Economics of Government Spending

Dr Moyi Harry Ruben: 0922166557


Policy makers are divided as to whether government expansion helps or hinders economic growth. Advocates of bigger government argued that government programs provide valuable public goods such as education and infrastructure. They also claim that increases in government spending can bolster economic growth by putting money into people’s pockets.

Proponents of smaller government have opposite view. They explain that government is too big (32 States) and the higher spending undermines economic growth by transferring additional resources from the productive sectors of the economy to government, which uses them less efficiently. They also warn that an expanding public sector complicates efforts to implement pro-growth policies such as fundamental tax reform, because critics can use the existence of budget deficits as a reason to oppose policies that could strengthen the economy.

Which Side is right?

The author argues that a large and growing government is not conclusive good to better economic growth or performance. Indeed, reducing the size of the government would lead to higher incomes and improved competitiveness. There are also philosophical reasons to support small government, to say development reaching the people is a laymen philosophy, properly prepared budget and well-control financial economics will facilitate development faster than much money spend on paying large team of workers.

Economics of Government Spending

Any economic theory does not automatically generate conclusions about the impact of government outlays on economic performance. Indeed, almost every economist would agree that there are circumstances in which lower level of government spending would enhance economic growth and other circumstances in which higher levels of government spending would be desired to fight stagnation.

On the other hand, if government spending is zero, presumably there will be very little economic growth because enforcing contracts, protecting property and developing an infrastructure would be very difficult if there were no government at all. In other words, some government spending is necessary for the successful operation of the rule of laws. For a good government, the benefits must outweigh the costs.

  1. Costs Vs Benefits. Economists will generally agree that government spending becomes a burden at some point. Either because government becomes too large or because outlays are misallocated. In such cases, the cost of government exceeds the benefit.
  2. The extraction Costs. Government spending requires costly financing choices. The federal government cannot spend money without first taking that money from someone. All of the option used to finance government spending have adverse consequences. Taxes discourage productive behaviors, investment, particularly in the current tax system in the country, which imposes higher tax rate on works, savings, investments and other forms of productive behavior. Borrowing consumes capital that otherwise would be available for private investment and in extreme cases, may lead to higher interest rates. Inflation debases a nation’s currency, causing widespread economic distortion.
  3. The Displacement Costs. Government spending displaces private-sector activity. Every Pound that the government spends necessarily means one less Pound in the productive sector of the economy. This dampens growth since economic forces guide the allocation of resources in the private sectors, whereas political forces dominate when politicians and bureaucrats decide how money is to be spend. Some government spending, such as maintaining a well-functioning legal system can have a high rate of return. In general, however, governments do not use resources efficiently, resulting in less economic output.
  4. The negative multiplier Cost. Government spending finances harmful intervention. Portions of the federal budget are used to finance activities that generate a distinctly negative effect on the economic activities. For instance, many regulatory agencies have comparatively small budgets, but they impose large costs on the economy’s production sector. Outlays for international organizations are another good example. Direct expenses to taxpayers of membership in organization like East African Community, is often trivial compared to the economic damage resulting from anti-growth policies advocated by these multinational bureaucracies
  5. The behavioral subsidy costs. Government spending encourages destructive choices. Many government programs subsidize economically un-desirable decisions. Welfare programs in the case of West, encourage people to choose leisure over work. Unemployment insurance programs provide an incentive to remain un-employed. WFP provide food in the UN IDP camps encourage dependency of handout. These are examples of government programs that reduce economic growth and diminish national output because they promote misallocation or under-utilization of resources.
  6. The behavioral penalty Costs. Government spending discourages productive choices. Government programs often discourage economically desirable decisions. Saving is important to help provide capital for new investment, yet the incentive to save has been undermined by government programs that subsidize housing, and education. Why should a person set aside income if government programs finance these big-tick expenses? Other government spending Programs-Medicaid is a good example generate a negative economic impact because of eligibility rules that encourage individual to depress their incomes artificially and misallocate their wealth.
  7. Market Distortion Costs. Government spending distorts resource allocation. Buyers and sellers in completive markets determine prices in a process that ensures the most efficient allocation of resources, but some government programs interfere with competitive markets. In both heath care and education, government subsidies to reduce out of pocket expenses have created a third-party payer problem. When individuals use other people’s money, they become less concerned about price. This undermines the critical role of competitive markets, causing significant inefficiency in sectors such as health care and education. Government programs also lead to resource misallocation because individuals, organizations, and companies spend time, energy, and money seeking either to obtain special government favour or to minimize their share of the cost of government.
  8. The inefficiency Costs. Government spending is a less effective way to deliver services. Government directly provides many services and activities such as education, airports and postal operation. However, there is evidence that the private sector could provide these important services at a higher quality and lower cost. In some cases, such as airports and postal services, the improvement would take place because of privatization. In other cases, such as education, the economic benefits would accrue by shifting to a model based on competition and choice. (Not Quality without quantity).
  9. The Stagnation Costs. Government spending inhibits innovation. Because of competition and the desire to increase income and wealth, individuals and entities in the private sector constantly search for new options and opportunities. Economic growth is greatly enhanced by this discovery process of creative destruction. Government programs, however, are inherently inflexible, both because of centralization and because of bureaucracy. Reducing government or devolving federal programs to the state and local levels can eliminate or mitigate this effects, but within the framework of cost effectiveness.

Keynesian analysis argue that higher or lower levels of government spending will stimulate or dampen economic growth.

Hawks argued that another related policy issue is the role of budget deficits. Unlike Keynesians, who argued that budget deficits boost growth by injecting purchasing power into the economy, some economists argued that budget deficits are bad because they allegedly lead to higher interest rates. Since higher interest rates are believed to reduce investment and because investment is necessary for long-term economic growth, proponents of this view assert that avoiding deficit should be the primary goal of the Fiscal Policy.

While deficit hawks and Keynesians have very difficult views on budget deficits, neither school of thoughts focuses on the size of the government. Keynesians were sometimes associated with bigger government but as discussed above have no theoretical objectives to small government as long as it can be increased to jump-start a sluggish economy. By contrast, the deficit hawks were sometimes associated with smaller government but had no theoretical objectives to large government as long as it is financed by taxes borrowing.

Therefore, economic theory is important in providing a framework for understanding ow the world works, but evidence helps to determine which economic theory is most accurate to the choice of the status of the government. What matter would be the following:

  1. Does spending hinder economic performance because of the taxes used to finance the government?
  2. Would the economy damage be reduced if the government have some magical sources of free revenue?
  3. How do academic researchers measure the adverse economic impact of government consumptions and investments? (Answers next Article)

Hence, this pump priming concepts do not necessarily mean that government should be big. Instead, the theory asserted that government spending especially deficit financing could provide short-term stimulus to help end recession or depression. These schools of thought argued that policymakers should be prepared to reduce government spending once the economy recovered, in order to prevent inflation, which they believe would result from too much economic growth. Theorists even postulated that there was a trade-off between inflation and unemployment and that government officials should increase or decrease government spending to steer the economy between too much of one thing or too little of the other.

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