Big government & growth

Big government is bad for economic growth. That's the finding of this new paper (pdf) from economists at the ECB.
The effect is large. Controlling for a few obvious things, they estimate that, within OECD countries a one percentage point  rise in the share of government spending in GDP cuts growth by 0.13 percentage points a year. This implies that the rise in government spending we've had in the UK since 2000 (from 37.2% of GDP to 42%) would, if sustained take half a point off GDP growth, making us more than 5% worse off in 10 years' time than we would have been had spending stayed at 2000's levels.
The cross country growth equations that this finding is based upon are, of course, subject to many problems. Not least is omitted variables bias. Could it be that there's something that's correlated with big government which itself depresses subsequent growth?
However, the paper doesn't altogether uphold the orthodox neoliberal case for smaller government. It estimates that it is indirect taxes, and not income taxes, that depress growth most.
This implies that a a cut in excise duties and VAT and rise in income tax could actually increase growth. As indirect taxes are regressive, it would also increase equality.

Comments

[Maynard Handley]

Of course since growth is a means to an end, not (for normal human beings) an end in itself, the point is all rather irrelevant, isn't it?

How about you get back to us when you have determined whether large government is good or bad for human happiness?

[reason]

5% in 10 years is BIG? What does a recession cost? (Which makes me wonder how robust the results are).

[Meh]

reason asks the right question here, IMO.

[reason]

It seems to me however, that the actual methodology would be very difficult to do properly.

Think about government pension schemes and private pension schemes for instance. (Same with health insurance). Mostly they do the same thing, so moving them to or from the public sector has almost nothing to do with the real structure of the economy (but on the other may have a lot to do with the intertemporal sense of security of residents).

I agree it is clear that some government spending (defence, badly designed social security etc) has clearly a dead weight loss, and excessive government debt in particular crowds out private investment. But the question is hard to test well. The great variety of systems that have over the long term in per capita terms performed remarkly similarly (with scientific advances mostly being the limiting factor) suggests that the effect is not that great.

[cjcjc]

Are you going to post this one on Liberal Conspiracy?
They haven't quite got the message...

[Mark Wadsworth]

Your last para, totally agreed, that's just commonsense. VAT is by far the worst tax on business/enterprise/employment...

http://markwadsworth.blogspot.com/2007/12/business-taxation.html

[chris strange]

Shame that excise duties and VAT are controlled by the EU and therefore either have to be above the EU required minimum rates or are completely outside the UK governments control.

[Mark Wadsworth]

CS, all the more reason for leaving the EU, then. Which would also enable us to replace entire welfare system with a Citizen's Basic Income.

[jackspar]

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