I take issue with this article published in Macrobusiness:
Sorry Coalition, “big Government” doesn’t kill growth
During the Federal Election campaign, Labor’s shadow treasurer, Chris Bowen, confirmed that the overall tax burden would hit 24.8% GDP by 2026-27 under Labor, up from 23.5% in 2019-20:
Mr Bowen told The Australian Financial Review that his number was lower than the 25.7 per cent of GDP that Treasurer Scott Morrison claimed Labor would deliver, but higher than the Coalition’s ceiling of 23.9 per cent.
Mr Bowen said the alternative would be spending cuts to essential services.
“Let me be clear: tax-to-GDP will be higher over the medium term under both the Coalition and Labor government. Either that, or the Coalition will continue to deliver more savage cuts to Medicare and education,” he said.
The admission was immediately seized upon by Treasurer Scott Morrison, who claimed that a higher tax burden would damage the Australian economy’s growth:
“Labor might want to think you can have a tax-to-GDP ratio approaching 26 per cent and that will have no impact on the Australian economy. They are kidding themselves…”
The Coalition’s 23.9% of GDP ceiling on tax is based on the National Commission of Audit’s recommendation that taxation revenue as a share of GDP should be capped at 24%.
The assumption that higher tax equals less economic growth is a popular one among conservatives, not just in Australia.
However, four American academics have published an important new book, entitled “How Big Should our Government Be?”, which examines in detail the vexed issue of government size and growth.
According to the Washington Post, which provides a good summary of the book, there is actually a positive correlation between the size of government and economic growth per capita:
Using data on 12 advanced economies from 1870, the authors of the book conclude with the following:
“In the century and a half since then, government expenditures as a share of GDP have risen sharply in these countries. Yet they didn’t experience a slowdown in their long-run economic growth rates. The fact that economic growth has been so stable over this lengthy period, despite huge increases in the size of government, suggests that government size probably has had little or no impact on growth.”
The authors also note that “A national instinct that small government is always better than large government is grounded not in facts but rather in ideology and politics,” and that the evidence “shows that more government can lead to greater security, enhanced opportunity and a fairer sharing of national wealth.”
In particularly, the authors call for more investment in infrastructure, education, as well as proper safety nets for the unemployed and those that get sick.
The Turnbull Government should take note as it considers taking an axe to Australia’s public services.
MY REBUTTAL:
Let me start by saying that I am not in favor of austerity as a response to a major economic slow-down. If anything that will exacerbate unemployment and prolong the contraction. Instead I advocate major infrastructure programs to stimulate the economy. But with two caveats: (1) investments must generate a market-related return on investment; and (2) there must be strong involvement from the private sector. Investment in assets that do not generate direct revenue leaves future taxpayers with a pile of debt and no income (or saleable assets) that can service (or repay) it. Involvement of the private sector should be structured to ensure that the benchmark of market-related returns is not superseded by projects selected to win the most votes. Also, the private sector should have skin in the game to restrict cost blowouts. They are not immune to cost blowouts but are not in the same league as big government.
I also believe that weak government will harm an economy. We need strong regulators, rule of law, police and military to ensure stability. Also spending on education and science to foster growth.
But the article by Jared Bernstein in the Washington Post typifies the kind of rubbish pedaled to voters around election time. And seems to have been swallowed hook-line-and-sinker by the author of the MB article.
Where do I start?
First, the fact that a book by four unnamed academics is cited as proof in itself should tell us how much credibility to attach to their claims.
Second, the author mentions that there is “a positive correlation between the size of government and economic growth per capita…”. A positive correlation is any correlation coefficient greater than zero. The highest correlation is a value of 1.0 which represents a perfect fit. No correlation coefficient is provided in either article and judging from the graph I would assume it is closer to zero than 1, meaning there is only a vague correlation. If you ignore the line drawn on graph, the data looks randomly scattered with no clear trend.
Also the author overlooks that he is only dealing with a sample of 12 countries, which again would give a low level of confidence in any result.
Further, in the WP article the author concedes that correlation is not equal to causation: “That positive slope in the figure on the left above could easily be a function of reverse causality: As economies grow, their citizens demand more from them.” This is omitted in the MB report.
Then the study of data for the 12 economies from 1870 up top the present is used to argue that growth in government expenditures does not hinder GDP growth. I would be surprised if the data didn’t show growth in government across all countries as it spans the era from horse-drawn carts up to the area of modern jets and space travel. From the country GP with a stethoscope to modern nuclear medicine and MRIs. From slate and chalk to super-computers and digital technology. Of course the demand for infrastructure has grown exponentially over that time. To argue otherwise would be stupid.
But that is not an argument in favor of a welfare state or increased government expenditure. In fact, most of those advances in technology were driven by private individuals and not by government.
Finally, I will use another graph from “How big should our government be,” Bakija et al in the same Washington Post article to argue the case for lean government (as opposed to small government circa 1870):
The graph shows that tax revenues as a percentage of GDP have steadily declined, since the late 1990s, for every country except France. Why has this occurred in even model welfare states like Sweden and, to a lesser extent, Canada? Simply because they reached “peak welfare” in the 1990s and realized that the only way to revive GDP growth was to reduce the role of government in the economy.
The only one who hasn’t accepted the evidence is France. Which may well be contributing to their poor economic performance.
The magic pudding state – The Drum Opinion (Australian Broadcasting Corporation)
Benjamin Herscovitch writes:
It seems many of us have been taken in by the conceit that the welfare state can offer never-ending free lunches. We expect governments to offer more social security payments, health care, education, etc., all the while assuming that we will not have to pay for it. It is time to let go of the delusion of a magic pudding welfare state and get our expectations for social services in line with our willingness to pay for them.
Read more at The magic pudding state – The Drum Opinion (Australian Broadcasting Corporation).
US: Poverty rates
From the US Department of Health & Human Services:
I suspect that most US voters are concerned about poverty (don’t believe everything you are told during an election) but where they differ is on how to address the issue. The view from the left is to raise taxes on the rich in order to increase welfare benefits to the poor. The right believe the solution is to get the economy back on track. That would create more jobs and increase tax revenues — which could enable more welfare spending. It is important to avoid the trap of long-term welfare dependency, but the solution is always going to be a compromise between the two extremes.
If Republicans want to be taken seriously by Black and Hispanic voters they need to pay more than lip service to fighting poverty.
Australia: Becoming a welfare-dependent state
Extract from an opinion by Robert Carling:
In democratic welfare states, the proportion of the electorate that attracts more in social benefits from government than it pays in tax has become so large that candidates who promise to curb the welfare state have a hard time winning elections.
The same issue has been raised in the United Kingdom, where a recent study by the Centre for Policy Studies revealed that 53.4% of households receive more in benefits than they pay in taxes……
The Australian Bureau of Statistics (ABS) has compiled data on total taxes paid [including GST] and total social benefits (cash and in kind) received by households in 2009–10 classified into five slices (quintiles) from bottom to top according to their private income. The first three quintiles (that is, 60% of households) each received more in direct social benefits than they paid in taxes……
via Centre for Independent Studies: Self-sustaining leviathan.
Five Challenges facing President Obama
On his inauguration in 2009, Barack Obama inherited a massive headache from the GFC. With unemployment stubbornly above 9 percent, efforts to create new jobs have so far proved futile.
- Low interest rates from the Fed failed to stimulate new investment. Richard Koo coined the phrase balance-sheet recession to describe private sector reaction to a financial crisis. Low interest rates have as much effect as pushing on a string. Corporations and households alike have no wish to borrow in the face of falling asset prices and erosion of their own balance sheets — and banks have little desire to lend.
- Quantitative easing failed to lower long-term interest rates and stimulate employment. Instead it revived inflation expectations, creating a surge in commodity prices.
- The trade deficit widened despite the falling dollar, reflecting an inability of US exports to compete in offshore markets — and a loss of manufacturing jobs as foreign exporters made inroads into US domestic markets.
- Fiscal stimulus, whether through tax cuts or spending on education or infrastructure not only failed to create sustainable jobs but has left the taxpayer with a mountain of public debt.
- The home construction industry, a major employer, remains stagnant. Inventories of new and existing homes amount to more than 12 months sales at current rates — when one includes “shadow inventory” of homes repossessed, in foreclosure, or with mortgages delinquent for 90 days or more.
Deflation threat
When the housing bubble collapsed, households and corporates were threatened by falling values and shrinking credit. Savings increased and were used to repay debt rather than channeled through the financial system into new capital investment. A deflationary gap opened up between income and spending: repaying debt does not generate income as new capital investment does. The gap may appear small but, like air escaping from a punctured tire, can cause significant damage to overall income levels as it replays over and over through the economy. The only way to plug the gap is for government to spend more than it collects by way of taxes, but the result is a sharp increase in public debt.
Five point plan
Companies are unwilling to commence hiring until consumption increases — and consumption is unlikely to increase until employment levels rise. The only solution is to create sustainable jobs while minimizing borrowing against future tax revenues.
- Stop importing capital and exporting jobs.
Japan and China have effectively maintained a trade advantage against the US by investing more than $2.3 trillion in US Treasuries. The inflow of funds on capital account acts to suppress their exchange rate, effectively pegging it against the greenback. Imposition of trade penalties would result in tit-for-tat retaliation that could easily escalate into a trade war. Capital flows, however, are already tightly controlled by China and others, so retaliation to capital account controls would be meaningless. Phased introduction of a withholding tax on foreign investments would discourage further capital inflows and encourage gradual repatriation of existing balances over time. Reciprocal access to capital markets could then be negotiated through individual tax treaties. - Clear excess housing inventories.
Supporting prices at current levels through low interest rates will prevent the market from clearing excess inventory. Stimulating demand through home-buyer subsidies would achieve this but increases public debt and, as Australia discovered, leaves a “shadow” of weak demand if the subsidy is later phased out. Allowing home prices to fall, on the other hand, would clear excess inventory but threaten the banking sector. Shoring up failing banks also requires funding, although this could be recovered over time through increased deposit insurance. - Increase infrastructure spending.
Infrastructure projects should not be evaluated on the number of jobs created but on their potential to generate future revenue streams. Whether toll roads or national broadband networks, revenue streams can be used to repay public debt. Projects that generate market-related returns on investment also open up opportunities for private sector funding. Spending on education and community assets should not be funded with debt as they provide no viable revenue streams for repayment. The same goes for repairs and maintenance to existing infrastructure — they should be funded out of current tax revenues. Similarly, research and development of unproven technologies with open-ended budgets and uncertain future revenues. - Raise taxes to fund infrastructure investment.
Raising taxes to repay debt, as FDR discovered in 1937, has the same effect as a deflationary gap in the private sector and shrinks national output. But raising taxes to fund infrastructure investment leaves no deflationary gap and increases the overall level of capital investment — and job creation — within the economy. - Increase austerity.
Cutting back on government spending merely re-opens the deflationary gap between income and spending. Reducing regular spending in order to free up funds for infrastructure projects, however, would leave no deflationary gap while accelerating job creation within the economy.
Bi-partisan approach
The magnitude and extent of the problems facing the US require a truly bi-partisan approach, unsuited to the rough-and-tumble of a vibrant democracy. Generational changes are required whose impact will be felt long after the next election term. It will take true leadership to forge a broad consensus and set the US on a sound path for the future.
Published in the November issue of Charter magazine.
America’s Economic Stalemate – Martin Feldstein – Project Syndicate
The two parties’ hardline stances anticipate the upcoming congressional and presidential elections in November 2012. The Republicans, in effect, face the voters with a sign that says, “We won’t raise your taxes, but the Democrats will.” The Democrats’ sign, by contrast, says, “We won’t reduce your pension or health benefits, but the Republicans will.”
Neither side wants any ambiguity in their message before the election, thus ruling out the possibility of any immediate changes in tax expenditures or future Social Security pensions. But, for the same reason, I am optimistic that the stalemate will end after the election. At that point, both Republicans and Democrats will be able to accept reforms that they must reject now.
via America’s Economic Stalemate – Martin Feldstein – Project Syndicate.
The country’s economic policy is being run according to the election timetable. Compare that to the Swiss democratic system from a few days ago. Makes you wonder, doesn’t it?
A Proven Principle Behind Obama’s Jobs Plan – NYTimes.com
It wasn’t until the 1940s that economists realized that a balanced-budget stimulus could be effective, too. As I’ve discussed in earlier columns, economists starting with Walter S. Salant and Paul A. Samuelson realized that during a depression or in near-depression conditions, any government expenditure fully funded by taxes will increase national income approximately one for one, without raising national debt. This is known as the balanced-budget multiplier.
The public improvements suggested in the president’s proposal would have been fully paid for by the bill’s tax surcharge. And any new legislation we now consider could also pay for such improvements with tax increases, so as not to raise the national debt even temporarily. This idea should still have common-sense appeal to Americans in this time of high unemployment, just as the idea of winter work does on the farm.
via A Proven Principle Behind Obama’s Jobs Plan – NYTimes.com.
Short-Term Stimulus Won’t Help U.S. in Long Run: Glenn Hubbard – Bloomberg
The president’s announced jobs plan centers on the need for additional short-term stimulus designed to boost aggregate demand and jump-start economic growth. In some recession scenarios, such action, if timely, can indeed raise output and employment.
In our current state, however, calling for additional spending and temporary tax relief without addressing longer-term economic challenges may exacerbate the likelihood of another recession in the coming year.
This is because the U.S. economy suffers from structural problems predating the financial crisis, particularly an excessive reliance on household consumption and government spending, and insufficient attention paid to business investment and exports. The financial system and the economy need to adjust in the face of this structural shift.
This observation points out two problems with the case for stimulus being made by Obama. The first is that near-term and temporary support for household incomes does little to counterbalance the chilling effect of announced future policies. Uncertainty becomes the enemy.
via Short-Term Stimulus Won’t Help U.S. in Long Run: Glenn Hubbard – Bloomberg.