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Some simple economics of growing government
There are three basic, and fairly benign or at least unavoidable reasons why government tends to grow when societies get richer and more complex.

Baumol's law
First, there is the simple fact that much of the public sector consists of services where its difficult to raise productivity. Industry can raise productivity much easier and therefore it can also pay higher wages. If labor productivity rises at 3% a year wages can also rise at 3% a year without raising labor cost.

In much of the public sector, it isn't possible to do this. How would you raise labor productivity in defense, police, education, stuff like that. So then there is a choice, either public sector wages grow much lower (or not at all), which in the end isn't tenable as nobody would want to work in the public sector anymore, or wages rise grosso modo at the same rate, but this makes the public sector more expensive. 

So basically there is an automatic tendency of the public sector to grow disproportionally.

Information asymmetries
When economies become more advanced, knowledge is ever more specialist, labor ever more divided and society becomes disproportionally more complex. Markets tend to cope less well with complexity, basically because they depend on buyers to make informed choices for the price mechanism to work well. That becomes increasingly hard if what you buy isn't a simple commodity, but a product or service whose qualities are difficult to assess first hand.

This fundamental shift often result in so called information asymmetries, situations in which one party of a transaction knows much more than his/her counterpart. The danger is that these information asymmetries are opportunistically exploited by the party with the information advantage. 

The classic example is the market for lemons, an article written by George Akerlof (for which he received the Nobel price in economics). It's the market for second hand cars. Second hand car dealers generally know more about the cars they are selling, and some have a tendency to exploit this information advantage. 

The problem is that buyers are often unable to distinguish a good from a bad second hand car, and therefore they're not willing to pay a premium for a good second hand car. This leads the market to settle on a sub-optimal outcome in which bad cars (lemons) chase good cars out of the market because owners of good cars are unable to find people willing to pay a premium price.

Now, there are market solutions available, like warranties, money back guarantees, stuff like that. But these add complexity of their own in the form of additional transaction cost (the drawing up of contracts and clausules, negotiating, recourse to courts in case of disagreements, etc.). 

The problem is very general in advanced economies. Just a few examples:
  • People do not know whether the food they eat contains risks and the producers often have little incentive to tell you or vehemently deny that there is a problem (cigarettes, sugar, trans fat, additives etc.). Market fundamentalists invoke 'free choice' but this can easily evolve into the freedom to be conned.
  • People often do not know whether their doctor, dentist, lawyer is the best, or even sufficiently qualified, or actually whether he/she even works in their best interest and in general it's difficult to assess their quality before entering into a relationship with a doctor, lawyer, etc.
  • For instance, you might want to read about pervasive problems with financial advisers
  • Do you know you've bought the cheapest flight, the cheapest hotel room, etc.
  • Do you think the medicine you're taking is effective, doesn't have side effects, etc. Market fundamentalists who are against government and regulation might want to think twice before they abolish the FDA. There are already enough quacks selling very dubious stuff to desperate people.
  • We could argue the same for the SEC, abolish it and the NYSE and Nasdaq will quickly turn into the bulletin board or pink sheets, where you basically cannot trust any security.
Changing preferences
As people get richer, their preferences change. Additional dollars for private spending start to run into the law of decreasing returns at a certain point. More importantly, as people get richer they start to place more importance on stuff like a safe environment, on healthy products, on a cleaner environment, better schools for their children, better healthcare, etc. all sectors which make disproportionate claims on the public sector (through regulation, justice, law enforcement or direct government involvement).

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Some simple economics of growing government - by stpioc - 03-11-2016, 02:01 AM

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