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Public expenditure

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The delegation to the government of the power to control selected components of a country's resources by the exercise of public expenditure may be expected to affect the distribution of income among its people people, their freedom of choice, and the country's level of prosperity. Views differ concerning the proper extent of such delegation and concerning the way in which the delegated power should be exercised.

Contents

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[1]

  • 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.)
(For definitions of other terms see the public expenditure glossary).

Composition

Government expenditure in the OECD countries typically accounts for between 35 and 50 per cent of GDP, most of which is spent on health, education and social security (see table). It falls into three economically distinct categories:

- 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 [2] 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 [3], but the political philosopher Will Kymlicka argues that, too, could have averse motivational consequences[4]. The legal philosopher Ronald Dworkin proposes the adoption of an "equality of resources" criterion[5], and the eminent economist Amartya Sen proposed instead the criterion of "equality of capability"[6], 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[7].

International differences in income distribution are revealed by comparisons of national Gini indexes, which indicate a tendency toward less inequality in Europe than elsewhere. 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[8] (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 [9], 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."[10]. The concept was further developed in the 19th century by John Stuart Mill, who termed it "Representative Government" [11].

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 [12]. 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 [13]

Economic effects

Public expenditure may be expected to affect a country's accounting aggregates such as its gross domestic 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[14], 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 market. That presumption arises from the evident inability of governments to acquire even a small fraction of the immense quantity of detailed information - about resources, production possibilities, consumer preferences and their interactions - that is routinely processed by everyday transactions in even the simplest of economies. However, the alternative of a 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 also hampered, by difficulties of access to information about the welfare gains and losses of those affected: and also by the conceptual obstacle to their aggregation created by the impossibility of knowing what goes on in someone else's mind. (Some insight is often provided by introspection, however, 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[15], which makes extensive use of mathematics and formal logic. Its theoretical formulations are highly abstract, but the theory has practical implications that were explored by Amartya Sen in his Nobel Prize lecture on the subject. He argued 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[16].

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 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 [17].

The "democratic dilemma", as formulated by Arthur Lupia and Mathew McCubbins[18], 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 necessary 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 than socialism but more 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

  1. Glossary of Statistical Terms, OECD, 2009
  2. Jeremy Bentham: An Introduction to the Principles of Morals and Legislation, Oxford University Press, 1970
  3. John Rawls: A Theory of Justice, Harvard University Press, 1971
  4. Will Kymlicka: Contemporary Political Philosophy, Clarendon Press, 1989
  5. Ronald Dworkin: Sovereign Virtue, Harvard University Press, 2002
  6. Amartya Sen: The Idea of Justice, Alan Lane, 2009
  7. Robert Nozick: Anarchy, State and Utopia, Basic Books, 1974
  8. Marion Smiley: "Dependence, Autonomy, and the Welfare State", Chapter Two (excerpted) of Welfare Dependence': The Power of a Concept, Thesis Eleven.2001; 64: 21-38[1]
  9. John Locke On Civil Government
  10. Adam Smith: An Inquiry into the Nature And Causes of the Wealth of Nations, Book 5, Chapter 1, Part 3, (first published 1776)
  11. John Stuart Mill Representative Government
  12. Kenneth Arrow: Uncertainty and the Welfare Economics of Medical Care. American Economic Review, December 1963
  13. Akerlof G. (1970), "The Market for Lemons: Quality Uncertainty and the Market Mechanism", Quarterly Journal of Economics 84, 488-500. [2] (Google abstract)
  14. Kawachi, Kennedy, Lochner and Prothrow-Stith. Social Capital, Income Inequality, and Mortality, American Journal of Public Health. 1997 Sep;87(9):1491-8.[3](abstract)
  15. Kenneth Arrow: A Difficulty in the Concept of Social Choice, Journal of Political Economy, August 1950
  16. Amartya Sen: The Possibility of Social Choice", Nobel Prize lecture 1998
  17. James M Buchanan: The Constitution of Economic Policy, Nobel Prize lecture December 1986
  18. Arthur Lupia and Mathew McCubbins: The Democratic Dilemma, Cambridge University Press, 1998 (Google Books extract [4])
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