Public expenditure

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.)

Categorisation

The principal categories of public expenditure are:

• government investment,
• government consumption,
• transfer payments

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 economic growth because they do not involve increases in measurable 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. No measures are available of the extent to which people benefit from reduced anxiety, better health or more enjoyable leisure - all of which are increases in economic welfare.

The major component of the cost of public expenditure is the foregone benefit that could have been obtained from other uses of the resources involved, but there can also be costs arising from the "crowding-out" of private-sector investment. It has been argued that when government bonds are used to finance consumption rather than investment, the total of the country's investment is diminished, leading in time to a loss of potential output. Crowding-out is seldom complete, however, but depends upon a range of factors including elasticities of demand for investment and for money . During a recession, however, crowding-out may to some extent be offset by "crowding-in" as government spending makes up for the deficiency in private sector spending, leading to a recovery of demand and an increase in private-sector investment. The balance between crowding out under particular circumstances is a matter of controversy .