The Corner

When Government Grows, the Economy Shrinks

In the midst of the European debt crisis, economists at the European Central Bank just produced a paper that looks at how growth in the size of government affects economic performance. The authors, António Afonso and João Tovar Jalles, provide “evidence on the issue of whether ‘too much’ government is good or bad for economic progress and macroeconomic performance, particularly when associated with differentiated levels of (underlying) institutional quality and alternative political regimes.”

Here are some key findings.

We analyse a wide set of 108 countries composed of both developed and emerging and developing countries, using a long time span running from 1970-2008, and employing different proxies for government size […] Our results show a significant negative effect of the size of government on growth. […] Interestingly, government consumption is consistently detrimental to output growth irrespective of the country sample considered (OECD, emerging and developing countries).

Basically, an increase in government spending (whether financed by taxes or by borrowing) reduces economic growth. This is consistent with a paper from a few years ago by Harvard Business School’s Lauren Cohen, Joshua Coval, and Christopher Malloy. To their surprise, those authors found that federal spending in states caused local businesses to cut back rather than grow.

The average state experiences a 40 to 50 percent increase in earmark spending if its senator becomes chair of one of the top-three congressional committees. In the House, the average is around 20 percent.

For broader measures of spending, such as discretionary state-level federal transfers, the increase from being represented by a powerful senator is around 10 percent.

In the year that follows a congressman’s ascendancy, the average firm in his state cuts back capital expenditures by roughly 15 percent.

There is some evidence that firms scale back their employment and experience a decline in sales growth.

Another interesting finding from the ECB paper is the positive role played by institutions on growth.

Similarly, institutional quality has a significant positive impact on the level of real GDP per capita. […] Moreover, i) the negative effect of government size on GDP per capita is stronger at lower levels of institutional quality, and ii) the positive effect of institutional quality on GDP per capita is stronger at smaller levels of government size.

On the other hand, the negative effect on growth of the government size variables is more attenuated for the case of Scandinavian legal origins, while the negative effect of government size on GDP per capita growth is stronger at lower levels of civil liberties and political rights. Finally, and for the EU countries, we find statistically significant positive coefficients on overall fiscal rule and expenditure rule indices, meaning that having stronger fiscal numerical rules in place improves GDP growth.

I hope someone in Washington is listening — or reading this paper. (Thanks to Bruce Bartlett for the pointer.)

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

Most Popular

Education

The Shame of the Teachers’ Unions

No other group has shown as much contempt for its own work during the coronavirus crisis as teachers. Their unions are actively fighting to keep kids out of the classroom and also to limit remote instruction, lest it require too much time and attention from people who are supposed to be wholly devoted to ... Read More
Education

The Shame of the Teachers’ Unions

No other group has shown as much contempt for its own work during the coronavirus crisis as teachers. Their unions are actively fighting to keep kids out of the classroom and also to limit remote instruction, lest it require too much time and attention from people who are supposed to be wholly devoted to ... Read More
World

Massive Explosions Devastate Beirut

A series of massive explosions detonated in Beirut on Tuesday, with footage showing a mushroom cloud and shockwave emanating from the city port. [embed]https://twitter.com/air_intel/status/1290676373485490177[/embed] It is still unclear what caused the explosions. Lebanese security forces claimed the ... Read More
World

Massive Explosions Devastate Beirut

A series of massive explosions detonated in Beirut on Tuesday, with footage showing a mushroom cloud and shockwave emanating from the city port. [embed]https://twitter.com/air_intel/status/1290676373485490177[/embed] It is still unclear what caused the explosions. Lebanese security forces claimed the ... Read More
World

A Shattered City

On the menu today: Unraveling the mystery behind yesterday’s devastating, jaw-dropping explosion in Beirut; reports suggest that Joe Biden’s vice presidential search isn't going well -- although one report suggests his list is down to two contenders; and yesterday’s primary leaves one less thing to worry ... Read More
World

A Shattered City

On the menu today: Unraveling the mystery behind yesterday’s devastating, jaw-dropping explosion in Beirut; reports suggest that Joe Biden’s vice presidential search isn't going well -- although one report suggests his list is down to two contenders; and yesterday’s primary leaves one less thing to worry ... Read More
U.S.

Our Summer of Cultural Suicide

Cultural suicide used to be a popular diagnosis of why things suddenly just quit. Historians such as Oswald Spengler and Arnold Toynbee cited social cannibalism to explain why once-successful states, institutions, and cultures simply died off. Their common explanation was that the arrogance of success ... Read More
U.S.

Our Summer of Cultural Suicide

Cultural suicide used to be a popular diagnosis of why things suddenly just quit. Historians such as Oswald Spengler and Arnold Toynbee cited social cannibalism to explain why once-successful states, institutions, and cultures simply died off. Their common explanation was that the arrogance of success ... Read More

What or Who Decides This Election?

We know where to watch in the next few weeks but have no real idea what we will be watching. Yet pundits, the media, and the Left seem giddy that their polls show a Trump slump, as if they have learned nothing and forgotten nothing from 2016. But in truth, the news cycle over the next three months may well favor ... Read More

What or Who Decides This Election?

We know where to watch in the next few weeks but have no real idea what we will be watching. Yet pundits, the media, and the Left seem giddy that their polls show a Trump slump, as if they have learned nothing and forgotten nothing from 2016. But in truth, the news cycle over the next three months may well favor ... Read More