The Government and the Private Sector
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  The Government and the Private Sector
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nick
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« on: December 29, 2006, 08:49:35 AM »

Interesting Blog entry I found at an Economic blog I frequently read.  All of the posters on this blog have PhD's in Economics or Finance.

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Every so often, I like to check things that everyone knows are true. Its amazing how often it turns out that something we all know is true doesn’t seem to mesh with the data for some reason.

One thing we all know to be true, at least those of us who are from the good old US of A (I know there are some of them foreigner people that read this blog, and I suspect one or two of them may even be French!) is that the private sector is more efficient than the public sector. Presumably this means that the greater the government’s share of the economy, the slower growth (say, growth in real GDP per capita) will be.

Well, this is self-evidently true, but let’s plug in some numbers, just for grins. Everything we need is available from the BEA's NIPA Tables.

Table 1.1.6 gives us data on Real GDP and its components (including total federal plus state and local Government consumption expenditures and investment). From this we can determine government’s share of the total economy. Going back to 1950, this figure hit a peak of about 34.33% in 1953, and bottomed out at 17.53% in 2000.

(I note that post-Gerald Ford, government’s share of the economy rose as high as 22% three times. Each time was under Ronald Reagan, and the last time was in 1986. So much for Ronald Reagan being a small government kind of guy compared to, say, Jimmy Carter.)

Government shrunk as a percentage of the economy every single year under Clinton, reaching a minimum of 17.5% in 2000. Since then, its had ups and downs, and in 2005, was at about 17.7%. (Obviously, given the massive growth in the Federal budget under GW, that’s due mostly to state and local government shrinking relative to the economy as a whole.)

NIPA Table 7.1 gives us real GDP per capita, from which we can compute annual percentage change in real GDP per capita.

The table below shows the correlation between real annual percentage growth rate in GDP per capita, and government as a percentage the economy in period t-X.

X__Correlation
0___-0.00871
1___-0.00748
2___0.04079
3___0.03249
4___0.01029
5___-0.01209
10__0.20349
15__0.08522
20__0.07019
25__0.16416
30__0.07019

Now, this is simplistic a simplistic analysis, but ten to 25 years out, spending by the private sector is not more likely to lead to growth than spending by the government, and in fact, the opposite may well be true. (I note that using more sophisticated tools a few years back doing something similar, I got similar results.)


Possible reasons why this result might be observed:

1. It could all be an illusion. A different period of time might show different results. Long time readers will note I simply picked the time period I normally pick when the data is available. I start at 1950 to give the economy enough time to get over the effects of the Great Depression and WW2, which were special cases if there were any.

2. Government spending may be more geared toward the long term. Spending on education and infrastructure, for example, take a long time to pay off.

3. Government spending is geared toward institutions that are necessary for the long term functioning of the economy. Even the DMV, which is always exhibit A of inefficiency, is never privately run – perhaps because doing so is difficult. Eliminate the DMV and society can continue relatively unchanged for a year, or two… but eventually things break down.

4. Market failures mean the profit motive creates private sector incentives that are inefficient and violate the Invisible Hand outcome – creating excess pollution and otherwise imposing private costs on third parties, generating paperwork rather than output (e.g., think the health insurance industry), etc. Arguably, a significant part of the legal and accounting industries are geared toward increasing deception and obfuscation, and often these are among the most lucrative private sector careers open to a lot of people.

5. In the private sector, there is often more gain to exploiting short-term inefficiencies that might well disappear by themselves anyway than there is to producing anything real, which is a tremendous waste of resources. (Think number of stockbrokers.)

6. The private sector is made up of people. People are lazy in the private sector just as they are lazy in the public sector.


Two additional commentaries about the these results

1. These results are for the US, for the range of government to private sector observed in the data. Anyone who tries to extrapolate from this that having the US government run the entire economy will be more efficient is a fool. At what ratio of government to private sector do we start seeing more government sector inefficiencies and fewer private sector inefficiencies? Well, who knows? That would require a lot more work, and this is an unpaid hobby.

2. It may be that with different accounting rules, private sector spending’s advantage over government spending (note the extremely low correlations) might disappear altogether. Government spending appears in ledgers at cost whereas private sector spending includes improvements made. This accounting artifact makes private sector spending look more efficient than it is in the short term.


Since today I seem to be enumerating, let me try enumerating one more thing… why do we believe in this private sector is efficient myth? I can think of a few reasons offhand:

1. The Private Sector accounts for over 80% of the economy. Most people work in the private sector. We have a vested interest in believing we’re better than the alternative.

2. The media, which tells us how everything works, is in the hands of the private sector. They have a vested interested in believing the private sector is better than the alternative.

3. Media’s advertisers are in the private sector. They have a vested interested in all of us believing the private sector is better than the alternative.

4. One of the purposes of government is to set rules and correct market failures. But a very, very big part of the private sector is geared specifically toward finding ways around those rules and exploiting market failures. Criticizing government is a way to justify such anti-social behavior, or at least focus attention elsewhere.

Your thoughts?
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Nym90
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« Reply #1 on: December 30, 2006, 02:06:00 AM »

I think you make excellent points Nick.

One thing I've always found interesting is how people view government and business as fundamentally different. They really aren't actually in some ways. I think one could view government as merely business on a larger scale; one that has 300 million shareholders. It has the ability to do things that no business would do, since no business would ever be able to raise the funds that government can, and also because business needs to make a short term profit usually and is less likely to be willing to take a short term loss for possible but unknown long term gain (think of the construction of the interstate highways, or the space program as things that would fit this).

I think that one is not really fundamentally better or more efficient than the other. Both have strengths and weaknesses, and the best economy is one that combines the two, and isn't too reliant on one or the other. I think that the physical process of actually doing something is usually going to be better done by private enterprise. Once we know what we want to do, private business will usually do it better than government will. However, I would argue that the process of deciding what we should do is better left to government. That enables the decision to be made by everyone and not just dominated by the wealthy or elite.

I think that overall the best economic system is one where the framework of decision making about the economy is in the hands of government, which then contracts out for the actual work to private businesses. Government steers the boat, but business rows it, so to speak. There are obviously exceptions to this, but I think that for most things this model works best.

You do make very good points about the fact that government as a whole does a far worse job of self-promotion. I think government in general needs to do a much better job of explaining why it does what it does, and focus more attention on PR (in a sense it's unfortunate that this is necessary, but it is).
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David S
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« Reply #2 on: December 30, 2006, 12:36:38 PM »

All I can say is that the house I live in, the clothes I wear, the car I drive, the food I eat, the PC I'm using now, and just about everything I see around me were all provided by private enterprise. The government on the hand has given me two idiotic wars, high taxes and they deliver the mail.

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opebo
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« Reply #3 on: December 30, 2006, 02:35:15 PM »

False dichotomy, obviously.
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David S
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« Reply #4 on: December 30, 2006, 08:55:46 PM »

All I can say is that the house I live in, the clothes I wear, the car I drive, the food I eat, the PC I'm using now, and just about everything I see around me were all provided by private enterprise. The government on the hand has given me two idiotic wars, high taxes and they deliver the mail.



That's a little extreme.

Government has provided the roads you drive on, for one thing.

I think most of the roads around here are contracted out to private contractors, by the government. Garbage pickup in this area is done the same way.
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muon2
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« Reply #5 on: December 31, 2006, 01:23:55 AM »

All I can say is that the house I live in, the clothes I wear, the car I drive, the food I eat, the PC I'm using now, and just about everything I see around me were all provided by private enterprise. The government on the hand has given me two idiotic wars, high taxes and they deliver the mail.



That's a little extreme.

Government has provided the roads you drive on, for one thing.

I think most of the roads around here are contracted out to private contractors, by the government. Garbage pickup in this area is done the same way.

You've hit on an important difference. For many government services, the government is basically a central clearinghouse, not a direct provider of goods and services. Typically goverment steps in when there is a public desire that is broad-based, and not easily met by individual private contracts. The government acts as a group buyer, not unlike a big company purchasing insurance for its employees.

Roads are a good example. The public wants them, but if individual homeowners contract only for their own piece of pavement, the roads would be inconsistent and of little use to anyone. Government exerts its buying power to collect a share from the users and contract to build and maintain the roads for the benefit of the users.

Public frustration with government occurs when the collections outweigh the perceived benefits. This can come from government adding services that don't adequately benefit the payers or from government ineffectively using its power to get efficient delivery of those services that are broadly expected.
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