Big government not so smart

Treasurer Wayne Swan’s second budget speech will not be remembered for long. It was probably one of the most boring presentations we have ever heard from any politician. At times, even the Treasurer’s own body language seemed to suggest that he wished it would all be over soon. What will remain of Swan’s speech, though, is a lasting legacy of debt: more than $188 billion by 2013. It also means that the Commonwealth government will grow much bigger.

It has become somewhat unpopular to talk about “big” versus “small” government these days. The chattering classes much prefer to ponder about things like “smart” government - as if anyone would oppose the idea and call for “dumb” government instead. In any case, the whole “small versus big” question looks pitifully old-fashioned ever since President Obama solemnly declared: “The question we ask today is not whether our government is too big or too small, but whether it works.”

Unfortunately, Obama gave us another false alternative. Nobody would argue that government should not work. Of course it should. But this does not answer the question whether governments should be big or small. Yet there is an answer to this question, although it is probably not the one that President Obama, or Treasurer Swan for that matter, would like to hear.

Most of us agree that governments must do everything they can to promote economic growth and prosperity. At the very least, they should not stand in the way of wealth creation. As numerous empirical studies have shown, this has a lot to do with the size of government. Smaller governments have a much better track record of promoting growth, whereas bigger governments usually go hand in hand with a sluggish economy. There is not a single study showing that more government spending increases economic growth.

The OECD once analysed the relationship between the size of government and growth rates for industrialised countries over a period of more than three decades. The result was clear: where governments accounted for below 30 per cent of GDP, the economy grew by more than 4 per cent per year on average. On the other hand, governments taking just under half of GDP only managed growth rates of below 3 per cent.

Roughly speaking, for every 10 per cent of GDP that government consumed, economic growth rates suffered about 1 per cent, according to the OECD. This may not sound dramatic, but over longer periods of time it makes a big difference in prosperity levels.

In another survey, Ludger Schuknecht of the European Central Bank and Vito Tanzi of the International Monetary Fund came to similar results. They showed that across the board, smaller governments produced better outcomes not only in economic performance but were also better at reaching other goals such as civil liberties, political rights, or better energy efficiency. Their conclusion was that governments could achieve better social and economic results at much lower levels of spending. To put it more bluntly: simply throwing money at problems does not solve them.

Decades of economic studies on the relationship between government spending and economic performance do not leave the slightest doubt: size matters. Our politicians these days may talk a lot about “smart government” or “government that works” but we, the voters, should not get distracted by these fashionable new slogans.

The concept of giving government a greater role in shaping our economy and society has been tested to destruction and it has never worked. For this reason, we ought to be careful when politicians try turning back the wheel and lead us back onto the slippery slope towards bigger government.

The spending plans announced in Wayne Swan’s budget are leading Australia down a path that will eventually slow our economic growth. They are also dangerous because of the vast amounts of debt he has planned. Public debt of $188 billion would mean annual interest payments of $7.6 billion. This is money that cannot be spent on hospitals, schools or transport. It is also money that will have to be raised in taxes. And it is almost twice the amount the government currently spends on infrastructure.

Over the past 15 years, Australia enjoyed the benefits of having a comparatively small government, healthy public finances, and strong economic growth. Swan’s budget signifies a departure from all of this. The Treasurer is leading us towards big government, permanent deficits, high debt, and slow growth. As it turns out, this is the very opposite of smart government.