Social Democratic America (14 page)

FIGURE
4.6 Government revenues and economic growth in Denmark and Sweden Government revenues: Government revenues as a share of GDP. Includes all levels of government: central, regional, and local. The lines are loess curves.
Data sources
: for 1960–2007, OECD, stats.oecd.org; for pre-1960, Vito Tanzi,
Government versus Markets
, Cambridge University Press, 2011, table 13.2, with a minor adjustment. GDP per capita: Natural log of inflation-adjusted GDP per capita. A log scale is used to focus on rates of change. The vertical axis does not begin at zero. The lines are linear regression lines; they represent a constant rate of economic growth.
Data source
: Angus Maddison,
www.ggdc.net/maddison/historical_statistics/vertical-file_02-2010.xls
.

When the United States is compared to countries like Denmark and Sweden, a common objection is that the latter are small and homogenous.
²³
But the point here has nothing to do with similarities or differences between these three countries. The point is that developments over time
within
each of the three countries tell a similar tale. In each, government taxing and spending rose substantially—in the United States to about 35 percent of GDP, in Denmark and Sweden as high as 60 percent—with no apparent impact on economic growth.

FIGURE
4.7 Government revenues and economic growth, 1979–2007

Government revenues: Average level of government revenues as a share of GDP, 1979–2007. Includes all levels of government: central, regional, and local.
Data source
: OECD, stats.oecd.org. Economic growth: Average annual rate of change in GDP per capita, adjusted for initial level (catch-up), 1979–2007.
Data source
: OECD, stats.oecd.org. The correlation is .11 (with Ireland and Norway excluded). “Asl” is Australia; “Aus” is Austria.

Some might still object that only small, homogenous nations can have a
big
government without hurting economic growth. The story would be that a large, heterogeneous nation like the United States may do just fine with a rise in government spending of up to 35 percent of GDP, but beyond 35 percent growth will slow down. It's conceivable that this is true, but the story is based on assumption rather than evidence, so there is reason for skepticism.

Let's extend the inquiry to the full set of twenty rich longstanding democratic nations, concentrating, for reasons of data availability, on the recent era. Given the shifts in the world and domestic economies in the 1970s, I focus on the 1980s, 1990s, and 2000s.
²⁴
Specifically, I look at the period from 1979 to 2007 (both of these years were
business-cycle peaks). When comparing economic growth across nations, it's necessary to adjust for a process known as “catch-up,” whereby countries that begin the period with lower per capita GDP grow more rapidly simply by virtue of starting behind.

Figure 4.7
shows the average level of government revenues (horizontal axis) and the average catch-up-adjusted economic growth rate (vertical axis) in these countries between 1979 and 2007. There is no association between the size of government and economic growth. More detailed cross-country studies have reached a similar conclusion.
²⁵

Though I favor significant changes to America's social programs, I see a need for only limited restructuring of other economic institutions, such as our financial system, corporate governance, labor relations, and so on. But might a shift toward more generous public social programs hurt the economy by disrupting the coherence of its current institutions and policies?

An influential perspective on differences among the world's rich nations, known as the
varieties of capitalism
approach, contends that economies perform better to the extent that their institutions and policies are coherent.
²⁶
According to Peter Hall and David Soskice, those policies and institutions aren't drawn up in advance by a master planner, but because of selection pressures they end up fitting together. The result is a relatively coherent package—a gestalt, a whole that functions more effectively than the sum of its parts. So if we graft a set of social democratic government policies onto America's liberal market economy, will we upset the gestalt and thereby hurt the economy?

Hall and Soskice suggest that rich economies fall into one of two groups. Coordination is market-based in “liberal market economies,” such as the United States and the United Kingdom. Coordination is based largely on nonmarket or extramarket institutions in “coordinated market economies” such as Germany and Austria. Neither type, according to Hall and Soskice, is inherently better at generating good economic performance. What matters for successful economic growth is not the type of economic coordination, but the degree of institutional coherence. Countries with coherent institutions—that is, with consistently market-oriented or consistently non-market-oriented institutions and policies—should grow more rapidly.
²⁷

FIGURE
4.8 Institutional coherence and economic growth, 1979–2007

Economic growth: Average annual rate of change in GDP per capita, adjusted for initial level (catch-up), 1979–2007.
Data source
: OECD, stats.oecd.org. Institutional coherence: degree of coherence of institutions and policies within and across economic spheres.
Data source
: Peter A. Hall and Daniel W. Gingerich, “Varieties of Capitalism and Institutional Complementarities,”
British Journal of Political Science
, 2009. The correlation is .01 (with Ireland and Norway excluded). “Asl” is Australia; “Aus” is Austria.

Peter Hall and Daniel Gingerich have created a measure of institutional coherence for twenty rich nations, focusing on two economic spheres: labor relations and corporate governance. Nations score higher to the extent that their institutions and policies are coherent within each sphere and consistent across both spheres.
²⁸

Figure 4.8
shows countries' institutional coherence and their rates of growth of GDP per capita from 1979 to 2007 (adjusted for catch-up). There is no indication of the hypothesized positive association between coherence and economic growth. All along the
coherence spectrum—at the high end, in the middle, and at the low end—there are some fast-growing nations and some slow-growing ones.
²⁹

The hypothesis that institutional coherence is good for economic growth makes sense. But the empirical record suggests it's wrong. Nations with hybrid institutions and policies, or with a mix that changes over time, have grown just as rapidly as those with more coherent arrangements.
³⁰
Concern about a potential slowdown in economic growth resulting from inconsistent or shifting policies and institutions is therefore unjustified.

Daron Acemoglu, James Robinson, and Thierry Verdier also contend that there are two varieties of capitalism, but in their view one does tend to perform better than the other.
³¹
They hypothesize the following:

• Countries choose between two types of capitalism. “Cutthroat” capitalism provides large financial rewards to successful entrepreneurship. This yields high income inequality, but it stimulates entrepreneurial effort and hence is conducive to innovation. “Cuddly” capitalism features less financial payoff to entrepreneurs and more generous cushions against risk. This yields modest income inequality but less innovation.

• Because of the difference in innovation, economic growth is initially faster in cutthroat-capitalism nations. But technological advance spills over from cutthroat nations to cuddly ones, so growth rates then equalize. Over the long term, the level of GDP per capita is higher in cutthroat nations (due to the initial burst), while economic growth rates are similar for both types.

• Average well-being may be higher in cuddly countries because the more egalitarian distribution of economic output more than compensates for the lower level of output.

• Nevertheless, it would be bad for all countries if the cutthroat-capitalism nations switched to cuddly capitalism. That would reduce innovation in the (formerly) cutthroat nations, thus reducing economic growth in all nations.

Acemoglu, Robinson, and Verdier say their model might help us understand patterns of economic growth and well-being in the United States and the Nordic countries—Denmark, Finland, Norway, and Sweden. The United States has chosen cutthroat capitalism, whereas the Nordics have opted for cuddly capitalism. The United States grew faster for a short time, but since then, all five countries have grown at roughly the same pace. America's high inequality encourages innovation, so the Nordics can be cuddly and still grow rapidly because of technological spillover from the United States. If America were to decide to go cuddly, innovation would slow. Both sets of nations would then grow less rapidly.

How does this square with the data? To keep things simple, I'll compare the United States with just one of the Nordic nations: Sweden.

An indicator of financial incentives for entrepreneurs is the top 1 percent's share of household income. An indicator of the extent of cushions against risk is government expenditures' share of GDP. Both are shown in
figure 4.9
, going back to 1910. What we see in the data is a lot of similarity between the United States and Sweden until the second half of the twentieth century. Government spending begins to diverge in the 1960s, and income inequality diverges in the 1970s.

Sweden's top 1 percent get a smaller share of the total income than their American counterparts, but are incentives for entrepreneurs really much weaker in Sweden? Although Swedish CEOs and financial players don't pull in American-style paychecks and bonuses in the tens of millions of dollars, there is little to prevent an entrepreneur from accumulating large sums of money. In the 1990s Sweden undertook a major tax reform, reducing marginal rates and eliminating loopholes and deductions. It lowered corporate income and capital gains tax rates to 30 percent and the personal income tax rate to 50 percent. Later, it did away with the wealth tax. In the early 2000s, a writer for
Forbes
magazine mused that Sweden had transformed itself from a “bloated welfare state” into a “people's republic of entrepreneurs.”
³²

FIGURE
4.9 When did the United States go “cutthroat” and Sweden go “cuddly”? Top 1 percent's income share: share of pretax income, excluding capital gains.
Data source
: World Top Incomes Database, topincomes.g-mond.parisschoolofeconomics.eu. Government expenditures: government spending as a share of GDP.
Data sources
: Vito Tanzi,
Government versus Markets
, Cambridge University Press, 2011, table 1; OECD, stats.oecd.org.

Suppose the incentives for entrepreneurs began to differ in the two countries around 1960 or 1970. The model predicts that innovation would diverge as well. Acemoglu, Robinson, and Verdier refer to a measure of patent applications per capita that shows the United States leading Sweden starting in the late 1990s. This timing is consistent with the model's prediction if we allow a substantial lag. But they also cite a measure that has the United States ahead of Sweden in 1980. This suggests that America's innovation advantage may have preceded the type-of-capitalism choice, rather than followed it.