A few weeks ago, a piece on Bloomberg looked at the question of whether government spending cuts hurt the economy. (Hat tip: Hot Air) First, the authors remind us that a large public debt saps economic growth:
In a paper released this year, economists Carmen M. Reinhart, Vincent R. Reinhart and Kenneth Rogoff said that periods of debt overhang — when accumulated gross [ed: public] debt exceeds 90 percent of a country’s total economic activity for five or more consecutive years — reduce annual economic growth by more than one percentage point for decades.
Over 20 years, the authors write, there can be a “massive cumulative output loss” that reduces gains by 25 percent or more. The U.S. went over the 90 percent threshold after the 2008 financial crisis…
To grow robustly, the U.S. must reduce that debt overhang. But that would mean genuine spending cuts: large enough to give us a budget surplus. And that would cause a recession, right? Maybe not:
In the 1990s, Canada, for instance, reduced debt-to-GDP ratios through an aggressive combination of actual, year-over- year spending cuts and higher taxes. The result wasn’t malaise but a burst in activity.
The same happened in the U.S. right after World War II. In 1944 and 1945, annual government spending (in 2005 dollars) averaged about $1 trillion and represented more than 40 percent of GDP. By 1947, it had plummeted to $345 billion in 2005 dollars and 14 percent of GDP. Even facing the demobilization of millions of soldiers, the economy soared and unemployment fell despite almost universal fears that the opposite would happen.
Such outcomes are not flukes. Research by economists Alberto F. Alesina and Silvia Ardagna underscored that fiscal adjustments achieved through spending cuts rather than tax increases are less likely to cause recessions, and, if they do, the slowdowns are mild and short-lived.
…[especially] when spending reductions are accompanied by policies such as the liberalization of trade and labor markets…
Read the whole thing; they cite more examples of countries who achieved growth through government-cutting measures, like Sweden, or the UK in the 1990s. There are still more examples, which they didn’t cite: the UK in the 1980s (where Thatcher’s spending cuts enabled an economic boom), the U.S. in the early 1920s (where Harding’s spending cuts did likewise), and more.
Why should that be? Advocates of Big Government – some with Nobel prizes, some in the White House and some on GayPatriot – scream at us that only growth in government (such as “stimulus” measures) can give us a growing economy.
Well, they’re just wrong. The channels are many, by which growth in government hurts the economy – and conversely, cuts to government are what would help the economy. I can’t touch on all of the channels, here. In brief:
- – A growing government inherently threatens people with future tax hikes and/or inflation (money-printing). (As we see with Obama, today.) The threat guts business confidence (in technical terms, it lowers the NPV; of all investment efforts that don’t service the government). Conversely, under a shrinking government, the threat recedes; confidence is restored.
- – Government does things less efficiently than the private sector. As government becomes a larger share of the economy, the economy is inherently less efficient and productive.
- – Government spending grabs economic resources from the private sector, raising private sector costs over what they would have been. That drives marginal businesses ‘out of business’. Conversely, government cuts will release economic resources back to the private sector, lowering costs for everyone and letting new/small businesses thrive.
We all know there is some “optimal size” for government spending, as a percentage of the economy. If it were 0%, we’d have anarchy: no police, no courts, no military (all of which I would rather have). And if it were 70%, 80% or more, we’d have communism, a system that always fails. The optimal size is somewhere, between those extremes. This phenomenon has a name: the Rahn Curve.
More on the Rahn Curve, perhaps, in a future post. For now, suffice to say that studies show an optimal size of 17-23% (totalling all government at all levels). If we were on the ‘wrong’ side of it, then the more government spends, the slower we are going to grow. Sound familiar? Sound like the story of the last 5-10 years? Indeed, with our government spending now over 40% of GDP, we are far to the ‘wrong’ side of the Rahn curve. The way forward lies in cutting government.