27 January 2013
STANFORD – A successful society needs effective, affordable government to perform its necessary functions well, and that includes sufficient revenue to fund those functions. But a government that grows too large, centralized, bureaucratic, and expensive substantially impairs the private economy by eroding individual initiative and responsibility; crowding out private investment, consumption, and charity; and damaging incentives with high tax rates. It also risks crowding out necessary government functions such as defense. That is today’s Europe in a nutshell, with America not far behind.
The recent death of James M. Buchanan, the father of public-choice economics, is reason to reflect on his sage warnings. Buchanan was awarded the Nobel Prize in 1986 for bringing to the study of government and the behavior of government officials the same rigorous analysis that economists had long applied to private economic decision-making. Buchanan concluded that politicians’ pursuit of self-interest inevitably leads to poor outcomes.
Buchanan’s analysis stood in marked contrast not only to Adam Smith’s dictum that the pursuit of self-interest leads, as if “by an invisible hand,” to desirable social outcomes, but also to the prevailing approach to policy analysis, which views government as a benevolent planner, implementing textbook “solutions” to market failures.
According to this view, if markets do not fully internalize all of the costs of private action – environmental pollution is a classic example – some “optimal” tax or subsidy supposedly can correct the problem. So, if a monopoly is restricting output and raising prices, regulate firms and industries.
When weak demand leads to recession, increase government spending and/or cut taxes by just the right amount, determined by a Keynesian multiplier, and – presto! – the economy rebounds quickly.
Buchanan considered such analysis romantic. He showed that public officials, like everyone else, are driven by self-interest and governed by the rules and constraints operating in their economic environment. Households have a budget constraint. Firms have technological, competitive, and bottom-line constraints. For politicians, the ability to exercise power – for their own interests or those of vested interests – is constrained by the need to get elected.
Buchanan predicted that, by hiding the full costs, the ability to finance public spending through deficits would lead to higher spending and lower taxes at the expense of future generations, whose members were not directly represented in current voting. He predicted ever-larger deficits and debt – and ever-larger government as a result.
On this issue, Buchanan was, unfortunately, prescient – and well before financial crisis and deep recession led to yet another jump in the size and scope of government, accompanied by large deficits and exploding debt in the United States, Europe, and Japan. Buchanan argued tirelessly for lower government spending, balanced budgets (even a balanced-budget amendment to the US Constitution), and streamlined regulation.
Buchanan, along with Milton Friedman and many others, correctly pointed out that government failures are as numerous as market failures. So, even in areas like infrastructure or education, it is necessary to compare the benefits and costs of the imperfect fiscal and regulatory policies likely to be implemented by fallible, self-interested officials with potentially imperfect market outcomes.
These government failures include rent-seeking, pork-barrel spending, social engineering, regulatory capture, and induced dependency. Market failures or claims of unmet need are not sufficient to prescribe government intervention in the private economy, because the cure may be worse than the disease.
There are, of course, important, successful government programs. In America, the post-World War II G.I. Bill financed higher education for demobilized soldiers, and was a highly beneficial public investment in human capital. Social Security has helped reduce poverty among the elderly. The military has kept the US safe and free.
But the gap between textbook solutions drawn up in universities and think tanks and the reality on the ground can be vast. More spending or regulation does not always lead to better outcomes.
Government spending is no less subject to diminishing returns than anything else. Programs become entrenched, develop powerful constituencies, and are hard to shrink. Few programs are targeted carefully enough to real needs – or to the really needy – as politicians buy votes by spreading coverage far beyond what is needed to achieve programs’ stated goals. Hence Buchanan’s disdain for romanticizing government action.
In country after country, one casualty of the ongoing debate over spending, taxes, deficits, and debt has been efforts to make government more effective and efficient. In most areas of government, from defense to entitlements, better outcomes can be achieved at much lower cost, which should please both the left and the right.
For example, America’s federal government has 47 separate job-training programs in nine different agencies, costing almost $20 billion a year, most of which the Government Accountability Office reckons are ineffective or poorly run. President Barack Obama added the 47th – for green-energy job training – in 2009. The success rate was so poor (a tiny percentage of participants got targeted jobs) that the Labor Department’s Inspector General recommended shutting it down – and this at a time of massive unemployment, with firms listing millions of job openings but unable to find workers with the required skills.
We have seen what ultimately results when unsustainable spending leads to exploding debt: economic chaos and human tragedy. Somewhere between “romanticized” government solutions to problems and Buchanan’s self-interested government officials, we must find leaders willing to eliminate poorly performing programs; modernize, streamline, and consolidate others; improve services; and limit pressure for ever-higher growth-destroying taxes.
Michael Boskin is Professor of Economics at Stanford University and Senior Fellow at the Hoover Institution. He was Chairman of George H.W. Bush’s Council of Economic Advisers from 1989 to 1993, and headed the so-called Boskin Commission, a congressional advisory body that highlighted errors in official US inflation estimates.