Effects of Public Expenditure on Production, Economic Development and Planning, Economic Stability and Distribution

Public Expenditure and its Effects

on Production, Economic Development and Planning

Effects of Public Expenditure

Public expenditure incurred according to the sound principles of public finance, exerts healthy effects on the entire economy of a nation. The ultimate effects of public expenditure, in the form of greater production, more equitable distribution of wealth and all-round economic development of a country, are always expected to be present, if the expenditure is incurred after considerable thought and utmost rationality.

Gone are the days when it was advocated that the state should interfere the least in economic activities and the government is merely an agent for the people – responsible for the maintenance of justice, police and army. In those days public expenditure on economic activities was normally considered a waste. Contrary to this, a new concept of public expenditure has been developed by the modern economists. Today, public expenditure is regarded as a means of securing social ends rather than just being a mere financial mechanism. In present times, Wagner’s Law of Increasing Public Expenditure – both extensively and intensively, is considered universally true. The trend of rising public expenditure is not confined to any particular country, but it is found in almost all countries of the world, irrespective of its socio-economic and political set-up. Every public expenditure is considered desirable, when it is not wasteful, but has a positive effect on production, distribution, consumption and thus maximizes economic and social welfare of the country as a whole.

Effects of public expenditure can be studied under the following heads:

a)      Effects of Public Expenditure on Production.

b)      Effects of Public Expenditure on Distribution.

c)       Miscellaneous Effects of Public Expenditure including Consumption.

Effects of Public Expenditure on Production: While analyzing the effects of public expenditure, Dalton very correctly said that just as taxation, other things being equal should reduce production as little as possible, so the public expenditure should increase it as much as possible. He further added that the level of production and employment in any country depends upon the following three factors:

1)      Effects Upon the Ability to Work, Save and Invest: If public expenditure increases the efficiency of a person to work, It will promote production and national income. Public expenditure on education, medical services, cheap housing facilities, means of transport and communications, recreation facilities etc. will increase the efficiency of persons to work. At the same time, public expenditure can promote saving on the part of the lower income groups by providing additional income to them, for a person who has larger income can be normally expected to save a larger amount. Finally, public expenditure, particularly repayment of public debt will place additional funds at the disposal of those who can save. Thus, it is evident that public expenditure can promote ability to work, save and invest and thus promote production and employment.

2)      Effects on Willingness to Work, Save and Invest: Public expenditure also affects the people’s willingness to work, save and invest. Pension, provident fund, interest-free loan, free medical aid, unemployment allowances and other government payments provide security to a person and, therefore, reduce the willingness of persons to work and save – after all, why should a person work hard and save when he knows fully he will be looked after by the government when he is not in a position to earn any income, i.e. he finds his future fully secured. In the absence of any savings, the question of investment does not arise at all.

3)      Effects on Diversion of Resources: Public expenditure also affects the diversion of resources. For example, if the government wishes to attract productive resources to a particular industry, it will start giving financial assistance from its own funds to such an industry. In the same way, if the government wishes to attract productive resources to a particular area or region, it will start giving a variety of incentives in the form of bounties, subsidies etc. (such as land at concessional rates, cheap electric supply and water, loans on nominal rates of interest, freedom from sales tax, income-tax etc. for a certain period, production subsidy etc.) to the industrialists to achieve this objective.

Effects of Public Expenditure on distribution: Public expenditure has its effects not only on production but is also a most powerful weapon in the hands of the government for bringing about an equitable distribution of wealth. For bringing about an equitable and just distribution of wealth the government can use not only its taxation policy but public expenditure policy can also help to a great extent in achieving this very objective. In fact, the role of taxation and public expenditure in removing inequalities of income is complementary and supplementary. If the government intends to minimize the economic inequalities that existed in the society, it should levy maximum about of taxation on richer sections of the community, because their taxable capacity is undoubtedly high. The income so earned through taxation should be spent on providing various types of facilities, subsidies and amenities to the poorer section of the community. For example, the state can extend to the poor benefits of old age pensions, social insurance, free medical aid, cheap housing, interest-free loans, subsidized food etc. This will automatically bring redistribution of wealth (national income) in favour of the poorer section of the community. On the contrary, public expenditure which confers larger benefits to the richer sections of the community, e.g., subsidies on luxury goods, provision of subsidized milk, other foodstuff etc. tends to widen the gap of inequalities. As Dalton puts, “That system of public expenditure is best which has the strongest tendency to reduce inequalities of income”. Public expenditure has, thus, an important role in reducing economic inequalities in the community.

Miscellaneous Effects of Public Expenditure:

Effect of Public Expenditure on Consumption: Public expenditure also affects consumption. Due to public expenditure the size of consumption tends to increase in the economy. Since public expenditure tends to redistribute the income in favour of poor people and their marginal propensity to consume being high, the overall impact of public expenditure leads to a rapid increase in the consumption of the economy. Many social goods are provided to the poor sections of the community for consumption at relatively cheaper rates, e.g. free medical aid, subsidies foodstuffs (rationing scheme), expenditure on education, public parks, playgrounds, libraries etc. with the results that the real income of beneficiaries increases and their capacity to consume, save and invest also improves.

Effect of Public Expenditure on Economic Stability: It is an admitted fact that public expenditure has proved to be a powerful tool for bringing about economic stability in the country. It is an excellent instrument for regulating and controlling volume of employment in a country. The government should make a substantial increase in public expenditure at a time of depression, because this will help bring about an automatic increase in the volume of employment. On the contrary, the government brings about a substantial reduction in its expenditure at a time of boom (inflation), because this will help save the economy from the adverse effects of inflation. Inflation is a condition when investment exceeds savings. In this situation the aim of the government should be to have a surplus budget, i.e. the governments spend less than its revenue. The funds acquired by means of a surplus budget may be used to provide additional capital to those sectors of economy which experience shortage of capital so that the total productive capacity of the economy may increase. The rising price-level may also be checked by increasing the production of goods and services leading to control of inflation.

Effect of Public Expenditure on Economic Growth: There is a close relationship between public expenditure and economic growth. According to John Adler, a rising proportion of additional output should be developed to capital formation, so that the economic growth of an undeveloped country may be speeded up. For this purpose, twofold change in the government budget is required. Firstly, the government budget should be raised so that a rising proportion of the additional output may be available for development purposes. Secondly, a rising proportion of government revenues should be used to finance expenditure on development. The basic infrastructural facilities required for economic development can be provided with the help of public expenditure. In this way, public expenditure has a significant role to play in the process of economic growth.

Effects of Public Expenditure on Employment: Unemployment is the burning problem in underdeveloped countries, developing countries and now even in developed countries of the world. Public expenditure can play a vital role in influencing the level of employment in an economy. According to Prof. J. M. Keynes “The government should step up its expenditure on public works such as roads, buildings, canals at the time of depression and unemployment. This will add the volume of employment in the economy.” On the contrary, the government should cut down its expenditure to deal with the problem of the shortage of human resources in a country.