4.5.1 Public expenditure Flashcards
What are examples of current spending?
What are examples of capital spending?
What is the significance of govt spending?
- Is a key component of aggregate demand
- Can have a regional economic impact e.g. from spending on regional infrastructure projects
- Important in providing public & merit goods
- Can help to achieve greater equity in society
How can government spending can affect household incomes?
- Welfare state transfers
o Universal child benefits / unemployment benefit
o Public (state) pensions
o Targeted welfare payments - linked to income - State-provided services (which offer “in-kind benefits” to people)
o Education – helps to reduce inequality of market incomes
o Health care – state provided health services
o Social housing e.g. Provided by local authorities
o Employment training
Explain the justifications of government spending
- To provide a socially efficient level of public goods and merit goods and overcome market failures
a. Public goods and merit goods tend to be under-provided by the private sector
b. Improved and affordable access to education, health, housing and other public services can help
to improve human capital, raise productivity and generate gains for society as a whole - To provide a safety-net system of welfare benefits to supplement the incomes of the poorest in society –
this is also part of the process of redistributing income and wealth. Government spending has an
important role to play in controlling / reducing the level of relative poverty - To provide necessary infrastructure via capital spending on transport, education and health facilities – an
important component of a country’s long run aggregate supply - Government spending can be used to manage the level and growth of AD to meet macroeconomic
policy objectives such as low inflation and higher levels of employment - Government spending can be justified as a way of promoting equity.
- Well-targeted and high value for money public spending is also a catalyst for improving economic
efficiency and competitiveness e.g. from infrastructure projects
Why are free market economists sceptical of the impact of government spending in improving the supply-side?
- They argue that lower taxation and tight control of government spending and borrowing is required to allow the private sector of the economy to flourish (this is associated with the crowding-out theory)
- They believe in a smaller sized state sector so that in the long run, the overall burden of taxation can come
down and thus allow the private sector of the economy to grow and flourish.
What is the crowding out theory?
The crowding out view is that a rapid growth of government spending leads to a transfer of scarce productive
resources from the private sector to the public sector where productivity might be lower. It can also lead to higher
taxes and interest rates which then squeezes profits, investment and employment in the private sector.
Increased government borrowing may lead to higher demand for loanable funds and therefore a rise in market interest
rates e.g. on bonds. This might then increase borrowing costs for private sector businesses.
What is an evaluation of the crowding out theory?
- The probability of 100% crowding-out is remote, especially if an economy is operating below its capacity and if there is a plentiful supply of saving available to purchase newly issued state debt
- Keynesian economists are opposed to fiscal austerity and argue instead that fiscal deficits crowd-in private
sector demand and investment. - Well-targeted, timely and temporary increases in government spending can absorb under-utilized capacity and provide a strong positive multiplier effect that eventually generates extra tax revenue.
- Another criticism of the basic crowding-out theory is that the available supply of loanable funds is not limited
to domestic sources, external finance is available from other countries
What is crowding in?
When an increase in government spending/investment leads to an expansion of economic activity (real GDP) which in turn incentivizes private sector firms to raise their own levels of capital investment and employment. Crowding-in is a view supported by Keynesian economists
What are the micro impacts of cuts in G (fiscal austerity)?
- Output, jobs and profits in construction, transport & defence sectors
- Effects on real income and relative poverty of households
- Effective demand for goods and services e.g. welfare caps might change the pattern of demand for goods
and services - Cuts in pension spending might lead some people to delay their retirement
What are the macro impacts of cuts in G (fiscal austerity)?
- Multiplier effects of cuts in public sector spending and employment
- Lower fiscal deficit might help investor confidence / attract investment
- Risks of deflationary pressures if cutting spending creates excess capacity (negative output gap)
- Bank of England more likely to keep interest rates at very low levels
