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Why the Spanish may be better off without a government

The state’s most important economic role is to get out of the way

30 April 2016

9:00 AM

30 April 2016

9:00 AM

On 26 October last year, the Spanish government shut up shop in preparation for a general election. This duly took place in December but then a strange thing happened: after all the build-up, the arguments, the posters and the television coverage, the result was… nothing. The various parties were so balanced, so mutually distrustful and ill-assorted that no government could be formed. Since last October, therefore, there has been no government in Spain.

One can imagine that the average political correspondent would think this a terrible problem, maybe even a crisis. The Financial Times has referred to Spain ‘enduring’ months of ‘political uncertainty’. This is assumed to be a matter requiring furrowed brows and grave tones. But the economy seems to be taking a different view of the matter. It is bowling along more breezily than in a long time. The growth rate during the final quarter of last year was an annualised 2.9 per cent, which, in these days of dismal Euro-growth, is a star performance — easily beating the pants off Italy, France and even Germany.

The improvement has continued this year. Unemployment has fallen month after month and is now down to 20.4 per cent which, though awful, is an improvement on a year ago when it was 23.2 per cent. That is a much better showing than in most EU countries. In France, for example, which has the supposed advantage of an active government dedicated to fighting austerity, the unemployment rate has fallen by a mere 0.1 of a percentage point. One could begin to wonder whether having a government is such a good thing after all. In fact, if one looks around, a lot of the evidence seems to point in the opposite direction.

Switzerland probably has the weakest central government in all Europe. It is so puny that it does not even have a minister of education. Yet Switzerland is the most successful of all the European economies if one leaves out small tax havens and oil-rich Norway. Its GDP per capita is £52,000 compared with Britain’s modest £28,000.


Then let’s think what has been the most celebrated period of economic growth in Europe since the second world war? Was it the triumphant product of some bold Keynesian borrowing and spending enacted by a dynamic government? Not at all. It took place in Germany when it was a bombed-out wreck. On 7 July 1948, Ludwig Erhard, the Director of Economics, going well beyond his official authority, grabbed the power to abolish hundreds of price and production controls. He removed with a sudden yank a great blanket of government that covered the economy. He just let the market get on with it. The bureaucrats in the occupying forces were appalled. What would happen to poor Germany in the absence of their guiding hands?

What happened was spectacular economic growth. There had been terrible shortages of everything from bricks to stockings. These were replaced with jumps in production. Production of stockings, as it happens, soared from 23 million pairs in 1949 to 152 million in 1956. Industrial output overall rose 140 per cent over the same period. Some may say, ‘Oh yes. But Britain had a recovery too.’ Yes, it did. But Britain’s industrial production grew by less than a quarter of the amount in Germany. This was because Britain had a government that planned, rationed and managed whole industries.

There are plentiful ways in which governments damage economic growth. When governments decide on prices, they make them too high or too low. So either you get a wasteful surplus or else shortages and rationing. Prices set by a free and competitive market are much better at matching supply and demand. Then there is government investment. Being politically influenced, it tends to have a much lower rate of return than private investment. In other words, the resources of a country are not deployed to best effect. Since governments incorrectly believe that they spend well, they spend a lot. So they raise taxes or debt (which is nothing but delayed taxes). Taxes reduce the incentives to work and be enterprising.

As if all this were not bad enough, governments regulate and then regulate some more. If governments were boyfriends, you would call them control freaks. The controls and regulations are always ostensibly for the good of the people. But the unintended damage is extraordinary and vastly underrated. The cost of filling in the paperwork and making sure the regulations are abided by is so great that often only big companies can afford them and smaller, challenger enterprises cannot compete. The World Bank, in a dry academic study of why growth rates vary in different countries and what should be done, found that there would be ‘sizeable benefits from reforming the regulatory environment and in reducing the role of the state in business activities’.

In fact, nearly all academic studies find that government regulations reduce prosperity. John Dawson and John Seater, two American economists, estimate that extra regulation since 1949 has reduced US growth by 2 per cent a year. They make the mind-boggling assertion that if no new regulations had been imposed since that date, the USA would now be three times more prosperous than it is.

Which brings us back to Spain. One key reason why Spain has been doing better is that the previous administration, before it lost office, removed a couple of ways in which the government interfered. Formerly, companies often had to accept wage agreements made at a regional or sectoral level. The government removed this requirement: companies can make wage deals suitable for their own circumstances. Secondly government interference in redundancy payments was reduced. The payoffs required by law were brought down from 42 months’ pay for the longest-serving employees to 24 months when layoffs are ‘unjustified’ or 12 months if they are ‘for economic reasons’. These changes and other lesser ones have made it more attractive for companies to hire permanent staff again. The chances of getting a permanent job have consequently jumped by over 50 per cent — albeit from a very low base — according to economist Juan Ramón Rallo.

We probably do need governments for some things. But not anything like as many as we think we do. Across the world, they frequently reduce growth that would otherwise take place. In fact they are at their most useful when they devote their efforts to removing their rules and controls — just getting out of the way. Governments do not generate wealth. Businesses and individuals do.

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