Opinion & Commentary
Big spending, poor results
Treasury Secretary Ken Henry observed in a recent speech to the Whitlam Institute that the Whitlam government was ‘responsible for an enduring increase in the size of government’. No argument there.
But he went on to suggest this expansion ‘has never been reversed and I think I can safely say that it never will be’.
Not so fast Ken! It is true government spending has increased dramatically.
In Australia, commonwealth government spending was pushing 20% of gross domestic product before Gough Whitlam came to power. The Rudd government has taken the commonwealth’s expenditure share to 27.8% of GDP this financial year, following the biggest increase in federal spending since Whitlam. Spending by all levels of government in Australia was about 34% of GDP in 2007–08, even before the federal government’s stimulus. The Treasury’s last Intergenerational Report projected a further 4.75 percentage point increase in the government spending share of GDP by 2046–47 in the absence of changes to government policy.
But how big should government be? According to Henry, ‘the optimal size of government is not a question that can be answered by a technical economic analysis’.The issue, he says, ‘goes beyond aggregates to broader issues of wellbeing’.
Under Henry, Treasury has adopted a ‘wellbeing framework’. It identifies wellbeing with several criteria: the level of freedom and opportunity that people enjoy; aggregate consumption possibilities; the distribution of consumption possibilities; the level of risk that people bear; and the level of complexity people are required to deal with.
Yet no policymaker committed to improving the wellbeing of the Australian people based on this framework can be resigned to a permanent expansion in the size of government. On the contrary, there is abundant evidence that big government fails these criteria for promoting wellbeing.
The literature on the optimal size of government finds that beyond a certain size, government hinders rather than helps the private sector to capture gains from trade and to generate income and wealth. This results in a narrower tax base, so that government revenue and spending actually become smaller in absolute terms than if the government share of GDP remained capped at its optimal size. Limiting the size of government as a share of GDP not only expands aggregate consumption possibilities, it increases the scope for improved distribution of consumption possibilities through the tax system.
The threshold at which the government share of GDP begins to reduce rather than promote economic growth is necessarily imprecise. Gerald Scully calculated that the optimal size of government for the US and New Zealand was between 19% and 23% of GDP. It would be surprising if the optimal size of government were any larger in Australia. Remarkably, John Maynard Keynes took a similar view. Keynes agreed on 25% as the ‘maximum tolerable proportion of taxation.’
We can look beyond the implications of big government for economic growth to consider its implications for other indicators in areas such as health, education and the environment. Economists Vito Tanzi and Ludger Schuknecht conducted a review of the effects of increased government spending on a range of non-economic indicators in their book Public Spending in the 20th Century: A Global Perspective.
They found growth in the size of government in the post-war period was associated with worse outcomes in almost every economic and social dimension. They concluded the optimal size of government is less than 30% of GDP and that most governments in the developed world exceeded their optimal size between 1960 and 1980. Tanzi and Schuknecht argue the second half of the 20th century constituted a global experiment in the effects of the growth of government, which pointed to its failure to improve wellbeing as defined by Treasury. Yet Henry insists a ‘lack of evidence of a clear relationship between increased expenditure and better outcomes is not to say that more expenditure will not improve outcomes’. This sounds like a triumph of hope over experience. What makes the expansion in the size of government so insidious is that the economic possibilities and improved wellbeing that are forgone as a consequence are never seen by the public. As someone interested in promoting the wellbeing of the Australian people, Henry should be challenging this complacency, rather than resigning us to it.
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies.
