CHAPTER III

SOME THEORIES ON GOVERNMENT SPENDING

Public spending is one of the instruments of modern fiscal policy employed by governments to prevent or
mitigate economic fluctuations. The expenditures of the public sector may be financed through taxations, borrowing
and, to a very limited extent, the sale of government assets, goods and services. Deficit financing may be classified into
pump-priming and short- and long-run compensatory spending. These types of deficit spending are intended to attain a
fall capacity level of national income of maintenance of full employment. This chapter discusses expenditures and full
employment. We thus commence our analysis with a conceptual discussion of full employment.

The Concern of full Employment

At the outset, it must be emphasized that full employment does not mean no unemployment. It does not
necessarily follow that every man or woman in the economy who is fit and free for work is productively employed for
every day of his or her working life. There are seasons during which particular forms of work are scarce or simply not
available on account on the climate. There are also instances when certain groups of workers can no longer be
advantageously employed in their former jobs because of technological advancement and therefore may be out of work
until such time as they shall have acquired new skills that are in demand or prepared themselves for new jobs.
The concept of full employment, as defined by Beveridge in his report, refers to a state in which the number of
vacant jobs is always greater that the number of unemployed men, not slightly fewer jobs. “It means that the jobs are at
fair wages of such a kind, and so located that the unemployed men can reasonably be expected to take them; it means,
by consequence, that the normal lag between losing one job and finding another will be very short.”
Unemployed data refer to a certain point in time. There are always people who shift from one job to another,
and a small number of people who are difficult to place at short notice or who need retraining for other lines of work.
There may also occur seasonal unemployment in particular trades or in certain sectors of the economy. Several
institutional factors, such as the efficiency of the labor market, the adaptability of management and labor to changing
circumstances, the changeability of demand, and the continuous and efficient regulating policies of the state, will
determine whether the minimum margin of unemployment will be nearer, say five or two per cent of the labor force.
All these factors may be reduced to the three conditions of full employment given by Beveridge, namely: (1)
adequate total outlays, (2) controlled location of industry, and (3) organized mobility of labor. Hence, it would not be
accurate to say, for instance, that when there are two million chronically unemployed men in an economy and 2
1/4million vacant jobs there is full employment, until the above conditions are satisfied.
Seasonal unemployment – refers to that arising in particular industries through seasonal variation in their activity,
brought about by climatic conditions or change in fashion.
In agriculture, as pointed out by United Nation experts, seasonal unemployment is usually brought about by natural
circumstances. This is very true Philippines agriculture where the farmers are busy during certain seasons (e.i., planting
and harvesting season) of the year but are idle during the interim period.
Unemployment is structural – if there is unemployment labor, but hardly unemployed productive capacity. This is
characteristics of less developed countries (LDC’s), where the dearth or capital or low rate of capital formation pose a
major obstacle to development. These countries must force themselves to save if they were to minimize structural
unemployment and thus hasten their economic growth. An outstanding example of a Western country confronted by
unemployment of a structural kind is given West Germany immediately after World War II. The migration of refugees
from East Germany and the destruction of real capital to a large extent accounted for widespread structural
unemployment during the early post-war year. Today, there is full employment in the Federal Republic of Germany.

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Cyclical unemployment – means lack of work caused by business cycle changes in the volume of work available. This
is differentiated from unemployment traceable to seasonal factors, turnover, technological changes and immobility of
labor and capital. Cyclical unemployment as it occurs during depression in industrialized countries is characterized by
both idle labor and idle productive capacity. In such a setting, output is highly elastic so that an increase in aggregate
effective demand will bring about an expansion in output and employment relative to the price level. Keynesian
economics is concerned with such a situation. Keynes advanced the theory that during periods of mass unemployment,
government expenditures must be raised to generate employment, income and effective demand, and output. The
virtual elimination of mass unemployment in the United States, England and Germany during the 1930’s could be
attributed in large measure to the ideas of Keynes.

BASIC PREMISES OF PUBLIC SPENDING POLICIES

The underlying thesis of fiscal policy and public spending is that production depends upon the total effective
demand for goods and services currently produced (that is, aggregate expenditure on consumption and investment) as
long as there are available unemployed productive resources of every type, and output is consequently highly elastic.
The less the availability of unemployed productive resources, the less elastic the output and the greater the tendency for
increases in effective demand to lead to inflation. When, however, there are available unemployed productive resources
of every type, increases in effective demand (either consumption or investment or government expenditures) would
tend to increase output, employment and real income. In such a situation, the primary goal of government spending is
to raise aggregate consumption. Due to the higher level of government spending, incomes of consumers will expand,
and consequently consumption expenditures will rise. This is so because when we view the economy as an integral
whole, income and expenditure are exactly one and the same thing; every transfer of money is at the same time income
to the individual who receives it, and expenditures for the individual who parts with it. The effect of expenditures on
incomes is only part of the story when we consider the multiplier effect or the ratio of the final increase in income to
the initial increase in expenditure.
The mechanism can be explain thus: Individuals who are the recipients of the government’s expended money
naturally find their money incomes increased, and accordingly step up their rate of spending. This round of spending
will, in turn, increase the incomes of recipients who are in a position to increase their expenditures. And so is forged
the chain relationship of income creation and expenditure growth. “So each increase in expenditure results indirectly in
an increase in income larger than itself, provided, of course, that the increase in expenditure persists.”
The marshalling of government funds into this state of economy would assure the flow of disposable incomes
sufficient to stimulate demand and product.

DEFICIT FINANCING FOR STABILITY AND FULL EMPLOYMENT

Three types of deficit financing have figured in the economic literature and these are: (a) deficit financing for
offsetting depression and likely to be of a temporary character, (b) deficit financing for compensating inadequacy of
private investment and likely to be a quasi-permanent character, and (c) deficit financing for defense expenditure. The
most recent justification for deficit spending is for financing economic development.
The Concept of Pump-priming. Pump-priming, which attracted much attention during the early days of the
New Deal in the United States, refers to the injection of government funds into the income stream in sufficient
quantities and under proper circumstances in order to reverse the trend of anticipations and to generate recovery. This
emergency tool is by its nature a temporary device to restore the balance in the economic system during the cyclical
downturn, after which the system is expected to operate under its own power. This implies that the multiplier effect
will come into play, and the accelerator will re-enforce the increases in income, consumption and investments. As
distinguished from compensatory, spending, pump-priming views depression as a temporary breakdown and deficit
spending as a short run necessity, to be followed quickly by budgetary surpluses and a return to fiscal normalcy.
Accordingly, the role of fiscal policy is to serve as a starter, a simulative factor, as it were, during the
depression phase of the business cycle. The government, preferably through surpluses accumulated during prosperity,
should spend enough to start the ball rolling.
Initially the government injects money into the income stream. This funds provides the dynamic fuel for the
recovery ascent. The income stream is immediately affected by adding to the purchasing power of the nation in the
form of relief, wages and outright grants, plus payments for purchasing of materials employed in construction
undertakings. Aside from the primary employment in public works operation, such as the direct employment on the
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project, there is secondary employment created by the production of the necessary materials along with associated
services involved. The second part of the program is the lending portions which helps provide a congenial environment
for recovery. The extension of government loans to financial institutions and business firms aids in stemming the dash
for liquidity and reducing the rate of insolvencies.
The different stages in the pump-priming process call for actual spending by the government as the first stage
and the secondary spending by the recipients of public funds (i.e., both consumer and business spending), as the
secondary stage. With the realization of third stage, namely, stimulation of net private investment, our pump-priming
scheme shall have achieved its goal. Pump-priming is an effective fiscal device in advance societies where technology
and money markets are well developed. In underdeveloped countries where these institutions are hardly existent,
pump-priming might lead to inflation.
Short-run Compensatory Spending. Like pump-priming, this device was advocated by the Keynesians during
the Great Depression. Short-run Compensatory Spending is actually a deficit adequacies in private spending during
periods of falling prices and rising unemployment.
Like all new theories, short-run compensatory spending did not immediately gain public acceptance. In the US,
for instance, there was little or no evidence that public spending was to be a major policy, especially in the early part of
the first term of office of President Franklin Delano Roosevelt. Some date the beginnings of the policy from Keynes
visit to the US in June, 1934, when he said that if that country were to spend $200 million a month, she would go back
to the bottom of the depression; a net monthly deficit $300 million would hold her even, and one of $400 million
would bring full recovery. While there was no public recognition then that the government was deliberately…..
pursuing a deficit spending policy, the fact seemed to be that interest in other recovery measures waned. On the other
hand, the deficit spending policy developed a growing disposition on the part of many, within and outside the
Roosevelt Administration, to regard the deficits themselves as a major cause of the recovery.
By deficit spending we mean incurring expenditures in excess of revenue. Such an excess may result from a
reduction in tax receipts at a time when expenditures remain the same. It indicates an unbalanced budget wherein the
proceeds from taxation fall short of budgetary requirements. It refers to “government spending on public investment
(e.g.., hospitals, highways, etc.), or on subsidies to mass consumption (family allowances, reduction of indirect
taxation, subsidies to keep down the prices of necessities) – provided that spending is financed by borrowing. An
increase in scale of public outlay with a given rate of taxation will increase the total outlay of the community on home-
produced goods and services by a greater amount than the rise in the public expenditures itself, since the resulting
increase in income and the increase in productive activity will in turn lead to increased private expenditures.
Boulding assert that it is the direct responsibility government, a responsibility which no other agency in society
can assume, to prevent large fluctuations in the volume of unemployment and in the level of money income. The
control of the banking system and the manipulation of the monetary standards may be of some assistance in attaining
this end, but by themselves they are not powerful enough to prevent or arrest general depressions. They operate only
indirectly and do not strike at the root of the trouble. It seems, therefore, that they is only one agency in society which
is potent enough to accomplish these objectives, and that is the fiscal system.
Following this line of through, one may argue that even embarking upon such wasteful schemes as digging
holes in the ground and filling them up, as Lord Keynes has put it, is more fruitful than no work At all. Germany of the
middle thirties presented the case of the deficit – financed country without foreign assets (on much greater scale than
the U.S. New Deal Program), which succeeded in achieving internal expansion in economic activity to the limit of the
full employment and even beyond it. Germany’s pursuit of full employment policy required imposition of exchange
control as increases in public spending tended immediately to induce an increase in imports and consequently led to
balance of payments difficulties. On the other side, in the United State, domestic deficit spending dis not result in
severe and continuous balance of payment disequilibria. This was attributable mainly to a generally lower propensity to
imports. Moreover, the import-increasing effect of deficit spending tended to be offset by the devaluation of the dollar
in 1943 and capital flight from Europe.
The above discussion does not in any way confine the concept of full employment to human resources alone. It
likewise relates to the increased use of available natural resources to keep labor working. Full employment applies also
to other-than-human resources. It signifies, essence, the continuing utilization of productive capacity, material as well
as human, at a high level
Compensatory Spending in the Long-run

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 Compensatory Spending is undertaken by the government to offset the deficiency in private spending. It refers
to the use of government outlays as a means of counteracting the alleged long run tendency o the part of the economy
to operate at levels well below full employment. Government outlays for capital and no-capital goods and services will
be directed primarily into non-competitive areas where increased activity may favorably affect the private sector if the
economy.1
When anticipations2 of producers and consumers point towards contraction, compensatory expenditures must
be deficit expenditures.
The first expenditures should find their way into the hands of the unemployed and those with low incomes
because they re-spend their incomes and consumptions first. Long-run fiscal policy involves budget balancing over a
long period of time, with high taxes and surpluses to curb excessive booms and larger expenditures and deficit to arrest
deflation.
Thus, an annual budgetary balance1 is replaced with a cyclically balanced budget – a fiscal program much
more in consonance with economic reality. This policy takes a longer view of deficit spending. Although it does not
imply that deficits should be permanent, it claims that the program should not end with the disappearance of deficits.
To be effective, compensatory fiscal spending requires that public expenditures to be governed by national policy and
that they constitute a large proportion of total national, income, about one-fourth or one-third. 2
One fundamental proposition of Keynesian economics is that only an expanding economy can provide full
employment and increased use of natural resources. A continuing high level of employment, according to this school of
though, may be maintained only by injecting new purchasing power into the economy in a more or less steady manner.
The instrument for accomplishing this would be a series of fiscal measures for deficit spending. 3

Budget Program for Stability and Full Employment

Objections to deficit spending per se have been strongly and articulately expressed by the press and a great
majority of citizens, political leaders among them. Those objections are based on the time-honoured practice of
balancing personal and business budgets.
The fact of the matter is that most laymen, and some economists as well, fail to realize that the economics of
the system as a whole differs significantly from the economics of the individual. It is said that, “What is prudent
behaviour for an individual may at times be folly for a nation or a state.” While it is considered sound policy for the
individual to pay off his debts and try to balance his budget, what would happen if the government were to pursue the
same retrenchment policy, gradually retiring all debt within a given period and cutting down its expenditures? “the
surpluses that it would attempt to have would so reduce total spending and output that the economy would remain far
below its capacity, produce less tax revenues, and thereby defeat the aim of retiring the debt.” 1
In the consideration of post-war fiscal policy, emphasis has been laid not only on curing depressions but also
on achieving full employment and maintaining that same level which was achieved under the impact of war. Another
important feature of post-war thinking is the prominence given to taxation. After the war-time pressure for increased
taxes to prevent inflation, it seemed logical to adopt tax reduction as a device to increase production and employment.
Today, the prevailing school of thought is in favour of higher expenditures and lower taxes as a route to a desired
income level rather than through the balanced diet. To make fiscal policy work, modern governmental budgeting
comes in as a “balance wheel” of the system. The accepted functions of the budget are to make a consistent whole of
the entire policies of the government and to achieve a balance among the various, but related, objectives of the nation.
For a better understanding of the significance of the levels of government expenditures and revenue, the more
outstanding budget schemes are briefly discussed in the subsequent sections and comments given on fiscal policies.
There have been developed various types of budget policies directed towards the twin goals of stability and full
employment. Foremost of these are the annually balanced budget, the “Swedish” of the cyclically balanced budget, the
stabilizing budgetary policy, ‘”formula flexibility,” and the fully managed compensatory program. These schools of
thought will be discussed in turn.
1. Annually Balanced Budget – the annually balanced budget still meets with popular acceptance among
policy-makers and leaders, despite developments in fiscal theory. This principle calls the budget maintains

an exact balance between expenditures and revenue each year.

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 2. The “Swedish Budget” or the Cyclically – Balanced Budget – the cyclically-balanced budget program
was first implemented in Sweden in 1930, hence its other name, the Swedish budget. As the name
suggests, it is built around the principle of balancing the budget over the cycle.
3. The CED Plan – The Stabilizing Budget Policy – Departing from the rigid confines of the annually
balanced budget, the program advocated by the Committee for Economic Development (CED), an
organization of outstanding business lead has been devised on the recognition of the need for counter
cyclical fiscal policy, namely, surpluses during prosperous periods and deficits in times of recession. It is
also a proposal for meeting the problem raised by the managed compensatory policy, which well be
discussed later. To harness the stabilizing influence inherent in the budget, the CED made the following
policy statement:
Set tax rates to balance budget and provide a surplus for debt retirement at an agreed level of employment
and national income. Having set these rates, leaving them alone unless there is some major change in
national policy or condition of national life.
Under the CED program, the scale of public expenditures, determined on the basis of social long-run
needs, would remain fixed over the cycle, requiring no conscious management. Actually, however, certain
government expenditures would automatically increase in a depression. The merits of the CED program lie
partly in its complete emphasis and reliance on built –in flexibility of the budget. The CED, however, also
points out the inability to forecast economic stability.
4. Formula Flexibility – As discussed in the preceding section, there is need to go beyond the automatic or
built-in stabilizer as a compensatory device. They do weather fluctuations in the economy by cushioning
the recession and to some extent breaking the boom, but they “cannot bring about an actual rise income
and employment.
5. The Managed Compensatory Budget Program – this policy attempts to fit the budget to the changes in the
business cycle. When national income and employment are expected to fall, the managed compensatory
programs calls for a combination of expenditures increases and tax reduction in the amount necessary to
avoid or minimize instability or to reverse the downtrends

Some Related Proposals and Comments

1. Smithies Long-run Budget Policy – Arthur Smithies argues that level of long-run government
expenditures should be determined in formal correspondence with the CED’s stabilizing budget. “ the
long-run policy would determine the tax yields and expenditures at high level of employment and income
when no compensatory action is required to offset deflationary or inflationary influence in a private sector
o the economy.”
2. Friedman’s Framework for Economic Stability – Milton Friedman advanced the following of set of fisal
proposals for economic stability.
(a) The volume of government expenditures on goods and services of all kinds – defined the exclude
transfer expenditures of all kind – should be determined solely on the basis of the community desire,
needs and willingness to pay for public services.
(b) Changes in the level of expenditures should be made solely in response to alterations in the relative
value attached by the community to public services and private consumption.
(c) No attempt should be made to vary expenditures, either directly, or inversely, in response to cyclical
fluctuation in business activity.
(d) Since the community’s basis objectives would presumably change only slowly, except in time of war
or immediately threat of war, this policy would, with the same exception, lead to a relatively stable
volume of expenditures on goods and services.
3. Samuelson’s Neo-Classical Reformulation – Samuelson expresses agreement with a recently-evolved
special doctrine of modern policy which reacts against the earlier emphasis on variation of public
expenditures as a counter-cyclical device and against the earlier under-emphasis on tax policy.

The Growth of Public Spending

The patterns and trends of government spending seem to bear out the operation of Wagner’s Law – or the
“Law of Ever-Increasing State Activity”. It was formulated by Adolph Wagner, the Germany economist way back in

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1883, when he conducted a survey of public expenditures trends in a number of advanced countries in the 19 th century.
The operation of this Law could be traced, according to Wagner, to the “Pressure for social progress and resulting
changes in the relative sphere of public and private economy, especially compulsory public economy”. Wagner’s Law
states that.
“Comprehensive comparisons of different countries and different times show that, among progressive people,
with which alone we are concerned, an increase regularly takes palce in the activity of both the central and
local governments. This increase is both extensive and intensive: the central and local governments constantly
undertake new functions, while there perform both old and new functions more efficiently and completely. In
this way, the economic needs of the people, to an increasing extent and in a more satisfactory fashion, are
satisfied by the central and local governments”.
PARKINSON’S LAW
Wagner’s “law” still funds many adherents among economists, but a growing number of thinkers and
policymaker believe that this law does not fully explain the rising trend in government expenditures. They attribute this
to another law – the so-called Parkinson’s Law. Name. After its author, C. Northcote Parkinson. This law of
organizational growth, which is especially pronounced among administrative staffs, is based on two premise:
1.) The psychological desire of individuals officials to have more and more subordinates (but not rivals).
2.) The phenomenon that the personnel of an organization perform work from one another.
Basically stated, the first factor says that an officials would never want to have a potential rival in the organization
– he would see to it that junior officials be appointed under him, rather than witness is coming of a new face who
would present a veritable threat his position in some future time. For example, if A thinks he is overburdened with
work (whether the overworked is real or imagined), he would seek the addition of two subordinates under him, say, B
and C, in in such a manner that the work originally done by A cannot be done alone by either B or C.
The second factor is really a way explaining a combination of the resulting red tape and complexities of the
operations of the expanding organization. Hence, it will not be surprising to find somebody checking on the work of
another; of one member is revising the report of his fellow officemate; of some officials writing a communication
which does not have a direct bearing on the work done by his co-employees in the same department or division.

SOME PRINCIPLES OF GOVERNMENT EXPENDITURES

What should be magnitude and nature of government expenditures? Should the government broaden the scope
of its expenditures or should it reduce its activities drastically? Are there certain guidelines which may be followed in
arriving at appropriate expenditures policies? These are related question are frequently asked. The answer will
invariably depend on the particular objective sough to be attain through a given policy decision. To serve a guides, four
“principle of government expenditures” have been suggested by Professor Harold M. Somers as follows:
1.) Principle of minimum expenditures – There is a large school of thought which believes that the government
should spend the least it possibly can consistent with the protection of its citizens. The term “protection” may
be interpreted very narrowly to include some roads (but presumably private toll bridges and highways would
be widespread) and possibly postal services, although even the need for governmental provisions of the latter
may be doubtful.
2.) Principle of minimum interference with private enterprises – the principle of minimum expenditures would
generally also ensure minimum interference with private interprises. However, the government for another
reasons, may decide on some substantial volume of government expenditures. It may decide on public works,
for instance, to provide employment in a depression.
3.) Principle of minimum employment – The aim of government expenditures is sometimes to raise the level of
employment as high as possible. Then a question arises as to the best way of achieving that aim. In trying
achieve the aim of minimum
4.) Principle of minimum advantage – The traditional principle of government expenditures is that which propose
that the “maximum advantage” be achieved in all cases. The implication is that each should be spent where the
marginal social utility is the greatest.

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INFLUENCE OF GOVERNMENTAL DECISION MAKING ON EXPENDITURES
In any society, government decision-making profoundly affects individual choice of expenditures. When the
government enunciates a tax policy or an expenditure program, or commits itself to the attainment to broad but
concretely articulated socio-politico-economic goals, individuals respond to these either positively or negatively. In
fact it may be mentioned that while in representative democracy the citizens are ideally the repository of govern mental
powers and activities, in practice it is the elected officials who determine the goals of society, with individuals
preferences or responses of the governed being expressed in terms of opinion polls, referendum, public opinion
columns in newspaper, or through the ballots during election day. Thus while in a democratic society the individuals or
citizen is theoretically the sovereign, in actual practice it is the day-to-day and minute decision of government officials
that guide individual actions or creation.
Theoretically, when individuals are presented with various choices or alternatives of spending their income,
their decision would depends on:
a) Their individual preference schedules (the indifference curve)
b) Their income
c) The prices of these products
In case the case of “public” goods, however, the “price” as it criterion or determinant in individual decision
making pertains to the taxes which he must bear or pay to obtain or enjoy the use of these “goods”
It must be mentioned in passing that while consumer decision-making for public goods depends upon taxes, it
differ from private-sector or private goods. Very briefly these difference are:
a) The inability of individuals to control the amount purchased
b) Nature and knowledge of benefits
c) Uncertainty
d) Community interest motivation
e) Mixture of allocation and distributional activities

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 REFERENCES

Bator, Francis M. the question of government spending public needs and private wants. New York, Harper &
Brothers, 1960. 167.
Buchanan, James M. the Public Finance – Homewood. R.D. Irwin, 1960. 553 p. 18.
Due, John F. Government Finance, an economic analysis, 3rd ed. Homewood, III., R.D. Irwin, 1963, 618 p.
Chap. I.
Eckstein, Otto. Public Finance. Engliwood Cliffs, N.J.. Prentice Hall, 1964.
“A survey of the Theory of the Public Expenditures Criteria” in Public Finance: Need source and utilization.
Report of National Bureau of Economic Research. Princeton New Jersey, Princeton University Press. 1961.
Pp. 439-504
Goves, Harold M. Financing Government, 4th ed. New York Holt c1954, 618 p. Chaps. 21, 22.
Lutz, Hraley L. public Finance , 4th New York D. Appleton Century c1947, 730 p. Chaps. 2, 7, 9.
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California Bureau of Public Administration, 1961 76 p. Chap. 2.
Rao , V.K.R.V. Deficit Financing, Capital Formation and Price Behavior in an Underdeveloped Economy.
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Smithies, A., “Federal Budget and Fiscal Policy,” in A Survey of Contemporary Economics, ed. By H. Ellis
Philadelphia. Blakiston, 1949.
Taylor, Philip E. The Economic of Public Finance. 3rd ed. New York, MacMillan, 1961. 588 P. Chaps. 3.5.
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