The history of the composition of government spending is both complex and fascinating. Although government priorities have changed over the past 150 years, social spending has been the biggest ‘winner’. In the late nineteenth century, public spending focussed on public administration, investment, debt service and the military. In the following decades until about 1960, such growth focussed on developing public services and social safety nets, taking advantage of falling military spending after the two world wars. The following sixty years saw mostly further increases in social expenditure, especially on pensions, health and long-term care. Public spending on ‘goods and services’ has always averaged nearly half of total expenditure. By contrast, social expenditure has grown from less than 10% a century ago to 55% in 2017. Education spending has been stable at about 10% of total spending in recent decades, after rising strongly in earlier years. The share of public investment has been falling steadily, from 20% in the late nineteenth century to only 7% in 2017.

In the past decades, governments significantly expanded their ‘insurance’ role in the economy. The ‘all-insurance’ state today is expected to cover almost all risks and contingencies from social security, via protecting certain industries or the financial sector to supporting demand and mitigating international crises. Social expenditure reflects the most important ‘insurance role’ of government. Social expenditure has been on a continuous upward trend for decades and absorbed 24% of GDP on average in 2016. Projections for the coming decades point to further moderate increases in an optimistic scenario and very adverse dynamics with spending growing to well above 30% of GDP in pessimistic ones. Large additional social expenditure increases would be hard to finance and would crowd out other, productive spending. Such a world of ‘social dominance’ would not be stable and sustainable. Fortunately, we have all the policy levers to prevent it.

Public expenditure reforms over past decades have reinvigorated states and economies in many countries. A first group of countries already started to reform their public expenditure in the early to mid-1980s, as the negative side effects of high spending, taxes and deficits grew. A second group of reformers followed in the early to mid-1990s. These countries reduced public expenditure significantly as part of comprehensive reform agendas. Reforms focussed on consumption expenditure and the welfare state, and improved economic structures and institutional frameworks. This strengthened public finances, growth and employment. Only a few countries did not reform, and their public expenditure continued to rise strongly. In the 2010s, a third group of countries in Europe started to reform in the context of the global financial crisis. These countries also curtailed expenditure significantly and undertook institutional reform to the benefit of fiscal sustainability, growth and employment.

This chapter concludes by considering the four main themes of the book: 1) How public spending has evolved over time, initially focussing on sound rules of the game and essential public goods and services before shifting more and more to welfare spending while debt grew to record levels. 2) The huge differences in government performance and efficiency, the reinvigorating role of expenditure reforms and the pragmatic ‘optimal’ size of government, that does not require public spending of more than 30–35%, perhaps 40% of GDP. 3) The main fiscal risks in the social and financial sphere from an ever-growing ‘insurance role’ of the state, which has contributed to rising debt and could put stability and sustainability at risk. 4) The case for strong rules and institutions to contain public spending, debt and fiscal–financial vulnerabilities. If governments focus on their core tasks and do them well, they underpin a well-functioning market economy with prosperity, freedom, opportunity and trust. This is the message of the social market economy model and it holds for the challenges related to the Coronavirus crisis which had broken out when this book went into publication. Not heeding this message in the past has contributed to governments being over-burdened and over-indebted today. We will all benefit from a lean, efficient and sustainable state.

Government expenditure needs to be financed. The two ways to do so are via taxes or via deficits and debt. For the first 90 of the past 150 years, public expenditure broadly grew in line with revenue, except during wars and times of crises. This changed fundamentally in the 1960s and early 1970s as the ‘Keynesian revolution’ took hold. Over the past fifty years, revenue rose strongly, but public spending often increased even faster. Chronic deficits stoked a high and growing stock of public debt in much of the advanced world. Public debt in the largest countries is now similar to the level prevailing at the end of the Second World War. Future governments will also face significant liabilities from increasing public expenditure related to population ageing, as well as fiscal risks from the financial sector. These liabilities and risks imply higher expenditure which will need to be financed. At the same time, there are political and economic limits to both taxation and indebtedness.

Well-functioning governments are at the basis of a modern, democratic society, the rule of law and a market process that generates trust, opportunities, prosperity and freedom. To maintain the economic success of advanced economies and the trust of our citizens, governments need to do well on their core tasks: setting sound rules of the game in the market economy and providing high-quality, essential public goods and services. These include security, education, infrastructure, basic social safety nets, the environment and sound public finances. Public expenditure is an important tool in this regard, but more spending is not correlated with more trust – ‘better’ spending and better performance on core tasks is. This chapter also sets out the map of the book: How public spending has evolved over time and how it has been financed in Part I; government performance and efficiency, the role of expenditure reforms and the ‘optimal’ size of government in Part II; the main fiscal risks in the social and financial sphere in Part III; and the case for strong rules and institutions to govern public spending and limit fiscal risks in the concluding Part IV.

This chapter completes the discussion on fiscal–financial risks and looks at banks, shadow banks, central banks and international linkages. Banks have increased their resilience considerably over the past decade, supported by the international regulatory agenda. However, global indebtedness has increased further and bank balance sheets are often loaded with risky public and private credit. Moreover, there are fiscal risks from market-based finance: highly priced, low-quality credit held partly by a run-prone asset management industry, an under-funded pension industry and large derivative clearing houses. Central banks face risks from large asset holdings. International credit is very high and could transmit problems across borders. International safety nets have grown but so have demands for international support. Given record debt and debt increases, and our lack of knowledge and experience of how fiscal–financial risks will unfold in the future, building resilience is of the highest priority. This vindicates constraints on deficit and debt, such as the Maastricht limits and the regulatory agenda for the financial sector, and it provides a further argument for lean and efficient government.

The role of government has evolved significantly over the past 150 years. In the late nineteenth century, only about 10% of GDP passed through the hands of government. This was consistent with the prevailing view that government should only be minimally involved in the economy. By 1960, public spending had increased to 25–30% of GDP as governments focussed on delivering their core tasks: rules of the game, public goods and services and basic safety nets. Private choice still predominated and safeguarded both economic and financial freedom. The Keynesian ‘revolution’ from 1960 to about 1980 saw government grow to 50% and 60% of GDP in some countries and to over 40% on average. Over the next two decades, the classical ‘counter-revolution’ propagated smaller states. Many countries began fiscal reform and rules-based policy-making gained prominence. Spending growth came to a halt, and in some cases reversed. The years since 2000 have seen a revival of Keynesian thinking. Countries engaged in expansionary policies before the global financial crisis and experienced new record highs in public expenditure and debt thereafter. Another wave of reforms brought spending down in some crisis countries in the 2010s. However, public spending ratios on average rose well above the level of 2000.