Much of the Budget debate next week will be devoted to the future growth rate of GDP and of total public spending; but there probably won’t be much attention paid to the impact of particular elements of public spending on growth. Yes, people (particularly well-paid consultants) talk about the merits of individual projects like HS2; but it seems to be an article of faith among politicians of all parties that some government functions result in more growth than others. In particular, many politicians unthinkingly assume that spending on infrastructure, education and healthcare necessarily improves the economic efficiency of both the public and private sectors.
But is the conventional wisdom accurate? In a new study published today by the Centre for Policy Studies, I focused on an analysis of differences in the composition, not the total amount, of public expenditure in 19 OECD countries over the period 1996 to 2011. I found no support for many of the politicians’ most cherished assumptions. For example, there is no observable relationship across all the 19 countries studied between the money devoted to public expenditure on education as a proportion of GDP and economic growth. Neither did the level of infrastructure investment in roads have a discernible impact on prosperity. In the case of spending on health and welfare, the study found that higher average levels of relative spending on these functions had a negative correlation with growth.
This is disturbing. In 2011, spending on education, health and welfare accounted for two thirds of total public expenditure across the 19 countries analysed. If health and welfare spending have a negative impact on growth, then this suggests that the law of diminishing returns has reached a critical point. The implication? Expenditure needs to be trimmed back sharply to permit the private sector to expand.