Why we need public spending

1. Why we need public spending By David Hall d.j.hall@gre.ac.uk Public Services International Research Unit (PSIRU) University of Greenwich, UK www.psiru.org February 2011 Based on the report ‘Why we need public spending’, available from http://www.psiru.org/reports/2010-10-QPS-pubspend.pdf

2. Acknowledgements • The presentation is based on PSIRU reports ‘Why we need public spending’, available from http://www.psiru.org/reports/2010-10-QPS-pubspend.pdf , and ‘More public rescues for more private finance failures’ http://www.psiru.org/reports/2010-03-PPPs.doc , commissioned by Public Services International (PSI) and EPSU. • Previous versions of this presentation have been given at seminars organised by the Department of Economics of the University of Milan the Institute of Management Studies, Berlin, a meeting of the OECD working party on PPPs.

3. Economic role of public spending • Public spending and economic growth • Infrastructure, efficiency, equality, employment • Public spending and the crisis • PPPs, privatisation, dynamics and efficiency • Political contests over public spending

4. The economic and social role of public spending • Public services/spending/workers presented as: • Parasitic on ‘real’ productive sectors of the economy • ‘luxuries’ to be sacrificed for general economic benefit • Inefficient compared with private/market provision • Empirical evidence shows • Rising public spending is linked to economic growth • Post-crisis trends reflect long-term path • Productive benefits of health, education • Economic and social benefits of equality

5. Public spending as % of GDP (source: OECD stats http://stats.oecd.org/Index.aspx , PSIRU calculations)

6. Spending/GDP and GDP per capita, 2008, OECD

7. Long-term link between public spending and growthGovernment spending as % of GDP 1870-1996, ave of 14 countries

8. Recent trends: levelling-off or temporary dip?Government spending as % of GDP, USA, 1903-2010

9. Government spending as % of GDP

10. Government spending trends in developing countries 1980-2004Source: Yu B. et al 2009: Does Composition of Government Spending Matter to Economic Growth? http://ageconsearch.umn.edu/bitstream/51684/2/IAAE%20government%20spending.pdf

11. Questions and issues • Explaining the positive links • Productivity gains from infrastructure, • Productivity gains from public health/education • Demand effects of equalising income distribution • Employment impact • Political mechanisms so contestable • citizen not consumer preferences • General constraint of taxation? • But varying levels, and global trend is upwards

12. Infrastructure investment and growth 1991-2005Change in ave per capita growth between 1991-1995 and 2001-2005. Calderon and Serven 2008

13. Public and private capital spending on infrastructure USA 2007

14. Public healthcare is more efficient and effective • Life expectancy in USA is lowest in high income OECD, lower than Cuba • Infant mortality in USA is 2x the rate in Czech republic, Portugal, Japan

15. Public services and equality

16. Half the jobs in the world

17. Public spending, economic growth and democracy Source: C Boix ‘Democracy, development, and the public sector’ American Journal of Political Science, 2001http://pics3441.upmf-grenoble.fr/articles/demo/democracy_development_and_the_public_sector.pdf.

18. Public spending and the crisis – in context Some factors in the crisis • Unsustainable banking practices (CDS etc.) • Unsustainable personal borrowing (sub-prime) • Unsustainable corporate borrowing (leverage) • Inequality (wages-profits shares, high/low incomes) • NOT excessive government borrowing or spending • NOT numbers or wages of public employees

19. Household and government debt in Eurozone

20. Response to crisis: public spending and borrowing • Bailout of banks • Overall, the total value of actual and contingent support in North America and Europe rose to over US$14 trillion, equivalent to about 50% of annual GDP in those economies’ (Bank of England 2009a, p.6) • This equates to over $2000 for every person on the planet • ‘Stimulus’ to boost demand through higher deficit • Least impact if used for tax reductions • Most impact if used for public spending or benefits • Automatic stabilisers absorb shock: tax down, benefits up • Also spending on public services stabilises • counteracts 16% of economic ‘shocks’ • Especially spending on elderly, health care

21. Crisis: cost of rescuing the banks- equals global revenue from 30 years of privatisation

22. Crisis: Economic stimulus as % of GDP 2009

23. …plus the cost of boosting the IMF Source: Bolstering the IMF's Lending Capacity July 08, 2009 http://www.imf.org/external/np/exr/faq/contribution.htm, and PSIRU calculations

24. Higher government debt levels Source: European Commission

25. Corporate profits now at record levels

26. Private alternatives: investment and efficiency • Different channels for using private sector • Privatisation by sale of enterprises • PPPs • liberalisation • Key questions • cost of finance for investment • Efficiency • Relations between companies and state

27. A VFM framework for PPPs • Cost of capital always higher for private sector • Construction ‘on time’ is costly ‘turnkey’ contract, for bankers’ benefit • No systematic efficiency savings (IMF: “the theory is ambiguous and the empirical evidence is mixed.”) • Real transaction costs and uncertainty • No reduction in public spending under PFI schemes: government pays

28. PPPs pay higher interest rates: UK data Govt bonds pay 4.5%, PPPs 6%, post-crisis 7% Source: PAC 2010

29. The high cost of private finance Source: PSIRU calculations, OFWAT, D Helm 2006 ‘Ownership, Utility Regulation And Financial Structures: An Emerging Model’ 14 January 2006 http://www.dieterhelm.co.uk./publications/OwnershipUtilityReg_FinancialStructures.pdf.

30. PPPs/PFI: dynamic problems • UK cases • M25 motorway: worse technical option , financed by govt at private rates, long-term costs of £1billion • Major London Underground PPPs cancelled, = 25% by value of entire PFI programme • “we found no clear and explicit justification and evaluation for the use of PFI in terms of its value for money…The Department for Communities and Local Government has undertaken a limited analysis of capital costs on new build schemes but this did not take account of all project costs such as finance costs.” (HoC 2010) • “Many PFI housing procurements have taken very much longer, and cost a great deal more, than originally planned” (Hoc 2010) • Supporting PPPs post-crisis means that: “higher financing costs increased the annual charge of PFI projects by six to seven per cent and that between £500 million to £1 billion of higher cost has been built in over 30 years” • Refinancing advantages for companies, rarely an option for public authorities • Little evidence of learning process by government • Little monitoring of outcomes • high spending on advisers: “insufficient commercial and technical skills within the Agency. The Agency risks advisers controlling projects and having little incentive to transfer knowledge back to the Agency.” NAO 2010 • Same experience in France after decades of concessions

31. Metronet: no risk transfer, no efficiency • “The return anticipated by Metronet’s shareholders appears to have been out of all proportion to the level of risk associated with the contract. The parent companies were effectively able to limit their liability to the £70 million they each invested in Metronet at the outset. … In the face of this very limited liability it is difficult to lend any credence to the assertion that the Metronet PPP contracts were effective in transferring risk from the public to the private sector. …Now that it has failed, it is the taxpayer and the Tube passengers who must meet the cost. • “In terms of borrowing, the Metronet contract did nothing more than secure loans, 95% of which were in any case underwritten by the public purse, at an inflated cost – the worst of both possible worlds … If finance cannot be secured at reasonable terms without guaranteeing the vast majority of the debt, loans direct to the Government, which would enjoy the highest credit rating and significantly lower costs, would seem to be the more cost-effective option. • “Metronet’s inability to operate efficiently or economically proves that the private sector can fail to deliver on a spectacular scale…. The evidence is clear: it cannot be taken as given that private sector involvement in public projects will necessarily deliver innovation and efficiency, least of all if the contracts lack appropriate commercial incentives. Future assessments of the comparative value for money of private sector-managed models for infrastructure projects should not assume a substantial efficiency-savings factor; • House of Commons Transport Committee ‘The London Underground and the Public–Private Partnership Agreements’ Second Report of Session 2007–08 HC 45 16 January 2008.

32. Efficiency, privatisation, PPPs • Empirical evidence does not support assumption that private sector will be more efficient • “While there is an extensive literature on this subject, the theory is ambiguous and the empirical evidence is mixed.”(IMF, March 2004) • Studies across countries and sectors find no consistent difference • Water and electricity: “no statistically significant difference in efficiency scores between public and private providers.” (Estache et al, 2005) • Telecoms: global study comparing private and public companies found that “efficiency growth following privatizations…is significantly smaller than growth in public sectors.” (Knyazeva, Knyazeva and Stiglitz 2006) • Buses: no significant difference in efficiency between public and private bus operators, or mixed systems (Pina and Torres 2006) • Auditing: Australia: ‘outsourced audits are more costly’ (Chong et al 2009) • Prisons: Lundahl 2009 “privately managed prisons provide no clear benefit”

33. Some efficiency references

34. More efficiency references

35. Efficiency and liberalisation • Liberalisation expected to deliver efficiency via competition • Not found in EU liberalisation of network industries • “No evidence of consumer benefits from electricity/gas/telecoms liberalisation” (Florio et al, 2008) • USA unbundled electricity systems are less efficient: • electricity systems in deregulated states “have lower productive efficiency, and have also experienced decreases in efficiency over time. In particular, the vertical separation of generation, a hallmark of an effort to deregulate the industry, is associated with an adverse impact on productive efficiency” (Goto and Makhija 2009) • Deregulation halted in USA after California crisis 2000

36. USA: most states reject retail competition Source: USA Government EIA. Sept 2009. http://www.eia.doe.gov/cneaf/electricity/chg_str/restructure.pdf

37. Global political contests over public spending • Post-crisis global contests over public spending • Two key drivers, for IMF and some govts • curb growth of public spending on healthcare and pensions, ageing populations • But contrary to efficiency evidence on public healthcare • drive to cut stimulus packages • IMF concerned with lasting shift: why? • More upward pressures on public spending • climate change, broadband, development • Major political conflicts already especially in healthcare, pensions

38. Forecast increase in public health spending (IMF) “the top priority is to contain the high rates of spending growth that have led to marked increases in spending-to-GDP ratios over the past 50 years” (IMF 2010)

39. IMF and politics: effects of crisis and IMF ‘exit’ plans

40. Conflicts over healthcare • IMF fiscal targets vs healthcare public spending • “Many of the reforms involve difficult tradeoffs, as they • would result in a reduction in the quantity of services financed by the public sector.” • “the difficulty of health reform is underscored by the dearth of prominent reforms in advanced countries aimed primarily at reducing spending.” • USA healthcare conflicts • public health policies vs. incumbent corporate interests • Central and eastern Europe healthcare conflicts • Czech, Slovak, Poland, Hungary • public reject fees, privatisation of insurance/hospitals • Referenda, elections, court cases • Corporate use BIT law to constrain policies: Slov, Poland

41. Political choices • Why panic? • stimulus deficits unwind with recovery: automatic stabilisers, growth, inflation • Similarly debt: long-term wide variations happen • Long-run growth in public spending/GDP normal, linked to growth • UK makes extreme cuts as part of ‘exit’ from stimulus • 20% cuts in services • NHS undermined by GP contracting to public or private • Economic growth reverses: -0.5% 2010 Q4 • political backlash: students, business, unions, councils • Other major countries not making rapid exits • USA, France, Germany, Italy, China, India • Unemployment 10% in EU and USA, youth 20%+ • Bubbles, speculation, IMF, EU impose cuts on small EU countries • Latvia, Ireland, Greece, Portugal, Hungary • Yields/credit ratings not linked to debt/GDP, deficit/GDP

42. IMF: using exits to cut public healthcare, pensions A Status Update on Fiscal Exit Strategies” IMF Working Paper WP/10/272 http://www.imf.org/external/pubs/ft/wp/2010/wp10272.pdf

43. Cutting staff, services, benefits (40:30:30) A Status Update on Fiscal Exit Strategies” IMF Working Paper WP/10/272 http://www.imf.org/external/pubs/ft/wp/2010/wp10272.pdf

44. New demands: climate change • Global costs of measures required to cut carbon emissions between 1% and 3% of global GDP. • UN estimates about three-quarters of this will have to come from public finance. • So globally, public spending will have to be higher by about 1.5% of total GDP, just on account of actions to deal with climate change. • Problems with liberalised energy markets • “we should not accept the significant risks and costs associated with the current market arrangements… changes to the current arrangements are both required and inevitable.” (UK Committee on Climate Change, 2009 http://www.theccc.org.uk/reports/progress-reports

45. Broadband, housing • Other continuing needs for public investment • Broadband internet access • Telcos reluctant to invest in necessary networks, so governments have to raise public finance • Eg Portugal state provides 85% of the financing for a €1 billion investment programme. • Housing • Sub-prime crisis highlights role of public investment in affordable housing • Slum problems in developing countries requires public housing programme • General needs for investment in developing countries • Private sector does not invest any significant amount in infrastruicture in Africa, Asia, limited in Latin America

46. Conclusions • The economic, social, developmental and environmental role of public spending • General upward pressures on public spending: stimulus, infrastructure, healthcare, pensions, equality, climate change, broadband, development • PPPs and privatisation not efficient alternatives • intense political conflicts, national and global

47. Affordable and fair taxation “our tax collectors are like honey bees, collecting nectar from the flowers without disturbing them, but spreading their pollen so that all flowers can thrive and bear fruit” Pranab Mukherjee India’s  finance minister, budget speech, July 2009