Baseline Scenario has a great discussion of the relationship between government spending, inequality, and economic growth. At issue is a central debate in political economy; namely, does increasing government spending lead to slower rates of economic growth? This seems to be a popular question these days, with both Paul Krugman and Clive Cook chiming in on the topic.
This is hardly a new debate. Adam Smith and Karl Marx both raised similar questions more than 100 years ago. Today, the debate is usually framed as the U.S. vs. the European model, with each side pointing out the flaws in the other. Yes, Europe has slower rates of economic growth than the United States. Yes, the United States has lower rates of taxation (at least over the past twenty years) than Europe. Yes, social services are generally better in Europe. Yes, the United States has better health care system, if you can afford it. The argument goes on and on.
What both sides of the debate seem to be missing is the cultural element. The proposition that smaller government leads to higher rates of economic growth and prosperity—a point, at best, impossible to prove in the real world due to differences in factor allocations, political histories, and other facts which don’t often fit neatly into our theoretical models—has come to be accepted as common sense. But even conceding the point that smaller government lead to higher rates of economic growth doesn’t tell us what the ideal size of government should be. That question, it seems to me, is largely the outcome of specific national political cultures [glossary] which conceive of differing roles for the state. Higher taxes may indeed mean slower rates of economic growth. But they also may mean the provision of better services by the state. The expectation that the state provide at least some fundamental services to its citizens—ranging from national defense and policing to providing a minimum level of social safety to more expansive services like health care and education—is largely a function of political socialization [glossary] and political culture. And political cultures often prove incredibly resilient. Americans are unlikely to wake up tomorrow and demand a host of new services from the state (The Democrats are learning this the hard way as they try to reform the U.S. health care system). Similarly, most Europeans are unlikely to embrace the night watchman state [glossary] that seems to inform American political culture. Any debate that misses this is likely to have little effect in the real world.