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Big Government, Shrinking Economy: The Case for Small Government

August 7, 2019
By Douglas Carr

From 1960 to 1973, the U.S. economy grew by an average of 4.3 percent per year with a government share of 30 percent of GDP.

Long after today’s hot-button political controversies fade into obscurity, our country will face the consequences of how we answer a major question that divides the political parties: Are we to have a larger government providing more services from higher taxes, or a smaller government providing less services with fewer taxes?

Currently, the movement to expand government, inaccurately self-described as socialism, promotes a platform of government medicine, free college, generous welfare, strict regulation, and high taxes readily recognizable in Europe as social democratic policies.

Slow-Growing European Union

The recent sluggishness of European economies suggests an adverse effect from the continent’s outsized government sectors. Since 2010, the European Union’s GDP has grown by an average of 1.4 percent per year, whereas the United States has averaged 2.2 percent annual economic growth. Neither figure is good, but there is a clear and meaningful U.S. advantage.

Through the power of compound growth, the U.S. rate would leave its citizens over 35 percent farther ahead of their European counterparts by the end of an individual’s 40-year working career.

In the same period, since 2010, government spending as a share of the EU economies was 48 percent, compared with 40 percent for the United States, according to current data from the Organization for Economic Cooperation and Development (OECD).

Europe’s Fast-Growth Period

Europe’s sluggishness has been attributed to many factors, but history provides perspective.

European countries didn't always have sluggish economies. From the 1960s to the early 1970s, today’s basket cases—Greece and Portugal—were growing at impressive annual rates of 7.7 percent and 6.9 percent, respectively.

During that period, Spain’s GDP expanded by 7.3 percent per year, and Austria, Belgium, Finland, and France all averaged around 5 percent annual economic growth. Those historic rates are difficult to comprehend in light of recent growth rates under 1 percent for Greece, Portugal, and Spain and under 2 percent for the others.

Social-Democratic Welfare States

This dramatic loss of economic vitality coincides with the expansion of Europe’s social democratic welfare state. Since the early 1970s, one-fifth of the economies of Greece, Portugal, and Spain has shifted from the private sector to the public sector, as government expenditures have doubled as a share of the economy.

Austria, Belgium, Finland, and France all increased government spending by more than one-tenth of their gross domestic product, a jump in share from around 25 percent to roughly 50 percent for each.

The negative effect of large government upon growth is not limited to Europe. From 1960 to 1973, the U.S. economy grew by an average of 4.3 percent per year with a government share of 30 percent of gross domestic product (GDP), compared with today's more tepid growth and a government share approaching 40 percent.

When the notoriously ill-timed book Japan as Number One: Lessons for America was published in 1979, that country had grown by 9.7 percent annually from 1960 to 1973, with government expenditures accounting for around 20 percent of GDP. By the late 1970s, government expenditures had grown to 28 percent of GDP, while growth slowed to 3.5 percent. In the last couple of decades, Japan’s growth slowed to less than 1 percent, with government averaging nearly 40 percent of GDP.

Slow Growth Isn’t Preordained

Fortunately for our future, declining growth is not preordained. Sweden, in the aftermath of a financial crisis in the 1990s, cut government by 20 percent of GDP, and annual economic growth rose from 1.6 percent to 2.8 percent.

Plucky Ireland, forced by its European Union partners to swallow the cost of a bank bailout, saw government expenditures rise from around 35 percent of GDP to 65 percent. As the Irish have cut government back down to 26 percent of GDP, annual economic growth for the last three years has been a roaring 6.3 percent.

Economists have long known of the negative relationship between size of government and growth. Harvard University economist Robert Barro identified it in a 1991 article. Keynesian economists, who believe government spending stimulates growth, have questioned details of his analysis, but long-run facts show that growth slows as government expands and growth accelerates in the rare examples where government shrinks.

Government Reduces Private Investment

No matter their ideology, virtually all economists agree investment is a major contributor to growth. Governments invest less than the private sector. In 2015, for OECD advanced economies, governments invested 8.5 percent of their spending, while the private sector invested 32 percent of its share.

As the government share of these economies has increased, private investment has fallen, as the accompanying figure shows. Government infrastructure investment that could aid economic growth has been flat, squeezed in many countries by noninvestment government spending.

Curiously, in what may be a testament to inadequacies of our educational system, support for “socialism” is highest among the young, the very ones whose future is throttled by big government stagnation.

The difference between the U.S. 1960s growth rate of 4.3 percent and the recent 2.2 percent rate is that the higher growth rate results in double the standard of living over a career—greater opportunity, more jobs, better jobs, and fewer people left behind in a thriving economy.

The alternative of European-style social democratic stagnation is detrimental for the future of our children and our children's children.

Douglas Carr (dcarr@rstreet.org) is the president of Carr Capital Co. An earlier version of this article was published at The Hill. Reprinted with permission.

 

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