GOVERNMENT SPENDING AND INFLATION RETARD ECONOMIC GROWTH, BUT RELIGIOUS AND ETHNIC DIVISIONS DON’T

Inflation and government spending (except on defence and education) may retard economic growth, while trade increases it, according to new research by Professors Steven Durlauf, Andros Kourtellos and Chih Ming Tan, published in the March 2008 issue of The Economic Journal. But religion, ethnic division and location seem to play little or no role in explaining why some countries are rich and why others are poor.

The rise of China and India looks inevitable. It comes after the rapid growth of the East Asian ‘tigers’, and Japan before that. But why did these countries develop quickly, even as many African countries stagnated?

Some economists argue that so-called ‘fundamental’ differences between countries – such as how religious they are; or their ethnic split; or even where they are in the world explains why some grow faster than others. But this new analysis rejects these theories.

‘Standard’ economic variables – such as initial income, investment and the speed of population growth – all matter more than ‘fundamental’ differences.

But governments can still play a role. Higher government spending (except for that on defence and education) reduces growth. Higher inflation damages growth. And the more open a country is to trade, given its size and population, the faster it will grow.

These results come from analysing data across a wide variety of countries – and so there is no way of telling if a specific government initiative in any one country reduces growth. Every economist agrees that a court system and a police service are needed for stable economic conditions, for example, yet someone who didn’t understand the research might incorrectly conclude that abolishing the police (and thereby cutting government spending) would increase growth.

So we need to be careful when interpreting these results: the results are drawn from an average of more than 50 countries over a period of 30 years (1965-94). But these results do suggest that extra non-defence, non-educational government spending on average lowered growth over this period.

A word of caution is that large, unexplained regional differences in economic growth remain – for example, East Asian countries grow much faster than African countries. We can explain some of this difference – East Asians have in general a better education system and are more politically stable – but we cannot explain all of it.

There is also some evidence that some countries benefit more from investment (say) than other countries. Why this is so remains a mystery.

ENDS

Notes for editors: ‘Are Any Growth Theories Robust?’ by Steven Durlauf, Andros Kourtellos and Chih Ming Tan is published in the March 2008 issue of The Economic Journal.

Steven Durlauf is at the University of Wisconsin. Andros Koutellos is at the University of Cyprus. Chih Ming Tan is at Tufts University.

For further information: contact Steven Durlauf on +1 608 263 3859 (email: sdurlauf@ssc.wisc.edu); Andros Kourtellos on +357 2289 2447 (email: andros@ucy.ac.cy); Chih Ming Tan on +1 617 627 3138 (email: chihming.tan@tufts.edu); or Romesh Vaitilingam on 07768 661095 (email: romesh@compuserve.com).