Why U.S. Spending Needs a Swedish Massage

Commentary, Taxation, Frontier Centre

From Globe and Mail

In a book published last year, Swedish economists Andreas Bergh and Magnus Henrekson affirmed that, as a general rule, every 10-percentage-point increase in the size of government in wealthy countries reduces economic growth – by as little as 0.5 per cent a year, or as much as 1 per cent.

The authors cited Sweden as circumstantial evidence. Fifty years ago, they noted, Sweden and the United States spent roughly the same percentage of gross domestic product on government services: “a bit under 30 per cent.” In the 1960s and ’70s, Sweden doubled government spending to 60 per cent of GDP, before hitting the wall early in the 1990s. In the same period, U.S. government spending barely budged. While the United States maintained its standing as one of the world’s wealthiest countries, Sweden fell. “In 1970, Sweden was the fourth-richest country in the world on a per-capita basis,” the authors noted. “By 1993, it had fallen to 17th.”

In its 30-year transformation into Europe’s model welfare state, Sweden increased government spending by 30 percentage points of GDP – which, by the Bergh-Henrekson analysis, may have reduced its economic growth rate by as much as much as three percentage points a year. But let’s not deal with worst-case scenarios; let’s arbitrarily put the probable sacrifice in annual growth at one percentage point, even less than the authors best-case scenario of 1.5 percentage points.

The United States is now engaged in a fierce debate about government spending and government debt. By and large, Democrats favour an increase in the size of both. By and large, Republicans do not. From either perspective, though, the country’s growth rate in the next decade will determine whether it can sustain its rising debt, especially in a low-growth economy. What difference would an annual 1-per-cent sacrifice of growth make?

Average American income, per capita, is roughly $46,400 (U.S.). A one-percentage-point decline in growth would mean an average loss of $464 the first year. This annual loss, compounded over 30 years, would total $354,000. These losses are already under way. In the last decade, under Democratic and Republican presidents, the U.S. has increased the federal government’s share of GDP by five percentage points – meaning the economy has already sacrificed growth which, accumulated and compounded, would depress the income of the average American family by $5,000 a year within 25 years.

Higher growth means higher incomes, for people and for governments. By crude analysis, the growth sacrificed by Bush-Obama spending increases has invisibly added $750-billion to the country’s debt all by itself.

The Swedish economists concede that there are exceptions to every rule, that an occasional high-spending government experiences rapid growth and that an occasional low-spending government experiences slow growth. Economies are complex organisms that respond to all sorts of government pressures and incentives. The two economists also note that Sweden’s growth rate rebounded once it reduced government spending by 10 percentage points.

The Bergh-Henrekson correlation – the empirical evidence that higher government spending produces lower rates of growth – has been asserted by economists over the years. It has been asserted by experience, too. Hong Kong (population: 7.1 million) and Singapore (population: 4.8 million) are examples of the opposite: wealthy jurisdictions that spend with restraint and that consistently score at the top of global comparisons such as, once again, the 2011 Index of Economic Freedom.

Hong Kong’s tax revenues, as a percentage of GDP, stand at 13 per cent. Through good years and bad, across more than 35 years, Hong Kong has averaged growth of 5.9 per cent a year.

Singapore’s tax revenues, as a percentage of GDP, stand at 14 per cent. Last year, Singapore led the world in economic growth: GDP increased by 14.7 per cent.

(By comparison, Canada’s tax revenues, as a percentage of GDP, stand at 32.2 per cent.)

In their book Government Size and the Implications for Economic Growth, Messrs. Bergh and Henrekson based their arguments on the record of wealthy countries. They conclude that the fundamental determinant of economic growth is economic freedom. In comparing a smaller-government United States – though this is changing – with a bigger-government Europe, some facts are indisputable. Debt crisis notwithstanding, the average American still produces $46,400 in per-capita GDP, the average European (in the original EU 15 countries), $33,000.

Even a little bit of laissez faire, in other words, works.