Where should we be spending?

Tom McDonnell04/08/2010

Tom McDonnell: The current economic crisis has centred attention, in some parts, on the affordability of the current levels of public spending in Ireland. Much less attention is given to where this public money is actually spent, yet other OECD countries have very different breakdowns of spending to Ireland. At the macro level the breakdown of spending in Ireland has remained unchanged since at least the early 1990s and this suggests there hasn’t been any serious reflection given in Ireland to what it is we should be prioritising. For example, there is an abundance of economic literature pointing to the long term value of education spending, yet education spending has remained unchanged as a proportion of GDP since 1995. Should we therefore be giving greater priority to education spending at the expense of other public services? It doesn’t appear that much consideration is given to issues like these and the general practice at budget time is for across the board increases in good times and across the board decreases in bad times. Ireland can no longer afford to be so laissez-faire about how we prioritise spending.

OECD data (Table 1) shows the comparative level of government spending as a proportion of GDP during the Celtic Tiger years, for Ireland and for a selection of other Western European countries. What the data shows, is that before the onset of the economic crisis, public spending was low by Western European standards. Even if we measure public spending as a proportion of GNP, instead of as a proportion of GDP, we find that public spending was still lower in Ireland than it was in the EU 15 overall.

However, focusing on aggregate public expenditure by itself only reveals so much information. Table 2 shows the breakdown of public spending in Ireland, in 2008, by functional type. The ten categories shown in the table are those of the United Nations COFOG (category of the functions of government) system of classification. The underlying data is extracted from the OECD website.

As table 2 clearly highlights, social protection measures made up by far the largest proportion of overall public spending (33 per cent) in 2008, this was followed by health spending (19 per cent) and then education spending (13 per cent) and spending on economic affairs (13 per cent). Defence spending and cultural spending were the least costly of the ten categories of expenditure.

The set of pie charts reveals the breakdown of public spending in a selection of OECD member states for 1995 and for 2008. The big shift in the composition of public spending in Ireland over this period, was a movement away from spending on general public services (down from 17 per cent in 1995 to less than 8 per cent in 2008) and towards health spending (from 14 per cent in 1995 to 19 per cent in 2008).

The reduction in general public service payments is simply a reflection of Ireland’s ever reducing debt interest burden over the course of this 13 year period. With regard to health spending, the charts show that it had increased as a proportion of total spending for all six countries.

There is clearly a wide divergence in the overall levels of public spending in these countries. But it is also useful to note the wide divergence in the priorities accorded by the different countries to the various functions of government. This reflects the absence of any universal consensus about the appropriate role of government. The composition of public spending in any individual country, as well as the aggregate amount of spending, can be seen more as a matter of choice rather than a matter of agreed technical efficiency.
For example Germany devotes over 45 per cent of public spending to social protection measures, whereas the United States devotes just 19 per cent of public spending to social protection measures. On the other hand the United States allots the highest proportion of overall public spending to education (16 per cent) and Germany the lowest proportion (9 per cent).

Geopolitical considerations can also skew the composition of public spending; for historical reasons both the United Kingdom and the United States treat their military and their defence industry as active tools of state policy and consequently defence spending is given a much higher priority in these countries than it is in Ireland. On the other the relatively high priority accorded by Ireland to economic affairs (13 per cent) is better understood as ‘catch up’ when we consider Ireland’s infrastructural deficit compared to other advanced economies. By comparison, Belgium, with a much more mature infrastructure network than Ireland, devotes only 5 per cent of public spending to economic affairs.

The point here is that the appropriate levels of public spending, and the prioritisation given to certain functions of government, are not independent of the political, historical and economic contexts of different countries. As the context changes the appropriate level and composition of public spending will also change.
In this light we can see that the general context in Ireland post 2007/2008 is one of economic collapse and rising unemployment. The result of this was that in 2008 the level of public spending exceeded 40 per cent of GDP for the first time since 1995. Needless to say as GDP and unemployment have continued to move in opposite directions, the public spending ratio has continued to increase. However to look at the public spending ratio in 2010 is misleading because it captures the extreme negative edge of the economic cycle. Instead it is more informative to look at levels of public spending over an entire economic cycle, and over the economic cycle Ireland has had a comparatively small public sector.

Returning to the composition of public spending in Ireland, it is interesting to note the similarities in the breakdown of spending in 1995 and 2008. For example, despite an interim period when the public spending ratio was reduced by a quarter, we can see that social protection measures took up almost exactly the same proportion of national output in 2008 (13.8 per cent) as they did in 1995 (13.7 per cent). Education spending was 5.3 per cent of GDP in 1995 and in 2008. Public order & safety also remains practically unchanged at 1.9 per cent. There therefore seems to be a degree of consistency in the prioritisation given to different areas of spending. General public services was the only area of public spending to decline by more than 1 per cent of GDP, and as mentioned earlier, this change is merely a reflection of Ireland’s reduced debt interest obligations. Health spending which had been particularly badly affected by the public sector cuts of the late 1980s and early 1990s was the only area of public services that increased its share of GDP by more than 1 per cent from 1995 to 2008.

What all this suggests is that there has not been a fundamental rethink or serious reflection upon about how best to prioritise public spending between the different functional areas of public service. Rather there seems to have been a general attitude of increase each spending in each department by x per cent when times are good and reduce spending in each department by y per cent when times are bad. This is not good enough and Ireland can no longer afford such unthinking decision making. There is no reason to assume that what suited Ireland in 1995 or 1955 is in any anyway appropriate for 2010. It is time for Ireland to take public spending seriously.

Posted in: Politics

Tagged with: public spending

Dr Tom McDonnell

McDonnell, Tom

Tom McDonnell is senior economist at the NERI and is responsible for among other things, NERI's analysis of the Republic of Ireland economy including risks, trends and forecasts. He specialises in economic growth theory, the economics of innovation, the Irish and European economies, and fiscal policy. He previously worked as an economist at TASC and before that was a lecturer in economics at NUI Galway and at DCU. He has also taught at Maynooth University.

Tom obtained his PhD in economics from NUI Galway.


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