Download Government Intervention in OECD Member

Government Intervention in OECD Member Countries: Equity at the Expense of
Efficiency?
Marc Lombard*
Abstract
This paper examines the assumption that equity considerations prevalent in some of the
OECD so-called “welfare states”, and associated with substantial government intervention in
the economy, come at the expense of economic efficiency. To verify this assumption, the
paper selects the OECD’s five highest spending countries, in terms of government
expenditure as a percentage of GDP, as well as the five lowest spending countries in the
OECD upper median income group. The performance of eight economic indicators,
representative of both equity considerations and economic efficiency, is then evaluated with
respect to each group of countries. The paper concludes that while high-spending countries
largely outperform low-spending countries with regard to a more equal income distribution,
lower child poverty rate, and more generous social benefits, evidence of economic efficiency
is not as apparent, with productivity per hour and inflation rates being even between the two
groups, and difference in unemployment rates being challenged by the large incidence of
part-time and casual employment in low-spending countries. Even the marginal advance that
high-spending countries have over low-spending ones, in terms of GDP per capita growth,
can be questioned on the basis that this can be achieved by longer working hours, not in itself
a sign of economic efficiency.
1. Introduction: Government Intervention in the Economy
Of the many issues that divide economists, the one which is probably most debated is the
degree of government intervention in the economy, as seen through its many manifestations,
such as the size of public expenditure as a percentage of gross domestic product (GDP), the
degree of labour and financial market regulation, the structure and level of taxation (direct and
indirect taxes), etc.
In the so-called developed world (using OECD member countries as a proxy), this issue
basically pits two forces against each other: on the one hand (to use a favourite economic
term), are the interventionists (mostly Keynesian, with slight degrees of differentiation
between post-Keynesian, Neo Keynesian, new Keynesian, or simply unreconstructed
Keynesians). On the other hand are those who favour free markets (again with different
degrees of freedom). While the latter are dispersed throughout different schools of thought,
such as Classical, Neoclassical, New Classical, Supply-siders, Monetarists, Economic
Rationalists, etc., they have in common a certain aversion for government interference in the
market, perceived to be more harmful than beneficial. Keynesians, in comparison, justify their
interventionist approach on the basis of market failures, and the need for more equitable
outcomes, rather than the pursuit of economic efficiency, the key performance indicator of
free marketeers. According to Keynes himself, “the outstanding faults of the economic society
in which we live are its failure to provide for full employment and its arbitrary and inequitable
distribution of wealth and incomes” (Keynes, 1936).
While somewhat derided since the 1970s for the perceived incapacity of demand
management policies to tackle inflation and promote growth, Keynesianism appears to have
regained some favour recently, through the rescuing of free markets from the global financial
crisis, by governments’ massive fiscal stimuli and bail-outs.
The degree of government intervention in an economy is usually measured in terms of
public expenditure as percentage of GDP. In the OECD, in 2009, this degree ranged from
34% (Korea) to 56% (Sweden). Yet, government intervention can also take the form of
legislation and regulations, not illustrated by the size of its expenditure (e.g. the universal
medical coverage provided in Australia, a country whose public expenditure is well below the
OECD average).
Leaving aside more recent increases in government outlays due to the global financial
crisis, better country comparisons can be provided by a 5-year average expenditure prior to
2009. A marked difference in the size of government outlays as percentage of GDP can be
observed between Scandinavian countries (Sweden, Denmark in Table 1), and Australia, the
US and Japan. While the 5-year average for the two Scandinavian countries is nearly 53%, it
is only 34% for Ireland, 35% for Australia, and 36% for the US. The highest public expenditure
as a percentage of GDP recorded by an OECD member country since the early 1990s was
that of Sweden in 1993, with 70.9%; the lowest was Korea with 19.4% in 1991.
Government outlays have gradually increased over the years. At the turn of the 20 th century,
government expenditure in the major economic powers did not exceed 20% of GDP. The
advent of democracy in the 20th century (New Zealand was, in 1893, the first country where
women gained equal voting rights with men), and the associated provision of social welfare
benefits, as well as major world wars have contributed to increasing the share of government
spending in the economy.
Yet, extreme forms of government intervention (so-called “command economies”) such as
existed in communist societies have proved a failure in matching the development and
economic growth rate of mixed economies. The absence of free enterprise and private
property has stifled incentives and innovations, as witnessed nowadays by North Korea and
Cuba for example, and the demise, in the past, of the USSR and its satellite countries. Only
the repudiation of communist orthodoxy and the openness of its economy have enabled
China to prosper. Leaving thus authoritarian regimes aside and focusing purely on OECD
economies, the perception has been, in many quarters, that substantial government
intervention is detrimental to economic growth, and thus to overall standard of living. Unlike
developing countries, where defence is usually the major form of government expenditure, for
most OECD member countries, the largest share of government spending is allocated to
social welfare measures (cash social services – unemployment and sickness benefits,
pensions, family allowances, etc.), education, health, low-rent accommodation, etc. This focus
on equity considerations needs to be financed by taxation, which is then perceived by free
marketeers as causing inefficiencies through disincentives to work, to enterprise, or, for those
who are not directly recipients of government largesse, through a reduction in their standard
of living.
2. Equity vs Efficiency
The purpose of this paper is to examine whether the focus on equity considerations, by a
number of OECD countries, comes at the expense of inefficiency, as the popular belief would
suggest. To make this comparison between equity and efficiency worthwhile, eight economic
indicators most representative of both concepts have been selected. The degree of a
country’s performance is usually illustrated by four key economic indicators: 1) the growth rate
of its GDP per capita (the measurement per head, rather than global GDP, is needed in order
to eliminate GDP growth due purely to an increase of population, be it natural or through
immigration); 2) the country’s unemployment rate; 3) its inflation rate; and 4) its productivity
per hour (i.e. the GDP divided by the total number of working hours). This measure is
preferred to the other commonly used definition of productivity (GDP divided by people
employed), in order to moderate comparisons of GDP growth rates which could be due to
countries’ labour forces working different numbers of hours, retiring at different ages, or
having fewer or more days off per year.
Equity considerations are best reflected by social measures aimed at improving the quality
of life of either the general public and/or those most in need. To keep the comparison evenly
balanced with efficiency, equity considerations have also been illustrated by four major
factors. These are: 1) the degree of equality in income distribution; 2) child poverty rates (a
better indicator than poverty rates overall, by eliminating the incidence of self determination,
and low-income people living in medium to high-income households; 3) unemployment
benefits as a percentage of average wage; and 4) the amount of annual leave and public
holidays, reflecting quality of life considerations.
Other major policies associated with equity concern are the level of social benefits such as
pensions, maternity leave, and expenditure on health and education. These policies have
been left out here, due to the complexity in making valid comparisons between countries: for
instance, in the case of health the difficulty is in differentiating between the amount of
expenditure (whether private or public) and the quality of services provided. With regard to
medical services, the World Health Organisation established several years ago a ranking of
countries based on the efficiency of health services provided. (The World Health Report
2000). This included, among other aspects, the level of health (measured by disabilityadjusted life expectancy), health inequality (inequality in life expectancy), responsiveness
(how the system performed, meeting or not meeting a population’s expectations), fairness in
financial distribution (that the risks each household faces due to the costs of the health
system are distributed according to ability to pay rather than to the risk of illness). This
attempt at comparing countries has since been abandoned and the WHO no longer produces
such a ranking table, because of the complexity of the task (http://www.who.int/whr/en/). At
the time, the Report ranked France and Italy respectively as first and second best performers;
Australia was ranked 32nd and the US 37th. Of the 10 countries listed in this study, the United
States is alone in not providing universal medical coverage, at the time of writing.
In the case of education, while free compulsory schooling is available in all the countries
surveyed below, wide discrepancies in levels of performance do exist within some federal
states (notably the US). Finally, with regard to the level of pensions and maternity leave, the
absence of a uniform rate, and the presence of many rates applicable to different conditions
in different countries, make comparisons difficult to establish. Yet, unlike Australia and the US
where no maternity leave was available at the time of writing, many European countries offer
16 weeks at 100% of salary (eg. Austria, France, Luxembourg, the Netherlands, Spain,
Switzerland), the most generous being France with up to 26 weeks at 100% pay for the 3rd
child. (ILO, 2010, http://www.ilo.org/dyn/travail)
3. Representative Countries and Economic Indicators
As the size of government intervention in the economy is best illustrated by its level of
expenditure as a percentage of GDP, and in order to compare countries respectively in terms
of efficiency and equity considerations, this paper has selected, within the OECD, the 5
nations with the highest level of government expenditure as a percentage of GDP, as well as
the 5 nations with the lowest level, as an average over a period of 5 years, prior to the current
crisis. To make this comparison more valid (and thus minimise discrepancies between
countries with substantial differences in income), all the countries selected have a GDP per
capita over USD25 000. This has for effect to exclude, for instance, the former communist
countries of Eastern Europe recently admitted into the EU, as well as Korea.
The five largest spenders over the 5-year period 2004-2008 were, in order, Sweden,
France, Denmark, Austria and Belgium. Sweden and Denmark are representative of the socalled Scandinavian socio-economic model, the epitome of welfare states, associated with
high taxes and generous welfare provisions, as well as more egalitarian societies. France,
Belgium and Austria are representative of the so-called Continental socio-economic model,
i.e. welfare states associated with more regulated labour markets and extensive employment
protection legislation.
The five smaller spenders (well below the OECD average (see Table 1) were, in decreasing
order, Japan, the US, Ireland, Australia and Switzerland. The US and Ireland (along with the
UK) are representative of the so-called Anglo-Saxon model, associated with greater market
freedom, lower tax structure and a more flexible labour market. Japan, the world’s second
largest economy, has a unique model, whilst Australia can be regarded as a hybrid model,
being not particularly generous with the level of social provisions compared to the EU (it is, as
mentioned above, the only country with the US, of the 10 countries surveyed here, not to
provide mandatory maternity leave at the time of writing), yet, unlike the US, it provides
universal medical coverage.
While the OECD average for total government outlay as a percentage of GDP, for the
period 2004-2007, was 40, and the Euro area average was 47, the top 5 spenders ranged
from an average of 50 (Belgium) to 53 (Sweden). In contrast, the 5 lower spenders were well
below the OECD average, ranging from an average of 34% (Switzerland and Ireland) to 37%
(Japan). (Table 1)
Table 1 - General government total outlays
Per cent of nominal GDP
Selected countries
5-year average
2009
(2004-2008)
Sweden
53.1
56.2
France
52.9
55.5
Denmark
52.2
57.7
Austria
50.3
52.7
Belgium
49.6
54.0
Japan
36.9*
41.6
US
36.2*
41.5
Australia
34.6*
37.5
Ireland
34.4*
45.0
Switzerland
34.2*
33.9
Total OECD
40.4
44.8
Euro area
46.9
50.7
References
* = below OECD average
Source: OECD Economic Outlook 86 database (February 2010)
________________________________________________________________________
4. Equity Factors
With consideration of the 4 factors mentioned above, and starting with the Gini coefficient,
which measures the degree of income inequality within a country (where 0 equals perfect
equality), the high-spending countries had an average of 0.25 compared to 0.32 for the low-
spending countries. As expected, the Scandinavian countries of Sweden and Denmark had
the least unequal income distribution, while at the other end, the US, with 0.38 was
substantially behind the average of the low spenders. (Table 2)
__________________________________________________________________________
Table 2 – Equity factors
Gini coefficient
Child poverty rate
Unemployment
Days of annual
(1)
(2)
benefits as % of
leave & public
average wage (3)
holidays (4)
Sweden
0.23
4.0
58.3
38
France
0.28
7.6
57.4
35
Denmark
0.23
2.7
52.35
40
Austria
0.27
6.2
36.77
38
Belgium
0.27
10.0
33.54
32
Average
0.25
6.1
47.7
37
Japan
0.32
13.7
43.39
33
US
0.38
20.6
49.18
11*
Australia
0.30
11.8
19.9
30
Ireland
0.33
16.3
22.83
29
Switzerland
0.28
9.4
70.0
32
Average
0.32
14.3
35.06
27
(1) Gini coefficient based on equivalised household disposable income, after taxes and
transfers. The values of the Gini coefficient range between 0, in the case of "perfect equality"
(i.e. each share of the population gets the same share of income), and 1, in the case of
"perfect inequality" (i.e. all income goes to the individual with the highest income), mid-2000s
Source: OECD. StatExtracts, http://stats.oecd.org/index.aspx
(2) Percentage of children living below the national poverty line defined as % of households
with income below 50% of the national median income, mid-2000s. Data is based on
equivalised household disposable income, after taxes and transfers.
Source: Society at a Glance 2009: OECD Social Indicators;
www.oecd.org/els/social/indicators/SAG
(3) Unemployment benefits and wage rates are measured in terms of countries’ currency unit,
2004-2007. Source: OECD. Stat Extracts
(4) Source: ILO, http://www.ilo.org/dyn/travail, accessed April, 2010
* While there is no universal provision for annual leave in the US, a couple of states
(e.g.Illinois and Florida) do provide days of annual leave based on years of service.
__________________________________________________________________________
Of the 4 factors considering equity measures, child poverty rate was the one with the largest
gap between high and low-spending countries, the latter having an average child poverty rate
more than twice that of the high-spending countries (14.3 to 6.1). Once again, the incidence
of poverty was lowest in the two Scandinavian countries, and highest in the US, followed by
Ireland and Japan.
The difference in unemployment benefits was less marked (an average of 48% of the
average wage, for the high-spending countries, against an average of 35% for the lowspending ones).
Australia appeared to be the least generous by far of the 10 countries, with the
unemployment benefit representing only 20% of the average wage. However, of the four
indicators illustrating equity considerations, average unemployment benefits has to be the
least reliable, as it does not take into account the duration of the benefits (and its different
stages), which varies substantially between countries. Yet, longer duration would be expected
to be associated, in most cases, with those countries providing more generous benefits.
Days of annual leave and public holidays are also much more generous in high-spending
countries than low-spending ones, with an average of 37 days per year compared to 27.
While there was little variation for public holidays, ranging from 11 days in the US to 15 days
in Japan, there was a significant gap for days of annual leave, ranging from none in the US to
30 in Denmark. In the case of the US, while there is no universal mandatory annual leave,
some states (such as Florida and Illinois) do provide a few days of annual leave based on
years of service.
Overall, there is ample evidence, as shown above, that high-spending countries are much
more closely associated with equity factors than low-spending ones. For each of the
indicators surveyed, the average of the five high-spending countries largely dominates over
that the average of the five low-spending ones.
5. Efficiency Factors
When considering efficiency factors, the difference between the average of the highspending countries and that of the low-spending ones is not as evident as it is for equity
factors. In fact, low-spending countries only outperform high-spending ones in terms of GDP
per capita growth and low unemployment rates, and this by a relatively small margin,
compared to those that differentiated them in terms of equity. In the case of productivity per
hour worked, they are on an equal footing with the high-spending countries, and in the case of
inflation they are doing relatively worse than the high-spending countries, although marginally.
________________________________________________________________________
Table 3 – Efficiency factors
GDP/capita
Unemployment
Inflation 2004-
Productivity per
growth
rate, average
2007, percentage
hour worked
2004-2007 (1)
2004-2007 (2)
change from
2004-2007
previous year (3)
(4)
Sweden
5.06
7.2
1.1
2.10
France
4.50
8.6
1.9
1.43
Denmark
4.26
4.5
1.6
0.75
Austria
4.53
5.7
2.0
2.15
Belgium
4.09
8.1
2.1
1.45
Average
4.5
6.8
1.7
1.6
Japan
5.17
4.3
-0.1
2.05
US
4.96
5.0
3.0
1.50
Australia
4.80
4.9
2.7
0.95
Ireland
6.93
4.5
2.5
2.28
Switzerland
5.11
4.1
0.9
1.38
Average
5.4
4.6
1.8
1.6
(1) Growth rate of GDP per capita, percentage change from previous year, 2004-2007
Computed from GDP per capita, US dollars, current prices, 2004-2007
Source: OECD Factbook 2009: Economic, Environmental and Social Statistics
(2) As per cent of labour force, 2004-2007. Source: OECD Economic Outlook 86 database.
(3) Measured by CPI, 2004-2007, percentage change from previous year; Source: OECD
Economic Outlook 86 database
(4) Measured by GDP per hour worked, constant 1990 $US at PPP, 2004-2007. Source: ILO,
International Labor Organization
http://www.ilo.org/empelm/what/pubs/lang--en/WCMS_114060/index.htm
_________________________________________________________________________
Considering GDP per capita, there is virtually no marked difference among the 10 countries
surveyed. Leaving Ireland aside, with a growth rate of nearly 7% over 5 years, the gap
between the best and worst performers of the remaining 9 countries is only 1 % over the
same period of time.
Where low-spending countries clearly dominate is regarding the unemployment rate: an
average of 4.6% compared to 6.8% for the high-spending countries. France and Belgium, with
extensive employment protection legislation, are the worst offenders, both with an average
unemployment rate over 8%, while Japan and Switzerland are the best performers, both with
a rate below 4.5%. Yet, the extent of the unemployment problem can be misleading, as
under-employment is not taken into account. OECD common definitions of unemployment
exclude part-time employment, even when those surveyed only work few hours and are
desperate to secure full-time jobs. Part-time unemployment in the UK (or Australia), for
instance, is at a level well above that of France, a country with a higher unemployment rate.
There is also the case of hidden unemployment, where discouraged workers no longer
appear in the unemployment statistics. Fully or partially idle resources are not conducive to
greater efficiency, nor is full time casual employment, paid at very low wages.
With regard to inflation, high-spending countries provide both the best and worst performer:
Japan, with minus 0.1% (deflation symptomatic of woes facing Japan, for quite some years
now), and the US, with 3%. Finally, productivity per hour does not offer a clear cut image.
While the average for both groups of countries is nearly identical, there are good and bad
performers in both camps.
Conclusion
What can be drawn as a conclusion? It is well known that statistics not only can be open to
interpretation, but also need to be examined in the way they have been constructed. There is
also the choice of parameters, and the exceptions made. Nonetheless, and bearing in mind
these failings, this study purports to show that government intervention in the economy does
not need to be equated with inefficiency, and that the benefits it provides in terms of equity
consideration far exceed any potential loss of economic efficiency.
* Department of Economics, Faculty of Business and Economics, Macquarie University,
Sydney, Australia
3430 words
References
ILO, International Labor Organisation
http://www.ilo.org/empelm/what/pubs/lang--en/WCMS_114060/index.htm
ILO, http://www.ilo.org/dyn/travail
Keynes, J.M. (1936), The General Theory of Employment, Interest and Money, Macmillan
Cambridge University Press
OECD Factbook 2009: Economic, Environmental and Social Statistics
OECD Economic Outlook 86 database.
OECD, Global Pension Statistics project, www.oecd.org/daf/pensions/gps
OECD Social Indicators: Society at a Glance 2009
www.oecd.org/els/social/indicators/SAG
OECD.Stat Extracts http://stats.oecd.org/index.aspx
OECD: Pension at a Glance 2005, 2007, and 2009. www.oecd.org/els/social/pensions/PAG
State of Florida Employment Benefits
http://www.flofr.com/director/jobopp/ofrbenefits.htm#AnnualLeave
The World Health Report 2000 http://www.who.int/whr/en/
World Health Organisation, WHOSIS, WHO Statistical Information System
http://apps.who.int/whosis/data