Skip to comments.Canada, the Rahn Curve, and the Size of Government
Posted on 03/25/2014 8:25:38 AM PDT by Kaslin
Last month, I shared a very interesting video from Canadas Fraser Institute that explored the link between economic performance and the burden of government spending.
Theres now an article in the American Enterprise Institutes 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 Canadas Fraser Institute, entitled Measuring Government in the 21st Century, by Canadian economist and university professor Livio Di Matteo. Di Matteos 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.
And if you happen to think that 26 percent overstates the growth-maximizing size of government (as I argued last month), then its even more apparent that significant fiscal restraint would be desirable.
But Im more interested today in the specific topic of Canada and the Rahn Curve. The article has some very interesting data.
For a real-life example of how scaling back government has led to positive and practical economic benefits, Americans should look north. total government spending as a share of GDP went from 36 percent in 1970 (just over 2 percentage points higher than in the United States) to 53 percent when it peaked in 1992 (14 percentage points higher than in the United States). the federal and many provincial governments took sweeping action to cut spending and reform programs. This led to a major structural change in the governments involvement in the Canadian economy. The Canadian reforms produced considerable fiscal savings, reduced the size and scope of government, created room for important tax reforms, and ultimately helped usher in a period of sustained economic growth and job creation. This final point is worth emphasizing: Canadas total government spending as a share of GDP fell from a peak of 53 percent in 1992 to 39 percent in 2007, and despite this more than one-quarter decline in the size of government, the economy grew, the job market expanded, and poverty rates fell dramatically.
Simply stated, none of this should be a surprise.
The Canadian economy had the breathing room to expand when the burden of spending was reduced. Why? Because more labor and capital were available to be allocated by market forces.
This is one of the reasons why Canada now ranks higher than the United States in both Economic Freedom of the World and the Index of Economic Freedom.
And its also worth noting that spending restraint has facilitated significant tax cuts in Canada. Indeed, some American companies are moving north of the border!
Heres my video that includes a discussion of Canadas dramatically successful period of spending restraint in the 1990s.
P.S. You wont be surprised to learn that Paul Krugman would rather misrepresent supposed austerity in the United Kingdom rather than address the real success story of Canada.
P.P.S. More generally, Ive challenged all Keynesians to explain why Canadas economy enjoyed good growth when there was genuine spending restraint.
P.P.P.S. While Im a big fan of Canada, Im not fully confident about the nations long-term outlook.
Great Post! Thank you for this...I forwarded the link to many of my business associates. Should be preached from the housetops!
It should be preached from the housetops but anyone with any grounding in the real world should know that there is a point at which more government is counter productive. People used to grow up knowing that more rain produces greater crop yields up to a point at which more rain causes reductions in yield or even complete crop failure, the same is of course true of sunshine. They also knew that there is a point at which the final straw breaks the camels back. I find it dismaying that we have to have analysis from thinktanks to tell people so many things that used to be obvious to all but the hopelessly slow witted.
Why would anyone but a total Doofus think that there would NOT be a point at which further growth in government becomes counterproductive? Strangely enough some do believe exactly that.
I suspect that the 26 percent of the economy figure given as the point which should not be exceeded is definitely inflated by assumptions that certain things have to be done by government which could in fact be done by the private sector but that is just my suspicious nature I suppose.
This is precisely NOT a leftist's goal.
Too large for what?
The writer assumes we are talking about efficiency here. We aren't. We're talking about power, the power to accomplish political and private purposes.
The author is trying to make the wrong point and using the wrong argument to do it. He should instead re-read Machiavelli, and then perhaps he will be able to measure the hypertrophy of government, and develop a suitable metric tuned to the real purposes of overgovernment with which to do it.
He might arrive at a completely different conclusion.
If that we’re true we need a 100% tax rate, but they know it’s hogwash
I would expect that while the Laffer curve reaches its maximum at a relatively low tax rate, I don't think it's monotonically decreasing to the right. If you go far enough to the right that people have no choice but to work 14 hours days to avoid starvation, many people will work 14 hour days. Increasing the marginal tax rates from one where people have to work 12 hour days, to one where they must work 14, may increase total production slightly, and thus increase tax revenue a little bit. Revenue won't be nearly as high as it would with a much lower tax rate, but revenue will go up with increased tax rates. I would posit that portion of the Laffer curve is where communists think a country should be, since their economic models "work" there.
I wonder sometimes if those idiots actually believe ANYTHING they are saying or they just realize that a lot of American voters are stupid enough to believe it.
It seems that in this era there not only is nothing so stupid that millions of people won’t believe it but nothing is so stupid that they won’t believe and puff themselves up with pride and laugh derisively at those who DON’T believe the idiocy.
“IDIOCRACY” is a documentary, for sure. My mother used to tell me that it is not possible to be crazy and be aware that you are crazy, apparently she was right.
Thanks very much.
My pleasure. Nice to see so win around here still gets it.