Marc Robinson's Blog, page 4

“Bigger Government” in FT’s Best Economics Books of 2020

The Financial Times has listed “Bigger Government” as one of the best economics books of 2020. The FT’s chief economics commentator, Martin Wolf, writes that the book is “quantitative, meticulous and sobering”. Read the review here.

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Bigger Government: Interview on ABC Radio National

My interview on Australian ABC Radio National’s program “The Money” (Oct 29) on Bigger Government is now available on YouTube.

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Health Care: What’s at Stake in the Presidential Election

Of all of the issues facing Americans in next Tuesday’s presidential election, healthcare is one of the biggest. Healthcare is a huge financial burden on Americans. The bad news is that the burden is set to become even heavier in coming years. This is why bold reforms are needed to tackle the waste and profiteering which grossly inflate the cost of the US health system.

The US spends around 70 percent more of its national income on health than other advanced countries, with worse results. The competitivity of American business is undermined by high employee health costs. Insurance is unaffordable to many people who don’t have job-based coverage. Despite the astronomic premiums, even those with insurance run the risk of financial ruin if they require major hospital treatment. And although US governments only pay half of total health expenditure, the drain on the public purse is as large as in countries with “single payer” systems under which the government covers most health costs.

As bad as this is, it is going to get worse because total US health expenditure is set to increase considerably over coming decades. The aftermath of the COVID-19 pandemic will be a permanent rise in spending, including on strengthening defenses against future pandemics. But that isn’t the main problem. As highlighted in my new book Bigger Government, what will drive spending up most over the long term is the impact of the health technology revolution which is currently gathering pace. We are now at the beginning of an era of rapid expansion of the technological capabilities of medicine. The centerpiece of this is major advances in the biosciences, which are progressively deepening our understanding of how disease works at the molecular level. The result will be the increasing diffusion into mainstream medical practice of expensive precision and customized treatments. Population aging will add further to the pressure on spending.

Over the past thirty years, the share of US national income absorbed by healthcare increased 40 percent. Over the next thirty years, it is set to increase considerably more.

All this is without taking into account the potential cost of a reform which the country desperately needs: the creation of a system of universal health coverage, guaranteeing all Americans access to adequate healthcare. That so many people lack health cover in the richest country on the planet is not only a moral failure. It is also one of the reasons why America has suffered much more than other advanced countries in the face of the COVID-19 pandemic: lack of health insurance has prevented many from getting prompt medical attention after developing symptoms, leaving them to sicken and spread the virus to others.

The profiteering and waste of the US system are so extreme that eliminating them could pay for a substantial portion of future spending increases. But this would require a determined attack on three main problems: exorbitant provider payments (to hospitals, doctors and pharmaceutical companies), over-servicing, and excessive administrative costs.

President Trump has, during his term in office, worsened the state of the American healthcare system. The main thing the Republicans stand for is continuing efforts to cut government’s share of health spending by depriving more low-income Americans of healthcare. Trump’s last-minute drug price measures will have only limited effect, even if they don’t turn out to be merely a gimmick which the administration backs away from quickly if President Trump is reelected.

Senator Biden’s policies offer more, but it’s still disappointing. Setting aside welcome measures to control drug prices, Biden’s major cost-containment proposal is the “public option” – a government health insurance plan open to anyone who wants to enroll. The Biden campaign claims that the public option will put downward pressure on health spending.

Unfortunately, expectations about the effectiveness of a public option in restraining health expenditure growth risk proving exaggerated. A public option would do nothing about over-servicing, and virtually nothing about excessive administrative costs. It is only by reducing provider payment rates that it could potentially reduce the health cost burden.

Optimists think that the public option will have a huge impact here. This is because they think that hospitals and doctors delivering services under the public option would accept remuneration at relatively low Medicare rates, and that private insurers would then be compelled by competitive pressure to cut their provider payment rates as well. But this will probably prove unrealistic. It seems unlikely that a Biden administration would set provider payment rates under the public option so low. If it did so it would likely be faced with a coordinated refusal of most hospitals and doctors to participate. The flow-on effect on private insurance premiums is also likely to be less than the optimists assume. So in the real world, the impact of the public option on provider payment rates risks proving disappointing.

The best way of squeezing the waste out of American healthcare would be to move to a single-payer system, in which the government pays for most healthcare. A single-payer system would not only empower government to contain cost increases, but would lift the burden from American businesses and improve the health of all Americans. Sure, such a system would cost government more. But it would, over time, save Americans a lot of money. On any reasonable assessment, this would be a good deal for the average citizen.

Some opponents of a single-payer system point to countries like Germany as proof that it is possible to keep the lid on waste and profiteering even under a system where health coverage is provided by multiple insurers. While this is theoretically true, no country with a multiple insurer system relies on the weak force of a public option to control health costs. In Germany the government controls health insurance premium rates, caps hospital and doctor charges, and limits over-servicing through direct spending limits on all providers. Health insurance is compulsory, and the health insurance companies are non-profit entities. There is no way that the timid Biden reforms would permit the United States to emulate the successful German model.

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The Future US Debt Crisis

Faced with the pandemic, big deficits and increased debt are not only inevitable, but desirable – on a strictly temporary basis. This is something on which nearly all economists agree. But this does not mean that high debt has someone become acceptable in the longer term. In the longer term, it creates huge risks.

The United States illustrates the problem. US government has been for some time headed, slow-motion, towards a debt crisis. On current trends, federal debt will by the middle of the century reach twice the level of national income (GDP), according to the Congressional Budget Office’s recently-released Long-Term Budget Outlook. This would be more than 80 percent higher than the historical peak level of debt reached in World War II, and double current levels.

As shocking as the CBO’s projections may be, they are too conservative. Debt is in fact set to rise faster than they suggest, for at least two reasons.

Firstly, the CBO understates future spending growth. Its forecasts of government tax and spending are based on current laws. In practice, spending will increase more than this. As shown in my new book Bigger Government, there are four key areas where the pressure to spend significantly more will be irresistible: climate change, aged care, health care and infrastructure. Voters increasingly recognize that climate change is a real and urgent challenge, and political pressure for serious government action is mounting. Substantial investment to tackle crumbling and inadequate public infrastructure cannot be delayed much longer. That the US leaves so many elderly citizens unable to afford care is increasingly politically untenable given the growing number of elderly voters. Health care spending will grow even more rapidly than in the past, because of the impact of a technological revolution which is leading to increasing mainstream use of expensive precision and customized medicine. Spending in these four areas is likely to increase by more than 7 percent of GDP over the coming decades.

Secondly, the CBO forecasts underestimate the impact of the pandemic on government debt. They don’t take account of the cost of further stimulus spending. They also don’t factor in the degree to which business bailouts will ultimately add to government debt. Everyone knows that many of the pandemic loans and guarantees provided by Washington to business will never be repaid. In addition, there is the significant risk that the federal government could well also end up forced to bail out the pandemic-affected financial sector.

Once the economy recovers from the pandemic, America will need a long-term program to gradually reduce government debt, to a level well below that of 2020. This will require both tax increases and targeted spending cuts. According to the CBO, measures totaling 3.6 percent of GDP annually will be needed in order to reduce debt to 75 percent of GDP by 2050.

Anyone who thinks that substantial tax increases can be avoided is living in cloud cuckoo land. There is no way that most or all of the work of budget adjustments could be done through spending cuts. The idea that welfare cuts can restore fiscal health is particularly implausible when welfare spending is already so low that millions of Americans live in third-world poverty. As for health spending cuts, further reducing health coverage for low income people would be foolish as well as socially unjust. A key reason why the coronavirus pandemic has been so much worse in the United States is that it is the only advanced country without a system of universal health coverage. This has meant that Americans without health insurance have been unable to access prompt medical attention after developing symptoms, leaving them to sicken and spread the virus to others.

Joe Biden’s tax proposals, which would reverse President Trump’s unjust tax cuts, represent a welcome first step. But more is needed. Once the pandemic is over, the United States should consider imposing a substantial one-off wealth tax. The very rich should be asked to make a special contribution to restoring healthy government finances, in recognition both of their privileged position and of the fact that they have not paid their way in the past. One-off wealth taxes have been used by a number of countries in the past to help reduce extremely high levels of government debt – including both Germany and Japan after WW II.

Make no mistake about it. If, after the pandemic, the debt problem is not tackled, the consequences will ultimately be very grave indeed. It may take decades, but the chickens will eventually come home to roost. Americans should pay no attention to the siren calls of those who say that high government debt doesn’t matter. Sure, as long as interest rates remain extremely low high debt levels won’t cause a budgetary problem. But interest rates will not remain low forever. When they do rise, the combination of high debt and higher interest rates will wreak budgetary havoc. Claims by the advocates of “modern monetary theory” that government can avoid the problems of high debt by simply printing the money required are bizarre. If you want to know what will happen if debt isn’t eventually reduced to safe levels, have a look at the parlous state of Argentina today.

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Long-Term Care Spending Will Grow Greatly

Although it is not the main driver of rising health expenditure, population aging will be a significant source of pressure on government budgets in other areas. Age pensions will, in some countries, be part of the problem. In the United States, for example, Congressional Budget Office projections suggest that government age pension spending will rise by more than 1 percent of GDP over the next three decades. Even greater increases are projected in certain other countries.

As set out in my book Bigger Government, an even more universal and persistent pressure on spending will the need to address the crisis in long-term care for the aged. At present, those who draw the short straw in the dementia lottery, or who for some other reason require extended periods of residential care, face financial ruin unless they are rich. In the US, for example, the Kaiser Commission on Medicaid and the Uninsured observed in 2015 that “although most middle-class Americans cannot afford the high costs of long-term care, under our current system, they cannot qualify for help from Medicaid until they are essentially impoverished often as a result of spending all their savings to pay for their nursing home care.” The growing voting power of the elderly in the advanced world will likely make it impossible for governments to avoid opening their purse strings to address this problem. Already, the pressure has proved irresistible in a few countries such as Japan, Germany and the Netherlands. There can be little doubt that other advanced countries will be forced to move in the same direction in coming years. In the United Kingdom, the clamor for reform has become so great that the staunchly conservative government of Prime Minister Boris Johnson has recently foreshadowed a major expansion of government long-term care provision, to be financed by an earmarked payroll tax. In France also, the government has recently announced a major expansion of its role in the provision of aged care.

Long-term care spending is much more sensitive to population aging than is health expenditure. This is precisely because there is no tendency for the age at which people develop dementia or other grave disabilities to increase over time. The proportion of the population in the 80-plus age bracket is projected to double in advanced countries over the next thirty years, and the impact on long-term care needs will be huge.

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Population Aging & Health Spending

There is a widespread notion that demographic aging will be the most important single factor driving health expenditure up over coming decades – or that, at a minimum, its impact on spending will be as great as any of the other forces which may be at work to increase spending. This is, however, wrong. Why it is wrong is the subject of this blog piece.

This view of the role of demography in driving health spending is one which has, for example, expressed by fiscally conservative think tanks like the Peter G Peterson Foundation in the United States and the Fraser Institute in Canada. In a similar vein, Nouriel Roubini – the well-known macroeconomist who has been nicknamed “Dr. Doom” – recently nominated the “demographic time bomb in advanced countries” as the second of ten trends that would in his view make the 2020s a “decade of despair.” The impact of demographics on government healthcare spending – and its interaction with the lessons learned from the coronavirus crisis – was the main thing he had in mind.

The IMF also appeared to endorse when it warned back in 2015 that “age-related programs (health and pension spending)” – would be the big sources of pressure on government budgets over the long-term. The IMF is on record going back many years as emphasizing the supposedly high degree of sensitivity of health expenditure to demographic aging.

The problem is that this is a view which almost no serious health economist or health finance expert holds. Almost universally, they believe that, although demographic aging certainly has some effect on health spending, its impact is much less than that of other factors.

The mainstream view amongst health economists is that the most important force at work is the expanding technological capabilities of medicine (the role of which was discussed in my earlier blog piece).

Representative of the usual view of health economists of the impact of population aging are long-term health expenditure forecasts prepared by the OECD a few years back, which suggested that population aging would account for only approximately one-seventh of projected growth in health expenditure/GDP over the fifty years 2010-2060.

In my book Bigger Government: The Future of Government Expenditure in Advanced Economies, I argue that, although the OECD somewhat underestimates the impact of aging, it remains true that population aging will play only a distinctly secondary role in pushing health expenditure up in advanced countries generally over coming decades. The problem of rising health expenditure/GDP is not principally the consequence of the so-called “demographic time bomb.”

The book explains and assesses the principal theories and evidence concerning the way in which population aging impacts on health spending. In this blog, I highlight a couple of the main points.

“Common Sense” and the Impact of Demography Trends

Let’s start with why it seems to be pure common sense to assume that population aging will have a huge impact on health spending and coming decades. Medical spending is much higher for the elderly than it is for younger people. In the US, for example, average per capita health expenditure on people in the 65-84 age bracket is 3 ½ times that of average spending for people in the 19-44 age bracket. Spending on people in the 85+ age bracket is a whopping 6.8 times higher. Expressed differently, there is a steeply rising “age profile” of health expenditure.

United Nations forecasts suggest that between 2020 in 2050, the percentage of the population in the 65+ age group in high-income countries will increase from 18 percent to 28 percent. The percentage in the 80+ age bracket is projected to more than double, to 11 percent. Put that together with the age profile of spending, and it’s easy to see where predictions of a demographic time bomb in health spending come from.

But there is an extensive health economics literature showing that this line of reasoning is wrong. The main reason it is wrong is that it grossly exaggerates the impact of increasing longevity – that is, growing life expectancy in old age – on health spending. This is for a number of reasons, two of which are particularly important: the PTD effect, and the nature of the relationship between the increased prevalence of chronic conditions with population aging and technological advances.

The Proximity to Death Effect

In its pure form, the “proximity to death” (PTD) theory says that health expenditure does not depend on age, but rather on the number of years people are away from the end of their lives. This means that if, hypothetically, average longevity were to increase from, say, 75 years in 2020 to, say, 80 years in 2050, average health spending on a 78-year-old in 2050 would be the same as average spending on a 73-year-old in 2020 – because in each case this age represents about two years before the end of life.

The PTD effect is unquestionably real. Research has been conclusively established that quite a significant portion of lifetime health expenditure occurs, on average, in the last couple of years of life. Much of this is due to the high cost of the intensive health treatment which people tend to receive at the end of their lives.

To the extent that the PTD effect is at work, the impact of population aging on health expenditure is very considerably reduced.

We need to qualify this. As I show in in the book, the “pure” version of the PTD theory is wrong, and that chronological age does have some impact on spending. This means that increasing longevity does have some impact on health expenditure. This is why I said that the OECD projection mentioned above – which assume that the pure version of the PTD effect applies – understate, to some extent, the impact that demography will have on health expenditure over the coming decades. However, notwithstanding this qualification, it remains true that the impact of demography is distinctly secondary relative to the most important factor at work – the expanding technological capabilities of medicine.

Aging and the Increasing Prevalence of Chronic Conditions

A major area of increasing health expenditure is spending on the treatment of chronic conditions, such as diabetes, hypertension and chronic kidney disease. The prevalence of chronic conditions is highly correlated with age – elderly people suffer from these conditions much more than do younger people. This straightforward fact has sometimes been interpreted as implying that the main driver of rapidly increasing spending on the treatment of chronic conditions has been population aging.

This misses a crucial point. A large part of population aging has been increases in longevity – again, referring to life expectancy in old age. Advances in the technological capabilities of medicine have played a huge role in the increases in longevity which have been experienced in advanced countries.

The increasing longevity which has taken place in advanced countries over the last half-century is completely unprecedented in human history. The empirical research reviewed in my book makes clear the huge role which medical advances have played in this. Particularly important has been the way better medicine has dramatically reduced premature death from cardiovascular disease. My reading of the evidence is that medical advances have in fact been the number one force working to increase longevity, and have been more important even than behavioral changes such as the big reduction in smoking.

What this means is that it is wrong to interpret the high degree of correlation between increasing longevity and the growing prevalence of chronic conditions as evidence that population aging is the true cause of the problem. To the considerable degree that population aging is the result of the expanding capabilities of medicine, the pressure of spending on chronic conditions is more correctly attributed to the latter rather than the former.

This point is likely to be even more important in the future than it is in the past. As I show in my book, future increases in longevity are likely to depend even more on medical advances than they did in the past. Non-technological factors such as trends in health behavior are likely to be much less helpful than in the past, as evidenced by the growing problem of obesity.

The debate about the impact of demography on health spending has tended to be confused, partially because of the influence of a range of other less soundly-based notions – such as the so-called “compression of morbidity” effect. I explain and analyze these also in the book. Health economists are, unfortunately, partly to blame for the confusion. What is certain is that there is a need, both amongst health policy specialists and amongst fiscal analysts, for clearer thinking on the relationship between demographic aging and rising health expenditure.

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Bioscience Revolution To Drive Health Spending Up

In Bigger Government: The Future of Government Expenditure in Advanced Economies I show that government spending is set to increase greatly over the coming three decades in all advanced countries because of powerful external forces and pressures which will operate irrespective of the political orientations of governments. Overshadowing everything else will be very large long-term increases in health spending. In the United States, the Congressional Budget Office (CBO) has projected that government health spending will rise by 4.1 percent of GDP over the thirty years 2019-49, which is not greatly out of line with past experience.  In reality, however, the increase in spending will be appreciably larger than this – even in the absence of reforms that devote additional resources to reducing the ranks of the uninsured.

The US will not be alone in this. All advanced countries face the prospect of similarly large increases in government spending in this crucial area. An extremely conservative prediction is that government health expenditure will increase by at least 4 percent of GDP everywhere in the years up to the middle of this century.

Government health expenditure will grow because total – public and private – health expenditure will increase, dragging government spending up with it. Additional spending resulting from the rethink of health policies stimulated by the pandemic will only play a minor part in this. Nor will it be mainly due to population aging, even though many – erroneously – believe this to be the main force driving health spending up over the long-term.

The real story will be the expanding technological “capabilities of medicine” – and, more specifically, the way in which health spending is pushed up by the constant arrival on the scene of dazzling new medical treatments which are both highly effective and expensive.

We are now in the early stages of an era of particularly rapid expansion of the technological capabilities of medicine. The springboard of this is the unfolding bioscience revolution, which is progressively deepening our understanding of the molecular basis of disease. Especially important in pushing up health expenditure over coming decades will be the rapid diffusion of new precision and customized treatments. Recent years have already seen the arrival on the scene of growing numbers of new precision pharmaceuticals. These are drugs which are targeted at patients with specific genetic or other biomolecular characteristics, as identified by tests which look for telltale “biomarkers.” Customized medicine – involving treatments that are unique to the patient – has also been developing rapidly. It is, for example, clear that medicine will in future make extensive use of replacement organs and tissues grown from patients’ own cells. So-called autologous transplants will help to overcome both the problem of rejection of “foreign” donor organs, and the persistent shortage of donor organs.

Precision and customized treatments are expensive because they are complex and because they are inherently incapable of being mass-produced in a way that keeps their cost down via economies of scale. Take the example of Kalydeco, a recently-developed (2012) and stunningly effective precision drug for the treatment of cystic fibrosis (CF). Its cost – around $300,000 per patient year in the US – is eye-watering. It is more than seven times more costly than Pulmozyme, the major CF drug developed two decades earlier. Why? In part because Kalydeco is a complex drug which was expensive to develop. But the more important reason is that this precision pharmaceutical is targeted at only a tiny minority (about 5 percent) of CF sufferers, who have certain specific genetic variants of the disease. Its high development costs must therefore be recouped from a very small group of patients, rather than spread out over a larger patient population. Pulmozyme, by contrast, works – although much less effectively – for almost all CF patients. Expressed differently, it is the inherent lack of what economists refer to as “economies of scale” which ensures that precision and customized treatments are expensive.

The impact on spending of the arrival of increasing waves of such new treatments will be huge because their use will not be confined to applications such as the treatment of rare diseases like CF, but will be felt across the full breadth of medical practice. Precision pharmaceuticals are, for example, moving to center stage in the treatment of many cancers. An example is Keytruda, a highly effective drug which targets solid tumors with specific genetic characteristics – at a cost of around $150,000 per year. The treatment of other widespread chronic conditions will also be revolutionized. Take the case of diabetes. Today’s pharmaceutical treatments for type 2 (adult onset) diabetes don’t work terribly well for many patients. We now know that the main reason for this is that type 2 diabetes is not really a single condition, but rather a multiplicity of conditions based on a constellation of varying genetic and epigenetic malfunctions. What we can expect to see in future is the replacement of general-purpose drugs like Metformin with a growing number of precision pharmaceuticals designed to target specific variants of adult-onset diabetes. The story is likely to be the same for other chronic conditions, such as chronic kidney disease (CKD) – and possibly even for Alzheimer’s. Customized regenerative medicine will also play a growing role: for example, through the use of autologous kidney transplants for those with late-stage CKD.

All of this will deliver great benefits to patients, but at considerable additional cost.

Because these transformations in treatment technologies will affect such a large portion of patients, they will impact government health expenditure with full force. The only possible way of avoiding this would be to significantly scale back the scope and coverage of government-financed health services, so as to markedly reduce government’s share of total health expenditure. But this would be politically extremely difficult. In the United States, where government at present finances approximately half of total health expenditure, it is more likely that government’s share of health spending will increase over the long term — due, in particular, to measures to further reduce the numbers of uninsured persons and to improve pandemic readiness.

In most other advanced countries, where government pays 70 percent or more of health expenditure, substantially reducing the scope and coverage of government-financed health services would undermine the fundamental principle of universal health coverage.

There is nothing contrarian about the proposition that the expanding capabilities of medicine, driven by advances in medical science, will be the main actor in the unfolding drama of rising health spending. The view that scientific advances are the principal force behind the long-term growth in health spending is a mainstream one amongst health economists. What is different now is that the rate of technological progress has stepped up a gear.

This is something which none of the official forecasts of future health expenditure capture. Mostly, they assume that scientific advances will have the same impact on spending in future as in the past. This is, in effect, the assumption underpinning the CBO forecasts referred to earlier.

Official European Union health expenditure projections don’t even do this. For some unfathomable reason, they assume that the “non-demographic determinants” of health expenditure – a grab bag of factors in which scientific advances is included – will have a declining impact on spending over coming decades. Any European government which relies on these forecasts to plan future health spending is in for a rude shock.

We need to be a little sympathetic to the forecasters. The problem they face here is that it is inherently particularly challenging to model the impact on health spending of technological advances in health treatments. This is not to say that it is necessarily easy to model the impact of, say, demographic factors – something which I will return to in the next blog on this topic. But advances in medical science, and their impact on health expenditure, are particularly difficult to model. But it is highly unfortunate that standard practice these days is simply to lump technology in with a range of other factors as a residual – rather than being treated explicitly as a separate variable. This draws attention away from the central role of the expansion of the capability of medicine in driving long-term trends in health expenditure.

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Post-Pandemic Fiscal Consolidation?

Impacted by the COVID-19 pandemic, the budget deficits of advanced economies are projected to reach 15 percent of GDP on average this year. Debt, already high, is set to increase by more than 20 percent of GDP. What can and should be done to fix public finances after the pandemic is over?

The last thing the world economy needs is a post-pandemic austerity crusade to rapidly cut debt. But exceptionally high levels of government debt are dangerous in the long term. So fiscal consolidation will be required at some point. The question is when, and how fast.

It is easy to make out a case for gradualism. Today’s spectacularly high deficits are inherently temporary and will fall naturally as economies recover. The increase in debt won’t cause budgetary difficulties as long as interest rates remain low. Many economists think that structural forces will keep rates low for a long time to come, even after central banks stop flooding their economies with money. Consider the example of the US: if post-pandemic interest rates remained at the levels of the last ten years, an increase in government debt of 30 percent of GDP would increase government interest outlays by only about half a percent of GDP. This is why there is a persuasive case for relying on post-pandemic economic growth to gradually reduce the debt/GDP ratio over several decades. And if this isn’t enough, a one-off wealth tax could be used to pay off the pandemic-induced debt increment – while still avoiding austerity.

Unfortunately, however, restoring public finances is not quite as easy as that. This is because the problem is not just the debt position. It is structural budget deficits, which most advanced countries have been running for some time. Many – including the United States and the United Kingdom – have in fact run significant primary deficits for at least the past decade. But what makes the structural deficit particularly problematic is the fact that powerful spending pressures risk pushing budgets far more deeply into the red over coming decades.

The immediate spending pressures are clear enough: strengthening the capacity of healthcare to deal with crises like the pandemic, and the fight against climate change. What is less well understood is the magnitude of the long-term spending pressures which face governments in all advanced countries. As outlined in my book Bigger Government, healthcare is the biggest. Here, the long-term pressures have little to do with the pandemic. The most important is the way in which spending will be driven upwards by the rapidly-expanding technological capabilities of medicine, exemplified by high-tech precision and customized medicine. Technology has long been the main driver of health expenditure. Its impact on spending will be even greater in future because of the way in which the current bioscience revolution has speeded up technological progress in healthcare.

Healthcare isn’t the only source of pressure. The government spending effort required to tackle climate change – particularly via greening public infrastructure – will need to continue for at least three decades. But governments will spend more than they should because political resistance to appropriately high carbon taxes will lead them to make excessive use of subsidies to encourage the private sector energy transition. Population aging will force up spending on long-term care for the very elderly. Many advanced countries also suffer from serious infrastructure deficits which must be addressed. Conservatively, these spending pressures will add at least 7 percent of GDP in government spending in most advanced countries by the middle of this century.

There is no magic solution to the problem which these powerful spending pressures will create. Financing large permanent deficits through central bank money creation would be pure folly, whatever some fringe economists might suggest. The stark reality is that either taxes will have to increase, or major offsetting cuts will need to be made in other areas of government spending. In the United States, with its grossly deficient social safety net and generally poor level of government services, the choice should be clear: higher taxes will have to do most of the work. By contrast, relying largely on tax increases is likely to prove politically impossible in countries where taxes are already particularly high. In France, for example, voter tax resentment was one of the main triggers last year’s gilets jaunes movement, in response to which then Prime Minister Edouard Philippe told the Assemblée Nationale that “we have received loud and clear the message of exasperation about taxes”. In this type of context, major spending cuts are inevitable and – like it or not – there will be further cuts to the benefits provided by European welfare states.

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“Bigger Government” Podcast

To mark the publication today of Bigger Government: The Future of Government Expenditure in Advanced Economies, I am releasing a two episode podcast. The podcast is can be heard by clicking on this link, or may be heard on any of the main podcast directories (Apple Podcasts, Spotify, Castbox, Stitcher, Listen Notes etc).

Episode 1 outlines the main themes of the book, and then looks in detail at the future of health spending. Increased health spending will be the most important element of the projected spending increases of 7 percent or more of GDP up to 2050.

Episode 2 looks at the other main areas of spending pressure (global warming, long-term care and infrastructure). It then talks about the tough budget choices facing government. It outlines why, in this context, there is no money to finance fads like a universal basic income – something for which there is, in any event, no need.

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Is Austerity to Blame?

In many advanced countries, the parlous condition of public hospitals – due largely to inadequate funding – has been thrown into sharp relief by the coronavirus crisis. The United States, France and the United Kingdom are extreme examples. In these and other countries, many public hospitals were grossly stressed even before the pandemic, with patients waiting for hours in corridors, medical staff burnt out from constant overwork, shortages of supplies, and no spare capacity to absorb shocks such as the pandemic itself.

Healthcare is not the only area of public spending which has been under acute strain in recent years. Infrastructure, education and defense are other examples of areas which have been under great pressure in many countries. Low levels of government capital expenditure and maintenance have led to increasingly grave infrastructure deficits. Defense budgets have been under so much pressure in countries such as Germany that soldiers are undertrained and many military assets such as tanks are out of action because even basic maintenance has not been carried out.

The pressure on public spending has been palpable. But what has caused this? For many, the answer is simple: the policy of austerity implemented in the wake of the global financial crisis of 2007-08. They believe that governments have, over the past decade, cut total expenditure significantly in order to reduce their budget deficits, and that this is what has led to the intense pressure on public hospitals and other vital services.

There is one small difficulty here – namely, that this is not actually true. This can be seen by comparing pre-pandemic levels of government expenditure/GDP with those which prevailed prior to global financial crisis (i.e. 2019 or 2018 versus 2007). Expenditure/GDP was appreciably lower in only two of twenty-one major advanced OECD countries – Ireland and Israel. In all the others, government expenditure/GDP was either approximately the same or somewhat higher. (Note to economists: this is true irrespective of whether one looks at “raw” expenditure figures, or at cyclically adjusted expenditure.)

In France, for example, expenditure/GDP was – depending on the expenditure measure which is used – at least 1.5 percent of GDP higher in 2019 than it had been in 2007 – notwithstanding the constant carping about the alleged impact of austerity on public services that one hears in that country. Even in the United Kingdom, where the Cameron conservative government undertook major fiscal consolidation measures after 2010, public spending was no lower in 2019 than it had been in 2007.

All of the focus on “austerity” as the cause of budgetary strain distracts attention from what in fact has been the dominant source of budgetary stress. This is the powerful structural tendency of health expenditure and age pension expenditure to rise over time. Increases in spending have been so large in these areas that – in the absence of commensurate tax rises – they have put an enormous pressure on virtually all other areas of government spending. This is shown in detail in my book Bigger Government: The Future of Government Expenditure in Advanced Economies.

Health budgets have increased significantly over the past decade almost everywhere. Even in the United Kingdom, where the budget pressure on the National Health Service has been extreme in recent years, government health spending was in 2019 (at 7.5 percent of GDP) appreciably larger than it had been in 2007 (6.1 percent of GDP). The problem facing public hospitals has not generally been the consequence of cuts in funding, but rather that funding increases have not kept pace with large increases in the demand and cost of medical services.

Looking at public expenditure statistics the wrong way can obscure this important point. If we were to compare government spending levels in 2019 with those of, say, 2010 or 2012, we would come away with the impression that spending levels have indeed been cut quite substantially. But this would be entirely misleading. Government spending increased significantly in response to the global financial crisis, but in the form of temporary increases – in broadly the same way that there has been a big surge in temporary spending in response to the pandemic. This included increased outlays on unemployment benefits, discretionary financial support for businesses and spending on public investment projects. This temporary spending endured for some years in the wake of the financial crisis and was, in total, quite large. But if we want to understand underlying spending trends, we need to set this to one side.

Does this mean that “austerity” is a myth? Absolutely not. For those of us who are broadly Keynesian – including myself – there is a quite separate point. This is that the temporary spending implemented after the global financial crisis, which was essential to supporting the economy and promoting recovery, was generally insufficient and it was withdrawn to rapidly. Governments were by and large too quick to act to bring down deficits after the GFC. The consequence was that recovery was much slower than it should have been. In some European countries, recovery from the GFC was arguably incomplete even ten years later, just before the pandemic.

It is also important to acknowledge that if we look back further into the past – broadly, three or four decades back – there were indeed important periods when public spending/GDP was indeed cut significantly in many advanced countries. However, even then, these cuts in total spending were not by any means the only reason that many areas of public services were under intense pressure. Even then, the powerful upward pressure of healthcare spending and, increasingly, age pension spending was working to place considerable pressure on budgets as a whole.

And of course, there is the quite separate point that bailout countries like Greece (not an advanced country) and Ireland have indeed experienced very large spending cuts over the past decade. But it is absurd to draw a parallel between the swingeing cuts implemented in these countries and the budgetary policy in most advanced countries.

Focusing unduly on austerity as the source of pressure on government budgets in advanced countries generally in recent years is dangerous because it promotes the belief that, if we were to just stop obsessing about government deficits and debt levels, difficulties funding healthcare and other vital services would evaporate. But it is one thing to argue for more economic stimulus and a more relaxed view of deficits during an economic crisis – and an entirely different thing to argue that governments can and should run large deficits all the time. To do so would be both dangerous and irresponsible.

The reality is that given the magnitude of the spending pressures on government budgets in the coming decades, the solution is not to be found simply in running large deficits. A hard choice must be made – higher taxes, or major compensatory spending cuts elsewhere. There is no magic easy solution to this dilemma.

Data

Detailed statistics and other evidence of the budgetary pressure of recent years are presented in chapters 1 and 10 of my book Bigger Government.

Additional estimates of cyclically adjusted expenditure/potential GDP for European Union countries may also be found in the European Commission’s annual document Cyclical Adjustment of Budget Balances.

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