The Avoidable Slowdown Of Growth In Western Countries

In Western countries, the size of government increases at the same time that growth is slowing down.

06/22/2017 15:13 EDT | Updated 06/22/2017 15:15 EDT
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Toronto, Ontario, Canada

In the 1970s, the decade of my birth, the average Canadian could expect his inflation-adjusted income to increase annually by 3.1 per cent. In the past 20 years, this rate had slowed to 1.4 per cent. This "growth slowdown" is an experience shared by most Western countries, and it has become a topic of recurrent political debate. Many have suggested that to remedy the situation, the government needs to provide a jolt to the economy. To be frank, this is like asking a pyromaniac to play the firefighter.

First of all, a caveat: It is likely that we are overestimating the growth slowdown. The price indexes that we use to adjust for inflation generally tend to overstate the extent of price increases in recent decades, failing to fully adjust for quality improvements. There are also significant portions of what makes our lives better that go unmeasured. For example, the encyclopedia publishing industry has largely disappeared. Their lower output is thus contributing, in the official statistics at least, to the impression of a growth slowdown. Yet thanks to free online encyclopedias, we consume much more knowledge than in the past. This benefit goes largely unmeasured. The same applies to music and all the applications that exist on your telephone for which a mere decade ago we needed physical goods (address book, camera, watch, etc.).

Yet, even if we are overestimating the slowdown, it is hard to deny that things are not improving at the same pace as they once did.

A part of the slowdown can be explained by the fact that we have picked the low-hanging technological fruit. New technologies require more research than in the past, and the workers who can carry out this research take years to train. There is also the lingering impact of the recent financial crisis, as well as the impact of an aging population. All of these headwinds are slowing the ship of economic growth.

However, to these headwinds must be added the effects of another: the increase in the size of government. In Western countries, the size of government increases at the same time that growth is slowing down. Indeed, in the indexes of economic freedom that measure not only the size but also the scope of governments in society, most Western countries are experiencing either stagnation or a modest decline. In fact, when one looks at sub-components of the economic freedom index like business and labour regulations, the decline is even more pronounced.

Economic freedom, which provides a measure of the extent to which individuals can engage in mutually beneficial exchanges, is crucial to economic growth. As a result, those countries with the highest levels of economic freedom are the ones that experience the fastest rates of economic growth. Large governments restrict economic freedom through taxation and regulations that distort the decisions of individuals. In doing so, they are slowing down economic growth. For example, long regulatory delays in approving new drugs reduce research in the pharmaceutical industry, and high corporate tax rates dampen the incentive to make new investments and start new businesses.

Large governments also tend to exacerbate the other headwinds that slow down growth. The effect of an aging population need not be a severe problem, as such a gradual change allows businesses to adapt by using more capital instead of labour. However, an aging population is a serious problem when there are large government retirement programs that need to be maintained through increasing tax rates on a shrinking labour force.

It is true that there is a growth slowdown in Western countries. However, the reality is that far from being a solution, government intervention is a big part of the problem.

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