Labour reopens debate on how big the public sector should be

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The size of the boost is remarkable and timed to thump in just ahead of the election

The size of the boost is remarkable and timed to thump in just ahead of the election

The Government'S new spending plans will be announced on Tuesday.

The decision will be significant in three ways. It will be partly a political event, defining what the Government believes voters want from it. It will also have macro-economic significance, telling us about economic conditions during the next parliament should Labour win the election. And it will open up the much bigger debate about the nature, role andappropriate size of government in a developed nation during the next quarter century.

We will read lots about the political aspects of the statement next week so there is not much point previewing it here. The Government clearly believes it wins prizes by making promises to spend money on things voters say they want. This worked in the 1950s and 1960s, but since 1976 there has been a long-term downward trend in public spending as a proportion of national income. People naturally make the connection between additional taxation and additional spending and may vote differently to the way they respond in focus groups. So maybe the thing to watch will be whether the extra spending is really welcomed, though I suppose we will only really know the answer to that after the next election.

The size of the boost is remarkable, and timed to thump in just ahead of the election. We will get much more detail on Tuesday, including, according to the leaks, how some of the money from the mobile phone auction will be distributed. But even ahead of this you can see, as the graph shows, how after years of the tight clamp on spending, it is shooting up.

The macro-economic significance turns on the extent to which such higher spending leads to changes in the economy, including higher interest rates. A lot depends on whether additional spending is matched by additional taxation. Some work just published by Oxford Economic Forecasting suggests the loosening announced by the Chancellor at the last budget has made imbalances in the economy greater by boosting service sector output, but requiring higher interest rates which have hit manufacturing.

The Oxford group is concerned that in the coming years manufacturing output will be lower than it would have been as profits in the trading sectors are hit, leaving less money for investment. It argues that tax changes to boost private sector investment, and/or increased investment by the Governmentwould boost the long-term performance of the economy.

One has to be a bit cautious. There is a temptation to assume investment is always good and consumption always carries some longer-term penalty. Investment is only helpful to the economy if it is channelled into productive ventures. The investment in the Dome, the thick end of £1bn, has been largely wasted. We will know just how much has been wasted in accounting terms when the final figures come out and when we see what after-use is found for the buildings. But we will never know the opportunity cost - the losses that accrue from other ventures that might have been undertaken with the money.

Nevertheless the more general point that higher spending means higher interest rates and a higher exchange rate surely stands. People connect higher spending to higher taxation but they may not connect it with higher interest rates. That, of itself, may not matter: there are sound reasons for wanting to reward savers even better than we do. But if on Tuesday there are sharp increases in spending over and above the Government's present plans, it is important to recognise we are likely to have five years of relatively high interest rates as a consequence.

But perhaps the most important aspect of the spending plans will be what they say about the way a European left-of-centre government believes its role ought to develop. You have to look at what governments do, not what they say. The Government says it believes the size of government spending should remain broadly the same as a proportion of GDP. But since it also has to cope with pressures from demography and the rising real costs of health care, holding public spending steady is extremely difficult. Add back such functions as transport spending and the aim of holding spending steady as a proportion of national income will be very difficult. Besides, it may prove difficult to hold taxation even at its present levels if globalisation and the new technologies cut away at revenues, as many people expect they will. Governments may find themselvesdownsized, as has happened to many largecompanies. The key question is what size of government is optimal. Recent work by the OECD suggeststhere are gains to welfare if the size of the state sector rises to about 30 per cent of GDP, but once a country goes above that, the gains are less clear. Very high levels of spending seem to be associated with high unemployment and slow growth.

A new book* takes this further. Written by two economists, Vito Tanzi of the IMF and Ludger Schuknecht of the WTO, it argues big spenders do not achieve any better results than smaller spenders. So the core argument of many of the people pressing for higherspending, that it increases human welfare, is cut away.

I suspect most voters intuitively know this. Asked whether they believe they can spend their money better than the Government can for them they would reply that they can spend it better. Asked whether they want better government services even if it means higher taxation they may say they do want them - but may assume the additional taxation is slight or will be paid for by other people. Asked whether they will pay more for the same services or even worse ones, they may get rather ratty. We will see how people react on Tuesday. And we will see how they react at the next election - and the next election but one.


* Public Spending in the 20th Century, Vito Tanzi and Ludger Schuknecht, Cambridge University Press.