On Question Time this weekend, Theresa May was confronted by a nurse whose pay has been squeezed under the Coalition and Conservative governments. Her response to the nurse’s complaints was that “there isn’t a magic money tree that we can shake that suddenly provides for everything that people want”. Theresa May is of course right. There is, as far as we know, not a magic money tree. However, I fear that as an explanation for why nurses can’t have a pay rise, her statement is lacking.
That is not to say that there is no link between magic money trees and nurses’ pay. If there were indeed a magic money tree, then its harvest could surely be used to pay nurses more. The absence of such a tree is a necessary condition for it being impossible to pay nurses more – but it is not sufficient. The reason for this is that there are types of money that are not magical and do not grow on trees. In failing to address the availability of this more mundane form of money, Theresa May has, not for the first time, not really answered the question.
A more charitable interpretation of Theresa May’s statement is that she is trying to argue that we can’t afford to increase government spending above current levels. Government spending is financed by taxes or debt, which must be repaid from future taxes, so the ability of a government to afford a given level of spending is dependent on its ability to raise taxes. One reason that some developing countries struggle to fund public services such as health care is that they have weak public institutions and so can’t raise taxes very effectively. The UK and most other rich countries are much better at collecting taxes and have larger public sectors. But their scope for public spending is not unlimited, for two reasons: high taxes and a large public sector might have a distortionary effect on the economy, discouraging economic activity and squeezing out the private sector; or democratic processes might limit the size of the state by voting out governments that raise taxes.
This is all very complicated and hotly disputed, but one way to understand whether the UK could conceivable have higher public spending is to look at how we compare to other countries. The chart below (based on OECD data) compares public spending as a share of GDP with GDP per capita, for all OECD countries where data is available.
On both measures, we are roughly in the middle. GDP per capita in the UK is about the same as Japan, France and Finland, higher than Spain and Italy, and a fair bit lower than most other Western European countries. Public spending (as a share of GDP) is lower than in most Western European Countries, but higher than Japan, Australia or the US.
It is also fairly clear that, as far as this dataset goes, there is no relationship between the two variables. Sweden, Austria and Denmark have much higher public spending than the UK, but this doesn’t stop them having much higher economic output. On the other hand, Australia and the US manage higher economic output with lower public spending. It seems that (within the range of this chart) pretty much any combination is possible. Of course, this doesn’t prove that higher taxes wouldn’t be bad for the UK economy. Perhaps our economy is so fragile that it would be crippled by any tax rises. But if you are going to argue this you are going to have to convince me that it is impossible for us to achieve what much of the rest of Western Europe can.
The political question is more difficult to analyse. Yes, other countries have larger public sectors, but they also have different political cultures. Perhaps the British are fundamentally different to our European neighbours and would simply not stand for the tax rises that are required to finance better health care and pay rises for nurses. Perhaps we are and will always remain a low tax country.
I don’t have a strong opinion on the optimal size of government, but I do wish we could have an honest debate about it. When someone says “we can’t afford it”, we need to be clear that this is nonsense. What they are really saying is that they do not think that we should raise the taxes required to pay for it. This is a debate that we need to have, but saying “we can’t afford it” is not the way to go about it.
The phrase “magic money tree” is even worse: it is designed to ridicule the suggestion that public spending should be increased. A nurse asking for a pay rise is as stupid as someone who believes that money grows on magical trees. Repeating this phrase whenever anyone suggests spending public money on something is not only nonsensical but frankly offensive.
 This statement is not the main point of this post and I don’t want to hear from any macro-economists about the inflationary effects of magic money trees.
 Excluding Ireland and Luxembourg, whose results are heavily distorted by their role as tax havens.