Dr John MoffatRichard Price Building, Room F49Email: J.D.Moffat@swansea.ac.ukOffice Hours: Tuesday & Friday, 1:30-2:30pm
Learning Outcomes Students should be able to answer the followingquestions: What impact will increased levels of expendi...
Readings Armstrong & Taylor, chapter 2 Holtham Commission (2010), Fairness andaccountability: a new funding settlement f...
Keynesian Income-ExpenditureModel The importance of regional funding is explained by theregional multiplier which shows t...
Keynesian Income-ExpenditureModel The national income identity is:(1)where C=consumption; I=investment; G=government expe...
Keynesian Income-ExpenditureModel Substituting (2)-(4) into (1) gives:(5) Or:where:(6)is the regional multiplier The im...
Keynesian Income-ExpenditureModel To calculate the regional multiplier, we need estimatesof (c-m) which is the marginal p...
Keynesian Income-ExpenditureModel But treating investment and governmentexpenditure as exogenous is unrealistic More rea...
Keynesian Income-ExpenditureModel Substituting equations (8) and (9) along with (2) – (4)into (1) gives:(10)so:(11) Usin...
Crowding-out The Keynesian income-expenditure model assumesthat increased government expenditure does not causean offsett...
Crowding-out The Keynesian income-expenditure model also assumesthat the supply curve is horizontal and that there isther...
Crowding-out But crowding-out is unlikely to be a problem in thecontext of regional policy In relation to resource crowd...
Barnett Formula The devolved authorities receive their funding forspending on devolved areas through a block grantallocat...
Barnett Formula The change in the size of the Welsh block grant is given by:where ΔG denotes the change in nominal expend...
Barnett Formula• As spending increases, the Barnett formula shouldeventually lead to the following outcome:• Wales will re...
Barnett Formula As spending per head in the devolved regions iscurrently greater than in England (see next slide), thisim...
Identifiable Expenditure PerHead, 2006-2010 (£)2006-7 2007-8 2008-9 2009-10 2010-11North East 7,833 8,235 8,889 9,459 9,50...
Regional Expenditure Considerable anger surrounds current levels ofexpenditure per head across the regions of the UK Muc...
Regional Expenditure But is convergence of spending per head desirable? Many people advocate the distribution of publice...
Regional Expenditure The Holtham Commission (2010) undertook a needs-based assessment and calculated that Wales wasunderf...
Regional ExpenditureHoltham Commission (2010)Topic 5: UK Regional Funding 21
Regional Expenditure What does Lord Barnett think of the formula that hedevised in 1978? He said the following:“I do not ...
Regional Revenue It may be argued that, when judging whether thecurrent distribution of expenditure across the UK isfair,...
Net Regional Fiscal Balance PerHead, 2006-7Topic 5: UK Regional Funding 24Oxford Economics (2008)
Expenditure Allocation The total amount of money available for expenditureby the devolved parliaments is determined by th...
Summary The Barnett formula determines the size of the budgetfor the devolved parliaments of the UK Many people regard t...
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5 regional funding(1)

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5 regional funding(1)

  1. 1. Dr John MoffatRichard Price Building, Room F49Email: J.D.Moffat@swansea.ac.ukOffice Hours: Tuesday & Friday, 1:30-2:30pm
  2. 2. Learning Outcomes Students should be able to answer the followingquestions: What impact will increased levels of expenditure haveon regional income? How is funding distributed to the devolved regions ofthe UK? Explain why many people regard this fundingmechanism as unfair.Topic 5: UK Regional Funding 2
  3. 3. Readings Armstrong & Taylor, chapter 2 Holtham Commission (2010), Fairness andaccountability: a new funding settlement forWales, Available from:http://wales.gov.uk/docs/icffw/report/100705fundingsettlementfullen.pdf Oxford Economics (2008), Regional Winners andLosers in UK Public Finances, Available from:http://www.isitfair.co.uk/Reports/Public/OE%20UKPublicFinance.pdfTopic 5: UK Regional Funding 3
  4. 4. Keynesian Income-ExpenditureModel The importance of regional funding is explained by theregional multiplier which shows the impact of an increasein government expenditure (and other types ofexpenditure) on regional income To provide the intuition behind the multiplier, suppose theUK government decided to pay workers in Wales toelectrify the railway line between Cardiff and Swansea: This increases the income of these workers These workers spend a proportion of this income in Wales This is income to other workers in Wales These workers spend a proportion of this income in Wales And so onTopic 5: UK Regional Funding 4
  5. 5. Keynesian Income-ExpenditureModel The national income identity is:(1)where C=consumption; I=investment; G=government expenditure;X=exports; M=imports Assume for the moment that:(2) And that:where (3)(4)where c=marginal propensity to consume; m=marginal propensity toimport; t=marginal rate of taxationTopic 5: UK Regional Funding 5MXGICY000 ;; XXGGIIdcYCC 0 tYYY ddmYMM 0
  6. 6. Keynesian Income-ExpenditureModel Substituting (2)-(4) into (1) gives:(5) Or:where:(6)is the regional multiplier The impact of changes in autonomous expenditure can be calculated asfollows:(7)Topic 5: UK Regional Funding 6tmcMXGICY11)( 0000000000 MXGICkYtmck11100GkYkGY
  7. 7. Keynesian Income-ExpenditureModel To calculate the regional multiplier, we need estimatesof (c-m) which is the marginal propensity to consumelocally produced good and services This will typically be smaller when: The regional economy is smaller The regional economy is more specialised The regional economy is closer to other labour markets For Scotland, using information from input-outputtables, Harris (2009) estimates that (c-m)=0.39. If weassume that t = 0.2, then the simple Keynesianmultiplier equals 1.45Topic 5: UK Regional Funding 7
  8. 8. Keynesian Income-ExpenditureModel But treating investment and governmentexpenditure as exogenous is unrealistic More realistic specifications for investment andgovernment expenditure are as follows:where i<1 (8)where we assume that g<0 (9)Topic 5: UK Regional Funding 8diYII 0dgYGG 0
  9. 9. Keynesian Income-ExpenditureModel Substituting equations (8) and (9) along with (2) – (4)into (1) gives:(10)so:(11) Using this more realistic version of the multiplier, andhaving estimated that i=0.17 and assumed that g=-0.1, Harris (2009) calculates that k=1.58 in ScotlandTopic 5: UK Regional Funding 900000111MXGICtgimcYtgimck111
  10. 10. Crowding-out The Keynesian income-expenditure model assumesthat increased government expenditure does not causean offsetting reduction in consumption or investment This assumption will not hold if increased governmentexpenditure is financed by borrowing which in turncauses a rise in interest rates This is what is referred to as ‘financial crowding-out’Topic 5: UK Regional Funding 10
  11. 11. Crowding-out The Keynesian income-expenditure model also assumesthat the supply curve is horizontal and that there istherefore no impact on prices of increased expenditure This assumption will not hold if the economy is at or nearfull capacity In these circumstances an increase in public expenditurewill increase aggregate demand which in turn will increasewages and prices This moves the economy to a new equilibrium with highernominal wages and prices but unchanged real wages andoutput This is referred to as ‘resource crowding-out’Topic 5: UK Regional Funding 11
  12. 12. Crowding-out But crowding-out is unlikely to be a problem in thecontext of regional policy In relation to resource crowding-out, the regionaleconomy is unlikely to be at or near capacity or itwould not be a target for regional policy! Financial crowding-out will be a problem for theregion only if the region rather than the centralgovernment has to borrow to fund the increasedexpenditure or if the region is a very large part of thecountryTopic 5: UK Regional Funding 12
  13. 13. Barnett Formula The devolved authorities receive their funding forspending on devolved areas through a block grantallocation from Westminster Increases/decreases in the size of the block grant areallocated to devolved regions through the Barnettformula on the basis of: the size of the increase/decrease going to England population sharesTopic 5: UK Regional Funding 13
  14. 14. Barnett Formula The change in the size of the Welsh block grant is given by:where ΔG denotes the change in nominal expenditure onservices and W and E refer to Wales and England respectively α is given by: where POP denotes population Using ONS mid-year population estimates for 2010, an increasein expenditure of £1 billion on a devolved area in England leadsto an increase in expenditure of ((3/52) x 1 billion=) £58 millionin WalesEW GGEWPOPPOPTopic 5: UK Regional Funding 14
  15. 15. Barnett Formula• As spending increases, the Barnett formula shouldeventually lead to the following outcome:• Wales will receive a share of expenditure that isequal to its share of population• In other words, spending per head will be thesame in Wales and EnglandEWEWPPGGTopic 5: UK Regional Funding 15
  16. 16. Barnett Formula As spending per head in the devolved regions iscurrently greater than in England (see next slide), thisimplies that spending per head relative to England willfall if spending in England increases This is the so-called ‘Barnett squeeze’ But if spending falls, as it is forecast to do over the nextfew years, spending per head relative to England willrise in the devolved regionsTopic 5: UK Regional Funding 16
  17. 17. Identifiable Expenditure PerHead, 2006-2010 (£)2006-7 2007-8 2008-9 2009-10 2010-11North East 7,833 8,235 8,889 9,459 9,501North West 7,636 8,093 8,631 9,267 9,386Yorkshire and the Humber 7,033 7,332 7,867 8,462 8,512East Midlands 6,527 6,875 7,385 7,950 8,098West Midlands 7,097 7,502 8,015 8,613 8,679East 6,241 6,534 7,067 7,690 7,834London 8,352 8,806 9,355 10,146 10,198South East 6,208 6,524 7,091 7,513 7,529South West 6,531 6,896 7,481 7,977 8,096England 7,042 7,414 7,962 8,553 8,634Scotland 8,588 9,045 9,424 9,945 10,165Wales 8,260 8,609 9,144 9,726 9,947Northern Ireland 8,963 9,540 10,044 10,550 10,668UK 7,288 7,671 8,203 8,785 8,884Source: PESA (2011)Topic 5: UK Regional Funding 17
  18. 18. Regional Expenditure Considerable anger surrounds current levels ofexpenditure per head across the regions of the UK Much of this anger is directed at the fact that Scotlandreceives higher expenditure per head than Wales (andmany English regions) in spite of having, by mostmeasures, a stronger economy (see previous lecture) But, as shown above, the Barnett formula, if rigorouslyapplied, should eventually lead to convergence ofspending per head across the devolved regions andEnglandTopic 5: UK Regional Funding 18
  19. 19. Regional Expenditure But is convergence of spending per head desirable? Many people advocate the distribution of publicexpenditure on the basis of a needs-based assessment(as in, for example, Australia) A needs-based assessment would take account ofdifferent levels of demand for public goods anddifferences in the cost of providing a minimumstandard of public goods across the countryTopic 5: UK Regional Funding 19
  20. 20. Regional Expenditure The Holtham Commission (2010) undertook a needs-based assessment and calculated that Wales wasunderfunded by £400 million in 2010-11 This calculation was based on the six measures of needshown in the next slide The weighting attached to each measure of need wasdetermined by a statistical analysis of their influencein determining relative levels of expenditure acrossareas within the other countries of the UnitedKingdomTopic 5: UK Regional Funding 20
  21. 21. Regional ExpenditureHoltham Commission (2010)Topic 5: UK Regional Funding 21
  22. 22. Regional Expenditure What does Lord Barnett think of the formula that hedevised in 1978? He said the following:“I do not consider it is successful. I do not think it isfair… I thought it might last a year or two before thegovernment would decide to change it. It never occurredto me for one moment that it would last this long”(House of Lords Select Committee on the BarnettFormula, 2009)Topic 5: UK Regional Funding 22
  23. 23. Regional Revenue It may be argued that, when judging whether thecurrent distribution of expenditure across the UK isfair, the amount of revenue raised in each regionshould be taken into account Information on tax receipts is not collected on aregional basis by HMRC so the tax revenue from eachregion needs to be estimated The table in the next slide was calculated bysubtracting (estimated) revenue per head from(estimated) expenditure per head for each regionTopic 5: UK Regional Funding 23
  24. 24. Net Regional Fiscal Balance PerHead, 2006-7Topic 5: UK Regional Funding 24Oxford Economics (2008)
  25. 25. Expenditure Allocation The total amount of money available for expenditureby the devolved parliaments is determined by theBarnett Formula But the distribution of expenditure across those areasfor which they have responsibility is determined by thedevolved parliaments In other words, the ‘Barnett consequentials’ from anincrease in expenditure on, for example, health inEngland do not have to be spent on health in WalesTopic 5: UK Regional Funding 25
  26. 26. Summary The Barnett formula determines the size of the budgetfor the devolved parliaments of the UK Many people regard the Barnett formula as unfair andargue for a needs-based assessment to determine thedistribution of expenditure throughout the regions ofthe UK The devolved parliaments are free to spend theirallocations in whatever way they like across those areasfor which they have responsibilityTopic 5: UK Regional Funding 26

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