How big should government be?

“The question we ask today is not whether our government is too big or too small, but whether it works (…). Where the answer is yes, we intend to move forward. Where the answer is no, programs will end. And those of us who manage the public’s dollars will be held to account – to spend wisely, reform bad habits, and do our business in the light of day – because only then can we restore the vital trust between a people and their government.” (Barack Obama inaugural speech, 20 January 2009)

1. The role of government and the money it spends to fulfil its role has been one of the key questions of economics and political philosophy for centuries. However, only in recent decades, when governments had grown significantly in size have methodologies emerged to measure, assess and advise on the size, performance and efficiency of government and on the underlying policies.
2. One could say that there is significant scope for expenditure savings for many governments in advanced economies. Governments probably need at most 40% of GDP to do well and keep more money in the hands of their citizens. Experience shows that this size of government is not some pipe-dream number but it is realistic and reachable for advanced economies.
3. There is a huge variation in government performance and efficiency across countries. In some countries with big but well-functioning governments and strong policy programs, such as the Nordics, more spending may be less costly in terms of taxes, growth and employment. Whether the more equal income distribution is worth much higher spending – 10% of GDP or more – and more unemployment is a matter of judgement.
4. Hence, in “normal times”, there could be room for smaller and better government in many countries. Naturally, on which policies and sectors public money is going to be spent is a decision linked to the choices of citizens and taxpayers. Countries should pursue reforms of their institutions and policies. International competition and peer learning should exert pressure in this direction. On the other hand, population ageing and financial instability are important fiscal risks, notably for short- and long-term fiscal sustainability, that are certain or likely to materialise and raise public expenditure even further in the future.
5. In 2020, a less “normal period”, the COVID-19 crisis added further pressure to the government balance sheets, both to the assets side and to the liabilities side. Projections by the European Commission for most advanced countries suggest further major increases in government spending ratios in 2020. Indeed, expenditure ratios are expected to increase by an average of over 7% of GDP in 2020, and the highest ratios would reach about 60% of GDP.
6. Wrapping up, core public services need to be of high quality and well-financed and social expenditure or financial and economic crisis costs do not necessarily need to undermine fiscal sustainability, if sounder fiscal positions are achieved beforehand, somewhat like an insurance policy vis-à-vis the randomness of the future. For all this to happen, voters, politicians, and (fiscal) policymakers, need to agree in a durable way on those principles.