Social Welfare and Government Size

In this paper, we analyze the effect of government size on social welfare and GDP per capita growth for the sample of 36 OECD countries in the last six decades. Our initial results show that the effects are negative but smaller in absolute terms in the case of welfare than for GDP per capita. This result is robust to changes in the estimation method, to the use of smoothed variables, to the inclusion of dummy variables that control for expansions and recessions, and to additional control variables, such as the composition of expenditures and taxes, and public debt. However, and more importantly, we find that the effect of government size follows an inverted U-shape: positive and greater on social welfare than for GDP per capita growth when government size is below 35% to 40%, and negative beyond that threshold. Interestingly, the range of values for which government size positively affects growth and welfare expands significantly with government quality, productive spending, and low levels of debt. An efficient public sector on all these fronts is more important to maximize social welfare and critical to economic development than the size of the government per se. JEL Classification: E62, H50, O40