Famously, US Economist Arthur Laffer drew a sketch on a table napkin in 1974 (I gather, now on display in a Museum) and changed the terms of public policy debate:
A debate followed, as to where the peak was, and so where major states were relative to that peak.
(More on that later.)
This discussion, however, overlooks a key point: SHOULD government revenue be maximised (especially in the fairly short run)?
For, in the long run, it is growth that creates room for improved and increasingly widespread prosperity. That is, long before revenues peak and fall, economic growth rates will peak and fall as the dead-weight effect overwhelms the benefits of having a tax-funded government.
So, we come to the linked Rahn curve, perhaps best seen in a composite chart:
It is obvious, then, that pushing the size of government too far will hamper long-term innovation, investment and prosperity. Even more obviously, there will be a hotly contentious debate as to where points A and B are, and on whether economies are at points like C. Such has redoubled force in our region, as Caribbean nations need growth and adequate revenues to carry out government services that are valued by the public.
To get an idea of the long-term impact of even seemingly small differences in growth rates, let us ponder what would happen to $1.00 after 50 years at growth rates relevant to how fast economies might reasonably grow:
A lesson.
Of course, real world economic growth is notoriously variable and averaging 2 - 3% can be hard. In recent years, much of the Latin America-Caribbean zone has struggled to run more like 1 - 2% than 2 - 3%:
We need growth, for ourselves and for our children and for posterity beyond. This means that we have to face the government dead-weight question and we must work to build a reasonable, responsible consensus in the public interest. Likewise, we have to build an entrepreneurial class and long-term investor confidence. Growth comes in the end from successful, competitive enterprise. Another point where we must work long and hard to build consensus.
Government leaders, government-owned independent and social media leaders, educators, pundits and even parsons, I am looking straight at you. This is mission-critical for the Caribbean. The seven mountains of influence -- and yes it is not just useful for missiology -- must come together around a credible growth agenda:
Lurking, too, is the quality of government services question: is the government delivering good value for money? (And, across the Caribbean, a lot of people will say: no. Sadly, too often, for cause.)
Quality of services, of course, will be tied to the rate at which government piles up dead-weight on the economy.
This is a context in which we hear of an ideal: private sector-led, growing and inclusive economies.
A great-sounding ideal, but obviously harder to achieve than to describe in a clever turn of phrase. Not least, because investor confidence is often low and for cause would-be investors fear being viewed as cash-cows to be mercilessly milked or outright expropriated. And, if there is a tax cut (especially one suspected to be of short duration) investment in jobs-producing activities may be the last thing to rise. Some may want to grab the windfall and run (through a dividend or executive bonus etc), others may invest in office equipment not factory floor equipment (guess who carry more influence), and more. Broken trust in a society is intangible but very real.
So, the first key take-home lesson is that there is such a thing as too much government for the long-term good of a country. Where, once the political balance has shifted towards a large government with services and support that significant voting blocs become dependent on, it can be very difficult to pull back from that level, even if Government indebtedness -- such levels as a rule come with heavy deficit financing -- begins to spiral out of control. In short, it is easier to avoid a hole than to climb back out again.But, it may be very hard . . . and, tellingly in a democratic polity, unpopular . . . to resist the pressure.
Second, there is also too little government, providing we have services of adequate quality (starting with policing, courts, public health services, regulation of utilities etc).
Third, we must ponder the need to save, innovate and invest, leading to sufficient growth that tomorrow is better than today.
Fourth, we are therefore facing a need to see to adequacy of services and to adequacy of growth. Where, it is possible to be overtaxed with even good government. Where, too, if government is bad enough, the dead-weight effect kicks in a lot earlier and feeding in more money will make things worse. And if there is significant graft, corruption, fraud, etc, that too can feed a destructive spiral. Hence, the vital importance of transparency and good law enforcement for so-called white-collar crimes.
H'mm, that reminds me of the concerns of donor agencies that we have to have enough capacity that aid does not get wasted or -- worse -- aid can be counter-productive.
All of this is of double force for cases such as Montserrat, where the whole economy has been propped up for many years through grants in the aftermath of a massive natural disaster. It is clear that keeping a viable community going, restoring critical infrastructure and an adequate level of services, building up capacity and addressing improved governance all must be addressed. Addressed, at the same time as a credible economy transformation and development programme is put in hand to shift the dynamic to private sector-led, inclusive, self-sustaining growth that leads in time to an economy where a reasonable (but frugal . . . we cannot afford gold-plated approaches) level of government services is not a dead-weight on the local economy.
Calculations suggest, twenty years at 4 - 6% p.a. GDP growth while a tight rein is kept on net growth of the government services sector would do it. The obvious targets for sparking growth are:
- upgrade of a seaport starting with a breakwater,
- upgrade of an airport,
- restoration of fibre optics cable connectivity,
- development of geothermal energy, all tied to
- development of a new town,
- growth of the tourism sector,
- digital services,
- financial services and the like.
Montserrat is of course an extreme case due to a volcano disaster forcing evacuation of 2/3 of the land and loss of most key infrastructure, but a less drastic form of this same picture obtains across the Caribbean. We need to balance adequate, good government, social welfare, health, education and growth.
But, what are the levels?
People can be all over the map, and while figures don't lie, liars can figger.
However, I found an interesting analysis out of Bulgaria.
Dimitar Chobanov and Adriana Mladenova argue, based on OECD statistics and theoretical considerations:
The evidence indicates that the optimum size of government, e.g. the share of overall government spending that maximizes economic growth, is no greater than 25% of GDP (at a 95% confidence level) based on data from the OECD countries. In addition, the evidence indicates that the optimum level of government consumption on final goods and services as a share of GDP is 10.4% based on a panel data of 81 countries. However, due to model and data limitations, it is probable that the results are biased upwards, and the “true” optimum government level is even smaller than the existing empirical study indicates. Optimal government size is also, of course, influenced by the quality of a government.In the detailed argument, they write:
The research studies using various empirical techniques and different sets of countries conclude that the optimal government size (total government spending as a share of GDP) is between 17% and 40% of GDP, and the mode of the estimates is in the range of 20 to 30% of GDP, much lower than the current government share in most developed countries. In 2007 the OECD average of total final government expenditures is 40.4% of GDP, while for the Euro area the average is 46.2% of the GDP.I have seen others go all the way up to 70% for the revenue-maximising level, which is higher than the growth maximising level.
The take-home lesson is clear enough, however -- especially where typical governments in our region are going to be less efficient and effective than those that are in OECD countries.
We should be dubious about a government that runs beyond about 25% of GDP, and should consider carefully indeed on whether we can sustain such a level. Nor should we be naive that governments in our region will be adept at managing utilities and big "commanding heights of the economy" enterprises. Instead, we should seek to provide reasonable, ever improving but frugal core services, and we should be pushing capacity building and investments.
To do so effectively, we need capable and willing partners.
Pioneering, public-private partners, twinning initiatives, partnerships with universities and with business incubators. Where, tourism is important, there may be energy resources (such as geothermal energy) and where the digital sector is going to be vital. Nor should we neglect opportunities to bring technology to bear on agriculture.
All, much easier said than done.
Of course.
But we need to at least start by talking seriously about such matters. END
