Download Determinants and effects of government size: Overview of theory

Determinants and effects of government size:
Overview of theory and the Greek experience
Chris Tsoukis
Economics, London Metropolitan Business
School
Ministry of Economy, Competitiveness &
Shipping Senior Research Fellow, Hellenic
Observatory, LSE;
January 2011
Tsoukis - Government size
Outline
• International evidence on government/state
size
• A look at Greece
• Overview of literature
• Social conflict and government size
• Model
• Findings
• Empirical implications
Tsoukis - Government size
Evidence (Tanzi & Schuknecht, 2000)
• Secular rise in government size as a
percentage of GDP in industrial economies
• Significant cross-country differences.
• Government expenditure/GDP:
– < 10% pre-World War I;
– about 15% shortly after;
– of the order of 30% in 1960;
– of the order of 50% in 1994;
– after which there may have been regressive
tendencies).
Tsoukis - Government size
Tsoukis - Government size
Tsoukis - Government size
Greece – OECD data
(general government unless stated otherwise)
Tsoukis - Government size
Tsoukis - Government size
Three sets of questions:
• Q. no. 1 (positive): What are the determinants
of government size?
• Q. no. 2 (positive): What are the factors that
determine the evolution across time of this
government size?
• Q. no. 3 (normative): What are the
appropriate economic borders and optimal
size of the state?
Tsoukis - Government size
Overview of Literature
Economic development and country size as public services
require a certain critical size, so that smaller economies tend to
have bigger government (Alesina and Warciarg, 1998).
Openness may be linked to government size in a variety of
ways and with either a negative correlation (as in AlesinaWacziarg) or positively because openness is a source of
external destabilising shocks (Rodrik, 1996);
Ethno-linguistic fractionalisation and instability (Annett,
2001);
Modes of government and political representation proportional and parliamentarian systems induce bigger
government (Persson and Tabellini, 1999, 2004; Besley, 2004,
2005);
Tsoukis - Government size
Overview of Literature (2)
Productivity tends to raise the relative rise of government
services which are not subject to much productivity growth
(Baumol, 1967).
Unemployment and government size may also be positively
related (Nickell, 2004; Algan et al., 2002).
Meltzer and Richard (1981): (purely) redistributive
expenditure higher in more unequal societies (also Lipsett
1960; Prszeworski 2005).
Dixit and Londregan(1996): opportunist politicians may target
“swing” voters (as opposed to core ones), so spending related
to the nature of political game, but unclear implications for
government size.
Tsoukis - Government size
Limitations
No consensus.
Unclear whether and why these factors might
imply the evolution of government size
mentioned above.
Thus, the evolution mentioned above appears to
be largely unresolved (see Drazen, Chapter 14);
One seems justified to conclude that the
determinants of government size are rather
inadequately understood.
Tsoukis - Government size
This work:
Attempts to shed light on these questions (more the positive
than the normative one).
Question of government size embedded in a framework of
social conflict.
Extends previous work (Tsoukis and Tournemaine forthc’g)
which views the labour share (and therefore growth) as the
product of social conflict and bargaining between two classes,
capitalists and workers.
The size of the government sector is also the object of
bargaining, as it yields utility-enhancing services. Part of the
bargaining over factor shares may now be supplemented by
bargaining over government size.
This framework yields a rich set of empirically testable
insights on the determinants
of government size.
Tsoukis - Government size
This work - cont’d.
Not incompatible with the factors that were highlighted above.
Key such determinant
Bargaining power between capitalists and workers.
Bargaining power
Multifaceted concept: depending on labour and product
market structures (unions, employment protection, welfare
state, monopoly power in product markets, selfemployment/informal sector, corruption, etc.), structure of
politics (parties, elections, parliament), policy (regulation),
etc.
This framework can potentially explain the evolution of
government size, via (evolving) relative bargaining power of
Tsoukis - Government size
classes, as well as determinants.
Analytics 1
Capitalists’ (owners of firms) production function
depends on private capital and growth-enhancing
public services.
y=τΛk
Balanced budget, so rate of tax (τ) is also the size
of government spending on goods and services.
Workers consume their current wage bill.
Capitalists are assumed to be dynamic optimisers
whereas workers do not have the means of doing
so.
Tsoukis - Government size
Analytics 2
Rate of growth = incentive to invest (MRPK) –
γ: labour share
impatience = (1-γ)(1- τ)τΛ - ρ;
Barro (1990) rule for optimal (growth-maximising)
:
(
)
w
w
k
U
=
log
c
+
βτ
y
t
+
α
c
Workers’ utility:
t
t
β: extent to which public services are also utilityenhancing;
α: “status motive” or “keeping up with Joneses”
cW =γ(1- τ)y= γ(1- τ)τΛk
Tsoukis - Government size
Analytics 3
Capitalists’ utility: U = log(c + βτy )
k
t
k
t
t
Without public services yielding any utility (β=0),
both parties would choose Barro’s τ* - as both
growth and level of output involve (1- τ)τΛ,
which is maximised at τ= τ*.
β>0 changes that: It creates an asymmetry, as
this “social income” is not taxed (it involves only
τΛ) and workers may depend more on that.
Hence, workers are more inclined to support
measures that enhance current income (τΛk) as
opposed to growth (dependent on (1- τ)τΛ.
Tsoukis - Government size
The indifference map and contract curve (CC)
τ
IW
τ**
CC
τ***
IK
Tsoukis - Government size
γ
Implications 1
• A rise in worker bargaining power will imply both a rise in
labour share and a rise in the size of government
(expenditure) – particularly its utility-enhancing part.
• A rising β will tilt the contract curve upwards. Any rise in
worker bargaining power will therefore imply a faster rise in
government size (perhaps less of an increase will be
experienced by labour share). Thus, the rise in welfare state
may increase government size directly (to provide services)
but also because of this channel.
• An intensification of social comparisons (rise in α) shifts the
contract curve up. The size of government (and the labour
share) increases: As workers try to catch up and they cannot,
they demand higher provision by government instead.
Tsoukis - Government size
Implications 2
• Rate of time preference: It shifts down the contract curve and
decreases the size of government. Intuition: a more longtermist society (lower ρ) will want more government
spending as this is growth-enhancing. More broadly, we
should observe more long-looking societies (due to nature of
political system, temperament, etc) having more growthenhancing expenditure (infrastructure, etc) whereas more
short-termist ones having more welfare-enhancing spending
(ceteris paribus).
• A final determinant (or whole group of determinants) of
government size is the class game – unions, political parties,
their strength and organisation, nature of the game
(democracy or not), nature of labour but also product
markets (monopoly power, etc) regulatory framework, etc.
Any increase of worker power should increase both
government size and the labour share. Thus, labour share
becomes a useful proxy for the relative power of the worker
class (which needs to beTsoukis
instrumented
by such measures).
- Government size
Labour share by gov size (total
expenditure) – both % of GDP
Tsoukis - Government size
Tsoukis - Government size
Labour share by gov size (gov cons)
both as % of GDP
Tsoukis - Government size