Close up beer
It was recently reported that over 50 pubs a week were closing as a result of an increase in beer tax. There seems to be some surprise that private sector economic activity is reducing (ignoring the temporary effects of the recession). However, this is an inevitable result of public sector economic activity rising.

In the last few years there has been a transfer of national income from the private sector to the public sector of about 10% of total national income (therefore of about 20% of the private sector). This has come in two forms. Some of the increase in government spending has arisen as a result of increased welfare payments. This has no direct effect on private sector production because money is simply being transferred from one group of consumers to another: government production is not increasing. However, the welfare recipients will spend the money on different things from those that taxpayers who are paying increased taxes would have bought. Therefore there are additional disruptions to the normal dynamic process of changes in preferences leading to different goods and services being required to meet demands. This is a problem but not necessarily serious.

However, a good proportion of the increase in government spending is being spent on services – especially health and education. This involves a direct transfer out of private sector spending, and ultimately production, to public sector spending and production. There are lots of complexities and leads and lags but, ultimately, a substantial part of private sector production must completely shut down in order to release the economic resources necessary to provide more schools and hospitals (or, strictly speaking, largely more bureaucrats and administrators). The fact that pubs are closing down directly because of a beer tax is simply a more obvious mechanism than the less obvious mechanisms that occur when the state bids in the labour markets for more resources thus raising costs for other employers, ultimately leading to a reduction in private sector production.

Philip Booth 154x154

Academic and Research Director, IEA

Philip Booth is Academic and Research Director at the Institute of Economic Affairs and Professor of Finance, Public Policy and Ethics at St. Mary's University, Twickenham. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. Previously, Philip Booth worked for the Bank of England as an advisor on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs and on the editorial boards of various other academic journals. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

4 thoughts on “If the state expands, the private sector must shrink”

  1. Posted 24/07/2009 at 10:28 | Permalink

    Clearly if we express the ‘private’ sector and the ‘public’ sector (and maybe other ’sectors’ too) as a percentage of ‘the economy’, in total they will add up to 100 per cent; and if one percentage grows another (or others) must shrink.

    But if the whole economy grows, then both the private sector and the public sector can increase in ‘absolute’ terms. Indeed this is what has happened in the last two hundred years. Didn’t a political party promise (until recently) to ’share the proceeds of growth’?

    Does it matter? I suspect not much. By most ‘measures’, price controls don’t seem to increase the ’size’ of the state; but my goodness they increase its power. That is what most concerns me.

  2. Posted 24/07/2009 at 10:28 | Permalink

    Clearly if we express the ‘private’ sector and the ‘public’ sector (and maybe other ’sectors’ too) as a percentage of ‘the economy’, in total they will add up to 100 per cent; and if one percentage grows another (or others) must shrink.

    But if the whole economy grows, then both the private sector and the public sector can increase in ‘absolute’ terms. Indeed this is what has happened in the last two hundred years. Didn’t a political party promise (until recently) to ’share the proceeds of growth’?

    Does it matter? I suspect not much. By most ‘measures’, price controls don’t seem to increase the ’size’ of the state; but my goodness they increase its power. That is what most concerns me.

  3. Posted 27/07/2009 at 15:34 | Permalink

    Unfortunately, within the current system, we have no way of knowing how people really trade off pubs against hospitals. It is quite possible that if health and education were removed from the government’s hands, the share of the economy dedicated to these areas would be higher than they are today – though, of course, it would be very different health services and very different education services that would be provided. Currently, it is hard to ‘top up’ the government package; in some cases, it is even explicitly forbidden (e.g. privately purchased medicines combined with an NHS treatment).

  4. Posted 27/07/2009 at 15:34 | Permalink

    Unfortunately, within the current system, we have no way of knowing how people really trade off pubs against hospitals. It is quite possible that if health and education were removed from the government’s hands, the share of the economy dedicated to these areas would be higher than they are today – though, of course, it would be very different health services and very different education services that would be provided. Currently, it is hard to ‘top up’ the government package; in some cases, it is even explicitly forbidden (e.g. privately purchased medicines combined with an NHS treatment).

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