Q&A: Size of State Sector and Automatic Stabilisers

A student asks: “how does having a large state sector allow automatic stabilizers to act in a downturn?”

I am note sure how strong the link is between the size of the public sector and the impact of automatic stabilisers on the economic cycle. Intuitively it seems fairly clear that if the public sector is sizeable e.g. measured as a share of GDP and there is a downturn, the stabilisation role of the public sector can be large.

1/ A large state sector might be reflected in an extensive benefits system much of which provides income-related benefits .... so that when a recession comes and average incomes fall, the government injects more through welfare automatically.

2/ Second a large state sector might be built / financed around a progressive tax system .... so that reverse fiscal drag may happen - which means that people pay less in tax as their incomes and spending drop .... the state takes less out in tax.

3/ A large state sector also implies a high level of public sector employment, many of whose jobs are relatively immune from competition / recession .... giving a degree of employment stability

The UK has seen a rise in relative poverty over the last 20-30 years… so there are millions of families dependent on one or more income-related welfare benefits ... this makes the automatics stabilisers more powerful .... but it has serious consequences for the size of the budget deficit in a downturn

Here are some related blog posts on fiscal policy and the fiscal stimulus debate during the current downturn