A standard attack on Labour is that it has left the government dominating the economy, which spells doom for our future growth. Policy Exchange’s approach to this has been the most uncompromising and (as I shall show) wrongheaded; see this publication, mentioned by the Wolf, and utterly debunked by me.*
A state that actually dominated economic production is terrible for economic efficiency. For the UK to grow for 200 years has needed capitalism’s endless, restless search for better ways of doing things. Good ideas get rewarded and prosper– for a while – and bad ideas get thrown out. This doesn’t work when the state is in control, and ordinary commercial motives are absent. Imagine if the development of the IT industry had been all decided in think tanks and Whitehall. We would still be on BBC Microcomputers.
So, are we in a 50%-state economy? Superficially the government spends about £650bn of a £1400bn GDP economy. But does it feel like that? Um, no. Think about it: the state employs 6 million people, or about 20% of the workforce (h/t John Redwood). Half of the state’s spending is actually transferring money to people so that they can spend it themselves. Government consumption is about 20-25%. So, for example, Mrs Bloggs get £10k in housing benefit, and she decides where to rent. Ordinary market incentives still intact.
But this figure still overstates how much the government ‘dominates’ the economy. To see how, go over your annual transactions. How many of them involve dealing with the state? When you buy food, clothing, alcohol, leisure, meals out, holidays, and so on, do you deal with the State? In fact, go to Table 4.4 of this (large) document, and ask yourself – how many of these are state provided? Of course, this is deceptive: we ‘purchase’ a lot of things like health and education from the State without handing over money. Nevertheless, the number of transactions that involve the state being on one side is fairly small. Even if the government does take about 25% and use it to provide teaching and healthcare, most of the onward transactions from there on are private, decentralised affairs.
Consider a straightforward hospital visit, with some drugs provided free. The State pays £X to a nurse to look after you and £Z to get you drugs. Consider the drugs side of things. Of the £Z on drugs, most goes in a further transaction to a drug company, which then goes about decision making in the good ole’ capitalist way. Now consider the nurse. Yes, she is chosen according to state criteria, with baleful national wage bargaining: good nurses and bad nurses are paid the same, roughly, which is bad. But most of what is paid to the nurse gets spent on other things, most of which are subject to capitalist discipline:
What matters, as Congdon ironically reminded me, is the quantity of transactions that are state-dominated. In total the UK economy has about £60,000 billion of payments made– or 50 times the size of GDP. ** How many of these involve the government as buyer or seller? My guess: much less than 10%.
This distinction can be illustrated with a thought experiment. Imagine an economy – PrivateLand – in which the government ‘does’ nothing – produces no goods or services – except remove about 50% of the income of some people, and give it out to other people. Education, health, even defence are all provided privately. How the tax was gathered would affect economic incentives, but every further economic transaction takes place in a competitive marketplace.
Now consider an economy – SovietLand – where 50% of every economic activity is done by the state, paid for by taxation. The state takes tax, and uses it to provide, free, loads of groceries, clothes, iPods, holidays, financial advice, music etc that it makes itself.
Both these economies would have a 50% government-spending to GDP ratio. But PrivateLand would clearly be the most efficient. This is because prices and wages, and what is produced, and how, are all going to be decided by market participants, who get punished for doing things badly. In SovietLand, state competition undermines private provision, distorts wages, provides bad products, opens the field to corruption and favouritism, has unsackable employees, and so on. Queuing rather than price movement dominates.
So what matters is not “how big is the State” in terms of income/GDP. What matters is how much of the economy is subject to decentralised, capitalist discipline. You could imagine a small state – like, say, Medieval Britain – where the King actually took only 10% of the output, but where rules and restrictions (guilds) and custom utterly self-feeding capitalism taking hold.
And you could have a larger state – Sweden, say – that redistributed quite a bit, got Policy Exchange all hysterical, but had no nationalised industries and no stifling market-defying regulations. This could quite easily grow fast.
The likes of Policy Exchange, and all the hysterics worrying about how large the state has become in the last two years, are misusing one metric – the spending/GDP ratio – to present a false picture of how much of what we do is actually state-determined. Let’s be serious: spending on this naive measure jumped from ~39% to %48% in a matter of 4 years. Did this mean the government suddenly ‘taking over’ 10% of the economy’s production decisions? Of course not! The absolute volume of government-economy transactions probably grew a little, and the volume of private-private transactions probably fell a little. If the government had bought Tescos (£47bn annual sales worldwide – 3% of UK GDP) and started running it like a Quango, we would have had a hit to our productivity. But that is not what happened.
The interesting ratio would be that between the number of transactions involving the State and £60,000bn. I have no earthly clue what that is, except for “much much less than 50%”.
Does this mean the Left does not need to worry about Big government damaging economic growth? No, of course not. For a start, the State can damage the economy through pure regulation, by for example dictating what everyone should be paid according to some disastrous NEFish criteria. It can also damage at the margin. A single state supermarket might damage all the grocery market by undercutting unfairly. Its methods of redistribution also matter: taxes on rents are better than those on economic activity. But simply parroting the public spending/GDP ratio achieve very little indeed.
*In fact, Policy Exchange got so carried away with this idea that they mistakenly stated that the Private economy has not grown at all for a decade. David Smith put them right, embarrassingly
**To generate £1500bn of ‘value-add’, you need a whole lot more transactions, because only a small amount of each action involves adding more. Economic production involves taking something for £XX – a lump of iron, an hour of a graduate’s time, some flour and water – doing something with it, and selling it on for £XX plus a bit. The “a bit” is the value add.