WHAT IS THE OPTIMUM SIZE OF GOVERNMENT

The optimal size of the government is a problem that has attracted the attention of researchers for decades. Arthur Laffer illustrated that there is tax revenue maximizing tax rate, and in a similar way other authors try to identify the government share of gross domestic product which maximized the GDP growth.

The Institute of Market Economics (IME) is adding to the literature with their new study that estimates the optimum size of government, the share of government spending that maximizes economic growth.

Previous studies have tried to determine and quantify the optimum size of government, recognizing that not all governments and societies are the same, and most have shown that the optimum size is between 12 and 30 percent of GDP. However, IME finds that the government sector should be no larger than 25 percent (and perhaps considerably smaller) to maximize GDP growth:

• All major governments, including the United States, Germany, the United Kingdom, France and Italy greatly exceed the 25 percent level. The average government sector for the Organization for Economic Co-operation and Development (OECD) countries now exceeds 41 percent of GDP.
• In addition, the evidence indicates that the optimum level of government consumption of final goods and services as a share of GDP is 10.4 percent based on a panel data of 81 countries.
• However, due to model and data limitations, it is probably 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.

Furthermore, researchers indicate that policy makers who are enlarging their government sectors in the name of "economic stimulus" are likely to be retarding the renewal of economic growth and job creation rather than enhancing it.

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