Fiscal Crisis

A fiscal crisis may occur when a deficit develops between a state's expenditures and its tax revenues, which result in a rising and unsustainable level of [Page 312]government debt. Fiscal crises are characterized by a financial, economic, and technical dimension, on the one hand, and a political and social dimension, on the other. The latter dimension tends to have the major implication for governance, especially when a fiscal crisis necessitates painful and frequently simultaneous cuts in government expenditure and increases in taxes on individuals, households, and companies.

A financial and economic crisis will tend to arise from a fiscal deficit if government debt levels contribute to a loss of market confidence in a national economy, reflected in turn in instability in currency and financial markets, and stagnation in domestic output. A political and social crisis will tend to arise if both the fiscal deficit itself and the necessary corrective measure implemente to eliminate that deficit result in further losses of employment and output, falling living standards, and rising poverty.

The concept of a fiscal crisis first came to prominence in both developed and developing economies during the early 1970s, largely as a consequence of the breakdown of the Bretton Woods international economic order, the October 1973 Arab-Israeli War, and the resulting oil crisis. These events combined to produce inflationary world energy and commodity prices, resulting in declining output and employment, and a simultaneous demand for higher government expenditure at a time of falling government revenues. The concept of a fiscal crisis of the state arose in relation to this fall in government revenues. James O'Connor, a political economist influenced by Karl Marx, argued that the capitalist state was in crisis because of its need to fulfill two fundamental but contradictory functions, namely accumulation and legitimization. To promote profitable private capital accumulation, the state was required to financed expenditure on social capital, that is, investment in projects and services to enhance labor productivity, lower the reproduction costs of labor, and thereby increase the rate of profit. To promote legitimization, the state was required to finance expenditure on social expenses, notably on the welfare state, and thereby maintain social harmony among the workers and the unemployed. However, because of the private appropriation of profits, the capitalist state would experience a growing structural gap, or fiscal crisis, between its expenditures and revenues, which would lead in turn to an economic, social, and political crisis.

O'Connor asserted that the fiscal crisis of the state was actually a crisis of capitalism, for which the only lasting solution was socialism. Although the inflation and recession of the mid 1970s failed to deliver the downfall of capitalism, it did lead to a political crisis for the Keynesian social democratic welfare state. The increasing incidence of budget deficits became associated with the idea that government had become overloaded; that full employment was not a legitimate objective of macroeconomic policy; that the state had become unduly influenced by powerful interest groups, notably trades unions in the public sector; and that society had become ungovernable. The corrective action proposed was that the role of the public domain of the state should be rolled back, to thereby reduce the popular expectations on government, and the role of the private domain rolled forward, to enhance economic freedom and unleash the creative energy of the entrepreneur.

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