THE ECONOMIC ROLE OF THE STATE IN THE 21ST CENTURY

The last half-century has witnessed major developments in the economies of the industrial countries and in the role that the governments of these countries have played especially through the instrument of public spending. This article describes some of these developments and focuses on the role that the governments of these countries should play in the future. (1) The Growth of Public Spending The tax levels of many industrial countries are today at an all-time high. Only a century ago, the situation was far different. Discussing the optimal level of taxation in 1888, the French economist Paul Leroy-Beaulieu concluded that tax revenue of 5-6 percent of GDP could be considered "moderate," revenue of 8-10 percent of GDP would be "normal," while revenue beyond 19, percent of GDP would be "exorbitant" and would damage the growth prospect of countries (Leroy-Beaulieu 1888: 127-28). In the context of today's tax burdens on industrial countries, and even of many developing countries, such as Brazil or Argentina, that position seems extreme. However, it was far from extreme at the time Leroy-Beaulieu wrote his book. At that time, most of today's industrial countries had levels of taxation and of public spending of around 12 percent of GDP. (2) For example, in 1870, France and Italy had public spending and tax levels of about 13 percent of GDP, and the United States had even lower levels. The economic role of the state at that time was limited and was focused on "core" functions such as defense, protection of individuals and property, administration, justice, and large public works. These core functions were largely those described by Adam Smith in the Wealth of Nations. Table 1 shows that between 1870 and 1913, a period of intense globalization, there was little growth in the relative levels of taxation and public spending (Tanzi and Schuknecht 2000). In later years public attitudes regarding the economic role of the state started changing. In 1926, John Maynard Keynes called for the "end of laissez-faire" in a book of the same title and proposed a widening of the role of the state (Keynes 1926). In 1932, in an article in L'Encyclopedie Italienne, Mussolini predicted that the 20th century would become the "century of the state. " Mussolini had initially been an economic liberal but he changed his views during the Great Depression. Perhaps he saw political advantage in a larger role of the state in the economy. From an economic perspective, his prediction proved to be right. At the time when Keynes and Mussolini were expressing these views, other pressures were coming from both the political right and the political left for enlarging the role of the state. Countries that adopted fascism and communism or socialism endorsed the view that the state should play a larger role in the economy. Even Roosevelt's New Deal reflected this view. These pressures, together with developments such as the Russian Revolution, World War I, World War II, the advent of totalitarian regimes (both fascist and communist) in several important countries, and the Great Depression created a social environment and some of the economic conditions that ultimately were to encourage the phenomenal expansion of the economic role of the state that would take place in the rest of the 20th century (see Table 1). Public spending started to grow in the 1920s but grew slowly until about 1960. The great acceleration came in the period between 1960 and the mid-1980s when many countries, and especially the European countries, created mature welfare states that aimed at the economic protection of individuals from the "cradle to the grave. " In that period, in several European countries (Austria, Belgium, Denmark, France, Germany, Ireland, Italy, the Netherlands, and Sweden), public spending approached or exceeded 50 percent of GDP. This level of public spending, and the taxes needed to finance it, would have been considered unthinkable in the earlier part of the 20th century. …