The Rahn Curve


An interesting little idea that I'd not come across before: the Rahn Curve. It's analogous to the Laffer Curve, in that it says there's a level of public spending up to which more increases growth rates, over which it reduces growth rates.

It shows that growth is maximized by small governments that focus on core “public goods” like rule of law and protection of property rights. But when governments expand beyond a certain growth-maximizing level (the research says about 20 percent of GDP,....), the result is slower growth and less prosperity.

It's intuitively appealing to people like us of course and as with the Laffer Curve at extremes it's clearly and obviously true. Zero tax means zero government and without at the very least some form of defense, police and a criminal justice system there's not going to be much economic growth. When the government takes and spends all of the economy there's not likely to be much either. The argument will be, as with Laffer, what is that sweet spot? One interesting note is that Keynes himself thought that 25% of GDP passing through the government's hands was probably as high a portion as we would want.

However, it's also true that growth purely as growth isn't the only thing we want:

There is also another issue which can get lost – the fact that maximizing growth rates is not necessarily the government’s highest priority. Issues of equity, fairness and concern for the environment are arguably more important than maximizing rates of economic growth.

As indeed it is also arguable that they are not. But I'm entirely happy to accept that stricture, that economic growth isn't the only thing we want out of an economy. What this Rahn Curve does allow us to do though is keep insisting that, as ever in economics, there's a trade off here.

How much equity and fairness now are you going to insist upon at the cost of making our children poorer than they could be? Given that we can't have both, a decision has to be made. And that's very useful in itself: a counter to those who say that greater equity now will make our children richer. It won't.