The Rocky Road to Paradise: Why Economic Liberalization is Interrupted
Libertarians believe that reducing the size of government increases total welfare. Some believe that welfare would be maximized by eliminating government entirely. Whether shrinking government would be beneficial, however, depends not only on the level of welfare that could be achieved with no government, but on the path of welfare over time as the size of government is reduced.
Suppose, for example, that eliminating certain functions of government would create temporary disruptions. Even though higher overall welfare might eventually be achieved, this gain must be weighed against the cost of likely disruptions. Privatization of inefficient state-owned industries, for example, is likely to result in short-term unemployment, offsetting to some extent the long-term efficiency gains.
Another possibility is a situation in which inefficiencies of government offset each other. Eliminating one inefficiency before the other might create temporary welfare losses. An example would be a government-created monopoly of a polluting industry. Government failure to create private markets in water quality or to regulate pollution leads to production beyond the social optimum, since the firm does not bear the cost of pollution. As a monopolist, however, the firm produces below the social optimum. The combination of these two inefficient government policies could lead to production close to the social optimum. If, however, as government is being eliminated, the monopoly is removed before markets for water quality are established, production and pollution will temporarily exceed optimal levels.
Whether it is optimal to proceed with a program of government shrinkage depends on the nature of the path of overall welfare and on rates of time discount. In this article, I outline a simple model of the relationship between welfare and the size of government and simulate the model using a specific functional form for this relationship.
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