The political stars seem to be aligning for a liberal resurgence.

Americans are as uncertain about the economy as they have been in a generation; the political success of the Democrat Party over the past two election cycles have bolstered the confidence of liberals that their message is a winning one; and the massive intervention in the economy on the part of the Bush Administration has opened the door for even greater interventions and bailouts in the coming months. Every day it seems a new industry is asking for a government bailout.

Does all this signal that the era of small government is over?

First of all, let’s get something straight: whatever strides conservatives made over the past few decades, by no means was this an era of small government. In almost every aspect of the American economy government’s power has been omnipresent, and in many ways it has grown over the years.

Despite their efforts, conservatives never succeeded in actually scaling back the size of government. Government’s share of the American economy (federal, state and local) amounts to 36% of the economy. Not since the early 60’s has government’s share of the economy been less than 30%, while during the New Deal government spending was closer to 20% of the economy. In recent decades there has been no era of small government.

Yet conservatives have made great strides in limiting the scope of government interference in the economy, and those gains are very much in danger if the left is allowed to implement its agenda. Reagan streamlined the tax code, and for the most part Republicans and even moderate Democrats pushed policies aimed more at generating economic investment and growth than directing specific economic outcomes.

Government’s effect on economic opportunity and prosperity goes far beyond the simple effect of setting the size and priority of government budget. Rules, regulations, the rates and structure of the tax code can all have a dramatic impact on the shape of the economy and its prospects for economic growth. The worst effect of government can come from trying to micromanage the outcomes of the economy in ways large and small.

Unlike Europe and Japan, until now America has avoided the mistake of putting in place an industrial policy that would threaten the basic dynamism of the economy. Big government has been a drag on the productivity and growth, but at least the private part of the economy has been largely free.

The real danger of a resurgent left is not that it will continue or expand the growth in government spending—as troubling as that may be—but that liberals will try to use their newfound power to reshape the American economy into some utopian image and in the process destroy the foundation for future economic prosperity.

Liberals’ comfort with the use of government power to reshape the economic landscape—and with it the opportunities each of us has in shaping our own economic destiny—is the greatest danger we face in the coming years. President-elect Obama is already pushing an agenda that is rife with tax credits, new regulations, and selective government investments that amount to a de facto industrial policy along the lines of those that have failed so miserably in other countries where they have been tried. Picking winners and losers has led to economic stagnation in European countries and Japan, whose economies generation only about ¾ the wealth of our own.

In the coming months and years conservatives will be charged will need to fight the battle for free markets on two fronts: limiting the size and scope of government taxes and spending on the one hand, while simultaneously working to limit overt government direction of the economy. If we lose that battle the next decade will be characterized not only by large and growing government, but less economic freedom, dynamism, and growth in the economy.

David Strom is a Senior Policy Fellow with the Minnesota Free Market Institute