Government makes a difference in economics

Government makes a difference in economics. Government, as I have written before, not only crowds out private investment by doing the work that might be left up to the private sector, government might also stifle private investment through rules and regulations that might hamper attempts to create new goods and services. 

This difference in political structure between the United States and Western Europe might explain why W. Europe has been lagging the United States in GDP growth. Whereas the Eurozone was a peer with the United States before the Great Recession of 2008, it has lagged in GDP growth since. This chart from the economist Robin Brooks shows the lag in GDP growth in the Eurozone and Japan since 2008.

If you assume that Western Europe has sufficient capital, good infrastructure, and an educated population, then it has the factors that contribute most to GDP growth. What explains the difference in GDP growth since 2008? Much of this difference has to do with government spending, which has been adopted by Europe and Japan and crowds out private investment. Much of the government spending is devoted to the consumption needs of its citizens and is a path that has been democratically chosen. It is what Europeans want. But this choice is not without its tradeoff in slower growth.

I would also argue that part of the growth difference between the United States and Western Europe is explained by governance, so that even if there were the same amount of private investment, it is in part constrained by rules and regulations that are burdensome to private enterprise. Western Europe, though composed of many states, has some of the most restrictive environmental, worker and consumer protection regulations in the world. America, on the other hand, has a federal system of government, which includes a centralized system of federal laws that applies to all its citizens, but the existence of state laws in the United States allows for rules which fit more closely to the needs of the local populations. 

The benefit of this decentralized system of state laws allows a different set of rules to exist. It limits the need for federal laws. And it subsequently allows some places to be less restrictive than others. This in turn allows places for innovation to be tested, to take hold, to become established, and if successful, to become examples for people in other states to follow. 

For example, the self-driving service Waymo isn’t offered in Illinois, Indiana, Kansas, or Tennessee or any state in the Midwest, but it is offered in California and Arizona. And from all accounts Waymo is doing well in these places. In California and Arizona, the population density is sufficient to require a taxi service but not so great that vehicle traffic overwhelms the capabilities of the self-driving vehicle. Also, Arizona and California are less dense which means there is less chance of accidents with other vehicles. But most importantly these two states were chosen because of their year-round arid climate, whereas inclement weather (snow or rain) in other places may interfere with the sensor system of the Waymo vehicle.

This difference in state laws can capture the different circumstances that would allow a business to flourish.  This difference in laws from one state to the next allows new businesses the freedom to find places to operate in which they can be successful.

There are obvious benefits to having a more decentralized legal system, as it used to exist in Western Europe before the establishment of the European Union, because where these small instances of success are allowed to take hold, they can be imitated and adopted and allowed to grow.