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Whither the automatic stabilizers?

Given the storm clouds on the horizon, and the prospect of a slowdown/recession, one of the more interesting aspects of fiscal policy has to do with automatic stabilizers. As the economy turns, revenues will fall and expenditures on income support will naturally increase, driving the budget towards deficit and thereby propping up demand just as it is needed. The question is not whether the government should run a deficit per se, but given that the budget will naturally turn to deficit, would the government cut spending (thereby making the problem worse) for the sake of maintaining a balanced budget.

But it is also worth noting that the overall strength of these automatic stabilizers has been greatly weakened since the last time we had a recession in 1990-91. In the mid-1990s, the renamed Employment Insurance program introduced measures that severely reduced the eligibility for benefits. In part this was changes for seasonal workers, in part changes in hours required to qualify. Added to the growth of self-employment, where there is no eligibility for EI, we have a situation where only about 35% of the unemployed are able to access EI, down from about 80% before the changes.

Provincially, similar dynamics have taken place with regard to social assistance programs. Here in BC, for example, the decline the welfare rolls is roughly split between people leaving for employment, and policy changes that prevent people in need from accessing benefits (see this CCPA report for details). These include deliberate diversion tactics on the front lines, as well as three-week waits for benefits, a “two-year independence test” and time limits. I’m not expert on what has happened in other provinces, but I suspect that these types of changes are pretty common now in provincial welfare systems.

The upshot of this is that we are less prepared for a recession that we were the last time around. There are some important exceptions, to be sure, in seniors’ benefits (which are generally good and tied to inflation) and children’s benefits (which could be better but are also superior to what existed at the time of the last recession). But if things start to turn down in a big way, we should quickly revisit the rules on federal EI and provincial social assistance as part of our “stimulus package”.

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Comments

Comment from Dmitriy Kinaev
Time: May 8, 2008, 5:14 am

Automatic stabelizers are part of indescretionary fiscal policy. Indeed they are just that – automatic. Any government intervention will render them absolutely useless. In a recessionary situation (consecutive fall in GDP), as GDP consists of C+I+G+(X-M) C+I may fall, but G will rise, as the government increases transfer payments.

As the budget deficit grows, people are receiving more money, which helps to ameliorate the decline in real GDP. If carefully ochestrated, the budget deficit will be only temporary, as the GDP increases and the employment surges back to NAIRU.

Cutting spending in a recessionary situation, would greatly exacerbate the economic problem. It is a general rule that in a downturn, expansionary fiscal policy would “prime the economic pump”, and is of vital importance to revive the economy.

Kinaev, D.

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