Authors: David Smith
To secure for the workers by hand or by brain the full fruits of their industry and the most equitable distribution thereof that may be possible upon the basis of the common ownership of the means of production, distribution and exchange, and the best obtainable system of popular administration and control of each industry or service.
Exactly how far that committed Labour to Marxist state ownership was long a matter of debate. Co-operatives, for example, would appear to meet Clause Four’s requirements. It was, however, used to justify the wave of nationalization by the 1945–51 Attlee government, which, as described in the previous chapter, took a whole range of industries, including coal, steel and the railways, into state ownership.
In fact, while
Capital
in its three volumes provided the theoretical justification for workers to seize the economic levers and use them, Marx and Engels had already reached this conclusion in the
Communist Manifesto
they co-wrote in 1848. While to modern eyes some of the manifesto’s proposals seem revolutionary – a single monopoly state bank, monopoly state ownership of transport and communication and the abolition of property rights – others are quite mild. It proposed a graduated or progressive income tax and the extension of state ownership of factories and other means of production, but not complete control.
How wrong was Marx?
Marx was one of the most influential thinkers of the modern era, but history has not been kind to his economics. The rise of the middle classes in western capitalist societies defied his prediction of workers kept permanently in conditions of near-poverty. Capitalism has been kinder to the masses than communism. There were crises of capitalism, most notably in the Great Depression of the 1930s, and there was of course the Russian revolution of 1917. But Marx’s central prediction, of capitalist crises brought on by falling profits, did not stand the test of time. The domino-like fall of communism in Eastern Europe at the end of the 1980s, most dramatically with the collapse of the Berlin Wall, and its present minority status, pursued by only a few oddball countries, appears to signal that little more than a century after his death, Marx’s star has waned, possibly never to resurge. The record of economies run along Marxist lines, ostensibly for the benefit of the workers, was abysmal. Before the unification of West and East Germany in 1990, there was a widespread impression that the economy in the east, the old German Democratic Republic, was quite strong. Only when it was opened up to full view were its weaknesses revealed. Marx’s economics has not lasted. Keynes set the tone in the 1930s by describing
Capital
as ‘scientifically erroneous’ and ‘without interest or application in the modern world’. Marxist thought, he said, was based on a misunderstanding of Ricardo’s theory of value. That was a little harsh, owing much to the benefit of hindsight. The classical economists were seriously challenged by Marx’s critique and, in its time, his work provided an intellectual underpinning to the revolutionaries threatening the capitalism of the industrial age. The capitalists of the period and their intellectual supporters would have given short shrift to the suggestion that Marx did not represent a threat.
That is partly why his predictions were wrong. Even if you were to accept an analysis that suggested workers would tend to remain permanently downtrodden, this did not leave revolution as the only solution. Worker power could be and was exerted through other ways, not least through democratic socialist parties. A Marxist analysis would say that capitalism adapted, steering a course that accepted, under pressure, a more equitable distribution of income. Adam Smith would have said that this was always the way it was going to be.
Defenders of Marx, responding to the fact that workers had indeed made economic progress, enjoying rising living standards rather than stagnating on the breadline, used to point to the exploitation by industrial countries of their colonies. In other words, western workers had prospered only because of the downtrodden poor elsewhere. There is a flavour of that in the present debate over globalization. When the richest 200 people in the world have the combined income of the poorest 41 percent of the global population, or nearly half of the people of the world live on less than $2 a day, the existence of inequality is not in doubt. What is harder, however, is to argue that this emerges from Marx’s scheme of things. Inequality arises as much from the inability of so many people to participate in the capitalist process, for reasons I shall come on to later. The links between global inequality and Marx’s economics are at best tenuous, at worst do not exist at all.
Now that Marx has left us, muttering ever so slightly and with a bottle of capitalist champagne concealed under his coat, it is time to start thinking about something that can ruin any meal – paying the bill. We are not quite at the end of our meal yet, and some might say this is a contrived title for a chapter about what governments do. But it seems fair enough to me. The government’s most important role in the economy is, after all, raising taxation, for which we all have to pick up the bill, and redistributing it in the form of public expenditure. Sir Leo Pliatsky, a former senior civil servant at the Treasury and Department of Trade and Industry, called his memoirs
Getting and Spending
, after Wordsworth’s ‘getting and spending we lay waste our powers’. So let us have a look at the government’s core role in the economy, at fiscal policy. Fiscal means ‘pertaining to tax’ but fiscal policy is both government spending and taxation.
Why governments spend
These days the fact that governments spend many billions each year is taken for granted. As long as there have been governments there has been government spending. It is worth thinking briefly about why this is. The first justification comes with so-called ‘public goods’. These are services or institutions that benefit the community as a whole but which the public would be unlikely to pay for on a voluntary basis. Would we pay voluntarily for the police service? Perhaps not if we believed the headlines that say they spend all their time persecuting middle-class motorists rather than catching criminals. Would we fund the legal system, which is necessary but expensive, with all those highly paid lawyers and judges? And, while there is no shortage of patriotism at time of war, citizens might object to the cost of maintaining the armed forces when there is no threat on the horizon. The existence of public goods is one type of ‘market failure’. If the government did not provide them, they probably would not exist and a properly functioning legal system, for example, is necessary to the workings of the economy.
A second type of market failure comes with so-called uninsurable risks. Would a chronically sick person with no income be able to get private health insurance? No, unless the government required insurance companies to provide blanket coverage for everybody within an area. Even then, to spread the risks between the healthy and unhealthy, companies might be required to offer such cover across a very wide area. And if this is the case why should not the government itself offer or at least guarantee such insurance, paid for out of taxation? The same goes for a whole range of risks, including unemployment insurance for the persistently unemployed and sickness pay for regular absentees. Even if the government acts as insurer, or purchaser, it does not have to be provider as well. The government could buy its entire healthcare on behalf of patients from private sector doctors and hospitals, removing the need for a National Health Service. At time of writing it is doing that but only at the margin. The argument for an NHS funded out of taxation was that only a large organization (the biggest employer in Western Europe) could take advantage of economies of scale, provide healthcare even in sparsely populated areas and train sufficient staff.
While most economists accept that it is the role of government to provide public goods, its role in the areas of uninsurable risks and as a provider of services such as health and education has come to be challenged, although not yet by enough people to change the system significantly, at least in Britain. Similarly, governments use taxation and government spending to redistribute income from rich to poor. Free market economists would argue that modern governments have moved well beyond what should be their core competences. There is little prospect, however, of a return to smaller, simpler government.
Spend, and spend some more
Budgetary arrangements differ between countries, notably in the split between central and local, or federal and state, when it comes both to revenue-raising and spending. The basic rules are, however, the same everywhere. Revenues are raised to finance spending. If more revenues are raised than needed there is a budget surplus. If revenues are insufficient there is a budget deficit and the government – central, local, federal or state – has to borrow to make up the difference. That, in a paragraph, is public finance.
UK government spending, at the time of writing, is about £400 billion a year, in an economy with a GDP of some £1,000 billion, so roughly 40 percent. Under current arrangements, the level of spending is negotiated between the Treasury and other Whitehall departments on a three-year rolling basis. A Comprehensive Spending Review (CSR) occurs every two years, the third year of each settlement being the first year of the next. A significant portion of this spending is in the form of transfer payments – pensions and welfare benefits – and so should not be double-counted for GDP purposes. Even so, that 40 percent figure is fair to take when analysing the growth in public spending. The other main distinction is between current and capital expenditure. In the National Health Service, for example, current expenditure would include wages and salaries of doctors, nurses and other staff, and the annual drugs bill, while building a new hospital would plainly count as capital expenditure. The lion’s share of government spending is current. In recent years public–private partnerships, such as the private finance initiative (PFI), have been used to try to increase the amount of capital spending.
Before the twentieth century, the story of public spending was essentially one of war and peace. Governments spent, by and large, to maintain armies, and that spending rose sharply during times of war, when those armies swelled in numbers. Before the Napoleonic wars, for example, the British government spent about a tenth of GDP, a figure that rose to a third by the time of the Battle of Waterloo. Wars were expensive, and still are, necessitating both higher taxation and, more importantly, extensive and prolonged borrowing. That was not just a pre-twentieth century phenomenon. The burden of financing the Second World War seriously sapped Britain’s ability to continue as a major economic power in the post-war period.
Until 1914 public expenditure operated around a peacetime norm of 10 or 11 percent of GDP. This was the level in the early part of the century, the late Victorian and Edwardian eras. The First World War effectively ushered in a period of state control of the economy and, in its aftermath, public spending did not return to its peacetime norm, instead settling at a little over 20 percent of GDP. This was not just due to the cost of paying for the war, in terms of the interest on government debt, but also because of the beginnings of a government-provided welfare state. The Liberal government elected in 1906 passed legislation in 1908 introducing state old-age pensions, as well as David Lloyd George’s 1911 National Insurance Act, which provided elements of both unemployment and health insurance. This ratcheting higher of spending continued during and after the Second World War, a period that saw the Education Act of 1944, the National Health Service Act of 1946 (the NHS came into being in 1948), the National Insurance Act of 1946 and the National Assistance Act of 1948. This was the period when, following Sir William Beveridge’s 1942 report, the modern welfare state came into being, with the government taking responsibility for health, education, pensions and a range of benefits covering unemployment, sickness and other needs. It was also a time when state control of industry was significantly extended. By the early 1950s government spending had reached 30 to 35 percent of GDP, increasing further to between 45 and 50 percent by the mid-1970s, as welfare spending rose. The Thatcher government succeeded in reducing it, on average, to about 40 percent of GDP, where it has stayed.
The rise of government spending to about four times its pre-1914 level relative to the size of the economy, has been accompanied by significant changes in its composition. As recently as 1950, defence was the most important item of government spending, equivalent to 6.6 percent of GDP, followed by social security (5.1 percent), health (3.6 percent), education (3.4 percent) and housing (2.6 percent). Half a century later, social security had the biggest budget (12.4 percent of GDP), followed by health and personal social services (6.7 percent), education (4.6 percent) and defence (2.7 percent). The rise of the welfare state is clear, as is the declining importance of defence, the more so since the British government, like others, claimed the ‘peace dividend’ following the end of the Cold War. Housing, important in the period following both world wars – building ‘homes fit for heroes’ – has turned into only a tiny part of government spending, following the Thatcher government’s successful policy of selling council houses to their tenants, and the transfer of much of the remaining council housing stock to housing associations.
What is the right level of government spending?
How come it used to be the case that governments spent only a tenth of GDP on public services, and much of that on defence, whereas two-fifths is now regarded as the norm? Part of the reason is that in the past there was no universal state provision of education, healthcare and support for the poor. This did not mean there was no such provision. In Britain a network of voluntary organizations, charities, medical aid societies, friendly societies and churches, often acting with local or national government agencies, provided an informal welfare state long before Beveridge. School boards ensured most local children received an education well before the 1944 Education Act. One criticism of the post-war welfare state was that it swept aside many of these highly effective voluntary arrangements. Paying to see a doctor was commonplace, indeed expected. Many operated an informal system of cross-subsidies, making sure their wealthier patients paid but not chasing up the fees of poorer clients. On the first day of the NHS, 5 July 1948, many patients turned up at GP surgeries armed with their sixpences, it not having sunk in that from then on consultations and treatments would be ‘free at the point of delivery’. They soon became used to it. Within a few months the cost of the NHS was rising at a rate that alarmed ministers, a pattern that has continued to this day. Aneurin Bevan, the ‘father of the NHS’ in the post-1945 Labour government, was soon commenting: ‘I shudder to think of the ceaseless cascade of medicine which is pouring down British throats at the present time.’
The level of public spending varies over time and it also varies in content. Britain’s defence budget relative to the size of the economy has steadily shrunk with the dismantling of the Empire. Housing is no longer a priority area for government spending. When the Conservatives were in power from 1979 to 1997, some areas of the welfare state were chipped away and replaced by private insurance, for example indefinitely paying the mortgage payments of the unemployed. A policy was also put in place to reduce the attractiveness of the basic state old-age pension, and by implication increasing the incentive to contribute to private arrangements, by linking annual rises in the state pension to prices rather than faster-growing earnings. Privatization dramatically reduced the state’s role in the UK economy during the 1980s and early 1990s, transferring telecommunications, steel, gas, water and electricity from public to private sectors, whereas the earlier policy of nationalization had increased it.
The point is that there is no economically determined optimum for the level of government spending. It is a matter of political choice. It is also a matter of national preference. Britain’s 40 percent of GDP level (39.4 percent in 2002 according to the OECD) is high in relation to the United States, where around 30 percent (31.2 percent in 2002) is the norm. But it is low in comparison with other EU countries such as Germany, 46.2 percent, France, 50.9 percent, or Sweden, 53 percent. The fact that the level of spending is a political choice does not mean, of course, that it has no economic effects.
Getting crowded
‘There’s no such thing as a free lunch’ is the motto for this book, and there is no such thing as costless government spending. When Bevan fretted about the embryonic NHS’s medicine bill, it was because the market mechanism had been removed. For the first time there was no price constraint – the cost of a visit to the GP or of the medicine itself – on people’s healthcare. This is why, when services are funded out of taxation, rationing is common and, indeed, has been a feature of the NHS since its creation. The benefits of government spending are many. Governments can, through taxation, put money to more socially desirable uses. They can spend to keep the economy going during hard times (more of that shortly) or to help out hard-hit regions. However, there are costs too, and one way of thinking about these is in terms of crowding out.
What is crowding out? Right at the very start of this book I picked up on one of the commonly used definitions of economics, the one about it being all about the allocation of scarce resources. That definition is quite useful in the context of government spending, in two respects. The first is that markets achieve that allocation by means of price. Products that are in short supply will rise in price, restricting the demand for them, and encouraging people to switch to things that are cheaper and more plentiful. ‘Free’ public services such as healthcare operate in the absence of any price mechanism. Demand, as a result, can be limitless. This is why rationing is so common in public healthcare and other services. The second way the allocation of resources comes in useful as a concept is in thinking about the way the economy divides up between public and private sectors.