Intro: Growth tends to be stronger if government has less control over a country’s resources beyond the provision of goods and services that the free market cannot produce. The less government control of resources and lthe lower the level of income redistribution, the more land, labour, and capital that entrepreneurs can use to generate productivity and profits and ultimately create economic growth.
One of the major misconceptions in economics is that governments can create economic growth. Beyond State owned Enterprises (SOEs) (which have been proven time and again to be less efficient that their private counterparts), governments merely direct the resources from one area of the economy to another. As explained previously, economic growth tends to be stronger when the government provides a free business environment for entrepreneurs to thrive and limits its involvement in the economy to a minimum.
Take for example an increase in government spending on infrastructure. While a rise in government infrastructure spending will tend to increase profit opportunities for certain sectors of the economy (mainly construction companies), the land, labour and capital required to build new infrastructure will tend to come at the expense of profit opportunities in other sectors. A government-funded infrastructure project, for instance, may be detrimental for the residential real estate sector as real estate businesses find that profitability is lower as labour, land, bricks, and mortar now become costlier. Similar to monetary stimulus, fiscal stimulus merely puts more money into the economy without creating additional resources, putting upside pressure on inflation and breeding economic distortions.
Expansionary fiscal spending can have a short-term positive impact on real GDP growth but this inevitably comes at the cost of economic health and long-term economic growth. Although there is no magic number to the level that constitutes excessive spending, it is fair to say that it is lower than the current level of 40% of GDP OECD average. This helps explain why countries with higher government spending tend to have lower levels of GDP per capita. Using the examples of the Asian Tiger economies, which have very low welfare states and that have achieved spectacular growth over recent decades, the optimal level of government spending appears to be no higher than 15%, for purely economic growth and purposes.
Growth tends to be stronger if the government has less control over a country’s resources beyond the provision of goods and services that the free market cannot produce. The less government control of resources and less income redistribution, the more land, labour, and capital that entrepreneurs can use to generate productivity and profits.
The level of government spending is crucial both in terms of its impact on fiscal sustainability and economic health. Excessive spending is ultimately the cause of every fiscal crisis and given that spending tends to be much more ‘sticky downwards’ than revenues, deficits can emerge in the event of high spending even if taxes are very high.