Government versus Markets, By Vito Tanzi

It is great timing: a book by a distinguished economist about the relationship between governments and the financial markets, at the moment when that relationship is under the greatest of pressure both in the Eurozone and the US.

Vito Tanzi served for many years as head of fiscal affairs at the International Monetary Fund and as an economic minister in that most fiscally challenged country, Italy.

Tanzi's approach is to start with some history. The size of government as a share of GDP climbed through the 19th and 20th centuries, from 5-10 per cent in the 1870s to the 35-50 per cent norm by 2000. The climb was driven party by the financing of two world wars but also by a changing perception of the role of the state in the provision of social services.

Since 2000, in some cases earlier, the share of the state has started to decline, in terms of its tax revenues if not spending. Tanzi looks at the decision processes behind this rise: at Bismarck, Roosevelt, Beveridge, at the development of the European social model. He acknowledges the benefits from high public spending, for those countries tend to have high human development scores. However, some high-spending countries made huge cuts from the early 1990s onwards and still retained their excellent performance. Between 1992 and 2007, Sweden, Norway and Canada all reduced public spending by some 15 per cent of GDP without any serious consequences to their human development.

Tanzi concludes that "public spending of, say, around 35 per cent of GDP should be sufficient" for a government "to satisfy all the genuine objectives that realistically can be expected". "If public spending is efficient and well-focused", an even lower percentage should be possible. That is quite encouraging because even the higher level of spending, 35 per cent, should be within the taxable capacity of most modern democracies.

You could say that governments ought to have sufficient revenues to do everything they need to, provided they use those revenues effectively. Part of the problem, notes Tanzi, is that quite aside from not using their resources efficiently, they also seek to replace the market where it appears to be failing, rather than making the market work better. The result is that higher spending does not necessarily improve overall social welfare and wellbeing. All this is easier said that done. Still, if Sweden, Norway and Canada can succeed, maybe the rest of us can too.