Outline and discuss recent (1999-present) trends in the size of government and the composition of government expenditure in the UK and USA.

Extract taken from: OECD Library

The USA shows a similar account, government expenditure had increased or at least stayed the same consecutively from 2001 till 2008. Public expenditure on health, social and pension has also increased every year. Total tax revenue however has not increased annually and the government deficit fell in 2005 and 2006 before substantially increasing in 2007.

3.0 What is responsible for these trends? :

The growth of government has been accompanied by substantial changes in the composition of public spending 'reflecting the changing perceptions of what the state should do’. A hundred years ago government spending was almost restricted to ‘maintenance of the law and order, external security and to some very limited amount of government services and investment’. Then over the subsequent decades the provision of government goods and services increased considerably. However ‘real or exhaustive government spending did not grow much in most countries instead, especially cash spending often associated with social programs, grew rapidly’.

According to Mueller and Murrell (1985) public choice theory is the ‘natural framework’ in which to examine the question of government size, suggesting rationales such as the median-voter theorem. At the same time the role of interest groups is often mentioned as well, ‘the implicit argument here is that interest groups favour government outlays of quasi-private good nature and that log-rolling leads to a coalition of interest groups, which introduces a package of quasi-private goods into the public budget’ hence the size of government becomes too much, this suggestion was first described by Tullock (1959). However Breton (1974) disagrees with this view disputing that there may be ‘underinvestment in government activities because interest groups favour targeted tax reductions etc’. So whether the existence of interest groups leads to greater government expenditure is still debatable.

David R Cameron, (1978), gives five explanations of the expansion of the public economy:

Economic: A key reason for the increase in the scope of the public economy is derived from Wagner's ‘law of expanding state activity’ (1883). The law states that the ‘pressure for social progress leads inevitably to the growth of the public sector’. Cameron also notes Wagner’s consideration of the state’s growing role as a ‘provider of social overhead investments in such areas as transportation and education and the need, even in an authoritarian state, for the state to retain legitimacy by providing public funds to compensate for the human costs of economic development’. In addition Wagner's law implies that citizen's demands for services are sure to increase when economic affluence increases because taxes are income-elastic. If this is the case then we would anticipate that the greater the increase in economic affluence of a country during a specified period, the greater should be the expansion of the public economy. However Cameron is conscious of the opposition and rejection by several scholars of Wagner’s law including Bird (1971), Musgrave (1969), and Gupta (1968) as they discovered that ‘any positive cross-national relationship between economic growth and government share in the economic product disappears when analysis is confined to the wealthier nations of the world’ and this paper is analysing two wealthy countries.

Fiscal: Making use of Downs, (1960) and Buchanan and Wagner, (1977), their perception is to do with the ‘structure of the system of revenue generation as a determinant of how much revenue can be raised’. According to Downs since public goods are naturally non-divisible, ‘costs and benefits are not directly linked … benefits frequently are uncertain. In addition, public goods are, when taken as a whole, inevitably suboptimal, since each citizen will pay for some programs that provide no individual benefit’. Consequently, the costs, taxes, are seen to exceed the benefits of public goods. As a result only when public officials can hide the costs of policies in a ‘fiscal illusion’ can they spend large amounts without displeasing the public. Buchanan and Wagner (1977) argue the same point, ‘complex and indirect payment structures create a fiscal illusion that will systematically produce higher levels of public outlay than those that would be observe’.

Political:  Again directing to Downs (1960) he states that ‘in a democratic society, the division of resources between the public and private sector is roughly determined by the desires of the electorate’. But recent studies have suggested otherwise for instance, Tufte (1975, 1978), Kramer (1971), Hibbs (1978) and Nordhaus (1975) have understood that politics, puts forth a significant influence on the public. In particular two aspects of politics were highlighted that can influence the scale of growth of the public economy: firstly ‘the effect of electoral competition in bidding up the scope of expenditure programs’ and secondly the ‘effect of variations in the partisan composition, and presumably the ideological preferences of the government’.

Institutional: Government bureaucracies ‘develop internal pressures for self-aggrandisement and expansion’ is the argument of Downs (1964), Wildavsky (1974), and Niskanen (1971). This means that in countries where no single authority manages the majority of public spending- where, in other words, spending authority is fragmented the rate of increase in spending should be high. Therefore we expect that countries with a federal structure of government for example to experience larger increases in the scale of the public economy. A second characteristic of the institutional structure of government that may influence the expansion of the public economy is the ‘degree of fiscal centralisation’.

International in character: Larger nations, such as the United States, the economies are not resistant to the international economy. ‘A high degree of dependence on the international economy for markets for export industries may limit a government's ability to manage aggregate demand and control levels of unemployment and capital formation’, what's more a high degree of ‘penetration of the domestic market by external producers also limits the control by the national government over the economy’.

Cameron A Shelton, (2007) paper tests several leading hypotheses on determinants of government expenditure.  Among other results, he finds a new explanation for Wagner's Law, widespread evidence that ‘preference heterogeneity leads to decentralisation rather than outright decreases in expenditures’, that a vast amount of the expenditure that is associated with increased trade openness is ‘not in categories that explicitly insure for risk, and evidence that both political access and income inequality affect the extent of social insurance’. His approach yielded these results:

The increase in total expenditure related to greater trade openness is ‘attributable to categories that do not insure for risk’ this is in contrast to Downs (1978) who demonstrated a connection between trade openness and government finance.

‘In more populous countries and countries with greater ethnic fractionalisation, spending on many categories of public goods is decentralised: lower spending by the central government is significantly offset by higher spending by local governments’.

There are large and significant increases in local government expenditure amid a greater fraction of the population over 65.

Richer countries are older and spend more on social security this increases total expenditure. This is drawn from Wagner’s law.

‘Total spending net of social security actually declines with per capita income’.

Other rationales include:

Openness: as mentioned before David Cameron, (1978) demonstrated a link between trade openness and government finance using a sample of 18 OECD countries, one being the USA. Cameron found openness in 1960 to be a strong forecast of the increase in government tax revenues as a share of GDP. He assumed that more open countries were more heavily unionised which through collective bargaining, ‘lead to greater demand for government transfers in the form of social protection and re-education’.  Rodrik (1998) however hypothesizes that ‘government expenditure may serve as a form of insurance against external risk’. This is because in more open countries the income flows of households are obtained from firms which ‘do more overseas business and are as a result are subject to greater external risk such as exchange rate risk or supply or demand fluctuations abroad’. This would create demand for public insurance against external risk. Rodrik concludes that advanced countries with the necessary administrative capacity alleviate some of this risk through spending on social protection.

Country Size: Alesina and Wacziarg (1998) found that larger countries have smaller government consumption as a share of GDP. They argue that firstly, ‘sharing non-rivalrous public goods over larger populations results in lower per-capita costs of provision’ and secondly, ‘larger populations tend to exhibit greater heterogeneity in preferences over public goods provision’. Smaller countries are more open to trade as smaller countries are more ‘viable under open trading systems because they can benefit from spillovers due to foreign production’. Thus implying that smaller countries are both more open to trade and spend more on public goods.

Income Inequality: We have already seen that Wagner’s Law informs us of the effect of income but also the distribution of income in society may affect public spending. Meltzer and Richard (1981) in their paper, construct a general equilibrium model, they concluded that ‘redistribution in majority rule societies is positively related to a particular measure of skew in the income distribution: the ratio of mean to median income’.

Price effects: Baumol (1967) has put forward the idea that because the government sector is largely a ‘service industry with relatively low capital-labour intensities’, productivity rises are expected to be smaller in comparison to those in the manufacturing and primary sectors. Spann’s survey (1977a, 1977b) agreed, Bradford, Malt and Oates (1969) also confirmed this.

4.0 Conclusion:

‘The size of government, both absolutely and as a percentage of GNP has in the last decade reached unprecedently high levels in all Western countries’ (Nutter 19878). Many economists have disagreed with the thought that the growth of spending was caused by inevitable forces such as Wagner’s law and Baumol’s disease. But that it was nothing but a response to changing perceptions about what governments should do hence why the size of government expenditure may have increased is because it now has to fulfil more jobs. Furthermore the growth of government may reflect ‘a lack of confidence in the private sector’s ability to deal with some problems and a belief that public spending was the best way to deal with several risks faced by individuals’. Therefore public expenditure in addition to its growth has changed its composition towards more social objectives. ‘Expenditure on health, education, pensions and unemployment compensation has been justified by reference to the market’s failures both to guarantee outcomes that meet society’s equity objectives and to any of the possible causes of market inefficiency’. Many rationales have been put forward to answer why the size and composition of government expenditure has changed and several seem very plausible.

Bibliography

Books:

Mueller and Murrell. ‘Interest groups and the political economy of government size’. Public Expenditure and Government Growth. Francesco Forte and Alan Peacock. Basil Blackwell, 1985. Part1, chapter 1.

Tanzi and Schuknecht. ‘Public spending in the 20th century: A Global Perspective’. Cambridge university press, 2000.

Zandao Gianni. ‘Collective choice, Social welfare and Economic growth’. Public Expenditure and Government Growth. Francesco Forte and Alan Peacock. Basil Blackwell, 1985. Part1, chapter 5.

Editorials/Articles:

Alesina, Alberto and Romain Wacziarg. ‘Openness, Country Size and Government’, Journal of Public Economics, vol. 69, no. 3, pp. 305-321. 1998

Baumol, W.J. ‘The macroeconomics of unbalanced growth: The anatomy of urban crisis’, American Economic Review, 57, June, 415-426. 1967

Borcherrding, E. Thomas. ‘The Causes of Government Expenditure: A Survey of the U.S. Evidence’, Journal of Public Economics 28 (1985), page 359-382.

Breton A. ‘The Economic theory of Representative Government’, Chicago Aldrine, 1974.

Cameron, R David. ‘The Expansion of the Public Economy: A Comparative Analysis’, The American Political Science Review, Vol. 72, No. 4 (Dec., 1978), page. 1243-1261.

Meltzer, Allan and Scott Richard. ‘A Rational Theory of the Size of Government’, The

Journal of Political Economy, vol. 89, no. 5, pp. 914-927. 1981

Nutter G W. ‘Growth of government in the West’, Washington: American enterprise institute, 1978.

Rodrik, Dani. ‘Why Do More Open Economies Have Bigger Governments?’, The Journal of Political Economy, vol. 106, no. 5, pp. 997-1032. 1998

Tullock G. ‘Some problems of majority voting’, Journal of Political Economy, vol 67 page 59-71

Shelton, A.Cameron. ‘The Size and Composition of Government Expenditure’, January 11, 2007, Wesleyan Economic Working Papers.

Websites:

www.oecd-ilibrary.org. UK and USA statistical profile 2010.

[http://www.oecd-ilibrary.org/economics/country-statistical-profile-united-kingdom_20752288-table-gbr]

[http://www.oecd-ilibrary.org/economics/country-statistical-profile-united-states_20752288-table-usa]

---