The Impact of Government in a Shrinking Economy

Volumes have been written on the effect of government spending on economic growth. Observers of nearly all political persuasions (anarchists and totalitarian communists aside), believe there is an optimum point of government involvement in an economy. An economist by the name of Richard Rahn came up with his eponymous curve which attempts to use empirical data to plot growth rates in GDP versus government spending as a share of GDP. Unfortunately, Mr. Rahn's methodology's scientific efficacy is debatable, but it is intuitively obvious that there must be some point of optimum (if it isn't intuitively obvious consider this: in a state where there is virtually no government spending, economies collapse as crime and piracy run rampant - e.g. Somalia; and when government makes virtually all the economic decisions you end up with another kind of failed economy - e.g. the Soviet Union).

All other things being equal, the spending of governments would tend to fall along with the economy in the 2007 Depression. As income declines, so do tax receipts. States of the USA have to balance their budgets (more or less) and so must cut spending to match the decline of taxes. The US Federal Government (along with most other national governments) has no such restraints, and much is being made at present of how much deficit spending to make to 'help' the economy. Could too much government spending go past the point of 'help' and into 'hurt'? How much of the economy can be in the government's hands without collapse setting in?

The EU government spending as a percent of of GDP has tended around 50%, while by comparison, the USA has tended around 40%. If the OECD economies contract by 50% and government spending does not shrink along with it, the percentages will rise to 100% and 80% respectively. Obviously, this is well past the optimum.

At some point into the 2007 Depression, governments will likely be forced to shrink. This will not be a matter of libertarianism, but of practical economics. Painful choices will be made, some of them critical. Health care, education, national defense, police, fire departments, food stamps, pensions? Where will the axe fall?