Size matters: The case for small government

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 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 “socialist,” promotes a platform of government medicine, free college, generous welfare, strict regulation and high taxes readily recognizable in Europe as social democratic policies.

The recent sluggishness of European economies suggests an adverse effect from the continent’s outsized government sectors. Since 2010, the European Union has grown 1.4 percent annually while the U.S. has averaged 2.2 percent 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 further ahead of their European counterparts by the end of a 40-year working career.

In the same period, the EU economies had a government share of 48 percent compared with 40 percent for the U.S., using current data from the Organization for Economic Cooperation and Development (OECD). 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 basketcases — Greece and Portugal — were growing at impressive annual rates of 7.7 percent and 6.9 percent, respectively.

Spain expanded 7.3 percent per year, while Austria, Belgium, Finland and France all grew around 5 percent.  Those historic rates are difficult to comprehend in light of recent growth rates under 1 percent for Greece, Portugal and Spain, respectively, and under 2 percent for the others.

This dramatic loss of economic vitality coincides with 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 doubled in their relative sizes.

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

The negative effect of large government upon growth is hardly limited to Europe. From 1960 to 1973, the U.S grew 4.3 percent annually with a government GDP share of 30 percent, compared with today’s more tepid growth and government share approaching 40 percent. 

When the notoriously ill-timed book, “Japan as Number One,” was published in 1979, that country had grown 9.7 percent annually from 1960 to 1973 with government expenditure accounting for around 20 percent of GDP.

By the late 1970s, government expenditure 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 below 1 percent with government averaging near 40 percent of GDP.

Fortunately for our future, declining growth is not preordained. Sweden, in the aftermath of a financial crisis, cut government by 20 percent of GDP and 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, growth for the last three years has been a roaring 6.3 percent.

Economists have long known the negative relationship between size of government and growth. Harvard 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.

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. Government infrastructure investment that could aid growth has itself been flat, squeezed in many countries by non-investment government spending.

Curiously, in what may be 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 results in double the standard of living over a career — greater opportunity, more jobs, better jobs and fewer 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 is the president of Carr Capital Co., a financial and economic advisory firm, and he’s an associate fellow at R Street.