- An Army: To protect against foreign invaders.
- A Police Force: To protect against domestic criminals.
- A Court System: To settle honest disputes that arise, and to punish criminals according to objectively predefined laws.
Without the last two functions of government, it is easy to see that there would be little economic activity. Without a police force it would be difficult to protect anything that you've earned. If people could just come by and take anything you owned, we'd see three things happen:
- People would spend a lot more time trying to steal what they need and a lot less time trying to produce what they need, as stealing something is often easier than producing it yourself. This leads to a reduction in economic growth.
- People who have produced valuable goods would spend more time and money trying to protect what they've earned. This is not a productive activity; society would be much better off if citizens would spend more time producing productive goods.
- There would likely be a lot more murders, so the society would lose a lot of productive people prematurely. This cost, and the costs people incur in trying to prevent their own murder greatly diminishes economic activity.
A court system also promotes economic growth. A large portion of economic activity depends on the use of contracts. When you start a new job, normally you have a contract specifying what your rights and responsibilities are and how much you will be compensated for your labor. If there's no way to enforce a contract like that, then there is no way to ensure that you will end up getting compensated for your labor. Without that guarantee, many would decide it is not worth the risk to work for someone else. Most contracts involve an element of "do X now, and get paid Y later" or "get paid Y now, do X later". If these contracts are not enforceable, the party who is obligated to do something in the future might decide then that he doesn't feel like it. Since both parties know this, they would decide not to enter into such an agreement and the economy as a whole would suffer.
Having a working court system, military, and police force provides a large economic benefit to a society. However it is expensive for a government to provide such services, so they'll have to collect money from the citizens of the country to finance such programs. The financing for those systems comes through taxation. So we see that a society with some taxation that provides these services will have a much higher level of economic growth than a society with no taxation but no police force or court system. So an increase in taxes can lead to larger economic growth, if it is used to pay for one of these services. I use the term can because it is not necessarily the case that expanding the police force or hiring more judges will lead to greater economic activity. An area which already has many police officers and little crime will gain almost no benefit from hiring another officer. Society would be better off not hiring her and instead lowering taxes. If your armed forces are already large enough to deter any potential invaders, then any additional military spending drags down economic growth. Spending money on these three areas is not necessarily productive, but having at least a minimal amount of all three will lead to an economy with higher economic growth than none at all.
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