Wrong Medicine for this Economic Illness

It is a well researched and well known theory that economic/financial liberalization leads to economic growth. Very simply put, this liberalization reduces the size and control of government (public sector) relative to the private sector.

Reducing the public to private ratio spurs growth. Increasing this ratio retards growth.

Here are two extreme examples: Argentina and China. Argentina has a well educated population and many natural resources (like oil). In the early 1900s, it was the 10th richest nation (per capita) in the world. But over the last century its public sector has gradually taken over. Recently it seized all private pension assets and transferred them to its social security system. It is now the 82nd richest nation. On the other hand, China began its economic liberalization in 1978. Since that time, its economy has grown 70 times bigger.

Now let's turn to the United States. How much did the Federal Budget grow in the Clinton and Bush administrations? How was the economy?

Time Period Annual Budget Growth Economy Growth
2 Clinton terms 3.3% 5.6%
2 Bush terms 6.4% 4.8%

It is not a coincident that the economy was good in the Clinton years. His budgets grew at a modest 3.3% rate. This allowed the public sector to shrink in relation to the private sector. It spurred growth. Although Bush was considered business friendly and fiscally conservative, it sure didn't turn out that way. His budgets grew almost twice the rate during the Clinton Administration. As a consequence, the public sector grew in relation to the private sector. Thus, his economy was bad. In fact, it was only propped up for a few years through massive household debt expansion (see blog post). In the end, the larger government spending has retarded economic growth.

We are now struggling with poor economic growth. What should we do? Reduce the size of the public sector relative to the private sector! Unfortunately we are doing the opposite. In fact, it appears that we have started a new era of government expansion. The Obama Administration has offered a budget that is nearly 25% larger. Now that may be unfair because he is throwing money at the recession. But that is one of my points-Government expansion retards growth! Still, his budget does include much new spending. But let's look at the budget growth out three years, that should get past his expectations on poor economic growth. The 2011 budget suggests a 7.6% annual growth rate!

At our current rate of the government taking over the private sector, we will have poor economic growth for the foreseeable future.

Research on liberalization:
Geert Bekaert, Campbell Harvey, and Christian Lundblad, 2005, "Does Financial Liberalization Spur Growth?" Journal of Financial Economics, 77(1), 3-55.