Wagner’s Law of Increasing State Activities: Explanation, Graph & Criticism

1 year ago

Atiqur Rahman

10 minutes

Growth of Public Sector

The role and importance of public expenditure is very important both in developed and developing countries. According to Adam Smith, government expenditures are made to supply goods and services that are advantageous to a great society, but the private sector would not supply those due to profitability concerns.

Adam Smith, in The Wealth of Nations, viewed that the expenditure should be restricted to:

(a) Defense against foreign aggression;
(b) law and order in view of the maintenance of internal peace and
(c) public development work, specifically where the private sector is not ready to supply or supply is not as per requirement.

Besides these, the state expenditure is considered as unnecessary.

Economists explain that the government has to provide a number of facilities providing large societal benefits, but the provision of these facilities requires huge investment. The gestation period is also very high in such cases.

We use the term ‘public goods’ in the context of such goods which are provided by the government and provision which is not profitable for private enterprises because efficiency requires that these goods should be provided at a zero price. This is so because public goods are non-rival and non-excludable in consumption. It is either not possible or feasible to facilitate exclusion in the consumption of public goods.

In other words, due to feasibility reasons or cost concerns, one cannot limit the consumption of public goods to those who pay a price for them. Also, within limits, the consumption of a public good by some members of a society does not reduce the amount of it available to others. Common examples of pure public goods are defence, lighthouses, flood control, public fireworks, etc. Besides providing goods and services, government expenditures are also incurred on collective goods, transfer payments, subsidies, and tax provisions.

Further, expenditures of government are influenced by various interest groups, among which political parties and policymakers are more important as compared to other interest groups such as labour unions, trade associations, chambers of commerce, religion and occupational groups, military and bureaucracy, and even the unaffiliated citizens. The importance of these groups varies at different stages of the development of a society, from a traditional to a modern one.

Besides these interest groups, expenditures are also affected by the economic structure of a country as well as by sociological, geographic, demographic and technological factors. Nurkse has emphasized that the international demonstration effect also affects the government expenditures of poor countries.

In this context, there are two scholars who have provided views on the role and importance of increasing state activities in an economy:

Before explaining the laws, it is important to understand that these two theories are concerned only with resource-using public expenditure which is distinct from transfer payments. The distinction is caused mainly by the reasons for the growth of two types of expenditure. Resource-using public expenditure is related to public expenditure on goods and services and on domestic fixed capital formation, whereas transfer payments might grow due to quite different reasons.

Further, these two hypotheses are classified as macro models of the growth of resource-using public expenditure by Bailey (1995) as distinct from micro models of public expenditure growth. Macro models analyse the long-term growth of public expenditure, whereas micro models analyse the changes in particular components of public expenditure.

Wagner’s Law of Increasing State Activity

Explanation:

In 1883, Adolph Wagner (1835-1917), a German political economist, based on his study of public expenditure in industrial nations, propounded a law called “The Law of Increasing State Activity”. Wagner’s law is classified as a positive theory of public expenditure. It emerged in response to the absolute as well as relative growth experienced by the Western world during the second half of the 19^th century and in the 20^th century.

Wagner opined that the economic development of a nation leads to an increase in the activities and functions of the government. He explains that in progressive societies, governments at central and local levels constantly undertake new functions while they also perform old functions, and this leads to a regular increase in the activity of the government. The aim of government activities is to satisfy the economic needs of the people more efficiently and more completely so that there is an increase, extensive as well as intensive, in such activities and hence public expenditure.

Therefore, public sectors in industrializing nations grow as a proportion of total economic activity with the increase in per capita income and output, i.e., the share of government expenditure in total output increases inevitably. Although Wagner has based his study on industrial nations but according to him, the law is equally applicable in the case of developing countries.

Wagner views the relationship between the state and its citizens as such that the state exists independently of the individuals in society, but it has general responsibility for the economic and social welfare of society as a whole. According to him, a state performs three functions: providing administration and protection, ensuring stability and ensuring social and economic welfare of society.

According to Herber (1979), the hypothesis explains that “a fundamental cause-and-effect relationship exists between the growth of an industrializing economy and the relative growth of its public sector…relative growth of the government sector is an inherent characteristic of industrializing economy”. He further explains the hypothesis as efforts to find a predictable, long-run functional relationship between certain causal variables and relative public sector growth.

Graphic Presentation of Law:

Wagner’s Law of Increasing State Activities

Figure 1 shows the relative expansion of public sector economic activity over an extended period of time. On the horizontal and vertical axis, real per capita income (Y) and real per capita output of public goods (PG) are measured, respectively. PG¹ represents a constant proportional increase in the real per capita output of public goods with the increase in real per capita income, whereas PG² indicates that the public sector grows at an increasing rate. In other words, a proportional increase in the public sector is not constant but increases with the increase in total economic activity.

We now present some empirical evidence on the applicability of Wagner’s law. Goode (1986) analyses the growth of public expenditure for a period of 80 years (Table 1). He calculates the ratio of total government expenditures (of all levels of government) to GNP or GDP (in percent) in the case of five industrial countries at two points in time-1890 and 1970. The rising trends of government expenditures as a proportion of national income confirm the validity of Wagner’s law.

Table 1:

Country	1890	1970
Canada	9	32
France	14	49
Germany	13	32
United Kingdom	9	33
United States	7	30

(Souce- Richard Goode, Government Finance in Developing Countries, 1986)

Referring to some current data on the growth of public expenditure in various countries as provided by the World Bank, Table 2 shows general government final consumption expenditure as a percentage of the country’s GDP for the period 1960-2012. It includes all current expenditures on goods and services (including compensation of employees), government, and most expenditures on national defence and security (excluding government military expenditures that are part of government capital formation). It is clear from the table that the general trend in most of the countries remained increasing.

Table 2: General Govt. Final Consumption Expenditure (% of GDP)

Country Name	1960-70	1970-80	1980-1990	1990-2000	2000-2012
Australia	12.1	15.7	18.1	18.0	17.5
Brazil	12.1	10.3	10.7	19.2	20.2
Canada	16.6	21.1	21.7	21.6	20.0
China	7.5	9.0	14.6	14.8	14.2
Germany	—	19.4	20.8	19.3	19.0
European Union	15.5	18.3	20.5	20.2	20.9
France	16.9	19.1	22.4	23.2	23.8
United Kingdom	17.5	20.2	21.2	19.2	20.9
Indonesia	7.3	9.0	10.3	7.8	8.2
India	8.4	9.8	11.3	11.6	11.4
Israel	19.5	37.4	35.5	28.2	25.0
Italy	15.6	16.4	18.6	18.9	19.8
Japan	11.2	12.9	14.0	14.8	18.7
Kenya	13.4	17.7	18.3	15.8	17.1
Korea, Rep.	11.7	10.3	11.5	11.8	14.2
Sri Lanka	13.6	10.6	9.1	9.9	13.8
North America	17.2	17.3	16.4	15.6	15.8
Nigeria	—	—	11.6	9.6	9.3
Nicaragua	8.4	10.1	29.6	14.6	8.7
Netherlands	17.9	22.0	24.2	23.1	25.4
Norway	14.3	18.3	19.7	21.7	20.7
Nepal	—	7.7	8.8	8.8	9.3
New Zealand	—	17.0	18.8	18.0	18.6
Pakistan	10.8	10.8	12.5	12.5	9.3
Singapore	9.8	11.0	10.8	9.2	10.7
Sub-Saharan Africa	12.1	14.7	15.9	15.9	15.8
United States	17.3	17.0	15.9	15.1	15.5
South Africa	11.2	14.2	17.4	19.4	19.8
World	14.2	15.7	16.7	16.7	17.3

(source- World Bank)

Criticism

Wagner’s hypothesis is criticised in the context of the relationship between the state and its citizens as viewed by him. The law’s applicability at all times and to all societies is also questioned by Peacock and Wiseman. They have criticised Wagner’s hypothesis on three counts:

The law is not applicable to all the western nations.
As the law analyses long-term trends of public expenditure, it tends to ignore the process of growth of public expenditure.
It does not analyse the effect of war on public expenditure.

Wagner’s Law of Increasing State Activities: Explanation, Graph & Criticism

Growth of Public Sector

Wagner’s Law of Increasing State Activity

Explanation:

Graphic Presentation of Law:

Criticism

Read More in: Theory of Public Finance

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Growth of Public Sector

Wagner’s Law of Increasing State Activity

Explanation:

Graphic Presentation of Law:

Criticism

Read More in: Theory of Public Finance

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Related

Share Your ThoughtsCancel reply