1. Question 4: Government expenditure has tended to grow rapidly in most advanced
industrialised economies. Explain why some believe that is important to restrict the growth in
public expenditure. Suggest how public expenditure might be controlled.
Introduction
Government spending or government expenditure is classified by economists into
three main types. Government purchases of goods and services for current use are classed
as government consumption. Government purchases of goods and services intended to
create future benefits, such as infrastructure investment or research spending, are classed
as government investment. Government expenditures that are not purchases of goods and
services, and instead just represent transfers of money, such as social security payments,
are called transfer payments. Government spending can be financed by seignior age, taxes,
or government borrowing.
Policymakers are divided as to whether government expansion helps or hinders
economic growth. Some claim that government programs provide valuable goods such as
education and infrastructure. These government spending would help in bolster economic
growth by putting money into people’s pockets. Another group provides different point of
view. They explain that government is too big with higher spending undermines economic
growth by transferring additional resources from the productive sector of the economy to
government that apparently uses the resources less efficiently.
Industrialized economics tend to have high government spending as one of the
major portion contributing to the nation’s GDP. Table 1 reveals a number of features about
the government sectors of the industrialized market economies. All these countries have
sizable government sectors, particularly for many European governments that have
extremely large public welfare.
2007 GDP Govt GS of
Countries
(USD bil) Spending (bil) nation's GDP
Sweden 453.84 244.17 53.8%
France 2,593.78 1,377.30 53.1%
Denmark 310.50 157.42 50.7%
Italy 2,117.52 1,024.88 48.4%
Belgium 459.03 221.71 48.3%
Spain 1,439.98 681.11 47.3%
United Kingdom 2,803.40 1,250.32 44.6%
Germany 3,320.91 1,471.16 44.3%
USA 13,807.55 5,164.02 37.4%
South Korea 1,049.32 332.63 31.7%
Japan 4,384.38 1,354.77 30.9%
Table 1: General Government Spending (% of GDP) in year 2007
1

2. The Theory: Economics of Government Spending
Diagram 1 suggests that there is an optimal & modest level of government spending
which maximises the rate of economic growth. There will be very little economic growth if
government spending is zero. Government spending is essential and plays an active role in
enforcing contracts, protecting property and developing infrastructure and facilities for the
people. In other words, some government spending is necessary to bolster the economic
growth. Economic activity is very low or nonexistent in the absence of government, but it
jumps dramatically as core functions of government are financed.
Downward sloping curve in Diagram 1 shows that economy shrinks when
government grows too large that would cause higher spending. Economists will generally
agree that government spending become a burden at some point, either because
government becomes too large or because outlays are misallocated. From The Rahn curve,
we found that the more government spending as percentage of GDP will bring negative
impact to the economic growth rate. In such cases, the cost of government exceeds the
benefit.
Diagram 1: The Rahn Curve: Impact of government spending on Nation’s GDP
Some negative impacts of large government spending as follows:
1. Extraction Cost
Government spending requires costly financing resources. All options used by the
government to increase revenue before spending have negative consequences.
Higher taxes rate on personal income, saving and investment has discouraged
productive behaviour. Extracting consumes capital that otherwise would be available
for private investment may lead to higher interest rates and eventually will increase
the inflation rate.
2

3. 2. Displacement of scarce resources
Government spending displaces private-sector activity. Every dollar that the
government spends necessarily means one less dollar in the productive sector of
economy. Capital and financial resources that supposing been used for private
investment activity has been diverted into other sectors as the politicians and
bureaucrats decide on the usage of fund and financial resources. In short,
government do not use resources efficiently, resulting in less economic output.
3. Inefficiency in public services
Government spending is a less effective way to deliver services. Government directly
provides many public services and activities such as education, airports, utilities and
postal services. Private sector could provide these important services at a higher
quality and lower cost. In some cases, privatisation of airport and postal services has
improved the quality of services while enhancing efficiency of works.
4. Encouragement of wrong behaviour and mindset
Government spending encourages destructive choices. Many government programs
subsidise economically undesirable decisions. Public welfare programs encourage
people to choose leisure over works. Unemployment insurance programs in most of
the industrialised countries provide an incentive to remain unemployed. All these
programs have reduced the economic growth and diminish national output because
of misallocation or underutilisation of resources.
5. Discourage productive alternatives
Government spending discourages productive choices and desirable decisions.
Saving is important to help to promote capital for new investment, yet the incentive to
save money has been undermined by government programs that subsidise
retirement, housing and education. Good public welfare encourages people to
depress their incomes artificially and misallocate their wealth as they know they will
be taken care well.
6. Distort resource allocation
Government spending distorts resource allocation. Buyers and sellers in competitive
markets determine prices in a process that ensures most efficient allocation of
resources, but some government programs interfere with competitive markets. In
both health care and education, government reduces out-of-pocket expenses have
created “third-party payer” problem. Individuals become less concerned about the
cost and price of the public services that subsidised by the government. This
3

4. undermines the critical role of competitive markets, causing significant inefficiency in
health care and education sectors. Government programs also lead to misallocation
of resources where individuals spend time, energy and money seeking either to take
advantage of the government subsidies or avoid sharing the cost of government.
7. Inhibit innovation & creativity
Because of competition and the desire to increase income, individuals and entities in
the private sector constantly search for new alternatives and opportunities. Greater
economic growth is enhanced by the discovery process of “creative destruction.”
Government programs are inherently inflexible because of centralisation and
bureaucracy. As the result of inflexibility, the economy will become stagnant due to
lack of innovation and creative solutions.
Below are some alternatives to control government expenditure:
1. Reduce the size and scope of government
Downsizing exercise could be implemented to reduce the size and scope of
government. Restructuring of abundant government agencies and reduce the number
of exceed manpower in some government agencies could help to reduce
unnecessary expenditure. A smaller government will lead to better economic
performance and it also is the only pro-growth way to deal with the politically
sensitive way of budget deficits.
2. Re-inventing the public sector
The government should think of ways to restructure and re-invent the public sector in
order to improve efficiency and quality of works. Delivery systems of public services
need to be enhanced and improved. This would help to encourage a more efficient
use of resources within public sector while upgrading the quality of public services to
general public.
3. Devolve federal programs to state and local governments
In general cases, the federal government do not know what policies are best for
every state and locality. One-size-fits-all federal mandates rarely succeed as well as
the flexible programs designed by state and local officials who are closer to the
people affected. The federal government can promote accountability, flexibility, and
local control by eliminating many of the mandates on how state and local
governments address their own issues, and by letting them raise their own revenues
and create their own programs.
4

5. 4. Privatisation of major projects to private sector that could performed better
Malaysia is very successful in implementing “Privatisation” concept to devolve the
major infrastructure developments to private sector, such as highways, utilities
services and education. Private Funding Initiatives (PFI) Public-Private Partnerships
(PPPs) are ways to encourage more economy activities in private sector while
reducing the burden of government in developing the country. Privatisation can lead
to increased efficiency, more consumer choice, better use of scarce resources and
lower prices.
5. Building a knowledge-based system
One of the best ways to improve efficiency of public sector is to build and setup a
knowledge-based system. Investment in human capital, human resource training,
upgrade of technology and equipment are necessary to transform the labour-
intensive to knowledge-intensive public sector.
6. Terminate unnecessary welfare programs and reform wasteful programs
Reduction of outdated and duplicative programs could help the government to save
cost for giving subsiding unnecessary welfare programs. Eventually it could use the
savings to reduce income taxes across the board. This would help to increase
household income and encourage more spending in the private sector.
7. Remove procedural barriers and simplify regulatory policy
Bureaucracy and red tape have a considerable effect on a country’s economy
Deregulated markets encourage the efficient allocation of scarce resources since
decisions are based on economic factors. Excessive regulation can result in
unnecessary high costs and inefficient behaviour. By removal of procedural barriers,
it will save the taxpayer money, increase the efficiency of works and eventually
attracts foreign direct investment (FDI) into the country.
8. Low tax policy
The tax system has a pronounced impact on economic performance. Lower tax rates
will reduce barriers to working, saving, and investing, and therefore promote long-
term economic growth. For instance, Hong Kong has a low-rate flat tax that generally
does not penalise saving and investment, it raises revenue in a much less destructive
manner.
5