4.5

It is used for macroeconomic management to control AD and achieve macro objectives;

• Economic growth

• Low and stable inflation

• Balanced current account

• Low unemployment

The government may also aim for equity and equality by providing services to individuals or groups who would otherwise not receive them.

Additionally, it may be used to correct market failure.

Capital government expenditure - Spending on investment goods such as new roads, schools, and hospitals which will be consumed in over a year

General government final consumption - Spending on goods and services that will be consumed within the next year, such as the public-sector salaries

Transfer payments - Government payments for which there is no corresponding output, where money is taken from one group and given to another, e.g. benefits and pensions

The government also has to spend money on interest payments for national debt.

Current government expenditure - General government final consumption plus transfer payments plus interest payments

In most mixed and free economies, the lower the average income of the country, the lower is likely to be the percentage of GDP spent by the government.

This is because poorer countries tend to have a lower tax revenue, due to avoidance, inefficiency at collecting and a smaller amount of wealth to tax.

Moreover, citizens in higher income countries demand more services from their governments; government provided goods are income elastic. E.g. access to improving technologies means that more is demanded from teh NHS compared to what would be demanded of state healthcare in poorer countries.

However, amongst developed countries, there are significant differences in the size of government spending. E.g. the USA has much lower state spending, and this is due to attitudes in that country.

Free market economists argue that government spending is wasteful and causes inefficiency. However, the government is able to enjoy EoS when it provides goods, and this improves productivity.

They also provide the infrastructure, such as roads, necessary for the economy to run efficiently.

Education creates the human capital necessary for growth whilst the healthcare system reduces the number of days workers lose from serious illness. Spending on research and development may not be done by the private sector and the government will undertake it to give businesses a long term competitive edge.

Through spending, the government can create a multiplier effect and this can be focused on areas of the country with high unemployment, creating growth.

Government spending can cause large improvements in living standards. The government corrects market failure and provides public goods, which improves social welfare.

They are also important since they reduce absolute poverty by providing benefits and basic goods, such as education and healthcare. In developing countries, government do not have the resources to do this and this leads to malnutrition, poor water, etc.

There is some debate about how much the government can contribute to improved living standards. It is argued that the government will be inefficient at providing goods and services and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall.

It can be argued that the government suffers from the principal agent problem since they make decisions on behalf of the people and individuals may have spent that money differently. As a result there is a loss in welfare and so a fall in living standards.

However, the political system means that society decides the government and so therefore decides to an extent where it would like money to be spent.

In order to spend money above their tax revenues, the government has to borrow from individuals and businesses. However, the amount of money in the economy available to borrow does not increase. The government will therefore be competing with the private sector for finance and will cause higher interest rates. This will discourage firms from investing and individuals from buying on credit.

On top of this, the limited number of resources in the economy means that for every resource used in government spending, there are less resources available for the private sector. The result is that government borrowing crowds out private sector borrowing and spending and may lead to no real increase in AD.

Free market economists argue that investment would be more efficient if done by the private sector and that the government targets investment poorly and is wasteful.

The crowding out effect is felt most at full employment, but it is not always the case. Transfer payments have no impact on output and so would not cause crowding out as resources are simply taken from one group and given to another; the government isn’t taking resources from the economy. Moreover, when levels of unemployment are higher then extra government spending could lead to crowding in where it encourages investment through the multiplier.

In most cases, where government spending is high, levels of tax must be high in order for spending to be sustainable. High levels of tax may have a disincentive effect.

Oil-rich countries tend to be an exception, where revenue from oil can pay for most of government spending.

Spending should increase equality as it leads to redistribution and helps to provide a minimum standard of living for the poorest in society. It ensures everyone has access to basic goods, such as education and healthcare, which will help to give them a fair start in life.