Health care and the size of the state

First insertion on Heterodox Gazette Sam De Wolff: 5 november 2018

E.A. Bakkum is a blogger for the Sociaal Consultatiekantoor. He loves to reflect on the labour movement.

The problem of the structure of health care is described, notably the adverse selection and the moral hazard. Next the optimal size of the state budget is studied. Empirical time series of the state ratio are presented. Various factors increase the ratio. The law of Wagner and the Baumol effect are explained. It is also explained, that various social groups are rent-seeking. This is true for citizens, politicians and the state bureaucracy.

Recently the Gazette has studied various important state activities. First the general theory of the social security was explained. Such public services are the pillars of the welfare state. Next the principles of the pension system and social benefits were presented. Recently the primary, secondary and higher education have also been studied. In this series a description of health care is still missing, and the present column fills this lacuna. For the contents the books The economics of the welfare state (in short EW), Economics of the public sector (in short EP), De architectuur van de welvaartsstaat opnieuw bekeken (in short AW), and Öffentliche Finanzen in der Demokratie (in short OF) have been consulted1.

Health care

Health care supplies medical services to individuals, aiming to prevent and cure illness. In this column this is succinctly called care, and emphatically here various forms of social assistance (youth care, family care and the like) are excluded. In principle care is not a public good, because it is supplied for individual consumption. In this regard it can be compared to education. Nevertheless, care has various positive external effects. Some care reduces the risk of contagious diseases (p.264 in EW). And care keeps individuals productive, which furthers the national activities (EW 265). Empathy can bring about, that people want to help sick persons in general (EW 264). The state can use such arguments for justifying interventions in the market for care.

Insurances of health care

The insurance of the costs of health care is unavoidable, because only wealthy people can pay them by themselves. Care can be provided by means of private markets. Therefore in this column the patient is called a customer. The insurer uses the actuarial method for calculating the costs (contribution) for the insurance (policy). The actuarial method has the advantage, that each customer buys the policy, which matches his needs. The health care in the United States of America (in short USA) is based on this method, albeit with various exceptions (EW 262, 273)2. The necessity to insure the costs for care is an important cause for the problems on the market for care. For instance, chronical diseases can not be insured, because the future costs are already known. Since most ill persons can not cover these costs, the state must subsidize them (EW 268; OF 441, 444). Perforce the state intervenes in care.

Individuals can be divided in "good" (profitable) and "bad" (loss making) risks, dependent on their health. When an insurance for the costs of health care is effected, the customers are tempted to conceal their physical deficits. Therefore the insurer misses information. This phenomenon is called adverse selection. Adverse selection has as its consequence, that the private market fails. For, the insurer is not capable of differentiating the height of the individual contributions in accordance with the expected future costs. The economist C.B. Blankart has invented a solution for this. The starting point is, that each insurer calculates a contribution, which is based on the risks of the population as a whole. The insurer maintains a customer file, which describes the health history of each customer (OF 440).

Now, according as the real risks of the customer become clear, the insurer reserves a fund for covering the expected costs of sickness for this customer (OF 446 and further). The funds of the "bad" risks are covered by those, who turn out to be a "good" risk. However, private markets require, that the customer is free to choose his supplier. And now an individual with a "bad" risk kan not simply change to another insurer, because his present contribution does not cover the costs. Since the risk is known, the new insurer wants to calculate a higher contribution. This policy, where the insurers only accept healthy individuals as their customer (or at least the profitable ones), is called cream skimming (EP 318).

Blankart proposes to solve this by coupling the customer to his reservation fund. When a customer changes to another insurer, he can take along his reservation fund with him to the new supplier (OF 448). Then the contribution can remain the same. In this manner the private market can yet survive. The "good" risks kan simply change to another supplier with a lower contribution. Thus the reservation funds are paid mainly by the younger insured customers, who still have a clean file. Incidentally, in all existing health care systems the younger customers pay for the expenditures of the old ones (OF 446). Nevertheless, when your columnist understands Blankart well, this system of transferable reservation funds has never been tried in practice. Therefore the practical results are unknown. According to the economist J.E. Stiglitz the customer file significantly raises the transaction costs3.

Many states prefer a health care system, which makes the inclusion of certain treatments in the insured package compulsory (OF 440). The insurer must offer this package in a policy with a uniform contribution, without differentiation (OF 449 and further). This universal system is not optimal, because it forces healthy individuals (the "good" risks) to have an excessive insurance (OF 451). This incites individuals to omit their insurance. Therefore the state dictates this as an obligation (OF 446). For, it is morally unacceptable to refuse to supply health care to the uninsured individuals. Thanks to the obliged insurance free riding is prevented (OF 446). The state can compensate insurers, which have an excessive number of "bad" risks among their customers, for this (OF 450).

A variant of the fixed contribution is the income-dependent contribution (OF 453 and further). Then the state usually collects the contributions, and pays the insurers from this fund. When care is paid out of the yield of taxes, then the contribution is actually also dependent on income4. In such situations the care system is used to redistribute incomes, albeit in kind. Strictly speaking this is not desirable, because it further weakens the relation between needs and payment (the principle of benefit). However, the economist N. Barr believes, that redistribution in kind is advantageous, in comparison with a redistribution in money. For, then the hurt citizens (those who contribute) can be sure, that their money is indeed spent for improving the health of their fellow-men. This can be a mental reward for them (EW 265). On the other hand, such a redistribution is rather paternalistic.

Moral hazard

A problem in care is de situation, where the customer can change the probability of the risk or the incidental loss, for the benefit of himself. This is called a moral hazard (opportunism). An example is the lost wage due to a planned pregnancy. Indeed in the age category between 20 and 45 years the costs for care are much higher for women than for men (OF 454). Yet they both pay the same contribution. Incidentally, the moral hazard created by the customer is limited, because he is not a good judge of his own needs for care (EW 257, 263, 267, 287; EP 309; OF 440)5. Unfortunately this faulty knowledge also implies, that the customer does not really know his own preferences. Therefore the demand on the market is actually dictated by the supply (OF 440).

Picture of compensated demand curve
Figure 1: Compensated demand curve
    and social welfare loss

Nowadays the need of the customer for information is recognized by the state, and he tries to make the market more transparent by spreading information about the suppliers (EW 259; EP 309; OF 443). This is an important improvement. The state naturally also supervises the offered quality, and regulates it. This all reinforces the position of the customer. But yet the customer remains dependent on the physician, who advises him and sells his services (OF 440). The relation is more based on trust than on a market exchange6. Since the physician is often paid for his performance, he is inclined to push the supply upwards (EP 320; OF 441, 454; AW 421). The physician will intervene medically more often than is necessary. It is of course possible to reward the physician with a fixed wage, but this would reduce the incentive to perform7.

The need to cover the costs for care with an insurance reinforces the moral hazard. For, then the insurer pays as the third party in the transaction8. The customer loses the incentive to check the offer of the physician. For, an unnecessary treatment will hardly raise the contribution. The physician and his customer both tend to engage in over-production of care (EW 258, 267; EP 311, 314; OF 441)9. The over-production and -consumption of care reduce welfare, because the customer does not really want to pay for it. Insurers try to temper the over-consumption by asking a personal contribution of the customer for each treatment, or by giving no-claim reductions (EW 276; EP 306, 315, 319).

The figure 1 shows in green the compensated demand curve p(Q) of the customer. It represents the value p, which the customer attaches to an extra unit of care, when he has already received a quantity Q of care. Suppose the total product price is π and the personal contribution is ε, with ε<π. In this case the personal contribution leads to an increase of the consumer-surplus, but the costs for society are larger (EP 315). The red area in the figure 1 is the social welfare loss due to the (small) personal contribution10.

The state combats the moral hazard by imposing an upper boundary on the budget of health care (EP 276; OF 454)11. However, the politicians are pressurized by interest groups, which want to raise the budget (OF 461). They are rent seeking. It turns out that in this manner the costs for care become uncontrollable, at least as long as politics intensely interferes with the execution. The general interest is lost in the struggle for individual interests. Therefore, since the start of the eighties of the last century there is a search for other forms of organization in care (and incidentally also in various other policy fields)12.


The preceding text has shown that care is exchanged on the market. However, each market has its own peculiarities. The problems on the market for care are also found on other markets, but not with the same intensity. The regulation of the market for care, partly by the state, is inevitable. The intervention changes the interaction between demand and supply. The intervention is rigorous to such an extent, that the term quasi-markt is used. This constructed market aims to increase the efficiency of the supply, notably by means of competition (EW 287). The demand on the quasi-market partially originates from public funds (EW 287). However, demand and supply are separated, and decentralized whenever this is possible. The customers can themselves determine their supplier. This system has some similarity with the distribution of consumption vouchers (EW 287).

Competition in health care can be created by various constructions, both in the health insurance and the medical treatment. A way to curb the moral hazard is the integration of the insurer and the physician (EW 168). For, the physician-insurer must keep the contribution low in order to remain competitive. The physician-insurer does create the moral hazard of reducing the quality of the supply (EP 323). Nevertheless, this solution has been chosen in the USA. The English reform of health care since 1991 has also created room for such organizations13.

The size of the state

This paragraph again consults the books, mentioned in the previous paragraph. Besides, knowledge is obtained from Économie et finances publiques (in short EF), Public choice III (in short PC), and Political economy in macroeconomics (in short PE)14.

Time series

During the second half of the nineteenth century the industrial proletariat became discontented with its living conditions. The free markets of unbridled capitalism undermined the social well-being. The discontent was expressed in collective ideologies, such as socialism and the christian democracy. They wanted to control the economy by means of the state, possibly together with social organizations, in corporatism. Thanks to deliberations and planning an optimal economic order, which takes rational decisions based on facts, could perhaps be realized. However, during the twentieth century the experiences with state planning were disappointing (EF 222, 392)15. Apparently the unbridled expansion of the state and other collective organizations is not the solution to the complaints about private markets. Therefore in the last quarter of the twentieth century the question rose: what is the optimal size of the state?

Graph of state ratio in five European states
Figure 2: State ratio γ and social insurance Z/Y
    for the Netherlands, Belgium, Germany, France,
    and the United Kingdom. Source: Eurostat

Before elaborating on this question, a measure for the size of the state must be defined. Let G be the size of the state expenditures and Y the size of the gross domestic product. A useful measure is the state ratio, which is defined as γ=G/Y (OF 150; EF 437). The variable G also includes the transfers O by the state, such as subsidies and benefits16. When these are excluded, then one finds the real state quote ρ = (G-O) / Y (OF 150). The values of G and Y can be calculated by means of the market prices of products and services. Here a problem is, that many public goods do not have a market price. Therefore the value of G is commonly calculated by means of the factor costs. This is the sum of all rewards for the production factors (labour, capital, land), which are needed for the production of the public goods. Generally the calculation of the private production Y − G does use the market prices (OF 150)17.

The figure 2 shows time series of the state ratio γ for the Netherlands, Belgium, Germany, France, and the United Kingdom18. In the considered period 1990-2017 the values of γ are between 35% and 57%. The graphs show, that some states prefer a clearly larger size of the state than others. Apparently this is determined by the development of the national institutions. There is a path dependency, which merely allows for limited fluctuations of γ (EF 227). For instance the Belgian and French corporatism lead to a high state ratio (AW 441). Also take notice of the increased state expenditures since 2008, which aim to combat the consequences of the financial crisis and the following crisis of national debt. In the graphs this is only apparent as a ripple. The United Kingdom has relatively the strongest intervention, but also here the old level has been attained in 2017.

The figure 2 also shows the size of the social security Z (as dashed graphs), with the exclusion of the transfers in kind. These data for the same five mentioned states also originate from Eurostat. The values of Z/Y vary between 10% and 20%. Also here the largest differences occur when comparing states, and not in the time series of the separate state. For each state Z/Y is almost constant for the considered period, except for a ripple around 2008. The social security is also strongly determined by the institutions, and can not simply be changed. The difference (G-Z)/Y has values between 30% and 35%. Since there are various other transfers, also in kind, the real state ratio ρ is less. The German ρ is merely 13% in 2009 (OF 153)19. In any case it can not be concluded from the figure 2, that the transfers evolve differently than the production of public goods.

The social institutions evolve quite slowly. A period of a quarter of a century, such as in the figure 2, is too short for studying the national evolution. Therefore the figure 3 shows the same variables γ and Z/Y (or a similar transfer) for a longer period, namely a century (1900-2005). Such time series can not be found at Eurostat or the OECD, so that your columnist had to consult his own sources. Unfortunately each of these sources only gives the time series for a single state. Therefore the figure 3 gives a reliable picture of the development in time for each state, but not the differences between the states20. The essence of the figure 3 is, that during a century a big change occurs for each state. The institutions radically change. Notably during the First and Second Worldwar the state ratio expands significantly. Between 1960 and 1980 there is again growth, followed by a stabilization21.

Graph of state ratio for five European states
Figure 3: State ratio γ and social security Z/Y
    (or a similar measure) for the Netherlands, Belgium, Germany,
    France, and the United Kingdom.

The figure 3 illustrates, that a state ratio of 35% or (much) more is not strictly necessary. Moreover, the experiences of the Soviet Union have shown, that a state ratio of 100% slows down economic growth. It is generally assumed, that there is an optimal value of γ, where the economic growth gY peaks ("inverted U form": EF 455; PC 549 and further)22. However, the optimal γ could differ for poor and rich states (PC 550). Politics must carefully search for the optimal size of the state. In the figure 3 the various transfers have about the same growth rate as the state ratio of the concerned state. Apparently both the need for public goods and for transfers increases. But a large state also has disadvantages (EF 435). For, the state imposes various contributions on its citizens. Thus the citizens can no longer freely and at will dispose of their income, for instance for economic activities.

Causes of state expansion

Science gives insight in the optimal size of the state. Notably, much research has been done on the causes, which have led to the continuous growth of the state. When the causes of this growth are understood well, then the less desirable growth factors can be suppressed, so that the damage to the economic performance can be reduced, and the optimum is approached more closely. The present paragraph sums up a number of growth factors. The starting point is that G is a function of the income Y, the size N of the population, the national preference U for public goods, and the price τ of the public goods (OF 161; PC 507; PE 680). However, egoistic motives for obtaining rents can also make the state grow. In the past years the Gazette has regularly paid attention to such behaviour, based on self-interest. It is sometimes difficult to clearly distinguish between the group interest and the commonly shared preferences.

The law of Wagner

Already in 1876 the German economist Adolph Wagner predicted, that the state will grow faster than the economy (OF 141; EF 439)23. According as the citizens become more wealthy, their need for collective goods rises, such as infrastructure and regulations. The social security also is an indispensable part of industrialization (PC 508). It is a luxury good (EF 439). In a broader sense redistribution can be interpreted as a part of social security (PC 507, 530). Your columnist believes that the law of Wagner is credible. Expressed as a formula the law implies, that the elasticity of income of the state size satisfies εYG = (∂G/∂Y) / (G/Y) > 1. According to some economists this is indeed the case (EF 215, 439), but others believe that nowadays one approximately has εYG = 1 (OF 162; PC 509; PE 680). When the latter group is right, then the demand no longer justifies a rapid state expansion. Incidentally, even with a stable size G the state can always shift between policy fields.

Picture of optimal state ratio's
Figure 4: Optimal state ratio's for
    low, middle and high development

The value of εYG gives no information about causality. Not all G is a luxuy good. Wagner already suggests, that the state (G) may be a production factor (EF 440). For instance, education, health care, infrastructure and scientific research raise the labour productivity (EF 393, 449-450). Markets can benefit from the constitutional state and from various institutions (EF 451; PC 546). It has been suggested, that the expanding branches of services prosper thanks to state interventions, because these reduce the transaction costs (PC 522). Regulation curbs the natural monopolies, and restricts competition, for instance in order to eliminate negative externalities (EF 229; PC 506; PE 678). And redistribution furthers the social cohesion and political stability (EF 452; PC 546). It has an added value for the citizens (PC 516). Then the citizens will increase G, until the marginal product ∂Y/∂G equals the marginal costs τ of the public goods.

Recently, globalization affects G. On the one hand, the global competition enforces low taxes, in order to keep the prices of the export products low (OF 174)24. On the other hand, globalization requires a lot of regulation (EF 216). And it increases the economic uncertainty, because a deficit on the balance of payments can emerge due to the worsened terms of trade (PC 507). Subsequently this global conjuncture must be moderated by means of the social security (OF 174; EF 444; PC 508). It turns out empirically, that open economies with trade risks have indeed a relatively high state ratio (PC 507). Especially corporatist states are attached to income security (OF 174). This suggests, that the value of γ with an optimal economic growth gY differs for each type of state. The figure 4 distinguishes between lowly, moderately and highly developed states, and shows that a rising development leads to a higher optimal state ratio (PC 549-550)25.

Thus the law of Wagner has a productive and a consumptive side. The production Y requires a state G. But the citizens themselves also need G. In the end, in a democracy the voters determine the size G of the state (EF 456). The electorat is sometimes divided in the underclass, the middle class and the upper class. Generally, the underclass prefers a lot of G, and the upper class wants to restrict G. The median voter determines the standpoint of the majority (OF 118; EF 212; PC 514). Thus the middle class has a key position, because it can choose between coalitions with the underclass and the upper class (PC 515, 519). This model of the median voter reminds of the MAR theory of the social psychologist Mauk Mulder.

The Baumol effect

The size of the state is partly determined by the price elasticity of the public goods, namely ετG = (∂G/∂τ) / (G/τ). Here the price τ is somewhat artificial, because generally public goods are not supplied by the private market. The tax rate must be interpreted as a price. When G is measured physically (say, in units), then obviously ετG is negative (PC 507). Nonetheless, when ετG lies between -1 and 0, then the state ratio (in money) will rise with a rising price τ (EF 442; PC 507). The reason is, that G in the state ration is expressed as a monetary sum, and therefore includes τ. It turns out empirically, that |ετG| is (physically) probably indeed less than 1 (PC 510, 511). This conclusion leads to the so-called Baumol effect, also called the cost disease of Baumol (OF 163; EF 226, 441; PC 510; PE 680).

The economist W.J. Baumol remarks, that the price τ is determined in part by the labour productivity ap in the public sector. This ap rises slower than the productivity in the industry, because the public sector mainly produces services. It is difficult to automate services. Therefore the price level of public goods rises faster than the general price level (price index). It has just been stated, that this leads to a rising state ratio γ, because the demand rises inelastically. Note that the Baumol effect pertains specifically to the productive activities of the state, and not to the transfers. Transfers hardly require any production. So the Baumol effect can not explain the rise of the transfers (OF 163; EF 442; PC 511).

The Baumol effect can give cause for dramatic reflections about the future G 26. Fortunately, there are various factors, which weaken the Baumol effect. First, the labour productivity in the public sector can be improved, thanks to the information- and communication-technology (OF 163; PC 510). Furthermore, the private sector also increasingly produces services, and this affects the general price index (OF 163; EF 226; PC 510). Nonetheless, empirical studies suggest, that within the OECD the Baumol effect is indeed important (PC 510, 530)27.

Rent seeking: the citizens

The law of Wagner and the Baumol effect are causes of state growth, which are legitimate, wanted or unavoidable. The citizens appreciate a fairly strong state. But this can not explain all growth. The remainder of this paragraph discusses causes, where the various social groups use state growth as an instrument for personal rent seeking. obviously interest groups can be socially useful. The communitarianism argues, that such groups order the individual egoism and impose duties on their members, and further participation. The interest groups can be a form of social capital. In a pluralistic society the interest groups can be indispensable links in the social networks. They seek justice, but not rent.

But interest groups can also be the cause of injustice and stagnation. This is called institutional sclerosis (PC 556). Too much capital can be wasted in an unproductive lobby. Sometimes the state does not establish the right framework for the struggle between interests, and then a powerful group can be parasitic on the rest of society. This is undesirable, and in fact a case of administrative failure28. Naturally these interest groups prefer to receive their interest in the form of subsidies. However, this might attract the attention of the media and other groups. Therefore the interest groups often strive for transfers in kind, which are less conspicuous (OF 168; EF 211; PE 680-682). When they succeed in their intention, then the state ratio is unjustly raised. According to the economist Olson such interest groups will finally change into institutions (OF 169; PC 555). The corporatism is pre-eminently amenable to such abuses (OF 169).

Rent seeking: the politicians

The state ratio is determined by the national legislator, and therefore by politicians (EF 225). The politicians are elected by the citizens in periodical elections. Thus the national electoral system affects the state ratio (OF 154; PE 683). The political decisions follow the preferences of the citizens (OF 160). The median voter is leading. However, the politicians also seek rent for themselves (OF 166; EF 211). Politicians want to be elected, gain power, and promote their ideology (EF 212). They benefit from favouring certain groups in their rank-and-file. Therefore politicians promise, among others, transfers to these groups (PE 681). Such transfers are not necessarily in the general interest, and then there is over-production. Politicians can do this for tactical-electoral reasons, even when they are of good will.

A well-tried means is the engagement in coalitions with other politicians, which is based on a mutual support of each other's interests. Such occasional coalitions are called logrolling (OF 166-167; EF 444; PC 532). The costs of the exchange of favours is shifted to the minority outside of the coalitions, so that society can yet be hurt. For instance, the state ratio is increased without any need (OF 167). However, exchanging votes also has advantages. In this manner a minority can still satisfy its intensely felt needs, simply by effecting their realization by means of an exchange for less pressing concessions (EF 210). Then logrolling leads to more stability in the balance of power between the various groups (PC 532)29.

According to the political scientist W.D. Nordhaus, a political conjuncture can emerge, because the ruling politicans spend extra money immediately before the election (OF 172; PC 528; PE 228 and further). Later this returns as taxes, due to the national debt. Forthcoming elections make politicians myopic (EF 215)30. Furthermore, when the ruling politicians fear, that they will lose the elections, then they can spend extra money in order to thwart their successors31. The politicians obviously need funds in order to pay the rent for their rank-and-file. This requires unnecessarily high taxes. However, the tax system is complex to such an extent, that the voters underestimate the size of their liabilities. The economist A. Puviani was the first to discuss this phenomenon, which is called the fiscal illusion (OF 172; EF 442; PC 527, 531; PE686). For instance, the voters often do not understand the creeping increase due to the progression in the tax rates (PC 528).

It has just been remarked, that high taxes T hurt the exports, and limit the freedom of consumers. Furthermore, marginal changes of the taxes (this is to say, marginal increases or reductions ΔT) affect the individual behaviour (PC 536). The column about welfare economics has shown, that rising taxes cause a dead-weight loss (DWL) in consumption. In a similar way, higher taxes can discourage working, because they lower the freely disposable wage (PC 539). There exists much literature about the optimal level of taxes, which will minimize the distortion of behaviour. However, this subject oversteps the theme of the present column. In the future the Gazette will yet address it32.

In the discussion of the law of Wagner it has been remarked, that politicians can offer public goods in order to pacify social groups (OF 170). Sometimes this has social advantages, but it can also be an expression of political laziness33. A political system with direct democracy (referenda) between two elections probably reduces the rent seeking of politicians (OF 161, 173, 175; PC 531). For, between two elections the citizens can enforce their will by means of referenda, and for instance block an increase of the state ratio γ. Switzerland is commonly mentioned as the textbook case of the favourable effect of the direct democracy. In general decentralization reduces the growth of γ (PC 533).

Rent seeking: the bureaucracy of the state

During the seventies of the last century the political scientist A. Wildavsky pointed out, that the bureaucracy of the state disposes of a monopoly position (OF 170)34. Another economist, W.A. Niskanen, states that therefore politics can not simply dictate its will to the bureaucracy (OF 134, 170; EF 446; PC 362-368; PE 688). The politicians must supervise the execution of their policy, but they have less information and skills than the bureaucracy (OF 171; EF 219; PC 525). The bureaucracy strives for more income, power and expansion (EF 219; PC 362, 523-524). This leads to the over-production of collective goods. Thus it pushes up the state ratio (OF 171). Previously the Gazette has already presented a model of the state bureaucracy, in the column about collective property, which illustrates the over-production. When the bureaucracy forces up the wages of the civil servants, then this is called X-inefficiency (EF 221; PC 362).

The well-known economist J.M. Buchanan has, together with G. Brennan, developed the Leviathan model of the state (EF 447; PC 380-383, 529-30). In this model the politicians and the bureaucracy are presented as a coalition, with a collective interest. Then the politicians are no longer the supervisors of the execution. This changes the nature of the principal-agent dilemma. The citizens are still confronted with rent seeking politicians, but now these are backed by the power of the bureaucracy. In this (admitted, quite grim) situation the citizens can only control their politicians by means of the constitution (PC 380-381)35.


For many years your columnist has been active in politics, as a party militant. Rent seeking by citizens, politicians and bureaucrats, can be observed in practice. This conclusion is nothing new, because of old the traditional religions and psychology warn against the "sinful" human nature. The awareness of the earthly "brokenness" belongs to a virtuous image of man36. However, thanks to new institutional economics (NIE) and the public choice paradigm, knowledge about the mechanism of rent seeking is now available. This has the advantage, that policies can take into account such undesirable behaviour. Thus the state ratio γ can indeed be brought closer to its optimal level.

  1. See chapter 12 in The economics of the welfare state (2004, Oxford University Press) by N. Barr, chapter 12 in Economics of the public sector (2000, W.W. Norton & Company, Inc.) by J.E. Stiglitz, paragraph 10.3 in De architectuur van de welvaartsstaat opnieuw bekeken (2003, Uitgeverij Acco) by H. Deleeck, and chapter 19 in Öffentliche Finanzen in der Demokratie (2011, Verlag Franz Vahlen) by C.B. Blankart. The argument of Barr is most detailed, but rather badly arranged due to the many repetitions in the text. Furthermore, Barr praises the English National Health Service more than his arguments can justify. On the other hand, Deleeck is enthusiastic about the Belgian system of social security. See p.464 in his book. On p.476 he states: "For, we can thank the christian and social-democratic tradition for the pragmatic zeal for solidarity, equality and fraternity". In this sentence freedom and liberalism are strikingly absent. One would expect a more politically neutral stance of a scientist. (back)
  2. According to p.306 in Economics of the public sector the American states pay for the costs of health care of poor families and children, and of poor handicaped individuals, by means of the Medicaid program. The federation attaches certain conditions to this support, and in this manner restricts the freedom of state policies. The federation also contributes in the costs, up to 80%. (back)
  3. On p.318 in Economics of the public sector Stiglitz states, that the contribution to small insurers consists for 40% of administrative expenses. For larger insurers this part decreases to 6%. (back)
  4. See p.282 in The economics of the welfare state. According to p.272 the English National Health Service is paid for 75% out of the tax yield. (back)
  5. On p.264 and 286 in The economics of the welfare state Barr states, that especially the groups with the low incomes insufficiently use health care, because they lack the necessary knowledge. However, Barr does not prove this statement. It is evident that there is under-consumption among the uninsured people (p.264, 284). Such individuals often have a low income. According to p.268, poor people must obtain state subsidies in order to be able to pay their own contribution. See also p.441 en 448 in Öffentliche Finanzen in der Demokratie. (back)
  6. In the column about privatizations the view of the sociologist E. Tonkens is discussed, as is presented in Mondige burgers, getemde professionals (2008, Van Gennep). According to Tonkens the trust of the customer in his physician is the essence of care. She ignores the moral hazard, which is present in the behaviour of the physician. She supposes that politization and polarization are a guarantee for good morals in care. But the analysis in the present column advocates limitations of the political influence in care. Furthermore, Tonkens rejects transparency in care, because the costs of information are too high. She even believes, that the gathering of information leads to a class conflict between management and the shopfloor! All in all Tonkens refuses to reinforce the position of the customer with respect of the physician, although this relation is quite asymmetric. This attitude clashes with the title of her book. Tonkens hardly cites empirical evidence for supporting her arguments, at least in this book. (back)
  7. According to p.276 in Economics of the public sector the physician in the English National Health Service receives a fixed reward for each customer. This incites the physician to strive for the prevention of illnesses (p.277). On p.263 Barr notes, that physicians also attach value to a good reputation. In itself this is true. But already five years ago the importance of the income motive has been stressed. On p.422 in De architectuur van de welvaartsstaat opnieuw bekeken it is remarked, that the first hospitals often originated from convents. But the church leaders also appreciate luxury, or at least impressive buildings. (back)
  8. In the USA the situation is still more complex, because the employer pays the complete contribution for health care. See p.285 in The economics of the welfare state, or p.301 in Economics of the public sector. Indirectly, this is naturally still a part of the wage sum. On the other hand, sick people must often pay a personal contribution (p.306 in Economics of the public sector). The personal contribution can be deducted from the income tax (p.307). (back)
  9. On p.312 in Economics of the public sector it is remarked, that the American culture of claiming (by means of the courts) incites to increase the supply of care, because the physician wants to prevent claims from his customer. On p.267 in The economics of the welfare state it is remarked, that the marginal costs ∂p/∂Q of the customer are zero. For, the insurer pays for everything. The customer increases his consumption Q, until the marginal benefits are zero. (back)
  10. Note, that without a personal contribution the lost welfare can become abitrarily large, for an unsaturated demand and similar supply. However, according to p.314 in Economics of the public sector the demand saturates, because the treatment is unpleasant and requires time. This evidently depends on the individual in question. On the same page it is estimated that (∂Q/∂π) / (Q/π) is 0.14. When one has ε/π=0.2, then it follows that Δπ/π = 1 − ε/π = 0.8 and therefore ΔQ/Q = 0.14×0.8 = 0.11. The demand for care increases with 11%. On p.315 Stiglitz states, that over-consumption leads to a dead-weight loss (in short DWL). This is strange. The DWL occurs, when the customer must pay the full price π. Then he loses DWL in welfare, besides his extra costs (π − ε) × Q(π).
    It is naturally conceivable, that the individual attaches insufficient value p to care in his demand curve (figure 1). For instance, the less educated people (with low incomes) have a less healthy style of living than the highly educated people. Then the state can yet incite the individual to consume more care by means of a low individual contribution ε. However, then the state is actually paternalistic. When the state would consistently execute such an ideology, then finally the democracy is undermined. The autonomous choice is made impossible. A better approach would be to better enlighten and inform the less educated people. (back)
  11. On p.459 in Öffentliche Finanzen in der Demokratie Blakart states, that conservatives want to cover the costs by means of contributions. The social-democrats want to introduce a fiscal coverage. And the liberals propagate a large personal contribution of the customer. (back)
  12. On p.46 in New public management (2003, Routledge), edited by K. McLaughlin, S.P. Osborne and E. Ferlie, the authors S. Dawson and C. Dargie remark, that the performance of care is partially affected by factors in the environment (education, food, well-being, housing, etcetera). Deleeck mentions on p.419 in De architectuur van de welvaartsstaat opnieuw bekeken notably the factory inspection. (back)
  13. Traditionally, the English National Health Service is a state bureaucracy, which is paid mainly by taxation. Since 1990 reforms are implemented in the NHS. The organization structure of the districts has changed. Originally, each district was controlled by its own administration, which also managed the budget. In 1990 the executing organizations, such as hospitals, were separated from its administration. Henceforth the administration of the district concludes performance contracts with the executors. Incidentally, the hospitals remain non-profit organizations, with all the accompanying benefits and disadvantages. Since 1991 the general practitioners could request budgets, so that they also could conclude contracts with hospitals. See p.287 in The economics of the welfare state. In this manner they become small HMO's. In 1997 these collectives of general practitioners have been replaced by primary care trusts, which also act as an HMO (p.288). Nonetheless, the English state still intervenes much more in health care than the American federation. On p.283 Barr rejects the privatization of hospitals. He fears that then a gap will form between, on the one hand, good expensive hospitals, and on the other hand, cheap mediocre hospitals. Your columnist doubts whether this is justified. It is curious that the expenditures per person for care in the USA, with their private care system, is much higher than elsewhere in the world. See p.301 in Economics of the public sector, and p.424 in De architectuur van de welvaartsstaat opnieuw bekeken. (back)
  14. See chapter 11 in De architectuur van de welvaartsstaat opnieuw bekeken, and the chapters 8 and 9 in Öffentliche Finanzen in der Demokratie. Furthermore, see the chapters 5, 8 and 10 in Économie et finances publiques (2017, Economica) by L. Weber, M. Zarin-Nejadan, and A. Schönenberger, the chapters 21 and 22 in Public choice III (2009, Cambridge University Press) by D.C. Mueller, and the chapters 8 and 14 in Political economy in macroeconomics (2000, Princeton paperbacks) by A. Drazen. (back)
  15. In the column about collective property it is remarked, that in principle state enterprises take into account the general interest. This would save social costs. It is called the general interest approach. However, it turns out that in practice the general interest is too vague to include it in an efficient management. (back)
  16. Actually it is strange, that the transfers are seen as state expenditures. In fact the state merely takes money from one citizen, and subsequently gives this money to other citizens. Nothing is produced. Perhaps the transfers are included, because they still require a state intervention. The money is no longer freely available. On p.507 and 516 in Public choice III it is argued, that the redistribution increases the existential security, and therefore is a public good. On p.227 in Économie et finances publiques it is remarked, that redistribution is also done by means of taxes and the price policy. And on p.438 it is remarked, that the transfers are paid by taxes and by the contributions for social security. (back)
  17. This is to say, G − Y is expressed in market prices, and G in factor costs, which is actually strange. Then Y is called the GDP in market prices. According to p.43 in Macro-economische ontwikkelingen en bedrijfsomgeving (2004, Wolters-Noordhoff b.v.) by A.J. Marijs and W. Hulleman the difference of the values in market prices and in factor costs is the sales tax (say, VAT). Apparently the profit of the entrepreneur is also interpreted as a factor reward. Therefore the value in market prices is larger than the value in factor costs. (back)
  18. The data originate from the data file of Eurostat. The presented social security Z is only in money, and not in kind. Eurostat calls them social benefits. They are paid by means of taxes and the contributions of the insurances. Unfortunately for some states the file does not contain all data in the considered period 1990-2017. (back)
  19. Your columnist does not know exactly which transfers O = (γ − ρ) × Y are provided by the state, in addition to the social benefits. It probably concerns housing, family policies, health care, and the like. See p.436 in Économie et finances publiques. Blankart does not give an explanation here on p.150 in Öffentliche Finanzen in der Demokratie. (back)
  20. The values of γ can perhaps still be compared. They agree reasonably well with the values in the figure 2. The time series for the Netherlands originate from the nice book Het polderwonder (2002, Uitgeverij Contact) by F. de Kam and R.A. ter Hart. See p.104 for γ and p.113 for Z/Y (probably including support in kind). The time series for Belgium are from De architectuur van de welvaartsstaat opnieuw bekeken. See p.284 for γ (summation of incomes from taxes and contributions) and p.460 for Z/Y. The time series for Germany and the United Kingdom are from Öffentliche Finanzen in der Demokratie. See p.158 for γ and ρ. Note, that the figure 3 for Germany and the United Kingdom shows a time series of γ − ρ. This is an upper boundary of Z/Y. Blankart gives the data for the period before the Second Worldwar only in factor costs. Your columnist has multiplied these data with 0.75 in order to convert them to data in market prices (Y is larger in market prices). This makes sure, that they fit well with the post-war time series, which do use market prices. The time series of γ for France come from Public choice III. See p.503. The time series of the French transfers come from Économie politique de la protection sociale (2011, Presses Universitaires de France) by M. Elbaum. See p.17, which shows time series for the family policies, the unemployment benefits, the costs of health care, and the state pension. Your columnist has added these series in order to give an impression of the transfers by the state. It turns out that the summed values agree reasonably with the graph for Z/Y in the figure 2. Your columnist is aware, that notably the five dashed graphs represent different variables, and therefore can not really be compared. But here it is mainly the trend in time which matters.
    On p.159 in Öffentliche Finanzen in der Demokratie Blankart states, that the part of O in the German G has increased since 1950. The figure 3 shows, that this is not a universal trend for all states. The table 2 (see further in the footnote) does not show this even for Germany.
    On p.503 in Public choice III several values of γ (in %) are also presented for the Netherland, Belgium, Germany, France and the United Kingdom. Namely:
    Table 1: State ratio γ for five states
    These number roughly agree with those in the figure 3, but there are also clear differences. On p.520 the transfers O/Y are presented. Namely:
    Table 2: Transfers O/Y
    The agreement of these numbers with those in the figure 3 is poor, partly because it concerns different variables. But the table 2 and the figure 3 also differ for Germany and the United Kingdom, although they both (are supposed to) show transfers. For the present column it is not worthwhile to analyze, why these differences occur. (back)
  21. On p.679 in Political economy in macroeconomics it is remarked, that many states in South- and East-Europe raised their state ratio even in the period 1980-1994. Apparently they believed, that the optimal ratio had not yet been realized. (back)
  22. General does not imply unanimous. The labour economist and PvdA ideologist P.M. de Beer states on p.48 in Toekomst voor de publieke sector (2011, Wiardi Beckman Stichting), that the negative relation between γ and the enomic growth is weak. His empirical analysis mainly shows a large spread. But D.C. Mueller summarizes on p.551-552 in Public choice a series of empirical analyses, which all in all for the OECD states confirm the significant negative correlation. De Beer does not really refute this, so that for the moment your columnist accepts the general standpoint.
    De Beer expresses his left-wing inclination in his texts, which oppose the scientific mainstream. He emphasizes the "left-wing" arguments, which by their nature do not have a wide support. On the other hand, the insights of for instance the public choice theory remain under-exposed. Therefore his books are not suited for a first acquaintance with the generally accepted insights. Nonetheless, De Beer is a networker, with authority in the trade union movement. At the moment he is also the independent chairman of the (public) Knowledge platform for work and income (KWI). He is not a man to quarrel with. (back)
  23. The insight of Wagner must not be over-estimated. Wagner is a state socialist (catheter-socialist). When his law is consequently applied, then the state ratio will finally be 100%. This failed in the Soviet Union and its satellites, but also in the democratic states, such as France. (back)
  24. On p.44-52 in Toekomst voor de publieke sector it is argued, that high taxes do not hurt the economy. De Beer states, that there are no negative effects on the behaviour of individuals, as long as the marginal tax rate remains low. Namely, the marginal wage determines the choice for certain working-hours. See the column about the influence of social benefits on behaviour. However, De Beer does not tell, that the average tax rate forces up the wage level. Therefore the terms of trade worsen, so that the international competitive position deteriorates. This does hurt the domestic economy. This was precisely the reason, why the PvdA during the fifties promoted a guided wage policy. Furthermore high taxes naturally restrict the freedom of the citizens to consume. De Beer admits, that empirically the damaging effect of high taxes has been proved (p.48). However, he refers to the large spread in the measuring points, and believes that therefore it must be possible to compensate high taxes by means of economic growth. Economists call such a purposive selection of data cream skimming or cherry picking. Nevertheless, next De Beer doubts, that economic growth is desirable. Growth would lead to environmental pollution and to a rushed society (p.51). Here De Beer prefers growth-scepticism, just like for instance Femke Halsema. (back)
  25. When the optimal γ depends on the type of state, then this complicates the formulation of policies. For, the type of state is dynamical, so that the administration must regularly adapt the type of its state. An error in determining the type implies, that the administration will select a wrong optimum of γ. (back)
  26. On p.66-68 and 71 in Toekomst voor de publieke sector De Beer puts the difference in labour productivity of the private economy and the public sector on 2%. He states that in 2010 the public sector ratio (the real state ratio ρ) is 30% for the Netherlands. Suppose that in the future the ratio of the physical production in the public and private sector is kept constant. Then, due to the Baumol effect the public sector ratio ρ would rise to 39% in 2030 (p.69, 76, 140). De Beer concludes from this, that in the future G must rapidly continue to rise, just because of the Baumol effect! (back)
  27. On p.510-511 in Public choice 67% of the cost growth in the United States of America (in short VSA, 1959-1984) is explained by the Baumol effect. The remaining 33% are due to the rising wages of civil servants. So this concerns the rise of the price τ. According to p.511 the costs τ of public goods rose with 1.5% with respect to the price index, on average for the OECD states between 1960 and 1995. When one assumes ετG = -0.5, then the Baumol effect explains about half of the growth of the real state ratio ρ. According to p.165 in Öffentliche Finanzen in der Demokratie the Baumol effect can explain merely 31% of the growth of Y − O in the USA between 1902 and 1978. (back)
  28. The powerful group rejects austerity on the transfers, which it receives. Perhaps it does support austerity elsewhere, and these are again blocked by other powerful groups. Then apparently all groups have veto power. The negotiations reach an administrative deadlock, which even the state can not eliminate (p.693 in Political economy in macroeconomics). An example of such a deadlock is the explosion of the Dutch expenditures on disabled workers, until 1989. In A Dutch miracle (1997, Amsterdam University Press J. Visser and A. Hemerijck call this an immobile corporatism (p.74). (back)
  29. The exchange of votes reminds of the rational choice paradigm, which has been developed by the sociologist J.S. Coleman. (back)
  30. According to p.689 in Political economy in macroeconomics empirical studies show, that the voters reject extra state expenditures immediately before the elections, so that the ruling government is weakened. However, the ruling government can take this liberty, because it already has an electoral lead due to its administrative power. On p.690 it is stated, that the voters suffer from an illusion with regard to the budget deficit. They underestimate the burden, which the deficit will impose in the future. However, the importance of this illusion is controversial. (back)
  31. This fascinating find is mentioned on p.300 and further, and p.691 in Political economy in macroeconomics. For instance, suppose that the incumbent government attaches value to social security, whereas the opposition wants to spend more on infrastructure. Then the incumbent government can expand the social security by means of borrowed capital, which increases the national debt. When later the opposition comes to power, then the state debt is so high, that it must restrict its extra investments in infrastructure. The hands of the successor are tied, or the loser of the elections rules beyond its own grave. Besides the high national debt prevents, that the opposition can campaign with the promise of large investments (p.692). Such behaviour can be condemned on moral grounds. But when Drazen reflects on it, then shrewd politicians will certainly consider this option. The social choice theory studies such political phenomena. Also consider the formation of coalitions and the manipulation of the political agenda. (back)
  32. The Dutch economist B. Jacobs has written the interesting book De prijs van gelijkheid (2015, Prometheus - Bert Bakker) about this. (back)
  33. During the seventies Dutch ministers proposed extra public services to the trade union movement, in order to seduce it into moderating its wage demands. This policy failed. See the column about the Dutch trade union movement. This is called neo-corporatism, which incidentally is related to communitarianism. According to p.559 in Public choice III neo-corporatism can have advantages, as long as the democratic system can control the interest groups. In De architectuur van de welvaartsstaat opnieuw bekeken it is stated, that Belgium has a corporatist system, namely bipartite (paritary). See among others p.437 and 463. The state can only intervene by means of full powers. Moreover corporatism is pluralistic, with a christian and socialist pillar (p.440). (back)
  34. Thirty years ago the book Politieke economie (1987, Het Spectrum) appeared, edited by J. de Beus and F. Vuijsje, which collects a number of articles about economists. It analyzes the ideas of economists such as Buchanan, Olson and Wildavsky. It is striking, that at the time the authors of this volume can hardly understand these leading thinkers. Their ideas clash too much with the spirit of that time. (back)
  35. Besides the already discussed causes of the growing state ratio several others are proposed. On p.440-441 van Économie et finances publiques the theory of the shift is mentioned. It assumes, that social crises lead to extra state expenditures. After the crisis the expenditures remain above the old level (ratchet effect). This theory has some empirical support in the rise of γ during and after both worldwars. There is also the so-called flypaper effect (p.443). When the state transfers funds to lower administrations, then these consider it as a gift. This illusion is known from behavioural economics. The lower administration is insufficiently aware, that its citizens must pay the funds by means of taxes. Therefore the lower body will expend more than is rationally justified. See also p.528 in Public choice III. (back)
  36. The extreme left-wing politics, including the many variants of Leninism, believes that man is by nature willing to make sacrifices. Provided that the right social structure is imposed, the individual will give the highest priority to the collective. This argument is used in order to justify the class struggle, where the party elite acquires the state power by means of violence. In a moderate form this image of man leads to the plea for the aristo-democracy, where the people must submit to an enlightened elite. The theory of rent seeking stresses, that individuals are focused on the personal interest, also those in the elite. This picture of man is supported by the social psychology. It takes on an abstract form in type homo economicus. Thus the Leviathan model of Buchanan and Brennan becomes the opposite of the aristo-democracy. Your columnist derives his image of man from a compromise, namely the empathic egoist of Binmore. (back)