CAN LATIN AMERICA PROSPER BY REDUCING THE SIZE OF GOVERNMENT?
September 24, 2009
As Latin American policymakers ponder how to keep the region competitive and their economies growing, one area that should be carefully considered is the size of their respective governments, say Radhames Lizardo and Andre V. Mollick, researchers with the Cato Institute.
The authors' tested the hypothesis that government expenditures in excess of the optimal point as given by the Armey Curve (a graphical technique that basically attempts to predict how much government input is needed to maintain positive contribution to the overall system), tend to reduce economic growth.
What they found:
- When resources are wasted in sustaining an ineffective bureaucratic governmental system, opportunities to grow the economy are forfeited.
- When government overspends, it is because the government has overtaxed its citizens, which drives up the pool of private investments.
- If government is limited, private investment appears to be a positive and significant predictor of economic growth.
According to the authors, their findings corroborate the conclusion of other studies concerning the negative relation between economic growth and government consumption, and also the positive relationship between economic growth and investment.
On the question of an optimal consumption point for Latin America:
- The average consumption rate should be around 13.7 percent of the annual real gross domestic product; yet the actual average spending is about 22.71 percent of the annual real GDP.
- The findings from panel data analysis reinforce the message from the Armey Curve: an increase of 1 percent in government consumption as a share of real GDP leads to a reduction of economic growth varying from -0.22 percent to -0.28 percent across specifications.
Source: Radhames Lizardo and Andre V. Mollick, "Can Latin America Prosper by Reducing the Size of Government?" Cato Institute, Spring/Summer 2009.
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