Jan 2008 28

European Central Bank provides new evidence that shrinking the state can make us richer2

The European Central Bank has, today, released a new study "Government size, composition, volatility and economic growth" (PDF) which examines the effect of big government on the rate of economic growth.  It finds a substantial effect:

"In particular, a percentage point increase in the share of total revenue (total expenditure) would decrease output by 0.12 and 0.13 percentage points respectively for the OECD and for the EU countries."

This is big.  The numbers might sound small but blogger Chris Dillow explains how, if correct, the study implies that the growth of Government here in the UK in recent years is set to put a big dent in our national wealth:

"This implies that the rise in government spending we’ve had in the UK since 2000 (from 37.2% of GDP to 42%) would, if sustained take half a point off GDP growth, making us more than 5% worse off in 10 years’ time than we would have been had spending stayed at 2000′s levels."

One surprising result is that indirect taxation, such as VAT, does the most to undermine growth.  Other work, such as the dynamic model (PDF) commissioned by the TaxPayers’ Alliance from the Centre for Economic and Business Research has suggested that cutting corporation tax would be particularly effective.

This is a powerful contribution to the debate over the size of Government and shows the medium to long-term price we pay for the expansion of Government spending over time.  It makes the case for tax cuts more pressing.

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  • Acorn

    Matthew
    See this link to “Index of Economic Freedom”.
    You will see that the UK scores poorly on “Fiscal Freedom” and “Government Size”.
    The bit I can’t understand is “overall tax revenue as a percentage of GDP was 37.2 percent.” and “Government spending has been rising since the 1990s and in the most recent year equalled 44.7 percent of GDP.”
    The difference is 7.5 percent of GDP. I reckon that comes to, currently, about £105 billion. Is there something missing from these numbers or is that government borrowing?
    http://www.heritage.org/research/features/index/country.cfm?id=UnitedKingdom

  • cjcjc

    It’s larger than 5% of course because of compounding.
    The difference between 2 and 2.5% growth over 10 years is 6.1%, between 2.5 and 3% is 6.4%…