Big government reduces growth


This probably doesn't come as much of a surprise to readers here, but a raft of new papers add to the evidence that bigger government leads to lower growth. It comes by the way of a rejoinder to a comment on a paper by Andreas Bergh and Magnus Henrekson. The rejoinder, entitled "Government Size and Growth: A Rejoinder" finds:

In our 2011 survey of the literature in the Journal of Economic Surveys on the effect of government size on economic growth in wealthy countries we find a relatively consistent pattern: An increase in government size by 10 percentage points is associated with a 0.5 to 1 percentage point lower annual growth rate. This conclusion is questioned by Colombier (2014). In this rejoinder we present a rebuttal of Colombier’s argument based on a detailed scrutiny of his own statistical evidence and regression results. Furthermore, we note that several new papers that have appeared since our original article was published give support to our main conclusion.

They handily review the new papers that they believe support their conclusions:

Oto-Peralías and Romero-Ávila (2013) confirm a negative growth effect of government size and finds that the effect is stronger in countries with lower institutional quality.

Berggren et al. (2014) finds that government legitimacy exacerbates the negative growth effect of government size in the long run. Afonso and Jalles (2013) find that the adverse impact on growth from government size can be mitigated using fiscal rules such as the Stability and Growth Pact in the EU.

Afonso and Jalles (2014) confirm that government revenue has a negative impact on growth in the OECD, a result they find to be driven by taxes on income. On the expenditure side, they find adverse growth effects from public sector wages, interest payments, subsidies and government consumption, while spending on education and health boosts growth.

Notably, the survey by Gemmell and Au (2013) manages to miss our survey published two years before, as well as some of the key papers in the field, but still arrives at the consensus view, that there are negative output effects from higher tax rates (but positive growth effects from some categories of public expenditures).

More surprising than all of this is the fact that this debate is still raging so fiercely.