Public Expenditure : Theories of public expenditure; causes of growth of public expenditure and its impact on economy; internal and external borrowings.

September 30, 2024 by rawan239

Public expenditure is spending made by the government of a country on collective needs and wants such as pension, provision, infrastructure, etc. Until the 19th century, public expenditure was limited as laissez faire philosophies believed that money left in private hands could bring better returns.

In democracy, public expenditure is an expression of people’s will, managed through political parties and institutions. At the same time, public expenditure is characterised by a high degree of inertia and law-dependency, which tempers the will of the current majority.

Main objective of Public expenditure is to reduce the inequality of income. Expenditure on old age pensions, unemployment relief, free education, free mid-day meals etc. benefits the poorer classes of the community at the expense of the rich.Other objectives are:-

1. Provide social goods
2. Remove unemployment
3. Increase Production
4. Exploitation and Development of Mineral Resources
5. Promote Price Stability
6. Promote Balanced Growth
7. Reduce Inequality of Income

Wagnar’s law or “The Law of Increasing State Activity” states that “as the economy develops over time, the activities and functions of the government increase”.

According to Adolph Wagner, “Comprehensive comparisons of different countries and different times show that among progressive peoples (societies), with which alone we are concerned; an increase regularly takes place in the activity of both the central government and local governments constantly undertake new functions, while they perform both old and new functions more efficiently and more completely. In this way economic needs of the people to an increasing extent and in a more satisfactory fashion, are satisfied by the central and local Governments.”

Wagner explained his theory based on following bases:-

During industrialization process, public sector activity will replace private sector activity. State functions like administrative and protective functions will increase.
Governments needed to provide cultural and welfare services like education, public health, old age pension or retirement insurance, food subsidy, natural disaster aid, environmental protection programs and other welfare functions.
Increased industrialization will bring out technological change and large firms that tend to monopolize. Governments will have to offset these effects by providing social and merit goods through budgetary means.

Colin-Clark forwarded his view through “Public Finance and changes in the value of Money” about the growth of public-expenditure. According to them the share of government sector exceed 25% of the total economic activity in the economy, inflation occurs even in the balanced budget. In this connection his opinions are;

“When the government’s share of the aggregate economic activities reaches the critical limit of 25% the community behavior pattern changes and people produces less since incentive are harmed by the fact that increasing proportions of additional income must be paid in taxes under progressive tax system.”

Dalton’s Principle of Maximum Social Advantage – maximum satisfaction should be yield by striking a balance between public revenue and expenditure by the government. Economic welfare is achieved when marginal utility of expenditure = marginal disutility of taxation. He explains this principle with reference to

Maximum Social Benefit (MSB)
Maximum Social Sacrifice (MSS)

Peacock and Wiseman analyze the process of growth of public expenditure in terms of three different but related concepts; displacement, inspection and concentration effects. By the empirical analysis of the data of Britain on public expenditure, they were able to establish the relative growth of public sector expenditure in that country occurred on “step-like” pattern rather than on “continuous growth” pattern.

Musgrave and Rostow’s Development Model suggested that the growth of public expenditure might be related to the pattern of economic growth and development in societies. Three stages in the development process could be distinguished:

(a) The early development stage where considerable expenditure is required on education and on the infrastructure of the economy (also known as social overhead

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capital) and where private saving is inadequate to finance this necessary expenditure (in this stage, government expenditure must thus be a high proportion of total output);

(b) The phase of rapid growth in which there are large increases in private saving and public investment falls proportionately; and

(c) High income societies with increased demand for private goods which need complementary public investment (e.g. the motor car and urbanisation).

In recent years government expenditure is increasing faster than their ability to raise resources, because now their activities are not so restricted as only to maintain law and order and protect the country against external aggression. Therefore, when expenditure exceeds revenue, a deficit arises in the budget of the government. This deficit can be bridged by raising the revenue from taxation (by increasing the existing rates or by imposing new taxes) or by borrowing from the public. Both in developed and developing countries there are certain limits beyond which the taxation rates cannot be raised without adverse effects on the investment level or production and consequently on the rate of economic growth. Further, it taxes the rich and the poor alike which is not desirable for the welfare of any community.

Public Debt

Public debt is the total financial obligations incurred by the entire public sector of a nation, including guarantees and implicit debt. Public debt would include obligations evidenced by a legal instrument issued by the Central, State, Municipal, or Local Government or Enterprises owned or controlled by the Government; and other entities considered public or quasi public.

Internal debt refers to rupee-denominated debt, consisting of marketable securities (dated securities, treasury bills) and non-marketable securities (14 days Intermediate Treasury Bills, compensation and other bonds, securities issued to international financial institutions etc.).

External debt refers to the debt raised by the Union Government from non-domestic sources, namely, multilateral institutions like the International Bank for Reconstruction and Development (IBRD), International Development Association (IDA), Asian Development Bank (ADB) etc. or bilateral sources, i.e., directly from the foreign countries.

Liabilities in the Public Account (referred to as ‘other liabilities’) include National Small Savings Fund (NSSF), Provident Funds, Reserve Funds and deposits and special bonds issued to oil marketing companies, fertilizer companies and Food Corporation of India. ‘Other liabilities’ are not included in the public debt.Total liabilities reported in the budget documents of the Central Government have been adjusted so that the outstanding debt truly reflects the outcome of fiscal operations of the Central Government.