Measuring sticks: The size of government

Today's polarized debates about the role of government often boil down to a single issue: the size of government compared with the size of the overall economy, as measured in gross domestic product.

This is true on both sides of the debate. One recent proposal featured in the Wall Street Journal argues for a "golden fiscal rule" that the size of government as a percentage of GDP should always be shrinking; liberals frequently cite the higher ratio of government spending to GDP in many European countries.

But such comparisons are not very meaningful: The way we measure government's role in the economy is limited, inaccurate and unrealistic. If we want to understand how government and the overall economy interact, knowing the size of government tells us little if we are not measuring how government activities contribute to our economy over time.

The problem is that most government goods and services are provided free, so they do not have market prices like, say, mouthwash or financial planning. Standard national accounting — in GDP and related economic indicators — addresses this by assuming that the value of government is exactly equal to what government spends, without any consideration of what government actually produces or of the value of this public output.

In a report released this week by my organization, Demos, we make the case that, in at least four critical ways, this GDP framework ignores or obscures public value in our economy, leaving us ill equipped to fashion policy to drive national success in the 21st century.

The first problem is that much of what GDP measures as personal, private spending — which counts for two-thirds to 70 percent of the economy — is highly socialized consumption. It is not financed directly from households' private earnings, but from public sources or from publicly subsidized private sources.

Government benefits through social insurance and the social safety net — about $2.3 trillion in 2012 — fund a large part of personal consumption. The same goes for nonprofit services and employer-provided benefits; these are counted directly as personal consumption. This is a huge oversight: In a 2011 Bureau of Economic Analysis study, the share of consumption from these "indirect" — mainly public or social — sources was found to be 30 percent in 2009, having quadrupled over the last five decades.

A third form of mismeasurement is the benefit of regulation, or what might be termed our regulatory saving. In its first 20 years, the Clean Air Act generated health savings and other benefits valued at $22 trillion, compared with $500 billion in compliance costs. Arguably, net regulatory gains on such a scale should be considered a form of national saving, but they're not. Indeed, across many areas of regulation, we have a saving rate that matches and at times dwarfs the national saving rate as it is usually measured.

Finally, there is the ever-expanding realm of nonmarket capital, including human, social, intellectual and natural capital. Nonmarket capitalization, which significantly depends on government activities like education spending, public safety, research investments and environmental protection, is much larger than market capitalization as measured in private investment; it is also more significant for long-term prosperity. Yet it is ignored in our national accounts, jeopardizing our future prosperity.

Human capital is the most closely linked to government activities, as it is mainly an output of public educational investments, combined with student and parental investments. The public money we spend on teachers' salaries helps produce high school graduates, many of whom become college graduates (indeed, mostly public-college graduates); these graduates, in turn, have been our country's most important asset for growth since the mid-20th century.

In one leading model, gains from educational investment added $3.7 trillion to our national wealth in 2009, more than four times the value of public education as measured in GDP that year. The return on educational investment is clearly enormous, yet it is nowhere to be found in the GDP story of growth.

In obscuring the value of government, the GDP story is leaving us in the dark about potentially crippling trade-offs between fiscal and regulatory austerity and our needs as a society. If we ignore public value in our economy, we will be unable to craft effective policies for a better economic future. If we ignore the economic contribution of regulation, we are less likely to want more of it, exposing our children to greater social risks and costs.