Sadly, service starvation isn’t the right answer

Without improved productivity in publicly funded education, policing and even in the military, we’ll have to lower our expectations.
by Kenneth Rogoff

As the world watches the US grapple with its fiscal future, the contours of the battle reflect larger social and philosophical divisions that are likely to play out in various guises around the world in the coming decades.

There has been much discussion of how to cut government spending, but too little attention has been devoted to how to make spending more effective. But without more creative approaches to providing government services, the cost will continue to rise inexorably over time.

Any service-intensive industry faces the same challenges. Back in the 1960s, economists William Baumol and William Bowen wrote about the “cost disease" that plagues these industries. The example they famously used was that of a Mozart string quartet, which requires the same number of musicians and instruments in modern times as it did in the 19th century.

Similarly, it takes about the same amount of time for a teacher to grade a paper as it did 100 years ago. Good plumbers cost a small fortune because here too the technology has evolved very slowly.

Why does slow productivity growth translate into high costs?

The problem is that service industries ultimately have to compete for workers in the same national labour pool as sectors with fast productivity growth, such as finance, manufacturing and information technology. Even though the pools of workers may be somewhat segmented, there is enough overlap to force service-intensive industries to pay higher wages, at least in the long run.

The government, of course, is the consummate service-intensive sector. Government employees include teachers, policemen, waste collectors and military personnel.

Modern schools look a lot more like those of 50 years ago than do modern manufacturing plants. And while military innovation has been spectacular, it is still very labour-intensive.

If people want the same level of government services relative to other things they consume, government spending will take up a larger share of national output over time.

Indeed, not only has government spending been rising as a share of income; so too has spending across many service sectors. Today the service sector, including the government, accounts for more than 70 per cent of national income in most advanced economies.

Agriculture, which in the 1800s accounted for more than half of national income, has shrunk to a few per cent. Manufacturing employment, which accounted for perhaps a third of jobs or more before World War II, has shrunk dramatically. In the US, the manufacturing sector employs less than 10 per cent of all workers.

So even as economic conservatives demand spending cuts, there are strong forces pushing in the other direction. The problem is worse in the government sector, where productivity growth is much slower even than in other service industries. Surely, part of the problem is that governments use employment not just to provide services but also to make implicit transfers. Moreover, government agencies operate in many areas in which they face little competition – and thus little pressure to innovate.


Education, where the power of modern disruptive technologies has barely been felt, is a good place to start. Sophisticated computer programs are getting quite good at grading middle-school essays, if not quite up to top-teacher standards.

Infrastructure is another obvious place to expand private-sector involvement. It was once widely believed that drivers on privately operated roads would constantly be waiting to pay tolls. Modern transponders and automatic payment systems, however, have made that a non-issue.


US president in the 1980s Ronald Reagan,described his approach to fiscal policy as “starve the beast": cutting taxes eventually forces people to accept less government spending. But government spending continued to grow because voters still want services that government provides.

Today it is clear that reining in government also means finding ways to shape incentives so innovation in government keeps pace with innovation in other service sectors.

Without more ideas about innovative provision of government services, battles such as the one playing out in the US today can only become worse. Politicians will promise to do a better job, but they cannot succeed unless we identify ways to boost government services’ efficiency and productivity.

The Australian Financial Review