1. Theme 2 – Public Sector and Mixed Economy
Public Economics

2. Public Sector and the Economy

4. The Size of Government How to measure the size of government
Number of workers
Annual expenditures
Types of government expenditure
Purchases of goods and services
Transfers of income
Interest payments
Budget documents
Unified budget
Regulatory budget

7. Government spending, % of GDP
1870
1913
1920
1937
1960
1980
1990
1996
Austria -
14.7
15.2
35.7
48.1
48.6
51.7
Belgium
21.8
30.3
58.6
54.8
54.3
Canada
13.3
18.6
28.6
38.8
46.0
44.7
France
12.6
17.0
27.6
29.0
34.6
46.1
49.8
54.5
Germany
10.0
14.8
25.0
42.4
32.4
47.9
45.1
49.0
Italy
11.9
11.1
22.5
24.5
30.1
41.9
53.2
52.9
Japan
8.8
8.3
25.4
17.5
32.0
31.7
36.2
Netherlands
9.1
9.0
13.5
19.0
33.7
55.2
54.0
49.9
Norway
3.7
13.7
29.9
37.5
53.8
45.5
Spain
9.3
18.4
18.8
32.2
42.0
43.3
Sweden
5.7
6.3
8.1
10.4
31.0
60.1
59.1
64.7
Switzerland
2.7
4.6
6.1
17.2
32.8
33.5
37.6
Britain
9.4
12.7
26.2
30.0
43.0
39.9
United States
3.9
1.8
7.0
8.6
27.0
31.8
33.3
AVERAGE
15.4
18.3*
28.5
47.1
Australia
21.2
31.6
34.7
36.6
Ireland
28.0
48.9
41.2
New Zealand
26.9
38.1
41.3
39.5
39.1
40.4
TOTAL AVERAGE
20.7
27.9
42.6
44.8
45.9
Source: IMF
*Average without Germany, Japan and Spain undergoing war or war preparations at his time

12. The future of the state...

13. Reasons for government growth
Macro models
Wagner and the stages of development
Peacock and Wiseman’s displacement effect
Micro models
Baumol’s unbalanced productivity growth
Brown and Jackson’s microeconomic model
Role of politicians, bureaucrats and interest groups.

14. What are the Legitimate Economic Functions of a Government?
Depends on chosen economic system…
Least
individual
freedom
Most
Centrally Planned Socialism: Government owns all resources and makes all important economic decisions
Decentralized Capitalist Economy: Limited government; individuals and firms make all important economic decisions

15. Three Normative Aspects of Public Sector Economics
Public expenditure theory
What government expenditures do we expect, and why?
How should government carry out its desired functions?
Theory of taxation
What principles should guide design of government tax policy
Theory of fiscal federalism

16. Two Goals of Economies 1: EFFICIENCY
Efficiency is mainly a positive concept
Economists measure efficiency as Pareto Optimality
Definition: An economy-wide allocation of resources is efficient if in order to increase one person’s utility at least one other person’s utility must be decreased
Example
An allocation in which I have everything and you have nothing is an ‘efficient’ allocation (Pareto Optimal)
The only way to make you better off is to take some away from me

17. (Efficiency continued…)
Consider all ‘efficient’ points given our existing resources
Called the Utility Possibility Frontier
Must be downward sloping
To increase 1’s utility we must take utility away from 2
Points below line are attainable but not efficient
Could give some to both 1 and 2 and make them both better off (Pareto Superior moves)
Points beyond line are unattainable
Would require giving more utility to both 1 and 2 which is impossible

18. 2: EQUITY (FAIRNESS) Equity is mainly a normative concept
End-results equity
Asks whether outcomes are fair.
For example: Is it fair that over half of income in the country goes to 20% of households? If not, what should be done to correct it?
Process equity
Asks whether rules determining process are fair, regardless of allocation.
For example: Do children of wealthy families start with an advantage due to their family’s wealth? If so, then what should be done to level the playing field?

19. Allocative function
Market failures distort the allocation of resources in the economy
Incomplete markets
Characteristics of goods and services prevent efficient supply
Existence of externalities.

20. Distributive function
Fairness
Inequality in income distribution
Criteria for evaluation.

21. Stabilisation function
Macro-economic objectives
3 premises of stabilisation (Keynes):
The market economy is inherently unstable
Macroeconomic instability is a form of market failure that is highly costly to an economy
Governments are able to stabilise the economy by means of appropriate macroeconomic policies.
New Classical Macroeconomics
Neo-Keynesian theory.

22. Direct versus indirect government intervention
Direct government intervention refers to the actual participation of government in the economy.
Indirect government intervention to the regulatory function of government.

23. Direct versus indirect government intervention
Direct intervention
Indirect intervention
Actual participation in the economy
Tax individuals and companies
Borrow on financial markets
Execute budgeted spending
Examples:
National defence
Electricity
Infrastructure
Provision of school text books
Regulatory function
Enacting law or proclaiming legally binding rule
Indirect taxes and subsidies
Examples:
Labour laws
Anti-tobacco laws