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

U.S.

How to Bend the News

This, from ABC, is a nice example of a news organization deliberately bending the truth in order to advance a narrative that it wishes were true but is not: Venerable gun manufacturer Colt says it will stop producing the AR-15, among other rifles, for the consumer market in the wake of many recent mass ... Read More
Education

George Packer Gets Mugged by Reality

Few journalists are as respected by, and respectable to, liberals as The Atlantic’s George Packer. The author of The Assassin's Gate (2005), The Unwinding (2013), and a recently published biography of Richard Holbrooke, Our Man, Packer has written for bastions of liberal thought from the New York Times Magazine ... Read More
U.S.

Trump’s Total Culture War

 Donald Trump is waging a nonstop, all-encompassing war against progressive culture, in magnitude analogous to what 19th-century Germans once called a Kulturkampf. As a result, not even former president George W. Bush has incurred the degree of hatred from the left that is now directed at Trump. For most of ... Read More