Public expenditure

(For definitions of the terms shown in italics in this article, see the glossary on the Related Articles subpage).

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.)

Composition

Government expenditure typically accounts for between 35 and 50 per cent of GDP. It is mainly made up of;

- 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 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 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.

The quantification of the economic effects of public expenditure is subject to errors and uncertainties arising from the practical difficulty of determining the preferences of those affected and the intellectual obstacles to the aggregation of their gains and losses of economic welfare. In contrast, social welfare is necessarily maximised, according to the theorems of welfare economics, by market forces operating under conditions of perfect competition and flexible prices. For those reasons, it is generally presumed that social welfare is reduced if the public sector controls the provision of goods and services that could otherwise be supplied by the private sector. That presumption is tenable only in the absence only in the absence of significant amounts of market power, and it has been argued that it need not hold when there is appreciable interdependence among members of a community.

It is nevertheless common practice to evaluate public expenditure proposals, such as road improvements, using the technique of cost-benefit analysis. The conceptual difficulty of making interpersonal comparisons of welfare is evaded by employing the Kaldor-Hicks criterion that gainers should be able to compensate losers, and the practical difficulties of assessing the values of time and of life are overcome using observations of market conduct. Such assessments are necessarily approximate, and for many aspects of public expenditure they are not feasible. No objective criterion is available that can usefully be used to assess the relative merits of expenditure on defence and education, for example.