Public Spending And Social Progress

Studies | Federal Spending | Social

No. 232
Thursday, June 01, 2000
by Gerald W. Scully


Introduction

1The enormous growth in government spending over the past century was by and large promoted and defended in the name of economic and social progress. While economic progress can be defined as a rise in per capita income or gross domestic product (GDP), social progress, or improvement in the quality of life, usually refers to improvements in physical conditions of life such as life expectancy and infant mortality. A broader notion of social progress could encompass the development of political institutions such as democracy and the rule of law.

"Does government spending improve the quality of life?"

Government Spending and Economic Progress. In a previous NCPA study I showed that government spending can promote economic progress - up to a point.2 Government spending on such things as roads, education and criminal justice positively affects per capita GDP. But beyond some level the tax burden necessary to finance government becomes a drag on economic growth and reduces per capita GDP below what it otherwise would be. By this standard, I found the optimal level of U.S. taxation to be 21 percent of GDP. Yet taxes as a share of GDP have not been in this range since 1949. Had the United States stuck with the 1949 level of taxation, our compound rate of economic growth over the period 1950-95 would have been 4.8 percent, compared to the actual growth rate of 3.4 percent.

Today average government spending in developed countries is 45 percent of GDP. In fact, for decades government spending in almost all developed countries has far exceeded the level at which it increases the rate of economic progress. It continues at levels that reduce growth rates below what they otherwise would be.

Government Spending and Social Progress. This paper examines the effects of government spending on social progress. The spending we are concerned with is government consumption expenditures: the portion of government spending that actually buys goods or services such as school buildings and teachers' salaries. In most countries, this is 40 percent to 60 percent of total government spending. The rest of government expenditures go for transfer payments or payments on government debt. Transfer payments simply redistribute income after it is earned and taxed away by government. Much of the increase in total government spending in developed countries in recent years has been for transfer payments and debt service. But government consumption expenditures have also increased, and even if they remained constant as a portion of GDP the absolute level of government spending has increased as GDP has grown.

It has been assumed that government consumption spending buys goods and services that improve the quality of life. But remarkably, very little is known about what has been achieved for the tax dollars spent. The only paper I have found that addresses quality of life gains from the growth of public spending is a 1995 study by Vito Tanzi and Ludger Schuknecht.3

Tanzi and Schuknecht examined the progress of certain social indicators over more than a century and compared this progress with the growth in public spending. They used noneconomic indicators - such as infant mortality, the death rate and years of primary schooling - as well as economic indicators such as the share of national income going to the lowest 40 percent of all households. They found that as total government spending as a portion of GDP grew from 1870 to 1960, it had a positive effect on economic growth and social progress but "that the growth in spending after 1960 may not have brought about significantly improved economic performance or greater social progress."4

Moreover, they found that in recent years social progress in some newly industrialized economies (Chile, Hong Kong, South Korea and Singapore) and in industrialized countries with governments that spent less than 40 percent of GDP ("small" government countries such as Japan, Switzerland and the United States) is no worse than in countries that spend more than 50 percent of GDP ("big" government countries such as Sweden and the Netherlands) or those that spend 40 to 50 percent of GDP ("medium-sized" government countries such as Canada, Germany and Ireland).

Clear inferences from their paper are that public spending for social progress in industrialized countries has reached a level of diminished returns and that a prudent reduction in the size of government can occur without social harm.5

"At what point does a dollar increase in public spending buy less than an additional dollar's worth of social progress?"

Evaluating the Results of Government Spending. This study examines the effects of government expenditure on certain noneconomic measures of social progress, using 1995 data on 112 countries. It addresses these issues more precisely than Tanzi and Schuknecht by asking and answering two basic questions: (1) at what level of government expenditures per capita does spending cease to have any positive impact (the marginal benefit is zero) and (2) beyond what level of expenditures does spending cease to be worth its cost (the point at which the marginal benefit equals the marginal cost)? The answer to the first question tells us at what level of public spending an increase in expenditures results in no additional improvement in social progress. Hence, any government expenditure beyond this level is unnecessary for advancing the quality of citizens' lives. The answer to the second question tells us at what point a dollar increase in public spending buys an additional dollar's worth of social progress.

Spending above the level at which the marginal benefit is zero is a clear waste of resources. Spending at the level for which the marginal benefit is zero represents the maximum possible social progress. However, that maximum level is not the optimal level because as spending approaches the level at which the marginal benefit to social progress equals zero, we must spend much more than a dollar to achieve a dollar's worth of improvement. The optimal level of government spending is the point at which marginal benefit equals marginal expenditure, where an additional dollar of spending will yield a dollar of social progress.

Three empirical issues need careful handling. First, what is social progress? Second, how much weight should be given to each of the attributes of social progress? And third, how can we avoid bias in measuring social progress?

Issue: Defining Social Progress. Social progress or improvement in the quality of life may be a subjective concept that arises from one person's life experience relative to others. If so, it would be hard to measure. If social progress is treated as an objective concept, as is done here, it involves a finite set of attributes that can be measured and compared across environments and through time.

"This study constructs several indexes to measure social progress."

While per capita gross national product is an obvious choice for a single measure of well-being, it has been criticized as too narrow to capture "basic needs."6 The most widely employed measure of basic needs is the physical quality of life index (PQL), an average of literacy, infant mortality rates and life expectancy. The PQL is one of the aggregate indices of social progress used here. But the PQL index also has been criticized as too narrow in scope to fully capture differences in quality of life. Hence, I have constructed a multidimensional index that contains 16 social progress indicators. Using such a large number of indicators, many of which are intercorrelated, precluded the omission of relevant variables that would significantly affect the results. Income or GDP per person is an important measure of the ability of a society to make expenditures for social progress, but it does not measure social progress per se. Thus it is an input to, rather than an outcome of, social progress. By contrast, the social progress indicators used here measure outcomes.

Issue: Assigning Weights to the Attributes of Social Progress. How much weight should be given to each of the attributes of social progress in constructing an aggregate measure? The conventional practice is to weight them equally. However, while a representative individual might have an equal preference for any or all of the attributes of social progress, it is not likely. And it is not possible to say in advance exactly what the preferences of society are and how much society is willing to pay for them. Accordingly, two other ways to objectively weight the attributes also are employed. Using all three weighting schemes gives some assurance that the results are not distorted by the peculiarities of the weighting method.

Issue: Avoiding Measurement Bias. Any functional form imposed on the data is arbitrary. To ensure that the empirical results are not largely due to the particular mathematical function used, several nonlinear models were estimated.

In what follows, this paper discusses the attributes of social progress, the optimal levels of government expenditures that were found by performing some statistical tests and the conclusions that can be drawn from the analysis.


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