Last month, I shared a very interesting video from Canada’s Fraser Institute that explored the link between economic performance and the burden of government spending.
There’s now an article in the American Enterprise Institute’s online magazine about this research.
The first half of the article unveils the overall findings, explaining that there is a growth-maximizing size of government (which, when put onto a graph, is shaped like a hump, sort of a spending version of the Laffer Curve).
One recent addition to the mounting evidence against large government is a study published by Canada’s Fraser Institute, entitled “Measuring Government in the 21st Century,” by Canadian economist and university professor Livio Di Matteo. Di Matteo’s analysis confirms other work showing a positive return to economic growth and social progress when governments focus their spending on basic, needed services like the protection of property. But his findings also demonstrate that a tipping point exists at which more government hinders economic growth and fails to contribute to social progress in a meaningful way. …Government spending becomes unproductive when it goes to such things as corporate subsidies, boondoggles, and overly generous wages and benefits for government employees. …Di Matteo examines international data and finds that, after controlling for confounding factors, annual per capita GDP growth is maximized when government spending consumes 26 percent of the economy. Economic growth rates start to decline when relative government spending exceeds this level.
This is standard Rahn Curve analysis and it shows that the public sector is far too large in almost all industrialized nations.
And if you happen to think that 26 percent overstates the growth-maximizing size of government (as I argued last month), then it’s even more apparent that significant fiscal restraint would be desirable.
But I’m more interested today in the specific topic of Canada and the Rahn Curve. The article has some very interesting data.
For a real-life example of how scaling back government has led to positive and practical economic benefits, Americans should look north. …total government spending as a share of GDP went from 36 percent in 1970 (just over 2 percentage points higher than in the United States) to 53 percent when it peaked in 1992 (14 percentage points higher than in the United States).
…the federal and many provincial governments took sweeping action to cut spending and reform programs. This led to a major structural change in the government’s involvement in the Canadian economy. The Canadian reforms produced considerable fiscal savings, reduced the size and scope of government, created room for important tax reforms, and ultimately helped usher in a period of sustained economic growth and job creation. This final point is worth emphasizing: Canada’s total government spending as a share of GDP fell from a peak of 53 percent in 1992 to 39 percent in 2007, and despite this more than one-quarter decline in the size of government, the economy grew, the job market expanded, and poverty rates fell dramatically.
Simply stated, none of this should be a surprise.
The Canadian economy had the breathing room to expand when the burden of spending was reduced. 
Why? Because more labor and capital were available to be allocated by market forces.
This is one of the reasons why Canada now ranks higher than the United States in both Economic Freedom of the World and the Index of Economic Freedom.
And it’s also worth noting that spending restraint has facilitated significant tax cuts in Canada. Indeed, some American companies are moving north of the border!
Here’s my video that includes a discussion of Canada’s dramatically successful period of spending restraint in the 1990s.
P.S. You won’t be surprised to learn that Paul Krugman would rather misrepresent supposed austerity in the United Kingdom rather than address the real success story of Canada.
P.P.S. More generally, I’ve challenged all Keynesians to explain why Canada’s economy enjoyed good growth when there was genuine spending restraint.
P.P.P.S. While I’m a big fan of Canada, I’m not fully confident about the nation’s long-term outlook.
Canada’s Federal budget will be balanced in 2015-2016. Try to imagine that scenario for the U.S. !
More than anything, the Canadian economy got room to compete internationally when the burden of government shrunk. Competitiveness is the key, and lack thereof the hallmark of demise. No wonder a grand coalition of politicians and bureaucrats are trying to create a majority among the statist minded to impose worldwide coercive collectivism and eliminate competition.
Eventually, we are inevitably headed towards a new cold war — same war, with rearranged players and coalitions. Those who want to impose a worldwide low growth, flatter effort-reward curve cartel will be the new block of international statism, against those of the freer minded who bet that the benefits of breaking out of the cartel outweigh the risks and consequences of retribution from the statist axis. In the end, the steeper effort-reward curves, being associated with higher productivity, will inevitably prevail.
The process of human cultural evolution towards higher productivity cannot be stopped. But for those on the statist side it will be a long painful exercise in extinction, like the many cycles of coercive collectivism the world has had over the centuries under various flags, Red, Brown, Black, Green etc. Billions of the voter lemmings will sacrifice themselves to the dead evolutionary branch of statism… Until humans start interjecting the DNA of insects, such as ants and bees, into their genes. Then things may change…See, there is hope for statism.
But I digressed…
Evolution and survival of the most productive is the only thing that supports the Rahn Curve. And while this will lead to the ultimate triumph of Rahn reality, in the short to intermediate term, things are a lot grimmer.
The public would readily accept the plausibility of the Rahn Curve. Except for one thing:
Government redistributes visibly and immediately, while the Rahn Curve promises future compounding growth. Superior, but delayed, gratification is not a dominant attribute of the majority. Voter-lemmings remain voter-lemmings. If only delayed gratification had any traction at the polls.
So while, in anything but the very short term, the benefit of higher compounding growth tramples immediate redistribution, in the short term, a dollar of redistribution in the next election is worth five perpetually compounding Rahn growth dollars in the future. The long term advantage of compounding growth holds even for those in the lower part of the prosperity spectrum. That is how, by the end of the cold war, the American poor had come to enjoy a standard of living higher than the Soviet elite.
But when the trajectory difference is not as great as Capitalism vs Communism, standard of living divergence takes longer.
To be more precise, government redistribution is more than immediate. Typically, government redistributes in negative time. It first pays out by borrowing, but does not have to immediately collect, only when a few years later the deficit inevitably grows to alarming proportions. So government pays immediately according to need, but can wait a few years until it must inevitably come around and collect according to ability. For example, Obamacare is now in the “handing out according to need” phase. The “collecting according to ability” phase must inevitably come sooner or later.
This time lag makes it even easier for politicians to sell the redistributive big state philosophy, as the more productive fail to realize that they must inevitably become the targets. Even worse, the entire environment that gives them incentive to use their competencies must be eventually dismantled by the flattening of the effort-reward curves.
Once most are milking almost everyone else, with politicians and bureaucrats acting as middlemen, then it becomes impossible to let go. Those who let go simply become milked without anyone to milk. From a purely ethical standpoint this could be a legitimate alternative. But from a utilitarian standpoint it becomes an impossible pipe dream. When effort-reward curves flatten, desire to produce, innovate, progress also flattens. The dream peters out into a dead evolutionary branch. Sorry folks, Darwinism applies.
Let’s be worried, but not pessimistic; at least not in the long term. After all, long accumulating distortions can go into correction rather quickly and suddenly. Who ever thought in 1980 that the collapse of communism was less than a decade away? But be careful and worried. For those of us outside the iron curtain, the collapse of communism was rather painless. Those on the socialist side of the curtain were not so lucky. They suffered a painful readaptation that permanently wiped out many families and descendants for a lifetime. Don’t end up the same way when attempts to postpone the inevitable correction increase the distortions of the flatter-effort reward welfare state, and most of the industrialized world suffers a painful correction that wipes out many-many people and families.
BTW, which side of the welfare state curtain are you on?
Do the figures include Provincial government spending? Most Canadians remember the WSJ article about Canada’s perilous finances as a turning point (published in the 90’s). The result? Our dollar was devalued to boost exports and Federal spending and transfers to Provinces, were cut back. Unfortunately, the Provinces have by and large continued their profligate ways.
I fear a crisis worse than the early 1990’s is ahead of us when you consider the state of Provincial balance sheets.
[…] Canada, the Rahn Curve, and the Size of Government […]
Dan Mitchell is absolutely correct in his observations of Canada’s recovery from the economic malaise created by excessive government.
The problem stems from an apathetic electorate and an oversupply of arrogant politicians that see that have never succeeded in business but see the way clear to gain prestige and security by manipulating the masses into thinking government is the solution, not the problem.
In team B we have Defending Champions Spain currently yet again prepared
to get the world cup home yet again. Once again they did
splendid task World Cup qualifiers and have the service of gamers
like Torres, Ramos, Villa, Mata and their star Aim Keeper Iker
Casillas. The 2nd team in the pool is Final World Cup finalist
Netherlands which will have the solutions of gamers like Kuyt, Robben, and their notify striker
Robin Van Persie who is likely excellent in English Leading League for Manchester United.
The third crew in the pool is from South America Chile, they done effectively in World Cup qualifiers.