Bigger government bad for growth

Readers of Ideas would be pleased to know the latest research on the impact of government size on economic growth supports the argument of CIS: excessive government size is harmful to growth. This research is summarised in two articles written by Andrew Bergh and Magnus Henrekson in the Journal of Economic Surveys (full copies of the articles are available on request to the CIS).

Bergh and Henrekson note a number of difficulties with research in this area.

Firstly, there is the issue of whether government size impacts on economic growth, or growth impacts on government size. In other words, which direction is causation? If an economy grows strongly, governments awash in extra tax revenue could spend this money, thus increasing the size of government. This could incorrectly be interpreted as meaning that a larger government size has actually caused the economic growth. Conversely, government spending goes up in recessions: this could incorrectly be interpreted as the spending causing slower growth. Good research papers, examined by Bergh and Henrekson, address this problem as best they can.

The better papers cited by them also separately analyse developing and developed countries, because the effects of government size can be quite different for these two groups.

Sifting through all this evidence, Bergh and Henrekson in summary find that an increase in government size of 10 percentage points in developed countries is associated with economic growth that is 0.5% to 1% lower per year. This is a further impetus for the continuing work of the CIS in advocating smaller government.

Nevertheless, some may point to Sweden as a country that could combine high taxes with high growth. However, Sweden has been reducing government share of the economy for some time and according to Bergh and Henrekson may have achieved its growth because it has other (non-tax) policies that are particularly friendly to growth. Therefore, if Australia fails to halt the forecast increase in taxes over the next few years, then this (further) increases the need to implement growth and productivity enhancing reforms in areas such as labour market, competition, infrastructure, foreign investment and planning.