public spending

SOCIO -ECONOMIC IMPACT

25-Oct-13Public Spending 1

Public Spending

Based on Case Study: “Diminishing Marginal Returns to State Spending”

Presented by:Swapnil Soni & Anand Gupta

Master of Management-I SemIndian Institute of Science

2Public Spending

Index

Facts of the Case Study

Introduction to Public Spending

Development history of Public Spending

Factors deciding Public Spending

Returns on Public spending - Increasing & Diminishing

Negative Returns on Public spending

Revenue Churning

Politicians in Public Spending

Optimal level of Public Spending

References25-Oct-13

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Facts of the Case

Public spending (PS) is the major state governed economic catalyst to socio-economic change in the country.

Although PS has been considered to yield proportionate growth & development of country but recent studies indicate diminishing returns & sometimes negative return to it.

In 1870 government of developed countries with PS being 8% of GDP confined itself to limited number of activities such as defense and law.

PS rose to 15% of GDP by 1920. The higher taxes that was introduced to pay for the 1st World War allowed government to maintain higher spending.

By 1937 the average for industrial countries reached nearly 21% of GDP to combat The Great Depression.

The 3 decades after the Second World War witnessed the largest increase in public spending mainly reflecting the expansion of welfare state.

Since 1960, countries with lower PS have relatively lower unemployment, greater efficiency and innovation and higher level of registered Patents.

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Introduction to Public SpendingDefinition of Public Spending Government acquisition of goods and services for current use

to directly satisfy individual or collective needs of the members of the community is classed as government final consumption expenditure.

Government acquisition of goods and services intended to create future benefits such as infrastructure investment or research spending, is classed as government investment.

Fiscal tool of government for economic welfare of country

Measure of Return on Public Spending Ultimate Return on Public Spending is economic growth &

welfare that can be measured by: GDP growth Unemployment rate Inflation rate

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Keynesian economics Classical economists

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Public Spending

Loss of Resource

Economic Contraction

Public Spending

Aggregate Demand

Production accretion

Favorable Offshoots Adverse Offshoots

Criticism by two schools of thoughts

http://en.wikipedia.org/wiki/Keynesian_economics

http://en.wikipedia.org/wiki/Classical_economists

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Economist asserted: A severe recession or depression may never end if the government does not intervene.

The Great Depression was ended by government spending programs such as the New Deal (Relief, Recovery & Reform) between 1933 & 1940 and military spending during World War II.

Obamacare- a health insurance initiative by Democratic party although opposed by Republican & tended US Govt Shut down for a short period.

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Role of Government

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Finance for Public Spending Government revenue

Taxes Non-tax revenue (revenue from government-owned corporations,

sovereign wealth funds, sales of assets, or Seigniorage) Government borrowing Printing of Money or Inflation

Application of Public Spending(Harmonizing the wealth distribution & Capping the Financial crisis) Public Goods & Services -Health, Education & Defense (non-exclusive &

non-rivalry)

Externalities – promoting positive & curbing negative Monopolies – uniform distribution of Resources to avoid dead weight

loss

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8Public Spending


Role of Public Spending in Economy cycle

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Rank CountryTax burden % GDP

Govt. expend. % GDP

Top 5 countries

1 Kiribati 39.0 114.6

2 Zimbabwe 31.7 97.8

3 Timor-Leste 24.6 97.0

4 Cuba 41.2 78.1

5 Maldives 21.0 63.1

Other countries

23 United Kingdom 38.9 47.356 United States 26.9 38.9111 India 18.6 27.2147 China 18 20.8

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(2011 Index of Economic Freedom by The Heritage Foundation and The Wall Street Journal)

Statistics of Public Spending

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Development history of Public Spending

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Development history of Public Spending (in context of Developed countries)

Pre-World War I 1870: at beginning only 8% of GDP & limited to Defense, Administration, law

& order But late 1870 Spending increased to 11% 1913: increased to 13%Slow growth of Public Spending

Post-World War I 1920: increased to 20%Rapid growth of Public Spending due to Military & Warfare spending

Pre-World War II 1937: increased to 24%

Post-World War II 1960: increased to 24% 1996: increased to 45%

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Factors deciding Public Spending Public spending is a dependent variable on numerous external &

internal factors important to be observed for budgeting to attain the optimal level of Return. Economists- Aschauer, Peterson, Wagner, Hosley, Francis etc- have given numerous factors, Some major are:

Time World war-I & II directed PS an unpredicted way of growth

Technology Emergence of latest technology & lack of it decides portion of GDP in PS

Geography Availability of resources that are opportunity for investment incite PS

Demography Desire of population for growth & sacrifice for it

Financial strength PS differs in Developed & Developing countries

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IN WHAT AREA PUBLIC SPENDING DO THERE APPEAR TO BE INCREASING RETURN?


Question-1


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Returns on Public spending

S.N. COUNTRY

1970-1980 1980-1990 1990-2000 2000-2010

Public Spending

GDP growth(average

real)Public

SpendingGDP growth

(average real)

Public Spending

GDP growth(average

real)Public

SpendingGDP growth

(average real)

% of GDP % % of GDP % % of GDP % % of GDP %DEVELOPED COUNTRY Diminishing Return

1 United States 30.0% 3.1% 31.4% 2.9% 32.8% 3.4% 32.4% 1.6%2 Canada 34.0% 4.0% 38.8% 2.8% 46.0% 2.4% 44.7% 1.8%3 France 42.6% 2.9% 46.1% 2.4% 49.8% 1.7% 55.0% 1.2%4 Germany 41.4% 2.7% 47.9% 2.3% 45.1% 2.3% 49.1% 0.9%5 UK 37.6% 1.6% 43.0% 2.7% 39.9% 2.8% 43.0% 1.5%6 Japan 26.3% 4.3% 32.0% 4.0% 31.3% 1.3% 35.0% 0.8%

DEVELOPING COUNTRIES Increasing Return1 India 12.3% 3.9% 9.0% 5.9% 16.0% 5.6% 14.4% 7.5%2 China 27.2% 10.4% 16.6% 9.1% 13.6% 10.4% NA 10.5%3 Indonesia 2.1% 8.4% 18.4% 5.4% 17.9% 4.0% 18.1% 5.3%

4 Philippines 13.4% 6.6% 19.6% 1.7% 20.4% 3.0% 21.4% 4.7%

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Statistical analysis of Return on Public Spending

Source: www.worldbank.org

http://www.worldbank.org/

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Developing Countries with Increasing Return

1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 12.3% 9.0% 16.0% 14.4%

GDP growth 3.9% 5.9% 5.6% 7.5%

1%3%5%7%9%

11%13%15%17%

12.3%

9.0%

16.0%14.4%

3.9%5.9% 5.6%

7.5%

India

1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 13.4% 19.6% 20.4% 21.4%

GDP growth 6.6% 1.7% 3.0% 4.7%

3%

8%

13%

18%

23%

13.4%

19.6% 20.4% 21.4%

6.6%

1.7%3.0%

4.7%

Philippines

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1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 27.2% 16.6% 13.6% #FMT

GDP growth 10.4% 9.1% 10.4% 10.5%

3%

8%

13%

18%

23%

28%27.2%

16.6%13.6%

10.4% 9.1% 10.4% 10.5%

China

Developing Countries with Increasing Return

1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 2.1% 18.4% 17.9% 18.1%

GDP growth 8.4% 5.4% 4.0% 5.3%

1%3%5%7%9%

11%13%15%17%19%

2.1%

18.4% 17.9% 18.1%

8.4%

5.4%4.0%

5.3%

Indonesia

IN WHAT AREA PUBLIC SPENDING DO THERE APPEAR TO BE DIMINISHING OR NEGATIVE RETURN?


Question-2


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Developed Countries with Diminishing Return

1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 30.0% 31.4% 32.8% 32.4%

GDP growth 3.1% 2.9% 3.4% 1.6%

3%

8%

13%

18%

23%

28%

33% 30.0%31.4%

32.8% 32.4%

3.1% 2.9% 3.4%1.6%

United States

Major Areas of Public Spending:Defence- 14%Education- 15%Pension-16%Welfare-12%Others- 24%

Results of Public Spending:•Increasing in unemployment rate•More Tax burden•More Government borrowing•Economic crisis

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1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 34.0% 38.8% 46.0% 44.7%

GDP growth 4.0% 2.8% 2.4% 1.8%

3%

13%

23%

33%

43%34.0%

38.8%46.0% 44.7%

4.0% 2.8% 2.4% 1.8%

Canada

1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 42.6% 46.1% 49.8% 55.0%

GDP growth 2.9% 2.4% 1.7% 1.2%

5%

15%

25%

35%

45%

55%42.6%

46.1%49.8%

55.0%

2.9% 2.4% 1.7% 1.2%

France

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1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 41.4% 47.9% 45.1% 49.1%

GDP growth 2.7% 2.3% 2.3% 0.9%

5%

15%

25%

35%

45%

55%41.4%

47.9% 45.1%49.1%

2.7% 2.3% 2.3% 0.9%

Germany

1970-1980 1980-1990 1990-2000 2000-2010

Public Spending 37.6% 43.0% 39.9% 43.0%

GDP growth 1.6% 2.7% 2.8% 1.5%

5%

15%

25%

35%

45%37.6%

43.0%39.9%

43.0%

1.6% 2.7% 2.8% 1.5%

United Kingdom

EXPLAIN DIFFERENCE BETWEEN DIMINISHING & NEGATIVE MARGINAL RETURNS IN CONTEXT OF PUBLIC SPENDING


Question-3


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Statistical analysis of Negative Return on Public SpendingIncrease in Unemployment Rate vindicates the Negative Return on Public Spending in Educational development sector


S.N. COUNTRY

2008 2009 2010 2011

Public Spending

on Education

Unemployment Rate

Public Spending

on Education

Unemployment Rate

Public Spending

on Education

Unemployment Rate

Public Spending

on Education

Unemployment Rate

% of GDP % % of GDP % % of GDP % % of GDP %

DEVELOPED COUNTRY Negative Return1 United States 5.5% 10.6% 5.4% 16.3% 5.6% 29.0% NA 31.3%

2 Canada 4.8% 6.7% 5.0% 7.5% 5.5% 11.5% NA 12.9%

3 France 5.6% 7.0% 5.9% 34.8% NA 39.8% NA 41.1%

4 United Kingdom 5.4% 24.0% 5.6% 24.4% 39.9% 32.6% NA 33.4%


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2008 2009 2010 2011

PS on Education 5.5% 5.4% 5.6% 0.0%

Unempl. Rate 10.6% 16.3% 29.0% 31.3%

3%

8%

13%

18%

23%

28%

33%

5.5% 5.4% 5.6%

0.0%

10.6%

16.3%

29.0%31.3%

United States

2008 2009 2010 2011

PS on Education 4.8% 5.0% 5.5% 0.0%

Unempl. Rate 6.7% 7.5% 11.5% 12.9%

1%

3%

5%

7%

9%

11%

13%

4.8% 5.0% 5.5%

0.0%

6.7%7.5%

11.5%12.9%

Canada

2008 2009 2010 2011

PS on Education 5.6% 5.9% 0.0% 0.0%

Unempl. Rate 7.0% 34.8% 39.8% 41.1%

3%

13%

23%

33%

43%

5.6% 5.9%0.0% 0.0%

7.0%

34.8%39.8% 41.1%

France

2008 2009 2010 2011

PS on Education 5.4% 5.6% 39.9% 0.0%

Unempl. Rate 24.0% 24.4% 32.6% 33.4%

3%8%

13%18%23%28%33%38%43%

5.4% 5.6%

39.9%

0.0%

24.0% 24.4%

32.6% 33.4%

United Kingdom

EXPLAIN WHAT IS MEANT BY REVENUE CHURNING.


Question-4


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Revenue Churning

A transfer is churned when at least the same level of voter satisfaction could have been achieved by lowering the voter's tax burden by the amount of the transfer.

The familiar example of churned transfers is that of the middle class which is taxed, then given back a significant portion of those taxes in the form of social security benefits or unemployment insurance.

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Money taken from the people in taxes is often returned to the same people in terms of improving desired infrastructures- development of transport, schools, medical aids etc.

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Revenue Churning

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Statistical analysis of Revenue Churning by juxtaposition of Tax revenue & Public Spending

S.N. COUNTRY

1990-2000 2000-2010

Public Spending Tax Revenue Public Spending Tax Revenue

% of GDP % of GDP % of GDP % of GDP

DEVELOPED COUNTRY

1 United States 32.8% 12.1% 32.4% 12.5%

2 Canada 46.0% 14.4% 44.7% 15.2%

3 France 49.8% 22.1% 55.0% 23.2%

4 Germany 45.1% 11.0% 49.1% 10.9%

5 United Kingdom 39.9% 27.0% 43.0% 28.3%

DEVELOPING COUNTRIES

1 India 16.0% 8.7% 14.4% 10.1%

2 China 13.6% 6.8% NA 8.5%

3 Indonesia 17.9% 11.6% 18.1% 11.8%

4 Philippines 20.4% 12.8% 21.4% 12.6%



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Revenue Churning

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1990-2000 2000-2010

Public Spending 32.8% 32.4%

Tax Revenue 12.1% 12.5%

3%

8%

13%

18%

23%

28%

33%32.8% 32.4%

12.1% 12.5%

United States

1990-2000 2000-2010



3%

13%

23%

33%

43%

46.0% 44.7%

14.4% 15.2%

Canada

1990-2000 2000-2010



1%3%5%7%9%

11%13%15%17% 16.0%

14.4%

8.7%10.1%

India

1990-2000 2000-2010



1%3%5%7%9%

11%13%15%17%19% 17.9% 18.1%

11.6% 11.8%

Indonesia

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Revenue Churning

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Taxation & Dead weight loss Tax tends to dichotomize the supply curve into customer’s & supplier’s share of tax creating a zone of dead weight loss

Revenue churning & political inefficiency•An efficient pattern of transfers is one in which the needless deadweight losses a government imposes on its subjects do not persist.

•Deadweight losses are not necessarily a sign that a government is politically inefficient.

•Deadweight losses may simply reflect the reality that taxes are difficult to raise without causing large shifts in consumption and effort.

•The funds raised at high cost though may be buying something useful to the public, such as roads or care for the poor.

•But when the funds provide no useful service one can begin to ask whether resources are being wasted.

WHY DO POLITICIANS HAVE LITTLE INCENTIVE TO SPEND PUBLIC MONEY WISELY?


Question-5


30Public Spending

Politicians in Public Spending

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•Fiscal policy is governed by politicians only

•Politicians and bureaucrats are in charge of spending money of the faceless, nameless taxpayer, who has no direct control over how the money is spent. And therefore, they have very little incentive to spend it wisely

•Taxpayer has no direct say in how the money is spent. The taxpayer can’t cut the government off if he/she doesn’t like how the money is spent

•since government decision makers are not spending their own money, and are not directly accountable to anyone whose money is being spent, they have little incentive to:

Hire qualified workers and fire unqualified workers. Make sure contractors don’t over charge. Economize on purchases. Initiate work on fruitful projects, and cut off wasteful ones.

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Politicians in Public SpendingStill Politicians spends public money! Why?

Government decision makers have little incentive to spend taxpayer’s money wisely, but that doesn’t mean they lack motivation for other things. Like everyone else, they are motivated to further their own personal self interests, such as their political careers and size of their bank accounts. And in doing so they tend to:

Dole out government contracts to campaign contributors, who may not be the best for the job.

Spend money so they can tell constituents they’ve brought money to their district Spend money so they can tell constituents something is being done to solve their

problems, regardless of if it actually helps. Spend all their budgets regardless of need to avoid inducing a budget cut. If a

certain department doesn’t spend its entire budget then it’s a clear signal that it can do with less, and no bureaucrats wants to be in charge of a smaller budget next year.

Examples:

One of the most famous cases of government waste was a Pentagon purchase of $600 toilet seat covers back in the early ’80s.

Another famous and more recent case is Alaska’s “Bridge to Nowhere“, a project that was allocated $320 million to build a bridge to an Island with a population of 50.

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http://www.time.com/time/magazine/article/0,9171,960748,00.html?iid=chix-sphere

http://www.heritage.org/research/budget/wm889.cfm

IS IT POSSIBLE TO TALK AB OUT OPTIMAL LEVEL OF PUBLIC SPENDING? HOW MIGHT THIS LEVEL BE DETERMINED?


Question-6


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Effect of Public Spending on Economic Welfare of Nation

AS (Aggregate Supply) & AD (Aggregate Demand) curves are functions of Price (inflation rate) & Quantity output (GDP)

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Increase in Public Spending• More income of household• More purchasing power & more Demand• Aggregate Demand curve shifts rightward (AD1 to AD4)• Inflation rate increased from point a to b• Unemployment reduced from point a to b

A country has certain maximum capacity of GDP production at certain conditions. Actual GDP below this maximum GDP level indicates unemployment . Here in considered figure gap between a to b witnesses this. To mitigate this there is requirement of money flow in economic system that gives rise to Public spending

Thus it is rational to operate between point a to b where a country has less unemployment maintaining less inflation. This gives government an optimal level of public spending.

Quote : “Working occasionally is beneficial when others are working more”

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Size of Government - Growth Curve

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If government undertake activities in the order of their productivity, at first Govt expenditure would Promote Economic growth (moves from A to B above) but additional expenditure would eventually retard growth

Reference: Institute of Market Economics by D. Chobanov & A. Mladenova in 2009

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References

Websites www.worldbank.org www.populationcommission.nic.in www.gov.uk/government/topics/public-spending www.wikipedia.com www.youtube.com

Research Papers The economic role of the state in the 21st Century By Vito Tanzi Public spending in the 20th century – a global prospective By VITO Tanzi and Ludger

Schuknicht Government spending in simple model of Endogenous growth by Robert J. Barro Public spending in developing countries by Shenggen fan & Neetha Rao Economic Growth with Optimal Public Spending by BeenLon Public Investment & Productivity growth in group of seven by David A. Aschauer

Books CFA Level-I & II by CFA institute

Tools used Microsoft Encarta (Encyclopedia for offline references) Microsoft Excel (for data analysis & graphs)

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http://populationcommission.nic.in/

http://www.gov.uk/government/topics/public-spending


http://www.wikipedia.com/



They said it….

“Increased Taxation is the Price of Growth” (James Tobin)

“Government role is not to do what individuals do but to do what they don’t” (Keynes)

“Government spending is only tool to curb Poverty” (Gabbraith)

“If goods are consumed by people then they themselves should provide the cost of those goods” (Bowens)

Thank you!

public spending

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