How Much Government is Just Right? 26% of GDP

Here’s an interesting look at the Rahn Curve as applied to Canada:

Rahn Curve - Economic Growth vs %GDP Government

Rahn Curve – Economic Growth vs %GDP Government

http://finance.townhall.com/columnists/danieljmitchell/2014/03/25/canada-the-rahn-curve-and-the-size-of-government-n1814058

Canada, the Rahn Curve, and the Size of Government
Daniel J. Mitchell | Mar 25, 2014

Last month, I shared a very interesting video from Canada’s Fraser Institute that explored the link between economic performance and the burden of government spending.

There’s now an article in the American Enterprise Institute’s online magazine about this research.

The first half of the article unveils the overall findings, explaining that there is a growth-maximizing size of government (which, when put onto a graph, is shaped like a hump, sort of a spending version of the Laffer Curve).

One recent addition to the mounting evidence against large government is a study published by Canada’s Fraser Institute, entitled “Measuring Government in the 21st Century,” by Canadian economist and university professor Livio Di Matteo. Di Matteo’s analysis confirms other work showing a positive return to economic growth and social progress when governments focus their spending on basic, needed services like the protection of property. But his findings also demonstrate that a tipping point exists at which more government hinders economic growth and fails to contribute to social progress in a meaningful way. …Government spending becomes unproductive when it goes to such things as corporate subsidies, boondoggles, and overly generous wages and benefits for government employees. …Di Matteo examines international data and finds that, after controlling for confounding factors, annual per capita GDP growth is maximized when government spending consumes 26 percent of the economy. Economic growth rates start to decline when relative government spending exceeds this level.

This is standard Rahn Curve analysis and it shows that the public sector is far too large in almost all industrialized nations.

The quoted material has a lot of links to other good stuff in the original, so “hit the link”…

The article referenced this article from which they lifted the graph, that I’m lifting here too. It would be better with numbers on the axis, but Economists often like to leave off actual quantifiable stuff in the interest of avoiding needing to do actual work and / or research… Oh Well…

https://danieljmitchell.wordpress.com/2013/10/11/more-academic-evidence-that-bigger-government-means-less-prosperity/

While I’m always cautious about drawing sweeping conclusions from any single piece of empirical research, these results make a lot of sense.

Rahn CurveThe Rahn Curve (which is sort of a spending version of the Laffer Curve) is based on the theory that a very modest level of government, focusing on providing core public goods, is associated with better economic performance. But once government gets too big, than the relationship is reversed and higher levels of spending are associated with weaker performance.

So it’s no surprise that bigger government has particularly bad effects in nations that already have bloated public sectors. Here’s the video I narrated on the Rahn Curve, which provides additional analysis.

Just a snippet to give you the flavor. Hit the link, lots of good stuff on the other end…

There’s a wiki on it, that isn’t very good, Oh Well..

https://en.wikipedia.org/wiki/Rahn_curve

The Rahn curve is an economic theory, proposed in 1996 by American economist Richard W. Rahn, which indicates that there is a level of government spending that maximises economic growth. The theory is used by classical liberals to argue for a decrease in overall government spending and taxation. The U-shaped curve suggests that the optimal level of government spending is 15–25% of GDP.

That’s it. The whole thing (other than references). I’ve bolded one bit.

FWIW, I came to this topic via another page that looks to have ‘reinvented it’ on their own. One of the comments basically said that, and that got me thinking maybe this would be something other folks had not heard of before.

http://captaincapitalism.blogspot.com/2016/03/more-proof-freedom-is-best-economic.html

A bit irreverent (have I mentioned that I like irreverent?…) and not as academic as most things Economic. But the guy looks to have actually gathered data and graphed real world stuff. Unfortunately, while he has numbers on his graph, he didn’t bother to put any labels on the numbers… so you get to guess which axis is a what… He generally found a downward sloping curve, which isn’t all that surprising given that he was mostly looking at developed economies with large governments. At this point, with the passing of Hong Kong into China, I’m hard pressed to think of a country with less than 15% GDP sucked up by government.

Captain Capitalism
Rantings and tirades of a frustrated economist.

Wednesday, March 30, 2016

More Proof Freedom is the Best Economic Policy

[…]
Arguably one of my best charts I ever compiled proved me correct – government spending as a percentage of GDP versus economic growth. Albeit boring and now making your eyes glaze over like Ben Stein in Ferris Bueller’s Day off, the chart showed a NEGATIVE correlation between government spending and economic growth with a correlation coefficient of around .3.

The problem is that was 20 years ago and the data I had was not the greatest, merely what was available on the OECD at the time. So I figured it was time to pull new data and see if this relationship still held true. And boy howdy has it!

Here he has a graph with a line sloping from upper left to lower right and numbers on the sides. But not labeled what is a which… I think the vertical is government as %GDP, but the lowest value on the graph is an outlier at about 28%, well over the 25% upper range for optimal. The horizontal is single digits that I presume are %GDP Growth Rates. About 5% at the best end, about 0.5% to 1.5% when government share of GDP hits 50%. At some time in the past I heard a quote (attribution escapes me right now…) that ~”No government long survives once Government is over 1/2 of the economy” which might explain why all his highest data points stop at about 52%. Perhaps an accidental existence proof of that saying…

Not only did the relation between government and economic growth continue to be negative, but the strength of the relationship increased to a correlation coefficient of -.55 (-.56 if you only use a decade’s worth of data).

Now like all economic studies there are caveats and considerations. The data above does not include Japan, Canada, New Zealand, Mexico, China or Greece. I have NO idea why the OECD doesn’t have enough data on these countries to make a 20 year study, but they simply don’t (though the 10 year correlation I calculated DOES include Japan). So it’s merely the data I had to work with. And of course, the OECD does not include most 2nd and 3rd world nations. Only the nations who have been providing them with their economic data. Still, all these asides, if we are to look at the EMPIRICAL EVIDENCE economic growth is VERY NEGATIVELY correlated with the size of government. Even more so since you’d think SPENDING as a percentage of GDP would correlate positively with economic growth…but that is in a deluded Keynesian wet-dream world.

Regardless, this new data only merely re-proves what we all know to be logical and common sense:

A freer people are a more productive people. If you let people keep the majority of their wealth and fruits of their labor they will work more, create more, innovate more, and your economy will grow more. It’s not only logical and empirically proven, it’s simply moral. Of course, the parasites of society will whine and contest and complain otherwise, desperate to use the force of government to enslave you to support them, but it doesn’t change the fact that a smaller government results in a better and ever-more progressing society. The issue is simply if society wants to vote for parasitism and dependency of excellence and independence.

So there you have it. Both a theoretical Named Curve and a plot of real data for the portion of the curve that exists in the real world and is able to report data…

In Conclusion

I think it’s pretty clear that the reason the world is “trapped” in about 2% economic growth is because we have about 35% to 50% “government”. It is a bit unclear from his graph if that allows for any State and Local government costs. In the USA, last I did the numbers, Federal was about 35% GDP but add in State and Local we’re on the edge of 50%. (From memory, but the article is posting in here somewhere ;-) or maybe it was in a comment… why I like things related to the thread, so I can find them later…)

It’s also pretty clear that it’s darned hard to get large economic growth with a Fat Assed Government sitting on your face and eating your lunch. Want more economic growth and more prosperity for all? Both Laffer and Rahn (and a LOT of economic history) all point to the same thing: SMALL GOVERNMENT!!! Preferably between about 15% and 25% of GDP. MAX. That means one giant diet for The Federal Government and a wholesale Liposuction for the EU.

The notion that you can “spend your way to prosperity” via loads of Government Debt and ever expanding government is just broken. The data shows it.

So please, policy makers: STOP the debt train. CUT government. Get the whole thing down below 1/4 of the entire economy, and just get the hell out of the way. We’ll all be better off for it.

Sadly, I have no idea how to get facts and reality into the brains of folks afflicted with Socialist, Social-Liberal, or Progressive attitudes. They seem to have a thought style that starts with “Does this idea or information please me? Yes, accept it uncritically and fabricate whatever is needed to protect it. No, reject outright and commence character assassination and insults. Critical analysis need not apply.” They are “fact resistant” and “reason as a last resort, if ever” based in their thinking. It seems essential to get some kind of feel-good endorphin rush before they will accept or remember anything. (Not a slam, just a lifetime of observation filtered through Occam’s Razor. I have other complaints about many “heartless” uber-analyticals who never seem to feel or give a damn at all about others… but that’s not the problem here.)

So my only recommendation is that one needs some of those more ‘heartless’ types in positions of power since they, at least, can be motivated by greed to cut the Government so as to get more growth in the economy and in their own stock portfolios.

I wish there were a “rational analysis” party… but there isn’t. Sigh.

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About E.M.Smith

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
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11 Responses to How Much Government is Just Right? 26% of GDP

  1. Larry Ledwick says:

    Makes perfect sense to me.

    If you accept the concept that one way to control an undesirable thing is to tax it (sin taxes) then a necessary conclusion is that if you reduce those costs the behavior you are trying to control will increase. The Progressives have no problem accepting that idea wholeheartedly when they are trying to regulate something. Cut miles driven to improve the air, increase gasoline tax. Keep people from using plastic bags in grocery stores, levy a fee for each bag over and above their cost. etc. etc.

    If that it true, than it is only logical that the inverse also follows if you cut predatory costs, fees and taxes and the money will go elsewhere. Probably to a more desirable and constructive use. A little while ago as a result of a conversation with a friend I tried to figure my total tax burden to government. With current tax rules someone who makes between median wage and about 100K per year (US dollars), pays in total in excess of 55% – 60% of their income to taxes, or fees mandated by government. Probably more than that as I probably missed a few deeply hidden indirect taxes like corporate taxes passed on to retail pricing as a cost of doing business. You end up with a list of
    Federal tax, state tax, social security fees (both the employers and employees share) local sales tax on all purchase with remaining spendable income, plus Federal and state excise tax on all fuels, plus fees mandated by government like car registrations. Incidental costs of compliance such as tax preparation. The portion you spend on legally require insurance above and beyond what you would voluntarily spend based on your own assessment of risk benefit (ie mandatory auto insurance, professional insurance and license fees, and of course the Affordable Care Act (a tax by Supreme court decree) and even if that had not occurred in practical terms a tax/fee required by government.

    I probably missed a few but in a simple list form:
    Federal income tax
    State income tax
    Social Security deductions (both employee and employer shares)
    local sales taxes on almost all purchases
    taxes on fuel
    excise taxes on essential services (sewer fees, cell phone fees, use fees attached to water bills and energy etc.)
    mill levies for fire protection and special districts like mass transit
    mill levies for property tax and that portion of those taxes passed on to renters in their rent
    Disposal fees for old tires, and car batteries and similar “recycle” fees mandated by law.

    When you go through your expenses with a fine tooth comb you find you are getting taxed and fee’d every time you turn around. In many cases double taxed as the goods get taxed at multiple levels.
    (ie pay federal and state income tax then get hit again with sales tax on the money left over if you use it to buy anything but tax exempt items like some food)

  2. Larry Ledwick says:

    On the “heartless” vs “feel good” question, life is basically a life boat dilemma.
    Progressives and liberals are willing to sink the life boat to try and save more people than they can possibly afford to save. Conservatives will try to triage the losses for the most benefit for the whole.

    Two absolutely opposite value systems and views of what is right, there really is not a way to reconcile them other than to have more or less equal representation of those two views in the population.

    Cycles in our economy and politics are probably at their root, driven by that balance in proportion between the two philosophies in the society.

  3. EM this site http://www.oecd.org/ctp/tax-policy/revenue-statistics-ratio-change-latest-years.htm gives data for Japan and New Zealand but the interesting one in this group of countries is Switzerland which has a low tax rate (note the states/cantons do the taxing and give money to the Federal Government -it has direct democracy. A country with alow tax rate and one of the highest GNP is Singapore which is not in the OECD. This http://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS has some information This is another source. https://www.cia.gov/library/publications/the-world-factbook/fields/2221.html
    Anyway your are right too much government expenditure results in a slowing of growth and possibly like USSR, Cuba, Myanmar/Burma, North Korea, Zimbawe & Cambodia even a falling of living standards. Switzerland and Singapore are examples of the reverse

  4. Serioso says:

    Why guess the numbers when they are readily available? In the United States, total government spending (federal, state, and local) is about a third of gdp:

    http://www.usgovernmentspending.com/total_spending_chart

  5. I suggest don’t be confused about the “establishment” really wanting economic growth. They don’t. A wealthy, productive, and self actualized population cannot be controlled. An impoverished, non-productive, and stunted population can be made dependent upon government handouts and thus can be controlled. That this is the path to the destruction of society and the end of high technological civilization is a desired end of the “establishment” and not a mere side effect of poor judgement and repeatedly failed policies. It is accomplished with willful purpose and malicious intent.

    I say this because of the moral principle that if a person or group implements a policy that achieves a certain end which is counter to their stated end. If they keep doing the same thing, only more so, while pretending to be aiming at their stated end, what is achieved is in fact their ultimate goal. What they say is nothing but a misdirection to seduce the population to go along to get along. Who ultimately pays? Everyone! Even the “establishment”. It is this they call “progress”.

    Clearly, what they do is not for your benefit. Especially if you are a member of the maker population as opposed to the taker and destroyer population. You, as a maker, will be the first to be crippled and made nonproductive. Soon afterward, the takers and destroyers will cease to exist. Your challenge is to figure out how not to be collateral damage.

  6. Chuckles says:

    In ‘The Law and the Profits’ C.N.Parkinson put the number that people would willingly pay for ‘government’ at about 10%-15% (if I remember correctly), which he correlated with the ‘protection money’ villagers were prepared to pay village chiefs and the like to keep the bad guys away.

  7. stan says:

    Regulation has huge costs. Compliance costs have soared in the last 7 years. Just because govt doesn’t tax and spend the money doesn’t mean that govt hasn’t imposed the same burden on growth.

  8. John Robertson says:

    26% is far too much, that represents a ratio of 1 taker for every 4 makers.
    10% is the point where the marks start hunting for a new con.
    Being one non productive person for every 10 contributing.
    The people who fill the ranks of our governing kleptocray have no interest in a healthy economy, their whole scheme depends on keeping their clients poor and stupid.

    I like what I know of the Swiss.
    Taxes paid at local level,federal level dependent on the locals remitting a percentage to them.
    Keeps all parties accountable.
    At least more accountable than the idiocy of a federal department of local affairs.
    Education.
    Welfare.
    Health.
    Roads…..

  9. p.g.sharrow says:

    Originally the US Federal government was supported by the states based on their population. This lead to a poll tax. Those that supported the government, paid the tax, got to vote. Then “sin taxes” on tobacco and booze were added,BATF, as well as tariffs on imports. Lincoln put in place an income tax to fund the US efforts during the War between the States. One of several unconstitutional things done during his Dictatorship. An amendment to the constitution was instituted to make a tax on income legal and later Social Security was added to force tax payments from everyone with a job.
    In every case the Federal government has grabbed power and funding streams while forcing the states to fund greater burdens for social welfare and education. Things that were not originally within the States purview…pg

  10. gareth says:

    EM wrote “So please, policy makers: STOP the debt train. CUT government. “…
    But they won’t, will they.
    Their interests (extracting money from the proles to justify themselves and their empires, and to promote their world-view) are not the same as ours (not to be robbed blind by the govt.).
    They don’t care about debt. Provided it doesn’t end in bloody revolution in their lifetime they will live off the fat of the land till the end of their days.
    Doomed, we are.

  11. E.M.Smith says:

    @gareth:

    PWP People With Pitchforks we will become… doomed they are…

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