Procyclical State Policy

James Surowiecki blames federalism and the state governments for holding back recovery:

Fiscal policy at the national level is countercyclical: as the economy shrinks, government expands. At the state level, though, the opposite is happening. Nearly every state government is required to balance its budget. When times are bad, jobs vanish, sales plummet, investment declines, and tax revenues fall precipitously—in New York, for instance, state revenues in April and May were down thirty-six per cent from a year earlier. So states have to raise taxes or cut spending, or both, and that’s precisely what they’re doing.

But is it really the case that federalism dooms states to running pro-cylical fiscal policy? Consider this seemingly unrelated story from Chile from a few months ago:

Thousands of government workers marched on downtown Santiago last November, burning an effigy of Chilean Finance Minister Andres Velasco and calling him “disgusting” as a strike for higher wages paralyzed public services.

Five months later, polls show that Velasco is President Michelle Bachelet’s most popular minister. During a three-year copper boom he and central bank President Jose De Gregorio set aside $48.6 billion, more than 30 percent of the country’s gross domestic product, that he is now using for tax cuts, subsidies and cash handouts to poor families.

The Chilean peso has risen almost 10 percent against the dollar this year to become the best-performing currency among emerging markets. The country’s economy is expected to grow 0.1 percent in 2009, as the region contracts 1.5 percent

There is no reason California could not have done the same thing. The growth of Silicon Valley has been a tremendous windfall for California. Revenue for the state government soared over the past decade. It, and more, was all spent. California could be cutting taxes and boosting spending simultaneously if they hadn't squandered their money on reckless spending.

So why the difference? It isn't federalism, but rather leadership. Chile had a finance minister with guts and intelligence (Harvard professor in economics). California had dysfunction and ill-designed referenda. The blame for the current sorry state of state finances lies not in federalism.

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