The Ranting Kraut

19.3.2006 – 27.9.2010

Were the supply-siders right?

Posted by rantingkraut on May 15, 2008

A short report by the Centre for Policy Studies, Keith Marsden’s “Big, not Better?”, published in April this year claims to provide evidence from 20 countries that slim governments work better. It’s a conclusion I like to hear. Unfortunately the evidence is less than solid.

The report compares 20 industrialised economies and classes their governments as big or slim depending on which side of a 40% of GDP threshold their government revenue and expenditure lie. Slimmer governments are shown to have lower top rates of tax, higher average growth figures and lower debt and deficit burdens on average.

Marsden then goes on to argue that slimmer governments also fared better in terms of social gains with inequality only slightly higher while achieving higher growth in employment and spending on public services while also spending more on defence.

The choice of success indicator is decidedly odd in some cases [1]. How much of a success story high employment growth is, for example, depends on the wider context: if near full employment is maintained throughout, then employment growth should largely be constrained by population growth and migration. It is possible then that slim economies with large employment growth figures simply had high unemployment to start with.

Unemployment rates given in the statistical appendix are consistent with this interpretation: Total unemployment rose from an average of 6.9% to 7.5% for the slimmer governments [2]. Among these averages we find substantial falls in unemployment for Australia, Canada and Ireland. On the other hand, Latvia and the Slovak Republic –two high unemployment economies– only enter the sample during the later 2000-2005 period. Without them, average unemployment would have been 5.98%.

When it comes to spending on public services and defence spending, the indicators chosen are input variables. Outputs may be harder to measure and compare, yet they should be what matters. Didn’t Britain’s New Labour government demonstrate that improvements –e.g. in the NHS– need not be reflective of spending increases? Shouldn’t that line of reasoning be one of the main supports for a pro-supply side argument?

Increased spending on public services, at first sight, looks like an odd indicator for the success of slim government. Doesn’t a rise in public service spending show that government is getting bigger? Well, that depends on how you look at it. The increase noted refers to real expenditure rather than expenditure as a percentage of GDP. The argument could therefore be made that increased spending on public services becomes economically sustainable in slimmer governments, where public finances seem to be better managed [3].

So, “Big, not Better” does present some background data consistent with support for supply side economics. It does this on the basis of a small, incomplete data set and a very crude analysis. Keith Marsden’s verdict that “… the analysis and prescriptions of the early supply siders were correct” therefore seems like a daring conclusion to be reached on this basis. With a more detailed discussion and a more cautious conclusion this report would have deserved to get taken more seriously. As it stands, one should be reluctant to rely on it in support of a small government agenda [4].

[1] Choice of time periods is another potential issue. GDP growth figures are given for the 1998-2008 period while export and investment growth averages are based on 2000-2005 data. For a number of indicators the 1990-2000 interval is compared to the shorter 2000-2005 period. It is not immediately clear what motivated the choice of time period, although this may simply be an issue of data availability.

[2] It fell from an average of 7.2% to 6.7% for bigger governments.

[3] This still would be a tentative argument. The relevant data in the statistical appendix are patchy, with budget data missing for 4 of the 10 slimmer government economies.

[4] The media reaction to this report turned out to be supportive to neutral nevertheless:

http://www.telegraph.co.uk/opinion/main.jhtml?xml=/opinion/2008/04/07/do0701.xml

http://news.bbc.co.uk/1/hi/business/7333749.stm

Keith Marsden “Big, not Better?” Centre for Policy Studies

http://www.cps.org.uk/cpsfile.asp?id=1013

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