How big is too big?

When it comes to the government, anyhow, the answer seems to be that most of the developed world is experiencing economic sclerosis as a result of having a bloated government.

While I generally agree with the conclusions (and am not that surprised to see that the data show government size to be hampering economic growth), it is worth looking at some of the implications of the econometrics in more detail:

• The authors find that a 1% increase in government spending leads to a .13% reduction in economic growth. However, when they include spending squared, they find that there is at most a weakly significant effect. There are good reasons to believe that the relationship between government size and growth is nonlinear, and I'm guessing they just didn't find the right non-linearity. Nonetheless, the nonlinearity they are finding would seem to imply that reductions in government size would be less effective in stimulating growth in countries with big governments than in countries with small governments. This is not good news for those of us who are in favour of small government, as cuts in government spending will have their smallest effect in the economies that need the cuts the most! The authors only briefly mention this point in a footnote.
  
• It is very easy to look at the regression results and calculate things like "the optimal size of government is 0," or "the most inefficient size of government is 76% of GDP," or "maximal government is just as efficient as 52% of GDP," or other such interesting claims. However, all of these claims would be made out of sample, and are thus invalid. The results hold for government sizes between (roughly) 18% and 67% of GDP, but not outside those bounds. This may be a no-brainer for people with economic training, but I don't think bad statistics are generally generated for economists' consumption.
  
• One of the results that struck me as odd was where the authors examined the components of government revenue and their effect on growth. They argue that direct taxes have little effect on growth, while indirect taxes and social contributions have a negative effect. I'm not sure why this might be the case, and I sincerely doubt that the prevalence of loopholes in income tax code or the relative difficulty in evading indirect taxes relative to direct taxes holds the answer. I think the answer lies in misinterpreting the regression coefficients. Say you can raise revenue in one of 4 ways: direct taxes, indirect taxes, social contributions, and "other" (e.g. inflation, revenue from sales, plundering neighbouring states, etc) If the government wants to raise one dollar, it has to do it one of those 4 ways. This means that, for each country, the percentage of income coming from each of these 4 sources sums to 100%. This is important, because that means in order to run a regression you must omit one of the variables (in this case it is "other"), but this necessarily implies that the coefficients of the 3 reported revenue sources are to be interpreted relative to the missing variable, not on their own. So direct taxes are no worse than "other," and are not as bad as indirect taxes or social contributions, but we can't say they have no effect. In other words, you need to treat it like a dummy variable!
• On the same issue, the problem may also lie in the fact that the authors don't appear to control for government size in those regressions (note: they might in fact control for it, I just don't see it). It seems plausible that governments would increasingly rely upon revenues from indirect taxes and social contributions as they grow larger. In other words, governments can only tax income up to a certain point, and if they want more income, they need to tax something else. This would imply that the result is not in fact causation, but rather correlation. Basically, increased government size leads to using indirect taxes and contributions more as well as reduced growth. This makes it look like indirect taxes and social contributions slow growth down if you don't control for it.
  

HT: Thoughts on Freedom

Speaking Ill of the Dead

Despite the federal govenment's difficulty in issuing an apology to the Stolen Generation, they seem to have no problems offering their condolences to the people of Indonesia over the death of former dictator Suharto. This, of course, is a man who was extremely corrupt, purged nearly one million dissenters, and was responsible for the human rights violations in East Timor, arguably one of the worst genocides since the Holocaust. What of these atrocities? Well, Kevin Rudd described these as "controversial." Alexander Downer described Suharto's human rights record as "less than desirable."

My initial thoughts on these comments was that I was rather unimpressed by the lack of conviction our leaders had for such a despicable character. Granted, in a few weeks they will likely change their tune (As far as I remember, Pinochet got a similar treatment) . But it did get me thinking...when is it OK to speak ill of the recently deceased? Somehow I doubt that Hitler's treatment of the Jews in 1945 was described as "controversial," and I sure don't remember anybody in the west describing Saddam Hussein's treatment of the Kurds as being "less than desirable." True, most of the west was at war with these men when they died, but I'd guess the same is true of such figures as Idi Amin, Pol Pot, Joseph Stalin, or Slobodan Milosevic. Yet at the same time, historical figures like Mao Ze Dong or Che Guevara seem to have, to some extent anyhow, been forgiven for their transgressions.

There are a number of rulers alive today that history will likely remember as cruel despots. Fidel Castro has killed thousands of political opponents, and imprisoned tens of thousands more. Little is known of the civil rights existing within Kim Jong Il's North Korea, but I suspect there is quite a bit of information suppression going on there. Robert Mugabe is widely regarded as a generally not-nice guy. And I can see Hugo Chavez regime travelling down an even uglier path any day now. Perhaps I'm being overly morbid, but I wonder who history will forgive and who history will celebrate?

The $800,000,000 squiggle

The Australian Broadcasting Corporation has just announced that they are revamping their logo. I'm glad they issued a press release because I might never have noticed, regardless of what the new logo ultimately will be. The simple fact is that I almost never watch the ABC or the ABC2. I think in the past year my wife and I combined to watch one episode of Summer Heights High. Yet how much do I pay for it? According to their financials, the ABC lost around $800M last year (which the government chipped in to make up the difference), which makes my household bill at least $80, and probably much more. So for the pleasure of watching the ABC, I pay approximately $80 per hour. Meanwhile, I've never paid a dime to Seven, Nine, or Ten, and yet get a lot more viewing pleasure out of those channels.

There is very little justification for the government to provide goods and services that a market would provide anyhow, and markets have absolutely no problems providing the goods the ABC provides (radio, television, and internet programming). Moreover, the evidence is that the ABC does what they do rather poorly, routinely getting about half the viewership of the "big-three" channels. In the modern world, the only reason why the government should own any media outlets is that they want to be able to engage in thought control, like the third world military rulers and middle eastern theocratic dictators who control the press for that very reason.

Privatize the ABC. Not only would you save the taxpayers some money, but whoever takes over the ABC couldn't help but improve the programming, giving consumers a better variety of programs for their enjoyment

Bush's Stimulus Package

So, the venerable G W Bush has decided to launch a stimulus package to fix the U.S. economy. Anything to take the focus off of the debacle that is Iraq, I suppose. But seriously, the fact that the stimulus package is news (as opposed to the fact that Bush thinks it will work) is really an indictment of just how little the public understands of economics. First things first, the notion of economic stimulus through Keynesian mechanisms is asinine. Here's an analogy. You owe your bookie $1,000, payable today. You have that $1,000 in your pocket. Your bookie calls you and says he won't come pick that money up today, but instead will pick it up in a week. Do you spend that $1,000 now and work your butt off over the next week to get another $1,000 to pay him off, or just hold onto the original $1,000 until the bookie comes to pick it up? Bush thinks you'll choose door number 1. Most economists think you'll take door number 2. They may call it "Ricardian equivalence" or the "permanent income hypothesis," but really it simply boils down to the fact that normal people aren't going to go nuts and drop twenty large on random goods when you push the collection date of their (tax) debt into the future.

However, let's put all the foregoing to the side for a moment. Let's say you do think this sort of economic stimulus will work. You really should be irate at Bush for waiting until now to do it! If Bush just has to wave his magic wand to make the economy perform better, why is he waiting until now? Why not do it when the economy is going along just fine, so that it will perform even better? Surely if you can turn a (say) 0.5% growth rate into a 1.5% growth rate, the same economic policy will turn a 2% growth rate into a 3% growth rate. In other words, if the government can do better than markets when markets are down, why can't they do it when markets are up? Also, in a completely unrelated question, why is government size generally inversely correlated with government growth?

Oh, hey, I do know the answer to this. Markets rarely perform poorly. And when they do, we really shouldn't call the government to fix it, because the poor performance is likely attributable to the government messing something up.