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Wednesday, January 03, 2007

Does Big Government help reduce Income Inequality?

Here's an interesting piece that examines the Government spending/GDP ratios in countries across the world.
In US, as per the 2005 estimate, federal government expenditure constitutes 19.7% of the national GDP. The corresponding figure for India is 18.75%!!

As one would expect, for most Western European countries, the figure is around 50%. For instance, in Norway and the United Kingdom the Government taxes away more than 40% of the national output.

As always, the data lends itself to different interpretations. The purported intention of having a big government is to ensure a more equitable distribution of income. If Government does indeed help alleviate gross inequality of income, there ought to be a negative correlation between the Govt Spending/GDP ratios and the Gini Index, which is a measure of income inequality.

But, this is clearly not the case -

Country Gini Index

Norway 25.8
India 32.5
UK 36.0
US 40.8

The United Kingdom, whose Govt Spending/GDP ratio is more than twice that of US or India, has a higher level of Income Inequality than India!! Hence, the cliched argument of the socialists that governments need to spend more to reduce income inequality doesn't hold water.

Instead, a more plausible theory is that countries that are culturally and ethnically homogeneous are more likely to be egalitarian in terms of income distribution. Denmark, Japan, Sweden and Norway are all excellent examples of nations that are predominantly homogeneous and hence more egalitarian. In contrast, melting pots like US, UK and India tend to be less egalitarian because of the sheer ethnic diversity of their populations. Spending more money on wasteful government programmes is not going to make a positive difference, as shown in the case of UK.

PS: I must admit I haven't considered the redistributive part of Government Spending separately. These figures would include expenditure on Defence which is not redistributive. Even after making allowance for that, the case against big government appears pretty strong.

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