Public Expenditure

Jerry Miner

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351495752
• Edition: 1
• Topic: Economics
• Subtopic: Public Finance
• Index: Economics

In all highly industrialized countries public expenditures are a substantial and growing share of total economic activity. The authors integrate normative and positive theory and empirical analysis of public expenditure, concentrating on the optimal provision of public goods and the estimation of their costs and effects. This volume emphasizes the techniques that are available for reaching collective decisions about the provision of public goods and stresses the importance of income distribution and intergovernmental fiscal relations. In a mixed economy, where the public sector is growing faster than the private sector, the nature of public expenditures must be closely evaluated and studied. This book is designed to focus on and delineate controversies about public expenditure--to define what it is, analyze its function, show how it operates, and finally to evaluate research on this important subject.The book considers the theories of leading economists (Kenneth Arrow, Lionel Robbins, Carl Shoup, James Buchanan, Paul Samuelson, Richard Musgrave, and others) in arriving at a clear statement of theory in its application to operational problems. Appropriate attention is paid to current techniques such as program budgeting, cost-benefit analysis, and the analysis of the determinants of public expenditure. The book is unique in its emphasis on the integration and critique of contemporary theories of public expenditure, of distributional concerns, and of the political framework of public expenditure decisions. It provides a necessary resource for professional economists required to deal with public expenditure problems in research or practice.

1
The Nature of the Public Sector

Perhaps the most general observation that can be made about government activities is that they have grown, both relatively and absolutely, in all countries of the world. This commonplace observation must necessarily serve as the starting point for any systematic treatment of the political economy of public expenditure, for the growth of government lies at the heart of continued controversy over the role of the public sector. This controversy is particularly acute in a mixed economy where the public sector is growing more rapidly than the private and where it often appears that this growth is at the expense of, or contributes to a diminution in, private economic activity. In any economic system, regardless of the relative growth of public and private activities, there will be continuously difficult and controversial choices in selecting the appropriate composition of government expenditure and in choosing among alternative government programs that are intended to accomplish social goals.

It is, therefore, useful at the outset to describe the major factors that have contributed to the growth and changing character of governmental outlay.

The Growth of Government

Wagner’s law, that there is an expanding scale of state activity, is empirically verifiable, but somewhat deficient analytically (Musgrave, 1969, pp. 73–75). The question is, What are the political and economic causes of the growth? Relevant empirical evidence is examined below (see Chapter 9).

There is no doubt that wars among nations have been a major factor contributing to the increase of government activities. National governments expand the scope and range of their activities greatly in the conduct of war. New programs of regulation and direction of the private economy are undertaken. To secure increases in output, governmental outlay is expanded for productive facilities, as well as for transportation and other social overhead capital. Not all of these facilities are dismantled after the war. Peacock and Wiseman argue that a “displacement effect” occurs (Peacock and Wiseman, 1961, pp. 25–31). Public revenue grows during the war, both from higher rates of taxation and from the imposition of new levies. This leaves the public sector in a relatively affluent state at war’s end. With new and unmet social wants, public expenditure will increase in response to the availability of tax revenue. The displacement effect appears to have operated briefly in Great Britain and West Germany after World Wars I and II, but less strongly in the United States (Musgrave, 1969, pp. 91–109).

The growth of government in developed and underdeveloped countries in the years since World War II is also attributable to a high level of international tension and the accompanying importance of the military and its technology. Indeed, modern military technology appears to have a dynamic quality of its own, absorbing increased public resources almost without regard for the existing state of international tensions.

Economic growth is a factor that has both facilitated and made necessary the expansion of the public sector, at least in absolute terms. In most countries, in most circumstances, government expenditures are limited by the availability of tax revenues. Since tax revenues have a positive elasticity with respect to national income, economic growth brings an increase in the volume of revenue from the existing tax structure. This increase is typically accompanied by an increase in government expenditure. The classic Gladstonian phrase is that “expenditure depends on policy.” Expenditure also depends on revenue.

An additional factor that has contributed to the growth of the public sector is urbanization. A common pattern appears in all economies that have moved to higher stages of development. The processes of economic growth are initiated in manufacturing. The growth of manufacturing involves an increase in urbanization and a decline in the relative importance of agriculture. The growth of an urbanized area provides the necessary complement of service activity to accompany manufacturing and the concentration of population. Economic activity becomes more specialized and interdependent; new increases in the level of output require additional facilities for communication and transportation. Occupations and firms within the developed and urbanized economy are thus more highly specialized. A larger volume of social overhead capital is necessary to sustain the increased complexity of patterns of transportation and communication, and to further encourage specialization and interdependence. Additional services for police and fire protection and sanitation are required to meet the needs of a concentrated population.

In this setting, increases in economic activity, and the accompanying specialization and interdependence, tend to generate a large volume of externalities.¹ These may be in the nature of private external economies made available to producers, as where a new steel fabricating plant can sell to firms in an area at lower transportation cost. Externalities may also impose costs on other producers, as where the congestion of city streets by delivery trucks reduces the volume of retail trade.

Externalities may also affect households. Consumers may enjoy an external benefit from the location of specialized warehousing facilities within an urban area. But households may suffer losses from a new factory, as in the common example of smoke pollution.

The privately induced external costs of an urbanized existence, whether they affect producers or consumers, are often the occasion for governmental intervention. Frequently this takes the form of regulatory activity, as with efforts to control air pollution or water pollution, or to control patterns of land utilization through zoning and subdivision regulations. In some cases the externalities from the private sector require additional governmental programs with major expenditures. Traffic congestion in the urbanized area is met by new facilities for urban transportation. Water pollution will require additional public facilities for water treatment.

In other cases public programs in the urbanized area emerge from externalities that contribute to the failure of private markets. In a declining residential neighborhood no one property owner may have adequate incentive to rehabilitate his property. The rationale for a public urban renewal program is that government intervention is required to internalize the externalities of neighborhood decay, by substituting public control over land use for private control. A different type of externality, with distributional consequences, occurs in housing. In this country the private market is apparently unable to provide housing at a satisfactory price and of a quality to meet the needs of low-income urban residents. In the absence of direct income subsidies a partial income redistribution is made available by means of public housing, with a consequent growth in the public sector.

The growth of the public sector in response to these externalities and other sources of market failure, including inequities in income distribution, assumes many and varied forms. In some cases, as with regulations for air and water pollution abatement, it is intended that private costs should more nearly reflect social costs; there should be a resulting improvement in aggregate resource allocation. In other cases public programs will express a range of preferences that are not reflected in market forces, as where governments consciously redistribute income to the less affluent. The public sector will alter the private market choices that are available to households, as it taxes away a part of their income.

An additional factor that has contributed to the growth of government is generally described as economies of scale. There are certain kinds of economic activities that may be provided at lower cost per unit of output when the scale of the enterprise is enlarged. Individual householders cannot economically provide their own police and fire protection, water supply, waste disposal, and the maintenance of streets in front of their homes. The traditional range of municipal services has come to be provided publicly because economies of scale exist and because there are substantial external benefits from the provision of such services to all households. And again, most of these services and their growth are associated with urbanization. The increased urbanization generates the needs. The higher levels of income that are associated with urban employment are accompanied by a willingness to pay for an expanded level of public activities, at least in developed countries. Activities that were formerly private consumer goods now become collectively provided public goods.

The growth of government attributable to economies of scale implies that this kind of public sector expansion yields a larger real output in relation to a given cost of inputs. But there is an additional characteristic of government output in mature economies that works in the other direction and is attributable to the predominance of services in the composition of government expenditures.

Productivity increases occur in industries that are capital intensive; very little government output is of this nature. Moreover, prices paid by public agencies for inputs must stay roughly in line with private sector input prices. In consequence, as Baumol points out, if there are relatively inelastic demands for public services, resources must be continuously shifted from the high productivity sectors of the economy to the “unprogressive” service sectors (Baumol, 1967, pp. 415–26). Since a wide range of government activities, particularly in urban areas, consists of the provision of services, and hence suffers from low rates of productivity increase, there is an inexorable increase in government expenditure, and average productivity for the economy as a whole will tend to fall (see Chapter 9).

The relationship between economic growth and the growth of the public sector is by no means a simple phenomenon, in either developed or developing countries. In a developed country with a mixed economy, such as the United States, much of the growth of governmental activity arises, as noted above, from the social overhead requirements and external costs generated by the private sector. The public sector is not the prime mover, although often public sector activities induce a favorable growth response in the private sector. For a developing economy the growth stimulus is more likely to reside directly in the public sector. The developing country will assume responsibilities for economic planning and hence for the provision of infrastructure development that impose a heavy burden of government expenditures.

The relationship between urbanization and the growth of the public sector in developed and developing countries is strikingly similar in one respect. As the agricultural sector declines in importance, the agricultural population moves to the urbanized area more rapidly than it can be absorbed. Public authority is required to provide minimum levels of subsistence for the unabsorbed population, a requirement that often entails an expanded public expenditure for a broad range of social services. The developed countries of western Europe and the United States and the developing nations of Africa and South America have shared this pattern of experience.

To a greater degree than developed countries, most of the developing countries with mixed economies encounter a continuing need to strengthen and supplement private market structures. Where there are impediments to the organization and financing of private activities, national governments often assume additional responsibilities for the inadequacies in both product and financial markets.

Apart from the generalized forces that appear to operate in almost all economies to produce an increase in the public sector, there are influences that may be operative and important in special circumstances. The age composition of the population may shift as birth rates rise; this will cause increased demands for expenditures on public education. The proportion of the aged may increase, with additional expenditures for pensions, medical care, and other social insurance measures. The agricultural population, whatever its size, seems to occupy a favored position vis-à-vis the public purse in a great many countries, as shown by farm price supports in the United States.

Given both the generalized and specialized forces at work, and their different impact from country to country, it is not surprising that patterns of statistical regularity are somewhat elusive (Musgrave, 1969, pp. 91–124). The ratio of either total government expenditures or civilian expenditures to gross national product shows only approximate regularity over time, and a cross-section analysis of these ratios at a point in time produces a much less satisfactory fit.

Public Sector Goals

The economic objectives of the public sector are conventionally described under four headings: the efficient allocation of resources, the stabilization of economic activity, an equitable distribution of income, and the promotion of economic growth.

The public sector may also pursue entirely noneconomic objectives or objectives that are only loosely related to economic objectives. Participation in international organizations might fall into this category, or a concern with highway beautification. The pursuit of noneconomic objectives may or may not require additional public resources. Where resources are required, traditional efficiency considerations enter; that is, there will be choices among the means for accomplishing noneconomic objectives, and it may be possible, in some but not all circumstances, to establish trade-offs among economic and noneconomic objectives.

The four economic objectives or responsibilities of the public sector can be elaborated briefly.

The public sector, in all modern governments, should adopt policies that assure full employment and confine fluctuations in the price level to limits that do not interfere with the effective operation of the economy.

The public sector has a responsibility for the efficient allocation of resources, both in private markets and within the public sector itself. Regulatory public policy should be directed toward offsetting or countering imperfections in private markets so that such markets may serve more effectively as guides to private decisions. Regulatory activity is not important as resource-using for the government itself; rather it affects the private use of resources, as with zoning regulations and building codes. Such activity is usually set apart from the economic objectives that require budgetary outlays for their implementation.

Within the resource-using activities of the public sector there should be attention to technological efficiency in order to maximize outputs from a given volume of inputs, and there should also be attention to efficiency in the sense of satisfying the wants of the citizenry for public goods.

Governments have responsibility for influencing the distribution of income among the regions of an economy and among producer groups, and may implement this responsibility by controlling or offsetting market imperfections. In addition, governments assume responsibility for the distribution of income among the rich and the poor. If private markets do not yield a distribution of income that is socially acceptable, modifications by way of taxes or transfer payments may be necessary for correctional purposes. Redistributional measures need not be limited, however, to tax and transfer payments but may also embrace government expenditures for goods and services that are directed to specific regions or specific groups in the population (see Chapter 9). Moreover, the redistributional measures themselves, that is, the devices employed and not just the outcomes, are a matter of policy concern. As Marglin has pointed out, the size of the economic pie and its division may not be the only factors of concern to the community — the method of slicing the pie may also be relevant.²

The fourth general goal is economic growth, defined as an increase in per capita real income over time. Real economic growth is necessary if the conditions of material existence are to improve. Improvement, measured in these terms, has come to be very widely demanded as evidence of ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Table of Contents
• Foreword
• Preface
• 1 The Nature of the Public Sector
• 2 The Pure Theory of Public Expenditure: Partial Equilibrium
• 3 The Pure Theory of Public Expenditure: General Equilibrium
• 4 Market Failure, Public Policy, and Public Expenditure
• 5 The Politics of Collective Choice
• 6 Program Budgeting
• 7 Benefit-Cost Analysis
• 8 Fiscal Federalism
• 9 Determinants and Consequences of Public Expenditures
• Name Index
• Subject Index