June 14, 2012

A larger state does not mean lower economic growth

Some commentators argue that there is an inverse relation between the size of the state and economic success: the way for a country to achieve higher growth is by lowering taxes and reducing government spending.

The fallacy of this has been shown recently by the Financial Times chief economics commentor Martin Wolf on his blog.

His evidence is the following diagram showing each country's growth rate against its average tax rate. There is a large amount of variation in tax rates from Japan at 30% of GDP to Denmark at 56%. Yet there is no relation with growth rates. High tax countries have grown just as fast or slowly as low tax countries.

Growth versus Taxation

The chart shows that there are countries with a small state and low growth (Japan, Switzerland) just as there are countries with a big state and relatively high growth (Finland, Sweden).

Wolf suggests that, in view of this pretty convincing evidence, those who call for tax cuts in present circumstances are not so much seeking to promote growth for the greater good of society, as they claim, but expressing a political choice in favour of a smaller state with fewer public goods, less social capital, greater inequality and lower taxes.

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