Arnold Kling  

The Deficit Argument, III

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The Deficit Argument, II... The Language Barrier...

Responding to my previous post, Brad DeLong offers a theory of government spending that is certainly, well, different.


one percent faster real GDP growth does not leave federal spending unchanged. A lot of government services require that bureaucrats be paid salaries: their salaries rise as fast as GDP per worker rises. Still more government programs--Social Security, unemployment insurance--are keyed not to an absolute poverty standard but to people's wage levels.

What I was suggesting was that the ratio of government spending to real GDP would be reduced arithmetically by an increase in the denominator. DeLong disagrees. The starting point for his dissent is that higher real GDP would come from higher worker productivity, which would lead to higher real wages. True enough.

He also points out that Social Security payments are indexed to wages, so that Social Security payments would be higher in a high-real-growth scenario. Also true enough, although one might question whether this is a desirable property of the Social Security formulas.

However, Medicare is the big enchilada when it comes to future entitlements, and I cannot come up with a good argument for why Medicare costs should rise proportionately with real wages, particularly given the original assumption we are making that biotechnology becomes an engine for higher productivity and faster growth.

Finally, DeLong says that if real wages are higher in the economy, then they must be higher for government workers, also. However, he assumes implicitly that all of this gets passed along as higher cost to the government--there is no increase in productivity in the government sector.

The theory of stagnant productivity in government and other service sectors has a rich history. It is known as Baumol's "cost disease" thesis. (See also Gordon Tullock's survey article.)

DeLong's assumptions about the relationship of government spending to real GDP imply large, persistent cost disease. I would think that the information and biotechnology revolutions should provide a cure for cost disease, unless the problem is bureaucratic inertia.

For Discussion: If the government is indeed subject to cost disease because of bureaucratic inertia, do you agree with DeLong's conclusion that our only viable option is to maintain taxes at high levels in order to finance government spending?


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COMMENTS (8 to date)
David Thomson writes:

This is a key reason why we must be wary of granting bureaucrats more power over our lives. There simply is little way to accurately judge the productivity of these individuals. A private sector entity eventually goes out of business if it fails to deliver the goods. Not always so, for government officials. They merely need to successfully beg for more money from our elected officials.

Bernard Yomtov writes:

Haven't real Medicare costs risen substantially faster than real wages over the past twenty years - something like 6% vs. 2%? Even adjusting for changes in the 65+ population Medicare growth looks like about 4.5%.

This has not been a period lacking in technological advances in medicine.

Perhaps I misunderstood.

Arnold Kling writes:

The technological innovation in medicine over the past twenty years has tended to increase utilization rather than to decrease costs. The balance may shift at some point in the future (less invasive surgery, less expensive diagnostic tools, use of pharmaceuticals instead of hospital stays, etc.).

Or the balance may not shift.

But the point is that medical productivity is not mechanically tied to real wage increases. Therefore, an increase in productivity in the rest of the economy will not *raise* Medicare costs.

DeLong's pessimistic theory is that higher productivity in the rest of the economy raises government spending. That is the view that I am disputing, and my case does not depend on whether or not medical innovation per se raises Medicare spending.

Bernard Yomtov writes:

Yes. I understand. I was trying to address a specific point, rather than your entire argument. You seem to say that:

1. Medicare costs are a big part of future entitlement costs.

2. There is no reason to think that Medicare costs will rise proportonately to real wages.

3. Advances in medical technology might well lead to decreased costs, or at least costs relative to wages.

My points are:

1. Recent history does, in fact, give us a reason to think that Medicare costs will rise.

2. Recent technology advances have not had the effect you hope for.

As you point out, things might change, but the evidence suggests that this is just a hope.

Jane Galt writes:

Yes, Bernard, but that's not the point. Mr. Kling is saying that, all else constant, rising productivity/GDP will decrease the share that government has of the economy. DeLong is saying that rising productivity/GDP will simply produce a corresponding rise in government spending as indexing forces up wages and CPI-linked entitlements. Medicare costs will rise as much as they will rise whether or not economy-wide productivity increases; they are thus irrelevent to the discussion.

David Thomson writes:

“The bottom line is that governments have grown in recent decades, that they did not do so earlier, and that economists do not really know why.”

---Gordon Tullock

I don’t find it at all difficult to understand why governments continue to grow. It makes perfect sense to me. Specific voting blocks and ensconced bureaucrats often act like little children relentlessly harassing their parents for more candy. It is simply far easier for the elected official to give into their demands. After all, they are not spending their own money! The brats will inevitably become more demanding. That's just human nature.

The typical citizen cannot afford to fight each and every budget battle. Thus, the public sector bureaucrats will win most fights by default. One might abstractly disagree with the granting of more money to a particular government agency. But who can take a day off of work if the total is less than .000000000001% of your own tax bill? Alas, to paraphrase a famous politician---a dollar here and a dollar there, and eventually we are talking about real money.

I wish, for example, that we could privatize the U.S. military. It is appalling that so much waste occurs. Unfortunately, this is a role which only the government can perform. That is why it’s so important to think twice before allowing the creation of a new bureaucracy. They quickly become virtually impossible to dismantle. We should not want the government handling any duty unless it’s absolutely unavoidable.

Mark Bahner writes:

"For Discussion: If the government is indeed subject to cost disease because of bureaucratic inertia, do you agree with DeLong's conclusion that our only viable option is to maintain taxes at high levels in order to finance government spending?"

It depends...what is Dr. DeLong's goal?

If Dr. DeLong's goal is to maximize economic growth, I'd say the heavy majority of empirical evidence indicates that maximizing growth can only be achieved by significantly reducing government spending.

The evidence for all OECD countries is here:

http://www.house.gov/jec/growth/function/exh-4.gif

Note how, as total government spending (at all levels of government) increases, economic growth decreases. (Note: As I recall, U.S. total government spending is about 35% of GDP. And--suprise!--our growth rates are about 3.8% per year...if we're lucky. If we total government spending by about half, I think we could consistently get growth of 5-8% per year.)

The evidence for the U.S. also supports the proposition that significantly reducing government spending could significantly increase growth. Here is: 1) a graph of federal spending, as a percent of GDP, and 2) ten-year percentage growth rates. Looking at both graphs, one can see that, as our federal spending increased, our economic growth went down.

http://www.house.gov/jec/growth/govtsize/fig-3.gif

http://www.house.gov/jec/growth/govtsize/fig-2.gif

The question is, is Dr. DeLong's goal to maximize economic growth? (I personally don't think that is his goal.)

Mark Bahner writes:

"I don’t find it at all difficult to understand why governments continue to grow. It makes perfect sense to me. Specific voting blocks and ensconced bureaucrats often act like little children relentlessly harassing their parents for more candy."

Yes, at the risk of being politically correct, I put the growth of governments in the 20th century down to democracy. Specifically, women's suffrage. :-)

Hey, don't yell at me! I'm just calling 'em like I see 'em. :-)

Until the early 1920's, women didn't have the vote in virtually every country. Further, women have tended to like big government, because they've historically worked at jobs (i.e. motherhood) that are untaxed. So they've (on average!...not every single woman) seen the benefits with government, without directly experiencing the costs (i.e., their earnings taken for taxes).

But my prediction is that government sizes around the world have peaked, and will now head downward. The reason? More women working, and more competition among democracies. (For example, no one from the U.S. would moved to Russia during the 20th century...but a fair number might in the 21st. Similarly, few people from India could afford to come to the U.S., especially until the late 20th century, when airplane tickets came way down in price.)

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