Adam Smith's roles for government and contemporary U.S. government roles: is the welfare state crowding out government's basic functions?

• Author: Lipford, Jody W.

Government's role in economy and society is constantly debated. Views range from that of anarchists, who believe in no government, to that of totalitarian socialists, who believe in complete state control of economy and society. Most people adopt a view somewhere between these extremes, yet even moderate views may differ vastly.

For more than half of U.S. history, government's role in the United States and other developed countries was relatively minor. Taxes and expenditures as a percentage of aggregate economic output were small, and regulations were few. (1) This role began to change significantly in the late nineteenth century, as Germany instituted the first elements of the welfare state. Since that time, even countries that avoided the extremes of fascism and socialism have adopted a more expansive role for government. In developed Western democracies, governments have advanced the welfare state through a host of programs, such as public education, government-provided or -funded health care, and old-age pensions. Government taxing and spending as a percentage of aggregate output have risen, and regulations of the private economy are now numerous and complex. (2)

In this article, we do not take a position on what the state's role should be. Our aim is simpler and more objective. We first examine the roles Adam Smith advocated in his classic book An Inquiry into the Nature and Causes of the Wealth of Nations ([1776] 1976). Smith believed that government's proper roles in society should be limited, but well defined: government should provide national defense, the administration of justice, and public goods. In other words, it should protect citizens from external and internal aggression and supply goods that the free market may not provide.

After carefully considering Smith's writings in this essay, we compare the contemporary roles played by the U.S. government to the roles Smith envisioned. Examining government expenditures over time, we find that carrying out the roles Smith advocated has come to account for an increasingly smaller share of total government spending and that expanding the social-welfare state in the form of transfer payments has taken up an increasingly larger share of total government spending. This trend is evident at national, state, and local levels of government.

We turn next to a consideration of the consequences of an ever-expanding welfare state, which may not be limited to the creation of "big government" or the crowding out of private investment. If the roles that Smith advocated are essential to the maintenance of a safe and prosperous society, then escalating expenditures for transfers may ultimately threaten the government's capacity to provide the services that Smith deemed truly beneficial.

Ideas and Theories about Government's Role in Society

We begin with anarchy. Although the theory of anarchy appeals to staunch individualists, its possibility is a "conceptual mirage," in the words of James M. Buchanan (1975, 3). Because individuals may not abide by ethical rules, these rules may be insufficient to provide order, without which society deteriorates into chaos and lawlessness. Mancur Olson makes an economic argument against anarchy, saying that it yields "little production" (2000, 7). Without the state to enforce property rights, the losses from theft, from the use of resources for the prevention of theft, and from the organization of production so as to avert theft make anarchy impoverishing and infeasible.

To preclude the losses stemming from anarchy, people form governments. Buchanan argues that people willingly forgo some of their liberties to form a social contract that establishes formal order through coercive means. (3) Thus, the "protective state" is born. With order established, productivity rises, and investments aimed at the prevention of theft fall.

Randall Holcombe (2004) takes a different approach to government's origins. He argues that governments result not when social contracts are made, but when those with coercive power undertake to protect citizens' incomes. These protectors extract their own incomes from the protected citizenry. The citizens try to bend this coercive process into a form of government that minimizes internal and external predation.

An established government may take a number of forms, from a stationary bandit to majority rule, but Olson argues that as long as the government has an encompassing interest, it will implement growth-enhancing (or market-augmenting) policies, such as secure property rights and contract enforcement. Yet the state may do far more than establish law and order and implement growth-enhancing policies. It may also provide public goods, funded through mandatory taxes in order to overcome the citizens' incentives to free ride. (4)

Advocates of limited government have long recognized the government's propensity to grow in size and scope beyond the provision of order and public goods. The perception of market failure (Bator 1958) provides a rationale for government growth, not only to correct purported resource misallocations by the market, but also to provide macroeconomic stability, the need for which has seemed especially urgent since the Great Depression.

The threat of Leviathan government, which Buchanan clearly recognizes, comes not only from ideologues and bureaucrats, but also from majorities who vote to redistribute income in their favor and to fund projects that do not pass aggregate benefit-cost tests. Because democracies do not limit government and may even foster its growth, Buchanan argues for constitutional constraints to delineate and circumscribe government's functions.

Government growth in democracies seems irresistible, however. Robert Higgs (1987) reviews and critiques explanations of government growth, including the modernization hypothesis, the assumed necessity of government-provided public goods and social welfare, the role of interest groups in income redistribution, and ideology. His own work focuses on crisis as a source of government growth, and his detailed analysis of twentieth-century U.S. economic history shows how the crises of two world wars and the Great Depression led directly to larger government through the expansion of its roles in many areas and through changes in ideology and public perception regarding government.

Expounding on the link between democracy and liberty, Holcombe (2002) argues that as countries become more democratic, liberty may diminish. If a majority faces few, weak, or weakening constitutional constraints, an expansion of democracy means that individual rights will succumb to the majority's wishes. (5) Resource allocation, formerly determined by individual decisions and private contract, will be determined instead by majority rule.

The tendency toward expansion of government power is exacerbated if politicians who seek to increase their power also weaken the constraints on that power. As Charlotte Twight (2002) argues, the citizens' political transactions costs of constraining government are not exogenous, but can be increased by power-seeking politicians...