Political economy of the size of government: What shakes and what shapes


Jamaluddin Ahmed

It is a fact that no society throughout history has ever obtained a high level of economic affluence without a government. Where governments did not exist, anarchy reigned and little wealth was accumulated by productive economic activity. 

After governments took hold, the rule of law and the establishment of private property rights often contributed importantly to the economic development of the Western civilization, and it has similarly impacted on other societies as well. 

Having a government is a necessary, though by no means sufficient, condition for prosperity. It is also a fact, however, that where governments have monopolised the allocation of resources and other economic decisions, societies have not been successful in attaining relatively high levels of economic affluence. 

Economic progress is limited when governments constitute zero percent of the economy and when it is at or near 100 percent as well. The experience of the old Soviet Union is revealing, as was the comparison of East and West Germany during the Cold War era, or of North and South Korea today. 

Too much government stifles the spirit of enterprise and lowers the rate of economic growth. If no government is too little, but all-encompassing government is too much, what is about right from the standpoint of maximizing economic welfare. Review of theories of government growth raises more questions than answers. 

However, it will also show that the relationship between government growth and economic efficiency is more complex than many classical liberals would like to believe. Economic growth may slow as countries reach a more advanced stage of economic development that also sees an increase in demand for governments, but without a causal connection. 

Growth in governments can also give rise to a drive in search for greater efficiencies on the part of reform-oriented politicians, making government growth more sustainable and increasing the efficient size of governments. Review of theories of government growth raises more questions than answers. 

However, it will also show that the relationship between government growth and economic efficiency is more complex than many classical liberals would like to believe. 

Economic growth may slow as countries reach a more advanced stage of economic development that also sees an increase in demand for governments, but without a causal connection. 

Growth in governments can also give rise to a drive in search for greater efficiencies on the part of reform-oriented politicians, making government growth more sustainable and increasing the efficient size of governments. 

Classical liberals have traditionally been concerned with growth in the size of governments because of its potentially adverse implications for economic efficiency and living standards. However, they also recognize that growth in governments can weaken the rule of law and undermine the voluntary relationships that constitute civil society. 

To the extent that classical liberals have mainly focused their advocacy on policies that promote economic efficiency, they may have unwittingly contributed to an induced expansion in the size and scope of government by easing the revenue and other constraints on government growth. 

Classical liberals need to locate arguments for more efficient tax and spending policies within a broader framework of advocacy for rules and institutions that promote limited government. The size of government as a share of the economy has been on a rising trend since the Glorious Revolution of 1688–89, which established Britain as a modern constitutional democracy (Greg Clark 2007). 

International conflicts such as the Napoleonic Wars and World Wars I and II had a ratchet effect, with the government’s share of the economy remaining above its pre-War level in the wake of these conflicts. The brief trend to smaller governments in the nineteenth century was reversed from around 1900 onwards, aided by the two world wars, the Great Depression, and the rise of the social welfare state in the post-World War II period. 

The growth of government spending in the twentieth century was documented by Tanzi and Schuknecht, who noted that countries with relatively smaller governments have economically outperformed their bigger government counterparts, without underperforming on a broad range of social, environmental and other indicators. 

This implies that many governments throughout the developed world likely surpassed their efficient or optimal size from around 1960 onwards (Vito Tanzi and Ludger Schuknecht 2000).

J. M. Keynes is a central figure in the emergence of the welfare-state paradigm, which he elaborated by rejecting the two extremes of state socialism and laissez faire and defining a middle ground between them. 

This new paradigm sanctioned ‘the enlargement of the role of government’ for the purpose of correcting deficient demand (Keynes, 1936:380-1). The problem with the new paradigm was that it consisted of the middle ground between two extreme options in an extreme case: the Great Depression. 

After the Western economies recovered, growing liberalization of international trade and (later) of capital flows challenged the role and competence of government’s economic management. 

Eventually, the welfare state reached its limit in the 1990s, when fiscal deficits and public debt grew to proportions that destroyed government’s ability to intervene effectively: additional government spending raises interest rates, which negates any stimulus it provides to demand. 

Paradigm Shift : 

There are numerous signs that the tide of big governments is receding. Interest is growing in the high compliance costs of government. The appearance of Osborne and Gaebler’s book Reinventing Government (1992) suggests that governments are trying to increase the efficiency of public spending. In his 1996  Paradigm Shift. 

There are numerous signs that the tide of big government is receding. Interest is growing in the high compliance costs of government. The appearance of Osborne and Gaebler’s book Reinventing Government (1992) suggests that governments are trying to increase the efficiency of public spending. In his 1996 State of the Union Address, US President Bill Clinton announced that the ‘era of big government is over’. 

In the late 1990s, there is talk, and even some action, in the United King-dom, the United States, Australia and New Zealand on replacing welfare handouts with ‘workfare’. The principal reason for this disillusionment with big governments is that, if it grows beyond a certain point, the public sector reduces welfare rather than increasing it. 

In his overall analysis of the link between taxes and growth, Gerald Scully, a leading pioneer in the field of the optimal size of government, has observed that: 

Economic theory suggests that up to some level, government expenditures increase the productivity of private economic resources. The provision of national defense and a judicial system protect private property and individual rights. Other publicly provided goods, such as infrastructure, also enhance private productivity. 

Thus, up to some point, government expenditure acts as a positive externality on private economic activity … Beyond some optimal size of government, increased taxation acts as a negative externality on the private sector (Scully, 1996:4-5).

 (To be continued)


Jamaluddin Ahmed is General Secretary, Bangladesh Economic Association and

Chairman, Emerging Credit Rating Limited