The Myth of Small Government

Liberals too easily subscribe to a basic precept of conservatism: that where it concerns government, smaller is better. But empirically, this position is (as) unsupportable (as most other conservative idiocies).

In 1900, total US govt spending (fed + state + local) was about 8% of GDP. Spending stayed above 10% of GDP between WW1 and FDR, passed 20% during the New Deal, spiked during WW2, then settled back to about 22% in the late 1940s. It’s climbed steadily ever since, briefly passing 40% in the aftermath of the Great Recession, having since fallen back to the high 30s.

As a function of GDP, US government spending since WW2 has been triple to quadruple what it was during 19th century. If indeed government spending was inimical to economic growth, one would expect to see a massive slowdown in GDP growth. One in fact sees the opposite: the golden age of American economic growth coincides with (by far) the largest government America’s ever seen.

Looking at per capita GDP growth since 1790, one finds that the best 50 yr period for growth before WW2 was 1842-1892, during which per cap GDP increased about 180%. But since WW2, 50 yr growth rates have almost always been higher, and usually much higher: more than 200% for 50 yr periods ending during 1997-2000, and more than 190% during such periods ending during 2004-2008. Even with the great recession, 50 yr per cap GDP growth only slipped to about 175%. And it’s worth noting that 50yr growth for the period 1843-1893 is only 153% (with the Panic of 1893).

100 year growth rates tell a similar story. During 1910-2010, US per cap GDP increased by about 650% – the intervals 1900-2000, 1901-2001, 1902-2002, on up to present all have growth of between 600 and 710%. By comparison, pre-WW2 100 yr growth never even reaches 400%, and is usually closer to 300%.

The story is told and retold the world over: since WW2, fast economic growth does not happen in the absence of a large govt directing resources to critical industries (viz., health, education, insurance). To judge whether a government is large, I like to use a simple pair of metrics: how much does a government tax and-or spend as a function of GDP; shaded by one particular fact: to what extent does government directly own and control the means of production.

Practically every rich country in the world taxes and spends more than 30% of GDP – some of the richest countries are in the 50-55% range. The notable exceptions are Singapore and Taiwan, rich countries whose respective govts only spend about 17-19% of GDP – but those governments have massive direct ownership and control of economic production.

Taiwan’s economic miracle (1952-82) SLOWED considerably after its government sold off a large fraction of its stake in firms and banks. Even today, Taiwan’s govt can balance its budget while spending 18% of GDP and taxing only 13%, with the difference coming via (non-tax) revenue in state-operated firms. (Kuwait’s govt is a useful illustration: taxing 1% of GDP while spending 30%, without running a deficit.)

Singapore’s state-owned and operated holding company, “Temasek Holdings”, has assets worth about 50% of Singaporean GDP. This wd be like a US govt agency owning $8T of (mostly) US corporate and banking stock, making buying and selling decisions politically – pouring capital into favored industries and firms. You may recall how central bankers recoiled at the idea of moving the SS trust fund (about $3T) into corporate stock – they feared the politicization of investment decisions. Just how ginormous is an $8T portfolio? To get to that value, the US govt wd have to own 50% of all the stock traded on the NYSE. In Singapore, that’s the way “business” is done.

Today, every country with a small government is poor, and every rich country has a large government. The chicken and egg question cannot be seriously entertained. If small government is so awesome for economic growth, why are there no small-government economic powerhouses? Why havent big-government states in the west withered – why has growth only accelerated since WW2, with the rise of big govt?

My best guess (ok: WAG) is that up to a certain point in development, an economy does just fine letting the market allocate the bulk of resources. But beyond that point, market failures in key areas undermine the larger economy, and growth is greatly enhanced by govt diverting resources (thru tax/spend policies) into those areas. Up till 1900, the government didnt do very much beyond defense. Since then, govt is the prime spender in education, insurance and health.

Few question the usefulness of public education – differences are usually about how the state should spend on education (vouchers, busing, etc) – not whether it should. Five year olds cant go to the bank to borrow for their education; their parents do not come close to enjoying the full returns on their investment in their children’s education – and thus it is that access to capital and externalities destroy what mt otherwise be a functioning private market for education. Worldwide, education simply does not happen in the absence of massive government spending, no matter the returns to education.

The benefits of govt spending on Health, writ large, are also intuitive. 19th century workers just werent worth a whole lot – when one got sick, it was (to be crass) not cost-effective to treat them – not that medical technology at the time cd do much. However it was cost-effective to prevent disease – especially the contagious kind – and countries who wd become rich got into building sewer systems, greatly reducing the toll of infectious disease. (The WHO, operating significantly in the developing world, still considers sanitation as part of a nation’s healthcare budget.)

As people get more valuable (ie, as they accumulate more human capital), their sickness and death becomes more costly, and treatment makes economic sense. As proof of the usefulness of govt provision of health insurance, one notes the developed country in which the govt is LEAST involved in health expenditures, has both the highest health costs AND the highest mortality rates (from birth to age 75). Reasonable minds can differ as to why the private market for healthcare fails by itself – but the starting point is the fact that it fails spectacularly.

The last primary area of big government spending is insurance, and this is the trickiest case to consider. Modern states spend a fortune on health and old age insurance, considerable sums in many other areas of insurance (unemployment, welfare, disability, depositors), while heavily regulating practically every insurance that they dont directly provide (homeowners, auto, earthquake, etc.). The threshold question is itself challenging: how does insurance create value by reallocating risk? Perhaps insurance is only a facilitator of growth, permitting greater risk-taking. Any look at the financial services sector shows the modern human desire for insurance is insatiable. This line of inquiry will be be continued….

As that wrinkly bad-hair dude said: greed is good. But big govt is also good, and liberals should not be shy about it. it should not go without saying that markets remain an indispensable tool for resource allocation – attempts to operate without them, in Russia, China and Cuba, all met with economic disaster. But the medium between Maoist China and present-day Burma – is indeed happy. In the developed world, bigger is better: With their biggest-in-class governments, Scandinavian growth rates (per cap GDP) have outstripped the anglo world (US, UK, Canada, NZ, Australia) since WW2.

refs:

per cap us gdp growth courtesy of: http://www.measuringworth.com/index.php

us govt spending: http://www.usgovernmentspending.com/

http://en.wikipedia.org/wiki/Government_spending#As_a_percentage_of_GDP

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28PPP%29_per_capita

other fun stuff:

http://en.wikipedia.org/wiki/Temasek_Holdings

http://en.wikipedia.org/wiki/Taiwan_Miracle

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