San Diego Objectivist Study Group

Daniel J. Mitchell at the Cato Institute has made another informative video on basic economics. The video asks a simple question: Since the government is a necessary institution in a free society, how big should the government be, in terms of government spending as a percentage of GDP, in order to maximize the growth of the society’s economy? Mr. Mitchell in the video explains the Rahn Curve, a graph similar to the Laffer curve, with the independent variable standing for government spending (federal, state, and local combined) and with the dependent variable showing the function of economic performance.

As expected, the Rahn Curve shows a skewed bell curve. Without government spending, as in the case of anarchy, there is no economic growth. As government spending increases, the growth rate of the economy increases. Then, at some point, the size of the government yields a peak rate of economic growth, and beyond this optimal size, the economic performance declines in a linear, negative slope.

The salient question is, what is the optimal size of government on the Rahn Curve? From the available empirical evidence, economists since the 1990s have given a wild range of numbers, from a low of 15 percent of GDP to as high as 25 percent of GDP. Their average converges at about 20 percent of GDP, which, according to one report, the U.S. government’s girth had not been seen since 1949.

But that is not all. Two other factors, explains Mr. Mitchell, could point to a much lower optimum for the right size of government. First, these working economists computed their estimates of economic growth based on vastly different models of policy constraints, policies such as taxation, monetary model, regulatory reach, and international trade, which individually can significantly affect the efficiency of the economy. But second, the economic data the economists used are limited to those countries (including Hong Kong) that are already in decline; they cannot be extrapolated to see how those countries would fare in the present era if the size of their respective governments were smaller. What the historical data do show is that all modern countries a hundred years ago spent less than 10 percent of GDP on the functions of government.

For comparison, the combined spending on government in the U.S. is over 40 percent in the present day. (The Europeans spend over 50 percent, according to one graph in the video.) The current administration’s ambition is to double government spendings in ten years!

It is a six-minute video worth watching.

This entry was posted on Wednesday, June 30th, 2010 at 5:22 pm and is filed under Objectivist Culture. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.