Even If the Economy is Doing Well, the People May Not Be

Listener: 29 November, 1997.

Keywords: Regulation & Taxation; Social Policy;

The table below shows the government’s current spending on employees, goods and services. It does not include spending on transfers such as social security benefits or debt servicing. It includes spending by local government as well as central government. The most important items are health and education, but there is also spending on government administration and advice, on law and order, on the environment, on the arts and so on.

Public Consumption as a Share of GDP

The graph shows that this spending was about 17 percent of GDP in the early 1990s, but has fallen to about 14 percent and is projected to remain below that level. If the level of the 1990s had been maintained, government spending on goods and services would be about $3 billion a year or 20 percent more. (A similar calculation for social security transfers would suggest spending about $2 billion a year, or about 12½ percent, more. This column focuses on the purchases side of the government’s spending.)

The decreases were not offset by improved efficiency in the public sector. Despite the rhetoric, there is no evidence of major productivity gains that would not have happened anyway. Rather, there seems to have been a conscious decision by the political process to reduce government spending. Economic theory, before it gets overrun by ideology and self interest, might say the dramatic cut represented a shift of preference from public to private spending by the National (and latterly coalition) government of the 1990s. It may not reflect the public’s preference. The few available opinion polls suggest a majority of the public would prefer more public spending on health, education, law and order, and the environment, even (I stress this “even”) if they have to pay higher taxes.

We are told that too much government spending (and its consequential higher taxation) is bad. Of course excess of anything may well be bad for everything else, but that it is a long way from arguing the New Zealand government’s spending level is excessive. It is a little below the rich OECD average. Moreover, the empirical evidence cannot find a correlation which says the lower-than-average government spenders are high-than-average economic growers. Some US economists say government spending is too high, but others say it is too low. Whatever, they are talking about the US federal spending, whereas the New Zealand government spending includes much done by US states and local authorities. There is no objection to arguing against the public’s choice in favour of less public spending and more private spending. But using pseudo-economic arguments to justify personal preferences is naive or deceitful.

Public spending is a means of varying the mix of goods and services in the economy. Arguing we cannot choose a different mix from that determined by private spending – that we should not spend more on health, education, culture, the environment, law and order, and so on than the market allows – is nonsensical.

A more subtle approach claims the best mix can be obtained is by giving the money to individuals. Recent practice suggests the theory does not work. Rather than cheerfully spending more on education fees, private health services and insurance, donating to charities, arts foundations, and green groups (or doing lots more voluntary work), individuals complain bitterly that the government is failing the community. Partly this is because the government cut spending on the poor and those on middle incomes, and gave the tax cuts to the rich.

But where government spending is socially efficient, cuts in spending increase the inefficiency. Alleged gains from spending cuts often merely shift greater costs onto individuals. That once granny would have been in hospital care and now she is at home and her family is doing their best to cope, or you are paying education fees or for medical insurance, is a gain to the taxpayers (or rather the rich who get the tax cuts), but the costs to the family may be more. Sometimes there can be no coherent private response to this widespread cost shifting. Are you confident that you can deal with an emergency while the fire brigade does other things? (The advice to the very rich is emergency training for the butler.) We may well be building up a frightening problems for our future. A resource pressed police may not do anything about a minor burglary which may be the beginning of some kid’s career with a nefarious end.

Perhaps the $5 billion cut in government spending (including the social security cuts) has contributed to the fiscal surplus, but has done so by increasing the social deficit, thereby replacing government debt problems with social problems. Two decades ago we use to tell the story of the Brazilian colonel who after a coup, went to some Chicago school economists, took their economic advice, on and being told it was successful asked “how come the economy is doing well and the people are not?”. Today we can tell the story about New Zealand.