Do We Have to Choose between Government Services and Economic Growth?

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DO WE HAVE TO CHOOSE BETWEEN GOVERNMENT SERVICES AND ECONOMIC GROWTH?

A Study by Economists Andreas Bergh and Magnus Henrekson

FOR IMMEDIATE RELEASE: June 2010

Debates about the proper size and role of government are all around us. Is there a tradeoff between government services and economic prosperity? If so, what are we to make of Scandinavian countries, where high tax rates and large government sectors have been coupled with high rates of economic growth?

To answer these and other questions, leading Swedish economists Magnus Henrekson and Andreas Bergh study governments’ expenditures and how they finance their activities. Their analysis, just published in Government Size and Implications for Economic Growth (AEI Press, 2010), shows that:

  • In rich countries, there is indeed a negative correlation between the size of government and the rate of economic growth (the authors find that a 10 percent increase in government size results in a 0.5 to 1 percent decrease in annual growth rate).

  • Annual economic growth affects the well-being of citizens. A decrease in growth of 0.5 percent translates into several billion dollars less for government and individuals.

  • What governments do and how they finance their activities have different effects on growth. In other words, not only is government size important, but how and where tax revenue is spent matters for growth (for example, spending on education and infrastructure increases the rate of economic growth).

  • Having a small government does not guarantee economic growth. Some countries with small governments have stagnant economies. Other factors positively impact economic growth, among them well-defined property rights, a noncorrupt legal system, a stable currency, and an open, free economic system.

  • Some countries with high taxes enjoy above-average growth because they compensate for high taxes by employing market-friendly policies in other areas (such as free trade and open markets).

  • Lastly, high rates of personal taxation encourage individuals to work less in the marketplace and more at home where they perform their own service tasks. This hampers the development of an extensive service sector and lowers economic growth.

Andreas Bergh is a research fellow at the Ratio Institute in Stockholm, Sweden, where he researches welfare state reform and institutional economics.

Magnus Henrekson is president of the Research Institute of Industrial Economics in Stockholm, Sweden. His research focuses on institutional determinants of entrepreneurial activity and explanations for cross-country differences in economic performance.

INTERVIEW REQUESTS:

The authors are based in Sweden; to set up an interview, please contact them directly. Andreas Bergh can be reached at andreas.bergh@ratio.se (011.46.70.779.0734) and will provide Skype information upon request. Magnus Henrekson can be reached at magnus.henrekson@ifn.se (011.46.70.222.9700). For all other media inquiries, please contact Véronique Rodman at vrodman@aei.org (202.862.4871) or Hampton Foushee at hampton.foushee@aei.org (202.862.5806).

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