The Rahn Curve – Economic Growth and Level of Spending

Readers Question: Does the Rahn Curve support the empirical evidence? If not, why not? Can you prove that there is a relationship between the level of Government Spending and GDP growth.

The Rahn Curve suggests that there is an optimal level of government spending which maximises the rate of economic growth.

Diagram of Rahn Curve

rahn-curve

Proponents of the rahn curve tend to use it as a tool to argue that government spending hinders economic growth. For example the Centre for Freedom and prosperity [link] point to empirical studies which suggest that the optimal level of government spending is between 15 and 25% of GDP. That page also shows links to other reports and empirical studies which would be worth investigating for your paper. However, you should bear in mind:

  • Government spending in US is approx 37% of GDP, in UK approx 43% of GDP, in western Europe some countries have more than 50%
  • The Centre for Freedom and prosperity has a clear ideological stance that they dislike government spending. It is not surprising they highlight studies which show results favourable to their belief in reducing the role of government
  • There is a rather tenuous link between growth rates and levels of spending. There are many factors that influence rates of economic growth and I am dubious that people can ever isolate just one factor (levels of government spending) to prove either higher or lower growth rates.

For example, when countries are in a certain stage of development growth tends to be higher and government spending a smaller % of GDP. However, this does not necessarily prove the high growth is caused by low spending. A more convincing explanation would be that at certain stages of development it is easier to maintain high growth rates (e.g. China and India) and it maybe that these growth rates could have been even higher if the government had invested in infrastructure improvements.

Government Spending is Too Vague. To say that the optimal level of government spending is 20% is like plucking a figure out of the sky. It depends on what the government spends its money. If the government is spending money on generous benefits for the unemployed it is unlikely to be boosting growth rates. If the government is spending money on overcoming market failure such as providing education, training and infrastructure improvements then these can be helpful in increasing growth rates.

Some argue with ideological fervour that government spending is always ‘inefficient’ But, this is lazy economics; some government spending can be inefficient, but, there is no reason why it has to be always inefficient.

I am rather dubious of the Rahn Curve; there are too many difficulties in deciding whether the level of government spending can influence the rate of economic growth. It would be more useful to examine whether privatisation of state owned industries can have a noticeable impact on influencing growth rates.

There is also another issue which can get lost – the fact that maximising growth rates is not necessarily the government’s highest priority. Issues of equity, fairness and concern for the environment are arguably more important than maximising rates of economic growth.

Optimal Levels of Government Spending

Nevertheless, it is still worth considering the optimal levels of government spending.

For example, increasing state benefits will at some point have a trade off – of lower economic growth.

A current issue is the level of state pensions and the optimal age for retirement, reducing state pensions (making people work longer) will probably lead to lower government spending and higher rates of economic growth.

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22 thoughts on “The Rahn Curve – Economic Growth and Level of Spending

  1. economic growth is the objective of the government and othe fiscal policy concerns(inflation,employment,balance of payments…distribution of income)…..government spending should be increased only when there is supreme meltdown in the economy..but must be an optimal level of spending..because just increasing spending mean increasing budget deficits and decreasing gdp growth rates(only when spending above what our resources allow)

  2. “Some argue with ideological fervour that government spending is always ‘inefficient’ But, this is lazy economics; some government spending can be inefficient, but, there is no reason why it has to be always inefficient.”

    Yes, there is. As Milton Friedman famously pointed out no one spends someone elses money as carefully as he spends his own. Government bureaucrats are spending someone elses money on behalf of yet another person. They have no incentive to spend that money efficiently.

    1. “As Milton Friedman famously pointed out no one spends someone elses money as carefully as he spends his own.”

      On the contrary, if that were true there would be fewer recessions and there would be no housing booms.

      Housing booms are driven by reckless investment by those with excess savings. A government could always spend some of that money more wisely, redistributing it to boost wages at the bottom so that consumption rose in line with savings growth, rather than lagging behind. Then perhaps the remaining savings would be better directed towards productive investment rather than speculation!

  3. Depending on the motive and quality of the government bureacrats, I can arguably say that, in some cases, some categories of public spending stimulate investment and thereby growth enhancing, while in others it depresses it. so, policy recommendations should be drawn on prudently setting priority in public spending as an awakening siren if public policy is to enhance forces of economic growth.

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