4.5 - Public expenditure

Question 1

Why does the government spend money?

Answer 1

• The government spends money for a number of reasons.
• It is used for macroeconomic
  management to control AD and achieve macroeconomic objectives: economic growth, low
  and stable inflation, balanced current account and low unemployment.
• Moreover, they aim
  for equity and equality by providing services to individuals or groups who would otherwise
  not receive them.
• Additionally, government spending can correct market failure by providing
  public goods and fixing externalities.

Question 2

Capital Expenditure

Answer 2

• Capital expenditure refers to government spending on long-term investments and assets that are expected to provide benefits over multiple years.
• Examples include infrastructure projects (e.g., roads, bridges), public buildings, and investments in education or healthcare facilities.
• Capital expenditure contributes to economic growth and productivity by enhancing a country’s physical and human capital.

Question 3

Examples of capital expenditure

Answer 3

• Infrastructure projects (e.g., roads, bridges), public buildings,
• Investments in education or healthcare facilities.

Question 4

Current Expenditure

Answer 4

• Current expenditure consists of day-to-day government spending on recurring items,
  > such as salaries, maintenance, and operational costs.
• This category includes expenses related to running government agencies, providing public services, and covering welfare programs like unemployment benefits.
• Current expenditure maintains the existing level of public services but does not typically contribute directly to long-term economic growth.

Question 5

Transfer Payments

Answer 5

• Transfer payments are government payments made to individuals or groups without any expectation of goods or services in return/no corresponding output payment
• Examples include social welfare payments (e.g., unemployment benefits, pensions), subsidies to specific industries, and grants to local governments.
• Transfer payments are redistributive in nature, aimed at providing support to individuals or entities in need.

Question 6

Reasons for the Changing Size and Composition of Public Expenditure in a Global Context:

Answer 6

• Public expenditure varies across countries and over time due to factors such as economic conditions, government priorities, demographics, and political ideologies.
• In response to economic crises or changing economic conditions, governments may increase spending to stimulate growth or reduce spending to control deficits.
• Changing demographics, such as an aging population, can lead to increased spending on healthcare and pensions.
• Political ideologies can influence the composition of public expenditure, with some governments favouring social welfare programs and others emphasising defence or infrastructure.

Question 7

Significance of Differing Levels of Public Expenditure as a Proportion of GDP on:

Answer 7

o productivity and growth
o living standards
o crowding out
o level of taxation
o equality

Question 8

Significance of Differing Levels of Public Expenditure as a Proportion of GDP on:
> productivity and growth

Answer 8

• Higher levels of public expenditure on investments (capital spending) like education, healthcare, and infrastructure can enhance human capital and physical capital, thereby contributing to productivity and long-term economic growth.
• Through spending, the government can create a multiplier effect and this can be focused on areas of the country with high unemployment, creating growth.

Question 9

Significance of Differing Levels of Public Expenditure as a Proportion of GDP on:
> Living standards

Answer 9

• Public expenditure on welfare programs, healthcare, and education can improve living standards by providing essential services and social safety nets.
• The government corrects market failure and provides public goods , which improves
  social welfare.
• Some governments reduce absolute poverty by providing benefits (eg: job seekers allowance)
  and basic goods, such as education and healthcare.

Question 10

The significance of differing levels of public expenditure
as a proportion of GDP on:
> Crowding out

Answer 10

• Excessive government spending can lead to crowding out, where increased government borrowing raises interest rates, potentially reducing private sector investment and economic growth.

Question 11

Explain crowding out

Answer 11

• In order to spend money above their tax revenues, the government has to borrow from individuals and businesses (bonds).
• However, the amount of money in the economy available to borrow does not increase.
• The government will therefore be competing
  with the private sector for finance and will cause higher interest rates . (as demand for loans has increased)
• This will
  discourage firms from investing and individuals from buying on credit.
• On top of this, the limited number of resources in the economy means that for
  every resource used in government spending, there are less resources available for the private sector.
• The result is that government borrowing crowds out private sector
  borrowing and spending and may lead to no real increase in AD.

Question 12

Free market economists perspective on investment

Answer 12

• Free market economists argue that investment would be more efficient if done by
  the private sector and that the government targets investment poorly and is
  wasteful.
• In a recession, private sector firms are not borrowing that much because their expectations are low.
• So the crowding out is either weak or does not happen at all.
• Evidence from previous two recessions suggests interest rates have not increased significantly when governments have borrowed money

Question 13

Evaluate crowding out

Answer 13

• The crowding out effect is felt most at full employment, but it is not always the case.
• Transfer payments have no impact on output and so would not cause crowding out
  as resources are simply taken from one group and given to another; the government isn’t taking resources from the economy.
• Moreover, when levels of unemployment
  are high then extra government spending could lead to crowding in where it encourages investment through the multiplier.

Question 14

The significance of differing levels of public expenditure
as a proportion of GDP on:
> Level of taxation

Answer 14

• The level of public expenditure is often linked to taxation policies. - Higher public expenditure may require higher taxes, which can impact disposable income and economic incentives.
  > high levels of tax may have a disincentive
  effect leading to lower productivity and lower economic output

Question 15

● In most cases, where government spending is high, levels of tax must be high in
order for spending to be sustainable. High levels of tax may have a disincentive
effect.
> Which countries are an exception to this

Answer 15

Oil-rich countries tend to be an exception, where revenue from oil can pay for most
of government spending.

Question 16

The significance of differing levels of public expenditure
as a proportion of GDP on:
> Equality

Answer 16

• Public expenditure can reduce income inequality by providing social support to disadvantaged groups and funding education and healthcare accessible to all citizens.
  > Eg: transfer payments

Question 17

Why should government spending increase equality?

Answer 17

• Spending should increase equality as it leads to redistribution and helps to provide
  a minimum standard of living for the poorest in society.
• It ensures everyone has
  access to basic goods, such as education and healthcare, which will help to give them a fair start in life.

Question 18

How can you show crowding out on a diagram?

Answer 18

• Initial outward shift in AD due to increase in G.
• Then inward shift in AD due to crowding out effect.