When Big Can Mean Small

About 10 years ago a study was prepared for the Joint Economic Committee. This is one of four standing joint committees of the U.S. Congress.

The committee was established as a part of the Employment Act of 1946. This committee is responsible for reporting the current economic condition of the United States and for making suggestions for improvement to the economy.

This research paper was prepared to investigate The Size and Functions of Government and Economic Growth. The study was conducted by three economics professors:

• James Gwartney, Florida State University
• Robert Lawson, Capital University (Columbus, OH)
• Randall Holcombe, Florida State University

Their basic conclusion: the bigger the government, the more its economy suffers.


Their findings are vital to know in the context of my series of blog articles about the rapid increase in the US deficit, and accompanying growth in aggregate debt level.

Here are a few of their key conclusions:

• Rather than devising new programs to spend any surplus that may emerge from the current economic expansion (circa 1998), Congress should develop a long-range strategy to reduce the size of government so we will be able to achieve a more rapid rate of economic growth in the future.

• Government should provide for a legal/physical infrastructure for the operation of a market economy and a limited set of public goods in order to provide a framework conducive for economic growth.

• However, as government moves beyond these core functions, it will adversely affect economic growth because of:

  1. The disincentive effects of higher taxes,

  2. The diminishing returns as governments undertake activities for which they are ill-suited, and

  3. An interference with the wealth creation process, because government is not as good as markets at adjusting to changing circumstances and finding innovative new ways of increasing the value of resources.
  

Now before I go on to cite a few more findings, you will want to reflect on the current debates in Congress. These discussions and actions have led to a rapidly increasing size of government. While the growth in government is now at seemingly hyper-speed pace, readers can appreciate that this growth has outpaced our commercial economic expansion for many years now. (Refer to the graph in my August 18 blog posting.)

That has been apparent in many ways most recently (but not limited to just this year), including:

• Many aspects of the $787 billion stimulus package which frankly are just for spending and not clearly to stimulate the US out of recession in the near term,
• A $410 billion omnibus spending bill, packed with lots of pork from both political parties,
• Economic impact of proposed cap & trade legislation to curb greenhouse emissions, and
• The latest debate about health care reform along with nearly a $1 trillion cost over the next ten years according to the Congressional Budget Office (see my July 30 post).
  

Now in the latest attempt to pay for this, our government talks about increasing the taxes only on the wealthiest of Americans, ie, those who make $1 million and more a year.

Notice how all of this runs contrary to the research conducted just a decade ago for the Joint Economic Committee.

• In the US, government expenditures as a share of GDP have grown during the last several decades. At the same time, the investment rate has declined and the growth rates of both productivity and real GDP have fallen.

  An empirical analysis of the data from 23 leading countries shows a strong negative relationship between both (a) the size of government and GDP growth and (b) increases in government expenditures and GDP growth.

  A 10 percentage point increase in government expenditures as a share of GDP is associated with approximately a one percentage point decline in the growth rate of real GDP.

  An analysis of a larger data set of 60 countries reinforces this conclusion.
  

So bottom line:

If government expenditures as a share of GDP in the United States had remained at their 1960 level, real GDP in 1996 would have been $9.16 trillion instead of $7.64 trillion, and the average income for a family of four would have been $23,440 higher.

Leading countries currently spend 15 percent of GDP or less on the core functions of government-protection of persons and property, national defense, education, monetary stability, and physical infrastructure. When governments move beyond these core functions, the empirical evidence indicates that they retard economic growth.

These findings help provide a foundation for upcoming articles about the rapidly growing size of the US debt.