1. Role of Government, Public Policy and Public Spending Vito Tanzi

2. Main Thesis The essential or fundamental role of the state is not to correct for market failures, but to make the market work as efficiently as possible. When the state focuses on correcting the market, it often prevents the market from developing.

3. I. Historical Background: Industrial Countries 1.Laissez-Faire Period Adam Smith and Basic Role of State As a reaction to Mercantilism Focus on allocation and institutions Level of public spending before First World War

4. 2. Changing Role of State: Structural Factors: New work relationships and the invention of unemployment and the invention of retirement and the advent of business cycles Urbanization Limitation to tax revenue (and the First World War)

5. 3. Changing Role of the State: Intellectual Factors: Socialist ideology Soviet Russia – Challenge from Wagner and redistributive role of state Keynes and the end of laissez-faire Fascism in Germany and Italy Impact of the Great Depression and the New Deal Democratization and role of masses Keynes and stabilization role The Keynesian Revolution

6. 4. Changing Role of State: Role of Economic Profession Public goods Natural monopolies Externalities Merit goods Built-in flexibility Stability and size of public sector Cost-benefit analysis PPBS

7. 5. Musgrave’s Trilogy: Allocation Branch (essential) Redistribution Branch (optional) Stabilization Branch (optional)

8. 6. Growth of Public Spending in last 50 years Level of Spending Welfare States Public Spending and its impact Fiscal churning Socio-economic indicators

9. 7. Role of State through its main instruments: Public spending Tax expenditures Regulations Differences in use among countries

10. II. Historical Background: Developing Countries 1.Lower time span – since Second World War 2.Impact of decolonization on nationalization of enterprises on role of state

11. 3. Structural Factors: Low taxing capacity Informal economy Low human capital Weak private sector

12. 4. Early intellectual influences: Public sector as driving force Harrod and Domar view and implications for taxation and public spending Focus on resource mobilization Allocation role of state As entrepreneur Through tax incentives Through import substitution Great use of regulations as substitute for spending

13. 5. Later influences: Growing attention to equity Growing role of human capital: And spending on education And spending on health Growing dependence on foreign assistance Consequence for role of public sector

14. III. Role of State and Public Spending in the Future in Industrial Countries

15. After World War Two: Market failure as a justification for larger government role Larger government role prevented the development of many markets This perpetuated the justification for continuation of government role

16. In more recent years: Private markets have been created or have developed in many areas Technological developments have challenged the notion of natural monopolies Globalization has opened many opportunities

17. Furthermore: Demographic changes can put pressure on future spending without reform “Fiscal termites” can reduce capacity to raise high tax levels Therefore: Need to rely more on markets Need to make spending programs more targeted Future spending limits of 30-35% of GDP?

18. IV. Role of State and Public Spending in the Future: Developing Countries

19. At present, enormous range in share of public spending to GDP More than 40% of GDP in Brazil; only 10% in several other countries Great differences in capacity and willingness to tax Still great reliance on regulations as a substitute for spending Public spending still too focused on urban areas Still identification of benefits from spending with budgetary costs of spending Role of state still too broad

20. In the Future Need to reduce range of public spending (and tax burden) – perhaps to the 15-25% of GDP More efficient use of regulations Reduction of focus of spending to urban areas and middle classes Make sure that budget for education and health is not hijacked by those who deliver the services Focus on improving the working of the market