Public Sector Reductions: A Viable Policy? Essay, Research Paper
In recent decades, the various economies of the world have seen a fundamental shift away from Keynesian economics towards neo-classical and liberal economics. The consequence of this has been the re-emergence of a market oriented laissez-faire economic doctrine, which despises government and anything, which may restrict the supremacy of the market. The idea that the private sector is the real source of economic growth and hence that there is the need to trim down the ?inefficient? public sector and divert its resources into the private sector in order to promote higher standards of living is held sacrosanct by some, but deemed to be outright fallacious by others. This essay will aim to analyse the rationales behind the new economic order?s attempts to reduce the size of the public sector and determine its validity within an economic context.
The proponents of the new economic order have argued for the necessity for economic change away from Keynesianism, and this is encapsulated in Friedman?s argument that laissez-faire is more egalitarian, as it will lead to increased economic growth and prosperity in the long-run. The partial basis for this argument lies in the economic theory that the market provides a means of achieving a perfectly functioning economic system with the most efficient means of allocating the factors of production. This serves to maximise not only consumer sovereignty, but also economic efficiency with no welfare loss, which means that any (government) interference in this process creates rigidities leading to allocative and technical inefficiencies. Therefore, it is argued that government involvement in the private sector fosters inefficiencies and distorts the natural market allocation of factors of production, by reducing the incentive to undertake certain types of production, which restricts economic growth. Hence, it is further argued that government and their regulations are a restriction upon the growth of choice and freedom, and lead to governmental overload, as well-intended interventions are ultimately counter-productive. This is especially the case given the reason that private firms cannot operate in a heavily regulated environment because their strength lies in innovation and not obedience to rules. Due this process politicisation of economics has artificially affect the economic cycle due to political opportunism, especially in relations with Government Business Enterprises (GBE) and industry protection, which in the long run foster inefficiencies and have a negative multiplier effects throughout the economy. These negative multiplier effects are caused by higher costs for factors of production, as indicated by Hopkin?s Study, which estimated that the cost of regulation is costing the economy about 9% of GDP output.
The major problem with the ideas proposed above is that many of the economic arguments are based on economic theories, models, and formulas which lack empirical support. The idea of utility maximisation (Homo Economus) for one, which underpins many of the neo-classical and liberal theories, is empirically non-existent. Due to the fallacious nature of the idea of utility maximisation, its application under perfect competition will produce excessive boom, bust, inflation and unemployment cycles as suggested by the Santa Fe Institute. Even if we were to accept the idea of utility maximisation, it might produce individual rationality, but lead to collective irrationality especially in relation to environmental control. On the evidence presented, if we can prove definitely that the private sector is the real source of economic growth, then all subsequent arguments about the evils of government can also be taken to be true. However, here lies one of the most fundamental problems with the New Right (NR). It assumes that the private sector is the real source of economic growth. Hence, it would only be logical to rebut anything which might interfere with the private sector, as promoting inefficiency and restricting economic growth (such as government interventions); but much of this reasoning is based on anecdotal evidence and is ideologically driven. It might very well be argued that the private sector is not the most efficient provider of certain types of goods and services under the model of perfect competition, where consumer knowledge is highly imperfect, such as in the area of health: hence regulations are needed. This can be most aptly demonstrated in the British health system, whereby there has been an explosion in costs and inefficiencies, while in the US fee based health services are about three times as expensive as collective organised health plans.
However, by erecting arbitrary distinctions between the public and private sector, the NR fails to link the critical role performed by government in contributing towards private sector growth by providing a favourable economic environment (as suggested by Stretton). Therefore, the idea of a ?free market? is in reality a fallacy in logic, a ?non sequitur,? given the fact that the modern free market requires a host of artificial regulation by government to keep it functional (as we see with the legal system.) The critical functions of governments can be taken a step further, especially in areas where market failure occurs, such as in the provision of infrastructure such as roads, education, hospitals and police, which are critical for the proper functioning of the private sector. Furthermore, government interventions do have positive impacts on society and economics through higher standards of living and equality, and discrimination prevention. Otherwise, economic inequalities will adversely affect both demand and supply, as demand becomes more volatile and supply is affected by under-investment. By instituting antitrust legislation to prevent anti-competitive behaviours and by regulating natural monopolies in order to achieve efficiency, such regulation is not only socially responsible, but is also economically beneficial. However, most importantly, the need for government intervention is purely economic (involving the national interest), especially in relation to investment. This is because intervention in investment is needed, not only to prevent possible market failures, but also because investment is so critical to aggregate demand and supply, that it is in everyone?s interest to ensure a stable economic environment. Not only will this reduce the cyclical fluctuation, but also increase economic efficiency due to a more stable environment. This claim can be justified by the rate of economic and productivity growth in the OECD during the Keynesian regulatory era, (high growth), in comparison with the neo-classical and liberal non-regulatory era, (low growth). However, it may be retorted that regulation creates inflationary pressures, (as seen in the seventies); but what this serves to indicate is the confusion suffered by the NR, as the inflation was caused by the Vietnam war and the oil shocks, which combined to undermine regulation. However, there does exist a legitimate argument for public sector reductions in order to create a more democratic command structure capable of more efficient welfare delivery. Such economic irrationality from the NR, as suggested by Galbraith, is also caused by the intellectual stubbornness of the right. Such ideological rigidity has led the NR to adopt a fundamentalist leaning, suggesting that the only reason why its economic policies have not been successful is continuing government interference. Hence, their policies need to be more extreme in order to rectify the problems.
Another argument mounted against government interference in the private sector by Public Choice theorists such as Downs, arises from the fear of ?Capture? by interest groups. The foundations of this argument suggest that governments, because of their democratic nature, are susceptible to the influences from pressure groups, (such as unions), who seek to represent a collection of self-interested individuals who will disadvantage the wider interests of the community, due to rational voter ignorance. Public Choice theorists further argue that there is no such thing as the common good, only collective selfishness. Hence, governments should not interfere in the market, as this will further promote special interests to the disadvantage of the majority. Therefore, the only means to achieve the best outcome is for self-interested people to be guided by the invisible hand (Smith). Another related concern from the NR in relation to special interests affects governmental regulations. It is believed by the NR that regulations acts as a form of corruption, by redistributing income towards privileged sectors, whilst stifling innovations by insulating certain sectors from competition.
The problem with the above analysis concerns the inherent contradiction in the claim by the NR. It appears that when unions are formed to improve conditions for workers, it is seen by the NR as subverting the rights of the majority by catering to special interests. However, when the group is comprised of entrepreneurs, it is perceived by the NR as minority protection from the misguided impulses of the majority, which is necessary for the process of wealth creation, which in the long run will benefit the majority. The essence of this argument is summarised by Thompson ??heavily disguised under the terms of freedom and liberty, which tends to centralise power and coerce diversity into an acceptable uniformity.?
Neo-conservatives have also added weight to the above debate by suggesting that governments take on additional tasks, for which they are not suited, far too eagerly. Hence, weak government results from government involvement with transfer payments and other public sector interventions. This in sum is seen as harmful, neglectful, and wasteful because it reduces the incentive to undertake work, which leads to economic decline and develops an over-reliance on the state, which in turn restricts the creation of a better life for Australians. In addition, the welfare state also undermines the traditional family unit, by increasing individual independence, which caters for special interests. Hence, it is argued that governments need to increase the incentive to work and decrease dependency on welfare, and this can primarily be achieved through cuts in services and in taxes.
The promotion of incentives by itself is quite beneficial in encouraging additional economic growth, but the process undertaken by the NR in the name of long-term economic benefits raises serious equity issues. Gilder, for example, suggests that the rich deserve positive incentives to work harder, namely through tax cuts (Laffer curve), while the poor deserve the negative incentive to work, namely poverty and starvation. Such ideas are socially irresponsible, but are also economically questionable, especially when many are already working at their optimum level. In a Kinsley study, from Forbes 400 richest Americans, only 59 could be considered truly self-made in productive activities, and this serves to question the effectiveness of incentives for increased productive economic activ
Farser suggests that big governments and budget deficits also contribute towards inflation, due to the Public Sector Borrowing Requirement (PSBR) , which inhibits our growth potential by reducing the efficacy of the private sector as costs of production increases. Excessive government spending is believed by Supply Side Economists to have contributed towards the recent economic slowdown and inflationary pressures, which reduces the incentive to work, save and invest. This is because (as argued by the Institute of Economic Affairs), the political mechanism ignores basic market rules, which leads to increasing taxation rates and bureaucratic growth. It has been further argued that the situation is being exacerbated by governments attempting to artificially achieve full employment, and equitable distribution of income, than would have occurred under the free market. In more detail, the PSBR used to fund the public sector deficits contributes towards the crowding out effect, which occurs when an increase in the public sector outlays diverts spending from the more ?productive? private sector. The increases in government expenditure will boost aggregate planned expenditure, which will increase equilibrium expenditure caused by the positive multiplier effect, and therefore increase GDP. However, the problem arises when the demand curve for money shifts to the right, thus increasing Interest Rates due to the increased demand for money and the inflationary fears of central banks. This will increase the cost of investment, leading to a subsequent decrease in private sector expenditure and hence have long-term negative consequences for the economy, caused by the multiplier effect. Another reason for decreasing the PSBR was concern for intergeneration inequity, which can arise due to excessive government borrowings, and place excessive servicing burdens on future generations.
The problem with the squeezing out hypothesis as advocated by the NR is that it relies on a static model, whereby higher savings (S) leads to higher investment (I), resulting in higher income (Y) or (S > I > Y), which means that firms will simply borrow to invest on the basis that there are additional savings available. This analysis is far too simplistic, and fails to consider that investment is driven by expected demand and rate of return. The more appropriate approach would be to assume that government outlays would contribute towards productivity growth, as increased investment leads to higher income and hence contributes towards higher savings for reinvestment (I > Y > S). The crowding out hypothesis also fails to take adequately into consideration the negative multiplier effects from the reductions in government outlays, and reductions in research and development undertaken by the government. Such ideas of deriving long-term economic benefits from structural reform (reducing crowding out), as suggested by Friedman, has seemed very elusive, while in the short-term there has been an increase in unemployment leading to increased welfare expenditure, and a more volatile economic cycle.
Traditionally, economists have not seen government as a given, and this has led to the belief that government intervention is only a second best option. However, as suggested by Logue and Mishra, government involvement in the private sector serves to only complement the market principle, and does not seek to tamper with income distribution inside the market; rather, it represents a principle of needs provision for the disadvantaged, which serves to reduce cyclical fluctuations. Due to this, the following argument mounted by the NR is severely misguided.
The NR has argued that GBE?s are inefficient due to the rate of return, hence the need for privatisation. However, what they fail to realise is this is a very deceptive indication of efficiency as the primary task of GBEs is not profit maximisation, but service provision. Another reason why GBEs may not seek profit maximisation is that this could become politically embarrassing for the government. The process of privatisation has often lead to inadequate provisions for competition, which has lead to a decline in service and higher prices. This became apparent under Thatcher. Instead of improving efficiency and reducing government regulation, Thatcher?s ill-considered privatisations led to increases in bureaucratic red-tape as mountains of regulations were needed in order to prevent consumer exploitation. The situation changed, in the words of Thompson ??from close intervention to intervention from a distance.” GBEs also contribute to national unity and equity by providing essential services to remote and disadvantaged groups. Hence, GBEs should not be run on private sector lines or privatised given that their primary function is to provide a community service. As a part of this process of privatisation there has also been an introduction of the user pays principle: this is designed to ensure less over-consumption of public goods due to its pricing policy, which discourages wastage while at the same time enabling governments to spend less, so that they can use the money elsewhere. The major problem with the user pays principle is that it is regressive, and will widen existing economic inequalities.
Governmental regulations today are very much needed in order to promote social justice, equity, economic growth and the over-accumulation of excessive market power. In totality, government regulation is better than a system of laissez-faire. However, this essay is by no means suggesting that the market has no role to play in the economy, nor is it suggesting that regulation is the be all and end all; but there does exist a need for a logical approach to economics free from ideological dogma. Hence, the rather black and white argument mounted by the NR for the increased dominance of the private sector over the public sector needs to be reviewed, and economists need to take further into consideration the relative importance of the public sector on economic growth.
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