1. Public Spending
SOCIO-ECONOMIC IMPACT
Based on Case Study: “Diminishing Marginal Returns to State Spending”
Presented by:
Swapnil Soni & Anand Gupta
Master of Management-I Sem
Indian Institute of Science
Public Spending
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2. Index
 Facts of the Case Study
 Introduction to Public Spending
 Development history of Public Spending
 Factors deciding Public Spending
 Returns on Public spending - Increasing & Diminishing
 Negative Returns on Public spending
 Revenue Churning
 Politicians in Public Spending
 Optimal level of Public Spending
 References
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3. Facts of the Case
 Public spending (PS) is the major state governed economic catalyst to socio





economic change in the country.
Although PS has been considered to yield proportionate growth &
development of country but recent studies indicate diminishing returns &
sometimes negative return to it.
In 1870 government of developed countries with PS being 8% of GDP
confined itself to limited number of activities such as defense and law.
PS rose to 15% of GDP by 1920. The higher taxes that was introduced to pay
for the 1st World War allowed government to maintain higher spending.
By 1937 the average for industrial countries reached nearly 21% of GDP to
combat The Great Depression.
The 3 decades after the Second World War witnessed the largest increase in
public spending mainly reflecting the expansion of welfare state.
Since 1960, countries with lower PS have relatively lower
unemployment, greater efficiency and innovation and higher level of
registered Patents.
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4. Introduction to Public Spending
Definition of Public Spending
 Government acquisition of goods and services for current use to directly
satisfy individual or collective needs of the members of the community is
classed as government final consumption expenditure.
 Government acquisition of goods and services intended to create future
benefits such as infrastructure investment or research spending, is
classed as government investment.
 Fiscal tool of government for economic welfare of country
Measure of Return on Public Spending
Ultimate Return on Public Spending is economic growth & welfare that
can be measured by:



GDP growth
Unemployment rate
Inflation rate
Public Spending
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5. Introduction to Public Spending
Criticism by two schools of thoughts
Keynesian economics
Classical economists
Loss of
Resource
Aggregate
Demand
Adverse Offshoots
Favorable Offshoots
Public Spending
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6. Introduction to Public Spending
Role of Government
 Economist asserted: A severe recession or depression may never end if the
government does not intervene.
 The Great Depression was ended by government spending programs such as
the New Deal (Relief, Recovery & Reform) between 1933 & 1940 and military
spending during World War II.
 Obamacare- a health insurance initiative by Democratic party although opposed
by Republican & tended US Govt Shut down for a short period.
Public Spending
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7. Introduction to Public Spending
Finance for Public Spending
 Government revenue


Taxes
Non-tax revenue (revenue from government-owned corporations, sovereign
wealth funds, sales of assets, or Seigniorage)
 Government borrowing
 Printing of Money or Inflation
Application of Public Spending
(Harmonizing the wealth distribution & Capping the
Financial crisis)
 Public Goods & Services -Health, Education & Defense (non-exclusive & non-rivalry)
 Externalities – promoting positive & curbing negative
 Monopolies – uniform distribution of Resources to avoid dead weight loss
Public Spending
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8. Introduction to Public Spending
Role of Public Spending in Economy cycle
Public Spending
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9. Introduction to Public Spending
Statistics of Public Spending
(2011 Index of Economic Freedom by The Heritage Foundation and The Wall Street Journal)
Rank
Country
Tax burden % GDP Govt. expend. % GDP
Top 5 countries
1
Kiribati
39.0
114.6
2
Zimbabwe
31.7
97.8
3
Timor-Leste
24.6
97.0
4
Cuba
41.2
78.1
5
Maldives
21.0
63.1
Other countries
United Kingdom
23
38.9
47.3
56
United States
26.9
38.9
111
India
18.6
27.2
147
China
18
20.8
Public Spending
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10. Development history of Public Spending
Public Spending
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11. Development history of Public Spending
(in context of Developed countries)
 Pre-World War I
 1870: at beginning only 8% of GDP & limited to Defense, Administration, law &
order
 But late 1870 Spending increased to 11%
 1913: increased to 13%
Slow growth of Public Spending
 Post-World War I
 1920: increased to 20%
Rapid growth of Public Spending due to Military & Warfare spending
 Pre-World War II
 1937: increased to 24%
 Post-World War II
 1960: increased to 24%
 1996: increased to 45%
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12. Factors deciding Public Spending
Public spending is a dependent variable on numerous external & internal
factors important to be observed for budgeting to attain the optimal level of
Return. Economists- Aschauer, Peterson, Wagner, Hosley, Francis etc- have
given numerous factors, Some major are:
 Time

World war-I & II directed PS an unpredicted way of growth
 Technology

Emergence of latest technology & lack of it decides portion of GDP in PS
 Geography

Availability of resources that are opportunity for investment incite PS
 Demography

Desire of population for growth & sacrifice for it
 Financial strength

PS differs in Developed & Developing countries
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13. Question-1
IN WHAT AREA PUBLIC SPENDING DO THERE APPEAR
TO BE INCREASING RETURN?
Based on Case Study: “Diminishing Marginal Returns to State Spending”
Public Spending
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14. Returns on Public spending
Statistical analysis of Return on Public Spending
1970-1980
S.N.
DEVELOPED COUNTRY
1
United States
2
Canada
3
France
4
Germany
5
UK
6
Japan
DEVELOPING COUNTRIES
1
India
2
China
3
Indonesia
4
Public
Spending
COUNTRY
13.4%
1990-2000
2000-2010
GDP growth
GDP growth
GDP growth
GDP growth
Public
Public
Public
(average
(average
(average
(average
Spending
Spending
Spending
real)
real)
real)
real)
% of GDP
%
Diminishing Return
30.0%
3.1%
34.0%
4.0%
42.6%
2.9%
41.4%
2.7%
37.6%
1.6%
26.3%
4.3%
Increasing Return
12.3%
3.9%
27.2%
10.4%
2.1%
8.4%
Philippines
1980-1990
6.6%
% of GDP
%
% of GDP
%
% of GDP
%
31.4%
38.8%
46.1%
47.9%
43.0%
32.0%
2.9%
2.8%
2.4%
2.3%
2.7%
4.0%
32.8%
46.0%
49.8%
45.1%
39.9%
31.3%
3.4%
2.4%
1.7%
2.3%
2.8%
1.3%
32.4%
44.7%
55.0%
49.1%
43.0%
35.0%
1.6%
1.8%
1.2%
0.9%
1.5%
0.8%
9.0%
16.6%
18.4%
5.9%
9.1%
5.4%
16.0%
13.6%
17.9%
5.6%
10.4%
4.0%
14.4%
NA
18.1%
7.5%
10.5%
5.3%
19.6%
1.7%
20.4%
3.0%
21.4%
4.7%
Source: www.worldbank.org
Public Spending
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15. Returns on Public spending
Developing Countries with Increasing Return
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
India
16.0%
14.4%
12.3%
9.0%
7.5%
5.9%
5.6%
3.9%
1970-1980
1980-1990
1990-2000
2000-2010
Public Spending
12.3%
9.0%
16.0%
14.4%
GDP growth
3.9%
5.9%
5.6%
7.5%
Philippines
25%
20%
15%
10%
13.4%
6.6%
5%
0%
21.4%
20.4%
19.6%
1.7%
3.0%
4.7%
1970-1980
1980-1990
1990-2000
2000-2010
Public Spending
13.4%
19.6%
20.4%
21.4%
GDP growth
6.6%
1.7%
3.0%
4.7%
Public Spending
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16. Returns on Public spending
Developing Countries with Increasing Return
China
30%
27.2%
25%
20%
16.6%
15%
13.6%
10.4%
10%
10.5%
10.4%
9.1%
5%
0%
1970-1980
1980-1990
1990-2000
Public Spending
27.2%
16.6%
13.6%
GDP growth
10.4%
9.1%
10.4%
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Indonesia
18.4%
2000-2010
10.5%
18.1%
17.9%
8.4%
5.4%
4.0%
5.3%
2.1%
1970-1980
1980-1990
1990-2000
2000-2010
Public Spending
2.1%
18.4%
17.9%
18.1%
GDP growth
8.4%
5.4%
4.0%
5.3%
Public Spending
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17. Question-2
IN WHAT AREA PUBLIC SPENDING DO THERE APPEAR
TO BE DIMINISHING OR NEGATIVE RETURN?
Based on Case Study: “Diminishing Marginal Returns to State Spending”
Public Spending
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18. Returns on Public spending
Developed Countries with Diminishing Return
United States
35%
30%
32.8%
31.4%
30.0%
32.4%
25%
20%
15%
10%
5%
0%
Public Spending
GDP growth
3.1%
2.9%
3.4%
1970-1980
1980-1990
1990-2000
2000-2010
30.0%
31.4%
32.8%
32.4%
3.1%
2.9%
3.4%
1.6%
Major Areas of Public Spending:
Results of Public Spending:
•Increasing in unemployment rate
•More Tax burden
•More Government borrowing
Defence- 14%
Education- 15%
Pension-16%
Welfare-12%
Others- 24%
Public Spending
1.6%
•Economic crisis
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19. Returns on Public spending
Developed Countries with Diminishing Return
Canada
46.0%
50%
40%
44.7%
38.8%
34.0%
30%
20%
10%
0%
4.0%
2.8%
2.4%
1.8%
1970-1980
1980-1990
1990-2000
2000-2010
Public Spending
34.0%
38.8%
46.0%
44.7%
GDP growth
4.0%
2.8%
2.4%
1.8%
France
60%
50%
46.1%
42.6%
55.0%
49.8%
40%
30%
20%
10%
0%
2.9%
2.4%
1.7%
1.2%
1970-1980
1980-1990
1990-2000
2000-2010
Public Spending
42.6%
46.1%
49.8%
55.0%
GDP growth
2.9%
2.4%
1.7%
1.2%
Public Spending
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20. Returns on Public spending
Developed Countries with Diminishing Return
Germany
60%
50%
47.9%
41.4%
49.1%
45.1%
40%
30%
20%
10%
2.7%
0%
2.3%
2.3%
0.9%
1970-1980
1980-1990
1990-2000
2000-2010
Public Spending
41.4%
47.9%
45.1%
49.1%
GDP growth
2.7%
2.3%
2.3%
0.9%
United Kingdom
50%
40%
43.0%
43.0%
39.9%
37.6%
30%
20%
10%
0%
Public Spending
GDP growth
Public Spending
1.6%
2.7%
2.8%
1.5%
1970-1980
1980-1990
1990-2000
2000-2010
37.6%
43.0%
39.9%
43.0%
1.6%
2.7%
2.8%
1.5%
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21. Question-3
EXPLAIN DIFFERENCE BETWEEN DIMINISHING & NEGATIVE
MARGINAL RETURNS IN CONTEXT OF PUBLIC SPENDING
Based on Case Study: “Diminishing Marginal Returns to State Spending”
Public Spending
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22. Negative Returns on Public spending
Statistical analysis of Negative Return on Public Spending
Increase in Unemployment Rate vindicates the Negative Return on Public Spending
in Educational development sector
2008
S.N.
COUNTRY
2010
2011
Public
Public
Public
Public
Spending Unemploy Spending Unemploy Spending Unemploy Spending Unemploy
on
ment Rate
on
ment Rate
on
ment Rate
on
ment Rate
Education
Education
Education
Education
% of GDP
DEVELOPED COUNTRY
2009
%
% of GDP
%
% of GDP
%
% of GDP
%
Negative Return
1 United States
5.5%
10.6%
5.4%
16.3%
5.6%
29.0%
NA
31.3%
2 Canada
4.8%
6.7%
5.0%
7.5%
5.5%
11.5%
NA
12.9%
3 France
5.6%
7.0%
5.9%
34.8%
NA
39.8%
NA
41.1%
4 United Kingdom
5.4%
24.0%
5.6%
24.4%
39.9%
32.6%
NA
33.4%
Source: www.worldbank.org
Public Spending
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23. Negative Returns on Public spending
United States
Canada
35%
29.0%
30%
14%
31.3%
12%
10%
25%
20%
8%
16.3%
15%
10%
12.9%
11.5%
6%
10.6%
5.5%
5.6%
0.0%
2009
2010
PS on Education
5.5%
5.4%
5.6%
10.6%
16.3%
29.0%
0.0%
France
2008
2009
2010
2011
4.8%
5.0%
5.5%
0.0%
Unempl. Rate
31.3%
6.7%
7.5%
11.5%
12.9%
United Kingdom
39.9%
39.8%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
41.1%
34.8%
5.9%
0.0%
0.0%
2008
2009
2010
2011
PS on Education
5.6%
5.9%
0.0%
0.0%
Unempl. Rate
PS on Education
7.0%
34.8%
39.8%
41.1%
Unempl. Rate
Public Spending
5.5%
PS on Education
0.0%
Unempl. Rate
0%
2011
7.0%
5.6%
5.0%
2%
2008
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
4.8%
7.5%
4%
5.4%
5%
0%
6.7%
23
23
32.6%
24.0%
5.4%
33.4%
24.4%
5.6%
0.0%
2008
2009
2010
2011
5.4%
5.6%
39.9%
0.0%
24.0%
24.4%
32.6%
33.4%
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24. Question-4
EXPLAIN WHAT IS MEANT BY REVENUE CHURNING.
Based on Case Study: “Diminishing Marginal Returns to State Spending”
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25. Revenue Churning
 A transfer is churned when at least the same level of voter satisfaction could
have been achieved by lowering the voter's tax burden by the amount of the
transfer.
 The familiar example of churned transfers is that of the middle class which is
taxed, then given back a significant portion of those taxes in the form of social
security benefits or unemployment insurance.
Money taken from the people in taxes is often returned to the same people in
terms of improving desired infrastructures- development of
transport, schools, medical aids etc.
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26. Revenue Churning
Statistical analysis of Revenue Churning by juxtaposition of Tax revenue & Public Spending
1990-2000
S.N.
COUNTRY
2000-2010
Public Spending Tax Revenue Public Spending Tax Revenue
% of GDP
% of GDP
% of GDP
% of GDP
DEVELOPED COUNTRY
1
United States
32.8%
12.1%
32.4%
12.5%
2
Canada
46.0%
14.4%
44.7%
15.2%
3
France
49.8%
22.1%
55.0%
23.2%
4
Germany
45.1%
11.0%
49.1%
10.9%
5
United Kingdom
39.9%
27.0%
43.0%
28.3%
DEVELOPING COUNTRIES
1
India
16.0%
8.7%
14.4%
10.1%
2
China
13.6%
6.8%
NA
8.5%
3
Indonesia
17.9%
11.6%
18.1%
11.8%
4
Philippines
20.4%
12.8%
21.4%
12.6%
Source: www.worldbank.org
Public Spending
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27. Revenue Churning
35%
United States
32.8%
Canada
32.4%
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
30%
25%
20%
15%
12.5%
12.1%
2000-2010
Public Spending
32.8%
32.4%
Tax Revenue
12.1%
12.5%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
16.0%
India
10.1%
1990-2000
2000-2010
Public Spending
16.0%
14.4%
Tax Revenue
8.7%
10.1%
Public Spending
15.2%
1990-2000
2000-2010
46.0%
44.7%
14.4%
15.2%
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
14.4%
8.7%
14.4%
Tax Revenue
5%
1990-2000
44.7%
Public Spending
10%
0%
46.0%
Indonesia
17.9%
11.6%
18.1%
11.8%
17.9%
18.1%
Tax Revenue
27
2000-2010
Public Spending
27
1990-2000
11.6%
11.8%
25-Oct-13

28. Revenue Churning
Taxation & Dead weight loss
Tax tends to dichotomize the supply curve into customer’s & supplier’s share of tax
creating a zone of dead weight loss
Revenue churning & political inefficiency
•An efficient pattern of transfers is one in
which the needless deadweight losses a
government imposes on its subjects do not
persist.
•Deadweight losses are not necessarily a sign
that a government is politically inefficient.
•Deadweight losses may simply reflect the
reality that taxes are difficult to raise without
causing large shifts in consumption and effort.
•The funds raised at high cost though may be
buying something useful to the public, such as
roads or care for the poor.
•But when the funds provide no useful service
one can begin to ask whether resources are
being wasted.
Public Spending
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29. Question-5
WHY DO POLITICIANS HAVE LITTLE INCENTIVE TO
SPEND PUBLIC MONEY WISELY?
Based on Case Study: “Diminishing Marginal Returns to State Spending”
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30. Politicians in Public Spending
•Fiscal policy is governed by politicians only
•Politicians and bureaucrats are in charge of spending
money of the faceless, nameless taxpayer, who has no
direct control over how the money is spent. And
therefore, they have very little incentive to spend it
wisely
•Taxpayer has no direct say in how the money is spent.
The taxpayer can’t cut the government off if he/she
doesn’t like how the money is spent
•since government decision makers are not spending their own money, and are not directly
accountable to anyone whose money is being spent, they have little incentive to:
Hire qualified workers and fire unqualified workers.
Make sure contractors don’t over charge.
Economize on purchases.
Initiate work on fruitful projects, and cut off wasteful ones.
Public Spending
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31. Politicians in Public Spending
Still Politicians spends public money! Why?
 Government decision makers have little incentive to spend taxpayer’s money
wisely, but that doesn’t mean they lack motivation for other things. Like everyone
else, they are motivated to further their own personal self interests, such as their
political careers and size of their bank accounts. And in doing so they tend to:




Dole out government contracts to campaign contributors, who may not be the best for
the job.
Spend money so they can tell constituents they’ve brought money to their district
Spend money so they can tell constituents something is being done to solve their
problems, regardless of if it actually helps.
Spend all their budgets regardless of need to avoid inducing a budget cut. If a certain
department doesn’t spend its entire budget then it’s a clear signal that it can do with
less, and no bureaucrats wants to be in charge of a smaller budget next year.
Examples:
 One of the most famous cases of government waste was a Pentagon purchase of $600 toilet seat
covers back in the early ’80s.
 Another famous and more recent case is Alaska’s “Bridge to Nowhere“, a project that was
allocated $320 million to build a bridge to an Island with a population of 50.
Public Spending
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32. Question-6
IS IT POSSIBLE TO TALK ABOUT OPTIMAL LEVEL OF PUBLIC
SPENDING? HOW MIGHT THIS LEVEL BE DETERMINED?
Based on Case Study: “Diminishing Marginal Returns to State Spending”
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33. Optimal level of Public Spending
Effect of Public Spending on Economic Welfare of Nation
AS (Aggregate Supply) & AD (Aggregate Demand) curves are functions of Price (inflation rate) & Quantity output (GDP)
Public Spending
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34. Optimal level of Public Spending
A country has certain maximum capacity of GDP production at certain
conditions. Actual GDP below this maximum GDP level indicates unemployment .
Here in considered figure gap between a to b witnesses this. To mitigate this there
is requirement of money flow in economic system that gives rise to Public spending
Increase in Public Spending
•
•
•
•
•
More income of household
More purchasing power & more Demand
Aggregate Demand curve shifts rightward (AD1 to AD4)
Inflation rate increased from point a to b
Unemployment reduced from point a to b
Thus it is rational to operate between point a to b where a country has less
unemployment maintaining less inflation. This gives government an optimal level
of public spending.
Quote : “Working occasionally is beneficial when others are working more”
Public Spending
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35. Optimal level of Public Spending
Size of Government - Growth Curve
If government undertake activities in the order of their productivity, at first Govt
expenditure would Promote Economic growth (moves from A to B above) but
additional expenditure would eventually retard growth
Reference: Institute of Market Economics by D. Chobanov & A. Mladenova in 2009
Public Spending
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36. References
Websites





www.worldbank.org
www.populationcommission.nic.in
www.gov.uk/government/topics/public-spending
www.wikipedia.com
www.youtube.com
Research Papers






The economic role of the state in the 21st Century By Vito Tanzi
Public spending in the 20th century – a global prospective By VITO Tanzi and Ludger Schuknicht
Government spending in simple model of Endogenous growth by Robert J. Barro
Public spending in developing countries by Shenggen fan & Neetha Rao
Economic Growth with Optimal Public Spending by BeenLon
Public Investment & Productivity growth in group of seven by David A. Aschauer
Books

CFA Level-I & II by CFA institute
Tools used


Microsoft Encarta (Encyclopedia for offline references)
Microsoft Excel (for data analysis & graphs)
Public Spending
36
36
25-Oct-13

37. Thank you!
They said it….
“Increased Taxation is the Price of Growth” (James Tobin)
“Government role is not to do what individuals do but to do what they
don’t” (Keynes)
“Government spending is only tool to curb Poverty” (Gabbraith)
“If goods are consumed by people then they themselves should provide
the cost of those goods” (Bowens)
Public Spending
37
25-Oct-13