Calling In The Armey

 

I often lament how large the state has become in the UK, in terms of public services sub-optimally performing because they have become too bloated (as per Gammon’s Law, diseconomies of scale, etc). But in my book Benevolent Libertarianism, I also devote some time to considering the trade-off between money put into public services and money spent in private enterprise. I explore the matter of a healthy ratio of public and private spending in GDP, and ask if most of the spending was on private goods and services and we just had a small state - only functional for defence, law, health, social services, police, welfare, roads, and a few other light regulatory things - would all the money spent in the private sector be money well spent, or would it just mean we buy lots more consumerist stuff we don’t really need?

Last time I looked, total UK government spending was about 45% of GDP, which is large. If you tend to dip into economics, you’ve probably heard of the Armey Curve - an inverted U-shaped relationship where, as the public share of GDP rises from a tiny level, the economy often benefits (via public goods, infrastructure, human capital, etc), but beyond some threshold additional public spending tends to deliver diminishing or negative returns to growth. There has been much debate over the decades about the optimal percentage, but there’s a general consensus that 45% is way too high - although the optimal figure is also contingent on exactly what the money is being spent on. If the UK government was spending 45% of GDP primarily on defence, law, health, social services, police, welfare, roads and a few other light regulatory things, and all those sectors were thriving, it would be a different proposition to the one we are currently faced with; a bloated state that’s out of control with its spending, and the sectors performing poorly (in some cases dreadfully).

A smaller state would shift spending towards greater private consumption and private provision of things the state used to supply, but in many cases with better value for money. But it isn’t self-evident what the optimal trade-off is, because it’s a hugely complex, variable and intractable set of considerations. When private spending is allocative and productive, it increases productive capacity and long-run welfare. But when it’s consumerism with low social return, like unnecessary marketing-driven upgrades, or over-consumption of low-value goods we don’t really need, then shifting public money to private consumption can reduce social welfare if it replaces productive public services.

The big challenge is twofold. Firstly, no single “optimal” ratio exists, because range and composition matter more. And secondly, if we shrink the state to a “minimal” model, private substitutes will emerge - but unless private markets and institutions can fully and equitably fill the gaps, there will be a different kind of deterioration in social cohesion.

I have a chapter in Benevolent Libertarianism devoted to striking this balance. But, alas, there is very little appetite in most developed countries to even acknowledge this problem, let alone attempt to solve it. The Armey Curve should serve as a continual reminder that public spending has a positive impact on the economy up to a certain optimal threshold, after which it has a detrimental, negative effect. But politically, it’s far easier to expand spending than to rein it in, because often the benefits are visible and immediate while the costs are diffuse and long-term - and the general public is frequently seduced by low-hanging fruit and offers of so-called ‘free lunches’.