THE BLOG
11/02/2012 06:24 pm ET Updated Jan 02, 2013

The Small Government Fallacy

The fallacy that strong government impedes growth is now damaging the U.S. economy, something that small government advocates don't want to hear. Blindly downsizing government in the name of efficiency leads to very little growth and major recessions. In spite of the evidence, candidates Romney-Ryan continue to advocate privatizing everything from public education to social security, while further deregulating Wall Street.

More and more economists report that weakening government's power to regulate and tax has stagnated economic growth by taking away wealth from the very majority who are the engine of our consumer society and diverting its profits to the least productive segment of society, the holders of capital or rentiers who live off the dividends and capital gains that have much lower tax rates than ordinary income earners.

The result is the U.S. has fallen to the lowest ranking on income inequality. The CIA World Fact Book ranks the U.S. 94th in income equality below all developed countries, Iran, and Russia. In fact, the U.S. is just above Jamaica and the poorest African countries. Wealth -- both income and assets -- has become concentrated among fewer and fewer Americans, in other words. And it has damaged our growth and world standing.

It is an example of the failure of weak government policies that instead of creating more prosperity for all, has diverted it to the wealthiest. And the resulting record income inequality has damaged economic growth say many studies, such as a recent IMF study by Andrew Berg and Jonathan D. Ostry that suggests income inequality might shorten our economic expansion by one-third in jobs lost and goods products.

According to the authors:

"... a careful look at the varying levels of inequality in different countries demonstrates just how much societal divides in wealth really matter. Countries with high inequality are far more likely to fall into financial crisis and far less likely to sustain economic growth," said the authors in a recent Foreign Affairs article.

And it is not uncontrollable technological and social change that has produced a two-tier society. Nobel Economist Joseph Stiglitz argues in a recent review of his latest book, The Price of Inequality, that it is the exercise of raw political power by moneyed interests over legislative and regulatory processes. "While there may be underlying economic forces at play," he writes, "politics have shaped the market, and shaped it in ways that advantage the top at the expense of the rest" (such as taxing the holders of wealth at lower rates than employees' wages and salaries).

This has enabled them to funnel its benefits to the wealthiest via lower taxes on their investments or business-friendly decisions by the highest court, while taking it from the areas that foster growth -- education, infrastructure, as well as the research and development of new products and processes. The subsequent decline in adult incomes has caused a huge drop in wealth for the 80 percent who comprise the consumers that power economic growth.

Stiglitz says:

"Many at the bottom, or even in the middle, are not living up to their potential, because the rich, needing few public services and worried that a strong government might redistribute income, use their political influence to cut taxes and curtail government spending. This leads to underinvestment in infrastructure, education, and technology, impeding the engines of growth."

Its most graphic evidence is how much of our productivity surge has not been returned to those who created such wealth since the 1970s. That was when the philosophy of "government is the problem" took hold. A coincidence? Hardly. Big business decided to bend the rules their way to impede collective bargaining in the Red States and foster wholesale deregulation of industries, using the rationale of globalization to suppress the wages of American workers and put them in direct competition with workers of developing countries.

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Weak growth over the past decade in particular can mainly be traced to the fall in household incomes, and what consumers can really afford. If their incomes were growing as in 2000 before the Bush tax cuts and wars, for instance, then we would already be back to 1990s levels of economic growth.

So we do not have to accept slower growth, if we recognize and right the record inequality that has caused our market economy to repeatedly crash, educational standards and technological research to decline, and so our ability to compete in the global economy.

Because politics created the loss of wealth and slower economic growth, writes Professor Stiglitz, politics can also reverse the decline.

Harlan Green © 2012