4.

0 PUBLIC EXPENDITURE PROGRAM

General objective

By the end of the lesson the learner should be able to explain the meaning and nature of
public expenditure
Specific objectives
By the end of the lesson the learner should be able to
explain the meaning and objectives of public expenditure
to account for the size and growth of public expenditure
explain the theories that explain increase of public expenditure
explain the effects of public expenditure
account for the growth of public expenditure
explain the role of development expenditure of developing countries

4.0 Meaning of public expenditure

This refers to the expenses which the government incurs for its own maintenance, for the society,
as well as for the economy as a whole

4.1 Objectives of public expenditure

Public expenditure's objective is supposed to provide security for the country or state and to
promote the well being of the citizens. Major government spending can be classified as national
defense, education, social welfare, interest on the national debt and pensions.

4.2 Size and growth of public expenditure

Public expenditure increases over the years due to the following reasons:
4.2.1 Expansion of state activities
According to Adolph Wagner (1883) public expenditure increases in response to the law of
increasing expansion of public activities. He maintained that there is a persistent tendency both
towards an intensive and expensive increase of state function and activities.

4.2.2 Internal security

Wagner also referred to the maintenance of international security as an important factor for the
increase in government expenditure. Enforcement of law and order for maintaining peace and
security has led to the expansion of legal and administrative systems and police force. There
have led to an increase in public expenditure.

4.2.3 Defense
Every country pays greater attention to its defense preparedness against foreign attacks. As a
result public expenditure on equipping its armed forces with the latest armaments has
increased.

4.2.4 Welfare activities

Modern states are welfare states which provide free education, medical facilities, social
security measures, maintain historical monuments, museums and pubic libraries, encourage
sports, cultural and heath programmes. Consequently, public expenditure has tended to
increase.

4.2.5 Population increase

The increase in population has resulted in increase public expenditure on the people. The state
has to spend more on roads, railways, schools, colleges, houses etc

4.2.6 Urbanization
With the growth of population, there is migration of population from rural to urban areas in
search of employment. Exiting cities expand and new cities come up. These require huge public
expenditure in providing amenities such as water, street lighting, sewerage, road, transport,
schools, houses, etc
 4.3 Theories of increase in public expenditure

There are two theories that explain increase in public expenditure namely:-
a. Wagner’s law of increased public expenditure
b. Wiseman and Peacock Hypothesis.

1) Wagner’s law of increased public expenditure

Adolph Wagner (1835-1917) was a German economist who based his law on historical facts
prevailing in Germany.
According to him, there has been an inherent tendency for the activities of different layers of
government to increase both intensively and extensively.
Increase in public expenditure is at higher rate than economic growth. He attributed increase in
public expenditure to the following-:
(1) Expansion of the traditional function of the state e.g defense, maintenance of law and order,
provision of social overheads, maintenance of the state. e.t.c
(2) Increased awareness of government responsibility to the society rather than in traditional
role eg giving pension to it retiring workers, provision of public goods, social welfare
activities, culture enrichment etc.
(3) The need to provide and expand the sphere of public goods was being increasingly
recognized.
NB However there are other factors that tend to increase public expenditure that he left out.

2) Wiseman and Peacock Hypothesis

Wiseman and peacock did their study of public expenditure behavior in UK for the period 1890-
1955.
The main thesis for the two is that public expenditure doesn’t increase in a smooth and continuous
manner but in fort of step like fashion.
According to the 2, at times, some social or other disturbances takes place creating a need for increased
public expenditure which the existing public revenue cannot meet.
Due to the deficit budget as a result of the increased expenditure, the government and its people
review the position and the need to find a solution of the important problem that has come up and
agree to undertake adjustment to finance the increased expenditure. E.g. they can agree to increase
taxes or public borrowing.
The time when the government and the people are deliberating on what to do to finance the
expenditure, is known as the ‘inspection effect.’
The movement from the older level of expenditure and taxation to a new and a higher level is
referred to as the displacement effect.
At a new tax tolerance level, (i.e. new expenditure level) ,people are now ready to tolerate a greater
burden of taxation and as a result, the general level of expenditure and revenue goes up. This way,
the public expenditure and revenue get stabilized at a new level until another disturbance occurs
to cause a displacement effect.

4.4 Theories of Public Expenditure

There are various theories of public expenditure which includes:

i. The doctrine of Laissez faire
ii. Individual choice theory
iii. The authoritarian conception/ the organic theory
iv. Optimum level of public expenditure theory
v. The ballot box theory
vi. The positive theory of government expenditure

1) The doctrine of Laissez faire

This one is based on the principle of minimum state intervention in the working of the economy.
‘Governments are always and without exemption the greatest spendthrifts of society,’ according
to Adam Smith, because, they spend other people’s money. Adam Smith believed that individual
people acting in self interest will promote public good under the guidance of the ‘invisible hand’.
The implication of this theory was a low level of public expenditure and taxation but the need for
some increase in public expenditure was conceded.
2) Individual choice theory
Emphasis in theoretical discussion of public finance shifted to the consideration of the basis on
which collective decision in the public sector should be made. Writers such as Ferra (1850)
advocated individual choice as the basis of social choice and of collective decision making. The
problem of this approach was the aggregation of individual preferences and of relating them to
policies.

3) The authoritarian conception/organic theory

The organic theory avoided this difficulty, since it was based on the assumption that the decisions
were made by ruling group

4) Optimum level of expenditure theory

Having accepted the need for some public expenditure, economists turned their attention to the
question of what was its desired level. This theory is associated with W. Stanley Jevons (1835-
1882), an English Economist. The theory postulates that, as a person’s consumption increases,
each additional (marginal unit) of a good consumed gives lower satisfaction (utility) than the one
before. Thus the consumer experiences diminishing utility.
The theory is based on the relationship between the satisfaction derived from the consumption of
goods and services provided by that state and the sacrifice involved in paying taxes to finance
public expenditure.
The marginal theory sheds some light on how people behave. We may not go round calculating
our diminishing marginal utility of each good we consume. Nevertheless, all of us are aware that
there is some point at which the burden of taxation appears greater than the various state benefits
are worth to us. We may not be able to put a figure on that point and it may not be the same for all
people ,but we may prefer to go without some public goods and services rather than pay more in
taxation to finance the increase of public expenditure.
The optimum level of public expenditure can be defined as the point at which the benefit to all
individuals from additional expenditure is equal to the additional sacrifice by those involved in
paying more tax.
5) The ballot box theory
In a democratic society, people have the opportunity to decide how much they wish to provide for
themselves and how much they want the state to provide for them. Their individual preferences
can be expressed by putting on vote in the ballot box at the next election for a political party whose
manifesto most closely reflects their views. It is the majority vote, which is the aggregate of
individual preferences that gives the government the mandate to carry out its policies.
The problem however is that at a general election, people vote on a number of issues and for a
‘manifesto package’ containing various proposals.
Consequently elections have no opportunity to express the views on a particular issue or measure.
Also not all of the proposals in a manifesto may be equally acceptable to them.

6) The positive theory of public expenditure

This theory has been advanced by present day writers such as A. Down, J. Buchaman and G.
Tullock. It could perhaps be described as the ‘clinging to power theory, since it is based on the
assumption that, in a democratic society, governments seek to maximize their lifespan while voters
seek to maximize the benefits they receive from the government. An increase in public expenditure
is popular with voters if they do not pay taxes to finance it.

4.5 Effects of Public Expenditure

Public expenditure has far reaching effects on production, employment and distribution in the
country. We discuss these effects as under:

4.5.1 Effects of Public Expenditure on Production

According to Dalton, production and employment in a country depend on three factors:
(a)Ability of the people to work, save, and invest;
(b) Willingness to work, save and invest’
(c) Diversion of economic resources as between different uses and localities.
Public expenditure influences these factors in a number of ways and thus helps in increasing
production and employment within the country. The ability and Willingness to work, save and
invest depend on the nature of expenditure. The former increase with the increase in the
efficiency of workers which, in turn, raises production and employment.

On Social Insurance. Public expenditure on social insurance benefits such as unemployment,

sickness, maternity, old age pensions, etc. tends to increase the purchasing power of workers
indirectly. When these facilities are provided by the state, the workers indirectly. When these
facilities are provided by the state, the workers are not required to spend on them, thereby
increase their real purchasing power. The money so saved is spent by them on other articles. It
means an increase in their standard of living which raises their efficiency and production.

If, on the other hand, the workers spend the money so saved on gambling, drinking, etc. their
ability and willingness to save fall which adversely affect their ability and willingness to save
fall which adversely affect their ability to work, thereby reducing production.

On Basic Facilities. Public expenditure on basic facilities also tens to raise efficiency and ability
to work. When the state provides such basic facilities as cheap ration, low-rent houses, mid-day
meals to children, cheap milk, etc. the ability to save increases. This, in turn, tends to raise their
ability to work, thereby increasing production.

On Education and Public Health. Public expenditure on education and public health has direct
welfare effects on society. Expenditure on education is regarded as investment in human capital
because it helps in skill formation and thus raises the ability to work and produce core. Similarly,
public health is also another form of investment in human capital. Healthy workers, who are free
from diseases, work more and raise production.

On Economic Overheads, Basic Industries, etc. Public expenditure on economic overheads,

basic industries, etc also helps in increasing the productive capacity of the economy. Public
expenditure on power, transport, communications, irrigation, soil erosion. Land reclamation, etc
tends to increase the supply of resources for production over a long period. Moreover,
expenditure on roads, railways, and other means of transport also affects the mobility of men and
materials, which, in turn help in increasing the productive capacity. Further, the development of
basic industries like iron and steel, engineering, heavy chemicals, fertilizers, etc. is very helpful in
the development of other industries. Again, public expenditure on river valley projects helps in
providing larger employment opportunities. It provides protection against floods ad drought,
thereby avoiding loss of resources.

On Credit and Banking Facilities. Public expenditure in providing credit and baking facilities
also helps in increasing the productive capacity of the economy. It is through bank nationalistion
and/or through state and cooperative banks and opening of a network of branches throughout the
country that the state can provide cheap and better credit and banking facilities to agriculture,
industry and trade, and thus help in increasing their productivity.

On Backward Regions and Areas. Public expenditure on the development of backward regions
and depressed areas helps in providing employment through basic facilities. The private enterprise
is shy to invest in these areas. It is only the state which by providing all types of basic facilities
like roads, railways, power, industries, etc develops such areas whereby the people get jobs and
the production power of the area increases.

In the Form of Grants and Subsidies. Public expenditure in the form of grants and subsidies to
farmers, firms and industries is highly productive. When there is a bumper crop, the prices of farm
products fall considerably. The state can save them from disaster through price support. It can
purchase their surplus stocks at fixed minimum prices. In order to encourage higher production,
the state can provide such inputs as fertilizers, seeds, pump sets, etc at subsidised prices. Similarly,
the state can help develop industries by providing them subsidies. Some of the industries have
high costs in the initial stage of production. As a result. The prices of their products are high and
they are not in a position to compete in the market, and thus they meet an early death. To save
such industries, public expenditure in the form of subsidies may enable them to develop without
charging high process from its customers.
On Information. Public expenditure on providing information in the form of such publicity
media as TV, commercial broadcast, etc helps private and public enterprises in getting their
products publicized. As a result, their sales and production increase. Similarly, public
expenditure on employment news, bureaux and exchanges helps in placing the right man at the
right job and in this way provides larger employment opportunities and tends to increase
productivity.

4.5.2 Effects of Public Expenditure on Diversion of

Resources
Public expenditure affects the pattern of production through the diversion of resources from
existing uses to more productive uses. In fact, government expenditure in itself is a diversion of
resources from private to public uses. Public expenditure induces people to divert their resources
to more productive uses in the following ways:

1. On Infrastructure. Public expenditure on the development of roads and railways helps in

diverting resources to more productive uses when the market for products becomes large.
Again, public expenditure on generation of power supply and irrigation facilities helps in the
diversion of resources to large industries and agriculture. Further, public expenditure on
providing research technical education, etc tends to divert economic resources in order to
create conditions of economic stability. Further, when public expenditure is made on such
long-run infrastructural facilities as roads, railways, power, irrigation, etc it is trying to divert
resources from their present to future uses which are more productive.

2. On Backward Areas. Public expenditure on the development of backward regions or areas

brings diversion of resources from more developed to less developed areas. Such diversion
takes place when the government incurs more expenditure in the form of transport, power,
and on the establishment of public enterprises in a backward region. Grants made by the
government for the development o such areas helps in diverting natural and human resources
from the developed to backward areas.

3. To private enterprise. Public expenditure in the form of loans and subsidies to private
enterprise helps in the diversion of resources into productive channels. Sometimes loans and
 subsidies are made conditional. They are dependent on the quality of the product. In such cases,
diversion of resources leads to the production of better quality product. In such cases, diversion
of resources leads to the production of better quality products as against inferior goods.

4. On defence. Public expenditure on defence or war leads to the greatest diversion of resource.
Such expenditure diverts resources from peaceful uses to war uses. It is normally regarded as
the wastage of human and material resources which can otherwise be used for social benefits.
But to defend a country s the foremost duty of government. It provides security to life and
property and saves the nation from foreign domination. All expenditure on defence is not
wasteful rather it is productive indirectly. Defence expenditure on the construction of roads,
bridges, aerodromes, shipyards, and on other means of transport and communications help in
building infrastructure in the country which are ultimately used by the civilian population. It
also provides employment to people engaged in their construction. Moreover. Public
expenditure incurred in maintaining the armed forces in the form of supplies of food, clothing
and other materials increases their demand and production and helps in increasing
employment opportunities manifold. No doubt, when resources are diverted from their private
uses to war, their supplies to the masses are reduced which adversely affect their standard of
living. But this is only a temporary phase so long as the war continues.

4.5.3. Effects of public expenditure on income distribution.

Public expenditure by increasing social welfare helps in reducing inequalities of income and
wealth. According to Dalton, it is only progressive expenditure that tends to reduce inequalities.
A progressive expenditure is one when a person with lower income receives larger benefits as
compared to a person with higher income. Public expenditure for purposes of income distribution
is of two types: transfer expenditure and exhaustive expenditure. In the case of transfer
expenditure, low income groups are given cash benefits in the form of unemployment, sickness,
disablement, dependents, and maternity benefits, and old age pensions. All such expenditures by
the state help the poor and middle income groups in raising their incomes indirectly. Exhaustive
public expenditure also tends to reduce income in equalities and it is in
the form of free and cheap services of commodities, such as free education, free medical facilities,
free milk or meals to school children, free transport for school children and for workers subsidized
rations, subsidized lunch to workers, rent – free quarters, etc.

There are also intangible benefits such as providing rent and recreation centres, public parks
reading rooms and libraries etc. Which tend to raise the efficiency of workers indirectly. Such
non-monetary benefits increase the real income and standard of living of the workers and masses.
Public expenditure of both transfer and exhaustive types helps in the redistribution of income. On
the other hand, if such benefits reduce the desire to work and save, they will tend to reduce the
incomes of the beneficiaries. Consequently, the inequalities are not reduced. To conclude with
Dalton, "that system of public expenditure is best which has the strongest tendency to reduce the
inequalities of incomes.

4.5.3 Effects of public expenditure on economic stability

Increase in public expenditure tends to raise national income, employment output, and prices. An
increase in public expenditure during deflation increases the aggregate demand for goods and
services and leads to a large increase in income via the multiplier process. It has the effect of
raising disposable income thereby increasing consumption and investment expenditure of the
people. The public expenditure includes expenditure on such public works as roads, canals, dams,
parks, schools, hospitals and other buildings, etc. And on such relief measures as unemployment
insurance, pensions, etc. Expenditure on public works creates demand for the products of private
construction industries and helps in reviving them, while expenditure on relief measures stimulates
the demand for consumer goods industries. But the effectiveness of public expenditure primarily
depends upon the public work programme, its importance in the economic system, the volume and
nature of public works and their planning and timing.

4.5.4 Effects of public expenditure on economic

development
The effects of public expenditure on economic development lie in increasing the growth rate of
the economy. But investment in the capital goods sector may increase production in the long run.
Therefore, public expenditure should also be directed towards meeting the immediate needs
of the economy, so as to raise agricultural and industrial production, and to increase the
production of essential consumer goods.

Rise in growth rate of the economy. Public expenditure on the establishment of heavy and basic
goods industries in the initial periods increases the growth rate of the economy. But investment in
the capital goods sector may increase production in the long run. Therefore, public expenditure
should also be directed towards meeting the immediate needs of the economy, so as to raise
agricultural and industrial production, and to increase the production of essential consumer goods.

Increase in employment, income and production. Public expenditure on economic and social
overheads provides larger employment opportunities, raises incomes and, above all, the productive
capacity of the economy.

Increase in revenue and profit. To increase the production of certain essentials commodities,
to end private monopoly in various spheres, and to control the "commanding heights" of the
economy, the state starts public enterprises. These bring revenue to the government and profits.

Reduction in inequalities. Public expenditure tends to lessen inequalities of income and wealth
by raising the earning capacity of the people. This is done by providing educational facilities and
through skill formation

Help to private enterprise. Public expenditure helps in encouraging private enterprise by

establishing state-owned financial and banking institutions to provide cheap credit.

Regional balance. Public expenditure helps in bringing about regional balance in the economy
by diversifying industries in backward and less developed areas of the country. Thus public
expenditure is one of the important instruments for economic development.
4.6 Growth of Public Expenditure

There has been a phenomenal increase in public (centres, state and civic bodies) expenditure
over the years. The following reasons are given for this.

Expansion of state activities. Adolph Wagner, a German economist, writing in 1883 propounded
the law of Ever-increasing state activity. According to Wagner, public expenditure increases in
response to the law of increasing expansion of public activities. He maintained that there is a
persistent tendency both toward an intensive and expensive increase of state functions and
activities. New duties are being continuously undertaken and old ones are being performed on a
large scale. As a result, public expenditure is increasing steadily.

Internal security. Wagner also referred to the maintenance of internal security as an important
factor for the increase in government expenditure. Enforcement of law and order for maintaining
peace and security has led to the expansion of legal and administrative systems and police force.
These have led to the increase in public expenditure.

Defence. Every country pays greater attention to its defence preparedness against foreign attacks.
As a result, public expenditure on equipping its armed forces with the latest armaments has
increased. As Adam Smith said long ago, Defence is better than opulence." So public expenditure
on defence is essential.

Welfare activities. Wagner wrote about the increase is public expenditure due to the expansion of
cultural and welfare activities of the state. Modern states are welfare sates which provide free
education, medical facilities, and social security measures, maintain historical monuments,
museums and public libraries, and encourage cultural, sports and health programmes.
Consequently, public expenditure has tended to increase.

Population increase. The increase in population on account of better health and medical
facilities leading to reduction in death rates has resulted in increasing public expenditure on the
people. The state has to spend more on roads, railways, schools, colleges, houses, etc.
Urbanization. With the growth of population, there is migration of population form rural to urban
areas in search of employment. Existing cities expand and new cities come up. These require huge
public expenditure in schools, parks, zoos, houses, etc. Simultaneously, the expenditure on civic
administration also increases.

Price Rise. In modern times, prices have a tendency to rise continuously with the increase in the
growth rte of the economy. As a result, the government expenditure on goods and services
increase. The rise in the cost of living further increases government expenditure by way of higher
salaries and enhanced D.A. to its employees in various civil and military departments.

Economic Development. Modern governments are engaged in the development of their

economies. They spend large sums on infrastructural facilities, on research and development in
various fields, on the development agriculture and industry, on the development of public sector,
etc. This has led to the increase in public expenditure.

Public Debt. The state borrows both internally and externally to meet its eve increasing public
expenditure. This further raises public expenditure in the form of repayment of loans and interest
charges.

Burden of democracy. Modern governments are democratic in nature. Countries are run on a
multi-party system with elections after four or five years.

Often governments fail due to lack of majority in the parliament. This necessitates frequent
elections. This tends to increase public expenditure. Further, there are "pressure groups'" and
"interest groups" within the parliament which want allocation of government funds for providing
public services in their constituencies. Moreover, according to the World Bank, wide spread
corruption in democratic countries has increased public expenditure manifold.

4.7 Development Expenditure Of Developing Economies

Development expenditure refers to public (government) expenditure of developing the economy.

The development expenditure of modern developing economies consists of expenditure on:
  Social services. Like education, health, social security and others;
 Economic services like agriculture, industries, minerals fuel and power, transport and communication and
others
 Community services such as roads and bridges, sanitation and others.
 On the other hand, the non-development expenditure of modern developing economies includes.
 Expenditure on general services such as defence, justice, police and general administration;
 Expenditure on unallocable and other purposes such as interest on public debt.

But in these countries, these two types of expenditure cannot be placed in water-tight
compartments. This is because without expenditure on defence, police etc., it is not possible to
keep up the pace of development if there is aggression from outside an unrest from within the
country. Unless there is peace on the boarders and protection of life and property within the
country, economic development is not possible. Similarly, interest on public debt may also be
regarded as development expenditure. This is because governments of developing counties borrow
both internally and eternally mainly for development purpose.

4.8 Role of Development Expenditure in a developing economy.

The role of development expenditure in a country lies in increasing the growth rate of the
economy, providing more employment opportunities, raising incomes and standard of living,
reducing inequalities of income and wealth, encouraging private initiative and enterprise, and
bringing about regional balance in the economy.

a) Heavy and basic goods industries.

Development expenditure on the establishment of heavy and basic goods industries in the initial
period increases the growth rate of the economy. But investment in the capital goods sector
increases production in the long run.
b) Consumer goods and raw materials.

To meet the immediate needs of the economy, development expenditure should be directed
towards increasing agricultural productivity to meet the growing demand for goods and raw
materials, and increasing the supply of consumer goods by encouraging establishment and
expansion of the small industries sector which may also provide sufficient employment
opportunities. The growth rate of the economy can be increased only when public expenditure
fulfills the short-term and long-term objectives of the development plan. Moreover, to prevent
inflationary tendencies within the economy, the public expenditure should secure a balance
between demand and supply of goods.

c) Economic overheads.

Economic overheads are such public works as roads, railways, canals, power project, etc. When
the government spends on such project, it provides employment to millions of an employment
people in underdeveloped countries. The provision for such services helps to increase production,
trade an commerce. As a results, employment and incomes increase.

d) Social overheads.

Development expenditure on social overheads like education, public health, cheap housing, etc,
makes the people healthier and efficient. It is the state which can create the "critical skills" needed
for rapid development by investing in human capital.

e) Allocation of resources.

Development expenditure helps in improving the allocation of resources towards desired channels.
In order to remove scarcities of food product, the state opens fair price shops and may even
subsidise food for the working classes to maintain their health and efficiency. It may fix minimum
prices for food grins, and through state trading and creation of buffer stocks encourage farmers to
produce more.
f) Public enterprises.

To increase the production of certain essential commodities to and private monopoly in various
spheres of production, and to supplement private enterprise, the sate may start public enterprises.
the services, to developed and conserve natural resources, to establish basic and key industries
like heavy electrical, chemicals, fertilizers, machine tools, defence production, etc, to undertake
state trading, etc.

g) To stimulate private enterprise.

Development expenditure helps in stimulating private enterprise through the establishment of

state-owned financial and banking institutions t provide chap credit of farmers, small and large
industries, traders, etc, development expenditure also encourages the agricultural and industrial
sectors of the economy by means of grants, subsidies, tax exemptions, etc. Moreover, when the
state spends on the creation of economic and social overheads like power, transport, education,
etc., they pave the ay for the establishment and expansion of the private sector. The creation of
the infrastructure leads to external economies that are reaped by the private sector.

h) To remove inequalities.

Developing counties are characterized by extreme inequalities of income and wealth.

Development expenditure tends to lessen them. Expenditure on education, public health and
medical facilities helps n human capital formation. As a result, the earning power of he working
populating is enhanced. As economic development proceeds rapidly through rising public
expenditure, the barriers to upward mobility are removed. Occupations expand and spread,
providing more jobs to the people. With acquisition of skills, the level of wages tends to rise
within the economy. Moreover, industrialization increases the share of wages and decreases the
share of profits in national income in the long run, and the gap between higher and lower incomes
is narrowed.

i) To remove regional imbalance.

Development expenditure helps to remove regional imbalance in the economy. if things were left
to market forces, commerce, banking, industries and almost all the main activities would be
localized in a few selected regions, and the rest of the economy may be in a state of
perpetual backwardness, as was the case developed areas and backward regions can be
developed by staring a certain projects like building a dam, digging a canal, starting new
industries, etc. Such project will not only promote but also secure larger employment
opportunities, thereby increasing per capita output and income of such areas in developing
countries.