The Evolution of Public Spending in the OECD Countries – Part I

11 Mag

by Arturo Hermann

  gdpThe impressive increase of the ratio of public spending on GDP (Gross Domestic Product)

One leading aspect of the economic evolution has been the long-term increase of public spending (PS), not only in absolute but also in relative terms, as shown by the ratio PS/GDP. This ratio has increased (OECD data) for the most important Countries from 5-10% of the XIX century, to 10-20% of the early decades of XX century, to 40-50% of the latest decades.

For space reasons, we do not address in detail the issue of distribution of public spending by function.

The theories

This phenomenon was first analysed by Adolph Wagner (1835-1917), who observed that economic and social development carries with it an enlargement and diversification of the functions of the public sector, with a corresponding importance of “public goods” and policy action. Starting from these insights, three lines of research can be identified, which often tend to be blurred:

(I) Public choice theory, which underscores the role of interest groups in lobbying the political system for obtaining more public resources in their favour. The limitations of these studies lie in the circumstance that they tend to appraise public spending only as a negative phenomenon, a kind of unwelcome departure from the optimizing world of perfect markets and perfect competition.

(II) A number of theories belonging to the fields of institutional and evolutionary economics, which point out the role of the public sector in providing the legal and institutional framework, and the policies — for instance competition, education, research and innovation, industrial, social, environmental — necessary for ensuring a (relatively balanced) development of the system.

This happens also on account of the growing complexity of capitalistic institutions and the corresponding importance of market imperfections at micro and macro level.

(III) Keynesian theories, which investigate the macroeconomic imperfections, in particular the tendency of effective demand to lag behind the supply of full employment (however defined).


The tendency of effective demand to lag behind the supply of full employment

As the previous data indicate, public spending plays a relevant role in the formation of effective demand. But there is also another paramount component of this demand, which is constituted by the process of credit creation.

This process has constantly increased in the last decades for both public sector (as an important way to finance public spending) and private sector (as a relevant way to increase the spending capacity of families and firms). As can be seen in the links below, these figures have reached a considerable level for the most important Countries, with prevailing values between 150% and 300% for private debt and 90%-150% for public debt.

Since the data indicate that the attempts at reducing public spending have not succeeded in recovering the Countries from economic crisis, we focus attention on a macroeconomic explanation of the tendency of effective demand to lag behind the supply of full employment.

In this regard, it is interesting to note that, in the absence of public spending and credit creation, no significant extra-profit — in the meaning of a remuneration of investments exceeding its “normal” level — would be possible for firms.

As a matter of fact, labour cost constitutes an aggregate cost for the system of firms. This cost can be brought to zero if employees spend all their earnings but can never become a source of profit.

But, very interestingly, not even the entrepreneurs’ investment expenses can create an aggregate profit for the firms as a whole. In such a case, in fact, to the profit of an entrepreneur must correspond the expense of another, so that the net result for the firms would be zero.

As a consequence, the aggregate profit must derive from sources “external” to the system of firms: these sources take two interrelated forms: public spending and credit creation.

True, the entrepreneurs can increase their consumption. However, this process finds many limitations, especially in the presence of scale-economies associated with mass consumption. This aspect can help explain why the marginal propensity to consume tends to be lower for the richest sections of populations.

In this reasoning we do not consider international trade whose balance, in terms of effective demand, is zero at world-level. This happens because the total value of exports must be equal to the total value of imports. Needless to say, the effects of international trade should be carefully considered in a more complete analysis, because there are notable differences in economic power and opportunities between Countries.




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