States of Guernsey economist Dr Andy Sloan provides an economic perspective on the growth of government spending

May 16th, 2011 by Dr Andy Sloan

Dr Andy Sloan, States of Guernsey Economist, gives a non-political presentation to the Guernsey Chamber of Commerce lunch on government spending (click image to expand - ©RLLord)

The text is a transcript of a presentation given by Dr. Andy Sloan, States of Guernsey Economist, to the Guernsey Chamber of Commerce lunch meeting at the OGH Hotel in St Peter Port, Guernsey on 16 May 2011.

———

The idea of giving a talk on this subject seemed a good idea when Barry Cash, Director of the Guernsey Chamber of Commerce, and I first talked about it a month or so back but last night when I sat down to fathom out what I was going to say I’ll admit that I had more than a few second thoughts. Second thoughts because I realised that the Guernsey Chamber of Commerce flyer said that The Economist’s byline for its special supplement back in March had said that public spending had the potential to be one of the biggest political issues of our time.Clearly as a civil servant the last thing I want to be is political, especially in public.

I have my own views on many matters naturally, but the role of the civil servant is to set aside personal views and preferences, and present all facts and arguments to our political lords and masters so that they can make decisions, led by political considerations if they so choose.

That might be a bit of a rose tinted spectacles way to put it, and I’m not so naive as to suggest that I am not, nor indeed is anyone, influenced by my own opinions.  It is impossible not to be. But today I am going to attempt to broach the subject in an agnostic manner, politically speaking, and discuss the issue of government spending, and spending growth as much as I can from an economic perspective.

So let me just set some minor ground rules for my talk.  I am not going to criticise or comment on the States of Guernsey …… the current machinery of government… individual decisions… or any issue remotely close.

I’m going to try to talk in the abstract.  If and when I refer to any example of States issues, it will be merely to hopefully illustrate a point.

However, we can take as read that whatever I say, obviously there’s no argument against the suggestion that the States should not be as operationally efficient as possible, no-one, not even lazy good-for-nothing civil servants, want waste for waste’s sake.

But one of my motivations for agreeing to give this talk was that on occasion I find myself saying ‘yeah … but…’ when listening to debates about public spending and find myself wanting to add an explanatory footnote to the debate.

There is as I’m sure you’ll all be aware an Financial Transformation Programme in the States and it’s been put in place to try and save money. I’m not going to comment on it specifically and any views I have will stay personal…. as a policy not an operations person, I’m not particularly involved in the delivery of the project.

However, I refer to it because I remember Tribal Helm’s first report being published to a general and quite garrulous admonishment that the States of Guernsey delivered ‘Gold plated services’ and the absence of a ‘value for money’ culture.

I personally found this reaction a bit perplexing.

After all, we were talking about an organisation that had been in the fortunate situation of having more money than it needed for as long as most people could care to remember – our present reserves that total 20 odd % of GDP are a testament to that.

So in that historic environment, to me it would have been most strange if services weren’t gold plated. If I may be as bold to suggest it was an entirely rational response to having more money than was needed. And that’s not to condone this.

I refer to this only to make the point that government is populated by human beings and human beings respond to incentives, usually quite rationally. I used to teach public policy economics to undergraduates and masters students. One of my lectures used to be on the growth of government spending and in one lecture I used to go through 17 different theories and models to explain expenditure growth.

One of the seminal ‘government as bureaucracy’ models was developed by William Niskanen and, time and the lack of a flip chart precludes me from taking you through the theory today, it was based on an assumed rational behaviour of a bureaucrat to incentives.

Niskanen sets out the ‘Ps’ that motivate a bureaucrat in the absence of sales or profit targets – Pay, Power, Prestige and Promotion and makes the logical point that the size of a bureaucrat’s budget that he (or she) is responsible for is likely to be the key determinant of each.

Ergo, it is in the bureaucrat’s self interest to try and maximise his budget. He then goes on to show, how through asymmetric information and other things that it’s budget maximisation is a fairly straightforward task irrespective of whether they are set by politicians or the public and those theories are quite interesting. The point Niskanen’s was trying to make was that budget maximisation was an entirely rational response to the incentive set faced by the bureaucrat.

What Niskanen and similar theories do is explain away how it’s possible to have more government than people sign up for. Clearly however, they can’t explain away all government spending growth as experienced over the last 100 years or more. And that spending growth is pretty astounding.

That self same article in The Economist presented a table of Government spending as a proportion of GDP of 13 developed Western States. As an average it had risen from 10% to 47% over the past 100 years. Notwithstanding that spending has risen as a result of the global downturn, that’s near enough a fivefold increase. And those figures don’t take into full account tax transfers and subsidies which give a higher measure.

This is in somewhat a digression but it’s such a high number, it’s worth mentioning – in 1992 by this higher measure the Belgian State accounted for 82% of GDP (I took this from an old text of mine, I don’t have today’s number.)  (For current government spending as a percentage of GDP scroll down this page on Wikipedia.)

To help try and fathom out what has been behind that secular rise in the size of the State it helps to try and be clear what the role of government is.

Clearly there’s the basic libertarian night watchman state that creates private property rights and the rule of law (ie so that a market economy can work) and provides defence. Over and above that a raft of textbooks will suggest the State has generally three further roles: to provide public goods, correct market failure and redistribute income.

And generally it is the increased demand for the first and third of those roles that’s driven spending growth over the last century. That’s not to say that correcting market failure hasn’t gotten more costly, the demand for and costs of financial regulation being just one example but that’s a story for another day.

It’s assumed that as societies become wealthier their tastes and preferences leans towards more and more public goods. That’s not always going to be the case, but it’s a good rule of thumb. As society becomes wealthier, it feels more able to afford greater provision. This general rule has been prevalent since the early 20th century and is known as Wagner’s rule, named after the economist, not the composer.

I’d suggest that it’s no coincidence the argument generally used to support spending cuts is usually done on affordability grounds, rather than attempting to suggest that there’s little or no need or justification for public provision of the service or good in the first place.

Public goods are services are usually provided free (leaving aside for today the issue of fees and charges) and as such there is no price mechanism to limit demand. Demand or the extent of provision is thus driven by other influences, societies tastes and preferences, or, on occasion, influencers – lobby groups and campaigners – with little appreciation of or indeed concern for the full or true costs.

We’re lucky I think because we don’t really suffer too much in Guernsey from the neighbourhood campaigners for ‘more public spending in my backyard’.

We’re also lucky because it’s pretty transparent how much our Government costs. Studies show that the less the true cost of government is apparent and understood through complicated tax systems, the greater the demand is for public services. It’s a concept called fiscal illusion and I do think that we’re fortunate in Guernsey that we’re so small, things are transparent, and we only have a single layer of government.

I don’t say this lightly, but I believe this is a significant safeguard against unintentional or unwanted expenditure growth.

However much we’re not afflicted by that issues, we share the generic problem common to the most of the developed West, in that we face growing spending pressures on the three big ticket public spending items: health, education and social security.

Education is perhaps the simplest to consider. As work and society develops, the need for education and the (often forgotten) desire in itself for education increases. Work becomes more complex and more and greater skills are required.

Dr Andy Sloan, States of Guernsey Economist, addresses the Guernsey Chamber of Commerce lunch meeting at the OGH Hotel (click image to expand - ©RLLord)

How provision is funded, should the burden fall on the individual or society at large? is a particularly acute political debate in the UK right now. And again I make the point that the debate is mainly focused on cost, not on whether current provision is of the right type or set at the correct levels. And I feel it’s an interesting point to note that the terms of reference have changed. Time was that the benefits of an educated workforce was something that was generally accepted as good for society at large and as such paid for by society. Now the emphasis is on how much the benefits accrue to the individual and thus it is much more acceptable to argue that the individual should bear the cost.

However behind that debate is the fact that education spending doubled in France, Germany and the UK from the end of WWII to beginning of the 1990s, a period before the present issues of funding reared its head. Illustrative of the general point that, as societies have got richer and the working environment more complex, spending has gone up.

That’s a demand side argument as it were.

On the supply side there is another seminal work amongst public policy economists called Baumol’s law. It’s one that generally isn’t disputed although there’s no specific agreement on how great its contribution is to expenditure growth. Simply put it explains that public services are generally labour intensive and the scope for productivity gains that exist in the private sector aren’t as readily available.

An example illustrates the point, you can easy imagine that the amount of labour required to make a car at the most productive car plant in Europe, Nissan in Sunderland, is a lot less than it would have been making the Model T back in the 1920s. However, the amount of qualified nurses and doctors per patient in a modern hospital anywhere in Western Europe won’t have declined anywhere near the same amount over the same timescale, in fact it probably increased.

Baumol’s work was to recognise the issue that the relative price of the majority of public services increases with time and this issue is particularly the case in healthcare.

And in healthcare, we have demand issues writ large. Why?

Because of technology improvements and increasing life expectancy.

So in healthcare, our number one spend in Guernsey, both supply and demand side factors are creating upwards pressures on expenditure.

The story is similar for social security spending: demographics are increasing the amount and price of services demanded, in several ways. As we live longer, the need for care increases as there are more and more elderly infirm that need looking after and as we’re around longer we draw on the state through pensions and other services for longer.

I don’t need to tell this audience, that the problem isn’t just one of increasing life expectancy, but the changing demographics beneath the elderly and the problem with reduced numbers of workers beneath them to fund the system. And what I don’t have time to address is how best to ensure that there is a sensible standard of living across all society in retirement ie the issue of what levels of public section pension provision is appropriate.

HSSD’s 20/20 Vision Document sets out the health issues in greater detail and puts a marker down that as a society we’re going to have to address them. It sets out quite transparently that various methods of funding of healthcare in the future will need to be considered including fully tax funded models and mixtures of public and private funded provision.

These issues are complex: we know that relative costs and demand is going to rise in key areas of public expenditure, but how are we going to decide the trade off between provision and costs.

How do we address problems of intergenerational equity? It is fair that the young pay for the provision enjoyed by the elderly today but receives less when it is their turn. Did the old really pay in as much as they are getting out?

How do we as a society decide what we think is fair, reasonable and acceptable level of public provision? And is that affordable? Do we set the level and then find a way to pay for it or do we allow our notion of acceptable cost determine the level of provision?

Do we think standards of health care should be determined by wealth or is health care a true and pure public good?

And how do we reconcile the answers to those issues in a society that purports to have some of the highest income levels in the world.

And we need to address these issues against the backdrop of needing to maintain a competitive tax regime which is after all the bedrock of our economic success.

That backdrop also includes a hard budget constraint, increased spending on these areas means less on others which in itself in difficult choices unless we assume that there’s a morass of expenditure on services that aren’t needed or wanted in the first place and when we spend by my back of the fag packet arithmetic around £9,500 per head of population compared to Jersey and the Isle of Man’s £11,000 that doesn’t seem that likely.

These aren’t easy tasks, I wish I could conclude with a glib, the future’s bright, the future’s orange. But the issue of government spending growth has come once again to the fore as deficits positions across the West have become difficult and unsustainable which makes the ticking issue of demographics a real and present danger.

The Economist’s article seemed to assume that there was somehow an upper bound or maximum to State expenditure. Theoretically that’s not the case, the level of State expenditure can rise or fall reflecting tastes and preferences across society. The practical limit to the west is competition from lower spending states in the Far East with lower levels of services, spending and thus tax rates.

These are the same constraints that face us here in Guernsey and these are these are real and present issues. We are fortunate that our current starting point is one of relative good fortune. However, there are no easy answers, these are problems that we as a society face and are one’s that our current and future politicians are going to be responsible for resolving.

Public choice theory often explains away the way government solves the problem of knowing the right level of expenditure and services is by reference to seeking to obtain the preferences of the median voter or that government tries to maximise utility of society at large, after all we all want life to get better. And each of us will have our own personal views of the right course to take and they’ll all differ.

These are quite abstract concepts but finding the solutions to these long term problems in our method of government is akin to finding answers that the majority of the States’ members support.

As I once publicly said, and was gently ridiculed for saying so, it’s a complicated task running a government!

 

  1. No Comments

Have your say