Government size, factor accumulation, and economic growth: evidence from OECD countries

This study examines the role of government size in explaining the differences in economic growth rates of the 19 Organization for Economic Co-operation and Development (OECD) countries over the 1971-1999 period using a random coefficients model. Our results indicate that, on average, total factor productivity growth, as well as the productivity of capital, are weaker in countries where government size is larger. The advantage of a small government sector, in general, likely reflects the greater efficiencies resulting from fewer policy-induced distortions (such as the burden of taxation), the greater discipline of market forces which fosters efficiency of resource use, and the absence of crowding-out effects that weaken the incentives to create new capital which embodies new technologies. From a policy perspective, this does not mean that the optimal policy is one that minimizes the size of government. Rather, a small as opposed to a large government could potentially be as effective in providing the legal, administrative, and governance infrastructure critical for growth, as well as for offsetting market failures. At the same time, the country-specific results indicate that the nature of country-specific institutions as well as the mix of government activities are as important for growth performance as the aggregate size of government. (C) 2002 Society for Policy Modeling. Published by Elsevier Science Inc. All rights reserved.