Saturday, 27 October 2012

Is there an optimal size of government?

A recent blog post by Brian Caplan reminded me of a great post by Scott Sumner from a about month ago about the issue of an optimal size of government. He compares the Scandinavian model, which to a narrow conservative mind presents somewhat of a paradox where a large size of government coexists with high levels of economic freedom, to the current US system of relatively smaller government, but decreasing economic (and personal) freedom.

Brian Caplan has the story where he disagrees with Sumner’s distinction between the terms 'size of government' and 'market freedom'. Where Sumner makes an important difference, Caplan thinks market freedom cannot be achieved with a high expenditures to GDP ratio within an economy. Sumner responded to this soon enough, saying that expenditure to GDP ratios "vastly overstate the difference between the Nordic and Singaporean [for example] models. That's why I focus on variables like MTRs [marginal tax rates] and tax complexity, which do a far better job of picking up the extent of market distortion". 
(the discussion continues...)

I agree with Sumner, as I also hold an opinion that efficiency rather than absolute or relative size is a much better and more precise estimate. Efficiency of the government service can tell us much more of its impact on the people’s welfare than its size. This is of course only in the case of Western democracies, since there is a certain institutional threshold beneath which it is futile to discuss the size or efficiency of an extractive state.

Sumner uses the perfect example of efficiency, Scandinavian countries.

Scandinavian countries excel in personal and economic freedom. They top the lists of economic freedom for a long time and are perfect examples of how a favourable formal institutional environment influences the set of informal economic institutions necessary to ignite reforms and create a more dynamic and innovative society. This is the reason behind their success. But there is much more. 

Apart from a persistently favourable institutional environment in which structural reforms are much easier to do (read an earlier text on the reasons behind Swedish success and quick recovery), they have much more to brag about. Here's from a text by Tim Worstall (I recommend you read the whole thing): 
"My basic starting point is that the social democracies of Scandinavia, the Nordics, are roughly what most people have in mind when they talk about a liberal society. Government takes a large percentage of the total production of the country (up to 50% say) and the uses this to provide public goods, social and welfare services and to redistribute income. 
We're generally told from the right of the political aisle that such societies cannot work. Taxes will be so high that all initiative, all economic growth, will be snuffed out. This clearly isn't true as they're rather nice places to live and they have perfectly standard, if not better than many other European countries, economic growth.
But it's also true that they violate some of the canons of the left side of the political aisle. Capital and corporation taxes are low for example. Sweden doesn't even have an inheritance tax. The basic national income tax rate in Denmark is 3.76%, the top one 15%. The tax systems of all four countries (Denmark, Sweden, Norway and Finland) are more regressive than the tax systems of either the US or UK. Yes, top rates of income tax are higher: but they raise a great deal more money in heavily regressive and high rates of VAT.  
There is no national minimum wage in any of the EU Nordics. Taxation for social spending tends to be bottom up rather than top down. In Denmark, as an example, the social security taxation is set by the commune, a grouping of as few as 10,000 people. The rate might be 25 - 30% added to that national income tax noted above. This is collected and spent locally. Sure, communes will group together to set up services a single commune would not need: specialist hospitals for example. But money and decisions are local, only moving to a higher level when necessary.  
In the American sense this would be like running say, Medicaid from the county level upwards rather than as it does work, from the Federal Government downwards."
Scott Sumner adds more:
"... in America the government schools are almost all local monopolies, whereas Sweden has a 100% universal voucher system allowing students to attend any school they wish. Thus one could argue that the role of government in the US education system is effectively much higher than in Sweden. In general, the Nordic countries are famous for privatizing many government services that are done by the public sector in the US (airports, passenger rail, air traffic control, fire prevention, etc.)

...The US government is presumably the world’s largest, and hence is probably less efficient than smaller governments ... Countries like Switzerland, Sweden and Denmark are not just smaller than the US, they are also more fiscally decentralized. So one definition of “small government” would be government that is highly decentralized.

Another definition might involve the number of regulations with which citizens must grapple. I’d guess that the US has more regulations than any other country in the world, but I am not certain. I do know that our tax system is extremely complex, and this is the main source of frustration that I face when dealing with government ... In contrast, in Sweden the government simply sends you the bill. There are no forms to fill out. I’d much prefer the Swedish system even if tax rates were higher....

Using this approach I’m not sure whether the Nordic governments are all that big, and I’m not sure the US government is all that small. Surprisingly, the Heritage Foundation seems to agree, as they rate the US and Denmark roughly equally in terms of “economic freedom,” despite the fact that ... Denmark’s government is the world’s largest, as a share of GDP."
An "optimal" size of government should be determined by the voters of a country, on local decision-making levels. Politicians can only affect its efficiency, and the efficiency of government institutions. It is in that perspective where politicians fail, and where nations fail

4 comments:

  1. Interesting idea. I think it would be also interesting to have a follow-up regarding possible factors that determine both "size of government determined by voters" and "the efficiency of government institutions". (Something that goes back to the A&R idea of Why Nations Fail, but relating specifically to gov. size and efficiency rather than degrees of development...)

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    1. I agree, that's an interesting subject from any perspective we think about it.
      Regarding the size determined by voters this is supposed to be the outline for optimal efficiency chosen by them specifically and on a local level. This is a necessary level of redistribution, presumably without the existence of political rent-extraction. Does that necessarily make it the most efficient distribution or the most efficient social contract? Elinor Ostrom would suggest that it does. So would, I think, Acemoglu & Robinson.

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  2. Comparisons with the Scandinavian nations are fraught with peril. You have very small sized, homogeneous cultures with a long history of stability, and honesty in government.

    This would make them more successful than most other nations no matter which system they chose. And it makes one wonder how much more successful they may be with an even smaller amount of government.

    It is false to think that these experiments may be replicated with a large, diverse nation with a ever more corrupt and inefficient government.

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    1. true, but even from that perspective, the reason behind the Swedish success is the different development of their informal institutions, which have developed on positive trails of their formal institutions. Very similar to the US actually, except for the recent growth of its welfare state. (when I say recent I mean in the past 30 years or so).

      The difference among the efficiency of their governments is, in my opinion, primarily due to the divergence of mentalities (i.e. informal institutions), where I think the US has taken a turn to the worse.
      Someone might think that the collectivistic approach in Sweden was the reason behind their success, but I beg to differ; it's the focus on economic and personal freedom that placed them on a much higher wealth level, with much less inequality.
      Cronyism in the US (among other things) is destroying the principles of personal and economic freedom that made the US a great nation.

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