Institutions and government spending in 20 th century

1. Institutions and government spendingin 20th century 17th December 2012

2. Lessons from last Thursday… • Institutions are important factors affecting long-term development (growth vs stagnation) • This is particularly true for property rights • Institutions have “a life of their own” • They are far from engineered or designed • They have potentially long life-span • Their dynamics is affected by needs of the economy as well as the vagaries of politics • Most destructive economic upheavals have been associated with sudden upsets in property rights

4. Source: John J. Wallis: American Government Finance in the Long Run, 1790 – 1990, Journal of Political Economy 14, 2000

6. Peter Lindert: Growing public (2004) • Welfare state (& public sector in general) has grown with extension of suffrage • This is true across countries and decades • This is true regardless of political system or parties in place • It is tied, then, with the politics as well as “technology” of public-sector operation • It is not a left-wing conspiracy • It is not a result of just cautious, thorough design either • The welfare state and current public sector is a result of of spontaneous growth/bloating

7. Examples of such spontaneous development • Changes to taxes • Changes to expenditures

12. Overall impact • PIT rates have declined and are simplified • Revenue from direct income tax has grown less important and less available • Revenues have been replenished through other sources: • Indirect taxes (VAT) • Payroll taxes (Social insurance payments) • Most of these are regressive! (Why?) • The result is a regressive overall tax system in many welfare-state countries

13. Source: http://economix.blogs.nytimes.com/2010/12/01/who-pays-for-big-government/

14. Expenditure: spending on welfare • Biggest items as a % of GDP of OECD countries: • Year 1995 2009 • Public pensions 6.9 7.0 • Unemployment benefits 1.8 • Basic assistance (welfare) 2.9 • Healthcare 6.8 7.0 • Public housing 1.0 • Public education 5.2 5.1

15. Life expectancy and retirement in Europe

16. Benefits from pension system • Low-income earners: • Low education => early labor force entry (by up to 10 years) • Long period of contributions • Social insurance rates are overall regressive • Low life expectancy => short period of benefits (by up to 6 years) • Earlier exit from the system relative to other groups • Replacement ratio • Highly progressive (benefits lower incomes) • High-income earners • High education => late entry into labor force • Shorter period of contribution • Social insurance rates are overall regressive • High life expectancy => long period of benefits • Hit by progressive replacement ratio • Note: this is often the only publicly discussed item when discussing the redistributional consequences of pension systems • Middle-income earners • Maturita/university => more similar to high-income earners (late entry) • Life expectancy in-between: close to high-income groups in some countries and low-income groups in others • Replacement ratio: progressivity usually strongly hits at higher than middle incomes, so middle-income groups are not his as badly • Conclusion: who benefits and who pays over the life-time is unclear a priori – it DOES NOT follow that pension systems benefit the poor, they likely benefit the middle

17. Benefits from pension system (continued) • Men vs women • Women have higher life expectancy (by many years) • Women retire earlier • Women also spend less time in labor force (childbearing) but have lower unemployment • Women have lower wages • Immigrants vs natives • Frequently natives contribute (if they work) but may have limited access to benefits in old age (+ migration) • Illegals only contribute, limited chance of benefits

18. Education

20. Education • Education is treated in most rich states as a public good • Primary and secondary education • Highest return to education (>15, even 20%) • (Mostly) universal in access and provision • Highly educated people reap greater benefit, of course • Tertiary education • Enrolment far from universal • Children of highly educated parents have significantly higher chances of enrolment

22. Many welfare state policies operate as subsidies for the better-off • Not just tertiary education and pensions • Tax breaks • Mortgage interest deduction • Business expenses • Lower rates on interest on savings and capital • Public sector employment • Requires higher education • Higher rate of unionization than unskilled labor • Higher incidence of guaranteed job tenure • Labor market regulations • Job protection (affects hiring and firing) • Severance pays • Untaxed fringe benefits (work hours, overtime compensation)

23. Evaluating the welfare state • Some policies are redistributive towards the poor • Many public policies, however, redistribute FROM the poor to the middle (or rich) • Public (tertiary) education • Public pensions (potentially) • Public sector jobs (require high education) • The tax system with loopholes • Why? See Wallis (2000) and Lindert (2004): • Because those are the people who VOTE! • They are also very adamant about keeping their perks

24. How does that relate to the whole property rights story? • Property rights enable growth when they are stable • Property rights are stable… • When they are sustainable technologically (e.g. ripping off CDs) – but this change is usually gradual • When they are not undermined by politics (i.e. no sudden movement, revolutions, expropriations) • This means clear-cut support by majority of decision-makers • Current welfare state • has been supported by a wide coalition of middle-income voters • This coalition has lasted at least since WW2 • The coalition supports it precisely because they benefit from it • But recently, the status quo is upset by technology: • Medical technology increases life-span, affecting demographic make-up • Communications technology improves mobility of jobs and capital

25. Deficit as % of GDP in OECD

26. Same stats, PIIGS

27. Same stats, chronic offenders

28. The punch-line • Instability of the whole system has lasted for some time now • The trends are getting more ominous • Not only higher mobility undermines tax base • Growth has slowed down • Claims on public resources have shot up and will even more so in the future • Yet, reform has been elusive • In spite of international pressure (Maastricht treaty) • In spite of continuing public debate • This is because the powerful coalition can defeat reform

29. The austerity policy in Europe • Who is against? • The pensioners (Greece – pensions are under attack) • The public servants (Greece – cuts in public sector) • The university students (Spain – indignados) • Where are the cuts? • Unemployment benefits and welfare • Some in education • Some in pensions • Where reform is slow in coming? • Labor market regulations • Privatization of SOE • Public sector jobs (halt in hiring – indignados again)

30. Conclusions • The problem is chronic, recession only put it front & center (Buffet: “When the tide turns, that’s when we learn who’s been swimming naked”) • It looks like many governments have hit the budget constraint • Long-term shift in what is taxed and how it is taxed (tax avoidance) • Upshot: either find a new source of income or face the inevitable cuts

31. Sources • Peter Lindert: Growing Public (Volumes 1 & 2), Cambridge University Press, 2004 • John J. Wallis: American Government Finance in the Long Run, 1790 – 1990, Journal of Political Economy 14, 2000 • Klara Sabirianova-Peter, Steve Buttrick & Denvil Duncan: Global Reform and Personal Income Taxation: Evidence from 189 countries, IZA working paper 4228, June 2009 • Casey Mulligan’s blog & NYT • “Taming Leviathan”, 17th March 2011, The Economist • OECD website