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Friday, September 22, 2017

Public Expenditure

Unit – 4: Public Expenditure
 Meaning of Public Expenditure
Public Expenditure refers to Government Expenditure. It is incurred by Central and State Governments. The Public Expenditure is incurred on various activities for the welfare of the people and also for the economic development, especially in developing countries. In other words The Expenditure incurred by Public authorities like Central, State and local governments to satisfy the collective social wants of the people is known as public expenditure.
Objectives of Public Expenditure:
The major objectives of public expenditure are
a)      Administration of law and order and justice.
b)      Maintenance of police force.
c)       Maintenance of army and provision for defence goods.
d)      Maintenance of diplomats in foreign countries.      
e)      Public Administration.
f)       Servicing of public debt.
g)      Development of industries.
h)      Development of transport and communication.
i)        Provision for public health.
j)        Creation of social goods.
Importance of Public Expenditure

Gone are the days when any kind of state intervention in the socio-economic affairs of a country was considered as a positive hindrance in the smooth working of the economy. The state was to act as passive spectator and the countries were left to the free working of the economic forces. It was Prof. J. M. Keynes in the twentieth century, who realised that state interference is necessary to keep the economy of a country in a stable equilibrium and the road leading to the destination of full employment. At a time when there was world-wide depression (1929-30), the economies of the world were facing the acute problems of overproduction and mass unemployment, private investment was showing a chronic deficiency, the emphasis was shifted from private spending to public spending. The doses of public spending served to uplift the economic system of the world through the interaction of multiplier principle, from the cruel hands of worldwide depression. The importance/significance/role of public expenditure may be studied under the following heads:

1)      Economic Development and Planning: Public expenditure plays a crucial role in the economic development and planning. The success of economic planning depends on the public expenditure because: (i) Economic planning itself requires heavy public expenditure; (ii) For the success of economic planning proper allocation of public expenditure is to be done on different items, such as, roads, transport, irrigation, electricity and power, industries, agriculture etc; (iii) the government is required to establish and manage the working of several government undertakings including public utility undertakings; (iv) Speedy capital formation is to be undertaken, and (v) balanced economic development. All these require heavy public expenditure. Planned development programmes cannot be undertaken without increasing public expenditure.
2)      Reduction in Disparities of Income and Wealth: Today, great emphasis is being given in almost all countries of the world to the reduction of disparities of income and wealth. Public expenditure has a vital importance in the attainment of this vital objective. Programmes for the uplift of the poor and backward classes may be undertaken by adopting a suitable policy of public expenditure.
3)      Economic Stability: Economic stability of a country depends on the public expenditure. In case of depression, heavy public expenditure is to be incurred for increasing investment, capital formation and employment and also for saving the economy from adverse effects of depression. On the contrary, in case of boom period public expenditure is incurred in such a way as to increase production and control the rising price-level.
4)      Economic-Social Welfare: Economic-social welfare in a country depends on the amount of public expenditure incurred on them. Economic and social welfare programmes like labour welfare, child welfare, women welfare, welfare of physically and mentally handicapped persons, welfare of scheduled castes, scheduled tribes, backward classes and backward areas, welfare of economically and socially weaker sections of the society etc. all these require huge public expenditure.
5)      Economic Development of Underdeveloped Countries: It is now unanimously agreed that public expenditure plays a positive role especially in the economic development of an underdeveloped country. The problems of underdeveloped countries are in such a magnitude that they cannot be left at the mercy of the old laissez-faire policy. Private sector cannot undertake the development projects, where the large amount of risk and capital investment is involved. The only available solution lies in the rapid increase of public expenditure.
6)      Increase in State Activities: Formerly, the activities of the state were limited, i.e. internal administration, maintenance of peace and order, judiciary and defence of the countries. Now-a-days the state is required to perform several functions over and above the basic functions, such as education, providing basic necessities like water and electricity, transport, establishment of basic industries in particular, labour welfare, banking including issue of currency, agricultural development, socio-economic welfare, medical assistance to industries and trade, entertainment etc. All these require huge public expenditure.

Difference between Public and Private Expenditure
a)      Difference as to motive: The motive of public expenditure is the welfare of the public whereas the motive of private expenditure is purely personal welfare. Further, (i) the scope of public welfare is wide whereas the scope of private welfare is limited; (ii) the object of public expenditure is of long-term nature whereas the object of private expenditure is of short-term nature.
b)      Difference as to Economy: Greater emphasis is placed on economy in case of public expenditure as against private expenditure. An individual tries to gain maximum utility out of his expenditure whereas the public expenditure does not have such an objective.
c)       Difference as to Adjustment of Income and Expenditure: Private expenditure is always adjusted according to income, whereas in case of public expenditure, the government collects revenue according to expenditure to be incurred. In other words, in case of private expenditure we follow the principle of income first and expenditure next; on the contrary, in case of public expenditure we follow the principle of expenditure first and income (revenue) next.
d)      Difference as to Elasticity: Elasticity exists in case of private expenditure, whereas electricity does not exist in case of public expenditure.
e)      Difference as to control: In case of private expenditure control exists in the hands of individual only who actually incurs the expenditure. On the contrary, the control is varied in case of public expenditure, such as, departmental control, assembly/parliament control and audit control.
f)       Difference as to Working: The scope of working of private expenditure is limited, i.e. himself including his own family, whereas the scope of working of public expenditure is quite wide.
g)      Difference as to Effects: The effect of private expenditure is limited, whereas the effect of public expenditure is wide and far reaching.
Classification of Public Expenditure
Different economists have classified public expenditure according to their own ideas about the suitability or importance of the base. The main bases of classification of public expenditure are as follows:-
(1)    Classification on the Basis of Benefit: Since the expenditure is incurred by the state with the objective of conferring benefit on the society, it can be classified on the basis of quantity of benefits which it confers on the various sections of the society. German writers such as Prof. Cohn and American writers such as Plehn have classified the public expenditure on the basis of benefit into four classes :
(i)      Public expenditure benefiting the entire society, e.g., the expenditure on general administration, defence, education, public health, transport etc.
(ii)    Public expenditure conferring a special benefit on certain people and at the same time common benefit on the entire community, e.g. poor administration of justice etc.
(iii)   Public expenditure directly benefiting particular group of persons and indirectly the entire society, e.g. social security, poor relief, public welfare, pension, unemployment relief etc.
(iv)  Public expenditure conferring a special benefit on some individuals, e.g., subsidy granted to a particular industry.
(2)    Classification on the Basis of Revenue: Prof. F.S. Nicholson classified public expenditure on the basis of amount of revenue obtained by the state in return for the services rendered. His classification is given below :-
(i)      Expenditure with direct return of revenue, e.g. poor relief as well as direct toll on wars.
(ii)    Expenditure without direct return, e.g. expenditure on education.
(iii)   Expenditure with partial direct return, e.g. subsidised railway services, education for which fees are charged etc.
(iv)  Expenditure with full return on event profit, e.g. gas service, post-office, public enterprises etc.
(3)    Classification on the Basis of Function :- Prof. Adam Smith classified public expenditure on the basis of functions of government in the following main groups  :-
(i)      Protection Functions: This group includes public expenditure incurred on the security of the citizens, to provide them with justice and counteract and external invasion and internal disorder, e.g., defence, police, courts etc.
(ii)    Commercial Functions: This group includes public expenditure incurred on the development of trade and commerce, e.g., development of means of transport and communication, public enterprises etc.
(iii)   Development Functions: This group includes public expenditure incurred for the development of citizens and country, e.g., education, public recreation etc.
(4)    Classification on the Basis of Importance: G. Findlay Shirras has classified public expenditure into two following groups:
(i)      Primary Expenditure: It includes all expenditure which must be incurred by every state, e.g., defence, maintenance of low and order, civil administration, payment of debts etc.

(ii)    Secondary Expenditure: It includes public expenditure on the remaining items, e.g., social expenditure, education, public health, poor relief, unemployment insurance etc.
(5)    Classification on the Basis of Necessary, Useful and Superfluous: Rosher classified public expenditure into following three groups:
(i)      Necessary Public Expenditure: It includes public expenditure which the state has to incur and which cannot be postponed.
(ii)    Useful Public Expenditure: It is that public expenditure which is desirable but can be postponed.
(iii)   Superfluous Public Expenditure: It is that public expenditure which the state may or may not incur.
(6)    Classification on the Basis of Productive and Unproductive :- Prof. Robinson classified public expenditure under the following two heads:
(i)      Productive Public Expenditure: Productive public expenditure is that which directly or indirectly develops natural and human resources and increases national income.
(ii)    Unproductive Public Expenditure: Unproductive public expenditure is that which does not result in any rise of national income, e.g. expenditure on war.
(7)    Classification on the Basis of Transferability: Prof. Pigou classified public expenditure into following two  groups:
(i)      Transferable Public Expenditure: An expenditure is said to be transferable when it takes the form of payment of money to people either gratuitously or in purchase of existing property rights.
(ii)    Non-transferable Public Expenditure: An expenditure is said to be non-transferable public expenditure when it is incurred to purchase current services of the resources of the nation.
(8)    Classification on the Basis of Constant and Variable Expenditure :- Prof. J.K. Mehta classified public expenditure into the following two groups:
(i)      Constant Expenditure: The constant expenditure is that amount which does not depend upon the services that are financed by it. The expenditure on defence is a clear example of the group of expenditure.
(ii)    Variable Expenditure: Variable expenditure is that which increases with every increase in the uses of public services by the people for whose benefit it is incurred. Expenditure on postal service is an example of variable expenditure.
Causes for increase in Public Expenditure
There has been a persistent and continuous increase in public expenditure in counties all over the world. It is due to the continuous expansion in the activities of the state and other public bodies on several fronts. The modern governments not only perform such primary functions as the civil administration as well as defence of the country, but also take considerable interest in promoting economic development of their countries. Today, the state is taking active part in social and economic matters, such as education, public health, removal of poverty and in commercial and industrial development. The public expenditure has increased enormously in recent years mostly due to the development activities of the state. Hence, the increase in public expenditure is fully justified.
One of the most important features of the present century is the phenomenal growth of public expenditure. Some of the important reasons for the growth of public expenditure are the following.
1) Welfare state: Modern states are no more police states. They have to look in to the welfare of the masses for which the state has to perform a number of functions. They have to create and undertake employment opportunities, social security measures and other welfare activities. All these require enormous expenditure.
2) Defence expenditure: Modern warfare is very expensive. Wars and possibilities of wars have forced the nation to be always equipped with arms. This causes great amount of public expenditure.
3) Growth of democracy: The form of democratic government is highly expensive. The conduct of elections, maintenance of democratic institutions like legislatures etc. cause great expenditure.
4) Growth of population: tremendous growth of population necessitates enormous spending on the part of the modern governments. For meeting the needs of the growing population more educational institutions, food materials, hospitals, roads and other amenities of life are to be provided.
5) Rise in price level: Rises in prices have considerably enhanced public expenditure in recent years. Higher prices mean higher spending on the part of the govt. on items like payment of salaries, purchase of goods and services and so on.
6) Expansion public sector: Counties aiming at socialistic pattern of society have to give more importance to public sector. Consequent development of public sector enhances public expenditure.
7) Development expenditure: for implementing developmental programs like Five Year Plans, Modern governments are incurring huge expenditure.
8) Public debt: Along with debt rises the problem like payment of interest and repayment of the principal amount. This results in an increase in public expenditure.
9) Grants and loans to state governments and UTs: It is an important feature of public expenditure of the central government of India. The government provides assistance in the forms of grants-in-aid and loans to the states and to the UTs.

10) Poverty alleviation programs: As poverty ratio is high, huge amount of expenditure is required for implementing alleviation programmes.
Justification for increase in Public Expenditure
Increase in public expenditure can be justified on the following grounds :
a)      Assists in increasing state activities,
b)      Increase in welfare activities,
c)       Reduces disparities between rich and poor,
d)      Boom for rapid economic development specially in underdeveloped and backward economy,
e)      Provides economic stability, and
f)       Brings prosperity etc.
The canons or principles of public expenditure are the fundamental rules which govern the public expenditure policy of the governments. The method and direction in which the public expenditure utilized is of paramount importance Professor Alfred G.Buchler made some guidelines for the utilization of expenditure by the public authorities. They are as follows:
a) Public expenditure should promote the welfare of the society.
b) Careful judgement should be exercised by the public authority and the electorate to ensure that the advantages of the public expenditure should exceed the costs and that the fund utilized by the governments will be more conducive to social welfare than the same funds would, if privately utilized.
c) Public expenditure should be utilized in the order of priority of welfare. That is, the services which will bring about maximum welfare should be undertaken first.
Prof. Findlay Shirras has explained four canons of public expenditure. They are canon of benefit, canon of sanction, canon of economy and canon of surplus.
CANON OF BENEFIT: The ideal of this is maximum social advantage. That is, public expenditure should be planned so as to yield maximum social advantage and social welfare of the community as a whole and not of a particular group. Public expenditure must be spent in those directions which will maximise utility. It is possible only when the marginal utility from different uses is equal. The public authorities should distribute resources so as to increase production, reduce inequalities of income distribution, preserve social life of the people, and improve the quality of social life etc. “Other things being equal, expenditure should bring with its important social advantages such as increased production, the preservation whole against external attack and internal disorder and as far as possible a reduction in the inequalities of income. In short, public funds must be spent in those directions most conducive to the public interest. i.e., maximum utility is to be attained in public expenditure.”---Findlay Shirras.
CANON OF ECONOMY: This implies that the state should be economical in spending money. It should not spend more than the necessary amount on items of expenditure. The sole aim is to avoid extravagance and corruption. Social benefit can be maximised when resources are not wasted. While incurring public expenditure social costs are to be minimised. To satisfy this canon Project Appraisal and Cost Benefit Analysis are to be adopted. “Economy means protecting the interests of the tax payers not merely in effecting economies in expenditure, but in developing revenue.”—Shirras.
CANON OF SANCTION: According to this canon, no expenditure should be incurred without the proper approval of the sanctioning authority. It also implies that the spending authorities should spend the amount for which it has been sanctioned and to see that the sanctioned amount is properly utilized. Public accounts are to be audited at the end of financial year. This canon acts as check on arbitrary, unwise and reckless spending of public funds.
CANON OF SURPLUS: This canon believes in the avoidance of deficit in public expenditure. According to Findlay Shirras,”Public authorities must earn their living and pay their way like ordinary citizens. Balanced budget must, as in the private expenditure; the order of the day. Annual expenditure must be balanced without the creation of fresh credits unrepresented by the new assets.”
Modern governments does not consider balanced budget a virtue always. In an inflationary condition a surplus budget is desirable as it reduces purchasing power of the individuals. Similarly, in the time of depression a deficit budget is recommended in order to enhance the purchasing power of the people. The canon of surplus is not relevant in modern public finance.
CANON OF PRODUCTIVITY: Public expenditure should promote production and increase the working efficiency of the people. Major part of public expenditure should be incurred on developmental activities. The aim of public expenditure should be maximum production, employment and income.
CANON OF ELASTICITY: There should be flexibility in government expenditure. That is, the government may be able to change its public expenditure policy with changing conditions. It means that public expenditure should increase during periods of emergency and reduce during normalcy.
CANON OF EQUALITY: This implies that public expenditure should be incurred in such a way that inequality in the distribution of income should be reduced. For achieving this canon the benefit of public expenditure should conferred more on the poorer section of the society.
CANON OF NEUTRALITY: Public expenditure should not worsen the production-distribution-exchange relationship instead of improving it. Public expenditure should result in increased production and productivity, reduced inequality of income and wealth and increased economic activity and exchange relationship.
CANON OF CERTAINTY: The public authorities should clearly know the purposes and extent of public expenditure to be incurred. This anon explains the preparation of public budgets.
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 rule 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.
Adverse effects of public expenditure
According to Prof. J.K. Mehta, “Public expenditure is a double-edged weapon. It can be much goods to the community, but if it is unwisely made, it can be do much harm.” The bad or adverse effects or dangers involved in the increase of public expenditure are as follows:
1)      Unnecessary Assistance to Industries and Business: If the government gives protection and provides financial assistance to those industries and business which have lost their shape and do not occupy any importance in the economic development of the country then it is mere wastage of public resources. It will lead to development of those industries and business which hinder the path of economic development and thereby the country is likely to go to the worse.
2)      Excessive Expenditure on Defence: If the government incurs excessive expenditure on defence, it will adversely affect the development of the poor and backward community of the country. Pakistan is the burning example of the same. From moral and human points of view also, excessive expenditure incurred on defence is treated as uneconomic and unnecessary. It will also affect the security and peace of the entire region.
3)      Tendency of gaining Political Influence: Now-a-days the concept of public expenditure is being applied by ministers in particular for gaining political influence and sounding vote bank. Huge amount of public expenditure is being done by both Central and State ministers in their respective areas just to gain political influence at the cost of other backward areas of the country / state. It leads to severe criticism and dissatisfaction amongst the masses. It is also one of the major factors of political instability in the country.
4)      Advantages to a Particular Community: Sometimes public expenditure is incurred just to give advantage to a particular community or class over the above the other communities. It will lead to division of the society in two clear-cut classes leading to class conflicts, feelings of superiority and inferiority and more movement’s unrest, strikes, dharnas etc. As a matter of fact, the peace of the entire country is badly hurt and disturbed .
5)      Rapid Increase in Taxation: In order to meet the rising public expenditure, government imposes new taxes every year leading to heavy incidence of taxation on the community. If it is not enough, then the government takes the shelter of deficit financing which leads to rapid inflation. The service class and poor classes in particular are adversely affected.
6)      Government Expenditure in Misuse of Scarce and Limited Resources and also Unproductive: According to traditional economists, government expenditure is the misuse of scarce and limited resources of the country and also unproductive. They are of the opinion only that public expenditure is productive which leads to physical increase in the production of commodities mean for direct consumption.
7)      Fear of Minority Political parties: Political parties led by minority groups are always fearful of the increases of public expenditure on the ground that the political party or parties in power, with use the public expenditure in fulfilling their own political interests.
8)      Dominance of Public Sector Reduced the Authority of Private Sector: While citing the dangers of increase in public expenditure, capitalists argue that it reduces the authority of private sector which is the backbone of capitalist’s economy.