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America's public expenditure problem

Written by Warwick Lightfoot Tuesday, 30 August 2011 11:53
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General Government Expenditure Ratio


Federal programmes are often delivered through joint funding with state governments.

State and local governments are important tiers of public sector intervention providing significant public services such as education. State governments also have as sovereign entities full tax raising powers and extensive powers of regulation. In 2011 the Federal Government with spend around 26 per cent of national income and state and local authorities will spend at least a further 16 per cent of GDP on providing public services. Some spending carried out by state governments is paid for by transfer payments from the Federal Government so in computing overall public expenditure by at the federal, state and local level it is important to avoid double counting.

General Government Expenditure is around 42 per cent of GDP. Slightly lower than the OECD average and lower than the EU average ratio. However it is much higher than the historic ratio of public sector spending that advanced economies exhibited until the late 1960s. It is also much higher that the rough rule of thumb for gauging the optimal level of public spending – where its benefits exceed its costs -  identified by economists of around a third of national income. When public expenditure exceeds 35 per cent of GDP over the economic cycle the full economic deadweight costs of the spending will not be matched by measurable outcomes from the resources deployed by through public intervention.


Many people working in financial markets and even economists in the United States often intuitively underestimate the scale of public spending in the America because so much attention is concentrated on the Federal Government, which accounts for 26 per cent of GDP, but the full picture is much closer to the OECD average.

This means that the United States confronts similar long-term structural problems to those that challenge other countries such as the European economies.


Even Bigger Public Sector Bills in the Future


What makes the American problem exceptional are several features that are particular to the United States. The Federal Government’s principal spending programmes Social Security and Medicare are unsustainable in terms of the benefits they offer and the rules that govern their financing given the demography of an aging population. The unfunded future liability that they represent is moreover greater than the public sector liabilities carried by other G7 economies apart from Japan and greater than those of the Euro-zone as a whole.


Public and Private Expense and Private Markets that do not work


The future management of these Federal Government public sector liabilities is made more difficult by the operation of private markets that are defective in terms of economic efficiency and welfare outcomes and raise the costs for anybody purchasing services through them.

The heath care market is fundamentally flawed and raises the costs of the public sector, public and private sector employers who provide health insurance for their employees and for individual households that have to meet medical insurance and co-payment bills.

The market in higher education has experienced more cost inflation than health care over the last thirty years. Since the late 1970s college tuition fees have risen over five times, while average household income has only risen slightly more than one and a half times. This raises the costs of both public authorities that fund education and private households that ultimately foot the costs for higher education.

The United States devotes roughly twice the resources of the OECD average to higher education and almost twice the resources of other advanced economies on healthcare. It is not clear in either case that the scale of resources represents either efficiency or social equity.

Warwick is the author of the forthcoming: America's Exceptional Economic Problem (Searching Finance, November 2011)

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