Russians Understand Optimal Size Of Government

Commentary, Role of Government, Frontier Centre

This week’s federal election may rank as the dirtiest and perhaps the least intelligent on record. Marred by mud-slinging, it demonstrated a dearth of new ideas from all the parties. The mere hint of anything different was condemned as an attack on “basic Canadian values.” The “tyranny of the status quo” aptly sums up the current state of our national politics.

Ignoring change carries a price. Policy ossification in a world of rapid movement invariably leads to crisis followed by upheaval. In the occasional happy instance — Roy Romanow’s courageous closing of redundant rural Saskatchewan hospitals comes to mind — strong medicine prevailed. In other cases — like the collapse of the Soviet Union — political structures simply fell apart amid economic chaos.

Despite a political party system verging on intellectual paralysis, Canada has fared better than many other countries. But our reluctance to modernize public policy in a time of accelerating globalization is proving costly. It lends the colossus south of us an appreciable competitive edge and leaves us with a scrawny Canadian dollar.

Old thinking plays no part in Russia’s plans for creating a prosperous democracy. This vast country is still struggling to recover from history’s most ambitious experiment in social engineering. The Soviet state incurred astronomical expenses in trying to maintain total political domination of its economy. The absence of a real price system to guide production and consumption meant economic incoherence. A lack of incentives, abysmal productivity, negligence and obsolete equipment produced huge systemic losses and dismally low living standards. In 1990, only 51 percent of Russian homes had hot water, only 66 percent had running water at all, and just 64 percent had central heating. Half of Soviet schools lacked indoor toilets.

Almost a decade after the fall of the ancien rĂ©gime, the painful transition from Russia’s threadbare condition is dogged by the immense problem of absorbing the surplus workforces of the bloated Soviet bureaucracies and obsolete, hopelessly uncompetitive state-owned enterprises. Civil war in parts of the Federation, the departure of regions into their own independent states and a currency collapse in 1997 have compounded high unemployment. The remaining Soviet republics, too poor to make a go of it on their own, remain in the Federation.

Many observers say, however, that Russia has turned the corner: capital flight is slowing while barter and the underground economy now figure less prominently in everyday life. Richard Vedder, a professor at Ohio University, believes Russia’s government, at about 35 percent of GDP, is too large for a developing economy. An immature justice system underlies the problem of mafia capitalism. Inefficient government monopolies, the power and rail industries particularly, use their political power to maintain counter-productive subsidies. Too much money is also transferred to regional governments, a policy that reduces the accountability of local politicians and invites wasteful spending — an almost eerie replay of the similarly unintended results of Canada’s equalization grants system.

Vladimir Putin, Russia’s president, has responded to the challenge with an ambitious program to convert Russia into a modern market democracy. It contains ideas that should be required reading for Canada’s leaders.

Putin’s Strategy of Development recognizes the wisdom of having government do a few important things well, rather than many things poorly. It will sharply cut back the Russian state’s social obligations and its involvement in the economy. State-funded pensions will be privatized and replaced with Chilean-style individual accumulation accounts. Services will be contracted out. State-owned enterprises are on the block, and those remaining will lose their subsidies, free utility privileges and tax exemptions. The plan identifies its main objective as “creating conditions for the emergence of the effective private owner.” Crucial to this is the creation of an effective western-style justice system based on the rule of law and property rights. To cap it off, Putin’s government will replace the Canadian-style progressive income tax system with a simple 13 percent flat-rate tax in January. Miscellaneous charges and payroll levies that raise the effective tax bite to over 70 percent will be abolished.

A principal architect of the plan recently spoke in Winnipeg. Andrei Illarionov, Putin’s personal economic advisor, will discuss the central issue of the 21st century: what is the optimal size of government? Too small a government, with no taxes, no infrastructure and no court system to enforce contracts — the Wild West, in effect — means little or no economic growth. Too big a government, on the other hand, with high spending and taxes, protected monopolies, business handouts and transfer payments, stifles growth. The magic point occurs where economic growth, wealth creation, and living standards are maximized. OECD studies suggest that this optimal result occurs when the government consumes 30 percent of the economy’s resources, while others place it between 15 and 20 percent. Illarionov wants to reduce the Russian state’s share of the economy from 35 percent to 17 percent. This reduction, he insists, would secure a sustainable growth of five percent-and perhaps as high as eight percent a year.

In Canada, the public sector consumes about 41 percent of GDP, according to OECD statistics. This is down from 51 percent in 1992, so major progress has been made. But the achievement pales when you consider that our American cousins maintain a level slightly better than the OECD optimal, 29.7 percent. On a provincial level, in terms of government employment, Manitoba continues to maintain one of the largest and most expensive public sectors in Canada. Our province employs an above-average number of provincial and municipal civil servants per capita, pays them more compared to other workers than any other province, and spends an above-average portion of the budget on salaries.

Keep an eye on Russia. If Illarionov’s reforms succeed and his goals for economic growth are met, one of history’s stranger twists will emerge. We may be consulting Russia on the optimal size of government.