The Rahn Curve and the Growth-Maximizing Level of Government
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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