Small government brings fast growth

On 11 January deputy president Zuma aired an ANC plan to raise real government spending 4.7% in each of the next three years. British Labour chancellor Brown is taking a similar extra annual 1% of GDP yearly for government spending. Global experience suggests UK and SA will both lose about 0,1% of real per-capita growth annually as a result of such increased spending. Brits earn 4-5 times what we do so maybe it won’t affect them too much but South Africans can’t afford to forego growth..

'Tax-spend' is easily measured as the percentage of taxpaying private incomes taken and spent by government. And more tax means less growth. As economist Gordon Tullock warned 31 years ago, 'the actual decision on the total amount of transfers from members of the subject group to the rulers must be made with some care. In general, increasing the percentage of the product produced by the subject group transferred to the ruling group will reduce the total product.' Tullock also noted the obvious, that government shouldn't kill the 'goose' by crippling the productive sector too much.

This overlooks how economic growth makes the cake bigger, and increases the tax revenues. We're all keen to share a fast-growing cake rather than just fight with government over our slice. Maybe government is stuck with a more short-sighted preference for more cake until the next election - even if the whole cake shrinks. How grand if they'd also 'go for growth' for everyone, but it's a lot to ask, since economic growth needs smaller government!

Taking away some of people's income depresses them as each tax rand is extracted, as any tax referendum would confirm. You may consider that tax rand lost or half-wasted or well-spent by government, but you know you're just as poorer now as when you're robbed less legally. And the numbers support this notion of the primary harm done by taxation.

In 1998 U.S. economists James Gwartney, Robert Lawson and Randall Holcombe reported on their study of the economies of 23 OECD countries to a US Congressional committee. From each country's growth rate and total government spending (as a % of GDP) 1960-96 they showed clearly how government spending, both within and between countries, affects economic growth. Broadly, 20% total government outlays at all levels of government as a percentage of GDP, allowed around 5% annual growth, while 50% government outlays only allowed around 2% annual growth. Naturally with no guarantees and depending on the nature of other aspects of governance. By 2000 the countries studied were all rich countries ranging from Luxembourg's $56,372 GDP per capita incomes to Portugal's $12,794 (in 1995 US$). South Africa's $3,985 is modest but the message is universal - small government for fast growth.

The authors of the study suggested how to design government policies for fast growth. A few 'core functions' are protecting property rights and creating a good growth environment. Larger government functions harm growth via tax disincentives, invading the private sector, causing wasteful 'rent-seeking' for state favours and crowding out private investment. OECD governments spend no more than 9%-14% of GDP on police and justice, defence and international affairs, education and highways, sanitation, sewage, environmental protection and central banking. Even some of these activities are better handled in the private sector without government involvement.

State consumption spending (as a % of total consumption) confirms the same steep effect. South Korea, Hong Kong and Singapore sustain over 5% real annual GDP per capita growth with a mere 15% government consumption. Denmark, Sweden and Israel support 35% government consumption and enjoy only 2% real annual real growth. Though size isn't everything, none of the richest 30 countries showed fast growth with big government.

The 18 countries in the $3,000-$10,000 per capita income range show the same effect. Hungary and Mauritius spent 15% on government and grew at 6.5% and 4.5% for three decades, while Panama and Gabon, spending 25%-30%, grew at only 1%. But some countries with reportedly-smallish government grew slowly, and two even shrank. Venezuela spent 14% and its GDP contracted by 0.88% per annum. Unfortunate South Africa’s government spent an average of 22% of total consumption over a 30 year period during which real per capita incomes declined by 0.09% per annum. What a waste of three decades during which citizens of other countries were rapidly growing richer. It's time we got growing!

If government size and quality both matter, what's easier to go for? Improve like Malaysia, or shrink like Hungary and China? Should our old dogs learn new tricks or retire gracefully?

Government officials resist change and spending cuts but can perhaps be bribed to go quietly. We all want lower taxes. Long-term government credibility depends on growth and prosperity for all. So smaller government must prove best for everyone. We'll regain our incentives to work hard for income we can keep. And forget the quality - leave it to our politicians to consider their futures, quit the harmful activities first, and concentrate on delivering or privatising cost-effective core functions. Then down upon their surprised heads will cascade the unusual reward of popular praise for smaller effort, better core services and high economic growth.

Author: Dr Jim Harris is a freelance researcher and writer. This article may be reproduced without prior consent but with acknowledgement to the author. The patrons, council and members of the Foundation do not necessarily agree with the views expressed by the author.

FMF Article of the Week\11 February 2003 - Policy Bulletin / 08 September 2009

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