Readers Question: Is large government spending bad for economic growth? to what extent does empirical evidence support this assertion?

How Government Spending Might Lead to Lower Economic Growth

• Higher spending leads to higher taxes. Higher income taxes may discourage people from working. High corporation tax might discourage firms from setting up in that country. (e.g. Ireland has attracted significant inward investment due to low corporation tax)
• Generous government welfare benefits may discourage people from taking a job, creating voluntary unemployment.
• Arguably government spending tends to be more inefficient than private sector spending. There tends to be greater bureaucracy and government civil servants don’t have the same profit motive as the private sector. (This leads to poor decisions like Concorde, Millennium Dome)
• Government spending decisions may be taken for political rather than economic motives (e.g. subsidising a failing firm to prevent politically unpopular job losses.)
• Government Borrowing to finance higher spending can push up interest rates and cause financial crowding out
• Higher share of government spending leads to lower share for private sector.

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General government gross debt is a definition of government borrowing used by the EU.

Generally, UK government debt is published as ‘public sector net borrowing’ – There are two measures of this public sector net borrowing – one which includes financial sector intervention, and another which excludes. see: UK National Debt

source: Stats on UK public finances at HM Treasury

1) Public sector net debt excluding financial sector intervention

2) Based on Maastrict criteria see below.

General Gross government debt gives a higher figure than just using public sector net debt.

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This is a list of government spending as a % of GDP.

The highest on this list is Zimbabwe with 97.8% of GDP.

Amongst developed countries, the highest levels of government spending include Iceland (57%), Sweden (52%) and France (52.8%)

China’s government spending accounts for only 20% of GDP

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Readers Question: The argument in Europe at the moment is whether the ECB should be able to buy bonds (new? old?) directly from governments as well as being able to buy old ones on the open market (“secondary market”?). Is it correct that in either case that the ECB would just the create Euros to buy the bonds? I am confused about when the central banks create money and when they use other reserves. I can already hear you asking me “Well where else would they get the money from?”, but talk of borrowing from China, and all the fuss over quantitative easing has left me just a bit confused.

The Central Bank can purchase bonds in two ways

• ‘Sterilised Bond Purchases’ This is when the Central Bank buys bonds without creating any new money. In this case, they use existing bank reserves. Therefore this policy is limited; they can only buy a limited quantity of bonds.
• ‘Unsterilised Bond Purchases. This is when a Central Bank (e.g. ECB) create money and use this newly created money to buy bonds.
• see also: unsterilised bond purchases

Bank of England and Quantitative Easing.

If you look at the Bank of England, they created over £200bn as part of their ‘asset purchase scheme’ and used this ‘newly created money to buy government bonds. They created money by simply increasing the amount of money (electronically) in their bank account. It is similar in principle to printing money and using that money to buy bonds from commercial banks.

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Readers Question: I am much in favour of governments defaulting on what they owe to private financial institutions (as opposed to other governments). This would be in line with the ideas fuelling the current OCCUPY THE WALL STREET movement. I would very much like someone to comment if this is at all possible and practical. Would that help to stop the 1% living off the fat of the … USURY (shameless and gotten out of hand)? from (why not default on debt)

A government could decide to default on the debt it owes private financial institutions. But, the cost would be very high for everyone in society (not just the richest 1%). Government debt is owned by a variety of private sector institutions, including commercial banks, investment trusts, and pension funds who buy government bonds.

If the government defaulted it would hurt the richest members of society, as the top financiers would lose money and see bank profits fall sharply. However, government default would also hit workers who have contributed to a pension fund. If the government defaulted, it would cause a serious fall in the value of pension funds; this would probably hit everyone who has a stake in a private pension.

If the government defaulted on debt, it would cause serious repercussions for taxpayers and the economy in the future. If a government decides to default, they won’t be able (or will find it very difficult and expensive) to borrow in the future. If a government can’t borrow easily this can affect everyone in society. For example, in a recession it is necessary for  government borrowing to increase (lower tax receipts / pay more on unemployment benefits). In a recession, government borrowing helps to stimulate the economy (expansionary fiscal policy) and also reduce the economic hardship of those made unemployment.

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Readers Question: The number of Rhinos that are killed every year for their horns is increasing. They may soon be extinct. What would an economist do about this?

An economist would say that if Rhinos are at risk of becoming extinct it would impose a significant social cost on society. Therefore the economic incentives should be changed so that there is a much greater cost to being involved in the Rhino trade. If necessary funds should be raised from a wider range of countries who indirectly are involved in the Rhino trade (e.g. Western economies giving financial aid to African countries for the policing of the trade).

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