Tuesday, March 9, 2010

IUC Inauguration - Is big government back?

I had the honor this morning to speak as a student represtentative at this year's academic inauguration ceremony at the IUC. The topic, mentioned above, spurred a lively discussion of the role of the government especially after the crisis last year. Giuliano Amato gave a fascinating speech concluding that we have an imbalance today with not enough regulation in the market. How can we provide umemployment benefits, when we don't provide ex ante policies that protect employment? How can we have competition without enforcing anti-trust laws? In his view, freedom has become power as we no longer care for our community or the future. It was not easy following such a brilliant lecture, but luckily my speech was already written so I didn't have a chance to worry too much. Here is what I had to say on the issue:

Rhetoric and Reality in Big Government

I would like to contribute to the discussion this morning by speaking about the rhetoric and the reality of big government in Europe and the United States. As we have seen big government may be understood as government involvement in the economy, which may be through regulation or through direct control of certain sectors and the supply of public services.

The size of government budgets have actually been growing since the end of the 19th century. This represents spending in areas like education, retirement or healthcare, areas which were previously left to the market. Although there is a notion that government began to get smaller after the 1980's along with privatization and deregulation of some sectors, it was really just a slowing of growth rather than a decline. For example, in the United States the total government budget was less than 10% in 1910, around 25% in 1950, 35% in 1980 and by now it has increased to just over 40% of GDP. In Europe we see a similar trend, with some countries reaching an even higher level of public spending. England, for example is similar to the US. Other countries like France and Germany are even higher, while the Nordic countries represent an opposite extreme of high government spending.

The recent financial crisis has had an obvious impact on government spending because of fiscal stimulus packages and increasing demand for social support programs such as unemployment. The US for example awarded 158 billion in 2009 on economic recovery (about 1% of GDP)3 while a total of 700 billion has been reserved for the bank bailout alone. Government debt as a percentage of GDP has also increased throughout the advanced G20 countries as a result of the crisis and is expected to continue growing over the next years. This will put an extra strain on government budgets as they have to repay those debts, possibly even at higher interest rates as the debt grows. Many other areas such as aging populations and increasing health costs will also add to budgetary stress.

Given these facts, what does it mean the when we talk about a re-emergence of big government? I think the real question we are trying to answer is, “What should the role of the state be?” When we pose the question as such, “Is big government back?” as it has been similarly posed in news magazines such as the Economist or Newsweek, we also hint at our political perspective on the issue, though the answer to the question about how large the state should be is not as clear cut as it may seem.

We may start by asking, what caused this increase in government spending in the first place? One economist, who conducted an analysis on the growth of public spending over the last century, concludes that an increase in democratic social voice, paired with prosperity and increasing lifespans resulted in this change. Helping others through social programs and other types of wealth redistribution would seem to be a positive development of the democratic state, but others argue that this increased social spending comes at the expense of overall economic efficiency.

These represent the two opposing views of the political theory of government: one which sees the government as a benevolent institution serving the desires of the public, and the other which sees the government as a Leviathan that uses its strength to extract wealth from the population. If we look back at the theories of public policy, we find that the benevolent dictator view was prevalent until the 1970s to 80s, and it changed around the same time as neoclassical efficient market theories came to be popular in economics.1 Although government budgets have been constantly on the rise, the theoretical change in the 1980s resulted in deregulation and privatization, the end of the traditional mixed economies that had been popular in Europe since the depression.

The Director of IMF's Fiscal Affairs department,Vito Tanzi is one who is opposed to high levels of government spending. He argues that increased public spending leads to increased inefficiency. On the other side of the argument is economist Peter Lindert, who's research into the history of public spending has found that over nine decades of data across countries, there is no evidence that increased government social spending had a negative impact on per capita GDP, but in fact he found that the opposite is true.

It is also possible to study the relative efficiency of government run programs versus privatized versions. Results are mixed, but it is not always true that the government is less efficient. For example, in Canada part of the rail system was privatized and part of the system remained public. Joseph Stiglitz determined that the public and private parts had nearly the same operating costs.

Edmund Phelps, another recipient of the Nobel prize in economics, also noted that “...relatively capitalist countries are not distinguished by high levels of wealth. The somewhat more socialist economies and more corporatist economies of Western Europe reach wealth levels exceeding the levels in the capitalist economies.” Savings and productivity, which create wealth are the same or even higher in countries such as Belgium, France and Germany when compared to the UK, US and Canada.

Further, I think we face an interesting dichotomy when we look at the rhetoric and the reality of government size in the US as compared to Europe. Historically in the US government spending has been lower than in continental Europe, with the result that the US does not perform as well in certain areas where public spending is important. For example the private US health care system is more expensive and has a less favorable outcome. Educational outcomes in the US are also worse (in math, science and functional literacy). US poverty is higher and infrastructure in Europe also tends to be more advanced. If we look at an extreme example the difference is clear. Sweden is a country with unusually high taxes relative to the rest of Europe. The government spends much more to promote better health, unemployment, and retirement benefits than the in US. However it has been found to be just as successful as the US even in terms of innovation.

In the United States it is common to hear arguments against government spending, regulation, and public services. It's criticized as being inefficient and socialist or even “European.” For example, one news article in a popular US business magazine said that President Obama's plans to reform financial regulation and increase social spending are distinctly “French.” Despite this sarcastic attitude toward big government, in recent years the US has increased overall spending dramatically – from 35% in 2006 to nearly 45% projected for this year. Most recently the bank bailout, the planned jobs bill and the health care debate show that government spending and involvement in the economy are in fact growing.

Whereas in the US the crisis has encouraged the government to increase expenditures on social welfare, the crisis may have an opposite effect in Europe. While in Europe there has historically been a more positive attitude toward social welfare spending, this may be changing. And the ability of governments to increase spending, especially at time of crisis, may be limited because of European Union treaty agreements. This seems likely to be the case in Greece, where they need to freeze public sector pay, increase the retirement age and reduce benefits to deal with their budget crisis and keep in line with debt and deficit limits. Direct government involvement in the economy may also be limited by EU competition law. For example in Italy a law was passed last summer to privatize water as part of national legislation to meet the desire of having an open and integrated market.

Since the theoretical shift in the 1980's that led to deregulation and privatization we have come to a time where markets are increasingly strong and governments are relatively week. When states have high levels of debt their actions are limited and when strategic sectors are privatized governments have less direct control over the economy. But is this a trend that should continue?

I think that as we all deal with the aftermath of the crisis we're likely to see a moderate increase in government size (in terms of both spending and economic intervention), but it seems likely that our political ideologies will keep big government at bay. That is unless we find ourselves in the face of another shift in political theory, as is bound to happen from time to time.

Thank you.