A Surprising Way Big Government Increases Economic Growth
These days, many conservatives want to shrink the government and cut taxes. Their good-faith position is that economic growth comes from the actions of businessmen. Government wastes money that would otherwise go into the productive economy.
This website has offered many counter-arguments to this position. The article “The Top 16 Things Government Does To Build the Economy” lists – no surprise – 16 different important things the government does that actually help to increase GDP and strengthen capitalism. My book All Societies Die devotes about 1/3 of its content to showing the positive contributions of government.
But let’s imagine for a minute that the stereotypes were right. What if government bureaucrats were useless? Most people think that teachers, the military and – depending on your politics – the police perform useful functions. But Washington D.C. is full of government functionaries. What if all the regulators and attorneys and accountants and policy wonks were all deadweight? Would we be better off if we got rid of them all?
There is a forgotten link between the state and economic growth that works even if government is completely useless. Government bureaucrats sitting behind desks with huge piles of documents rubber stamping this and rubber stamping that can still reduce poverty and increase wealth. This is one of the surprising findings that came out of a recent article my research team published in the journal Sociology of Development. (You can get a link to the Sociology of Development article itself at the bottom of the article on this website called Special Reveal For the Readers of This Website.) Most of that article was about other subjects. But there was one key finding that was highly relevant to the big government/small government debate.
Government has one of the highest Leontief multipliers of any industry. (Cohn et. al, 2023) Leontief multipliers measure the extent to which the expansion of economic activity in any one industry promotes economic growth in other industries. They are calculated by using GDP statistics to calculate where the money earned by every industry is spent. Tracing money as it flows through the economy tells you which sectors of our economy generate a lot of growth and which are economically less important. An industry with a big Leontief multiplier is an industry that creates a lot of other economic growth when it grows itself. It also kills a lot of other economic growth when it shrinks.
There are two primary causal mechanisms that cause industries to favorably impact other industries.
One, Type I multipliers, measure the impact of the purchase of inputs and supplies. A beer manufacturer who purchases hops and vats stimulates both the agriculture sector and metal manufacturing. Governments actually have low Type I multipliers because they don’t buy very much materiel. The one exception of course is defense spending. Leftists who wrote about the military industrial complex correctly noted that military spending does increase economic growth in our country. (The use of those weapons to destroy other countries does reduce economic growth in the areas that are active war zones. That however is another issue)
The second and more important impact comes from Type II-I multipliers. This is the stimulus to consumer industries that come from workers in a growing industry spending their wages. The more employment, and the higher the wages, the more consumption comes from workers spending their paychecks. My work on nineteenth century Norway showed that the Norwegian economy largely grew from domestic consumption based on the wages paid to fisherman and codfish processers.
Governments are labor intensive. They pay wages that are high by local standards. This means that governments write a lot of paychecks – and those paychecks are large. This is a gigantic economic stimulus to the places where government workers live. Capitol cities tend to be prosperous places. Metropolitan Washington D.C., including the Maryland and Northern Virginia suburbs is a prosperous place with a high standard of living. Washington D. C. has only two meaningful base industries, government and tourism. Almost everything else in the Washington area comes from government employees and the military spending their wages. They spend on housing, groceries, entertainment, and health care. The restaurant and bar scene in Washington is excellent – with many of the customers being in the public sector.
The Distrito Federal in Brazil is the richest of all Brazilian states. The Distrito Federal contains Brasilia – and almost nothing else. There are few other local industries. Surprisingly, the Amazonian states are wealthy too. Nearly all the population is concentrated in the capitol cities of those states. Most of the population in those capitols works for federal or state government.
Two of the richest cities in the United States are Columbus, Ohio and Austin, Texas. Columbus is the capitol of Ohio. Austin is the capitol of Texas. Both cities have large universities, Ohio State University and the University of Texas. Both of those universities are public. Both universities run large public hospitals. (OSU’s hospital is in Columbus. The University of Texas runs hospitals in Houston, Dallas and Austin. UT’s MD Anderson Cancer Center in Houston is one of the most prestigious anti-cancer hospitals in the world.) Public sector institutions in Ohio and Texas hire a lot of lawyers, a lot of skilled administrators, a lot of professors, a lot of engineers (think about the highway departments of both states), a lot of doctors and a lot of nurses. Those lawyers, administrators, professors, engineers, doctors and nurses spend their money in the local economy. In Ohio, that spending is generally concentrated within the Columbus metropolitan area. In Texas, most of the spending is based in Austin. There are however, significant spillovers into Houston and Dallas.
Shrink-the-state MAGA politicians want to get rid of useless government bureaucrats. Those government bureaucrats pay the bills for a lot of private sector people. Industries with high Leontief multipliers are a good thing. Government has the highest Leontief multipliers of any industry in the American economy.
Killing the goose that lays the golden eggs is never good economic policy.