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6 studies that demonstrate why small government is best

    Support for rational evidence based policy making is in short supply at the Home Office, according to recently-departed Liberal Democrat Minister Norman Baker MP.

    It is a familiar call – that ideological politicians and policymakers push aside their prejudice and instead follow the proven evidence of what works, as if it's a science whose wonders are waiting to be uncovered by the wonkish version of Stephen Hawking or Neil DeGrasse Tyson.

    It’s true the great monetarist economist - and somewhat of a hero at the CPS – Milton Friedman once said, “One of the great mistakes is to judge policies and programs by their intentions rather than their results.”

    Friedman made this statement while referring to the coalition of well-intentioned campaigners and special interests who pushed for minimum wage law. The problem is there are multiple ways of looking at outcomes – the campaigners would argue that the minimum wage has had a tremendous positive impact on the lives of the lowest paid, while Friedman and many of us on the so-called Right would argue that the true minimum wage is still $0, and the policy favours those currently in work at any given point over those seeking it due to jobs that will never be created. There is evidence both for and against both those alternative ways of looking at it.

    Nevertheless, if I indulge the calls for more evidence-based policy for the length of this article, it seems the science on the role of government and its effect on growth – something needed to raise the living standards of everyone - would overwhelmingly fall on the side of classical liberals. Here are just six studies from a long cannon of evidence:

    • Dimitar Chobanov and Adriana Mladenov for the Institute of Market Economics: “The overall results suggest that the optimal level of government spending is 25% [of national GDP] according to the Scully model. However, due to model and data limitations, the evidence is that the results are biased upwards, and the “true” optimum government level is even smaller and depends also on the quality of a government, and not only its size.”
    • Livio Di Matteo for the Fraser Institute: “numerous studies document a negative empirical relationship between government size and economic growth rates. As well, there seems to be an association between smaller public sectors and greater efficiency in public service provision, as well as better performance outcomes… While there is indeed a positive association between government spending and favourable societal outcomes, much of this association is for lower amounts of spending with improvements leveling off as spending or public sector size rises above a certain level… All other things given, annual per capita GDP growth is maximized at 3.1 percent at a government expenditure to GDP ratio of 26 percent; beyond this ratio, economic growth rates decline.
    • A report prepared for the U.S. Congress Joint Economic Committee in 1998 concluded: “There is overwhelming evidence that both the size of government and its expansion have exerted a negative impact on economic growth during the last several decades. As government outlays in the United States have grown from 28.4 percent of GDP in 1960 to 34.6 percent in 1996, investment as a share of GDP, labor productivity, and real GDP growth have fallen. Data for 23 OECD countries also revealed that higher government expenditures were correlated with both less investment and lower rates of growth during the 1960-96 period. An analysis of data for a larger set of 60 nations illustrates the same thing. Moreover, the size of government in the world's fastest-growing economies is generally less than 20 percent, and their non-investment government expenditures are approximately 13 percent of GDP, far less than the comparable figures in the United States and other OECD countries.”
    • Here at the CPS, Ryan Bourne and Thomas Oechsle found that: “Econometric analysis of advanced OECD countries for the period 1965-2010 finds that a higher tax to GDP ratio has a statistically significant, negative effect on growth. For example, an increase in the tax to GDP ratio of 10 percentage points is found to lower annual per capita GDP growth by 1.2 percentage points. A similarly statistically significant negative effect on growth is found with a higher spending to GDP ratio. Detailed regression analysis stripped out the impact of variables such as investment as a proportion of GDP, the growth rate of the labour force, and the growth rate of human capital.
    • A 2003 study by the European Central Bank made the point from a different angle - higher government spending does not lead to better outcomes compared with efficient economies: “Spending in big governments could be, on average, about 35 per cent lower to attain the same public sector performance. The calculations also point out that EU 15 countries show relatively low public sector efficiency when compared with the US and also the average of the other OECD countries in the sample… EU 15 countries are using 27 per cent more public spending than the “most efficient” countries with similar PSP indicators. Spending for the average of the other OECD countries is “only” 11 percent higher than necessary.”
    • Finally Andreas Bergh and Magnus Henrekson for the Institute of Industrial Economics (IFN) conclude that where contradictory evidence is available, factors such as other market friendly policies and in-country social factors compensate for the damaging level of big government: “Both the Scandinavian and the Anglo-Saxon welfare states seem able to deliver high growth rates for very different levels of government size. This does not mean low-tax countries can increase taxes without expecting negative effects on growth, nor that the various mechanisms by which high taxes distort the economy do not apply in Scandinavia. A more incisive interpretation is that there is something omitted from the analysis that explains how Scandinavian countries combine high taxes and high economic growth. We have suggested two such explanations—compensation using growth friendly policies and benefits from high historical trust (lack of apprehension) levels—but these at best remain only speculative, with ambiguous policy implications. Even if the debate regarding the existence of a correlation between growth and aggregate government size in rich countries now seems more or less settled, the research on policy change, institutions and growth is progressing rapidly.” Indeed, there are several studies that show how the free market has helped countries like Sweden thrive despite a statist economy.

    The bibliographies of most of the above studies provide a huge additional amount of studies outlining this trend. 

    Although calls for ‘evidence-based policy’ are typically used as cover for one ideological side of a debate to exert the superiority of their argument over their rivals without taking into consideration other possible outcomes (intended or unintended), I’m starting to come around.

    The Bunsen burners are off and the petri dishes examined. The small government classical liberals seem to have it. 

    Lewis joined the Centre for Policy Studies in April 2011 with responsibility for social media and digital engagement.

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