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Feed the Beast

Mark Thoma asks a question:

Why should government spending as a percentage of GDP stay constant as GDP grows? It seems that, as we grow wealthier as a society, we would want relatively more of the kinds of goods government provides, e.g. social insurance.

I think the answer is a whole lot simpler than that. Thoma’s speaking on the normative – that, as we become a richer society, we ought to spend more on social services for the poor. I agree with that. But in fact one doesn’t need to share my progressive views to see that G/GDP must rise unless we tempt a catastrophically – yes, catastrophically – amended social contract. In other words, the answer is positive.

Conservatives are right. Government sucks at providing most goods and services. Here’s a list of some things with which Uncle Sam should never involve himself:

These are all left better to the private sector. On the other hand, due to economies of scale, monopsony advantage, and network effects, the government has a comparative advantage in the provision of:

  • Medical care.
  • Retirement.
  • Defense.
  • Infrastructure.
  • Education.

Government’s comparative advantage above derives in part from standard economic analysis, but also a public, bipartisan conviction that these services should be provided by a robust public sector. This is not only a liberal consensus.

Now, the real gross domestic product is modified from its nominal counterpart with what economists call a “GDP deflator” from a given base year. It broadly tracks inflation. If price levels increase 10% in a given year, a 12% increase in nominal GDP isn’t too impressive. However, it is the broadest measure of inflation on the aggregate of (C + I + G). But take a look at individual price indices:

fredgraph

The above graph destroys any hope of a smaller government. Since 1988 education (purple) has increased almost seven fold. Healthcare (red) five fold. Food and beverage prices have only doubled, apparel costs have flatlined, while technology and entertainment prices have plummeted. Basically prices for everything the government is good for have a positive slope and everything it’s bad for have a negative slope. I don’t think any other graph could more clearly explode hopes for a smaller, or even flatlined, government.

The past thirty years has not been kind to the median worker. But all inflation isn’t created equal. It all comes down to relative prices. Items consumers spend on (C/GDP) benefit most from rapid globalization and technological change (Netflix… iTunes… Moore’s Law… etc.) and have experienced either incredibly slow inflation or even deflation. Things government can and should spend on (G/GDP) has experienced a disproportionately higher inflation. We can talk about “bending the cost curve” or whatever but a) nothing will bend it near consumer inflation and b) nothing will stop America from aging.

Fact of the matter is – as hard as evidence might be for the right-wing to swallow – so long as medical and educational price inflation outpaces the GDP deflator, G/GDP must rise to maintain the real value of government provision. That is to say that if we maintain a small government – forever at 20% of GDP – its real, inflation-adjusted value will continue to decline.

This is the level at which we must discuss the size of government. Once we fall into the realm of normative, conservatives will stress the inefficiencies of bureaucracy and ideals of free markets. But even at the positive, nothing can halt growth of government. This scares me because one of America’s flagship political parties is hell-bent not only on preventing growth of G/GDP, but also shrinking government despite hugely inflationary pressures to the contrary.

That scares me because I see no way to reconcile our current social contract with the demands of a smaller government. Needless to say, part of the inflation is secular and will ebb as the population ages into an equilibrium. It will ebb as technology moves from entertainment to medical care. It will ebb as online education revolutionizes the university. But it will ebb at a higher level than 1988 – and the size of government must reflect that fact of nature.

Without feeding the beast we will be starving ourselves. And it doesn’t take a progressive ideologue to see this. 

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13 comments
  1. You’re misusing the term ‘comparative advantage’. And you’re wrong about everything but defense–which is the classic, non-rival, non-excludable in consumption good.

    Take education (please!); in the US it was mostly privately provided, or provided by local governments on a fee for service model, until Horace Mann came along and used the police power of the state of Massachusetts to wrest it away from the people who’d made America the best educated nation in the world in the 19th century. See Tocqueville for confirmation.

    When one party has the legal right to use force to impose its ‘produce’ on others that is NOT evidence of ‘comparative advantage’.

    • There can be comparative advantage between countries. There can be comparative advantage between people. (Say a model and a genius). There can be comparative advantage between firms. It has nothing to do with “forcing” and “imposing”. I might have a company that has its private army and I’d have a comparative advantage in “getting my way”.

      Funny how you mention Americans as the best educated in the 19th century. Almost as if the postwar boom had nothing to do with a GI Bill.

      • Since the postwar boom started in September 1945, you’re right about the GI Bill. But, it’s clear you don’t understand the concept of ‘comparative advantage’. There have been a lot of private armies that were notoriously inept too.

        You find out what your comparative advantage is in the marketplace, through the interaction of supply and demand.

      • Nathanael said:

        Ashok describes comparative advantage correctly. You do not, Mr. Sullivan. In fact, the government has an ABSOLUTE advantage in the provision of all these services listed (education, health care, etc.) as well as a comparative advantage.

        Comparative advantage is NOT determined in the marketplace, Mr. Sullivan; you obviously weren’t paying attention when you studied Ricardo, since you don’t know what comparative advntage means.

        Comparative advantage, like absolute advantage, is a matter of production efficiency: how many units of product you can produce for a given number of units of input. The government is massively more efficient than for-profits or charity at production — less administrative waste, more efficiency — when it comes to education, health care, etc. The government has an *absolute advantage* in those things. Now, does it also have a comparative advantage? Yes, it does — because the “private sector” has an absolute advantage over the government in entertainment, technology, clothing, etc., and so the “private sector” will, according to Ricardo’s theories, stick with that stuff and leave the education, health care, etc. to the government.

        (As an aside, the theory of absolute advantage is well-established by historical fact; the theory of comparative advantage is unproven and probably false. The theory of comparative advantage applies in the case where England is more efficient at *everything* than Portugal, and suggests that Portugal will specialize in the production where it is the “least disadvantaged”, and suggests that England will leave that area to Portugal. In practice, given an absolute advantage in everything, England will produce everything and leave Portugal producing nothing — the theory of absolute advantage is correct and that of comparative advantage is wrong.)

      • Exactly. I would put it as this. A monopoly government or private firm has a comparative advantage in the provision of massively scaled services (healthcare, defense, etc.) The efficient industrial design would then either be direct public provision or a government-protected monopoly owned by private interests.

        The latter, however, allows private interests to collect rents unfairly and would result in a price above the marginal social cost. Therefore we want government.

  2. How do you cope with stories like this one;

    http://online.wsj.com/article/SB10001424127887323829104578623422748612116.html?mod=WSJ_Opinion_LEADTop

    ‘While I was at the DDOT, roughly 10% of bus-fare collection boxes were broken. In another city, getting a contract to buy spare parts to repair these boxes would be routine. The City Council publicly expressed outrage that we didn’t fix the fare boxes, since the city was losing an estimated $5 million a year in uncollected fares.

    ‘But the reason we couldn’t fix the fare boxes was that the contract for the necessary spare parts had been sitting, untouched, in the City Council’s offices for nine months. Due to past corruption, virtually every contract had to be approved by the council, resulting in months-long delays. Micromanagement by the council was endemic; I once sat for five hours waiting to discuss a minor transportation matter while City Council members debated whether to authorize the demolition of individual vacant and vandalized houses, one by one. There are over 40,000 vacant houses in Detroit.’

    Which is typical of government bureaucracy, but not of private businesses facing competitors.

    • This comment makes me believe you don’t actually have much attentive experience of real life in private businesses. Market discipline doesn’t promise that all companies will be efficiently run, only that there are thresholds of incompetence beyond which companies will fail. Companies will fail for other reasons too, but one of them is, for sure, a level of ineptitude that outweighs whatever positives it has going for it. Over time, attrition comes to very poorly run companies, and ceteris paribus (which it never etc.) the better-run companies will be more likely to survive. That means:

      * There can be plenty of poorly run companies extant at any given time.
      * The surviving companies don’t have to be perfectly run or even especially well run. They just need to be “faster than their chubby hiking partner, Fred.”
      * Even better-run companies have all sorts of inefficiencies tucked into them because corporations are human institutions and all human works are imperfect.
      * Ascriptions of generalized efficiency to business as a whole rest on survivor bias.

    • Nathanael said:

      Look at the unfixed breakage rate in private businesses — for real. Look at it. It’s often higher than 10%. Did you experience the Penn Central Railroad? Go research it.

  3. Rob said:

    This is the standard Baumal’s cost disease argument in every public finance textbook. I think it’s very valid and it’s nice to see it presented with the graphs to support it.

    However, I would note that in my view it’s an argument why real G *per capita* must rise. We could still provide the population with a constant level of government related services and have a falling G/GDP if inflation in [healthcare, education, etc] rises slower than nominal GDP/capita.

    In other words you need to combine a view of costs with a normative view on whether govt services should be in some sense luxury goods, inferior goods, or normal goods. Here you’re assuming normal goods, but it’s perfectly logical to say that we should provide some constant real amount, and if GDP increases faster than the relevant inflation, G/GDP should decrease.

    Generally I’m with Thoma, though.

  4. So here’s a come-on I just got for a webinar at my day-job…

    “CFOs receive dozens of capital funding requests every year, and throughout the year. The projects are diverse and hard to compare, while staff often submit biased business cases and spend too much time and energy lobbying for their pet projects.”

    There’s nothing magically effective about private business and business people.

  5. Mister Patrick R Sullivan is an annoying little goober, no?

  6. Derrick said:

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