Is Government Growth Inevitable? Insights from a 19th Century Economist

The late-19th century German economist, Adolph Wagner, observed that as progressive industrialized economies grow the public sector expands as a percentage of the overall economy. Wagner’s observation, which later became known as Wagner’s Law, or “The Law of Increasing State Activity,” has persisted through the ensuing century to the present.

Why does government spending increase? Wagner’s hypothesis is that, as economies grow and become more complex, governments evolve beyond their traditional duties of defense, justice and law enforcement. Ultimately citizens expect more services, whether that is social services like healthcare and retirement; regulatory oversight of the expanding economy; environmental and food safety, and so forth. Once provided, these services are difficult to ratchet back.

The United States is not exempt from Wagner’s Law. In the U.S. over the long run—as in all developed countries—the federal government has clearly been growing. Currently federal government expenditures are equal to 1/5 of our entire economy.

In recent decades the trend appears to have tailed off, but much of that can be attributed to end of the Cold War and the Clinton Administration’s harvest of the peace dividend in the 1990s, which drove down defense spending. The Infrastructure and Services and Interest spending categories have also declined modestly. In fact, spending growth has been driven primarily by entitlements.

Today the bulk of federal spending is entitlements such as Medicare and Medicaid, followed by defense. This is why the US government is sometimes described as a large insurance company with an army.

Going forward, more spending is likely. Larry Summers, in a recent presentation before the Center for Budget and Policy Priorities, laid out four reasons for this:

  1. AGING POPULATION: The baby boomers are reaching retirement and they are expected to live longer.  Both factors will increase demands on Social Security and healthcare, which currently make up the bulk of federal spending.
  2. WIDENING INCOME INEQUALITY:  More government money will be spent on social programs that functionally redistribute wealth
  3. SERVICES PRICE INFLATION:  One consistent economic phenomenon is that the cost of services generally outpaces inflation. Government is primarily a provider of services such as healthcare, law enforcement, education, etc that have not responded to significantly productivity gains.
  4. RISING NATIONAL SECURITY COSTS:  Our adversaries Russia, China , Iran and North Korea are all spending on the military at increasing rates.  That will eventually draw us into the same race.  Plus, defense spending is currently near its post-WWII low.

For federal property investors, this presents both good and bad news with respect to future opportunities. On the positive side, the federal sector (and the government sector generally) is large and growing. The fundamentals driving growth are likely to continue into the future. By extension one could argue that the fundamentals underpinning federal property investment are solid for the same reason. As an industry sector, government is poised for continued expansion, even in the face of political opposition.

Yet, the bad news is that entitlement spending has been the primary engine of growth, and this does not generate office-using employment to the same degree as most other spending categories. Further, entitlement spending is overwhelming all other spending and driving expansion of the national debt. To counterbalance, Congress has introduced harsh austerity measures in its appropriation of the (relatively shrinking) discretionary budget. This helps explain why federal agencies have been working to shrink the footprint and reduce real estate costs.

For taxpayers and citizens, these trends provide plenty of causes for concern. Yet, federal property investors may take solace in the knowledge that Wagner’s Law underpins the federal sector and, in the long run, growth is inevitable.