GOV IN ECONOMY

• Public expenditure


  Government spending for macroeconomic management, equity and equality, and correcting market failure
• Types of government expenditure

  • Capital expenditure (investment goods)
  • General government final consumption (goods/services consumed within a year)
  • Transfer payments (no corresponding output)
  • Interest payments on national debt
• The major areas of government expenditure are: defence (6%), protection (4%), education (12%), pensions (20%), welfare (15%), transport (2%) and health care (18%). 7% of all government spending is on interest repayments of loans.
• Composition and size of public expenditure

  Lower average income countries tend to have lower % of GDP spent by government due to lower tax revenue and less demand for government services. Developed countries have significant differences in size of government spending due to attitudes.
• Global Financial Crisis


  Led to huge increases in government spending on welfare and bank bailouts
• Since 2010 in the UK


  Government has followed a policy of austerity to reduce debt
• In Europe and Japan in the next decades

  Pressure on government spending due to aging populations
• Productivity and growth impacts of government spending

  • Can create economies of scale, provide infrastructure, develop human capital and R&D, and have a multiplier effect
  • Can also be wasteful and cause inefficiency according to free market economists
• Living standards impacts of government spending

  • Can correct market failure, provide public goods, reduce absolute poverty
  • Can also reduce incentives and lead to inefficient provision of goods/services
• Crowding out


  Government borrowing competes with private sector for finance, leading to higher interest rates and less private investment
• Crowding out is felt most at full employment, but transfer payments and high unemployment can lead to crowding in
• Level of taxation


  High government spending usually requires high taxes, which may have disincentive effects
• Equality impacts of government spending

  Spending can increase equality by providing a minimum standard of living and access to basic goods
• Taxation


  Used to pay for government spending, correct market failure, and manage the economy and redistribute income
• Types of taxes


  • Progressive (higher income pays higher rate)
  • Regressive (higher income pays lower proportion)
  • Proportional (same % rate regardless of income)
• Impacts of tax changes

  • Can affect incentives to work, tax revenues, income distribution, real output/employment, price level, trade balance, and FDI flows
• Automatic stabilisers


  Government spending and taxation mechanisms that reduce the impact of economic changes on national income
• Automatic stabilisers cannot prevent economic fluctuations, they just reduce the size of the changes
• The problem with lowering taxes to encourage investment is that it can be a 'race to the bottom' where countries have to continue to lower their taxes in order to make them the lowest to encourage investment; the eventual result is a fall in revenues for all countries
• Automatic stabilisers


  Mechanisms which reduce the impact of changes in the economy on national income; government spending and taxation are automatic stabilisers
• In a recession, benefits increase as more people are unemployed and so the benefits are a stabiliser as it means that the overall fall in AD is reduced, preventing too much change in the economy
• During a boom, tax increases as people have more jobs and higher incomes, and this tax reduces disposable income so decreases consumption and AD, meaning that demand doesn't grow too high
• Automatic stabilisers cannot prevent fluctuations; they simply reduce the size of these problem and there can be negative aspects to these stabilisers
• Benefits may act as a disincentive to work and lead to higher unemployment whilst high levels of tax can decrease the incentive to work hard
• Discretionary fiscal policy


  The deliberate manipulation of government expenditure and taxes to influence the economy; expansionary and deflationary policies
• National debt


  The sum of all government debts built up over many years
• Fiscal deficit


  When the government spends more than it receives that year
• The national debt can be measured in money terms or as a percentage of GDP, the GDP measure is often more useful because it gives an indication of how easy to will be for the government to finance a deficit or repay the national debt
• In 2018, the fiscal deficit is £48bn, 2.3% of GDP
• Cyclical deficit


  The part of the deficit that occurs because government spending and tax fluctuates around the trade cycle
• Structural deficit


  The fiscal deficit which occurs when the cyclical deficit is zero; it is long term and not related to the state of the economy
• Actual deficit


  The structural deficit plus the fiscal deficit
• Governments can have structural deficits, structural surpluses or structural balances
• If the government has a structural deficit, it is likely that national debt will grow over time as the government has to consistently borrow money to finance spending
• It is impossible to know what part of the deficit is structural and what part of it is cyclical, just as it is impossible to know the size of the output gap
• Factors influencing the size of fiscal deficits

  • Trade cycle
  • Unforeseen events
  • Interest rates
  • Privatisation
  • Government aims
  • Oil revenues
  • Number of dependents
• In the UK, the fiscal deficit peaked in 2010 at 10.1% of GDP
• 7% of all UK government spending is on interest repayments of loans
• The austerity policy managed to reduce the fiscal deficit by 75% since 2010
• There is a consensus view that fiscal deficits over 3% will lead to growing national debt as a proportion of GDP