ECONOMICS: Government spending as a percentage of GDP has fallen in recent years, because expenditure has not kept pace with the nominal growth in GDP
Government spending is a curious animal when seen through the eyes of a typical finance minister. Government spending is "good" when the minister is addressing the electorate, and the stronger the pace of growth the better, with the implicit assumption that such spending automatically improves the lot of the voters.
When addressing the financial markets, however, the message shifts: tight control of government spending is praised as a virtue, and high spending seen as profligate and unworthy of any finance minister worth his salt.
This double-vision is rendered more cloudy still by the way government spending is reported at budget time, with commentary focused on the monetary change in spending, as opposed to whether the government is pre-empting more or less of the State's resources.
The latter, government expenditure as a percentage of GDP, is a more appropriate measure but does not get the attention it deserves. It exposes the reality of whether the government is spending like there is no tomorrow or being excessively frugal.
The type of spending is important too. The Irish exchequer has always been careful in differentiating between current expenditure and capital expenditure, although to some degree the distinction is somewhat artificial (a new hospital is a capital item, for example, but to staff it one needs additional current spending), but in principle capital spending should create an asset for the state and hence a potential return over time.
Capital spending can also be of a once-off nature, whereas a government decision to hire more doctors or civil servants marks a permanent addition to current spending, as long as the workers remain on the payroll. Similarly, if a government commits to paying €100 per week to every benefit claimant, the total claimant bill will rise or fall with the number of claimants, which imparts a cyclical impetus to spending. The same is true for debt interest: the interest bill will depend on interest-rate trends, which are generally outside the control of the government and will rise and fall with the economic cycle.
So a large proportion of current spending is non-discretionary and it is not surprising therefore that over time most countries do not experience a radical shift in the share of government spending in GDP.
Interestingly, the Ireland of the Celtic Tiger has been an exception, regardless of how one measures current spending (unfortunately there are various definitions, often quoted selectively to prove a point).
Take gross voted current spending, which is the actual punts or euro spent by the exchequer excluding debt interest.
In 1990 the total spend was €9.9 billion, equivalent to 27.3 per cent of GDP. By 1994 this ratio had risen to 29.7 per cent, but by 1997 had slipped back to only 25.2 per cent of GDP thanks to the pick-up in economic growth.
By 2000 the ratio had fallen further to only 21.3 per cent, so the 1990s can be viewed as a decade in which government spending fell sharply in relation to GDP, and not one in which spending exploded, as popular imagination would have it. Spending did pick up strongly in 2001 and is projected to rise further in 2002, but the outcome may well be only 23.7 per cent or 3.6 percentage points below the 1990 figure.
Putting it another way, gross voted spending in 2002 is projected at some €30.1 billion, but would have to be at €34.6 billion. to match the 1990 figure in terms of GDP. Similarly gross spending in 2002 will be below the 1997 figure (23.7 per cent of GDP against 25.2 per cent) because spending has not kept pace with nominal GDP growth over the period.
One obvious point is that announcing a fixed percentage target for the growth of spending over time is not sensible, as growth in the economy may render the target hopelessly conservative or wildly profligate. Far better, perhaps, to concentrate on spending in relation to GDP, which has the added advantage of transparency on taxation.
If spending falls as a percentage of GDP, for example, then so too can taxes and the national debt, as happened in the 1990s. A rising spending trend, it follows, can only be financed by a higher tax burden in the long run either directly or indirectly via higher debt.
One caveat though: recent experience suggests that the spending outturn in relation to GDP can be wildly different from that projected, and most of the change in the spending burden was probably unplanned.
Dr Dan McLaughlin is chief economist at Bank of Ireland
