The Government and the Private Sector

“In this present crisis, government is not the solution to our problem; government is the problem…. It is no coincidence that our present troubles parallel and are proportionate to the intervention and intrusion in our lives that result from unnecessary and excessive growth of government.”

Ronald Reagan’s First Inaugural Address, January 20, 1981

Every so often, I like to check things that everyone knows are true. Its amazing how often it turns out that something we all know is true doesn’t seem to mesh with the data for some reason.

One thing we all know to be true, at least those of us who are from the good old US of A (I know there are some of them foreigner people that read this blog, and I suspect one or two of them may even be French!) is that the private sector is more efficient than the public sector. Presumably this means that the greater the government’s share of the economy, the slower growth (say, growth in real GDP per capita) will be.

Well, this is self-evidently true, but let’s plug in some numbers, just for grins. Everything we need is available from the BEA’s NIPA Tables.

Table 1.1.6 gives us data on Real GDP and its components (including total federal plus state and local Government consumption expenditures and investment). From this we can determine government’s share of the total economy. Going back to 1950, this figure hit a peak of about 34.33% in 1953, and bottomed out at 17.53% in 2000.

(I note that post-Gerald Ford, government’s share of the economy rose as high as 22% three times. Each time was under Ronald Reagan, and the last time was in 1986. So much for Ronald Reagan being a small government kind of guy compared to, say, Jimmy Carter.)

Government shrunk as a percentage of the economy every single year under Clinton, reaching a minimum of 17.5% in 2000. Since then, its had ups and downs, and in 2005, was at about 17.7%. (Obviously, given the massive growth in the Federal budget under GW, that’s due mostly to state and local government shrinking relative to the economy as a whole.)

NIPA Table 7.1 gives us real GDP per capita, from which we can compute annual percentage change in real GDP per capita.

The table below shows the correlation between real annual percentage growth rate in GDP per capita, and government as a percentage the economy in period t-X.


Now, this is simplistic a simplistic analysis, but ten to 25 years out, spending by the private sector is not more likely to lead to growth than spending by the government, and in fact, the opposite may well be true. (I note that using more sophisticated tools a few years back doing something similar, I got similar results.)

Possible reasons why this result might be observed:

1. It could all be an illusion. A different period of time might show different results. Long time readers will note I simply picked the time period I normally pick when the data is available. I start at 1950 to give the economy enough time to get over the effects of the Great Depression and WW2, which were special cases if there were any.

2. Government spending may be more geared toward the long term. Spending on education and infrastructure, for example, take a long time to pay off.

3. Government spending is geared toward institutions that are necessary for the long term functioning of the economy. Even the DMV, which is always exhibit A of inefficiency, is never privately run – perhaps because doing so is difficult. Eliminate the DMV and society can continue relatively unchanged for a year, or two… but eventually things break down.

4. Market failures mean the profit motive creates private sector incentives that are inefficient and violate the Invisible Hand outcome – creating excess pollution and otherwise imposing private costs on third parties, generating paperwork rather than output (e.g., think the health insurance industry), etc. Arguably, a significant part of the legal and accounting industries are geared toward increasing deception and obfuscation, and often these are among the most lucrative private sector careers open to a lot of people.

5. In the private sector, there is often more gain to exploiting short-term inefficiencies that might well disappear by themselves anyway than there is to producing anything real, which is a tremendous waste of resources. (Think number of stockbrokers.)

6. The private sector is made up of people. People are lazy in the private sector just as they are lazy in the public sector.

Two additional commentaries about the these results

1. These results are for the US, for the range of government to private sector observed in the data. Anyone who tries to extrapolate from this that having the US government run the entire economy will be more efficient is a fool. At what ratio of government to private sector do we start seeing more government sector inefficiencies and fewer private sector inefficiencies? Well, who knows? That would require a lot more work, and this is an unpaid hobby.

2. It may be that with different accounting rules, private sector spending’s advantage over government spending (note the extremely low correlations) might disappear altogether. Government spending appears in ledgers at cost whereas private sector spending includes improvements made. This accounting artifact makes private sector spending look more efficient than it is in the short term.

Since today I seem to be enumerating, let me try enumerating one more thing… why do we believe in this private sector is efficient myth? I can think of a few reasons offhand:

1. The Private Sector accounts for over 80% of the economy. Most people work in the private sector. We have a vested interest in believing we’re better than the alternative.

2. The media, which tells us how everything works, is in the hands of the private sector. They have a vested interested in believing the private sector is better than the alternative.

3. Media’s advertisers are in the private sector. They have a vested interested in all of us believing the private sector is better than the alternative.

4. One of the purposes of government is to set rules and correct market failures. But a very, very big part of the private sector is geared specifically toward finding ways around those rules and exploiting market failures. Criticizing government is a way to justify such anti-social behavior, or at least focus attention elsewhere.

Your thoughts?

(Update… Corrected correlation between Gov’t as a pct of the economy at t-1 and growth at time t.)

(Update 2…. I forgot to mention… as always, if you want my spreadsheets, just drop me a line.)