GOLDEN GROWTH
and businesses, or it can be a sign of bloated and ineffective bureaucracies. Whether government spending turns out to boost or dampen growth depends also on the way it is financed. In short, public spending’s impact on growth depends on institutional, financial, and economic factors (Bayraktar and Moreno-Dodson 2010). Keeping these caveats in mind, we must ask: do social transfers hinder growth in Europe? Governments are big in Europe mainly due to high social transfers, and big governments are a drag on growth. The question is whether this is because of high social transfers. The answer seems to be that it is. The regression results for Europe, using the same approach as outlined earlier, show a consistently negative effect of social transfers on growth, even though the coefficients vary in size and significance (table A7.4). The result is confirmed through BACE regressions. High social transfers might well be the negative link from government size to growth in Europe. A sizable economic literature argues that, unlike social transfers, public investment more often than not supports growth. Over the last decade and a half, public investment was higher in Eastern than Western Europe, as a share both of GDP and of total public spending, reflecting three factors. Since the east is more capital-scarce than the west, the return on investment is likely to be higher there. Also, capital flows downhill in Europe, enabling emerging economies to boost investment. Finally, the EU’s structural funds allowed prospective and new member states to increase public investment. So, while the evidence is less clear-cut than for social transfers, it suggests that public investment is more likely to help than hinder growth in Europe.
Bumblebees can fly Big government is associated with slower growth in Europe. But the estimations discussed above pick up only the average patterns across Europe, and there are clearly countries that manage to combine big government with healthy growth. To return to the example at the start of this chapter, Sweden has managed to grow richer with big government, just as a bumblebee seems to defy the laws of aerodynamics. Sweden is not alone. In fact, the role of government has increased since the end of World War II in many countries, even during the “golden age” of European growth from the 1950s to the early 1970s. As market economies became richer, governments grew bigger. Government spending as a share of GDP among the G7 countries doubled from about 20 percent in 1950 to more than 40 percent in 2010. Big governments might be more commonly associated with paper reshuffling and red tape rather than the frictionless machinery imagined by Max Weber (Gerth and Mills 1946). Yet the persistent rise in government size suggests a deliberate choice of societies to expand government. The fiscal footprint of governments through taxation and spending is only one feature of government. A growing literature explores the role of government more generally. This research comes under different names, including quality of government, good government, governance, government capacity, or institutions. Institutional economists point out that the accumulation of physical, human, and intellectual capital—emphasized by neoclassical and endogenous
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