Economics Report: Wagner's Law and Path Dependency in UK Public Sector

This economics report delves into the growth of the UK public sector, focusing on Wagner's law and the path dependency model to explain the evolution of government expenditure. It begins with an introduction to public economics, highlighting the government's role in production, regulation, and equity. The report excludes Baumol's law and the budget maximization theory due to their limited applicability to the UK context. It then examines Wagner's law, which posits that the public sector expands with economic growth, and provides evidence from the UK, including figures illustrating expenditure trends in key areas like healthcare and welfare. The limitations of Wagner's law are discussed, particularly its inability to explain relative public sector growth. The report then introduces the path dependence model, which emphasizes the interplay between government and voter interests, particularly during times of crisis and political equilibrium. The limitations of this model are also considered, including its disregard for external factors influencing expenditure and taxation. The report concludes by summarizing the strengths and weaknesses of both models in explaining the growth of the UK public sector, providing a comprehensive analysis of government expenditure and its influencing factors.

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Economics Assignment

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Introduction
The government plays in very important role in the economy’s production, regulations,
outsourcing, etc. The subject matter of public economics is concerned with the public
sector, the efficiency within the economy, the policies of the government and equity. This
paper looks at public sector growth theories and the theories which are suitable to explain
the evolution of public sector expenditure for the UK. Different theories have been
proposed which attempts to explain public sector growth. I will be focusing on Wagner’s law
and the path dependency model to explain the growth of the public sector in the UK. I have
excluded a few models for certain reasons. Baumol's law states that the public sector will
inevitably grow in relative terms and I chose not to look at this theory as UK’s growth in
public expenditure does not support this theory (Figure 4 & 5). The budget maximization
theory does not explain government growth but a rather excessive government, so it is not
suitable for this question. The rational choice model could possibly explain government
growth for the UK as it looks at changes in citizen preferences but proving changes in voter
preferences is difficult.
Government Expenditure
The public sector is run by central and local governments with the aim of increasing the
social and economic welfare of their citizens. Government expenditure includes social
security, health, education, defense and transport and is financed by taxpayers. The minimal
state is often cited as the bare minimum that a government must provide for an economy to
prosper, where the government provides property rights and law enforcement to allow for
the economy to grow. To ensure that the government can afford to provide these services,
they must collect revenue through taxes (i.e. capital/income tax).
Wagner’s law
Wagner’s ‘law of increasing state activity’ states that the public sector grows in absolute
and relative terms, with the government undertaking more activity as the economy grows
(Wagner, 1911). The growth of an economy leads to the need for: (1) administrative and
protective functions, (2) increased provision of goods and services, (3) government
intervention to control monopolies (Lamartina, 2011). In case of the UK, both the central
and local government increases their activities and undertakes new tasks which they believe
are in the interest of their citizens. Public expenditure increases as government divisions
expand and operate more functions than before. Figure 2 provides evidence of public
sector growth in absolute terms as each department is seeing large growths in expenditure,
with pensions and healthcare being the two biggest costs to the government.
Figure 1 illustrates the five biggest public expenditures. It illustrates that the % of GDP spent
on healthcare has been steadily increasing since 1960 from 3.3% of GDP to 5.1% in 2000 and
reaching 7.18% in 2017.Relative spending on welfare also increased between 1960 and 1994
from 3.6% to 8.55%, before seeing a decline and reaching 5.67% in 2017. Improved
healthcare has led to longer life expectancy1, from 71 in 1960 to 81 in 2015, meaning that
1https://data.oecd.org/healthstat/life-expectancy-at-birth.htm

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the government has to look after people who are retired for longer thus increasing the costs
to welfare through pension and care costs.
Peacock & Wiseman tested Wagner’s theory and found that “the rise in public expenditure
greatly depends on revenue collection” (Peacock, 1961), suggesting that economic growth
allows governments to collect more revenue and this, in turn, leads them to be able to
increase public expenditure. Figure 3 and 6 support this statement as it shows that GDP per
capita and government revenue follow a similar upward trend; government revenue
increases as people earn more money – taxable income increases.
Limitations
Although Wagner’s law supports the theory for public growth in absolute terms for the UK
(figure 2), the same cannot be said for the growth in relative terms. Looking at government
revenue and government spending as a % of GDP (figure 4 & 5), government expenditure
peaked in 1975 at 48% but has not grown in relative terms since then, with government
spending staying around the 40% mark since then. Government revenue has also followed a
similar trend to government spending.
In addition, it suggests that the public sector grows because income per capita increases,
leading to many scholars questioning if this can be empirically tested. Empirical analysis
testing Wagner’s law found that “the positive relationship between government
expenditure and GDP declines over time” suggesting that economies gradually head
towards lower levels of public spending (Lamartina, 2011) and that spending does not
always grow as Wagner suggests. Furthermore, unlike the path dependence model,
Wagner’s law does not take the provision of politics into account when explaining
government growth.
Another key criticism of Wagner’s law is that it “is not applicable to different societies”, as
governments do not always grow relative to the rest of the economy or may be overtaken
by the growth of the private sector (Peacock, 1961). The theory was developed during an
era of industrialisation, so the assumptions that he made in his model might not be
applicable to today where a lot of countries, including the UK, are in the post-
industrialisation era.
Path dependence model
The model devised by Peacock and Wisemen depicts that the level of expenditure is a result
of conflicting interest of the government and voters; governments want to maximise
spending and voters want to minimise paying taxes. They achieve equilibrium through the
election process, with voters likely to vote for government parties who promise lower tax
rates, and parties likely to avoid raising taxes to stay in power. Like Wagner’s law, this model
also emphasizes that public expenditure increases over a period of time, as seen in figure 2.
Peacock concluded that governments spend more during times of war, with expenditure
peaking during the first and second world war. This is also known as the displacement effect

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with expenditure increasing during “periods of social disturbance”(Peacock, 1961). Citizens
allow for higher levels of taxation during this period in order to generate funds to meet
increased costs. The expenditure falls after the ‘crisis’ is over but “remains above their pre-
crisis level”(Holcombe, 2005). This can help us understand relative defence spending for the
UK in recent years; government spending on defence has gone from 6.76% of GDP in 1960
to a record low 2.31% in 2017 (Figure 1) as the government prioritises other functions such
as education and healthcare.
Although relative spending on defence has fallen, overall spending has increased. Spending
on defence was relatively stable at around £23billion/annum until 2002. The 9/11 bombings
increased the pressure on the government to spend more on defence, and this can be seen
in figure 2 where spending on defence continues to increase from 2002-2012. This spending
was justified to taxpayers as they would receive increased safety in return from possible
attacks.
There were several attempts during the 1980s to increase taxes but without a justifiable
reason such as an imminent war, the public strongly objected against it and the attempts
were ultimately rejected(Holcombe, 2005). Income Tax rates under Margeret Thatcher
decreased from 30% in 19792 to 25% in 19883, emphasizing the need to meet public
demands in order to stay in government. National insurance tax rates increased from 5.1%
to 6% in the late 1980s, which can explain the increase in income through national insurance
between that period (figure 7).
Election constraints
The expenditure equilibrium level is determined by the party and the voter. If parties fail to
improve the welfare of their citizens, they may change their voting behaviour to better suit
their needs. The conservative party was voted into power after years of overspending and
controversial decisions such as agreeing to invasions of Iran and Afghanistan under the
labour party. Voters preferred the austerity measures of the conservative party as they
promised to help reduce the debt incurred in previous years (Conservatives, 2010). This can
be seen as the result of a political equilibrium, where the voters chose to limit government
spending in order to help reduce the national debt. This is illustrated in figure 5, where
government spending as a % of GDP has been declining from 45% in 2010 to around 40% in
2015. Although relative size of the government expenditure has declined, the government
can grow in other aspects and not just expenditure (Higgs, 1991), supported by more
efficient and productive government functions.
Limitations
The criticism of the path dependence model is that it ignores other factors that may force
the government to change levels of expenditure or taxation other than voters. The
2https://www.margaretthatcher.org/document/109497
3https://www.margaretthatcher.org/document/111449

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corporate tax rate in the UK is one of the lowest in Western Europe at 19%4, partly to entice
firms to locate their production factories and head offices here, which in turn helps the
government to reduce unemployment and raise income levels of local citizens in those
areas. Another criticism of the path dependency model is that it does not have the same
“behavioral foundation as the rational choice model”(Holcombe, 2005), citing that citizens
may not want to go back to periods of lower spending where they would lose some benefits
of increased government spending. This can be found in the Conservative government’s
policy to unify welfare credits, which will leave some people worse off than before and has
led to resistance from the public (Schraer, 2018).
Conclusion
Wagner's law helps to explain the growth of the UK government in absolute terms, but it is
difficult to attribute a rise in income to the growth of the public sector. as the theory was
developed during the industrial period, the assumptions may not be completely transferable
to today. The path dependence model helps explain that the public expenditure level is
determined by the voters and the government through a political equilibrium. However, it
ignores external factors that could affect expenditure levels.
Word count excluding references/ footnotes /graphs: 1588
4https://tradingeconomics.com/country-list/corporate-tax-rate?continent=europe

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Appendix
Figure 1: Categories of government spending as a % of GDP
Source: UK public spending 5
Figure 2:Categories of government spending (£billions)
Source: UK public spending6
5https://www.ukpublicspending.co.uk/recent_spending
6https://www.ukpublicspending.co.uk/recent_spending

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Figure 3: Government revenue (£billions)7
Source: UK public revenue
Figure 4: Government revenue as a % of GDP8
Source: UK public revenue
Figure 5: Government spending as % of GDP
Source: UK public spending9
7https://www.ukpublicrevenue.co.uk/past_revenue
8https://www.ukpublicrevenue.co.uk/past_revenue
9https://www.ukpublicspending.co.uk/downloadmult_ukgs.php?
shortc=1912_1910UKp&remainc=12c1li011mci_F0tF0t

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Figure 6: GDP per capita
Source: OECD10
Figure 7: Main sources of government revenue 11
Source: UK public revenue
10https://data.oecd.org/gdp/gross-domestic-product-gdp.htm#indicator-chart
11https://www.ukpublicrevenue.co.uk/past_revenue

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Bibliography
Conservatives. (2010). The conservative manifesto 2010. Conservative party.
Higgs. (1991). Eighteen problematic propositions in the analysis of the growth of
government. The review of Austrian Economics, 3-40.
Holcombe. (2005). Government growth in the Twenty-first century. Public choice, 95-114.
Lamartina, S. (2011). Increasing public expenditure: Wagner's law in OECD countries.
German Economic Review, 2.
Peacock, A. T. (1961). The growth of public expenditure in the United Kingdom. National
Bureau of Economic Research, 23-24.
Schraer, R. (2018). What is universal credit - and what's the problem? BBC.
Wagner. (1911). Sämtliche schriften und dichtungen. Breitkopf & Härtel.