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Why does government exist?

A significant factor which may drive macro economic growth is the dilemma of government spending and growth of spending. It is appropriate for us to make a comment as to the rancor on both sides of thepolitical aisle which is occurring in Washington - and on a worldwide level as well.

It is becoming evident, in our opinion, that our country and many parts of the world are attempting to come to grips with why governments exist. Now, this is not a political statement of sarcasm, rather we believe a valid, grinding process appears to be underway where citizens are in effect asking why governments exist and what the citizens of those countries want from their governments.

The questioning process which is taking place in our society may not end for some time. In our country, this "debate" at times is heated and emotional. The upheaval which has happened this summer in Greece, as riots in the streets along with potential austerity measures are grinding that country into a decision that will dictate the purpose of government.

Our country is going through the same process as politicians and citizens are attempting to answer the same question. Perhaps many people are not aware this is what is being decided, but in our opinion this is the core question which is being answered in our country, "Why does government exist?"

Some believe governments exist to regulate opportunity and growth. It is probably important to note that countries where government spending represents a very large piece of economic activity, growth tends to be lethargic. Recently, Swedish economists Andreas Bergh and Magnus Henrekson (authors of "Government Size and Implications for Economic Growth") wrote the following:

Fifty years ago, Sweden and America spent about the same on their government, a bit under 30.0 percent of GDP. This is no longer true. In the years leading up to Sweden's financial crisis in the early 1990's, government spending went as high as 60.0 percent of GDP. In America it barely budged, increasing only to about 33.0 percent.While America was maintaining its standing as one of the world's wealthiest nations, Sweden's standing fell. In 1970, Sweden was the fourth richest country in the world on a per capita basis. By 1993, it had fallen to 17th.

We surveyed the existing literature looking at the trade-offs between government size and economic growth throughout the world. While results vary, the most recent research, by Diego Romero-Avila in the European Journal of Political Economy (2008) and by Andreas Bergh and Martin Karlsson in Public Choice (2010) find a negative correlation between government size and economic growth in rich countries.

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We also investigated the claim that Sweden is proof that big government does not harm the economy. While Sweden has done very well compared to other developed countries in the last 15 years, it has also implemented sweeping pro-market reforms, including a national system of free school choice based on vouchers up through senior year of high school, a financially stable public pension system that can adjust payouts if contributions to the system fall for some reason, and comprehensive tax reform that has lowered marginal tax rates tremendously.

However, we in the U.S. appear to be moving toward more centralization of our economic system, rather than toward the free market. If the world's experience with this type of shift is any lesson, we should expect economic growth rates to slow, on a systemic basis, as this centralization process continues.

Now, this is not to say this is right or wrong, rather it is a statement that the citizens of our country are apparently currently wrestling with the trade-off of economic growth vs. economic equality. Our hope is that decision makers in the U.S. take the view that we need both economic growth and economic equality.

We envision the best outcome from this debate being the maintenance of our freemarket economic system, and one that is perhaps more "fair." A strong argument can be made that many free-market systems, if left unfettered, can become unfair to all participants. Over the long-term, free market systems are the most effective, if the public and all participants have faith that the systems are fair.

The issue of slower than normal growth may be with us for quite some time going forward. Debt and demographics are leading this parade. This environment does not herald the end of the American Dream - rather we expect the world's financial markets to more closely reflect the revised reality. It is our desire that this piece is taken in its spirit; that we harbor concerns U.S. economic growth going forward will prove to be systemically lower than has been the case for a number of decades. Demographics, debt and the country's desire for more economic "equality" may drive this outcome.
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Bill Greiner

Bill Greiner is the president and chief investment officer of Scout Investments, Inc.,a subsidiary of UMB Financial Corporation that offers investment management services for both managed accounts and mutual funds. UMB Bank, n.a., is an affiliate within the UMB Financial Corporation.

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