The Rahn Curve: What Makes Economies Grow?

Recently,  I read an article by Richard W. Rahn about public hoaxes. Although he wrote mostly about the Trump Russian collusion delusion, the most important part of his essay was at the end. There he noted the Democratic Party seems to be adopting the greatest hoax of all time. That deception is the claim that socialism actually works and “can lead to more equality and better quality of life for all.”

The Rahn Curve

Indeed,  Dr. Richard Rahn has done much to debunk this historically popular delusion with his discovery of the Rahn curve. The Rahn curve is a model that postulates there is an optimal size of government that maximizes GDP growth. Government size here means government spending as a fraction of the GDP. Plotting GDP growth rates vs. government spending as a share of GDP, we find GDP growth initially rises as spending increases until the optimal government spending level is reached. Increased government spending after that then causes economic growth to decline. As a model, the Rahn curve is shown below.

If there were no government spending and therefore no government, we would be living in Thomas Hobbes’ state of nature, with a “war of all against all.” In Hobbes’ famous words, our lives would be “solitary, poor, nasty, brutish and short.”  When government spends less than the optimal amount, increasing the spending for domestic and foreign security, commonly accessed infrastructure, and other necessities improves our ability to cooperate with each other to create wealth.

The postulate that there is an optimal size of government assumes that beyond some point government can not competently and efficiently allocate capital. Can this assertion be verified with empirical data? Most (if not all) governments in this world have a definite dirigiste character. Therefore, if the assumption of an optimal size for government is correct, we would expect almost all governments to be spending more than this optimal amount. They would then be on the declining branch of the Rahn curve. Can we verify this conclusion?

I have written about the Rahn curve twice before, once in the post The Rahn Curve and the Way Out of Economic Peril and once in the post The Rahn Curve, Hauser’s Law, the Laffer Curve and Flat Taxes. In both those essays I showed the graph below for the United States. It shows the U.S. GDP growth rate vs. total U.S. government spending as a percentage of GDP for every quarter from the first quarter of 1947 to the second quarter of 2015.

Although no trend line is shown, any trend line would clearly have a negative slope. At least since 1947, the United States has been on the declining branch of the Rahn curve.

Using GDP growth data from the World Bank and government expenditures of OECD nations as a percent of GDP from the Organization for Economic Cooperation and Development (OECD), I was able to produce the scatter plot below. Each point on the plot represents an OECD country’s annual GDP growth rate as a function of its government’s spending in 2013. The year 2013 was chosen because that is the last year for which the OECD currently displays the data.

Clearly, all of the OECD countries are on the declining branch of the Rahn curve.

What the preceding data demonstrates is that increasing government spending as a share of GDP causes a country’s GDP growth to decline.  This is true for all Western nations, as well as for a number of non-Western OECD nations (Israel, Japan, and South Korea). The Rahn curve has the smell of a culturally independent economic law.

Is there any other data that can support the supposition the Rahn curve is actually an economic law? What the Rahn curve implies is the government generally creates problems when it increases its control of the economy. Conveniently, the Heritage Foundation has given us an index, the Index of Economic Freedom, that measures the degree of government intervention in its economy. It is calculated every year for every nation on Earth for which there is data, The index is zero when a country’s government totally controls the economy. It is 100 when the government has absolutely no control over the economy. If we plot the same OECD countries’ GDP growth rates in 2013 versus their index of economic freedom for that year, we get the following graph.

The trend line for this data shows as governments exhibit less control over their economies (economic freedom increases), the GDP growth rate generally increases. There can be no doubt. Increasing government control of the economy is a prescription for economic stagnation and, if taken far enough, for increasing poverty.

Why the Rahn Curve Is True

All of the above  begs the following question: Why is government incompetent in investing capital beyond a limited number of applications? Why, ultimately, is the Rahn curve a correct vision of Reality?

Socialists and other dirigistes have always assumed the state can allocate capital to meet human needs much better than private companies. This assumption is directly contradicted by the Rahn curve. Why is this true?

There is a very direct theoretical answer to this question. However, even more important is the empirical evidence of historical experience that contradicts the socialist assumptions. This evidence can be found in the following essays.

• Historical Lessons on Economics and Politics
• More Historical Lessons From Europe
• Lessons From The Developing World
• The Human Development Index and Economic Freedom
• The Economic Decay of the West
• The Great Irish Economic Experiment with Capitalism
• Comparing Economies of All Countries on Earth in 2018

The theoretical explanation starts with the realization that human social systems, most especially the economy, are intensely chaotic. What this means can be explained in two different ways. The first is this: If you prepare two systems to be exactly identical, with the exception that their initial conditions are ever so slightly different, and they evolve into drastically different states, then those systems are chaotic. Another way to define a chaotic system is through the evolution of small perturbations. If such a perturbation grows and propagates through the system in unexpected and unpredictable ways, the system is chaotic.

In physics we can find systems that are chaotic for exactly the same reasons as chaotic human social systems. These are fluid N-body systems, where N is an incredibly large number. One of the most familiar examples is the planetary atmosphere, where N is the total number of molecules and particulates of all species making up the atmosphere. Each of the N components of the system has a number of degrees of freedom associated with it. Each degree of freedom is a variable belonging to the system component that can change in interaction with other system components. The three components of position and three components of velocity are among the degrees of freedom of atmospheric molecules. They change with collisions with other molecules.

In a human social system the basic components are (of course!) the human beings within them. In addition, interacting organizations of human beings can be considered components of social systems. These include companies, charitable organizations, and governments at all levels. The degrees of freedom of human beings are virtually innumerable. They include such things as the products people want to purchase and the quantities they desire at various prices. The degrees of freedom include the knowledge individuals have about the rest of the world. They include people’s desires for themselves, their families, and their country. Trying to enumerate the degrees of freedom of human beings and their organizations is an almost impossible task. And remember, each degree of freedom is a variable that can change on interaction with other human beings and other system components.

There is a second characteristic that makes chaotic systems chaotic. In such systems, components interact mostly pairwise with other system components. In the chaotic atmosphere, this means collisions between molecules in the atmosphere. In a social system, such binary interactions include commercial exchanges, conversations between people, reading someone’s book (an interaction between the author and the reader), participation in a social organization, and innumerable other social interactions. Because the system components are so numerous, these interactions are often random to a great degree. This implies perturbations to the system can propagate in unpredictable ways throughout the system. Think of the propagation of rumors! Think of the propagation and reaction to socialist ideas!

These characteristics of chaotic systems are what make the Rahn curve true. Elected officials and government bureaucrats can never anticipate all of the consequences of their decisions and policies. More often than not the results of their policies are harmful to society. The Great Depression of the 1930s was caused by a change in monetary policy by the Federal Reserve. Lyndon Johnson’s War on Poverty caused great damage to many families. The Great Recession of 2008-2009 was caused by a misguided federal housing policy. One could go on indefinitely about all the harm governments have created.

Government does have a constructive role to play in defending the social contract.  However, as politicians try to increase government’s role, they generally do more harm than just deny scarce economic resources to individuals and to the main producers of wealth, the corporations. This observation implies an optimal level of government spending exists. It implies the Rahn curve.

The Progressive Delusion

The progressives  of the Democratic Party operate under the great delusion that governments at all levels can be the main tools for solving social and economic problems. Yet, the chaotic nature of human social systems denies government the competency for solving or even ameliorating most problems.

Over a number of years, the Democratic Party has lurched ever farther toward the Left. Bernie Sanders, Elizabeth Warren. Kamala Harris, Tulsi Gabbard, Cory Booker, Kirsten Gillibrand, Julian Castro, Andrew Yang, and Alexandria Ocasio-Cortez are just some of the more prominent Democratic politicians espousing socialist policies. Some, such as Elisabeth Warren, resist being labeled socialist. However, when their proposed policies are examined, they begin to look decidedly pink, if not outright red. For example, Warren’s proposals for a wealth tax, medicare-for-all, free tuition for college students, and the Green New Deal look like a giant stride toward socialism. Clearly, these Democratic politicians do not understand the implications of the Rahn curve.

At the very end of his Washington Times essay, Richard Rahn writes the following:

The biggest hoax of all time is that socialism and communism work and can lead to more equality and better quality of life for all. In fact, socialism leads to economic stagnation or worse and increasing levels of coercion. Over the past two centuries, the socialist experiment has been tried in dozens of countries all over the world always with the same dismal results. …

At the moment, there are a number of people running for president in the Democratic Party calling themselves socialists. Would you invite someone to your home who proclaimed him or herself to be a Nazi (which in fact is a form of socialism, i.e. National Socialism or Nazism), or claimed they had an equal right to your stuff and would grab some of your things before leaving your home? Probably not — but once you buy into the notion that the “collective” is more important than the “individual,” there is no limit to what the “collective” (government) can seize in terms of a person’s property or liberties.

Ultimately, socialist regimes also shut down privately-owned and operated media and all journalists have to toe the government line. Perhaps, the folks at CNN and MSNBC would not notice the difference.

We should all take these words extremely seriously.

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