Fiscal Austerity and Public Investment: Is the Possible the Enemy of the Necessary?

In most rich democracies one finds a tendency for the share in public finance that is available for discretionary spending to shrink. This is because tax revenues do not keep pace with simultaneous increases in fixed expenditures and growing pressures for fiscal consolidation. The present paper assesses the capacity of governments under conditions of fiscal austerity to shift financial resources within the shrinking share of discretionary expenditure from old to new purposes, and thereby fund future-oriented investment aimed at making societies more equitable and efficient. For this reason an indicator for soft public investment is developed, which includes public spending on education, R&D, family support, and active labor market policy. We present data for Germany, Sweden, and the United States for the years 1981 to 2007 in order to explore the general dynamics of consolidation policies under the expectation that far more ambitious consolidation attempts will be made in the coming decade. Our results suggest that the capacity of governments to shift resources towards soft public investment decreases as pressures for fiscal consolidation increase.