Public expenditure

(For definitions of the terms shown in italics in this article, see the glossary on the Related Articles subpage).

Definitions

Public expenditure may be understood as spending by central (federal), state and local governments and by the public corporations, or simply as spending by the public sector.

(For statistical purposes, however, those terms are open to differing interpretations, and to promote comparability in the construction of national accounts, the OECD has published the following definitions

• The public sector comprises the general government sector plus all public corporations including the central bank.
• The government sector consists of the following resident institutional units: all units of central, state or local government; all social security funds at each level of government; all non-market non-profit institutions that are controlled and financed by government units.
• The general government sector consists of the totality of institutional units which, in addition to fulfilling their political responsibilities and their role of economic regulation, produce principally non-market services (possibly goods) for individual or collective consumption and redistribute income and wealth.)

Composition

Government expenditure typically accounts for between 35 and 50 per cent of GDP. It is mainly made up of;

- transfer payments, typically accounting for about half of the total and including, pensions, unemployment and disability compensation and subsidies to farmers;

- government consumption, including expenditure on law and order, environmental management, defence and public medical services;

- government investment, including payments for road and hospital construction.

The effects of public spending

(For definitions of the terms shown in italics in this article, see the glossary on the Related Articles subpage).

Definitions

Public expenditure may be understood as spending by central (federal), state and local governments and by the public corporations, or simply as spending by the public sector.

(For statistical purposes, however, those terms are open to differing interpretations, and to promote comparability in the construction of national accounts, the OECD has published the following definitions

• The public sector comprises the general government sector plus all public corporations including the central bank.
• The government sector consists of the following resident institutional units: all units of central, state or local government; all social security funds at each level of government; all non-market non-profit institutions that are controlled and financed by government units.
• The general government sector consists of the totality of institutional units which, in addition to fulfilling their political responsibilities and their role of economic regulation, produce principally non-market services (possibly goods) for individual or collective consumption and redistribute income and wealth.)

Composition

Government expenditure typically accounts for between 35 and 50 per cent of GDP. It is mainly made up of;

- transfer payments, typically accounting for about half of the total and including, pensions, unemployment and disability compensation and subsidies to farmers;

- government consumption, including expenditure on law and order, environmental management, defence and public medical services;

- government investment, including payments for road and hospital construction.

The effects of public spending

Social effects

Social justice

It is generally accepted that public expenditure can have a major influence upon social justice, but there is no consensus concerning the operational meaning of that term. The utilitarian criterion of welfare maximisation proposed by Jeremy Bentham is implicit in the widespread application of cost/benefit criteria to investment and consumption expenditure, but it is held not to be applicable to transfer payments because it has implications for income distribution that could have damaging effects upon motivation. The philosopher John Rawls claims to meet that objection by requiring only that there should be no more inequality than would be required for the benefit of the least well off , but the political philosopher Will Kymlicka argues that that, too, could have averse motivational consequences. The legal philosopher Ronald Dworkin proposes the adoption of an "equality of resources" criterion, and the eminent economist Amartya Sen proposed instead the criterion of "equality of capability", but the libertarian philosopher Robert Nozick rejects the entire concept of redistribution on the grounds that it would infringe every person's inalienable right to benefit from the employment of the talents with which he is endowed.

International differences in income distribution are revealed by comparisons of Gini indexes, which indicate a tendency toward less inequality in Europe than elsewhere (see the tutorials subpage). However, it is the general practice in all the developed countries to provide protection against extreme poverty by means of income-support payments or food supplements. The levels of those "safety-net" provisions are generally sufficient to eliminate life-threatening poverty, but provision above that level is influenced by perceptions of the danger of dependency (sometimes known as the Samaritan's dilemma).

Freedom of choice

Public expenditure can be thought of as the expression of the transfer of freedom of choice from individuals to government. The concept of a political system under which the people delegate powers to the state on condition that it uses those powers in their interest was put forward in the 17th century by John Locke , and the actions to be undertaken in the exercise of those delegated powers were described by Adam Smith in the 18th century as "erecting or maintaining those public institutions and those public works, which, although they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could not repay the expense to any individual or small number of individuals, and which it therefore cannot be expected that any individual or small number of individuals should erect or maintain.". The concept was further developed in the 19th century by John Stuart Mill, who termed it "Representative Government" .

It can be argued that a person's freedom of choice is not reduced when the state makes a choice that he would otherwise have made, and Kenneth Arrow has argued that state-provided insurance has the effect of increasing individual freedom of choice when market-provided insurance is not available, or when the market's provision differs from the competitive norm . Arrow identifies departures from the competitive norm in the provision of medical insurance, and Akerlov has argued that such departures can occur whenever there is asymmetric information

Economic effects

Public expenditure may be expected to affect a country's accounting aggregates such as its gross national product and its rate of economic growth. Investment in the infrastructure may be expected to affect transport costs, and the maintenance of publicly-owned assets may be expected to affect their future running costs. Spending on health and education may be expected to affect future output as a result of its effect upon human capital, and there is some evidence to suggest that reductions in income inequality resulting from social expenditure can increase social capital, although it has also been suggested that it can have output-reducing consequences arising from its effects upon motivation.

Public expenditure also has effects that are not reflected in conventional measures of output. Social expenditure and spending on health and education, in particular, generate welfare increases over and above those resulting from their effects on economic activity. Benefits from reduced anxiety, better health or more enjoyable leisure are among the increases in economic welfare that are not recorded in national accounts.

There is a strong presumption that economic welfare is reduced if the government undertakes the allocation of resources that would otherwise be allocated by the unimpeded operation of market forces. The theorems of welfare economics demonstrate that market forces operating under conditions of perfect competition and flexible prices guarantee the optimum allocation of a country's resources. A centrally-determined allocation of resources cannot offer such a guarantee because those responsible lack access to the information about the preferences of consumers that is automatically provided to a competitive market by their purchasing behaviour. But if market forces are impeded by monopolistic possessors of market power or by the presence of externalities, that information is distorted, economic welfare is diminished, and there is a possibility that public expenditure could be used to correct the deficiency.

The alternative of the market allocation of resources is not available for the supply of public goods such as defence and law and order, and public expenditure on their provision can have a decisive effect upon a country's economic welfare. The evaluation of such expenditure is hampered both by difficulties of access to information about the welfare gains and losses of those affected and by conceptual obstacles to the aggregation of their welfare gains and losses. Those conceptual obstacle arise from the fact that it is not possible to know what goes on in someone else's mind. But, although a full understanding is clearly impossible, some insight is often provided by introspection, and there are cases where an approximate comparison is all that is needed. There can be little doubt for example that a road improvement that saves a hundred lives yields benefits that outweigh the costs suffered by a few families who have to move to new homes.

Political influences

Political philosophy

An analytical approach to public spending decisions is provided by the modern form of social choice theory as pioneered by Kenneth Arrow, which makes extensive use of mathematics and formal logic. Its theoretical formulations are highly abstract, but the theory has practical implications that were explored in his Nobel Prize lecture on the subject by Amartya Sen. He argued that that decisions need not depend entirely upon comparisons of mental states, suggested that account should be taken of external factors that would be expected to affect well-being, such as inequality and poverty, and drew attention to empirical work on those topics.

The proponents of public choice theory reject the possibility that those responsible for the management of public expenditure can be expected to act in the interests of those affected by their decisions. They argue that the the assumption of utility-maximising behaviour that is a fundamental axiom of economic theory, leads to the conclusion that government decision-makers must be expected to seek to maximise their own welfare rather than the welfare of their countrymen. The Nobel Prize lecture by its co-founder, James M Buchanan, presents an accessible summary of its rationale .

The "democratic dilemma", as formulated by Arthur Lupia and Mathew McCubbins, contains elements of both theories. The dilemma arises when the majority of the electorate favour a proposal that would be against their interests because it is based upon a mistaken expectation of its consequences.

Political ideologies

The spectrum of ideological attitudes to public expenditure ranges from socialism which is the advocacy of public control of all forms of socially-important expenditure to libertarianism which is opposed to any public expenditure that is not neccessary for the maintenance of law and order or national defence. Among ideologies the lie within that spectrum is communitarianism, which gives social interactions less weight to than socialism but less weight than libertarianism . The ruling ideologies of the main political parties of the major industrialised countries , such as the "Republican", "Conservative", "Liberal", "Social Democratic", "Labour" and "Democratic" parties tend to lie within that spectrum and either side of its communitarian middle.

Notes and references

Economic effects

Public expenditure may be expected to affect a country's accounting aggregates such as its gross national product and its rate of economic growth. Investment in the infrastructure may be expected to affect transport costs, and the maintenance of publicly-owned assets may be expected to affect their future running costs. Spending on health and education may be expected to affect future output as a result of its effect upon human capital, and there is some evidence to suggest that reductions in income inequality resulting from social expenditure can increase social capital, although it has also been suggested that it can have output-reducing consequences arising from its effects upon motivation.

Public expenditure also has effects that are not reflected in conventional measures of output. Social expenditure and spending on health and education, in particular, generate welfare increases over and above those resulting from their effects on economic activity. Benefits from reduced anxiety, better health or more enjoyable leisure are among the increases in economic welfare that are not recorded in national accounts.

There is a strong presumption that economic welfare is reduced if the government undertakes the allocation of resources that would otherwise be allocated by the unimpeded operation of market forces. The theorems of welfare economics demonstrate that market forces operating under conditions of perfect competition and flexible prices guarantee the optimum allocation of a country's resources. A centrally-determined allocation of resources cannot offer such a guarantee because those responsible lack access to the information about the preferences of consumers that is automatically provided to a competitive market by their purchasing behaviour. But if market forces are impeded by monopolistic possessors of market power or by the presence of externalities, that information is distorted, economic welfare is diminished, and there is a possibility that public expenditure could be used to correct the deficiency.

The alternative of the market allocation of resources is not available for the supply of public goods such as defence and law and order, and public expenditure on their provision can have a decisive effect upon a country's economic welfare. The evaluation of such expenditure is hampered both by difficulties of access to information about the welfare gains and losses of those affected and by conceptual obstacles to the aggregation of their welfare gains and losses. Those conceptual obstacle arise from the fact that it is not possible to know what goes on in someone else's mind. But, although a full understanding is clearly impossible, some insight is often provided by introspection, and there are cases where an approximate comparison is all that is needed. There can be little doubt for example that a road improvement that saves a hundred lives yields benefits that outweigh the costs suffered by a few families who have to move to new homes.

Political influences

Political philosophy

An analytical approach to public spending decisions is provided by the modern form of social choice theory as pioneered by Kenneth Arrow, which makes extensive use of mathematics and formal logic. Its theoretical formulations are highly abstract, but the theory has practical implications that were explored in his Nobel Prize lecture on the subject by Amartya Sen. He argued that that decisions need not depend entirely upon comparisons of mental states, suggested that account should be taken of external factors that would be expected to affect well-being, such as inequality and poverty, and drew attention to empirical work on those topics.

The proponents of public choice theory reject the possibility that those responsible for the management of public expenditure can be expected to act in the interests of those affected by their decisions. They argue that the the assumption of utility-maximising behaviour that is a fundamental axiom of economic theory, leads to the conclusion that government decision-makers must be expected to seek to maximise their own welfare rather than the welfare of their countrymen. The Nobel Prize lecture by its co-founder, James M Buchanan, presents an accessible summary of its rationale .

The "democratic dilemma", as formulated by Arthur Lupia and Mathew McCubbins, contains elements of both theories. The dilemma arises when the majority of the electorate favour a proposal that would be against their interests because it is based upon a mistaken expectation of its consequences.

Political ideologies

The spectrum of ideological attitudes to public expenditure ranges from socialism which is the advocacy of public control of all forms of socially-important expenditure to libertarianism which is opposed to any public expenditure that is not neccessary for the maintenance of law and order or national defence. Among ideologies the lie within that spectrum is communitarianism, which gives social interactions less weight to than socialism but less weight than libertarianism . The ruling ideologies of the main political parties of the major industrialised countries , such as the "Republican", "Conservative", "Liberal", "Social Democratic", "Labour" and "Democratic" parties tend to lie within that spectrum and either side of its communitarian middle.