FIB Papers
W issenschaftszentrum Berlin für Sozialforschung
Veröffentlichungsreihe der Forschungsgruppe Internationale Beziehungen
P 92-303
The Expansion of the Public Economy, Revisited: The Politics of Government
Spending, 1961-1988
Thomas R. Cusack Geoffrey Garrett W issenschaftszentrum Berlin Stanford University
July 1992
W e would like to thank Bruce Bueno de Mesquita, Francis Castles, William Dixon, Patrick Dunleavy, Lloyd Gruber, Paul Holland, Peter Lange and Roger Noll for helpful comments and suggestions. Earlier versions o f this paper were presented at the Justice and Society Seminar, University o f California, Davis, and at the Politics and Organizations Seminar, Graduate School o f Business, Stanford University. Garrett gratefully acknowledges the support o f the Wissenschaftszentrum, Berlin, the Center for Advanced Studies in the Behavioral Sciences (NSF grant #BNS-8700864) and the Graduate Program in Public Policy, the Australian National University, Canberra.
Publication Series o f the International Relations Research Group Reichpietschufer 50
Die in dieser Arbeit vertretenen Auffassungen sind die des Verfassers und nicht notwendigerweise die der Forschungsgruppe Internationale Beziehungen
The views expressed in this paper are those o f the author and not necessarily those of the International Relations Research Group
ABSTRACT
The general decline in macroeconomic performance and the increasing degree to which national economies have become integrated into world trade and financial markets have prompted some to suggest that the latitude with which public officials canset fiscal policies has been reduced if not altogether eliminated. Public economies in an age o f interdependence are said to be converging on the level o f the least common denominator as elites attempt to enhance their nations’ international competitiveness. By extension, the important role that the political center o f gravity in a country plays in shaping the dimensions o f the public sector has been eliminated.
Aspects o f this question are examined using data from 15 major OECD countries for the period from 1960 through 1988. While there are signs o f stabilization in the overall size o f the public sectors in these countries, little evidence is found to suggest that any convergence is underway. Based on a pooled cross-section time-series analysis, evidence is presented which indicates that growing financial integration has had a dampening effect on the growth of the public economy. A t the same time, there is strong evidence to suggest that partisan influence on the expansion o f the public sector has been at w ork for significant periods o f time during these three decades.
ZUSAMMENFASSUNG
Der allgemeine Leistungsrückgang der Volkswirtschaften und die wachsende Integration der nationalen Ökonomien in die globale Handels- und Finanzmärkte haben zu der Auffassung einiger Theoretiker geführt, daß der Spielraum für fiskalische Politik beschränkt, wenn nicht gar ausgeschaltet worden ist. So wird behauptet, daß in einer Zeit der Interdependenz, in der die Eliten die internationale Konkurrenzfähigkeit ihrer Nationen zu erhöhen versuchen, die öffentlichen Sektoren auf der Ebene des kleinsten gemeinsamen Nenners konvergieren. Daraus folgend, sei die wichtige Rolle, die die bestimmenden politischen Kräfte eines Landes in der Gestaltung der Dimensionen des öffentlichen Sektors spielen, weggefallen. Aspekte dieser Frage werden anhand von Daten über 15 OECD-Länder für den Zeitraum 1960 bis 1988 untersucht. Trotz Anzeichen für eine Stabilisierung der Gesamtgrößen der öffentlichen Sektoren dieser Länder, gibt es wenig Beweise für eine Konvergenzbewegung. Mittels einer gepoolten Querschnitts- Zeitreihenanalyse wird nachgewiesen, daß die zunehmende finanzielle Integration dämpfend auf das W achstum der öffentlichen Sektoren gewirkt hat. Gleichzeitig gibt es starke Hinweise darauf, daß es während dieser drei Dekaden über große Zeiträume ein parteipolitisch bestimmten Einfluß auf die Ausdehnung des öffentlichen Sektors gegeben hat.
INTRODUCTION
Political scientists have long argued that the balance o f political power between the left and right has a significant impact on economic policies and outcomes among the advanced industrial democracies.1 W ith respect to the public provision o f welfare and other social services, it has been suggested that government spending is greater where powerful political parties o f the center-left are allied with strong trade unions than where the right is more dominant and organized labor is much weaker [Cameron 1978,1984, Castles 1982, Garrett and Lange 1991, Hicks and Swank 1992, O ’Connor 1988], There is, however, a significant limitation in these studies. Most have focused only on the postwar period up until the early 1980s, and hence they have not explored the extent to which historical patterns continued or changed during the last decade.2 But there are strong reasons for believing that the western political economies have been transformed in the past fifteen years [Hood 1989].
The integration o f the advanced industrial economies into global markets has increased rapidly since the mid 1970s, through the mushrooming o f international trade and financial transactions. The post-war trend o f ever increasing prosperity ended abruptly with the first OPEC shock and the onset o f stagflation, from which the western countries still have not completely recovered. The dawn o f this new economic environment was associated with significant changes in domestic political and institutional conditions. Leftist governments fell from power in many countries - including the bastions o f social democracy in Scandinavia - and the price o f electoral success for leftist parties that won or retained office - as in
Australia, France, New Zealand and Spain - appears to have been the abandonment o f many o f their traditional partisan policies. Trade unions were hit hard by declining employment in secondary industry, and centralized wage restraint regimes and pervasive labor quiescence - which had been a centerpiece o f most corporatist arrangements in the postwar - broke down in many countries, including Norway and Sweden.
These developments have reinvigorated the claims o f neoclassical economics that there is no place for "big government" in the contemporary advanced industrial democracies.
Economic decisions by governments are deemed, by definition, to be less efficient than those made in the private sector because they are affected by considerations other than wealth maximization. Moreover, by increasing total production costs in the private sector, extensive public provision o f welfare and other social services is seen to work de facto as a
government-imposed "ta riff on domestically produced goods and services. In addition, the rates o f taxation needed to fund the public economy are considered to generate substantial disincentives for domestic investment. The greater the integration o f national economies into the international system and the greater the competitiveness o f global markets, the stronger are seen to be each o f these constraints against extensive government spending.
From this perspective, even if there remain partisan-ideological incentives for leftist parties to expand the public economy, these are far outweighed by the deleterious economic consequences o f big government in the age o f interdependence and economic decline.
Moreover, since the health o f the macroeconomy is a powerful determinant o f electoral outcomes [Fiorina 1981, Kramer 1971, Peltzman 1990], leftist governments that seek to remain in power have no choice but to shadow the less expansive spending policies o f the right. Thus, the logical conclusion o f this approach is that there should have been a marked convergence in the spending patterns o f all governments since the mid 1970s.
There are, however, significant grounds for questioning this argument. The empirical evidence in the voluminous literature on the macroeconomic consequences o f government spending is inconclusive. Numerous studies report negative relationships between
government spending and economic growth [Grier and Tullock 1989, Landau 1985, Marlow 1986, Marsden 1983, Weede 1986a, 1986b]. Many others, in contrast, delineate equally strong beneficial effects o f public sector expansion [Friedland and Sanders 1985, Korpi 1985, Ram 1986]. Systematic reviews o f the literature show that all the statistical results are highly unstable and are very sensitive to small variations in the period o f years analyzed, the cases which comprise the sample, and the explanatory variables deployed [Castles and Dowrick 1990, Saunders 1986].
Moreover, just as assertions o f the deleterious consequences o f government spending can find theoretical reinforcement in neoclassical economics, powerful critics o f this
approach have recently emerged in the economics profession. They argue that interventionist economic policies - including extensive government spending are not necessarily detrimental to - and may actually promote - productivity and competitiveness in rapidly changing global markets that respond as much to quality as they do to price [Aschauer 1989, Porter 1990, Soskice 1991]. Contra neoclassical approaches, these scholars assert that the free play of market forces may often result in the under-supply o f essential collective goods. These include education and vocational training to increase skills in the labor market, research and development to promote technological progress, and other "infrastructural investments" that further the ability o f firms to compete in rapidly changing, quality-sensitive global markets.
This study does not purport to arbitrate in the debate over the consequences of government spending for macroeconomic performance in the integrated global economy.
Rather, its focus is on the politics o f the public economy in the age o f interdependence. There is no definitive evidence as to whether big government or public sector rollback is better suited to promoting competitiveness and economic growth in the contemporary period.
Furthermore, it is likely that significant political incentives remain for governments o f the left and right to pursue different policies. Thus, we might expect that historical partisan
differences in public spending should have endured despite the transformation o f the international economy in the past twenty years. In accordance with recent work, however, such partisan policy separation should only be apparent where leftist governments are allied with powerful trade unions or where powerful rightist parties confront much weaker labor movements [Alvarez, Garrett and Lange 1991, Hicks 1988]. It is in these cases where the preferred spending policies o f the left and right are likely to be most efficacious, even in the integrated and highly competitive global economy.
The paper assesses the validity o f this hypothesis o f continuing partisan separation in patterns o f government spending with respect to fifteen OECD countries over the period 1961-1988.3 Its central conclusion is that prevalent claims about the demise o f interventionist government are too simplistic and should be significantly modified. Financial integration and economic decline since the mid 1970’s have had a marked impact on western economies, including slowing - if not stalling - the expansion o f the public economy. However, while there has been some reduction in the power o f organized labor and the political left, these changes are neither as pervasive nor as strong as is often presumed. Moreover, the balance o f political power between left and right continued to be associated with ever greater divergence in patterns o f government spending up until at least 1983. This relationship has subsequently weakened, but only to the point where political conditions today have no discernible impact on rates o f change in government spending. Thus, historical effects o f the balance o f political power on the absolute size o f the public economy endure.
This paper comprises three sections. The first presents in more detail arguments about the effects o f interdependence and economic decline on the relationship between domestic political conditions and government spending. Section two evaluates these arguments empirically. The final section discusses the broader implications o f the arguments and findings for the political economy o f the contemporary advanced industrial democracies.
1. INTERDEPENDENCE, ECONOMIC DECLINE AND THE PUBLIC ECONOMY
a. Economic Change Since the 1960’s
The golden age o f economic prosperity during the 1950s and 1960s afforded leftist governments in the advanced industrialized countries considerable latitude to further their partisan preferences with respect to the public economy [Shonfield 1965]. A wide range of policies was consistent with non-inflationary growth and with low levels o f unemployment
as the societal pie seemed inexorably to expand. Furthermore, there was considerable public support for the extensive public provision o f welfare and other social services. Together, these beneficent economic and political conditions allowed center-left governments to erect large public economies without fear o f significantly depressing economic performance or prejudicing their prospects for reelection.
Since the 1960s, however, two important changes in the international political economy have altered substantially the environment in which decisions on the public economy are made. First, the economic performance o f the advanced industrialized countries declined precipitously in the wake o f the first OPEC shock in 1973. Growth rates on average dropped to about h alf o f their previous levels in the latter half o f the 1970s while inflation rates more than doubled . The 1980s saw only a partial recovery in economic growth, but inflation rates dropped significantly in the latter half o f the decade. Most significantly, unemployment stubbornly persisted at high rates.
Second, the degree to which the western economies were integrated into global markets increased dramatically. The integration o f international goods and services markets grew considerably in the 1970s and 1980s [McKeown 1991]. The average openness (exports plus imports as a percentage o f GDP) o f the OECD countries increased from around 40% in 1970 to over 65% in the mid 1980s.
It is more difficult to assess the integration o f capital markets. There has been an explosion in international financial flows in the past fifteen years [Frieden 1991:428]. But increases in such international transactions do not necessarily indicate growing capital
mobility. Rapid growth in capital flows might only indicate higher levels o f uncertainty about the best international investment strategies, rather than signifying a large reduction in the effective barriers to international financial transactions.4 In a widely accepted argument, Feldstein and Horioka [1980] suggest that capital mobility is better measured by the relationship between savings and investment than simply by the volume o f international transactions.5 Figure 1. depicts the relationship between private domestic savings and private domestic investment across the industrial democracies for each year during the period from 1960 through 1988.6 The savings coefficients for the annual cross national regressions show a strong general trend towards greater integration o f financial markets, even though the curve is not very smooth and is not so steep as one might expect given the growth in international capital flows.
— Figure 1: Savings/Investment Regressions —
b. The Domestic Consequences of Economic Decline and Interdependence
Economic conditions in the advanced industrial democracies have changed considerably over the past two decades. Economic performance in terms o f growth, employment, and inflation has deteriorated markedly. The ties that bind these national
economies have been greatly strengthened. It is commonly assumed that these sea changes in economic conditions have precipitated equally significant political changes - most
importantly for present purposes, great reductions in the scope for social democratic governments to expand the public economy. The combination o f economic decline and heightened interdependence is viewed both to have lessened the economic efficacy o f government spending and to have reduced political support for the expansion o f high levels o f publicly provided welfare and other social services. This suggests, in turn, that the influence o f government partisanship on the size o f the public economy should have diminished greatly since the halcyon days o f the Keynesian welfare state
There are three elements in this argument. First, it is often posited that there is a
powerful relationship between macroeconomic conditions and the implementation o f partisan policies. Specifically, many assume that while it might have been possible for center-left governments to pursue their partisan agendas when the societal pie was continually
expanding in the long boom o f the 1960s, interventionist big government became a luxury that could no longer be afforded with the onset o f stagflation in the second half o f the 1970s [Boltho 1982, Thurow 1980].
Second, it is argued that the scope for governments to pursue autonomous spending policies has been substantially reduced by the integration o f global markets. The Keynesian welfare state m ight have been quite effective in the more closed economies o f the 1960s when the manipulation o f domestic factors had a larger bearing on economic performance.
But the efficacy o f domestic interventions is said to have declined with the ever greater integration o f goods, services and capital markets as the critical decisions about consumption and investment have become increasingly made by actors beyond the control o f national governments. Indeed, some have gone so far as to claim that interdependence has undermined - de facto, if not de ju re - the economic "sovereignty" o f the nation-state [Freeman 1990].
Finally, many claim that the combination o f economic decline and heightened interdependence has reduced significantly the political demands for interventionist government. The unionized, manufacturing working class, the core support base for the extensive public provision o f welfare and social services, has shrunk considerably during the past twenty years [Dalton 1984; Crewe and Denver 1985], Moreover, the labor-capital cleavage has been crosscut increasingly by divisions between the tradables and non-tradables sectors, and between export- and import-competing firms [Cassing, McKeown and Ochs
1986, Frieden 1991]. In sum, the traditional constituencies for the expansion o f the public economy are considered to have eroded to the point where today it is no longer in the interests o f leftist governments to engage in large scale spending.
c. The Public Economies: Decline and Convergence?
There is more than an ounce o f truth in these arguments. The scope for leftist
governments to pursue their preferred policies has been reduced by poorer macroeconomic performance. The possibilities for effective counter cyclical demand management (through both deficit spending and loose monetary policy) have declined significantly with the greater integration o f global goods, services and capital markets. And the core constituencies o f the left have shrunk since the 1960s. But these do not necessarily mean that the size o f the western public economies should have converged at the levels which obtain where the political right is dominant?
Cursory examination o f trends in public sector spending since the 1960s does not strongly support this view (see Figures 2. and 3.).7 With respect to the overall size o f the western public economies, the data in Figure 2. show that government spending continued to increase in the late 1970s and early 1980s at least as quickly as had been the case in the 1960s. There has been some decline in the average size o f the western economies since about 1983, but this downward trend has been very small in relation to the public sector growth of the previous decade. The figure also shows that these overall trends generally obtain for different categories o f government spending. Government consumption and transfers - the two primary components o f the public economy - both grew up until the mid 1980s and have declined marginally since. The only significant exception to this pattern is the public debt, which has grown considerably and consistently since the first oil shock in 1973.
— Figure 2: Government Size —
M ore importantly for present purposes, Figure 3. reveals that there has been no discernible decrease in the variations in the magnitude o f government spending across the advanced industrial democracies in the past thirty years. In fact, the coefficient o f variation in government spending was greatest in 1981, and it was a little larger at the end o f the series than it was in the 1960s.
— Figure 3: Coefficient o f Variation in Govt Size —
d. Domestic Political Conditions
If assertions about the about the declining political and economic efficacy o f big government and hence the declining impact o f government partisanship on the size o f the public economy were correct, one would expect them to be reflected in convergence in cross national patterns o f government spending. Since the raw data presented above do not reveal such convergence, closer scrutiny o f the relationship between domestic political conditions and government spending should be undertaken. Let us begin by examining trends in the national political conditions that are often associated with the perceived sea change in the political economy o f the advanced industrial democracies - the weakening o f organized labor and o f left parties.
The data displayed in Table 1. show no pervasive cross-national decline in the numerical strength o f trade unions since the 1960s.8 On average, rates o f unionization increased in the period following the first OPEC crisis and then stabilized during the 1980s.
However, there has been considerable variation in trends across countries. For example, while rates o f unionization declined appreciably in Britain, Canada, France and the United States, they increased significantly in the Scandinavian countries. It should be noted, o f course, that much o f this growth in Scandinavian unions was in the white collar public sector, not in the traditional bastions o f social democracy, the blue collar working class unions.
Indeed, this bifurcation o f the union movement has significantly weakened the traditional solidarity on which the economic and political power o f Scandinavian unions has been based
[Martin 1991]. Nonetheless, it would be simply incorrect to assume, as is the wont of commentators in Britain and the United States, that the numerical strength o f unions has declined pervasively since the mid 1970s
— Table 1: Political Indicators —
W ith respect both to the vote shares o f different parties and to the allocation o f cabinet portfolios (see the second and third panels o f Table 1.), the ideological center o f gravity in most countries moved somewhat to the right during the 1980s (after moving considerably to the left in the latter 1970s).9 As would be expected, these trends were more pronounced with respect to participation in cabinet governments than to vote shares. More importantly, again there was significant variation in the experiences o f different countries. The balance of governmental power, for instance, moved substantially rightward in the 1980s in Denmark, Germany and the United Kingdom. In contrast, the fortunes o f leftist parties improved during the period in Australia, France and Sweden.
W e have constructed an overall index for the political center o f gravity which combines standardized scores for union strength, vote shares and cabinet participation. Annual average values o f this index give a general indication o f the shifting balance over time o f political power across all the industrialized democracies.10 This is graphically displayed in Figure 4.
There was a pronounced swing to the left in the period immediately after the first
OPEC-induced recession. This trend was reversed, however, after 1978 as the political center o f gravity for the western countries moved back to the right. The pendulum would seem to have begun to shift back again from 1985. Indeed, on this measure, the balance o f political power today is similar today to what it was in the mid 1960s - the halcyon days of
interventionist social democracy.
— Figure 4: Shifting Center o f Political Gravity —
e. The Economic Efficacy of Big Government
The case for the declining impact o f government partisanship on public spending, however, need not rest on assertions about changes in the nominal balance o f political power.
Instead, most arguments assert that even left governments have been forced to adopt more market-oriented strategies so as not to undermine economic performance. For example, at least part o f the success o f social democratic governments in Australia, France and Sweden in the 1980s is frequently attributed to U-turns away from traditional partisan policies.11 From this perspective, even if left governments still would prefer to ameliorate the dislocations associated with the free play of market forces, they understand that they can no longer do so without prejudicing macroeconomic performance - and hence their prospects for reelection.
It is clear that increasing economic interdependence in the past twenty years has had a marked constraining impact on the range o f effective economic policy instruments available to western governments. The case with respect to macroeconomic policies - primarily budgetary balances and interest rates - is straightforward. Attempts to dampen business cycles through traditional Keynesian demand management are largely ineffective in open economies where much o f the demand for domestic goods and services is in foreign markets.
These policies might, in fact, only lead to surges in imports, to downward pressures on exchange rates, and to balance o f payments crises (as was the case with M itterrand’s
"socialism in one country" experiment [Hall 1986]). The scope for individual governments to chart their own courses in monetary policy is heavily circumscribed by the integration of financial markets. Under floating exchange rates, governments that lower domestic interest
rates risk unwanted currency depreciations and significant outflows o f reserves and private capital. With fixed rates and mobile capital, it is simply impossible for governments to pursue independent monetary policies [Frieden 1991].
But the ineffectiveness o f these tools o f macroeconomic adjustment says nothing about the economic consequences o f large public economies, p e r se. The veracity o f assertions about the declining efficacy o f government spending (assuming it is balanced by tax revenues) rests squarely on the notion that large public economies - viewed as surtaxes on domestic goods and services - necessarily decrease international competitiveness, depress domestic investment, and lower economic growth. This assumes, in turn, that government spending is always less efficient than the private allocation o f capital. If, in contrast, one believes that some types o f government spending may produce equally good economic performance through the promotion o f desirable outcomes that are under-supplied by the market, then presiding over large public economies might still be a viable policy option for the political left under certain circumstances.
This is precisely the argument made by scholars who study "corporatist" or
"coordinated" political economies [Alvarez, Garrett and Lange 1991, Garrett and Lange 1991, Katzenstein 1985, Soskice 1991] and it is consistent with recent studies which suggest that there is no clear-cut relationship between government spending and economic growth [Castles and Dowrick 1990]. W hile students o f the economic effects o f organizational and institutional conditions do not assert that the unfettered operation of market mechanisms is never efficacious, they do suggest that such policies are best suited to situations where strong rightist governments may impose market disciplines on largely unorganized workers.
Conversely, they argue that large-scale government spending will be m ost conducive for productivity, competitiveness and economic growth where organized labor movements are sufficiently powerful to overcome the types o f free-riding behavior that might otherwise undermine interventionist government.
From this perspective, extensive public spending by left governments that are allied with powerful labor movements may promote international competitiveness not merely by inducing workers to engage in wage restraint, but also by reducing market failures.
Government-sponsored "active labor market policies" that provide extensive unemployment benefits and that assist in the relocation o f workers may facilitate efficient adjustment in the w ork force to changing international conditions [Flanagan 1983]. Public education and training programs may generate a "high skills equilibrium" that increases the competitiveness in rapidly changing, high value-added world markets [Soskice 1991, Streeck 1988].
Government investment in research and development may prove critical to industrial innovation and adaptation [Porter 1990]. These policies all involve extensive government
spending. But rather than acting as de facto taxes on national goods and services, they may serve to improve the quality o f these products and thereby to increase their competitiveness in global markets.
In sum, if these arguments are well-founded, there would be no reason to conclude that the effects o f variations in the political and organizational power o f labor on government spending would have changed significantly in the past two decades.
2.
THE INTERNATIONAL ECONOMY, DOMESTIC POLITICS AND GOVERNMENT SPENDING
In order to explore the relationship between domestic political conditions and
government spending in the age of economic decline and interdependence, we have analyzed panel data on the fifteen countries in our sample over the period 1961-1988. The dependent variable in the analysis is the annual rate o f change in general government spending (less expenditures on defense and interest payments on the public debt).12 Stickiness in the size o f the public economies within each o f the countries in the sample necessitated analysis o f the first difference, rather than the level, o f government spending. Moreover, it should be noted that the use o f the first difference in public spending removed the bias towards countries with high levels o f public spending before the first year in the analysis, 1961, that would be
implicit in non-differenced models. In all the equations estimated below, positive (negative) coefficients on explanatory variables suggest that they increased (decreased) the rate o f change in government spending.
Annual change in government spending for each country was regressed on four sets o f explanatory variables: domestic economic and demographic factors; measures o f the extent o f the integration o f a national economy into global markets; indicators o f changes in
international economic performance and their effects on national economies; and, domestic political conditions. The basic form o f the estimated equation is:
ESPENDit = a + b xNDEMit + b2NPRICESit + bJJEPit + b,TRADEit _ t + bsSTRADEit (I) +b6FINANil _ x + b2OILit + b&PCGit _ x
In accordance with previous studies, we have included measures for changes in relative size o f the pension age population and the unemployed (NDEM, b 1>0),13the relative prices between the public and private sectors (EPRICES, b2>0),14 and unanticipated changes in economic growth (UEP, b3>0).15 Increases in the proportion o f the population o f pensionable
age and the unemployed stimulate the public provision o f social security and other welfare services [Cusack, Rein and Notermans 1989, Hicks and Swank 1992, Pampal and Williamson 1989]. Building on B aum ol’s [1967] analysis o f the impact o f differential rates of
technological progress across economic sectors, scholars have posited the existence o f
"Baumol’s disease" with respect to the public economy [Berry and Lowery 1984, Neck and Schneider 1984].16Finally, it has been persuasively argued that unanticipated deteriorations in economic growth lead, ceteris paribus, to faster public economy expansion because o f the downward stickiness in many important government spending [Roubini and Sachs 1989].
To control for the effects o f international economic interdependence, w e included in the estimated equation the level o f trade (TRADE), changes in trade (ATRADE), and the extent of financial integration (FINAN).17 Given the widely analyzed institutional consequences of trade integration [Cameron 1978, Katzenstein 1985], one might expect that levels of trade would be associated with higher rates o f change in the size o f the public sector (b4>0). Short term increases in trade, and increases in financial integration, however, are likely to decrease the rate o f change in government spending - in accordance with the logic o f "lowest common denominator" competitiveness pressures emanating from heightened interdependence
(bs b6<0). The effects o f changes in the health o f the international economy on national political economies are delineated in terms o f the dependence o f countries on imported oil (OIL). Following previous studies, we would expect that oil price increases would tend to slow the rate o f change in government spending, and that this effect would be larger the greater the dependence o f national economies on imported oil (bjcO) [Alt 1987, Garrett and Lange 1986].18
Finally, domestic political conditions are measured by the index which combines standardized annual country scores for the strength o f trade unions and the electoral and cabinet ideological centers o f gravity in the electorate and in cabinet government (P C G , see note 10). If our arguments about the continuing importance o f domestic politics on the public economy are correct, w e would expect the greater the combined power o f organized labor and the political left, the greater the annual rate o f increase in government spending (bs>0).
— Table 2: Pooled Estimates for Model o f Public Sector Size —
The estimated model is reported in the first column o f Table 2.19 As expected, change in the demographic burden, relative prices, and unanticipated economic performance all had powerful effects on changes in government spending. Greater financial integration also had the expected strong negative impact on public sector expansion. In this model, however, none
o f the following variables, oil dependence, the level o f trade integration, and changes in trade integration had a statistically significant influence on government spending, although the oil dependence and the level o f openness coefficients w ere o f the anticipated sign.
M ost importantly for present purposes, even controlling for domestic economic and demographic factors and for international interdependence, the political center o f gravity was significantly and positively associated with growth in government spending. Thus, over the whole period 1961-1988, the greater the combined power o f the left and labor, the greater was the rate o f change in the size o f the public economy.
This model, however, does not take into account the fact that the political economy of government spending may have changed considerably since the 1960s. To control for any period effects, we introduced a series o f period dummy variables (1968-1973,1974-1979, 1980-1983, and 1984-1988) to ascertain whether the overall trend in changes in government spending has varied from the implicit benchmark period (1961-1967).20These variables were designed to delineate any effects o f changes in the domestic and international economic environment that are not captured by the other explanatory variables already included in the model (equation I.). Insignificant coefficients for the period dummies would suggest no substantive alteration in the rate o f public sector change, whereas significant positive (negative) coefficients would indicate that the rate o f change in the size o f the public sector was higher (lower) than in the benchmark period:
&SPENDit = a ' + b ' EDEMit + b'^P R IC E Sit + b'3UEPit + b\TRADEit _ t + b'5ETRADEit W +b'(^INANi,_1 + b7OJLü + b ^ C G ^ + 0^6873, + hwF7479, + hn y8083, + b'12Y848S, The estimates for this equation are reported in the second column o f Table 2. The results show that the specification o f the model was increased considerably by the addition o f the period dummies (the adjusted R2increased from .691 to .757, significant at the .01 level using W ald’s test). Consistent with more descriptive studies which argue that most
governments responded to the first OPEC shock with broadly expansionist policies but reacted to the second oil shock with more contractionary policies [Boltho 1982, Roubini and Sachs 1989], the results show that there was a strong secular increase in the rate o f change in the size o f the public economy in the period from 1974 to 1979, whereas the rate o f change in government spending has been significantly negative since then. Nonetheless, the coefficients on all the other variables in the model - including the political center o f gravity - are very similar to those reported in column one. The only important exception was the oil
dependence coefficient, which took the expected significant negative sign once the period effects were taken into account. Greater levels o f the power o f labor and the left were still associated with growth in government spending.
These results, however, are not yet sufficient to substantiate the claim that domestic political conditions continue to influence government spending. While the estimated equation in column two o f Table 2. controls for period effects, it assumes that the impact o f the
political center o f gravity on the rate o f change public spending was invariant over the whole period o f study. Critics could assert that just as the trend in public spending changed from the late 1970s to the 1980s, so, too, did the impact o f domestic political conditions.
This hypothesis is examined in the third column o f Table 2. Four interaction terms between the political center of gravity index and each of the period dummies were added to the estimated equation. Three o f these interaction terms were statistically significant and the percentage o f variance explained by the equation in column three (.779) is significantly higher (at the .01 level using W ald’s test) than that in column two (.757). Thus, the effects of PC G on change in public spending differed in important ways between the early 1960s and the late 1980s. In order precisely to delineate the conditional effects o f politics on public spending (i.e. in each o f the sub-periods), it is necessary first to re-arrange the estimated equation in the following way:21
bSPENDit = a" + b''EDEMit + b2EPRICESit + b JJE P u + b"4TRADEit _ t + b'^T R A D E it C111) +b'6FINANit. i + bjO ILit + b"y6873, + ö"y7479, + Z>loy8O83, + 2 ^ 8 4 8 8 ,
+PCGit{b[2 + b'^Y6873t + b'u Y7479t + b ’> 8 0 8 3 , + 2 )^ 8 4 8 8 ,)
In this equation, the conditional effect o f PCG on &SPEND in the benchmark (omitted) period, 1961-1967, is b12, whereas the coefficient for 1984-1988, for example, is (b12 + b16).
These data are reported in Table 3.
The results show that at the outset of period under analysis, 1961-1967, the strength of labor and the left had a powerful positive impact on changes in public spending. For the years 1968-1973, in contrast, the influence o f PCG was negligible.22 The effects o f partisan politics re-emerged after the first OPEC oil shock, when the impact o f the power o f labor and the left on the rate o f change in the size of the public sector was greater than had been the case for the period 1961-1967. This significant partisan separation continued during the deep recession following the second OPEC shock, although the magnitude o f the conditional coefficient was only half that for the period 1974-1979. Finally, PC G had no discernible impact on changes in public spending between 1984-1988.
Thus, simple assertions o f the demise o f partisan politics since the mid 1970s are unfounded. In the period immediately following the first oil shock, all governments responded to the recession by increasing public spending, but that the rate o f public sector expansion was far greater where powerful left parties were allied with encompassing labor movements. The overall trend was reversed following the second OPEC price hike as
governments reacted to the lessons o f 1974-1979 by curbing public spending. Partisan separation between the right and left also declined in this period. Nonetheless, there is no strong evidence o f partisan convergence in the 1980s. Only in the period 1984-1988 did PCG have a negative impact on the rate o f change in government spending, but this coefficient was very small and statistically indistinguishable from zero.
3. DISCUSSION
This paper has argued that the widely held notion o f the demise o f big government since the early 1970s in the wake o f the globalization o f the international economy and the secular decline o f economic performance among the advanced industrial democracies should be modified. There is no denying that these changes in international conditions have had wide-ranging effects on the political economy o f capitalist democracy. The integration o f global markets in goods, services and, most importantly, capital constrained the ability o f governments to pursue independent macroeconomic policies. The most significant
manifestation o f this change has been the declining efficacy o f monetary policy as an instrument for influencing domestic economic activity. For members o f the exchange rate mechanism o f the European Monetary System - and those countries that informally shadow it - this has been m ade explicit. For other countries, monetary policy today can only be used to influence the exchange rate, and hence only to have indirect impact on domestic economic conditions.
But w hat about the political economy o f government spending - the center-piece o f the post-war interventionist welfare state? Here, the evidence is more mixed. The traditional locus o f debates about the domestic consequences o f interdependence has been on the effects of the expansion o f trade. Yet despite the arguments o f historical institutionalists such as Katzenstein [1985] with respect to the positive relationship between trade, corporatism and the public economy, and notwithstanding the counter arguments o f neoclassical economists, neither the levels nor rates o f change in trade had any significant effects on changes in government spending during the 1970s and 1980s. In contrast, the rapid pace at which barriers to international flows o f capital declined in the past two decades did have the impact envisaged by most economists: greater international financial integration put a brake on public sector expansion.
The impact o f economic decline on government spending was much larger than that of interdependence. However, the nature o f the policy responses o f governments across the ideological spectrum differed greatly between the periods after the two OPEC price hikes in 1973 and 1979. Across all the western countries - irrespective o f domestic political
conditions - there was a marked increase in the rate o f growth o f government spending after the first oil shock in 1973. Governments o f all partisan stripes responded to the economic downturn in the manner to which they had become accustomed in the postwar period. In the
1980s, however, the trend o f faster public sector expansion to bridge over lows in the
business cycle was reversed across the board - in accordance with the popular wisdom on the rise o f neo-liberalism in the past decade.
There is some similarity in this inter-temporal pattern with respect to the effects of partisan politics on government spending. The stimulative impact on changes in expenditures o f the power o f the political left and organized labor increased significantly in the period between 1974 and 1979, to the point where these partisan effects were greater than they had been in the golden age o f the early and mid 1960s. This partisan divergence in government spending decreased in the early 1980s, but the political center o f gravity still had a significant influence on the expansion o f the public economy up until 1983. Only for the final period under analysis, 1984-1988, could it be credibly claimed that politics no longer mattered for government spending. But it should be noted that to say that political conditions had little impact on the growth o f the public economy in the mid and late 1980s is a far cry from assertions o f pervasive convergence in the expenditure policies o f governments across the western countries. Rather, the evidence in this paper merely shows that the historical differences between the patterns o f public spending in countries with powerful left parties and labor movements and those with dominant right parties and w eak unions did not increase in the late 1980s, as they had done both in the late 1970s and in the golden age. But partisan separation certainly did not decline in the 1980s.
In sum, while there is some good evidence o f a general flattening o f public sector expansion in the 1980s, there is far less support for the notion that domestic politics no longer matters for patterns o f government spending. This is consistent with arguments which suggest that government spending - at least in countries with strong labor movements and powerful social democratic parties - need not necessarily be a drain in macroeconomic performance, even in the harsh economic climate o f the past two decades. The bastions o f social
democracy in western Europe have long been very open economies - at least with respect to trade in goods and services. In these systems, government spending - while undoubtedly serving the partisan interests o f the left and their core constituencies - has also always been oriented to promoting international competitiveness [ Katzenstein 1985, Swenson 1989].
Instead of viewing government intervention as inimical to economic efficiency, governments in these countries have long had a strong commitment to the provision o f collective goods deemed necessary for competing in global markets. Indeed, recent research has shown that even the path breaking corporatist compromise, Sweden’s Basic Agreement o f 1938, was fundamentally concerned with promoting the competitive position o f Swedish firms [Swenson 1991]. While the importance o f competing in international markets certainly have increased in the past two decades, and while the range o f policy instruments at the disposal o f governments have definitely decreased with ever greater interdependence, this has not forced governments in corporatist political economies radically to alter their traditional commitments to high levels o f government spending.
This is not to say, o f course, that the political economy o f the corporatist systems has not changed in the past two decades. Flat tax reforms were pervasive in the 1980s and even the Swedish Social Democrats jumped on the bandwagon [Steinmo 1992]. Moreover,
national regimes o f centralized wage setting and voluntary wage restraint also broke down in the 1980s [Martin 1991]. But the distinctiveness o f the corporatist countries with respect to government spending has endured. W hile the response o f rightist governments in Britain and the US was to try to cut public spending wherever possible, radical surgery on the public economy was not required in the more corporatist systems precisely because governments in these countries had long ago realized that it was possible simultaneously to put a "human face" on capitalism while gearing their economies to compete effectively in international markets.
Endnotes
1. The seminal study remains Hibbs [1977].
2. For example, the most recent encompassing study o f the politics o f the public economy in political science - Hicks and Swank [1992] - ends its analysis in 1982.
3. The countries included in the study are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, Netherlands, Norway, Sweden, the United Kingdom and the United States. Reliable cross-national data on all the variables o f interest were not available for a w ider range o f OECD countries for the entire period. 1988 is the last year for which all the requisite data could be obtained.
4. Conversely, even if there were no flows o f capital across borders, global financial markets might nonetheless be highly integrated if capital were already efficiently allocated between countries.
5. The logic o f this approach is that the weaker the association between domestic savings and investment, the larger the available international sources for domestic investment, and
therefore the greater the integration o f financial markets. Bayoumi [1990] has recently refined this argument by suggesting that the integration o f capital markets is better measured by the association between private (rather than total) savings and investment, given the propensity o f governments to respond to increased capital mobility in private markets with offsetting adjustments in public savings and investment.
6. Data used to derive the relationship between private domestic investment and savings included series on GDP, government consumption, personal consumption, gross fixed investment, change in stocks, imports and exports; these were drawn from OECD (1980 and 1991) as well as IM F (1980 and 1990).
7. Averages for the fifteen countries in this study make up the data presented in Figure 3.
Included are the six main components o f general government total spending (expressed as a percentage share o f GDP): "external" spending (i.e., military and foreign transfers), transfers to households, civilian government consumption, interest payments, subsidies, and
investment. Data are drawn from Cusack [1991].
8. The union density measure is the size o f membership in unions expressed as a percentage of the labor force. Sources for labor force data were presented in an earlier note. In the main, data on union membership were drawn from Bain and Price (1980), Price (1989) and Visser (1989). A large number o f national statistical yearbooks as well as various issues o f The Europa Yearbook were also drawn from. In addition, various national embassies in Bonn provided data for m ore recent years.
9. The electoral and cabinet ideological centers o f gravity scores were constructed on the basis o f a series o f measures. First, for each year the share o f votes received by each party in the most recent national (normally parliamentary) election (analogously for the cabinet measure, the share o f cabinet seats held in the year) were assembled. These data were drawn from Austin (1986), Banks (various issues), The Europa Yearbook (various issues),
Inter-Parliamentary Union (1989), Jacob (1989), Mackie and Rose (1974,1982-87,1991), and Paloheimo (1984). Second, party vote (or cabinet seat) shares were then aggregated into five distinct categories representing the political orientation o f the parties. The five categories include, ultra left (UL), moderate left (ML), center (C), moderate right (MR), and ultra right (UR). Placement o f parties into these categories is based on classification provided by Castles and M air (1984), plus own codings. Finally, using the vote distribution scores (analogously for the cabinet measures), ULVOTE, MLVOTE, CVOTE, MRVOTE, URVOTE, the political center o f gravity measure was calculated. This is Gross and Sigelman’s (1984) weighted mean index (see below) which is computed in the following way:
ICG = 2 7]C;, i - l
where ICG is the ideological center o f gravity, Ti is a party category’s decimal share o f the vote (or o f cabinet se a ts), and Ci is the party category’s position on a left-right ideological continuum, which ranges from 1 for ultra-left (UL) in increments o f 1 to 5 for ultra-right (UR).
10. The center o f political gravity index was calculated thus:
PCG.ht = UDtt - V t , - C l t
where UD is the standardized score on Union Density, V is the standardized Vote
Ideological Center o f Gravity index, and C is the standardized Cabinet Ideological Center of Gravity index. Standardizations based on the observed means and standard deviations o f the indicators across the 15 countries over the period 1960 through 1988.
11. For Australia, see Castles [1988]; for France, see Hall [1986]; for Sweden, see Pontusson [1990].
12. W e are only interested in civilian expenditures and hence have eliminated the defense sector. Interest payments on the public debt have been excluded so as not to bias the results with the historical deficits accrued by governments. Data are drawn from Cusack [1991].
13. DEM is the sum o f the percentage o f people 65 years or older in the total population plus the percentage o f total population counted as unemployed members o f the labor force. The data are drawn from Bulatao [1990], ILO [1977], Maddison [1982] and OECD [1970, 1973, 1983, 1987a, 1990a, 1990b].
14. Relative prices are defined as the government consumption deflator divided by the GDP deflator. The data are from IM F [1979,1980,1981, 1 9 8 6 ,1987b, 1989] and OECD [1984, 1 9 8 7 ,1990c].
15. The unanticipated growth variable subtracts the rate o f GDP growth in a given year from the average rate o f growth for the preceding three years:
UG,= AI2-1 + A52_2 + A ^
3 •100
The data are from OECD [1991]. The indicator itself has been employed by Roubini and Sachs in their 1989 publication on fiscal policy in the OECD countries.
16. As a sector primarily engaged in service functions, government is highly labor intensive relative to the rest o f the economy. Given the tendency for wages across the economy generally to move together, the relative costs o f production in laggard sectors such as public services will tend to increase. Since there is a bias against downward movements in the provision o f public services, this entails the need for greater resources to be pumped into the public sector in order to maintain output levels similar to those generated in more progressive sectors. The ultimate effects o f these divergent movements is for the public sector to expand relative to the rest o f the economy as inflation in the public sector outstrips that in the private sector.
17. Trade is operationalized as the sum o f exports and imports as a share o f GDP. Data are from OECD [1 9 8 0 ,1 9 8 7 ,1990c] and IMF [1979,1980,1981, 1 9 8 6 ,1987b, 1989]. The financial integration measure is the absolute value o f 1 minus the ratio o f private investment to private savings:
1 -
Given the pooled nature o f the data used in this analysis, it was not feasible to deploy the cross sectional regression coefficients reported in the preceding section . The variable used here, however, captures the essence o f the Feldstein-Horioka argument by delineating the disparity between savings and investment (regardless o f which is larger). The data on private domestic savings and investment are from IM F [1980,1990] and OECD [1980,1991].
18. Oil dependence was calculated by multiplying the price o f oil in a given year (in constant
$ US) by the imported oil requirements o f a country (relative to the size o f its economy, in constant $ US). The price data are based on information drawn from various issues o f the IM F’s International Financial Statistics Yearbook and the 1987 issue o f the United N ation’s W orld Econom ic Survey. Data on the net imports o f oil are drawn lfom various issues o f the International Energy Associations publication, Energy Balances o f the OECD Countries.
19. A variety o f estimation techniques are available to use for such a design [see, e.g., Sayrs 1989 and Stimson 1985], In order to control for the impact o f three possible problems, i.e., heteroskedasticity, mutual correlation, and autoregression, we employed the
Cross-sectionally Correlated and Time-wise Autoregressive Model described by Kmenta [1971]. In each o f the three estimations reported in Table 2, there was little suggestion o f the presence o f either o f the first two problems and indications o f autoregressive error in only four o f the countries.
20. This periodization is more elaborate than that used with respect to the changes in political conditions reported in Table 1. The breakdown used here was designed more precisely to capture distinct epochs in the political economic history o f the western countries -1961-1967 represents the end o f the golden age; 1968-1973, the turmoil surrounding labor unrest in Europe and the Vietnam expansion in the US; 1974-1979, the first OPEC recession;
1980-1983, the second OPEC recession; and 1984-1988, the contemporary period - while maintaining roughly equal durations for each sub-period.
21. For a m ore detailed discussion o f the generation and interpretation of interactive models and conditional relationships, see Friedrich [1982] and Lange and Garrett[1985].
22. This may be indicative of the end o f the golden age in which all governments moved away from their traditional partisan policies in attempts to deal with the turmoil associated with the rise o f labor militancy in Europe and the Vietnam-led expansion in the US.
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