NCPA - National Center for Policy Analysis

How The Size Of Government Affects The Unemployment Rate

July 22, 1999

Economists examining a number of industrialized countries for an extended period of time have identified several important ways in which bigger government increases the unemployment rate. Among the factors they have identified:

  • Bigger governments impose higher income tax rates, which affect the work and leisure decisions of individuals; for instance, higher marginal tax rates could lengthen the time between jobs by reducing the returns to work for spouses providing a secondary income.
  • Large governments are more likely to finance public health insurance and unemployment insurance schemes that lower the cost of unemployment to the individual.
  • Government spending crowds out private spending -- most notably investment spending that could raise productivity and foster technological change -- and thus can reduce job growth.

For the United States, for example, economist Gerald Scully has found that the growth-maximizing size of government (and therefore the tax level) as a share of gross domestic product is approximately 23 percent. Analysis indicates that reducing the U.S. government's average share of GDP from 36.7 percent to 23 percent would lower the reported unemployment rate by about 2.9 percent.

In theory, it is possible for government spending to be allocated to growth enhancing infrastructure and education but in practice most outlays go for redistribution or government- mandated consumption that does not improve productivity.

All other factors being equal, bigger government reduces the size of the private sector. The level of government spending may be indicative of other governmental intrusions into the private sector, especially regulations which restrain economic growth and efficiency. The factors that enable big government also are likely to heighten regulatory activities.

Further, the unemployment rate is only the reported rate. The reported rate may be lower than actual unemployment due to government programs that encourage individuals to drop out of the work force or shuffle idled workers to welfare programs where they are not counted as unemployed.

Source: Burton A. Abrams (University of Delaware), "The Effect of Government Size on the Unemployment Rate," Public Choice, Volume 99, No. 3-4, June 1999.


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