Growth Maximizing Government Size and Social Capital

Our paper intersects two topics in growth theory: the growth maximizing government size and the role of social capital in development. We modify a simple OLG framework by introducing two key features: endogenous growth and a role for public officials in monitoring the public expenditures for intermediate goods and services supplied to private firms. Public officials have the opportunity to steal a fraction of public resources under their own control, subject to a probability of being caught and pay a fine. Hence, not all tax revenues raised by the Government reach private firms, as a fraction of them is being diverted by public officials, thus hampering growth. Under certain conditions on parameters, our main result establishes that, if the probability of detection or the fine charged on public officials who are caught stealing, or both, increase, then an increase of the tax rate is required in order to maintain an optimal growth rate, provided that also the number of public officials is increased as well. As both the probability of detection and the fine positively depend on the Social Capital level, we conclude that maximum growth rates are compatible with Big Government size, measured both in terms of expenditures and public officials, only when associated with high levels of Social Capital.