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Measuring the "Real" Government Size: Fiscal Spending and Regulation

Measuring the "Real" Government Size: Fiscal Spending and Regulation

LEE Dong-Won

Apr. 1, 2007

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I. The Size of Government

A government intervenes in the private sector through the means of fiscal spending and regulatory fiats. Fiscal spending provides public goods and service, while the laws and regulations influence private decision making in a myriad of ways. Although government intervention can help the economy run more efficiently by fixing the problems of market failure, excessive public expenditure and regulations hamper economic growth. For example, fiscal spending leads to an increase in tax burden and government debt, while heavy regulations discourage economic activities.

Fiscal spending is the conventional benchmark used to assess the impact of government on the overall economy. Regulation, however, also influences the economy by raising the cost of economic activities. Without properly accounting for the regulation, fiscal spending significantly underestimates the level of government intervention. Thus, a measure of the size of real government must include the regulatory side of government as well as fiscal spending.

The Real Size of the Government

The Real Size of the Government

The Korean government's fiscal spending has grown since the 1997 financial crisis, particularly in the areas of welfare spending and national development. General government outlays accounted for 29.4% of Korea's GDP between 2003 and 2006, up 7.9 percentage points from the 21.5% of GDP between 1993 and 1997. With fiscal spending outstripping tax revenue, the government's deficit has also increased. The consolidated central government deficit, excluding social security trust fund, was 2.1% of the GDP, on average between 1998 and 2005. The share of Korea's national debt in GDP more than doubled from 12.3% in late 1997 to 30.7% in late 2005.

In the wake of the 1997 financial crisis, the Korean government significantly reduced the burden of administrative regulations. From 1998 to 2000, for instance, roughly 4,500 pieces of rules and regulations were abolished. Nonetheless, the government has steadily increased the level of regulation since then. Between 2001 and 2007, the government introduced about 1,000 new administrative rules and regulations. To better understand where Korea is headed amid rising fiscal spending and regulatory interventions, one must look at what composes a government's actual size.

II. The Size of the Korean Government

1. Fiscal spending

The official statistics of Korean government's fiscal spending accounts for 28.1% of the GDP in 2004. Some experts, however, argue that the figure is misleading and the actual size may reach 37.9% of the GDP. The wide gap in spending estimates results from disagreement over whether public enterprises belong to the government. According to widely used international standards, government budget does not include the expenditure by public enterprises. The System of National Accounts, released by the United Nations in 1993, states that the concept of government spending applies to the central government, local governments, and all government-sponsored non-profit institutions, but not the public enterprises.

According to a new estimate by Korea's Ministry of Planning and Budget, Korea's fiscal spending accounts for 31.5% of the 2004 GDP, far lower than the 44.4%, the average fiscal spending for member countries of the Organization for Economic Cooperation and Development (OECD). Nevertheless, if per-capita income is used as the benchmark, Korea's current fiscal spending levels are not much lower than that of the US and Japan. In 2004, Korea's per-capita income measured by purchasing power parity (PPP) reached US$18,421. When the US's PPP-adjusted per-capita income reached US$18,421 in 1972, its fiscal spending accounted for 32.2% of the GDP. Similarly, Japan's fiscal spending was 32.6% of the GDP when its PPP-adjusted per-capita income reached the same level in 1987.

Fiscal spending as a share of GDP has decreased for most of the industrialized countries, but it has been increasing for Korea. In OECD member countries excluding Korea, average fiscal spending as a share of GDP fell from 48.1% in 1995 to 44.6% in 2004. During the same period, Korea's fiscal spending as a share of GDP grew from 20.8% to 28.1%. With rising welfare spending due to low childbirths and population aging, the government's fiscal spending is expected to increase further.

2. Regulations

The OECD classifies governmental regulations into two types: product market regulation and employment protection legislation. The former includes regulations on market competition, such as price control, barriers to market entry, and regulations on foreign investment and trade. The latter measures the rigidity of employment protection laws and regulations, such as minimum wage, layoff, and work hours.

Indices of Government's Regulations

 

Product Market Regulation

Employment Protection Legislation

Description

Designed to assess the impact of government's regulations on competition in the market

Designed to assess how strict a nation's labor laws and relevant regulations are

Contents

Price control, barriers to market entry, regulations on investment and trade

Regulations on hiring, firing, and contract renewals

Items analyzed

Whether entry barrier exists in an industry

Whether public enterprises exist in an industry

Whether there exist caps on foreigners' share holding

* A total of 805 items are subject to analysis

Guidelines for minimum wage and overtime pay

Procedures and grace period required to lay off workers

Retirement pay

* A total of 18 items are subject to analysis

Source: OECD

According to the indices, Korea ranked 12th out of 30 OECD member countries in terms of overall regulation level. The nation's regulatory intensity is equivalent to the European countries with a mixed-economy model (e.g., Germany and Finland ). Ranked 9th in product market regulation and 16th in employment protection legislation, Korean government's intervention in product market is stricter than in labor market. Overall, Korea's ranking as 12th reflects heavier emphasis on regulatory fiats than on intervention through fiscal spending.

OECD Ranking of Government Regulation

 

Product Market Regulation

Employment Protection Legislation

Final Ranking

Greece

5

3

2

France

8

5

5

Spain

10

6

6

Poland

1

19

7

Italy

4

9

8

Germany

15

8

11

Korea

9

16

12

Finland

14

14

14

Sweden

20

11

15

Japan

19

18

20

Australia

29

23

27

UK

28

27

29

US

30

30

30

Note: (1) The figures in the table are the average between 1998 and 2003. (2) The higher the ranking, the larger the regulation cost. (3) The final ranking is drawn based on the average of product market regulation and employment protection legislation.

Excessive regulation inhibits competition, undermines corporate efficiency, and thereby suppresses economic growth. On the other hand, deregulation raises productivity and aggregate income by promoting more efficient use of resources and by encouraging technological development. Keenly aware of the positive impacts of deregulations on the market economy, the US, Japan, and some European countries have eased regulations hampering market competition since the 1990s. Korea, however, has moved to strengthen the regulatory environment.

3. Government's real size

Real Size of the Governments

Real Size of the Governments

In order to measure the size of real government, the Samsung Economic Research Institute (SERI) used the fiscal spending as a share of GDP and the measures of regulations for 28 OECD countries. Combining the data available from the OECD, SERI calculated benchmark averages for fiscal spending and regulatory measures. According to the new index of ‘size of real government,' Korea ranked 21st among 28 OECD countries. ( Turkey and Mexico were excluded in the analysis due to the lack of reliable data.) The graph below shows that the Korean government is larger than the US and the UK that are known to minimize government intervention. On the other hand, most European countries have larger governments than Korea.

III. Suggestions

OECD member countries, excluding Korea, are divided into three groups. The first group consists of heavily regulated countries with high levels of fiscal spending. The group includes Southern European countries such as France, Portugal, Greece, and Italy. The second group with moderate regulations and large fiscal spending includes welfare states in Northern Europe, such as the Netherlands, Sweden, Finland, and Austria. The third group includes the US, the UK, Canada, and Australia, which spend and regulate less than other OECD members.

Korea is unique in that its regulatory environment is rather prohibitive in comparison to its low fiscal spending level. According to SERI, Korea's inclination to rely more on regulations than on fiscal spending is the highest among all OECD member countries. Countries facing difficulties finding new revenue sources tend to strengthen regulations.

Four Groups of OECD Countries

Four Groups of OECD Countries

Given recent increases in fiscal spending and regulation, Korea is likely to join the first group with high fiscal spending and heavy regulation. The Korean government needs to recognize that the first group has experienced lower economic growth and higher unemployment than others.

Thus, the Korean government must set up strategies to prevent itself from expanding its fiscal and regulatory size excessively. First, it must make an effort to turn itself into a small but strong government. To achieve this, it must streamline government organizations. It must also allocate financial resources in a more efficient manner and improve the tax collection system.

Second, the Korean government needs to adjust fiscal spending priorities. To this end, it should give a higher priority to innovation and knowledge creation. At the same time, it needs to make more effort to achieve social integration by strengthening the social safety net.

Finally, the Korean government has to ease regulations and improve the quality of regulations. For example, it can link government's innovation initiative to regulatory reform, set up a permanent body designed to overhaul regulations, and introduce incentive regulations.

The writer is a research fellow at the Public Policy Research Division, Samsung Economic Research Institute. Inquiries on this article should be addressed to dw2.lee@samsung.com.

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