Lewis Brown is Communications Manager of the Centre for Policy Studies
“We’re already massively expanding investment on major road schemes; but we will do more. So we’re announcing the largest programme of investment in our roads for half a century.” George Osborne, Autumn Statement 2013.
“The more controversial question is whether the government should not switch but should borrow more, at current very low interest rates, in order to finance more capital spending: building of schools and colleges; small road and rail projects; more prudential borrowing by councils for house building… Such a strategy does not undermine the central objective of reducing the structural deficit, and may assist it by reviving growth.” Vince Cable, CBI conference 2012.
The words are familiar, spoken to audiences the world over and of all political hues, receptive to the idea that certain key areas of public expenditure are conducive to growth.
While many argue that the battle to cut public expenditure levels in total has been won, such forms of spending have survived as ‘golden geese’ due to a perception as ‘investment’. If this were so, it would obviously be efficient to reallocate resources to those areas which promote growth.
Until now there has been little investigation into the impact of the composition of public expenditure by function or by type – consumption or investment – on economic growth. What there is tends to focus only on the merit of individual projects, like HS2 for example.
Such orthodoxies are often taken for granted until questioned, as Brian Sturgess does in ‘Not Paved with Gold’, a report published today by the Centre for Policy Studies. Examining data from across OECD countries on education, health, social protection (welfare) spending and capital expenditure on roads, Sturgess finds no evidence that so-called ‘investment’ leads to real GDP growth.
In the sample of 19 OECD countries for which data was available, the average proportion of public spending to GDP over 15 years was 47.5 per cent. This ranged from a high of Denmark with 57 per cent, to a low of Ireland with 23 per cent. As a result of the financial crisis, many major economies reverted back to discretionary fiscal spending on an extensive scale.
Across these OECD countries, the average level of total government expenditure to GDP rose from 45 per cent in 2007 to 51 per cent by 2010, sharply reversing a decline seen since 1996. Public expenditure across these countries is dominated by three government functions: Health, Education and Social protection. In 2011, these three categories accounted for an average of 65 per cent of total public expenditure.
Sturgess’ study shows that spending on education as a proportion of GDP had no discernible impact on economic growth, while the correlation between growth and spending on health and social protection were both negative.
Contrary to expectations, analysis of spending on road infrastructure for 29 OECD countries – one of the main categories of public capital expenditure and an area seen by politicians of all sides as ‘investment’ – also showed a negative relationship with real GDP growth.
These results should not be surprising – it has long been the view of many economists that the larger the size of the state, the lower a nation’s prosperity. The state is clearly too big across many OECD nations. Long-term growth in prosperity has led to growth in the size of public budgets, but public expenditure needs to be trimmed back across all functions of government to permit the private sector to expand.
GDP per capita growth of two per cent means the economic standard of living doubles in 36 years. Reallocating public expenditure in such a way as to raise annual GDP growth from 2 per cent to 3 per cent would release resources; an extra point on the growth rate would double income in just 25 years.
If politicians continue to talk about spending in these areas as an “investment”, this study suggests they will be getting an extremely poor return.
As Sturgess concludes: “There is no evidence justifying the continual rise in the size of the state and reversing its growth is simply a question of political will. To fail to do so will be at the cost of future living standards.” Let us hope politicians in this country remember these words during next week’s budget.