Defending the state

Big government is not an economic burden

October 25, 2010

For thirty years the recommendation of economists has been: roll back the state. Governments are told either to step back; or to create new markets, such as for carbon permits, and then step back. Big business is happy to hear this message and promotes it loudly.

What arguments are made for this view? First, we are told that redistribution, especially direct transfer of income as social welfare, weakens the incentive to work and creates an idle disruptive underclass. Second, since governments are less directly engaged with events on the ground, they supposedly have less information and manage the economy poorly through regulation and redistribution – as opposed to individuals and firms who make better decisions because they know their own situation. And, third, economists believe that state officials will do nothing but feather their own beds and those of their cronies.

None of these views are justified. Take incentives to work. Before the recent recession, the difference in equilibrium unemployment between the US and statist Europe was about two percent of the labour force. This was partly due to factors other than redistribution, but, even if it were all due to redistribution, it would be a modest price for the benefits of an active state. And this is in any case offset by the fact that unemployment insurance lets people take risks in their career – benefiting economic progress.

Likewise, even if welfare does create an underclass, abolishing welfare would probably create a much bigger underclass composed of those who fell out of the system and never clawed their way back. It is even possible that those countries with meagre welfare systems maximise the size of their underclass by having enough welfare to encourage some people not to work but not enough to help more diligent individuals suffering difficulties.

Similarly, it is false that individuals and firms are better informed than governments. Individuals are confused by the barrage of information they face and are influenced by advertising, while firms swing with market sentiment. Even what looks like an ‘innovative’ firm satisfying previously unnoticed demand and offering a new product is often just its creating such demand through marketing and hype. By contrast, governments have more analytical resources and are more detached. Beyond issues of information, governments have different incentives from firms: they aim to make the system work well, as opposed to just benefiting themselves.

Are state officials completely selfish? There is, of course, corruption – especially in weak legal jurisdictions. But the reality is that most public servants, like others, feel intrinsically compelled to do a good job because of moral conscience, workplace loyalty and personal pride. Even where they are of a shady type, the electoral incentives of their political bosses and the legal sanctions associated with abuse tend to keep them in check.

There is no relationship between the size of the state and economic performance. Taking World Bank data for all available countries over the period 1960-2008, one finds no correlation – negative or otherwise – between total tax take and GDP growth.

Few countries have a tax take below about 20 percent of GDP and few developed countries have it below 35 percent. If they had less, essential services that can only be financed by the state would stop and growth would suffer. Furthermore, if the state spends well on research and development and other targeted areas, it can do much to boost growth. The socialistic countries of Scandinavia routinely manage faster growth (and lower unemployment) than the US.

There is a strong positive correlation between the size of the state and various indices of well-being and happiness. This breaks down only when governments nationalise too many firms, causing inefficiency. In short, the state is good.