Theoretical and Empirical Analysis of Public Expenditure Growth

1. Theoretical and Empirical
Analysis of Public
Expenditure Growth

2. Introduction
• The decision about the quality and quantity of
goods and services provision is referred as Public
expenditure.
• Two distinctions are drawn, First, the costs of
goods and services through public sector budget.
• Second, rules, regulations and law introduced by government result by
private sector expenditure.

3. Introduction
• There is two broad categories of government
activity.
First
Exhaustive
public
expenditures
Purchases of
current/capital
goods and services
Second
Transfer
expenditure
s
Public expenditures
on pensions, subsidies,
debt interest etc.

4. Introduction
• Exhaustive public expenditures are purchase of inputs.
• Transfer expenditures are redistribution of resources.
• Determining the growth of public expenditures two
categories of
public expenditure are kept separately.
• Analytical model bring economic, social and political forces together.
• Two classes of modelsare discussed by this
chapteri.e. ‘macro- models’ and ‘microeconomic or decision
process models.

5. Macro-models of public expenditure
• Three models were examined;
• First, the ‘development models of public expenditure growth’.
• Second, ‘Wagner’s law of expanding state activity’.
• Third, Peacock and Wiseman's classic study of
public expenditure
growth.

6. 1. Development models of public expenditure
growth
• Public sector is seen to provide social infrastructure overheads, such
as roads, transportation, law, health and education.
• So, it is necessary to gear up the
economy for ‘take-off’ intothe middle stages of
economic and social development.
• In middle stages of growth the government continues
to supply
investment good
• Now public investment is compulsory to the
growth in private investment.

7. Development models of public expenditure growth
• Market failure exist in all the stages of development, which prevents
the push toward maturity.
• Musgrave argue that total investment as a proportion of GNP rises, the
share of public sector investment to GNP falls.
• Rostow’s argue that at maturity stage the mix of public expenditure
will shift to rise the expenditures on education, health, and welfare
services.
• Musgrave’sand Rostow’s modelsare broad sweeping
views of
development process.

8. 2. Wagner’s
Law
• A German economist, Adolf Wagner gave theory in 1880.
• Musgrave’s interpret Wagner’s law as an expression of the growth of
the relative size of the public sector.
• Wagner’s law states that “ as per capita incomes in an economy grow,
the relative size of the public sector will grow also”.
• According to this theory public expenditure increases
constantly as income growth expands.

9. 2. Wagner’s
Law
• Government roles are internal and external security, to provide social
services, and participation in material production.
• Market interaction complexity would require commercial
laws and contracts, then it need a system of justice to
administer such laws.
• Urbanized and densely populated areas results externalities.
• congestion need public sector intervention and regulation.
• Public sector services such as legal services,
police services and banking services emerged.

10. 2. Wagner’s
Law
• The growth of public expenditures on social services were explained
by Wagner in term of their income elasticity of demand.
• Income elasticity of government services are greater than 1.
• During economic development the government expenditures increases
more than per capita output.
• Demand of public expenditures dependon urbanization
and industrialization, age composition, and level of private sector
activity
• Supply of public expenditure depend on scale of production.

11. 3. Peacock and Wiseman’s
analysis
• Thistheory was developed in 1890s, Focused on
time pattern of
public spending.
• They argues that individuals enjoy the benefits of public goods and
services but don’t like to pay taxes.
• Close watch on electorate’s reactions are kept to the implied taxation.
• Tolerable level of taxation acts as a
constraint on government behavior.

12. 3. Peacock and Wiseman’s
analysis
• Normally public expenditure show gradual upward trend but in social
upheavals it is disturbed.
• To financesocial disturbances government must rise
taxation level, which is acceptable to the public during
crisis.
• There is displacement effect in which private
expenditures are displace for public expenditures during crisis
period.
• Lower rate of taxes and expenditures are replaced
by high level of taxes and expenditures.

13. 3. Peacock and Wiseman’s
analysis
• After heavy public expenditure people are ready to pay high taxes.
• In Inspection effect war and other social disturbances often force
people and government to find out solution of these problems which
were neglected previously.
• Third one is Concentration Effect, when an economy is experiences
economic growth there is a tendency.
• Federal government economic activities to grow faster rate than state
or local government activities.

14. 3. Peacock and Wiseman’s
analysis
• Three possible pattern of expenditures are shown in the figure.
•This figure shows that
civilian public expenditures
in the post war period
return to their original
growth path.

15. 3. Peacock and Wiseman’s
analysis
• Three possible pattern of expenditures are shown in the figure.
•Figure (b) represent the trend
in total pubic expenditure
experienced during the war
Period continues into the post
war period along With an
upward shift in the level of civilian public expenditure.

16. 3. Peacock and Wiseman’s
analysis
• Three possible pattern of expenditures are shown in the figure.
• In figure (c) represent there
Is an increase in post war civilian
public expenditure.

17. 3. Peacock and Wiseman’s
analysis
• Musgrave and Rostow public expenditure growth reflects government
role in the process of development as supplier of infrastructure capital
and social investments.
• They attempt to overcome market failure, especially where markets
failed to exist.
• Wagner’s on the other hand focused on income elasticity of demand
for public outputs and recognized market failure.
• Peacock and wiseman’s looks into the politics of the fiscal system in
an attempt to account for the time pattern of public expenditures that
they had observed.

18. A Microeconomic model of public
expenditure
• It set out the forces that generate demands for public outputs
• It examine the influences on the supply of public services.
• Demand and supply interaction determines level of
publically
provided services that will be supplied through public budget.
• Political and social variables will be shown to have a role to play.

19. A Microeconomic model of public
expenditure
• The initial remarks about the nature of the model that will be used are:
• First, it is a positive model of time pattern of public expenditure.
• Second, the model is not designed to show efficiency of public output
supply.
• Third, it is behavioral, but some of behavioral prepositions as well be
seen, are native.
• Fourth, in its present form as a pedagogic teaching device the model is
a comparative static one.

20. A Microeconomic model of public
expenditure
• Why public sector activities, over some period of time, rise in absolute
terms and relative to private sector activities?
• Outputs of public sector are extremely difficult to measure.
• Clarity about the nature of output of public sector
safe us from incorrect and vague inferences.
• Education is investment in human capital which
influence earning potentials.

21. A Microeconomic model of public
expenditure
• Some other multidimensional goods are police
services, sanitation
services, fire services or health services.
• For simplicity we
will
talk about
the
level of these public
sector
services.
• Public
sector
output identification problems should not
be
exaggerated.
• These problems are common to all
products, especially ‘services’ whether public or
private.

22. A Microeconomic model of public
expenditure
• Doctor or nurse is producing health care the patient is simultaneously
consuming it.
• Therefore, the consumption benefits of both public and private sector
goods that interest the consumer.

23. A Microeconomic model of public
expenditure
• The notion is summarized in the given figure

24. A Microeconomic model of public
expenditure
• Output level may be same by using different production function.
• The quality and cost of the producing output changes with
production function.
• Relation between public sector final outputs and set of public sector
activities is summarized as
• 𝑥𝑖 = ∅ 𝐿𝑖, 𝑀𝑖 and 𝐺𝑖 = 𝑔𝑖 𝑋𝑖, 𝑁 .
• Where 𝐺𝑖= final output of the ith public service

25. A Microeconomic model of public
expenditure
• 𝑥𝑖 = intermediate activities used to produce Gi.
• 𝐿𝑖 = labor inputs used in production of Gi
• 𝑀𝑖 = materials used to produce Gi, N= population size

26. A Microeconomic model of public
expenditure
• Public expenditure can be explained in terms of:
1. Changes in the demand for public sector final outputs;
1. Changes in the set of production activities
used to produce public
sector outputs and thus changes in the mix of inputs;
3. Changes in the quality of public sector outputs;
3. Changes in input prices;

27. “Iftikhar Yousafzai” is discussant of
this topic. He will Further discuss
this topic in class.