Restraining the welfare state

TheStar.com – opinion/editorialopinion
Published On Sun May 29 2011.   Michael Boskin

By winning an outright majority in Parliament for the first time since assuming office, Prime Minister Stephen Harper continued a remarkable series of national election victories backed by voters demanding at least a pause, and perhaps some reversal, of the growth of the welfare state.

Harper’s victory follows the Republican party’s resounding 2010 triumph in the United States’ mid-term election, a campaign largely fought on the size and scope of government, following the massive expansion of public spending in the wake of the financial crisis and recession. British Prime Minister David Cameron (who leads a centre-right coalition), likewise won on a platform to roll back the excesses of the welfare state.

Next up is French President Nicolas Sarkozy’s anticipated re-election bid. France has higher taxes and social-welfare benefits than the United Kingdom, Canada or the United States. Sarkozy, despite initial attempts to roll back some French entitlements, has thus far produced less reform than Cameron or Harper, let alone Ronald Reagan or Margaret Thatcher in the 1980s.

Some might argue that the economic problems faced by governments are so severe that simply being in power invites being tossed out of office, regardless of ideology. But Harper’s re-election suggests otherwise. Harper lowered Canada’s sales and corporate taxes (now well below America’s) and, like Cameron, desires more rapid fiscal consolidation than U.S. President Barack Obama.

The potential significance of these elections must be understood in the context not only of the recession and financial crisis, and the government interventions designed to deal with them, but also in the broader sweep of the historical evolution of these countries’ welfare states.

The following trends stand out:

• In all four countries, there has been a sizeable upward trend in government outlays as a share of GDP.

• In each country, there has been a sizeable increase in public spending in the last few years, particularly in the U.S. and the UK.

• France has the highest government spending as a share of GDP — well over 50 per cent, according to the OECD — and this has increased continually, decade after decade.

• The U.S. currently has the smallest share of government spending in GDP, although it has gained substantially on Canada because of the spending explosion since 2000 — President George W. Bush’s military spending and Obama’s social spending.

• The increase in Canada’s public spending as a share of GDP since 2000 has been the smallest of the four countries.

• Canada and the U.K. have had periods of important reductions in the share of government spending. In the U.K., the share fell four percentage points in 1980-1990 (the Thatcher revolution), and fell further until 2000. In the years prior to the financial crisis, Canada’s share fell from the mid-40s to about 40 per cent.

• Likewise, the Reagan Revolution in the U.S. stopped the upward trend in non-defence spending.

What about economic performance, as measured by real GDP per capita? The four countries rank exactly in inverse order of their government spending shares (according to both 2009 and pre-crisis 2007 data), with the U.S. highest, followed by Canada, the U.K. and France.

Voters appear to be onto something important. Of course, correlation does not prove causation; there are myriad other factors that affect economic performance besides the size, composition and nature of welfare-state spending (and clearly related taxes and debt). Moreover, governments provide services, from defence and law enforcement to a humane safety net, that are essential to a successful economy and society. But the size of the welfare state — and the erosion of incentives to work, save and invest, owing to high taxes and bloated transfer payments — is a major impediment to faster income growth.

This simple analysis should raise a red flag about how we think about the trade-offs between dynamism and security, or growth and redistribution. After all, real per capita income in the U.S. is about 40 per cent higher than in France, 22 per cent higher than in Canada, and 31 per cent higher than in Great Britain.

The relative histories have followed a similar trend (again, other factors are involved, not just taxes and spending). For example, the U.S. advantage over France has expanded from 25 per cent to 40 per cent since 1980, a period in which the share of government spending in GDP was stabilized in the U.S. (until recently), while it grew substantially in France. Likewise, French real per capita GDP exceeded the U.K. level in 1980, but was overtaken in 2000, and by 2007 lagged the U.K. by about 10 per cent. These differences are the equivalent of an entire generation of economic progress.

Those who want to control, reform and reduce government spending seem to have the big picture right. It is a prerequisite for substantial economic advance. That is the broad lesson of history — from the Reagan and Thatcher revolutions in the U.S. and the U.K., to Harper’s more recent experience, to the repeat performance that Cameron and the Republicans in the U.S. Congress are now trying to engineer.

Only time will tell if the recent elections in the U.K., U.S. and Canada signal a retreat from the growth of the welfare state or just a temporary respite.

But comparing the U.S., Canada, the U.K. and France reveals that the stakes are immense.

Michael Boskin, currently professor of economics at Stanford University, was chairman of president George H.W. Bush’s Council of Economic Advisers, 1989-1993.

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