Economic policy advice for the NDP, Part II: Defending big government

A while ago, there was a spurt of articles bemoaning the 'out-of-control' spending of the federal government, making the point that federal spending has been outpacing the rate of growth of GDP over the past five years. We are presumably expected to believe that future federal governments will be obliged by the inexorable logic of budgetary arithmetic to reduce spending.

This reasoning is wrong on many, many levels. Below the fold, I'll develop the arguments that can (and should!) be used to to explain why spending should not only not be cut, but can be significantly expanded without harming the economy.

Firstly, as I pointed out over here, the 'out-of-control' spending meme is based entirely on the statistical dodge of using a start date that best conforms to the story you want to tell. Here is a graph of federal expenditures and revenues as a share of GDP:

It's true that spending has grown faster than GDP over the past five years, but this growth is best characterised as a bounce off a very low base. As a share of GDP (see here for an explanation for why the GDP share is the correct measure), federal spending is still below the levels that John Diefenbacker's government administered. Claims that federal spending levels are in any way 'too high' should be dismissed out of hand. Unless, of course, they're employing some strange usage of the word 'high' that I wasn't previously aware of.*

And just what is the problem with high levels of government spending? Some people might at this point be tempted to confidently assert that high levels of government spending are incompatible with growth and prosperity. These people would be wrong. In his paper "15 Years of of New Growth Economics: What have we Learnt?" (pdf), Xavier Sala-i-Martin notes:

The size of the government does not appear to matter much. What is important is the "quality of government" (governments that produce hyperinflations, distortions in foreign exchange markets, extreme deficits, inefficient bureaucracies, etc., are governments that are detrimental to an economy).

For completeness, and because this is important for NDP strategists to understand, there are a couple of other points that Sala-i-Martin makes:

Institutions (such as free markets, property rights and the rule of law) are important for growth.

More open economies tend to grow faster.

So big government is not necessarily a drag on economic growth and prosperity, so long as it is smart government. In the next posts, I'll start in on what a smart social democratic government agenda would look like.

* Extra points to whoever gets this reference!

This is part of a series:

• Economic policy advice for the NDP, Part I: Inequality
• Economic policy advice for the NDP, Part III: The GST
• Economic policy advice for the NDP, part IV: Corporate income taxes
  
• Economic policy advice for the NDP, Part V: Give money to low-income households
• Economic policy advice for the NDP, Part VI: Climate change

Comments

[mh]

Try adding debt guarantees, contingent liabilities and contractual commitments, and program obligations... and then tack these for on all the provinces and you have a whopping $2.4 Trillion in total government liabilities (as of 2004/05, according to the Fraser Institute). BTW, this is 188% of GDP (in 2004/05)

Also, the federal deficit is forecast to be around $100 Billion for the next 5 years. Only one year of this will reverse most of the debt repayments in the last decade...... and then try adding up all the upcoming provincial deficits too .... and you get an ugly looking debt picture for Canada.

While I tend to agree with infrastructure spending, I do question the renovation tax credit, subsidies for residential mortgages, and credit support for car leasing. Anything to boost consumer spending is like giving more drugs to the drug addict. And I hope we don't start building bridges to nowhere like in Japan..........

[Robert McClelland]

The NDP doesn't really need to defend big government simply because there isn't a party with the credibility to attack them on the issue.

As for referring to spending as a share of GDP, I've pointed these facts out on many occasions to critics of big government. They simply don't listen. Most of them believe the size of the fedgov grew all through the 90s and refuse to believe otherwise.

[reason]

mh
I saw from a commentator (female) of Mark Thoma's what I thought was a very good solution on what to spend stimulus money on - subsidise investment in solar energy for households (perhaps 1 time with a fixed upper limit/household). Of course I think the commenter was from California. But it does seem to have lots going for it, as it has social benefit and improves individual cost flow.

[reason]

that should read ... individual cash flow.

[Trevor]

(Fishing for those extra points). Your referencing Hitchhiker's Guide to the Galaxy: "some strange usage of the word 'safe' that I wasn't previously aware of."

[Dingdingding! Yes! - SG]

On a more serious note, you state that "claims that federal spending levels are in any way 'too high' should be dismissed out of hand." I think this misses the point of what individuals opposed to many government programs would like to make. The spending is certainly not high in some objective sense when one compares to past spending levels, but is above what one could reasonably (subjectively) view as some optimal level of spending. It is not an historical comparison being made but a comparison of spending against some "ideal" level.

Also, comparing to 2000 does not need to be characterized as a "statistical dodge" but rather comparing spending to a level of spending that certainly was lower and did not lead us all off a cliff. That is, one might oppose cuts to government spending by claiming that current spending is somehow "necessary". Pointing to previous years when spending was in some sense lower, thereby demonstrating that some spending taking place now was not "necessary" five years ago.

Final thought, analyzing government spending as some "blob" makes little sense in my mind. Should one not focus on particular programs, one by one, either rejecting or accepting them on their merits (or some normative notion of what government ought or ought not to do)?

[Leo Petr]

@Robert: The lack of any credibility on the issue doesn't prevent the Conservative Party from shouting very loud claims contrary to reality and their own record. And, as an electoral strategy, this works depressingly well.

[Kosta]

As a proponent of bigger government, let me try to argue the contrary and put forth the case for decreasing gov't spending. The basic benefit of decreasing gov't spending is that it decreases taxes for each and every individual. Lower taxes is undeniably a *good thing* although the benefits could potentially be outweighed by the services which are cut.

And now let's apply (or perhaps misapply) the results of Sala-i-Martin from the blog and note: "The size of the government does not appear to matter much. What is important is the "quality of government" (governments that produce hyperinflations, distortions in foreign exchange markets, extreme deficits, inefficient bureaucracies, etc., are governments that are detrimental to an economy)." And while this argument indicates that bigger governments do not hurt growth if they are smart, the converse is also true, smaller smart governments do not hurt growth either.

So we have the opportunity to lower taxes, which is a genuinely *good thing*. Lowering taxes would mean a smaller government, and if that government is smart, it will be good for the country.

I think the decision is clear, lower taxes smartly (which means reduce services smartly) or increase spending smartly. It's not clear to me why increasing spending is the obvious choice (other than the fact that we're at historically low levels of spending right now).

[Matthew]

In interesting post. But doesn't government spending keep taxes higher than they need to be? Working in Ottawa for ahwile, I couldn't get over the amount of people I knew who were working on projects and programs that added only very marginal value (if any at all) to the country's wellbeing. Also, I think that big government usually is inefficient government.

[Matthew]

"And I hope we don't start building bridges to nowhere like in Japan.........."

Yeah, sorta like the new "economic development agency" for Southern Ontario announced in the budget. Just what we need, another political slushfund like Western Diversification and ACOA, courtesy of the Canadian taxpayer.

[Matthew]

Stephen:

While we are on the topic of economic advice for the NDP, what would your views be on a guaranteed national income of a certain amount. The idea has been around for awhile, but Raymond DeSouza (himself an economist as well as a priest) made a rather pursuasive case for it recently in the Post. People are poor because they don't have money - so send them a cheque. It seems much more efficient than the billions we direct towards middle-class government and non-profit bureaucrats and their programs to manage the poverty problem, while not really solving it. Cut out the middle man.

I suppose soem economists would argue that this would kill incentives to work. Maybe for some people, but I think its worth a try.

[Stephen Gordon]

what would your views be on a guaranteed national income

They're coming! In previous posts, I've expressed support for the idea, and I haven't seen anything to change my mind.

[Patrick]

I don't think guaranteed income needs to imply killing the incentive to work. It might actually be an incentive. We could say that guaranteed income for someone who is working is more than someone who is not and hasn't for a long time. And we say the if you loose your job, guaranteed income simply 'decays' over time down to the basic level.

[reason]

matthew, patrick,
re incentives to work - yes some people would be discouraged from working - but you wouldn't want to have them as colleagues. I count that as a plus. And I think there is a huge plus in terms of encouraging entrepeneuship (but providing a reliable safety net).

[Matthew]

"And I think there is a huge plus in terms of encouraging entrepeneuship (but providing a reliable safety net)."

I would have thought so too. A social safety net obviously lessens risk of failure and provides benefits (i.e. pension, dental) for the self-employed that would otherwise only be available through an employer. But it seems to be the Anglo-American countries that excel in producing entrepreneurs, even though they have relatively modest social safety nets and benefits for the self-employed are either stingy or non-existant. Many european countries (including the nordics) provide a lot of state benefits to the self-employed and yet their entreprenerial activty is less impressive. There is a study by the Fraser Institute that attempts to measure levels of entrepreneurship in different countries (seems to be free of any eggregious right-wing bias). The are several other studies as well. I'm sure a significant subset of entrepreneurs respond to economic incentives that they understand, but I think entrepreneurship is rather cultural in nature.

[reason]

Matthew,
I think regulation of product markets might be relevant there. I live in Germany, and to set up many businesses you need a certificate of competence. Hangover from the medieval guilds it seems.

[reason]

Another factor that could be relevant is demographics - did the study control for that. It is easier to find a new niche and expand it, if the population is growing.

[Matthew]

"...to set up many businesses you need a certificate of competence."

Wow, didn't know that.