Markets & economy

The triumph of the bureaucrats

There is a widespread lament that economic growth is disappointing. While demographics and structural problems are largely to blame, the increasing cost of interventions by governments in economies is also having a significantly adverse effect. Sandy McGregor discusses.

The response to the global financial crisis of 2008 has been a massive increase in regulation and legislation, much of which is having unintended negative consequences. These interventions are seldom subjected to cost-benefit analysis and compliance is becoming increasingly burdensome. There seems to be an inverse correlation between the size of government and economic growth: the bigger the share of government in the economy, the slower the economy grows. Rising productivity and efficiency play an important role in generating growth. Governments, with few exceptions, tend to use resources inefficiently. Transferring resources from the efficient private sector to inefficient government is bad for growth. Accordingly, it is unsurprising that since 2008 growth has disappointed.

The return of big government

These trends are clearly visible in South Africa but they are a global phenomenon. Prior to 1930 in most countries governments were, by modern standards, very small. The Great Depression of the 1930s and the subsequent World War changed all of that. Governments’ share of GDP expanded rapidly until it ultimately became unsustainably large, and the global economy collapsed into a frightening combination of stagnation and inflation. In the 1970s voters in democracies became extremely disgruntled. Tax revolts became the norm. There followed a change in political leadership, which implemented a retreat from excessive regulation and put a brake on the continuing growth of government. More important, globalisation destroyed the power of the nation state to conduct economic policy without regard to economic logic. Inflation was brought under control and growth resumed. Between 1982 and 2008 the world experienced one of its strongest periods of economic expansion driven by new technologies, emerging markets and expanding global trade. This ended in 2008 for developed economies and 2012 for emerging markets. An age of big government has returned.

One of the reasons why big government is bad for growth is that mistaken interventions are not easily corrected. In the private sector a company which makes a mistake either loses money or goes out of business. Government is not subject to this discipline. Indeed, the instinct of bureaucracy is to respond to failure by arguing that it did not do enough. When violence fails, the military argue we need more violence. When the US Federal Reserve or the Bank of Japan’s policy of quantitative easing (QE) failed to restore growth, the response was more QE. When legislation has unintended adverse consequences the response is not to repeal legislation, but rather to pass more laws. Flawed regulations breed more regulations. The process is endless.

Private sector under pressure

Ever-increasing legislation and regulation are placing a growing burden on the private sector. The regulatory environment has become so complex that it is beyond the ability of any individual to comprehend. At one time common laws defining how business should behave were simple, requiring integrity and honesty. Today thousands of lawyers are needed to implement the requirements of Byzantine legislation. As a business has to pass on its costs to its customers, the cost of regulation is borne by the consumer. A growing share of disposable income is going to fund this cost at the expense of what the consumer might regard as preferable.

The complexity of regulation is increasing. Two notorious examples are recent US laws regulating healthcare and banks. Both are about 10 000 pages long and have created employment for many thousands of lawyers. A common feature is that legislators understood little about the laws they were passing. In error, a speech praising US Senator Edward Kennedy was incorporated into the text of the healthcare legislation and no one picked it up. This is a good example of the poor vetting of complex legislation. The response of the bureaucracy to growing complexity is to encourage legislators to devolve their powers to government agencies. Increasingly broad powers are handed over to institutions which are subject to few democratic controls.

In history, devolved powers have often ended badly. The most notorious case is the German Third Reich, which was legally based on the Reichstag’s decision in 1933 to grant Adolf Hitler far-ranging powers to address the nation’s problems. The modern dilemma is that government has become too complex to operate without devolved powers.

Problems on home shores

We see all these alarming trends in South Africa. Government departments promote legislation without performing a cost-benefit analysis. The recent debacle regarding visas is a good example. It was obvious that the legislation would have a negative impact on tourism, the one business sector in South Africa which could potentially produce a lot of new jobs. The outcome was exactly what was expected by everyone except the Department of Home Affairs. Yet it took 15 months to fix this error. Part of the problem is that many government departments lack the skills to analyse the consequences of what they are doing. It is human nature to become defensive about error. In business a failure to admit error invites the risk of financial loss or bankruptcy. Government is not subject to these constraints and can persist in error.

ONE OF THE REASONS WHY BIG GOVERNMENT IS BAD FOR GROWTH IS THAT MISTAKEN INTERVENTIONS ARE NOT EASILY CORRECTED

More and more, as the role of government grows, the success or failure of nations will depend on the quality of their public service. Interestingly France, despite having a government constituting about 55% of GDP, manages to carry on without total disaster. Perhaps the reason why this is possible is that for generations France has recruited the best students from universities to become public servants. China is another example of a country where the best brains end up in government. Given our poor education system, which in itself is an example of uncontrolled government failure, it is difficult to replicate this in South Africa.

One concerning feature of the bureaucratic state is a global trend that the wages of government employees are growing faster than those in the private sector. In South Africa average wages of public servants now significantly exceed those in the private sector. The recent big pay hike for public employees has pushed government finances into a crisis situation where tax increases are probable. Rising salaries have crowded out other expenditures and have eliminated the state’s freedom to pursue other objectives. This is a manifestation of increasing bureaucratic power.

Where to from here?

The private sector adjusts to bureaucratic overreach by expanding into less regulated activities and jurisdictions. For example, increasing restrictions on the activities of banks is changing the structure of credit and investment markets. In response to an increasingly business-unfriendly environment, companies will relocate to more welcoming jurisdictions. As personal taxes rise to fund the government juggernaut, skills will migrate elsewhere. We all pay for the growth in the public sector not only directly through increased taxes, but also through higher costs of goods and services and slower growth and job creation. The burden placed on the economy by increasing government is an important contributor to the current economic malaise.

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