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What the U.S. Can Learn From Canada's Government

04/15/2014 12:35 EDT | Updated 06/15/2014 05:59 EDT

For several years now, the political debate in the United States has centred on whether the federal government should hike taxes or cut spending to tackle the deficit and rein in government debt. At the root of political "gridlock" is ultimately differing views among Democrats and Republicans with respect to the right size of government.

House budget chairman Paul Ryan, who, in his 2012 convention speech, spoke of the need for "hard limits on the size of government." President Obama, who, based on current projections, will have overseen an increase in federal spending as a share of the economy over his presidency, expressed a competing vision in a speech in December 2013 when he said that "government can't stand on the sidelines...because government is us."

Let's put politics aside and turn to evidence to help resolve this debate. Indeed, a large body of empirical research has examined the size of government that maximizes economic and social outcomes. Based on that research, the U.S. would benefit from smaller government.

One recent addition to the mounting evidence against large government is a study published by the Fraser Institute, entitled Measuring Government in the 21st Century. The study, authored by Canadian economist and university professor Livio Di Matteo, examines the relationship between the size of government and economic growth and a wide range of social outcomes such as life expectancy, infant mortality, homicide rates, educational attainment, and student reading proficiency.

The findings point to a positive return to economic growth and social progress when governments focus spending on basic services like the protection of property. But the findings also suggest a tipping point exists at which more government hinders economic growth and fails to contribute to social progress in a meaningful way. Government spending becomes unproductive when it goes to things from which regular Americans derive no tangible benefits such as corporate subsidies, boondoggles, and overly generous wages and benefits for government employees.

The fundamental question, then, is what size of government maximizes economic growth?

Like other researchers, Di Matteo analyzes total government spending (at all levels) as a percentage of gross domestic product (GDP). There are shortcomings to this yardstick, since it excludes government regulations and various special tax deductions which can distort markets and contribute negatively to a government's economic footprint, but it is the best available measure of the size of government.

After examining international data, Di Matteo finds that annual per capita GDP growth is maximized when government spending consumes 26 per cent of the economy. Economic growth rates start to decline when relative government spending exceeds this level. In other words, there is a hump-shaped relationship between the size of government and economic growth.

According to OECD data, the size of government in the United States was approximately 40 per cent of GDP in 2012. While Di Matteo's research is based on international data, it suggests considerable scope to reduce the size of government in the U.S. and boost economic growth in the process. This conclusion is supported by a larger literature that also finds a much small government would translate into higher annual economic growth.

For a real-life example of how scaling back government has led to positive and practical economic benefits, Americans should look north. In Canada the conventional wisdom for much of the second half of the 20th century favored increasing the size of government. This led to significant growth in government as a share of the economy from 1970 to 1992 with total government spending increasing from 36 per cent to 53 per cent of GDP over this period.

The massive growth in government spending and government debt led the country down a precarious path that attracted unwanted international attention. In fact, a 1995 editorial in the Wall Street Journal wrote that Canada had "become an honorary member of the Third World" and warned that it "could hit the debt wall."

In response, the federal and several provincial governments took sweeping action to cut spending and reform programs. This reform agenda reduced the size and scope of government, created the room for important tax reforms, and ultimately helped usher in a period of sustained economic growth and job creation.

Canada's total government spending as a share of GDP fell from a peak of 53 per cent in 1992 to 39 per cent in 2007, and despite this more than one-quarter decline in the size of government, the economy grew, the job market expanded, and poverty rates fell dramatically.

As the debate in Washington about the size of government presses forward, politicians would do well to consult the evidence. And the evidence shows there's ample room to scale back government to the benefit of the American people.