Harry Geels: Expansive government policy threatens efficient markets

April 30, 2024

^{This column was originally written in Dutch. This is an English translation.}

By Harry Geels

The public sector is expanding in most countries as a result of strong growth in the number of civil servants, partly facilitated by increasing government debt. This poses potential complications for a healthy functioning economy for several reasons.

One of the biggest, almost creeping trends of the last decades is the ever-expanding government. Things have been moving quickly, especially in recent years. Since 2020, the number of government employees has increased by an average of 7.5% per year, versus 2.2% in the private sector. Since 2018, the number of civil servants has grown by more than 20%, especially policy officers, for example in the context of the sustainability transition. And the government is far from ready. At the end of 2023, there was a multi-year record of vacancies: more than 25,000! This growth of government is problematic for several reasons.

Figure 1

1) Government growth withdraws workers from the private sector

A competition has arisen between government and business. In recent years, the government seems better able to attract people, including by emphasizing long-term job security, a better balance between work and leisure, better employment conditions and a sustainable and social policy. As mentioned, the government is now growing relatively faster than the business community, where, in recent decades, employment conditions have deteriorated, especially in the middle and lower labor segments.

2) Average productivity is slowed down (Baumol's Law)

If the number of government jobs grows faster than in the private sector, this will have a dampening effect on average labor productivity. On the one hand, because the government is rich in labor-intensive jobs in the fields of arts, education, health care and policy, which are simply difficult to automate. On the other hand, because the government has less financial pressure to work more efficiently. Because the labor productivity of governments generally increases less rapidly than that of the business community, the government naturally expands, also known as Baumol's Law.

3) Markets become less free and less efficient

Government policy is dominant in more and more markets. In most Western economies, government expenditure now amounts to more than 50% of GDP, while before the Second World War it was still below 20%. We can no longer call Western economies capitalist. The most striking example is the housing market, which has been completely bogged down by procyclical government policy. The fact that Minister for Housing and Spatial Planning Hugo de Jonge recently blamed 'selfish' private housing investors for the problems in the mid-rental segment is a bizarre reversal of the facts.

4) The problem of 'too small to comply' is increased

A related problem is that due to the expanding government, more and more (small) companies are drowning in bureaucracy and regulations. They become 'too small to comply'. This happens almost everywhere, from the independent GP who is incorporated into a general practice, to a small bank that is taken over by a large one. As Milton Friedman argued, many government policies are well-intentioned, but the question is whether their consequences – sectors dominated by increasingly larger companies that collaborate with governments – are ultimately the intention.

5) Inflation is becoming structurally higher

The expansion of governments, both in terms of labor and expenditure, over the past fifteen years can be nicely visualized by government debt as a percentage of total GDP. Figure 2 shows that that percentage has increased sharply almost everywhere in the world, in the US for example from 55.6% in 2010 to probably more than 126.9% by the end of this year. These are dangerously high percentages that can only be maintained through more direct and indirect taxes (inflation).

Figure 2

Source: https://www.visualcapitalist.com/

Need for more philosophical discussion about 'the new system'

The growth of government is an undeniable trend in recent years. That growth is far from over. France and Germany, for example, want to fully focus on (green and military) industrial policy again. That is politics where the government explicitly interferes with industrial production. Not everyone objects to the growing influence of governments and the cross-files that arise between governments and large companies. Many people apparently believe in social engineering and are against free markets.

Due to the major social problems, there is now much talk about the need for a 'new system'. The crucial elements are the role of the government versus that of the free market and the definition of freedom of citizens and companies. Nobel Prize winner Joseph Stiglitz recently wrote a book and an essay about this. He makes two striking observations. Firstly, that in the neoliberal system we have come to misinterpret 'freedom', namely freedom from oligopolistic and monopolistic companies to exploit consumers: yes, I agree, we live in a corporatocracy.

Secondly, he claims that the markets are to blame for the problems: 'But contrary to what Hayek and Friedman asserted, free and unfettered markets do not lead to efficiency and the well-being of society; that should be obvious to anyone looking around. Just think of the inequality crisis, the climate crisis, the opioid crisis, the childhood diabetes crisis, or the 2008 financial crisis. These are crises created by the market, exacerbated by the market, and/or crises which the market hasn't been able to deal with adequately.' Can I disagree with a Nobel Prize winner? We no longer have free markets at all!

The solution to all problems is not primarily about who the main culprits are – government or free market: they are so intertwined that that question can no longer be answered at all – but how both can work together in a 'good' relationship with each other to build a better future. For the five reasons mentioned above, the expansive government policy is an inefficient and, above all, premature approach to a solution.

This article contains a personal opinion from Harry Geels

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