The response to the COVID-19 crisis puts the spotlight on public spending and the role of the state in advanced countries:
The answers are far from obvious. As we wait for the COVID vaccine to help end the crisis, the time is ripe to reflect on whether “old wisdoms” are perhaps more relevant than one might think.
Governments are essential for our prosperity, opportunities, security and, also, for other public goods like the environment. Governments need to do well on these scores to be successful and trusted. Some claim that more money needs to be spent on this post-COVID but is that really warranted? Governments in advanced countries have grown enormously over the past 150 years and many will spend over 50%, or even 60%, of GDP this year. This is much more than required for a well-functioning state, it is much more than can be financed with a reasonable tax burden, and it also infringes more than necessary on individual freedom and responsibility.
Some observers argue more selectively: more should be spent on health, social issues and investment. But most governments do not lack money for investment and the private sector would happily help with the financing and management. It is rather bureaucratic and regulatory hurdles that stifle infrastructure projects. And not all public investment is super productive – white elephants are numerous and infamous. Similarly, there is no lack of money for social spending. In fact, health and other social spending have increased massively in recent decades – to an average of one quarter of GDP. But often the spending is inefficient and poorly targeted. There are huge differences in the quality of government spending and there is huge scope for improvement. Astonishingly, this reasoning is not very present in today’s discussions.
Few economists today are concerned about high spending driving high deficits and rising debt. Extremely low interest rates and risk premia plus new debt facilities and central bank debt purchases have put governments in a “land of milk and honey” without hard budget constraints. But this world invites ever new demands on government, and creates expectations it cannot fulfil. If this ever ends – and it surely will – high debt compounded by the fiscal headwinds from population aging and high private debt risks bringing many countries to their knees.
Discretion rather than rules seems to have become the order of the day. But do policy makers have the discipline and knowledge to do what is right without rules and constraints? Rules-based fiscal policy-making forces governments to live within their means – be more conscious of the burden on taxpayers. It forces them to be efficient and prove that spending choices are sound. It also forces governments with a notorious short-term horizon to take the longer view. Governments that take the longer view and deliver on their core objectives are more successful and more trusted.
These are the key challenges around public spending and the role of the state in the post-COVID world. If we do not address them after the crisis, we risk a spiral of instability, stagnation and growing conflict. The poor and vulnerable would ultimately be the biggest losers.