The Economic Role of Government
University of Tasmania
Friday 10 October 2003
by Des Moore
Director, Institute for Private Enterprise
Background: 28 yrs in Federal Treasury; head of most divisions, incl advising Treasurer & PM on external econ policy; spent one yr (1972) Royal College of Defence Studies, London; ended Treasury 1987 as Dep Sec; joined IPA think-tank; formed own think-tank (IPE) 7 years ago; produced studies on Vic Govt situation in late 1980s/early 1990s = Kennett Govt reforms; commissioned (1998) to report on The Need for Further Deregulation of Labour Market; appointed (2002) to Council, Australian Strategic Policy Institute; appointed (2003) to Commonwealth superannuation boards.
Give perspective on how and why my views of govt role has changed
Started in Treasury in 1958 = generally favourable view then of governments role, incl capacity to prevent recessions/maximize growth via Keynesian budgetary policies -Bill Phillips "machine" at LSE also "flexible" monetary policies - & to improve econ/society generally only 45 years ago - but difficult even for me to appreciate today full extent of gov/t intervention, both economically and socially.
Recall = high protection/gov/t encouragement of industries against foreign competition of workers via regulation of employer/employee relations fixed exchange rate, then on pound sterling protection of low income/disadvantaged thru social welfare and redistribution of incomes extensive provision of services by govt, such as education, health, electricity, water supply, etc considerable regulation of markets, partic for primary products, to reduce fluctuations in prices and demand greater regulation of marriage and divorce - and of alcohol consumption (6 oclock closing).
Why did govt play such a big role when I joined Treasury? - many influences, but mention just three
Firstly, a hangover from 1930s depression and conclusion many reached - ie this showed the fundamental flaw in capitalism Keynes 1936 General Theory provided the "answer" govt intervention to smooth out fluctuations in the business cycle - also apparently successful gov/t control of economies in World War 11.
Secondly, once major structural changes occur in democratic society, difficult to reverse = interest groups established with vested interests in status quo - indeed want more of same governments can be "captured" by interest groups which, because they are organized, can determine agenda and neglect interests of those not organized even though may be bulk of population - moreover, govts may for a time fund increased spending by borrowing rather than increasing taxes.
Buchanans public choice theory is very relevant - govt actions may be pursued according to interests of politicians, public servants and lobbyists rather than for the public good. US writer PJ ORourke illustrates in his Eat the Rich,where he reported the justification for Swedens large gov/t given him by a Swedish Minister her politicians response was- "You had to give something to the voters. We couldnt tell the voters we were going to cut". Her Ministerial responsibilities Consumer, Religious, Youth and Sports Affairs - almost ensured that she would try to obtain votes by promising that gov/t would improve things.
When a student at LSE in 1953 saw Salad Days - an entertaining musical centred around university students enjoying their final year, post exams in cast was a Minister responsible for ensuring continuance of Salad Days - his title was symbolic of how the potential role of gov/t then viewed in UK - Min of Pleasure and Pastime.
In similar vein, US journalist and writer, Robert Samuelson, argued in his 1995 book The Good Life and its Discontents that has been excessive raising of expectations by politicians but an inability to fulfil them argues this explains attitudinal surveys reflecting majority view that increased dissatisfaction with life and increased feelings of insecurity since 1950s feeling that parents had been better off this despite clear evidence of large increases in US living standards since the 1950s.
Thirdly, reversal of major structural changes requires economic or political "crisis" that provides enough evidence that existing structure or policies of govt are total failure Australia had external debt crisis in mid 1980s that changed attitudes to govt role - in Soviet Union continued provision of living standards well below those in capitalist countries contributed to major changes there - even then took long time for Russian officials to stop govt trying to dictate almost everything should or should not be produced when visited Soviet institutions in the early 1990s, soon became aware of the Russians ability to laugh at themselves and that typical optimistic joke was to assure visitors that things could only get worse, the idea being that eventually things would get so bad that something would have to be done - of course, even after the ten years of Wild West capitalism, Russia along with many other democratic countries still have highly interventionist governments and there is apparent electoral acceptance of such intervention but 30-40 years of experience of govt post WW 11 has changed attitudes in most democracies and led to a reduced role for government in many.
In 1985 US political scientist Steven Rhoads made useful analysis of change in perceptions - book = "The Economist's View of the World". He noted:
"Two decades ago many economists optimistically imagined a federal government that would selectively intervene in the economy to correct for market imperfections once the principles of public finance were better developed and disseminated. Few today have such a vision."
Such analyses led around then to recognition of phenomenon of "government failure" as well as market failure and that govt failure may be worse as attempts at economic planning in Soviet Union and Eastern Europe clearly were but lessons not always learned in 1980s Victorians also suffered from government failure, albeit on a smaller scale.
Back to Aus: in 1987 I resigned T- my experience of dealing with govts had also changed my view of gov/ts desirable role and in major way realized that benefits of govt intervention = much less and costs = much greater wider community had also become much more skeptical of possible benefits size of govt in OECD continued increasing up to about mid 1980s since then = about stable at 37% GDP although Sweden has reduced gen govt outlays from a peak of over 60% of GDP in 1982 to just over 50% today
For Aust OECD data shows overall size of govt has declined (outlays in general government sector =38% GDP in 1985 cf 33% now + privatizations have reduced size of government authorities sector ie outside general govt) Federal Opposition statements suggest Labor not proposing higher outlays in total seem to favour lower taxes.
The increased skepticism about govts capacities to do good reflected in this years BBC Reith Lectures - philosopher Onora ONeill = important analysis she attempted explanation of why apparent loss of trust in public services, institutions and people who run them her analysis extended beyond gov/t to behaviour of professionals and media - but the fact that lecture given in UK reflects widespread concerns about Blair Gov/t behaviour that has particularly raised question of trust in gov/t alleged use of "spin" = trying convince electorate thru media that gov/t is performing well, or will do so not simply a question of reasons for UK deciding to become involved in Iraq even more important in some sense = continuing promises to improve standards of public services generally - but users expectations not being met = decline in trust of Blair Gov/t.
ONeill argued that vital to functioning of society is whether behaviour of govts &professionals can be trusted - including what they say and write publicly - argues that individuals must accept obligation to act in trustworthy manner, and that this obligation must come ahead of claims to rights "I believe that human rights and democracy are not the basis of trust: on the contrary, trust is the basis for human rights and democracy" - and trust cannot simply be established through controls and regulation "if we want a culture of public service, professionals and public servants must be free to serve the public rather than their paymasters" in short, individuals rather than governments are primary determinants of trustworthy behaviour and satisfactory operation of society.
The Reduced Role of Government in 1980s/90s
With increased skepticism about govts capacities, and better understanding of effects of allowing market more freedom to determine industries that will grow, 1980s and 90s saw some major reductions in govt role but also considerable controversy about alleged adverse effects of more market-oriented policies.
Critics argued that so-called economic rationalist policies focus too much on achieving good economic results and too little on social consequences - this opposition has slowed economic reform and has required reforming govts to shift approach now more difficult to implement reform on its merits often has to be accompanied by "packages" that compensate losers even when losers may have been supported by others before reform - so reforming govts need also to be "compassionate".
Problem for economic reformers - many look only at adverse initial effects of reforms but second and third round effects may be favourable over medium term - and favourable from both an economic and social perspective look at some examples.
Reductions in protection of manufacturing in 1980s = initial unfavourable effects on some industries and some employees - but also helped expansions of other industries - lower protection reduces costs for non-protected industries - also reduces prices consumers have to pay - allows them to spend more on other goods or services hence reductions in protection likely to have net favourable effects for community as a whole.
Since end 1980s lower protection followed by increase in manufacturing production of 16 per cent - and manufactured exports now = 23 per cent of total exports cf only 16 per cent then true, manufacturing employment fallen 6 per cent but total employment up 25% = have shifted labour from inefficient to more efficient industries.
May be thought socially "unfair" that lower protection eliminated/reduced some businesses and their employment but was socially fair because rest of the community improved their living standards by not paying to keep the protected sector going arguably, also more socially desirable to have a community with fewer not dependent on others.
Look at one of last bastions of protectionism, the motor vehicle industry now accepts that protection will be phased out over next decade - but the price govt (ie the rest of us) are paying is to pay producers about $1 bn a year in the meantime, effectively providing a subsidy said to be about $80,000 a year per worker.
Regulation of Employer-Employee Relations
The 1980s saw govt start easing regulation of employer-employee relations that regulation began in early 20th century as reaction to industrial disruption in 1890s - but expanded greatly during following years not simply regulation laid down under legislation but added to by govt-established industrial tribunals interpretations in reality both legislative and judicial arms of govt became prime examples of public choice theory they "captured" the industrial relations system by deciding that detailed govt regulation needed to offset perceived bargaining imbalance between employers and employees argued that without third party intervention would be exploitation of employees and a greater inequality in earnings.
This has been a classic example of both govt and judicial failure to recognize realities - difficult for employers to impose conditions on workers when many employers compete for services of labour -today Aus has over 1,000,000 employers competing for services of over 9,000,000 employees also regulatory system did not reduce industrial disputation, probably increased it fundamental problem with third parties determining conditions to apply in employment relationships when fulfillment ultimately depends on whether both sides act in trustworthy way.
However, 1980s external debt crisis and the high unemployment at end 1980s brought things to a head govt, business, and even some trade unions realized that extensive regulation was having adverse effects on Australian businesses capacity to compete internationally and that wages and employment conditions set by industrial tribunals would not necessarily allow businesses to compete and improve productivity also likely to deter employment, particularly of unskilled workers various changes in regulation now allow wages and employment conditions to be determined more at enterprise or individual level.
But these changes still leave far too much govt regulation and third party intervention and still misunderstandings of adverse effects for example, low skilled are not protected by adjusting wages upwards through misnamed Safety Net awards because this prices many out of the labour market and raising low-wages benefits the upper half of the income scale because the majority of low wage earners live in richer households helping the bottom end should be done through social security, not wages.
Overall effect is that proportion of Australias working age population employed is lower than in countries with broadly similar political and legal institutions, but with less govt regulation of labour markets - even if only had same proportion employed as in the USA our employment levels would be much higher and Australia should have even higher rates of employment than the US so govt still needs to play a much reduced role in employer-employee relations.
Managing the Economy
During 1980s Labor govt tried to manipulate econ growth via agreement between govt & trade unions aim was stop large wage increases when economy approached full employment & labour in short supply this Accord to restrain wages growth then used as basis for monetary and budgetary policies designed to keep demand at high level and get faster growth without higher wage-induced inflation but these attempts to manipulate demand actually kept spending, borrowing and inflation at too high levels - ended in a boom-bust situation only stopped by very high interest rates - Mr Keating claimed was "the recession we had to have" - but would have avoided if no govt manipulation of economy.
Australia not alone in failure to succeed in government manipulation of the economy - led to major changes in govt use of budgetary and monetary policies recognition that govt econ management = much harder than Keynes thought in the 1930s also knocked the fundamental flaw in capitalism idea.
Overseas, OECD governments now generally stopped trying to fine-tune economy via budgetary/monetary policies - international economic organizations agree a much more medium term approach desirable many academic economists have also changed - at 1999 Conference of Economists at Latrobe University two prominent overseas economists, Professors David Hendry and John Taylor, told their audiences that Keynesian theory is outdated.
In Australia probably now bipartisan agreement that Federal government budgets should not be operated to try to anticipate or offset cyclical swings in the private sector also reflects recognition of difficulty identifying major business cycles - budget strategy is presented as a "medium-term objective of budget balance over the course of the economic cycle" States also concerned to avoid deficit financing.
Similarly, Federal govt now focuses monetary policy on control of inflation rather than employment over medium term and Reserve Bank is free to determine interest rates without govt interference but within the Govts stated inflation objective this an important recognition of need to avoid trying to manipulate interest rates to fine tune economy - and recognition that govts should not be able to manipulate rates for electoral purposes so, monetary policy now operates on medium term basis for public good.
Has Reduced Role of Govt Worked?
Big improvement in economic growth after allowing for inflation annual incomes per head increased on average by 2.7 per cent a year from 1992-93 to 2002-03 - compares with only 1.4 per cent a year in the 1970s and 1980s - over last ten years Australian living standards increased by an astonishing 30 per cent.
Faster productivity growth contributed over half the increase -this improvement in efficiency suggests economic reforms played an important role.
The earlier reduction in tariffs did not lead to an external crisis or to rise in unemployment indeed the rate of U actually fell from 11% in 1992-93 to 6.1% last year
The increase in national income was equally shared between wages and profits and, although there has been some widening in distribution of earnings and incomes, those at the bottom end received social welfare benefits that increased real incomes.
Difficult to avoid conclusion that reduced role of govt in many areas resulted in large economic benefits for most Australians at same time government intervention through social welfare system protected less advantaged.
Little evidence that increased material welfare offset by declining quality of life - concern that more competitive society has increased stress not reflected in health data- Australians have continued to become healthier during the 1990s - the death rate from almost all diseases (including cancer) is less than at end 1980s - external causes of death also declined, although slight increase in suicide rates - life expectancy has increased steadily over the past twenty years.
Where Government Has a Role But
Reduced role of govt consistent with individuals in modern societies now having relatively high(er) education and income levels individuals and businesses have better capacities than in past to undertake whole range of economic activities and govts have less need to involve themselves - apart from maintaining law and order and external defence, govts should thus in principle have limited role in conducting economic activities or intervening to protect or assist individuals or businesses.
But there is still justification in principle for govts to intervene where markets are not likely to operate competitively and to assist disadvantaged individuals with limited income earning capacities the main problem arises when politicians act in accord with public choice theory and/or where it is difficult to reverse structural changes made in the past.
Social Security and Taxes
Governments role in assisting those disadvantaged on low incomes needs to minimise adverse effects from government taxation required to redistribute incomes and to minimize deterrent effects on work.
Some use "poverty line" as guide to those needing assistance but difficult to justify redistribution based simply on such analysis - poverty line is constantly raised in real terms "poverty" living standard thus moves ever higher over time ie relative not absolute poverty - "poor" can never disappear in fact while population increases the number of poor will grow automatically also many start being "poor" but move up the income scale over time.
Major problem at present is that politicians keep "buying votes" by providing extensive social security - around 20 per cent of working age Australians (about 2.8 million) now receive income support - acts as deterrent to work, reduces GDP also lot of " churning" - benefits paid to middle and upper income groups = 5 per cent of GDP need to tighten eligibility to access such support (income and asset testing) increase requirement to look for work to be eligible (only about 15 per cent now required).
This is a classic example of public choice problem with government basic role justified but politicians cant handle and allow serious adverse economic and social effects.
Competition, Monopolies and Privatisation,
Major justification of having private sector provide most economic activity is that enterprises compete competition protects consumers and encourages efficient businesses - but private operators may also try to restrict competition - govts have an important role to ensure markets operate competitively - prevent monopolies or at least regulate them.
But public sector monopolies are not best way to avoid risk of private sector monopolies - privatization of public sector monopolies reduces likely interference in operations for political reasons and makes enterprises more accountable - most likely to produce a more efficient use of resources, provide better quality service - no significant reversal of the over 15,000 privatisations world-wide in recent years, including under Labour in the UK - the Blair Government is using threat of privatization to try to improve standards in public health and education sectors.
Environment and Education
The environment and education areas provide further examples of the in-principle case for government role to do what private sector would not do - govt intervention here does impose costs on individuals or impinges on their individual freedom - but the aim is to produce more-than-offsetting benefits for the community at large.
Government intervention is justified to ensure free and compulsory primary and secondary education because there are net "spin-off" benefits both economically and socially from having an educated community - but more limited justification on both economic and equity grounds for government assistance for higher education - qualified individuals have incentive to invest in educating themselves as graduates generally earn higher salaries - also difficult to see need for government operated universities no evidence from overseas that private universities result in lower standards.
Government intervention to regulate activitites that could damage environment also justified - individual factory or car owners have no economic incentive to limit emission of pollutants difficulty is, again, undue influence of lobby groups.
1. Reduced role of govt in 1980s/90s has produced economic benefits without significant adverse social consequences and is consistent with individuals higher education levels and higher incomes.
2. Governments role today should now be more as a protector of disadvantaged and regulator of private sector activity - not as a direct producer of goods and services other than defence and domestic law and order.
3. Existing government role still excessive - lesser role would improve economic efficiency and living standards would also improve society by eliminating government assistance to particular groups that have no needs basis for it and by increasing employment of lower skilled.
4. Important to recognize that advocates of big government role often pushing their own barrows - or some barrow that reflects their view of how the world should be organised - history tells us that we should be extremely cautious of jumping on to such barrows.
 ORourke claims the title of his book originates in Songs of the Economic Advisers, which include "Kill the poor, Eat the rich, Screw every other son-of-a-bitch" !
Using 1992-93 as a base avoids using the low base of the earlier 1990s recession as a starting point, which would produce an artificially favourable picture of developments since then. Using 2002-03 as the end point, however, includes the relatively slow growth of 1.4 per cent in that year.