Most everyone agrees that economies and societies around the world are going through structural changes of a historical nature, driven by a number of powerful forces including digital technologies and globalization. Over the past two decades, companies, especially large, global companies, have been going through major transformations to help them adapt to these structural changes. In particular, they have embraced digital technologies to improve their productivity while leveraging globalization to better manage their supply chains and reduce their costs.
Over these same period, government has lagged the private sector in improving its productivity and reducing its costs. In a study, The Evolving Structure of the American Economy and the Employment Challenge, which was published by the Council on Foreign Relations in March of 2011, Michael Spence and Sandile Hlatshwayo examined the changing structure of the US economy over the past two decades. Professor Spence is the recipient of the 2001 Nobel Prize in economics. He is currently in the faculty at NYU’s Stern School of Business, as well as professor and dean emeritus of the Stanford Graduate School of Business.
Their study divided the economy into two distinct sectors, tradable, - which includes mostly private sector industries, - and nontradable, - which includes government and a number of government related industries. The tradable sector is the part of the economy most exposed to global competition from foreign companies and suppliers. It includes most manufacturing, agricultural, mineral and energy products, and more recently, many business and financial services. The nontradable sector is the part of the economy that must be produced and consumed locally, including government services, health care, education, transportation, construction, retail stores, restaurants and hotels.
For each sector, they looked at employment statistics and value added per employee, - a measure of labor productivity, - since 1990, when the economic impact of the digital revolution and globalization started to accelerate.
“Employment growth in the U.S. economy between 1990 and 2008 was substantial, on the order of 27.3 million jobs, off a base in 1990 of 121.9 million. Virtually all (97.7 percent) of the incremental employment stems from the nontradable sector. This occurred despite dramatic labor-saving technology in information processing that ran across all sectors of the economy. The leading employment sectors are government and health care, in that order, both on the nontradable side. . . .”
“In 1990, value added per person employed (VAP) in the tradable and nontradable sectors was rather similar, the tradable sector at almost $80,000, roughly $10,000 above the nontradable figure. But the value added per person employed on both sides diverged slowly during the 1990s and then rapidly after 2000. VAP in the tradable sector grew at an average of 2.3 percent per annum, and the nontradable sector at 0.7 percent. By 2008, VAP in the tradable sector was just over 50 percent above that for the nontradable sector.”
In summary, the tradable sector, - which is where you find most private sector jobs, - significantly improved its VAP or productivity, but had negligible incremental employment, primarily because fewer workers are needed to do the same job as a result of the major increase in technology-based productivity, and because a number of jobs have moved to countries with lower labor costs. The nontradable sector, - which includes government and government-related jobs in industries like health care and education, - had virtually all the job growth during this period but significantly lower VAP. While the specific numbers have changed since 2008 given the impact of the financial crisis and subsequent global recession, the overall conclusions remain pretty much the same.
continuing growth of government in advanced economies like the US and Western
Europe is no longer sustainable given their aging populations and slow economic growth, says The Economist in a special report on The Future of the State published in March of 2011.
“How to slim the state will become the great political issue of our times,” is the byline of its introductory article, Taming Leviathan. “The state has kept on grabbing an ever larger share of the economy in the rich world for a century, and the state’s regulatory sweep has increased as well.” As this chart show, the average government spending as a percentage of GDP in thirteen rich world countries went from 10.4% in 1870, to 28.4% in 1960, and 47.7% in 2009.
“ . . . the forces driving this growth are powerful,” it writes, “but so are the reasons why it needs to be halted . . . there are pragmatic grounds now for politicians of all sorts to make the state more productive. With ageing populations to care for, many rich-world governments are on course for bankruptcy - unless they raise taxes to levels that would wreck their economies.”
Why has government grown so much in these advanced economies over the past century? The answers are fairly straightforward. Citizens in these democratic, affluent countries have continued to demand more services from their elected government officials. They want improved education, health care, safety, transportation, and so on. This is all part of becoming an advanced economy and an affluent society.
Even conservative groups, like the Tea Party in the US, which strongly argue that they want to cut back the role of government, reduce taxes, and provide significantly fewer services to everyone, don’t want those services reduced for them and their friends, families and communities. This was best exemplified during the heated debates prior to the passing of the 2010 Health Care Reform bill, where some of the most vociferous critics of health care reform where also demanding keep your government hands off my Medicare. The reality is that most people, even Tea Partiers and other political conservatives, want the government to continue to provide them services, albeit more efficiently, with fewer regulations and lower taxes.
It is also fairly clear that as the standard of living continues to go up in emerging economies, their citizens will demand many of the same government services enjoyed by those in the more affluent economies. Thus, even though the pressures to reform are nowhere near as intense in fast growing emerging economies, they will eventually feel these same pressures as their growth slows down while their government expenses continue to increase.
In my next blog, I will discuss some of the key actions governments have to take to help them adjust to these structural changes in the economy.