In the relevant literature, the size of the state is measured by reference to various indices. They include the percentage of public expenditures in GDP, tax revenues as a percentage of GDP and the number of people employed in the public sector as a percentage of the country’s labour force. Irrespective of the index used, it is clear that prior to 1929, the size of the state followed a slightly increasing trend, whereas after 1929, it grew substantially, following a strong upward trend. Fig. 3.1 illustrates this finding for the USA. As can be seen, with the exception of three periods that coincide with major war conflicts, federal spending as a percentage of GDP remained virtually constant for 150 years, and over the last two-thirds of the twentieth century, it increased dramatically, reaching the level of 30 % of GDP in 2000 (Alesina and Giavazzi 2006, 17). Moreover, for reasons that we shall explain later, it is important to note that, during the crucial decade of the 1930s, the
2According to Eichengreen (2007a, 6), while Europe realised its potential until the 1970s and achieved an “extensive” growth, as he defines it, Europe failed to capitalise on its innovating potential so as to achieve an “intensive” growth as well. The cause to which he attributes this failure is that the institutions on which European growth was based before 1970 (e.g. the cooperation of banks with large enterprises, employment protection, etc.) were not appropriate to encourage and assist entrepreneurship and the innovation to which it leads.
3This interpretation is based on econometric evidence presented by Friedman and Schwartz (1963) and more recently by Christiano et al. (2003).
tendency of federal spending to increase was more pronounced than in the period following the Second World War.
The growth in the size of the state was not limited only to the USA. Similar developments took place also in other democracies. Fig.3.2, for example, displays the same index for Sweden. Although the average value of the index was higher than that of the USA for the same period, the similarity in the pre- and post-1929 trend is preserved. The economic crisis of 1929 had a profound effect in the attitudes that prevailed globally, paving the way for a long-term increase in the size of the state, with a corresponding shrinking of the private sector.
How strong and how widespread this trend was in the post-war period can be seen in Table3.1. On average, public spending climbed from 27 % of GDP in 1960 to 48 % in 1996 for the 23 democracies listed. During this period, almost 50 % of GDP was under the control and management of politicians and officials. If we focus only on the countries of Europe, the public sector grew so much that the domain of voluntary exchanges shrank to just under 45 % of GDP.
In advanced Western countries, public spending soared from about 28 % of GDP in 1960 to 42 % in 1980. During the same period, government revenues (primarily taxes) rose from 28 % to 37 % of GDP. Public spending increased more than public revenues, and as a result, contemporary democracies started running deficits on a permanent basis and accumulating very high levels of debt. For example, while in 1960, only a few countries experienced significant public deficits (e.g. Italy, Canada, United Kingdom), in 1980, most had an annual deficit of around 5 % of GDP, which raised their public debt from about 43 % of GDP in 1970 to 60 % in 1990. The USA adopted a course which was parallel, albeit less statist. There the Fig. 3.1 Trends in the size of government in the USA
percentage of public expenditures from 20 % of GDP in 1937 rose to 31 % in 1980, while public debt increased from 45 % of GDP in 1970 to 61.5 % in 1997.4
As expected, the economic policies that contributed to the tremendous expansion of the state were not uniform. In the USA, for example, no nationalisations of industrial enterprises took place. On the contrary, in the UK and other European countries, many businesses that operated under private ownership and management were nationalised, and their productive activities were assigned to public monopolies administered by government appointees.5 This does not mean that there were no common features. The expansion of public employment, gratuitous provisions to citizens of various goods and services and state encouragement to rent-seeking activities by organised minorities are examples of common features.
Source : Tullock (1993) 70
60
50
40
30
20
10
0
1861 1880 1900 1920 1940
YEAR
%
1960 1980 1990
Fig. 3.2 Trends in the size of government in Sweden
4These figures come from Tanzi and Schuknecht (2000, 7, 52, 62, 65).
5To a considerable extent, the nationalisations concerned businesses in financial distress or unprofitable, and quite likely, they were carried out by coercive means. The coercive tactics against companies and individuals are confessed even by proponents of social democracy, such as Holland (1975, 123), who writes:
The planners were part industrial consultants, part banker, and part plain bully. They could only be this by going below the level of individual sectors and messing their hands with individual firms—normally the leading mesoeconomic firms within the sectors. The tech- nique involved getting the managing director of company X into the Ministry of Finance and letting him know that, unless he did A, B and C, the ministry would not hesitate to channel funds to his principal competitors Y and Z, grant them government contracts, concessions, etc., and permit them to encroach on his own market share.
Moreover, it is worth mentioning that, while in 1960 the number of civil servants corresponded on average to 12 % of the labour force, in the period 1980–1994, it increased to 18 %. According to Tanzi and Schuknecht (2000, 26, 31), during the same period, the cost, for example, of education (health) as a percentage of GDP increased from 3.5 % (2.5 %) to 6 % (6 %), and the percentage of unilateral transfers from 10 % of GDP in 1960 jumped to 23 % in 1995. These figures indicate clearly just how great the expansion of the state was. As for the impact of this expansion on economic growth and prosperity, recent studies, such as the one by Smith (2006), suggest that it was negative because big government means big waste, bureaucracy, corruption and in general dysplasias that increase the differ- ence between actual and potential GDP.6
Table 3.1 Shares of public expenditures in GDP
Countries 1960 1970 1980 1990 1996 1960–1996a
Australia 21.2 25.5 34 37.7 37.5 16.3
Austria 35.7 39.2 48.9 49.3 52.7 17.0
Belgium 34.5 36.5 50.7 54.6 54.5 20.0
Canada 28.6 35.7 40.5 47.8 46.4 17.8
Denmark 24.8 40.2 56.2 58.6 60.8 36.0
Finland 26.6 31.3 36.6 46.8 59.4 32.8
France 34.6 38.9 46.1 49.9 54.7 20.1
Germany 32.4 38.6 48.3 45.7 56.0 23.6
Greece 17.4 22.4 30.5 49.6 49.4 32.0
Holland 33.7 46.0 57.5 57.5 58.1 24.4
Iceland 28.2 39.6 50.8 39.9 37.3 9.1
Ireland 28.0 39.6 50.8 40.9 37.7 9.7
Italy 30.1 34.2 41.9 53.8 52.7 22.6
Japan 17.5 19.3 32.6 31.9 36.9 19.4
Luxemburg 30.5 33.1 54.8 45.5 49.3 18.8
New Zealand 27.7 34.4 47.0 50.0 42.3 14.6
Norway 29.9 41.0 48.3 51.3 46.4 16.5
Portugal 17.0 21.6 25.9 41.9 46.0 29.0
Spain 13.7 22.2 32.9 43.0 45.4 31.7
Sweden 31.0 43.7 61.6 60.8 66.1 35.1
Switzerland 17.2 21.3 29.3 30.9 36.9 19.7
United Kingdom 32.2 39.2 44.9 42.3 43.7 11.5
USA 28.4 32.5 33.7 34.8 34.6 6.2
Average share 27.0 33.3 42.8 46.3 48.0 21.0
aThis column gives the difference in the increase between 1960 and 1996 Source:OECD Economic Outlook, December 1997
6Observing the rigidities and distortions that the economic policies of Roosevelt created, Anderson (1940) warned about their negative effects on economic growth and advised the liberalisation of the economy by discarding the heavy interventions of the state.