefits is chosen (Buchanan andTullock 1999: 17).

In the following we present the asymmetry theorem and classic game theory, theidea of credible commitment, and finally themedian voter model. After each theoretical section, a hypothesis is presented.

2.1 The asymmetry theorem

James Buchanan uses the term “asymmetrical” in his seminal work, The Calculus of Consent (1962), to describe how the institution of majority votes pushesthe tax rate to rise to a suboptimal level (Buchanan andTullock 1999: 168). The asymmetry stems from a fundamental difference between the economic and the political system. In an economic market, a buyer shows his willingness to pay for a good or service. This implies a symmetric relation between supplier and demander. In the political system,payment and consumption areseparated due to the payment of taxes;consumption is individualized, while payment is collectivized (Buchanan and Tullock 1999: 149-200). This makes the political system vulnerable to organized groups,which are able to obtain benefits that far exceed the cost of organizing. The losers are stakeholders with diffuse interests for whom it does not pay to lobby – typically taxpayers and consumers (Nedergaard 2008: 301).

The asymmetry theorem predicts that interest groups might succeed in pushing government expenditure upwards. Also civil servants will benefit from a bigger budget (Kristensen 1987: 55). Likewise, several other (supply-side) theories of the public choice tradition point out that the administrative system can grow larger than optimal (e.g. Niskanen 1971; 1973; Dunleavy 1991: 181-209). This analysis testsimplications of the asymmetry theorem in two ways, so that expenditure growth generated by stakeholders both outside and inside the administrative systemis taken into account.

A general ceiling of total public expenditure (as is the case with the Budget Law) increases the political costs of increased government spending in one area, because expansion of one type of activity implies savings in other activities in order not to violate the overall expenditure ceiling. Initiatives such as the Budget Law are likely to weaken the political asymmetry (Kristensen 1987: 53). Hence, it becomes relevant to examine whether this was an objective of the Budget Law.

The asymmetry theorempredicts that government spending will increase, but it does notoffer a theoretical explanation of why public expenditure growth is often generated by cost overruns. Below, two versions of the classic Prisoner’s Dilemma (PD) will be presented as cost overruns are typically the result of a similar suboptimal logic (JørgensenandMouritzen 2005: 21-23).

Based on the classic budget policy literature, political and administrative actors are separated into advocatesof increased expenditures and guardians of the treasury (Wildavsky 1975: 7-10). The first version of the PD assumes that all spending advocates are interested in exceeding the budget for more funding. However, they are also interested in total budgets being adhered to in order to avoid collective sanctions. This leads to a suboptimal result: The total budget is exceeded, as illustrated by the PD below.

Figure 1: Individualistic Game

Expense advocate 2
Do not exceed the budget / Exceed the budget
Expense advocate 1 / Do not exceed the budget / B
B / A
D
Exceed the budget / D
A / C
C (equilibrium)

As shown in Figure 1, both players exceedthe budget. This is because it is most profitable for each actor to do so, although it provides a suboptimal outcome at the macro level (Kuhn 2007: 1-2). For the game tobe properly characterized as an individualistic PD, at least three conditions must be met, however:The following condition for the pay-off holds: A>B>C>D. The players should not be able to get out of the dilemma by taking turns exploiting each other, i.e. B>(A+D)/2) (Axelrod 1990: 10, 206). Players must be concerned only with their own pay-off and not the opponent’s (Sharpf 1998: 85).

The difference between the individualistic and competitive game is given by the players’ preferences (Sharpf 1998: 84). In the individualistic version,the players are concerned only with their own outcome; in the competitive version one player loses what the other wins, i.e. a zero-sum game. In both the competitive and the individualistic PD,the equilibrium is non-cooperative (Sharpf 1998: 87-88). The two games thus illustrate theoretically why public actors’ play concerning budgets can provide sub-optimal performance in both zero-sum and plus-sum situations.

Figure2: Competitive Game

Player 2
Cooperate / Do not cooperate
Player 1 / Cooperate / 0
0 / A
-A
Do not cooperate / -A
A / 0
0 (equilibrium)

The above theoretical presentation indicates that public spending will increase over time, and that gamesconcerning budgets will often lead to suboptimal results. Based on these theoretical expectations the first hypothesisis formulated:

Hypothesis 1: The Budget Law was adopted in an attempt to rein in spending driving dynamics contained in the Danish political and administrative system.

2.2 Credible commitment

The main point in the credible commitment literature is that efficient policy outcomes require political actors to limit their ability to pursue their own short-term interests. There are many situations where the benefits of commitment far exceed the benefits of discretion (North 1993; North andWeingast 1989).

The classic example of a credible commitment is the Odyssey’saccount ofOdysseus and the Sirens. When Odysseus let himself bebound to the mast, heobtained the (Pareto) optimal situation which allowed him to hear the Sirens’ enticing song and still make it home safely to Ithaca (Homer 1998: 144-148; Pierson 2004: 41-43). In other words, absolute freedom of decision-makers does not always lead to optimal outcomes, because with freedom comes uncertainty and inconsistency (Kydland and Prescott 1977: 473-474). There may be a need to restrict the operators of action, but this presupposes that players’ actions are credible. A commitment can basically be credible in two ways. First, it can be “motivationally credible”: An actor who is willing to be bound throughout the relevant time periodhas no vested interest in more freedom, and there is no need for monitoring and sanctioning. Second, a commitment can be “imperatively credible”,for instance if the actor in fear of sanctions will not act differently (Shepsle 1991: 247).

Credible commitments are a classic way to overcome the problems, which in game theory are often presented as a PD (Shepsle 1991: 248). The credible commitment approach considers the formation of the political budgets as a series of PD games. According to the credible commitment literature,this series of games will lead to increasing public spending because political actors are assumed to bemyopic:They have to be re-elected, and voters are more concerned with their own needs than those of future generations (Shepsle 1991: 251; Buchanan 1999: 99-100).

The above-mentioned debt problems are, according to Buchanan, not only attributed to individual incentives. He is critical of Keynesian economics where a correlation between government spending and tax burden is not necessary because debt is considered unproblematic (Buchanan and Wagner 2000: 55-120). Therefore, Buchanan spent much of his life arguing for a revision of the U.S. Constitution to prohibit government budget deficit (see, e.g. Buchananand Brennan 1985; Buchanan and Wagner 2000: 187; cf. also Wildavsky 1980; 1985).

Based on the above review, the Budget Law is seen as an institutional credible commitment mechanism. Hence, a second hypothesisis formulated:

Hypothesis 2: The Budget Law was adopted in an attempt to tie the political actors to pursue more long-term spending.

2.3 Median voter theorem

The median voter theorem predicts that the spending decisions of the political partiescorrespond to the median voter’s preferences. In Downs’ classic model, the political system is seen as an“economic” market where voters demand and politicians supply political decisions. Voters are assumed to be rationally informed and to have consistent preferences (Downs 1957; see also Mueller 2003: 231). When it comes to public budgets, Downs formulates the political parties’ decision rule as follows: “... expenditures are increased until the vote-gain of the marginal dollar spent equals the vote-loss of the marginal dollar financed” (Downs 1957: 52). Thus, according to the model, the total expenditure is determined by the median voter.

The theorem’s assumptions are often not met and the main assumptions are discussed below. First, the model is based on a two-party system where political parties can move as close to the middle as they want without losing votes to other parties (Downs 1957: 54). This is not the case in Denmark because of the proportional election system in which new fringe parties can emerge and gather votes.

Second, it is assumed that all voters vote, which is never the case (Mueller 2003: 232). When the model is applied to Denmark, the problem is limited, however, because of the comparatively very high turnout (Franklin 2004).Third, the model operates with only one political dimension, presumably the left-right economic conflict line. Hence, the model is not useful to treat, for example, conflict lines concerning values (Mueller 2003: 232).

Finally, it is typically assumed that voters’ preferences are static (Kurrild-Klitgaard 2011: 23). That is not the casehere because we include the effect of the economic crisis on voter preferences. This does not compromise the model’s basic prediction: Politicians follow the median voter. Nevertheless, the above-mentionedproblems indicate that the model should be used with caution. The third and final hypothesis states:

Hypothesis 3: The Budget Law was adopted because the median voter prefers tighter spending due to the economic crisis.

3Method

The article is a single case study of the adoption of the Danish Budget Law. In order to explain single case outcomes, a number of causes, which together could lead to a given outcome, are considered.In the following analysis, the perception of causality is based on Mackie’s(1980: 62) concepts, INUScausality and INUSconditions. An INUS condition is neither necessary nor sufficient if it stands alone. Instead, it constitutes one of several conditions which combined are sufficient to achieve a given outcome;in Mackie’s (1980:62) words: “... an insufficient but non-redundant part of an unnecessary to sufficient condition.”This approach makes it possible to identify combinations of conditions which combined are necessary for a given outcome to occur (Mahoney andGoertz 2006: 232-235). The above hypotheses are therefore neither competing nor mutually exclusive. Instead, it is investigated how the interplay between theoretical explanations may have triggered the adoption of the Budget Law.

Since the hypotheses refer to a wide range of empirical phenomena, the article draws on several types of data: descriptive statistics, interviews, data from the Danish election survey as well as secondary empirical data. Eight interviews with senior officials and representatives of the two major political parties (Liberals and Social Democrats) have been conducted. The interviewees act as informants.

Data from the Danish election survey is used to assess the voters’ attitudes towards the government’s expenditure policy. The survey, which has asked voters about their opinion after each general election since 1971,allows us to follow the evolution of public attitudes over the years of investigation (Stubager, Holm et al. 2013: 7)and to make it plausible if and how the voters’possible crisis awareness has affected decision-makers’ political preferences regardingexpenditure policy.General elections were held in 2007 (before the crisis erupted) and in 2011 (when the crisis had lasted a couple of years). The data is cross-sectional, but changes in voter preferences are presumed to equal changes in the general population, due to the law of large numbers.

4Analysis

The analysis containsfour sections.A brief presentation of events preceding the adoption of the Budget Law is followed by three sectionsin which each hypothesis is analysed. The conclusion discusses how the factors considered in the analysis explain the institutional change represented by the Budget Law.