Thursday, May 1, 2014

Fraser Institute Study: The optimal size of government

In 2013, the Fraser Institute released an extremely thorough study on the relationship between the size of government and economic growth. According to the study:

- "After controlling for confounding factors such as population, lagged per capita GDP, net debt to GDP, institutional factors of governance, economic freedom, and regional variation, etc... annual per capita GDP growth is maximized at 3.1% at a government expenditure ratio of 26% [of GDP]; beyond this ratio, economic growth rates tend to decline." [Today government spending in the US is around 40% of GDP]

- After controlling for the effect of confounding variables the authors found that a 10% increase in the size of government [measured as a % of GDP] would decrease the per capita GDP growth rate by around 0.9%.

-According to these estimates, the economy of a country with a public sector size of 30% of GDP would grow by over 33% within a decade whereas the economy of a country with a public sector size of 40% of GDP would only grow by 20%.

- The authors also found that economic freedom was a significant determinant of economic growth rates. According to their estimates, a 1 point increase on the Economic Freedom of the World Index (10 being highest) would increase per capita GDP growth by approximately 0.6% after controlling for numerous other variables.

These findings verify the classical liberal belief that the economy will grow fastest if government stays small and fosters an environment of economic freedom.

Fraser Institute study here:

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