Lecture on Public Finance Econ 301

B DEVS AND BDFIN THIRD YEAR started from August 14,2012

Lecture I

Introduction of students and the teacher

Overview of the Course What is Public Finance ? Expenditure, Revenue, Deficit which is met from Foreign aid , Borrowing ( Internal and External loan )and printing of notes. Financial System and the role of Nepal Rastra Bank (central Bank), Monetary Policy

Lecture 2

Participation of students is needed and ensured. In order reinforce student participation, two students are asked to summarise the lecture.

Example given from the students field visit : how they plan ( Program and activities) , how they budget ( budget ceiling, item wise expenditure ) and how they monitor(each evening presentation of the findings and correction of activities if required ) and account keeping and paper work and evaluation ( Final presentation and assessment by the teachers).

Objective To give exposure in the field –real world

Mission To give them opportunity to explore the life in the field

Vision To give them chance to interact with the government officials and the people at the grassroot level about their work , lifestyle and social and economic condition.

Plan consists of

1

a) Activities b) Budget c) Monitoring and evaluation

Activities are What When How and Where, Detail action Plan is needed which is measurable and monitorable.

Activities are translated into financial terms. How to spend and where the resources are collected from.

Monitoring and Evaluation is to keep track of progress and enable us to correct the course of implementation, if necessary.

Plan is the reflection of people’s want.

Budget is the modyfing factor of the want , it means availability of money and resources determine whether the plan and activities are realistic or not. Monitoring and evaluation are the stock taking of the capability of implementation and opportunity for the correction of the course of action.

Relate this student experience in the field visit to the subject matter of the Public Finance.

Lecture 3

How do you allocate Rs 500,000 if you get it from your father or mother or brother or sister

Submit Expenditure Plan . Why did you select the expenditure head and how did you allocate expenditure amount. Give justification.

Public Goods vis a vis Private Goods

Private Goods : Exclusivity, Price, divisibility, Property Rights, profit motive

2

Public Goods : Non exclusivity, Marginal cost zero, no price, benefits jointly and equally shared. One persons partaking of benefits does not reduce the benerits available to others Air pollution control, Radio Fm Mountains etc.

Since goods are available to all , consumers are not willing to pay. The cost of the social goods is borne by the government.

Its significance and implication in the economy

Public goods vis a vis Private goods

Public goods

1 Benefits to which social goods give rise are not limited to one particular consumer who purchases the goods. It is jointly and equally consumed by the beneficiaries.

2. One person’s partaking of benefits does not reduce the benefits available to others > Air pollution control. One person consumes the goods, it is not possible to prevent others from consuming it.( Excludability)

3 Indivisibility Public goods can not be divided into pieces.

4There is no property rights

5 Since goods are available to all , consumers are not willing to pay. The cost of the social goods is borne by the government.

Private Goods

3

Property rights

Exclusivity ( Exclude those who cannot pay the price)

Price

Rivalry.

Profit motive

The Lecture is based on H L BHATIA “ Public Finance” page 2

Musgrave and Musgrave Page 7

Lecture 4

Discuss the Great Depression 1929-33. Role of the Government in the economy- Laissez Faire Vis a Vis Modern Keynesian view.

Great Depression 1929-1933

Two significance of the Great Depression – Human suffering and the change in the government behavior in the field of public finance.

Started in USA, Stock Market Crash on October 29, 1929

Americans lost 30 percent of the share price in a single day.

Price of Stock plummeted by a huge margin

International trade plunged by half to two third as did personal income, tax revenue, prices and profits

Construction was virtually halted in many countries

4

Crop prices fell by roughly 60 percent.

Primary sectors such as farming , mining, logging suffered the most/

As personal income declined, consumers cut back their expenditure

Unemployment was high and there were few other jobs

Protectionist policy of the USA and retaliatory tariffs in other countries exacerbated which led to the collapse of the global trade.

The non-interventionist policy of the previous years was changed to active government intervention. There was increase in government expenditure( deficit financing), subsidy to the farmers, welfare expenditure.and Acts to regulate the economy

It is said that “ The great depression caused government intervention ,government regulated economy , and the establishment of the welfare state. “ It gave human face to the government policy.

Source of information “The Great Depression” in Wickipedia

First Five Year Plan of the USSR in 1928, which was the first attempt in the economic history of the World to coordinate the economic and budget policies at the macro level with a view to expedite the rate of economic growth.

Lecture 5

Theory of Public Expenditure ,

Classical Economists ( Adam Smith 1776 “ The Wealth of Nations”) were of the view that least interference from the government is desirable in the economic development of a nation.

5

The Laissez Faire economists had a dominant role in those days .But this view was jolted and was forced to revise after the Great Depression of 1929-1933. The active role of the government was acknowledged and recognized , so the Keynes views prevailed. When the Welfare Economics was propounded, the state’s role as an investor, regulator, and welfare was paramount.

The starting point for the expenditure theory is the failure of the market mechanism of the laissez faire economy. H . L .BHATIA pages 218-225

First Theory Range of public expenditure in the context of public goods and private goods. Production of road, bridges, hospital, schools, telecommunication, hydropower etc.

Ratio of government expenditure to GDP. It is a question of size of the budget which is determined through the principle of maximum Social Advantage.

Second Theory. It asks the question what public expenditure wants to achieve for the members of the society. What are the objectives ? –

A Critical minimum needs like law and order,justice, peace

B Growth

C Distributional justice( Equity, poverty alleviation, regional development, gender equity)

D Welfare. .

Criticism : It is difficult to identify the needs of the society. This question is addressed through vote.

6

Canons of Expenditure H . L .BHATIA pages 233-235

Judicious use of public funds with associated legal propriety needs to be ensured.

1Canon of Economy .The Government uses resources directly or places at the disposal of the society. There should be no wastage, Do not spend more than what is necessary2 Canons of Sanction No public funds should be used without proper authorization .Further that funds must be used only for the purpose for which they have been sanctioned3 Canon of benefit Public fund should be spent only if it is beneficial to the society. It is the principle of maximum social advantage. Allocation is made in different heads of expenditure.4 Canon of Surplus. Avoid deficit budgeting

Lecture 6

Increasing Public Expenditure Why?

Wagner’s Law of Increasing State Activities H . L .BHATIA pages 219

Mushgrave and Mushgrave “ Public Finance”

Adolph Wagner born in 1835 died in 1917 examined historical facts, primarily of Germany. According to him, there are inherent tendencies for the activities of different layers of a government to increase both intensively and extensively. There is a functional relationship between growth of the economy and the government

7

activities with the result that the government sector grows faster than the economy.

A number of reasons can be enumerated for this inherent long-term tendency recorded in history.

1.An expansion in the traditional functions of the state. Defence is increasingly more expensive.

2. State activities were increasing in coverage. Pensions, subsidy, direct provision of merit goods .

3 Expand the provision of public goods. Government investment in these activities.( road ,bridges, investment etc)

Wagner’s Law was based upon historical facts. It emphasized on the long term trend rather than short term changes in the public expenditure. He assumed that the economy functions smoothly without social disturbances.

Additional factors which contribute to the tendency of increasing public expenditure relate to the growing role of the state.

i. Growing population so make provisions for school , health facilities, drinking water

ii. Increasing urbanization – traffic , roads etc.iii. The size and nature of public services necessitates an

ever increasing specialization.iv. Protect the economy from the failures of the market

economyv. Public debtvi. Capital accumulation

8

vii. Vested interests to develop which demand an increase in public expenditure for own benefit

viii. Government bureaucracy has a tendency to expand.

Wiseman- Peacock Hypothesis H . L .BHATIA pages 223

Second thesis dealing with the growth of public expenditure was put forth by Jack Wiseman and Allan T. Peacock.,in the book “The Growth of Public Expenditure in the United Kingdom, 1890-1955”

The main thesis is that public expenditure does not increase in a smooth and continuous manner, but in jerks or step like fashion. At times, some social or other disturbance takes place, creating a need for increased public expenditure which the existing public revenue cannot meet.

Displacement Effect : The movement from the older level of expenditure and taxation to a new and higher level is the displacement effect/

Inspection effect: The inadequacy of the revenue as compared with the required public expenditure creates an inspection effect. Need to review the revenue position and the need to find a solution of the important problems that have come up and agree to the required adjustment to finance the expenditure. They attain a new level of tax tolerance. They are now ready to tolerate a greater burden of taxation and as a result the general level of expenditure and revenue goes up.

Thus each major disturbance leads to the government assuming a larger proportion of the total national economic activity.

9

Concentration Effect. Above mentioned fact is also called concentration effect.

Both of them are emphasizing the recurrence of abnormal situations which cause sizeable jumps in public expenditure and revenue.

Madhab Ghimire

10