Let me telegraph the punchline: While overall growth has slowed in the United States in recent decades, it has also slowed in most other advanced economies. And governments in these economies have very different policy footprints, including taxes, social policy, and where they draw the line between the public and private sectors. This suggests there’s little in the way of correlation between the size of government and growth. So, when you hear the conservative mantras about “job-killing taxes” and “government spending that’s killing growth,” often with President Obama’s name sprinkled in there somewhere, be aware that it’s an ideological, not an empirical, claim.
We begin with a figure from Saturday in the New York Times, showing slowing real per-capita GDP growth across these advanced economies: the United States, the euro area and Japan (the figure shows annualized 10-year average growth rates).
Most people’s first question upon looking at such a figure is “Why?!” That’s a good question (and the subject of the article; see link above) about which I’ll say a word or two later. But the point here is that it’s happening in the United States, where government spending is below average; in Japan, where it’s a few percentage points of GDP higher; and in the euro area, where it’s considerably higher.
An important new book, “How big should our government be?,” goes deep into this question of government footprint and growth. The figure on the left below plots real GDP growth (per capita, which is the right way to do this), against the change in tax revenue as a share of GDP. The “growing-tax-burden-kills-growth” mantra predicts a negative slope. The actual slope, as you see, is positive.
The figure on the right, tax revenue as a share of GDP, shows how low we are relative to these other countries, some of which do better than we do on growth per capita. The authors of the book, using data on 12 advanced economies starting all the way back in 1870, conclude:
“In the century and a half since then, government expenditures as a share of GDP have risen sharply in these countries. Yet they didn’t experience a slowdown in their longrun economic growth rates. The fact that economic growth has been so stable over this lengthy period, despite huge increases in the size of government, suggests that government size probably has had little or no impact on growth.”
Their measured conclusion is warranted. That positive slope in the figure on the left above could easily be a function of reverse causality: As economies grow, their citizens demand more from them. So we’re in the realm of correlations here, not causation. But the conclusion holds: Claims that more government crushes growth are simply not supported by the data.
Once reason that’s true, and this bit is clearly causal, is that government investments in public goods such as public infrastructure, human capital and poverty prevention have long been found to be pro-growth. By definition, the private sector will underinvest in such goods because they can’t easily profit from them.
Getting back to the first figure above (which shows long-term slower growth rates at times of slack in the economy), such investments can also play a key stimulative roll, replacing inadequate investment and labor demand that’s not forthcoming from the private sector. While the figure above is obviously telling a long-term story, I’d suggest that the lack of such public investments, recently sacrificed at the altar of budget austerity, is one culprit.
This implies that, contrary to the claim that the size of government is the problem, smart government investment would be a solution right now (and, yes, there’s also wasteful government investment; I’m not talking about “bridges to nowhere”).
But my main point is that when you hear people make blatant references to “job-killing taxes and regulations,” they’re blowing smoke. Don’t inhale, and quickly leave the area.