Theme 2 – Public Sector and
Mixed Economy
Public Economics
1
Public Sector and the Economy
2
3
The Size of Government
• How to measure the size of government
– Number of workers
– Annual expenditures
• Types of government expenditure
– Purchases of goods and services
– Transfers of income
– Interest payments
• Budget documents
– Unified budget
– Regulatory budget
4
5
6
Government spending, % of GDP
1870
1913
Austria
-
-
14.7
15.2
35.7
48.1
48.6
51.7
Belgium
-
-
-
21.8
30.3
58.6
54.8
54.3
Canada
-
-
13.3
18.6
28.6
38.8
46.0
44.7
France
12.6
17.0
27.6
29.0
34.6
46.1
49.8
54.5
Germany
10.0
14.8
25.0
42.4
32.4
47.9
45.1
49.0
Italy
11.9
11.1
22.5
24.5
30.1
41.9
53.2
52.9
Japan
8.8
8.3
14.8
25.4
17.5
32.0
31.7
36.2
Netherlands
9.1
9.0
13.5
19.0
33.7
55.2
54.0
49.9
Norway
3.7
8.3
13.7
-
29.9
37.5
53.8
45.5
8.3
9.3
18.4
18.8
32.2
42.0
43.3
6.3
8.1
10.4
31.0
60.1
59.1
64.7
2.7
4.6
6.1
17.2
32.8
33.5
37.6
Spain
-
Sweden
Switzerland
5.7
-
1920
1937
1960
1980
1990
1996
Britain
9.4
12.7
26.2
30.0
32.2
43.0
39.9
41.9
United States
3.9
1.8
7.0
8.6
27.0
31.8
33.3
33.3
AVERAGE
8.3
9.1
15.4
18.3*
28.5
43.3
46.1
47.1
Australia
-
-
-
-
21.2
31.6
34.7
36.6
Ireland
-
-
-
-
28.0
48.9
41.2
37.6
New Zealand
-
-
-
-
26.9
38.1
41.3
47.1
AVERAGE
-
-
-
-
25.4
39.5
39.1
40.4
15.4
20.7
27.9
42.6
44.8
45.9
TOTAL AVERAGE
Source: IMF
8.3
9.1
*Average without Germany, Japan and Spain undergoing war or war preparations at his time
7
8
9
10
11
The future
of the
state...
12
Reasons for government
growth
• Macro models
– Wagner and the stages of development
– Peacock and Wiseman’s displacement effect
• Micro models
– Baumol’s unbalanced productivity growth
– Brown and Jackson’s microeconomic model
– Role of politicians, bureaucrats and interest groups.
13
What are the Legitimate Economic
Functions of a Government?
Depends on chosen economic system…
Least
individual
freedom
• Centrally Planned
Socialism:
Government owns all
resources and makes
all important economic
decisions
Most
individual
freedom
• Decentralized Capitalist
Economy: Limited
government; individuals
and firms make all
important economic
decisions
14
Three Normative Aspects of
Public Sector Economics
1. Public expenditure theory
–
What government expenditures do we expect,
and why?
–
How should government carry out its desired
functions?
2. Theory of taxation
–
What principles should guide design of
government tax policy
3. Theory of fiscal federalism
15
Two Goals of Economies
1: EFFICIENCY
• Efficiency is mainly a positive concept
• Economists measure efficiency as Pareto Optimality
• Definition: An economy-wide allocation of resources
is efficient if in order to increase one person’s utility at
least one other person’s utility must be decreased
Example
• An allocation in which I have everything and you have
nothing is an ‘efficient’ allocation (Pareto Optimal)
– The only way to make you better off is to take some
away from me
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(Efficiency continued…)
Consider all ‘efficient’ points given our existing resources
• Called the Utility Possibility Frontier
1. Must be downward sloping
• To increase 1’s utility we must
take utility away from 2
2. Points below line are attainable but
not efficient
• Could give some to both 1 and
2 and make them both better
off (Pareto Superior moves)
3. Points beyond line are unattainable
• Would require giving more
utility to both 1 and 2 which is
impossible
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2: EQUITY (FAIRNESS)
Equity is mainly a normative concept
End-results equity
• Asks whether outcomes are fair.
– For example: Is it fair that over half of income in the country
goes to 20% of households? If not, what should be done to
correct it?
Process equity
• Asks whether rules determining process are fair, regardless of
allocation.
– For example: Do children of wealthy families start with an
advantage due to their family’s wealth? If so, then what
should be done to level the playing field?
18
Allocative function
– Market failures distort the allocation of
resources in the economy
– Incomplete markets
• Characteristics of goods and services prevent
efficient supply
• Existence of externalities.
19
Distributive function
– Fairness
– Inequality in income distribution
– Criteria for evaluation.
20
Stabilisation function
– Macro-economic objectives
– 3 premises of stabilisation (Keynes):
• The market economy is inherently unstable
• Macroeconomic instability is a form of market
failure that is highly costly to an economy
• Governments are able to stabilise the economy
by means of appropriate macroeconomic policies.
– New Classical Macroeconomics
– Neo-Keynesian theory.
21
Direct versus indirect
government intervention
•Direct government intervention refers to the actual
participation of government in the economy.
•Indirect government intervention to the regulatory
function of government.
22
Direct versus indirect government
intervention
Direct intervention
– Actual participation in the
economy
– Tax individuals and
companies
– Borrow on financial markets
– Execute budgeted spending
– Examples:
•
•
•
•
National defence
Electricity
Infrastructure
Provision of school text
books
Indirect intervention
– Regulatory function
– Enacting law or proclaiming
legally binding rule
– Indirect taxes and
subsidies
– Examples:
• Labour laws
• Anti-tobacco laws
23