The Rahn Curve and the Growth-Maximizing Level of Government

www.mustwatch.eu www.reformy.cz the burden of government spending has exploded in the past ten years in America and is expected to become even more onerous in the next ten years what does this mean for the US economy? I am Dan Mitchell of the Cato institute and this Center for freedom and prosperity video is going to discuss the Rahn curve as you can see on the screen the Rahn curve shows the relationship between the economy on the vertical axis and government spending measured as a share gross domestic product on the horizontal axis when there is no government the graph shows that economic output or growth is very low this is because in a state of anarchy workers savers investors and entrepreneurs do not have an environment conducive to productive behavior but as government begins to provide core public goods such as rule of law and protection of property rights economic performance improves simply stated people have a much greater incentive to produce when they know there are rules protecting life liberty and property but just like some food is good but overeating is bad the same thing is true for government spending the curve shows that there is a growth maximizing level of government spending but once the budget exceeds that point economic performance begins to slip the Rahn curve which is named after Cato institute fellow Richard Rahn is sort of the spending equivalent of the Laffer curve in both cases it is a very bad idea to be on the right side or downward sloping side of the graph In the case of the Laffer curve it means that tax rates are so high that the government actually loses revenue because people decide to earn and or report less income In the case of the Rahn curve it means that government is too big and this is reducing prosperity the most challenging question of course is figuring out whether government today is to a bigger too small in other words Where is America on the Rahn curve? We're going to flash a bunch of academic studies on the screen that show estimates the growth maximizing level of government spending now feel free at any point to pause the video If you wanna examine the findings of any particular study but you'll notice that what you see is that scholars generally conclude that economic performance is maximized when government spending is somewhere between 15 percent of GDP and 25 percent of GDP now the fact that there is such a wide range of estimates should not be too surprising economists are notorious for disagreeing with each other and to be fair this kind of empirical research is a big challenge since there are many other policies including taxation monetary policy regulation trade policy that also impact economic performance but you the viewer only need to understand one thing government spending in America today consumes 40 percent of GDP In other words the budget is way above the growth maximizing level even if you assume that twenty five percent of GDP is the right amount and other nations are by the way in even bigger trouble particularly places such as France where the burden of government spending exceeds fifty percent of economic output it is quite likely by the way that the right size of government is closer to fifteen percent or even lower the statistical studies you saw on the screen are constrained by a lack of data per countries with limited governments even relatively laissez-faire economy such as Hong Kong have government sectors that consumer early twenty percent GDP so what does it really tell us when researchers conclude the economic growth is maximized when government spending is about where it is in Hong Kong Would the results be different if we had examples of countries were smaller government? there's no way to answer that question but here's some food for thought let's look at this chart using data from an International Monetary Fund study showing that most nations in Europe in North America had very modest levels of government for much of their histories oftentimes consuming only about ten percent of GDP and America for example total government spending until the nineteen thirties average less than ten percent of GDP does anybody really think though that America what have grown faster in the eighteen hundreds and early nineteen hundreds if the burden of government spending was double from ten percent of GDP to twenty percent of economic output or let's ask the same question about England or Sweden the answer almost surely is no and this means that the academic studies on the Rahn curve today are almost certainly overstating the growth maximizing level of government for all intents and purposes today's research may be measuring that downward sloping portion of the Rahn curve Lets conclude with the one thing we can say for sure government today is far too big and this is hurting growth undermining prosperity and reducing competitiveness it doesn't matter whether republicans are spending too much money or democrats are spending too much money and it doesn't matter whether we're looking at America or other nations if we want a strong economy the Rahn curve tells us that we need to dramatically reduce the burden of government spending I am Dan Mitchell on behalf of the Center for freedom and prosperity thanks for watching this video and please share it with your friends and colleagues