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How to shrink the state

Summary:
Steve Barclay, the Prime Minister’s chief of staff, says he wants to “restore a smaller state”. This is mere virtue signalling. For one thing, the Tories’ actual behaviour shows no appetite for a smaller state. Quite the opposite. They oppose drug legalization; have authorized the security services to commit crime; and are seeking to suppress protest. But there’s something else. It’s that if you are serious about cutting government spending as a share of GDP you need much more than libertarian instincts. You need a strong economy. My chart shows the point, showing total managed expenditure as a share of GDP since 1955-56. It’s not easy to discern from this alone any great political changes. Yes, the share of government spending in GDP rose in the 1960s as social democracy became more

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Steve Barclay, the Prime Minister’s chief of staff, says he wants to “restore a smaller state”. This is mere virtue signalling.

For one thing, the Tories’ actual behaviour shows no appetite for a smaller state. Quite the opposite. They oppose drug legalization; have authorized the security services to commit crime; and are seeking to suppress protest.

But there’s something else. It’s that if you are serious about cutting government spending as a share of GDP you need much more than libertarian instincts. You need a strong economy.

My chart shows the point, showing total managed expenditure as a share of GDP since 1955-56. Tmegdp

It’s not easy to discern from this alone any great political changes. Yes, the share of government spending in GDP rose in the 1960s as social democracy became more entrenched, and also grew during the second New Labour administration from 2001 to 2005. But it also rose in the early years of the Thatcher administration – from 41.5 per cent in 1978-79 to 43.3 per cent in 1982-83. And it fell in the first few years of the New Labour government. Few, though, would argue that Thatcher believed in bigger government and Brown in smaller.

Instead, what stands out more are economic booms and slumps. Government spending rose as a share of GDP after the oil shock of 1973; during the recessions of the early 80s and 90s; during the financial crisis of 2007-09; and during the pandemic. And it fell during the booms of the late 80s and late 90s.

The state of the economy is a stronger determinant of the share of public spending in GDP than is the ideology of the government.

We can put this more formally. The OBR has estimates of the output gap going back to 1972-73. Between then and 2019-20 (that is, just before the pandemic), the correlation between that gap and the share of TME in GDP was minus 0.4. A weak economy means a higher share of government spending, and a stronger economy a smaller share.

By contrast, the relationship between the share of TME in GDP and dummy variable measuring whether the Tories or Labour are in government is statistically insignificant. Which tells us that the state of the economy matters more for the size of government than does which party is in government.

Now, you might think that the output gap is a bad measure. I’d agree. But another measure tells a similar story. If we look at five-year changes in real GDP and in the share of public spending in GDP we also see a negative correlation. For the TME share it was minus 0.43 between 1955-56 and 2019-20. And for the share of current spending in GDP it has been even stronger, at minus 0.56. If we look only at the post-1973 period – that is, to exclude the Golden Age of strong growth, the correlations have been stronger, at minus 0.61 for the share of TME in GDP and minus 0.63 for the share of current spending. And these figures exclude the pandemic year, and so understate the correlation for the whole period.

I’m not very numerate – though am more so than many MPs – but I do know that a fraction comprises two parts, a numerator and a denominator. You can reduce a fraction therefore not by reducing the numerator but by increasing the denominator. And history tells us that this has been the main way in which state spending shrinks as a portion of GDP.

If you are serious about shrinking the state, you need to do more than wave Hayek and Nozick at us (or, Gawd help us, Ayn Rand). What you also need is stronger economic growth.

Which brings us to a problem. The Tories cannot deliver this, for four reasons:

 - Brexit red tape is reducing trade and depressing GDP. Free trade agreements with other countries are unlikely to offset this damage.

 - They are still austerians, as we are seeing with Sunak and Johnson’s promise to raise NICs even during a cost of living crisis. The OBR foresees cyclically-adjusted net borrowing falling from 8.3 per cent of GDP this fiscal year to 1.5 per cent by 2026-27. That means weaker growth and hence a still-high share of public spending in GDP: the OBR forecasts that even in 2026-27 TME will be over 41 per cent of GDP, much higher than it was during the New Labour years before the financial crisis.

 - Tories electoral interests militate against promoting growth, even if they knew how to do so. A stagnant economy fosters reactionary illiberal attitudes and hence support for their culture wars.

 - Tory supporters’ and donors’ interests are antagonistic to faster growth. Policies to promote growth would hurt rentiers – such as shifting incomes from incomes to property, liberalizing planning laws or promoting competition. And higher trend growth would probably entail higher real interest rates, thus hurting rentiers still more.

If you are sincere about wanting to shrink government spending as a share of GDP, you cannot support the Tory party as it currently exists. Given the party’s lurch towards illiberalism, however, you cannot support Labour either.

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