THE GROWTH OF THE PUBLIC SECTOR
MACROECONOMIC ACTIVITY AND INTERNATIONAL TRADE
The term public refers either to the people affected by some property or activity or to government property and activities. The public sector is the governmental sphere of an economy. Economists classify four basic functions of the public sector: the provision of collective goods and services, the redistribution of income and wealth, the promotion of stabilization and growth, and the prevention of social costs and market failures from crime, pollution, congestion, and monopoly.
The word public refers to the public sector in the following terms: public administration, public debt, public economics, public employment, public finance (and revenues and expenditures), public insurance, public libraries, public office, public ownership, public policy, public schools, public servant, and public works. The word public refers to people in the following terms: public corporation, public goods, public health, publicly held, public offering, public opinion, and public relations. Some terms, such as public domain, public service, public utilities, and public welfare, can refer to either serving the people or to government operations. Companies can be nominally private but under so much control by government that in effect the operation is in the public sector.
The branch of economics that studies collective decisions and decisions that affect the public is called public choice. The field includes voting, bureaucracy, and the policies enacted by elected officials. Public finance, a much older branch of economics, examines actual and optimal taxes and incentives as well as the economic impact of fiscal policy. A key concept in public choice is rent seeking, the influence of various interests that seek to transfer wealth (unearned rents) to themselves at the expense of the public. But also the median voter theorem states that policy makers cater to the voters in the middle of a policy spectrum. Thus the policy outcome can vary. Public choice as a field of study does not imply any particular policy outcome or normative viewpoint.
THE GROWTH OF THE PUBLIC SECTOR
In ancient Greece public referred to politics and government, the private sphere being the family and nongovernmental enterprises, such as farming and trade. Until the 1800s public sectors were mainly concerned with the military, taxation, legislation, relief for the indigent, administration of state land, maintenance of royalty, public works, and control of trade. During the 1800s the public sector expanded into municipal police and governmental schooling. In the latter 1800s, responding to socialist movements, Germany, followed by Great Britain and other countries, expanded the public sector to include social security and other welfare programs on a national scale. In the early 1900s central banking extended government further into money and banking, especially after countries switched from commodity money to fiat money. Russia in 1917 established the Union of Soviet Socialist Republics, which put its whole economy in the public sector.
The income tax as well as the value-added taxes established in Europe and other countries facilitated a great expansion of the public sector. In the United States there was a large expansion of government under the New Deal of President Franklin Roosevelt, including the establishment of Social Security. The public sector expanded again during the 1960s with the introduction of Medicare and Medicaid. In the late twentieth century the public sector became more involved in protecting the natural environment.
Wagner’s Law, named after Adolph Wagner, states that economic growth is accompanied by an increased gross domestic product (GDP) share of the public sector. The public may demand greater collective services, such as better education, as wealth increases, but some theorists propose that much of the expansion is in response to previous interventions that create distortions. For example, a city policy that limits development can result in higher rentals, which then induce the city to respond with rent control. Governments have also increased their role in economic development by providing education, research, and infrastructure. Many government programs, such as medical care and housing subsidies, are in response to poverty and economic insecurity. War has also ratcheted up the public sector, as the size of government rises during wartime but then does not return to its prewar level. Governments now commonly seek to promote economic growth with investments in infrastructure and by the expansion of money and credit. Governments also finance activities such as basic research when markets are perceived as failing to provide sufficient amounts, as the benefits apply to the economy as a whole.
PUBLIC SECTOR PROVISION
The government can directly produce goods and services such as the military, postal service, schools, streets, highways, parks, police, and fire protection or contract out the production to private enterprise. Much of governmental expenditure consists of transfer payments. By imposing costs, government regulations can have the effect of taxation. For example, if firms are required to provide medical insurance to employees, that has a similar effect to taxing the firms and using the funds to subsidize the insurance.
Taxation has a social cost beyond the funds paid to government, an “excess burden” or “deadweight loss” caused by the reduction of output and investment caused by taxes. The amount of deadweight loss depends on the amount of the tax and the elasticity of the item taxed, that is, how its quantity responds to a change in price. Since land has a fixed supply, taxes on land value have no deadweight loss. There is also no excess burden if the tax, such as a pollution levy, also reduces social costs by a greater amount. User fees, based on benefits, also have no excess burden.
The effects of government borrowing depend on how the funds are borrowed, how the funds are spent, whether the spending stimulates the use of untapped resources, and the extent to which various financial investments substitute for one another. In some cases, government borrowing can raise interest rates and crowd out private investing, but in other cases, especially if there is high unemployment, if funds are borrowed from abroad, if the borrowing is for productive investments complementary to private investment, if private savings rise to offset government borrowing, or as noted by Benjamin M. Friedman (1978), if the borrowing uses short-term bonds that substitute for money, government borrowing can result in “crowding in” or a stimulus to private investment. Many economists think that optimally government should borrow money only for productive investments, including enhancements to human capital, and use current revenues for its collective consumption, such as military operations.
The size of the public sector can be measured by the total amount of spending, the share of GDP, workers employed, and public sector assets and liabilities. The U.S. federal government spent $2.5 trillion in 2005, 20 percent of GDP. State and local governments spent from their own sources $1.4 trillion, 11 percent of GDP. The relative size of government for the members of the Organization for Economic Cooperation and Development with developed economies grew from 27 percent in 1960 to 48 percent in 1996. Government outlays as a percentage of GDP in 1996 were 44 percent in the United Kingdom, and Denmark was the highest at 61 percent.
MACROECONOMIC ACTIVITY AND INTERNATIONAL TRADE
A large public sector can increase the trade deficit to the extent that taxation makes exports more expensive and to the extent that government spends its funds abroad, as in the case of a war. Governments mostly affect international trade with tariffs and restrictions, such as quotas, and with policies that affect foreign-currency exchange rates.
LABOR AND THE ENVIRONMENT
In most developed economies, public sector labor is about 15 percent of employment. Several studies have concluded that workers in the public sector tend to be better paid than those in the private sector. Government workers typically are under a civil service system by which it is difficult to fire an unproductive worker. A more fundamental element of the cost of labor in the public sector is Baumol’s cost disease, put forth by William J. Baumol and William G. Bowen (1966), who argued that productivity in services such as an orchestra or education has changed little compared to that in manufacturing, which explains the increase in relative costs in the service-intensive public sector.
With global warming recognized as an urgent issue, people increasingly seek remedies in government policy. The taxation of pollution is more efficient than regulations, as the former permits firms and households to adjust according to their individual costs and benefits. Pollution permits that trade in a market are also used to increase the cost to business of polluting more. Environmentalists have proposed a “green tax shift” that increases pollution charges while reducing taxes that have an excess burden, a policy that would minimize the economic costs of reducing pollution.
Advancing technology has meanwhile reduced the rationale for some large-scale government involvement, as knowledge becomes more easily accessible and the private sector becomes more capable of providing infrastructure, such as tolled highways and decentralized utilities. Nevertheless, conflict tends to expand the public sector, so the future role of the public sector depends on the interplay of advancing technology, threats to security and the environment, and the influence of theoretical knowledge and real-world experience in shaping public opinion.
SEE ALSO Capitalism; Economics, Public; Government; Planning; Policy, Fiscal; Policy, Monetary; Private Sector; Public Choice; Public Goods; Public Utilities; Socialism; State Enterprise; Taxes
Baumol, William J., and William G. Bowen. 1966. Performing Arts: The Economic Dilemma. New York: Twentieth Century Fund.
Edwards, Chris. 2005. Downsizing the Federal Government. Washington, DC: Cato Institute.
Friedman, Benjamin M. 1978. Crowding Out or Crowding In? Economic Consequences of Financing Government Deficits. Brookings Papers on Economic Activity 1978 (3): 593–641.
Gwartney, James, Randall Holcombe, and Robert Lawson. 1998. The Size and Functions of Government and Economic Growth. Washington, DC: Joint Economic Committee Study.
Harrison, Fred, ed. 1998. The Losses of Nations: Deadweight Politics versus Public Rent Dividends. London: Othila.
Papadimitriou, Dimitri, ed. 2006. The Distributional Effects of Government Spending and Taxation. New York: Palgrave Macmillan.
A "public sector" is comprised of local, state, and federal government agencies, as opposed to the "private sector," which is made up of households and businesses. Economists generally speak of the government and the public sector as the same thing. The public sector employs about one-sixth of the labor force, purchases about one-fifth of the total output of the economy, and accounts for about one-quarter of all personal incomes. Because the public sector includes all government activities, not just the federal government, it includes all forms of public employment. It includes teachers, many scientists, the military, police and fire services, and all other areas of public service employment.