The Future of Government : Mixed Economy or Minimal State ?

After nearly a century of expansion, the role of government has contracted, at least in qualitative terms, over the past twenty years. The assumption that this is a natural and inevitable trend is mistaken. The success of the 'mixed economy' in the period from 1945 to 1970, and the limited benefits generated so far by reforms aimed at a contraction of the role of government, suggest that radical contraction of the role of government is unlikely to be beneficial. Some of the privatisations of the recent past will ultimately have to be reversed either through renationalisation or through the establishment of new public entrants to markets where older public enterprises have been sold off. The Future of Government: Mixed Economy or Minimal State ? Over the past twenty years, many services previously provided by government agencies have been taken over by the private sector. In some cases, government business enterprises have been privatised. In other cases, government funding of services has been maintained, but the provision of services has been contracted out. It is natural to ask where a trend of this kind will, or should, stop. One way of looking at this question is to ask whether there are 'core' functions of government that cannot be undertaken by the private sector. Implicit in this question is an assumption that 'noncore' functions are candidates for privatisation or contracting out. An analysis based on this implicit assumption therefore leads towards a minimal role for government. The problem of drawing a boundary between the private and public sector is more usefully examined in the historical context of the expansion and contraction of government over the past hundred years. Most goods and services have at one time or another been provided both by the public sector and the private sector. The success of the 'mixed economy' in the period from 1945 to 1970, and the limited benefits generated so far by reforms aimed at a contraction of the role of government, suggest that radical contraction of the role of government is unlikely to be beneficial. The paper is organised as follows. The first section describes the expansion of government over the century from 1870 to 1970, and the subsequent retreat from intervention. Next, alternative methods of public and private provision of goods and services are described and the costs and benefits of microeconomic reform as it has applied to the government sector are assessed. The claim that contraction of the role of government is an inevitable reaction to developments in the global economy is critically assessed. Finally, issues relevant in drawing the boundaries between the public and private sectors are discussed. The Advance and Retreat of Government If we are to say anything useful about the future of government, it is wise to begin by considering the past. As Quiggin (1996a, p. 1) observes: In large measure the economic policy program of the past twenty years has been to dismantle the policies introduced in the previous thirty years, and to restore the situation prevailing fifty or even a hundred years ago when the guiding principle of economic policy was laissez faire. Yet there is little interest in finding out why laissez faire policies were felt to be unsatisfactory in the past, or even in any detailed analysis of the strengths and weaknesses of the interventionist policies that replaced them. Over the century from 1870 to 1970, the role of government grew fairly steadily. The State took over the production and supply of goods and services which had previously been provided, to the extent they were provided at all, by the private sector. Australia, a country settled as an arm of the British government's prison system, led the way in public provision of social welfare services, postal and telecommunications services, railways and roads, universal public education and public health services. Over the first half of the 20th century, other countries became more like Australia. Whereas Australia's state-owned railways and public utilities were an exception in the 19th century, by the early postwar period it was the United States' insistence on retaining such enterprises in private ownership that looked exceptional. After World War II the early Australian experiments with social welfare systems were matched, and on most measures surpassed, by European welfare states. The growth of the State from World War II to the 1970s was largely quantitative rather than qualitative, since the boundary between the private and public sectors was fairly stable. Public expenditure grew steadily as a proportion of gross domestic product (GDP) partly because of the increasing importance of sectors such as health and education, where public funding and provision played a large role, and partly because of demographic changes, particularly increased life expectancy, which led to increased expenditure on age pensions. By the 1970s, public expenditure, and the taxation needed to finance it, had reached around 40 per cent of GDP in Australia and more than 50 per cent in many OECD countries. Since much of this revenue was returned to households in the form of transfer payments, the public share of output and employment was lower, but was still around 25 per cent in typical OECD economies by 1970. The growth of the State was discussed in terms of the 'mixed economy', consciously proposed as a 'third way' between the unfettered capitalism of the 19th century and the comprehensive State socialism of the Communist bloc (Shonfield 1984). The mixed economy involved large-scale government involvement in an economy that was nevertheless predominantly private. The achievements of the mixed economy were substantial. For more than a quarter of a century, unemployment disappeared from the developed world. Economic growth proceeded at rates never equalled before or since. The development of extensive social welfare systems based on progressive taxation led to a reduction in inequality in incomes and an even greater reduction in inequality in living standards. The most important single factor encouraging the growth of government in the postwar period was the perceived success of Keynesian macroeconomic policies. Keynesian macroeconomic concerns led directly to government intervention aimed at controlling the financial system and stabilising the balance of trade. In addition, the perceived success of macroeconomic intervention generated an intellectual atmosphere in which proposals for microeconomic intervention, based on the notion of market failure, received a favourable hearing. Debate continues on the reasons for this 'Golden Age' and the factors leading to its breakdown in the 1970s (Marglin and Schor 1990). Simple explanations such as postwar recovery prove unsatisfactory on closer examination, as does the belief, dominant at the time, that prosperity was the direct result of Keynesian policies. Nevertheless, it is important to remember that the longest sustained period of strong growth and full employment in the history of the world economy coincided fairly closely with the period of maximum expansion of government. Although it is possible to argue that this expansion had gone too far by 1970, historical evidence gives little support to advocates of a minimal State. The breakdown of Keynesian macroeconomic policies in the early 1970s reversed the trend towards growth of government. The apparent success of free-market economists such as Milton Friedman in predicting and explaining the failure of Keynesianism enhanced the prestige of free-market views, though the gloss was taken off this achievement when the monetarist policies proposed by Friedman proved no more successful than the Keynesian policies they replaced. Higher unemployment implied increased expenditure on social welfare benefits and therefore generated pressure to cut back other areas of public spending. Finally, and perhaps most importantly, the loss of confidence in the capacity of governments to control over the economy implied a greater need to cultivate 'business confidence'. The retreat of the State from provision of public services began with the policy of privatisation initiated by the Thatcher government in the United Kingdom. Whereas previous conservative governments had denationalised some of the acquisitions of their immediate Labour predecessors, the Thatcher government began selling off enterprises such as British Telecom which had been in the public sector since their establishment. Policies of competitive tendering and contracting were designed to encourage private sector provision of publicly-funded services. The contraction of government in Australia began with the election of the conservative Fraser government in 1975, but proceeded slowly until the mid-1980s. The policies pioneered by the conservative Thatcher government were adopted in Australia, and, with greater enthusiasm, in New Zealand, by labour governments. A number of government business enterprises were privatised, and most others corporatised. Systematic programs of competitive tendering and contracting were introduced. Competition policies were applied to state and local governments. These trends have continued under the conservative governments of the 1990s. However, with the exception of the labour market, the pace of reform has slowed. In many ways, moreover, labour market reform involves an expansion of the role of the State, with the creation of a range of new criminal and civil offences, and the revival of old common law causes of action. The main difference is that the government is explicitly on the side of employers, rather than adopting the position of a neutral arbiter. In qualitative terms, the contraction of government over the past twenty years has been striking. The quantitative change in the ratios of government expenditure and taxation to GDP has been much less dramatic. This is primarily because the trends which led to expansion of the public sector over the postwar period have continued. Demand for services such as health and education, traditionally provided by governments, have grown. Demographic changes, reinforced by high unemployment, have increased the demand for transfer payments. Thus, in the absence of some transfer of activities from the private to the public sector, growth in the public sector share of GDP would have continued, and perhaps accelerated. The idea of 'State capacity' (Mann 1988) is useful in understanding the growth and contraction of government. Contrary to exaggerated claims about the effects of technological change and globalisation, the State retains a substantial capacity to intervene effectively in the economy (Weiss 1998). However, that capacity has not grown in line with the demands implied by the range of responsibilities taken on by governments in the postwar period. Public and Private Provision of Goods and Services As Australian history shows, almost any good or service can be provided by government. The first farm in Australia was the Government Farm on the site of the present Botanic Gardens in Sydney. It was not a success. Another unsuccessful venture was the Queensland government's establishment of publicly-owned butcher shops in the 1920s. Public provision of infrastructure services such as postal services, telecommunications and electricity was more successful. Just as there are no inherent limits to the scope of government, there are few activities which can be regarded as 'core' services in the sense that they can only be provided by government. The distinction between core and non-core functions is useful in the analysis of choices between contracting out and in-house provision of services by individual enterprises, including government business enterprises and other public agencies. Individual agencies have relatively well-defined objectives, which make the concept of core functions meaningful. This is not true of government as a whole. Almost any task undertaken by government can be, and has been, undertaken by private enterprises. For example, the transport of convicts to Australia was undertaken primarily by private contractors. However, the First Fleet was effectively a public venture, being under the direct control of Governor Philip, while the Second Fleet was controlled by the contractors, paid on a fixed rate per convict. As a result of the incentive to skimp on food and medical attention, around a quarter of the convicts in the Second Fleet died, and half were unfit for work when they arrived (Clark 1962) whereas the death rate for the First Fleet was minimal. Similarly, both police and military services can be, and have been, privately provided. Until the 19th century, reliance on mercenary troops was the rule rather than the exception in European wars. However, the crushing defeats experienced by mercenaries at the hands of French and American citizen armies led to the abandonment of this practice. Recent experience, such as that of European mercenaries employed by the Mobutu government in Zaire (now Congo) reinforces the point that private provision of military services is rarely satisfactory. More recently, private prisons have been revived, along with many of the problems of abuse of power and lack of accountability that led to their abandonment in the 19th century (Moyle 1994) As these examples illustrate, government enterprises perform poorly in some areas, while private enterprises perform poorly in others. The existing distribution of activities between the public and private sectors is, in large measure, the result of learning from historical experience. Following the experiments of the early part of this century, governments have largely withdrawn from small-scale enterprises, such as butcher shops. On the other hand, governments in Australia and most other countries took over the provision of a range of infrastructure services such as rail transport, postal and telecommunications services, where private operators had failed. Thus, the existing allocation of activity between the private and public sectors is not purely haphazard, as much discussion has tended to imply. 1.1 Quangos and Qangos It is important, also, to remember that the boundary between the public and private sectors is not sharp. Between the extremes of a government department and a private firm operating in lightly regulated competitive markets, there is a range of intermediate possibilities, which may be generically referred to as 'quangos' or 'qangos'. The term 'quango' has a curious history (Wettenhall 1981). Once, there were only NGOs -non-government organisations like the Australian Council of Social Service or the Returned Services League. However, it was observed that many so-called NGOs were closely tied up with government, often operating in symbiotic relationships with the government agencies with which they regularly dealt. In addition, particularly in the United States, there has been a practice of creating nominally private business organisations, with effective government backing, to perform what would normally be regarded as public functions. The Federal National Mortgage Association ('Fannie Mae') is an example. The term 'quasi-NGO' or 'quango' was coined as a mildly pejorative description of these hybrids. When economic reformers in Britain, and later in Australia, wanted to cut back the profusion of statutory authorities, they decided to appropriate the term to their own use. Unfortunately the acronym didn't quite fit. Statutory authorities could reasonably be described as quasi-autonomous governmental organisations, but there was no easy way to use the letter 'N'. Eventually they settled on 'national'. This was logically redundant in the United Kingdom and simply incorrect for Australia where most statutory authorities are run by state governments, but it worked. Some users took the process to its logical conclusion by dropping the 'U' and writing about 'qangos'. The reform of government is turning qangos (in the new sense) into quangos (in the old sense). When a government business enterprise such as a water authority is privatised, the result is frequently not a competitive firm, but a monopolist with profits determined more by government policy than by market performance. Such enterprises typically require close regulation to prevent exploitation of consumers. At the same time, they are so vulnerable to adverse policy decisions that buyers typically require advance guarantees of a favorable policy climate. Finally, the services provided by such firms are often such that they are 'too important to fail'. If such enterprises run into financial difficulties the government has no alternative but to bail them out. The term 'quango', in its original sense, has never been more appropriate than as a description of these quasi-private enterprises performing governmental