Government’s spending surge a threat to productivity

As we get closer to the productivity roundtable that the government hopes will solve all problems, various players are tipping their hand as to what they want the focus to be.

Unfortunately, many commentators on the left have indicated the focus should be squarely on increasing taxation — both to close the existing budget deficit and to fund additional government spending.

It has been clear for some time that the Treasurer is sympathetic to calls for an expanded role for government.

His much–cited essay on the future of capitalism outlined a vision of government returning to the centre of the economy, using taxpayer funds to direct and shape economic priorities.

This is a bad idea; both on its merits, and in terms of its negative impact on productivity.

The fact is government has been steadily growing in both its expenditure and regulatory dimensions for years now and each of these are a drain on productivity.

Focusing on expenditure, a full tally for all levels of government shows expenditure at 38.3% of GDP in 2023-24 and it is likely to have been higher in 2024-25, perhaps approaching 39%.The same measure before the coronavirus pandemic was usually in the range 34 – 35% of GDP.

Pandemic-era spending led to a spike above 40% for two years. However, true to the then–government’s word, most of that spending was temporary.

The huge deficits of that era did leave a legacy in the form of ongoing interest expense on theresulting public debt.

But otherwise, the pandemic can’t be blamed for expenditure now being about 4 percentage points of GDP higher than before it. That is a massive $100 billion plus, every year.

These increases have happened mainly at the federal level, although a good portion of the additional expenditure amounts to the federal government effectively bankrolling state expenditures and responsibilities.

An examination of program expenditure points to the seeds of increased federal spending being sown long ago.

Looking back to 2012-13 we see the rapid growth of expenses on disability support (the NDIS), aged care, child care, schools, public hospitals, pharmaceutical benefits and medical benefits — all programs that have been boosted by new policy initiatives since 2012-13 to roll out new social benefits or enhance existing ones.

The welfare state has been on a roll, but in addition defence and funding of state infrastructure projects have increased rapidly, as has debt interest expense as a result of the budget deficits.

All these programs together accounted for 35% of federal own-purpose expenditure in 2012-13 but for 63% of the dollar increase in annual expenditure up to 2024-25.

Each item has its own story, and we wouldn’t suggest that the growth was all avoidable. For example, some of it reflects population ageing and the increase in defence is a normalisation from a historically low level.

However, the growth in social spending also includes wasteful and ineffective spending.

That growth reflects the priorities of an earlier Labor government, and the subsequent Coalition government largely went along with it or felt they had to.

Unfortunately this political dynamic has created a situation where the main sources of growth in terms of employment and spending in the economy have been focussed in areas that are relatively low productivity (the care economy in particular).

To make matters worse, the current Labor government is doubling down on its previous spending increases in most areas. Aged care, childcare and Medicare are all areas where the government has unveiled substantial new spending commitments.

The government has agreed to increase its share of Gonski school funding. And it has promised or hopes to go further with ‘free’ TAFE and universal child care, while pressures for further increases in defence can be expected.

Of course this additional spending, though significant in its own right, is dwarfed by the growing costs of the NDIS.

The CIS warned long ago that the NDIS was likely to grow far faster than had been predicted at the time. Despite these prescient warnings, both sides of politics have made only modest efforts to rein in the NDIS monster.

Consequently, there are good reasons to be sceptical of rosy predictions of the NDIS cost–curve flattening (although staying at a level well above the growth of the economy) without substantial intervention.

It should be noted as well, despite the rapidly burgeoning costs, many participants and providers in the scheme report dissatisfaction with how the scheme is being managed.

While increases in spending in individual programs and areas are the measure of the increase in the size of government, this is not the root cause.

The bigger issue is the culture of dependency and entitlement has taken root in the population and political behaviour has become only too willing to accommodate and encourage it.

We have reached a point where a sizeable proportion of the voting age population — perhaps more than half — is dependent on government directly or indirectly through social benefits and employment for most of their income.

It is difficult to see the current government reversing this trend without a major change of mindset.

While there is some hope for the broader centre left of politics in movements like the ‘abundance agenda’, left wing parties across the western world have become the parties of higher taxes and bigger government.

Despite the political difficulties, the economic and social consequences of the growth in government spending and dependency on government will have to be faced one day.

The economic consequences include the unrelenting pressure for more deficits and more debt, which will make the economy more vulnerable to future crises and the government less able to respond.

Governments’ insatiable appetite for revenue also creates more pressure for taxes to rise, which in turn saps incentives for work, saving and investment — and thereby potentially compounds the problem of weak productivity growth.

The simple fact is that people respond to incentives. When the incentives encourage innovation, investment and ingenuity, people respond by increasing productivity. Our living standards grow.

However, when the incentives encourage us to fight over the distribution of the pie, even as it shrinks, the rot of entitlement and waste sinks in.

Turning this around will require more than a summit.

Simon Cowan is Research Director and Robert Carling is a Senior Fellow at the Centre for Independent Studies.