Govt sizing – too little or too large?
I came across the quantitative measurement of a country’s economic freedom in a report presented by Economic Freedom of the World. The report concludes that “Countries with more economic freedom have substantially higher per-capita incomes”, with their chart at page 17.
This shows that the least free countries also lags in per capita income and the most free ones have high income.
To derive to a Economic Freedom index, the Journal of Economic Survey assigned numerical marks to each country in each of the categories. There are four basic categories they classify their numbering into – Size of Govt, Legal Structures, Access to money, Freedom to trade, Regulations (Credit, Labor and Business). The one I am going to discuss now, is basically the first one, i.e. Size of Government: Expenditures, Taxes, and Enterprises.
As per their description, this category has four further sub-categories –
- General government consumption spending as a percentage of total consumption
- Transfers and subsidies as a percentage of GDP
- Government enterprises and investment
- Top marginal tax rate
Their basic argument goes like this (quoted from the report) –
“When government spending increases relative to spending by individuals, households and businesses, government decision-making is substituted for personal choice and economic freedom is reduced. … When government consumption is a larger share of the total, political choice is substituted for personal choice. Similarly, when governments tax some people in order to provide transfers to others, they reduce the freedom of individuals to keep what they earn. … They (Govt Capital) often operate in protected markets. Thus, economic freedom is reduced as government enterprises produce a larger share of total output. … Such rates (High income tax rates) deny individuals the fruits of their labor. Thus, countries with high marginal tax rates and low income thresholds are rated lower. … countries with low levels of government spending as a share of the total, a smaller government enterprise sector, and lower marginal tax rates earn the highest ratings in this area.”
But does it translate to prosperity? Does it at all contribute towards higher per capita income? Surprisingly, the statistics shows a negative correlation between Govt size and Per capita income. I tried to come up with a chart where I list out 20 countries with highest rating in Govt. size and their rank in World Bank per capita income list.
So, we’ve got an interesting list. Most of these countries are poor, except for tax havens and Singapore. Besides, the top ranked Hong Kong’s Military and Foreign relations are managed by Mainland China that scores poorly in the Govt size index.
Now let’s see how it looks like for the countries who are rated poorly. The bottom 20 of Govt size countries are –
So that becomes interesting, the list includes countries such as Scandinavian ones, Benelux members – countries those offer highest freedom to their population. And more interestingly, on an average, the average rank of these 20 countries is 99.5 in the per capita GNI compared to that of 123.85 for top 20 countries.
So, the end chart of top-10 vs bottom-10 looks like this –
FYI, the Top 10 avg drops to 12,502 if we keep Hong Kong out of the list.
Now let’s revisit the facts and hypothesis. Fact one – more Govt intervention/size is correlated to higher per capita GNI. Fact two – more economic freedom is correlated to higher per capita income. However, the hypothesis, as per the report, is that less govt intervention/size should contribute towards higher economic freedom!! How good is the hypothesis then? Doesn’t it falsify the conventional wisdom of higher Govt intervention implies less prosperity? In other words, doesn’t it falsify the neo-liberal economists and World Bank/IMF dogmas?
GNI Per Capita incomes are collected from World Bank Website.
The data about Economic Freedom Index are collected from Free the World website.