7 - Small versus Big Government and the Quest for Equitable Growth

Summary

It is often claimed that the shortest way to recovery and growth following transitional contraction is to diminish the role of the state. As proof of this, mainstream neoclassical economists cite a few carefully selected examples of successful nations with small governments and fast growth. However, in light of experiences in the world economy, the supposed alternative between big government and a lower rate of growth or small government and a higher rate of growth does not really seem to be an entirely valid one. If there were such a clear choice, then small government might be a better option, even at the cost of a temporary dropoff in public services. In fact, in the real world, such a solution may sometimes be appropriate, but the opposite situation is more likely to emerge: a positive correlation between the size of government and the pace of growth.

In transition countries, ‘small government’, that is, a relatively lower amount of income redistribution through the public finance system and the relatively minor involvement of the state and the public bureaucracy in economic affairs, usually means that institutions are weaker and that the shadow economy is larger. Meanwhile, ‘big government’ means that the state is more active and redistributes a relatively larger chunk of income through the government budget.

Government expenditure can accelerate the pace of growth, particularly if it is directed at institution-building, the upgrading of infrastructure, and human capital investment, especially education, health care, and research and development. Government expenditure can hinder growth if the bulk of state expenditures flows toward the bureaucracy, defense, and subsidies for non-competitive activities. In short, outlays can be productive or non-productive, investments can be oriented toward the future or toward current consumption, and expenditures can be well targeted or miss the target. The trick is to determine the proper mix between management by the state and management by the market.

Orthodox neoliberal economics suggests that a reduction in the size of government facilitates growth. However, during the early transition something quite different happened. Owing to the complexity of the changes, it is not possible to identify exactly the nature of the correlation, but there can be no doubt that during the early transition there was a causal relationship between the rapid shrinkage in the size of government and the significant fall in output.