Government and Growth

Summary

Assumptions

Model/Theory

  • Government should solve market failures 1. public goods. 2. externalities 3. monopoly 4. coordination failure and 5. income distribution.
  • Government role: 
    1. Rule of Law
    2. Overall size of government
      • Tax distortions. Laffer curve.
    3. Practice of planning
      • Historically included state-owned enterprises, government-owned banks, marketing boards, trade restrictions.
  • Why do governments do things that are bad for growth?
    • Other goals e.g. reduction of pollution, equity-efficiency trade-off (redistribution).
    • Corruption & Kleptocracy --> 1. corrupt govs spend more (not to lowest bidder) 2. policies pursued purely as opportunities for bribery e.g. quotas 3. undermine rule of law
    • Self-preservation - economic growth can be destabilizing.
  • Is the causation bad government --> poverty? Or poverty to bad government?
    • Income --> gov 1. bad government not always an impediment to growth 2. quality of gov improves with growth 3. can pay civil servants high wages 4. larger pie to share 5. honest gov. is a luxury good only rich countries can afford
    • Gov --> Income 1. Evidence gov can affect economy 2. Colonialism led to bad govs but was not due to income  - weak institutions and poorly constructed national boundaries (concerning ethnic groups etc.)
  • Income inequality
    • Kuznet's hypothesis - as a country develops inequality would at first rise than fall. 
    • inequality --> higher growth
    • Causes - Distribution of economic characteristics and circumstance e.g. technological advances, increases in international trade, superstar dynamic
    • Effects of inequality 
      1. Physical capital accumulation - more saving if more rich people (better initially for growth)
      2. Human capital accumulation - more education if more equality (better in the long-run for growth)
      3. Productivity = technology & efficiency e.g. inequality --> redistribution via taxes --> inefficiency from distortions and tax avoidance; there may also be pressure for redistribution from crime political instability
    • Economic mobility e.g. intergenerational mobility --> 1. better use of human talent in society 2. less political pressure for redistribution. causes of mobility 1. education access 2. nature of institutions and government 3. nature of marriages

Predictions

Evidence

  • Strong relationship between rule of law and factors of production (p.358) and rule of law and productivity (p. 359)
  • Wagner's Law says that the size of government increases as countries become wealtheir because a more developed economy requires more complex regulation and because many public goods require spending that rises more than proportionally with income (p.360)
  • Robert Barro (p.377) found some democracy is good for growth but too much is bad.
  • Average income level rather than level of inequality is the key factor in determining an individual's income level.
  • No statistical relationship between inequality and instability, or inequality and higher levels of redistributive taxation.

Evaluation

  • Reasons against government intervention 1. government failure 2. can successful privatizse many public goods 3. can successful deregulate many monopolies 4. equity-efficiency trade-off wrong where most redistribution is life-cycle related rather than real redistribution - and potentially negative efficiency costs.
  • Swings in opinion in the 1920s with the success of the Soviet Union and the subsequent Great Depression economists were in favour of government intervention, since WW2 and the failure of Communist countries economists are more laissez-faire but once again since the 2008 recession the pendulum is potentially swinging back the other way as China faired better than say the USA.
  • Economic effects of government are sometimes a result of the fight for power rather than economic policy per se. E.g. Paul Collier has cited the multiple equilibria 'conflict trap' or a peaceful & prosperous country.