Defending spending cuts

If I wanted to defend public spending cuts, I’d use this new paper from Andreas Bergh and Magnus Henrekson.
In a survey of the research, they find that big government does reduce long-run economic growth. In developed economies, if the share of public spending in GDP is 10 percentage points higher, annual GDP growth is 0.5-1.0 percentage points lower.
This implies that the planned cut in government spending - from 47.5% of GDP in 2009-10 to 39.8% in 2015-16 - would, if it’s not reversed, make the median worker between £40 and £80 a week better off by 2035.
You don’t have to believe that high taxes have big disincentive effects to think that big government reduces growth. I’d suggest two other mechanisms:
1. A Baumol effect. Big government usually means that a lot of economic activity is concentrated in sectors where productivity grows slowly - such as education or healthcare. This drags down overall growth.
2. Huge amounts of productivity growth come from exit and entry (pdf), rather than from existing organizations upping their game. The larger is government, the smaller is the sphere where this mechanism can work.
The standard riposte to all this is usually: how is it then that Scandinavian countries have combined big governments with good macroeconomic performance?
Bergh and Henrekson suggest a number of reasons. These economies tend to have very large exposure to international trade, and this encourages innovation, the division of labour and faster productivity growth. They are high-trust societies, which reduces the rent-seeking problems which often cause big government to reduce growth. And they score very highly on other measures of economic freedom. (This could be because of high trust: with people trusting companies to behave acceptably, demand for tight regulation is lower).
None of this necessarily justifies big cuts in public spending here and now: this research is consistent with the possibility that public spending cuts reduce growth in the very short-run. Nor does it in any way justify deficit fetishism. And you might argue that, in a post-crisis economy in which firms are starved of finance, these crowding out effects of big government are smaller than they would be in normal times.
Nevertheless, it does suggest that big government, in the long-run, is bad - albeit perhaps mildly so - for economic growth. Which is a little awkward for the statist left.

Comments

[Rob]

Of course, as you've said before, this does not necessarily rule out leftist approaches to redistribution.

The problem being reported here is with government *spending*, not government *taxing* (and your previous post casts doubt on the disincentive/Laffer effects of taxation at present levels). Therefore, if the government abstained from spending a large portion of tax revenue directly, and instead redistributed it according to progressive criteria, we would achieve many of the social benefits of a more egalitarian society without the costs of central government accounting for such a massive share of the economy.

[Marcin]

...Or it could suggest that the problem is a low-trust society. Perhaps the best way to foster that would be a big government with a lot of propaganda in favour of the kinds of values that have shaped Scandinavian societies.

[Prateek Buch]

Interested in this:Big government usually means that a lot of economic activity is concentrated in sectors where productivity grows slowly - such as education or healthcare. This drags down overall growth.
What is the evidence that if growth (as measured by GDP) is dragged down in this manner, that the quality of life that citizens enjoy is concomitantly dragged down?
strikes me that better healthcare and/or education (I know that neither are necessarily improved by more spending but can be...) could improve the quality of life that most people enjoy independent of their effects on GDP.

Or, put another way, could restricting growth in this way be a good thing?

Discuss

[Matthew]

You mean 39.8%, presuambly.

I read the paper briefly and wasn't sure if they tried to distinguish between types of spending - ie if you spend 40% of GDP through a CBI it would be rather different than if all 40% was govt consumption spending.

[chris]

@ Matthew - thanks: that typo's corrected.
You're right - they don't make that distinction.
@ Rob - I agree.
@ Prateek - there's certainly evidence that education has all sorts of good effects:
http://economics.uwo.ca/faculty/lochner/papers/nonproductionbenefits_dec10.pdf
But how well education is correlated with education spending is another matter.

[Ralph Musgrave]

I agree with Prateek Buch, but would put the point another way, as follows. The utility or worth of public sector output is not measured by the market. It is measured by voters at election time.

If voters want, for example, the number of public sector employees to remain constant relative to the number of private sector employees (even given no productivity increases in the public sector) then voters are in effect saying they regard the worth of public sector employees as being equal to that of private sector employees, regardless of traditional views on productivity.

Put another way, voters are saying that when private sector employee productivity rises by X%, so does that of public sector employees, because we the voters say so.

There is a bit of a philosophical quagmire here, namely the question as to how far and when should democracy overrule private free market decisions. But certainly the view that economic growth is curtailed by poor productivity increases in the public sector is an extreme and over-simple take on this philosophical debate.

[Paul Sagar]

Its only bad for the "statist left" if you assume that marginally higher economic growth in the long-run 1. benefits the worse-off better than the "statist left" alternative and comnectedly 2. That more private sector growth is better than the slow growth via health and education you note. I don't see any particular reason to grant these assumptions, especially not I the touted benefit is a mere £40-80 per individual

[Mercy]

Yeah looking at the price of a private healthcare plan in the US, that sounds like a shockingly poor trade.

[hans]

just a small comment on the swedish situation: swedish labour law does not provide any extra employment security to public sector employees compared to private sector (the only exceptions are judges and tenured university professors). this has enabled public sector organisations to restructure and reduce their workforces irrespective of privatization.
hence, exit and change can happen more easily also in the public sector.