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Archive for May 25th, 2012

It seems I was put on the planet to educate people about the negative economic impact of excessive government. Though I must be doing a bad job because the burden of the public sector keeps rising.

But hope springs eternal. To help make the case, I’ve cited research from international bureaucracies such as the Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank. And since most of those organizations lean to the left, these results should be particularly persuasive.

I’ve also cited the work of academic scholars from all over the world, including the United States, Australia, and Sweden. The evidence is very persuasive that big government is associated with weaker economic performance.

Now we have some new research from the United Kingdom. The Centre for Policy Studies has released a new study, authored by Ryan Bourne and Thomas Oechsle,  examining the relationship between economic growth and the size of the public sector.

The chart compares growth rates for nations with big governments and small governments over the past two decades. The difference is significant, but that’s just the tip of the iceberg. The most important findings of the report are the estimates showing how more spending and more taxes are associated with weaker performance.

Here are some key passages from the study.

Using tax to GDP and spending to GDP ratios as a proxy for size of government, regression analysis can be used to estimate the effect of government size on GDP growth in a set of countries defined as advanced by the IMF between 1965 and 2010. …As supply-side economists would expect, the coefficients on the tax revenue to GDP and government spending to GDP ratios are negative and statistically significant. This suggests that, ceteris paribus, a larger tax burden results in a slower annual growth of real GDP per capita. Though it is unlikely that this effect would be linear (we might expect the effect to be larger for countries with huge tax burdens), the regressions suggest that an increase in the tax revenue to GDP ratio by 10 percentage points will, if the other variables do not change, lead to a decrease in the rate of economic growth per capita by 1.2 percentage points. The result is very similar for government outlays to GDP, where an increase by 10 percentage points is associated with a fall in the economic growth rate of 1.1 percentage points.16 This is in line with other findings in the academic literature. …The two small government economies with the lowest marginal tax rates, Singapore and Hong Kong, were also those which experienced the fastest average real GDP growth.

The folks at CPS also put together a short video to describe the results. It’s very well done, though I’m not a big fan of the argument near then end that faster growth is a good thing because it generates more tax revenue to finance more government. Since I’m a big proponent of the Laffer Curve, I don’t disagree with the premise, but I would argue that additional revenues should be used to finance lower tax rates.

Since I’m nit-picking, I’ll also say that the study should have emphasized that government spending is bad for growth because it inevitably and necessarily leads to the inefficient allocation of resources, and that would be true even if revenues magically floated down from heaven and there was no need for punitive tax rates.

This is my message in this video on the Rahn Curve.

When the issue is government, size matters, and bigger is not better.

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Guido Westerwelle is supposed to be the German version of a libertarian. Currently serving as Foreign Minister, he was the chairman of the supposedly pro-market Free Democratic Party for 10 years and Wikipedia says he was known as a “proponent of an unlimited free market economy.”

Sounds like a good guy, right? Just the type of person who can explain that Europe’s problem is too much government. The kind of policy maker who can argue for cutting back the welfare state, slashing tax rates, and ending bailouts.

That’s the optimistic spin, but now let’s look at the column Westerwelle wrote for the Washington Post yesterday. Entitled “A Growth Pact for Europe,” he called for six reforms. Unfortunately, four of the reforms mean more government and two were meaningless boilerplate. Let’s look at what he proposed.

First, the European Union’s budget should be consistently oriented toward growth… The E.U. must utilize its resources better than before without spending more. Money is available for future-oriented tasks; in recent months, E.U. officials have been negotiating a 1 trillion-euro budget for 2014 to 2020. We should concentrate on using this huge sum consistently to promote growth and employment, innovation and competitiveness.

I’m glad he says they shouldn’t spend even more than is currently in the EU budget, but he apparently believes that government can redistribute 1 trillion euro in a way that boosts the economy. Good luck with that.

Second, unused E.U. funds must be activated. Around 80 billion euros in the regional cohesion fund have not been allocated to any concrete projects. The European Commission and member states must invest these funds quickly and effectively in new growth through better competitiveness.

Wow, he wants us to believe that wasting money faster is a recipe for growth. This is the same nonsense the Obama Administration was peddling.

Third, access to capital must be improved. …companies are not in a position to make sensible investments that would stimulate growth. The European Investment Bank is an instrument we could use to a greater extent and in a more targeted fashion, not least to ensure that small and medium-size businesses have better access to loans.

I guess this is the European version of the bastard child of Fannie Mae and the Export-Import Bank. But if anybody thinks government-subsidized cronyism is a route to prosperity, they’ve been asleep for the past 40 years.

Fourth, infrastructure projects must be promoted. …Our roads, railways, and energy and telecommunication networks are among the European economy’s trump cards. …State-of-the-art infrastructure opens new prospects for growth by making private-sector investment more attractive. We need to mobilize private capital for the cross-border expansion of European infrastructure and look at innovative forms of public-private partnership.

I’ll be the first to admit that infrastructure spending is less damaging that social welfare spending, but it is a bit of a fantasy to assume that there are lots of high-return projects languishing on the shelves.

Fifth, we must complete Europe’s internal market. In the 1980s and ’90s, realizing the “four freedoms” — the free flow of goods, capital, services and people within the E.U. — released tremendous forces for growth. Today, the expansion of the internal market to cover new spheres again offers great opportunities. That applies to the digitized economy, e-commerce and the energy sector, and it will strengthen small and medium-size companies by reducing red tape and ensuring better access to venture capital.

This boilerplate support for more free trade is fine, but I think all the big benefits of ending protectionism inside Europe already have been captured (and this is the one area where the European project has been a success).

Sixth, we want to strengthen free trade. Three-quarters of the world’s trade occurs outside the European Union. More than 80 percent of global growth is produced outside Europe. The E.U. must work toward making the Doha Round a success while also concluding more free-trade agreements with new and long-established centers of power.

Again, this a good sentiment, but I fear it is a throwaway passage. Almost every nation has empty rhetoric about completing the Doha round, but don’t hold your breath expecting it to happen anytime soon.

What’s notable about Westerwelle’s list is that there is nothing about the overall burden of spending, even though Europe is saddled with bloated welfare states. There is nothing about high tax rates, even though most nations have punitive systems that discourage work, saving, investment, and entrepreneurship. There is nothing about the overall burden of regulation and red tape, particularly the supposedly pro-labor rules that actually discourage hiring (the Germans did implement successful reforms last decade, so he would have been in a strong position to urge other nations to copy those changes).

Heck, even the World Bank has been willing to point out that big government has failed in Europe. So it’s hardly a positive sign that a supposedly strong free market lawmaker is basically arguing that even more government is the way to boost growth on the continent.

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