Thursday, 19 February 2015

The relevance of 25%

What defines a predominantly capitalist economy is the size of the capitalist sector. However, since the size of the voluntary sector is usually small and difficult to measure and the state sector is easier to quantify, it is frequently expedient to measure only the state sector to assess the degree of capitalism in an economy. Typically one measures the role of the state through three indicators – the value of the goods and services it produces through government and state owned enterprises and agencies, how much it spends and how tightly it regulates the other sectors in the economy.

Because government expenditure is the easiest to measure the most used indicator is public expenditure as a percentage of GDP. Globally, based on data used by the Economic Freedom Index (2014) the values range from 14.6% in Guatemala to 139.7% in East Timor. On the lower side of the distribution, with a share of less than 30%, there are more than one third of the countries, most of them too poor to have a welfare system with the notable exceptions of Macau, Singapore, Hong Kong, UAE, Taiwan and the Bahamas.

Among advanced OECD capitalist countries, this share varied between 5 and 15% in the early XX century, but it has risen to the current range of 30 to 58%. The lowest value is found in South Korea (30.2%) and the highest in Denmark (57.6%). Because the prevalence of extended families in Asian explains a lower social expenditure in those countries we note that among the other countries the one with the lowest share is Switzerland (33.8%). So, 25% is the standard amplitude of public expenditure among western capitalist countries.

The increase in the share of the state is mostly due to the creation of welfare systems while the widest amplitude reflects the greater variety in the forms of capitalism. I shall focus on the 25% amplitude because it illustrate better what drives the growth of the state sector and, concomitantly, the shrinking or slow growth of the capitalist sector.

An important insight to understand this amplitude is to look at the percentage of public expenditure devoted to collective goods which generally cannot be run under market capitalism. The OECD has produced this data for 18 of its members for the period 1995-2009. It shows that in 1995 the share of collective goods in total public spending ranged from 30.2% in Luxembourg and 54.9% in the Czech Republic, yet by 2009 its range had reduced to a minimum of 27.5% in Norway and 45.8% in Greece. This reduction may be the result of a faster rise in individual public spending or a reduction in overall government spending biased against investment.

The following table showing the percentage of collective spending in 2009 suggests that,

on average, two thirds of government spending is on individual goods which, theoretically, could be produced under a capitalist system. On average, the collective goods represent only 16% of GDP, ranging from a low of 12.1% in Norway and a high of 23.8% in Greece.

Spending on these goods is strongly influenced by the level of economic development, urbanization and geography. Surprisingly, it does not vary much with the form of capitalism. In fact, only in Hungary and Greece does spending in collective goods exceeds more than 20% of GDP.

So, what really differentiates the various types of capitalism is the government spending for individual consumption. This spending should be broken down into distinct categories. In particular we need to consider separately social spending which accounts for the bulk of individual spending.

The table below shows that public sector social expenditure ranges from 10% of GDP in South Korea to 30% in France. It also shows that mandatory private spending is negligible while voluntary social expenditure is meaningful only in the USA (10.2%), U.K. (5.3%), Canada (5.1%) and Iceland (4.6%).

To some extent total social expenditure is determined by per capita income, age and other demographic factors but it is clearly the result of political choices.

For instance, note that countries that rely more on voluntary private expenditure are not among the top spenders. Is this the result of more efficiency or less coverage? The data does not allow an answer to such question, but this question is fundamental to ascertain the relative comparative advantage of the public and private sectors in the provision of these services.

First, we must split this type of public expenditure into two subsectors: income redistribution and insurance services. This is not easy because redistribution is often made through the provision of subsidised services produced in the public sector. However, old age and survivors public pensions as a percentage of GDP are a good proxy for the size of public spending that could be provided by the capitalist sector. With this indicator we find a wide variability, with values below 3% of GDP for South Korea and Iceland and above 14% for Austria, Italy and France.

Overall, we have that a mere 25 percentage points of public expenditure separates the extremes in capitalist economic systems between market and state capitalism. However, one needs to know the composition of such expenditure to really understand how close each country is to the ideal of market capitalism. Moreover, one needs to bear in mind that the role of the state extends beyond public expenditure and production.

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