FEATURE

SHOULD GOVERNMENT BE INCLUDED IN THE NATIONAL ACCOUNTS? The contribution that government makes to GDP needs to be re-evaluated, says Julie Novak

he statistical measure of gross domestic using market prices is important since market product (GDP) is defined as the total prices are assumed to reflect marginal valuations by market value of the production of all individuals concerning the outputs produced.1 goods and services within a given However, in modern economies characterised Tterritory, typically for a country or regions therein, by the sizeable production of goods and during a period of time, typically a quarter or a year. services by public sector entities, rendering GDP may be valued at current prices or adjusted an appropriate value for the final output of for inflation. government is more challenging, given that much Conventional national income accounting of these are not sold on the market.2 practice dictates that, other things being equal, The convention adopted is that goods and an increase in government expenditure is services produced by government, but not sold automatically represented as an increase in GDP. in markets, should enter into GDP at factor cost. However, this begs an obvious question: Should As Richard Stone says: government expenditures be incorporated into national income accounting data? Answering this Since [public sector] goods are not sold question is the subject of this essay. they can only be valued at cost. In the present state of knowledge it is virtually Government expenditures impossible to approximate their value to in national income accounts their users in any other way.3 A considerable challenge for the construction of GDP statistics is to establish a value of production Exclusion of nonmarketed for an entire economy, given the heterogeneous goods and services from GDP array of outputs produced and the complex The extensive provision in modern economies of relationships between suppliers and demanders largely nonmarketed goods and for goods and services at various stages of the services, which are invariably supply chain. provided to consumers at zero or The resolution to this problem rests on subsidised cost by governments, aggregating the monetary values of production for poses numerous challenges not all goods and services. After making deductions only to the conceptual but also for the monetary values of inputs (including the empirical integrity of GDP as finished goods) used during intermediate stages conventionally measured. of production, GDP includes the monetary value of final outputs produced and made available for sale by private sector entities. Dr Julie Novak is a Senior Fellow at the Derivation of the monetary value of goods and Institute of Public Affairs. This article services produced by the private sector is reasonably is based on her PhD thesis on the straightforward, given that these outputs are sold relationship between government size at market prices. As noted by Joseph Stiglitz, and economic performance in Australia. et al. the aggregation of final private sector outputs

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The prevailing view is that spending on Similarly, Gerhard Colm suggested: outputs by public sector entities is an addition to national output and should thus be incorporated Money valuations do not have the same into various measures of GDP. While recognising significance in the various sectors of the that transfer payments, such as old-age pensions, social product. In the exchange sector they should be excluded to avoid double counting of are determined by prices that represent expenditures, John and Ursula Hicks argued that the supply demand relationship. In the the remaining government expenditures should realm of public activity, they are be included in the GDP measure: determined by costs. Here we assume the political bodies that appropriate the The protection of life and limb money consider government services at is presumably a part of final output, so is least worth their cost.6 the use of the roads for pleasure purposes. How do we draw the line between the noted that value of these services and the value of complications arose when attempting those services which ought to be deducted? to impute an appropriate value for The division seems to be entirely arbitrary. government goods and services for Consequently, if we want to measure something and not arrive at a figure for inclusion in national accounts. the national income which is what it is just because we say it is, it seems better One of the leading figures in the development to disregard this productive utilisation of of national income accounting in the twentieth public services, and to regard them (by century, Simon Kuznets, noted that complications definition) as being reckoned entirely into arose when attempting to impute an appropriate final output.4 value for government goods and services for inclusion in national accounts: John Hicks colourfully reiterated this position in the following terms: Having identified the final product of governmental activity we find difficulty in I can see no alternative but to assume that valuing a large part of it—direct services the public services are worth, to society in to individuals—in a way comparable to general, at least what they cost … One privately produced services. For the latter, may well feel considerable qualms about market prices to ultimate purchasers are a such an assumption—it is obvious that determining factor in individuals’ choices. the government spends far too much on For public services no such yardstick this, far too little on that; but if we is available. We know what they cost accept the actual choices of the individual the government; we do not know what consumer as reflecting his preferences they are worth to the individuals who … then I do not see that we have consume them.7 any choice but to accept the actual choices of the government, even if they James M. Buchanan and Francesco Forte are expressed through a Nero or a endorsed Kuznets’ general position that funding Robespierre, as representing the actual for, and provision of, public sector services not wants of society.5 subject to direct consumer charges should be

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excluded from national accounts to avoid the example, how should the contribution to quantitative overestimation of aggregate output. the national product made by expenditures This includes instances in which the supply on national defence, on highways, or on of publicly provided goods is constrained for schools, etc., be evaluated?9 any reason: In a 1992 paper published in Public Choice, The legitimacy of extending the exclusion Zane A. Spindler noted that the proponents for even to these cases can, perhaps, best including government outputs in GDP argued be shown by analogy. There are many that factor cost is theoretically equivalent to an ‘free’ goods in nature that are strictly implicit market price valuation under competitive limited in supply. The sun shines only conditions. However, the monopolistic nature of four hours per day on average in some public sector output provision, and the potential communities; clearly, ‘welfare’ could be contribution of bureaucratic budget maximisation increased by more sunshine. But no effort and rent seeking by special interests, would tend to is made to place a positive value on inflate public sector costs, thus rendering spurious sunshine because no market transaction any analogy between factor cost and market can produce more of the output. Instead, price evaluations.10 we assume implicitly that the adjustment Randall Holcombe supports the proposition processes of the economy act as to take that government output should be excluded from the differential availability of such ‘free’ GDP on these grounds: goods into account. Publicly supplied but limited goods and services seem no National income accounting conventions different. If the individual secures the value private sector output at its market enjoyment of these goods without direct value, and if government output is valued charge and cannot resell them through using the same standard, it should also some sort of a market transaction, no be included at its market value, which value should be included in national is zero.11 output estimates.8 Exclusion of intermediate goods and services from GDP The monopolistic nature of public The US Department of Commerce was an early sector output provision, and the adopter of national income accounting estimates, potential contribution of bureaucratic and had consistently included government budget maximisation and rent seeking expenditures at cost in its measurements. This by special interests, would tend approach was undertaken on the basis that to inflate public sector costs. the purchases of goods and services could be constructed as final purchases:

Oskar Morgenstern was also critical of the Individuals, nonprofit institutions serving treatment of government outputs in national individuals, and general government income statistics. are ultimate buyers in the sense that they do not buy for resale in the market. For the private sector, the pricing Accordingly, their purchases are not mechanism is a suitable mechanism by elements of cost in the value of other which to value the final amount of goods output produced for the market. Hence and services. For the government sector, there is a presumption that their purchases the pricing mechanism often offers no should be regarded as final products in any clue about the value of final product. For measure which purports to give a complete

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accounting of the entire output of private sector intermediate goods.'15 the nation.12 Bias toward expansionary fiscal policies This definition implies that the purpose of The Keynesian conception of macroeconomic national accounts is broader than just a measure theory holds that increasing government of consumers’ welfare. Final products, accordingly, expenditures should be used to help offset should be defined as all purchases by consumers, reductions in the value of private sector economic non-profit organisations, and governments that activities, be they in the form of consumption, are not resold in the market. investment or net exports, to ensure overall Kuznets initially perceived most government macroeconomic stability. outputs as being intermediate inputs used by the private sector and thus not to be included in GDP A number of economists have sought to measures, which seek to quantify the aggregate solve the problems posed by including market values of final outputs produced: the public sector in national accounts by simply removing government spending. At all times a major proportion of government activity is devoted not to the provision of services to ultimate A significant implication of the inclusion consumers (education, health, etc.), but of public sector spending in national income either to services to business (all types of accounts, according to Holcombe, is that it economic legislation, administration, and generates a bias in public policy favouring a larger adjudication) or to the maintenance of size of government. This is because increasing internal peace of external security. The government expenditures, effectively treated as latter is not a direct service to consumers: final outputs and counted at factor cost, will lead it is rather an antecedent and indispensable to an increase in GDP, even if the rising public cost of maintaining society at large—a spending and the coercive means of financing it condition of economic production rather displaces productive private sector activities.16 than an activity directly yielding final Cowen conveys a similar objection to economic goods.13 the conventional treatment of governmental expenditures in national accounts: Therefore, classifying intermediate outputs provided by governments in national output When it comes to national income aggregates would, according to Kuznets, entail accounting, and measuring GDP, we are a process of duplication unwarranted from a valuing every one of these different methodological standpoint. expenditures at $1. In our measurements, In a discussion of the appropriateness of national we are assuming that the quality, income accounting measures during periods of importance, and efficacy of government war, the economic historian Robert Higgs argued: stays constant as the size of government 'Defence purchases measure input, not output. grows … The larger the role of government Obviously, what people value is national security, in the economy, the more the published not the mere devotion of resources to the figures for GDP growth are overstating ostensible production of national security.'14 improvements in our living standard.17 Holcombe also criticises GDP measurements on the basis that most public sector output GDPP: Estimating Australian national consists of intermediate goods. As he explained: income without government 'Intermediate goods are not counted in total A number of economists have sought to solve the GDP, and for consistency, governmentally problems posed by including the public sector in produced goods should be treated the same as national accounts by simply removing government

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spending. The resultant ‘private sector GDP’ Some libertarians, most notably Murray therefore provides a statistical measurement of the Rothbard, have attempted to provide alternative performance of the private sector over time, with measures of aggregate output that depict fewer complications arising from the valuation of governmental activities as harmful detractions from outputs or the treatment of intermediate versus productive economic activities undertaken by the final outputs. private sector: In the Australian context, Wolfgang Kasper wrote a paper in the 1980s in which he removed Spending only measures value of output public administration, defence and community in the private economy because that services from the official GDP statistics to produce spending is voluntary for services rendered. a time series for ‘private domestic product’ (PDP). In government, the situation is entirely Using this PDP measure, Kasper showed that different: government acquires its money private sector economic activities had grown by coercion, and its spending has no below trend during the mid-1980s.18 necessary relation to the services that it More recently, Higgs removed government might be providing to the private sector. purchases from US real GDP to attain a ‘gross There is no way, in fact, to gauge these domestic private product’ (GDPP) series to services. Furthermore, every government illustrate that US GDPP has been effectively static conscripted dollar deprives the citizen of since the global financial crisis.19 expenditures he would rather have made.

Figure 1: National output including and excluding ‘government depredations’ (1960–2012)

Sources: ABS (Australian Bureau of Statistics), Australian System of National Accounts, 2011–12, Cat. No. 5204.0; Robert Batemarco, ‘GNP, PPR, and the Standard of Living,’ The Review of Austrian 1:1 (1987), 181–186; Murray N. Rothbard, America’s Great Depression (Bakersfield: Universal Press, 1975), 296. Notes: 1. Financial year data expressed in terms of current prices. 2. Gross private product (GPP) defined as GDP less gross operating surpluses of general government and government trading enterprises. 3. ‘Private product remaining with producers’ defined as GPP less ‘government depredations’ (total government expenditure or revenue plus interest received, whichever is higher). 4. Series includes interest income received and taxes paid by non-financial public corporations from 1989 and 1990, respectively, representing a structural break in the series during these years.

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It is therefore far more realistic to make the However, as noted in this essay, one of the opposite assumption … that all government arguably more important debates—the national spending is a clear depredation upon, rather accounting treatment of public sector goods and than an addition to, private product and services—remains unresolved. private output.20 Every government conscripted dollar With this view, Rothbard devised an alternative deprives the citizen of expenditures income accounting methodology that estimates he would rather have made. ‘private product remaining in private hands’ (PPR) by deducting ‘income originating’ within all government entities and the ‘depredations’ of total This essay provides several arguments that government expenditures or revenue receipts could be used to justify excluding governmental (whichever is higher) from official estimates of GDP outputs from conventional GDP statistics or, at at market prices (including taxes less subsidies). the very least, highlighting the need for a more Figure 1 provides an adaptation of Rothbard’s careful interpretation of GDP movements giving methodology for Australia using the historical due respect to movements in both private and national accounts series provided by the public sector statistical aggregates comprising Australian Bureau of Statistics (ABS). The level of GDP. These arguments are in addition to PPR is significantly lower than of GDP between conventional concerns that the contributions of financial years 1960 and 2012, with the proportion public sector activities to GDP arise at the expense of PPR to GDP declining from 70% to 61% over of private sector contributions, including through the period.21 This finding suggests that the relative ‘crowding out’ processes attributable to increasing burdens exerted by government depredations government activity. upon the private sector have increased over time. The adoption of either strategy would ensure The amount of estimated PPR has increased that the focus remains appropriately trained upon from $755 billion in 2009 to $899 billion in on the performance of the private sector, the fount 2012. However, PPR growth for the three years of national economic prosperity without which subsequent to the global financial crisis has private, or indeed public, material conveniences grown, on average, by one percentage point lower cannot be provided. than during the three years preceding the crisis. Notably, the annual private sector growth rate has strengthened, as the global financial crisis fiscal Endnotes stimulus package has been gradually wound down. 1 Joseph Stigltz, Amartya Sen, and JeanPaul Fitoussi, ‘Report by the Commission on the Measurement of Conclusion Economic Performance and Social Progress’ (2009). 2 Transfer payments undertaken by governments are not The GDP measure of economic activity has come included in the estimation of GDP; only purchases of under intellectual siege from many quarters over final goods and services are included. the last few decades. Environmentalists have 3 Richard Stone, ‘The Accounts of Society,’ Nobel Prize called for adjustments to GDP accounting for Lecture (1984), 122. various manifestations of ecological damage 4 John R. Hicks, and Ursula K. Hicks, ‘Public Finance in the National Income,’ The Review of Economic Studies 6:2 arising from production, while feminists argue (1939), 150. that GDP is limited in that it does not include the 5 John R. Hicks, ‘The Valuation of the Social Income,’ value of unpaid ‘household production’ such as Economica 7:26 (1940), 116. undertaking domestic chores. 6 Gerhard Colm, ‘Public Revenue and Public Expenditure These, and other publicly expressed concerns, in National Income,’ Studies in Income and Wealth 1 (1937), 184. have led official statistical and economic agencies 7 Simon Kuznets, ‘On the Valuation of Social Income— to increasingly use a suite of ‘well-being’ indicators Reflections on Professor Hicks’ article. Part I,’ Economica when assessing the effects of public policies. 15:57 (1948), 11.

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8 James M. Buchanan and Francesco Forte, ‘The Evaluation 14 Robert Higgs, Depression, War, and Cold War: Studies of Public Services,’ The Journal of in Political Economy (Oxford: Oxford University Press, 69:2 (1961), 116. 2006), 173–174. 9 Oskar Morgenstern, National Income Statistics: A Critique 15 Randall G. Holcombe, ‘National Income Accounting of Macroeconomic Aggregation (San Francisco: Cato and Public Policy,’ The Review of Austrian Economics 17:4 Institute, 1979), 6. (2004). 10 Zane A. Spindler, ‘The Overstated Economy: Implications 16 As above, 395. of Positive Public Economics for National Accounting,’ 17 Tyler Cowen, The Great Stagnation: How America Ate All Public Choice 38:2 (1982). the LowHanging Fruit of Modern History, Got Sick, and Will 11 Randall G. Holcombe, ‘Government: Unnecessary but (Eventually) Feel Better (New York: Dutton, 2011), 26, 28. Inevitable,’ The Independent Review 8:3 (2004). 18 Wolfgang Kasper, ‘Australia’s Negative Growth Rate,’ 12 Milton Gilbert, George Jaszi, Edward F. Denison, and IPA Review 40:1 (1985): 35–37. Charles F. Schwartz, ‘Objectives of National Income 19 Robert Higgs, ‘Government Bloat Is Not Growth: Real Measurement: A Reply to Professor Kuznets,’ The Review Gross Domestic Private Product, 2000–2011’ (2012). of Economics and Statistics 30:3 (1948), 183. 20 Murray N. Rothbard, America’s Great Depression (Bakersfield: 13 Simon Kuznets, ‘National Income: A New Version,’ Universal Press, 1975), 296. The Review of Economics and Statistics 30:3 (1948), 156. 21 This section refers to financial year data.

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