17/10/2012 12:49 BST | Updated 17/12/2012 05:12 GMT

Size Matters - in Which I Ask About the Role of the State

According to this graph, the British state is set to shrink in the next five years and go from "continental levels of public spending, to something sub-American in its miserliness." The Guardian's Aditya Chakrabortty makes a distinctive point, but its significance is hard to judge.

For some, this imminent retrenchment doesn't go nearly far enough - David Laws, for instance, finds the figure of 40% state expenditure as a proportion of GDP "shocking," and would like to see this share fall a priori. For others, the size of the state mustn't dip below a given shibboleth level, lest the devil takes the hindmost.

For some reason I find it hard to have a reasoned debate on the role of the state in our political economy - which is what the discussion about size ultimately stems from - on the basis of percentages, or comparisons of percentages between nations/eras. My starting point for such a discussion is a series of simple questions:

What outcomes do we seek from our political economy?

• Amongst these outcomes, what can purely private markets achieve alone, with little or no state intervention required?

• Regarding what's left, where on the spectrum of laissez-faire to direct state provision should the state's role in various domains lie?

• How much would it cost for the state to play those roles?

• How best can we pay for this activity.

Answering these questions would take far too long for one post, but the above framework at least allows me to think along the following lines. "I wish to see an environmentally and politically sustainable economy that enhances the capabilities of all to live fulfilling lives, and builds the capacity for coming generations to enjoy the same - how can we bring this about?"

In many domains, private markets in which goods and services are exchanged between individuals for money are appropriate, reducing the need for state expenditure. Reducing, mind you, not eliminating - even the most efficient markets in widgets requires a public infrastructure in which to function, something that's lost on many as Alex Andreou points out.

For those domains in which markets alone cannot fulfil the objectives we set, the state steps in - either as regulator, arbitrator, purchaser or provider. Classically at least this has been the approach - rely on markets until and unless they fail, and allow the state to step in and correct that market failure.

Increasingly, however, there's a recognition that because of the immense complexity inherent in a modern economy, the state has to play a more nuanced role, one in which it creates markets, nurtures innovation, tackles extreme inequality and does more to smoothen out the uncertainty that a globalised economy brings.

This recognition means we can frame those basic questions more specifically: if we value dignity in old-age, an educated and trained workforce, security against climate change and action on the social determinants of health, how can public and private entities best divide the tasks and how will they be paid for?

It's against that backdrop that the question of percentage-of-GDP does become relevant, in the context of how much tax revenue we can raise, from which sources, and how the state under a government of any creed will pay for our future needs.

There's an argument to say that because the tax intake has been at or around 35% of GDP for the last 35 years or so, it will remain at that level into the future, and we should bring state expenditure down to that point. It is not clear to me, however, that bringing government income and expenditure more into line should happen purely by reducing spending. There are ways to raise more revenue, not least by changing what it is we tax. Taxing wealth, especially that tied up in land values and other assets, would allow a larger, more stable tax base. Of course entrenched wealth brings with it the power to resist fair taxation, but if democracy cannot overcome vested interest then the liberal cause is worthless, and I for one live in hope that it isn't.

Further, we have to ask why public deficits arise in times of supposed plenty. Tory rhetoric may blame Labour profligacy, but looking at the record private sector surpluses (indicating a reluctanct to invest) that built up even in the boom years to 2007, running a (serviceable) deficit is the only option if we seek to maintain investment and the benefits it brings.

Thus, reforming how markets and institutions work to bring about that investment, in good times and bad, could change what the state spends on, and how much, altering the dynamic of how expenditure affects GDP and wider measures of prosperity. Spending today on building houses reduces the cost of housing benefit tomorrow; preventing obesity costs today but saves on care for diabetics and heart disease patients tomorrow; getting unions and companies to pay more for training today produces a more resilient workforce for tomorrow. If the private sector can't or won't invest in these things, the state either has to reform incentives and structures such that private investment occurs, or step up itself.

Although I plan to elaborate on the state's role in particular domains in later posts, ultimately it comes down to this. Where there are functions we value from our political economy, and private markets do not provide them or do so inequitably or unsustainably, does the state stand by and watch or does it do all it can to fulfil those functions? Through a mixture of institutional reforms, and counter-cyclical (and counter-domain, if that makes sense...) investment, the state's priority should be fostering a balanced economy, as balanced budgets will follow. Putting the fiscal cart before the economic horse will produce nothing but the very thing Vince Cable warned us of recently: "[getting] stuck on a downward escalator where slow or no growth means bigger deficits leading to more cuts and even slower growth. That is the way to economic disaster and political oblivion. We will not let that happen." Too right Vince.