A smaller state means faster growth

 
Allister Heath
THERE are many reasons why the coalition is losing the public debate on austerity – but one of them is that it is conceding too much intellectually to its opponents. Neither Tories nor Lib Dems made the positive case for a smaller state and a stronger, larger private sector during the bubble years, and this legacy continues to neuter their arguments today. Their post-crisis conversion to reducing spending has been entirely framed in terms of staving off national bankruptcy, implying that ever-more state spending would still be a good thing in different circumstances. There was some sense in this strategy – but it should have been accompanied by another message: with public spending at 51 per cent of GDP, it is economically right to reduce the size of the state – and would be so even in the absence of a spiralling national debt.

There is plenty of academic research that highlights how bloated states impoverish countries, regardless of whether or not they are technically affordable. The latest comes from two Swedish economists, Andreas Bergh and Magnus Henrekson, published by the Research Institute of Industrial Economics. It reports that an increase in government size of 10 percentage points of GDP is associated with a 0.5 to one per cent lower annual growth rate in rich countries. This suggests that the rise in spending from 36.6 per cent of UK GDP in 2000 to 51 per cent in 2010, to use the OECD measure, has been disastrous. This 14.4 percentage point increase in the public sector’s share translates into a reduction in the growth rate of the British economy of between 1.4 per cent and 0.7 per cent a year. Paychecks and living standards are thus much lower today than they would otherwise be. Had spending been restrained, we would be living in a substantially wealthier country today, regardless of the recession, with more jobs and resources at our disposal.

All the tightening to date has come from higher taxes – current spending hit a fresh record in November, and only capex has so far come under pressure – so it is no wonder growth remains weak. We need less spending, not just because we cannot afford to borrow as much, but because proper growth is impossible as long as the state sector, with its low productivity, high wastage and limited ability to innovate, remains this large.

Bergh and Henrekson find that the only way high tax and spending can co-exist with decent growth, at least temporarily, is if other policies are pro-market: low regulation, low inflation and the maximisation of other kinds of economic freedom. Sweden combined high (though falling) public spending as a share of GDP with decent growth because it liberalised many other parts of its economy in the 1990s (the modern Swedish model is no longer semi-communist). Again, the UK is going the wrong way: marginal tax rates on income and capital are rising, as is the overall burden of regulation, foreign investors are being frightened away, and inflation is out of control. The research also finds that high-trust societies are good for growth and cancel out some of the problems of bloated welfare states – but even if true, that observation is of limited use to George Osborne. Rather than being so defensive over the size of the cuts, he should confront his critics with the findings of these and other economists. Smaller governments are better for growth than larger ones – it is that simple.

allister.heath@cityam.com
Follow me on twitter: @allisterheath