Significance

Public expenditure is the value of goods and services bought by the State and its articulations.

Public expenditure plays four main roles:
1. it contributes to current effective demand;
2. it expresses a coordinated impulse on the economy, which can be used for stabilization, business cycle inversion, and growth purposes;
3. it increases the public endowment of goods for everybody;
4. it gives rise to positive externalities to economy and society, the more so through its capital component.

With its prioritised structure and its peculiar decision-making processes, it substantiates the prevailing kind of State.

In democracy, public expenditure is an expression of people's will, managed through political parties and institutions. At the same time, public expenditure is characterised by a high degree of inertia and law-dependency, which tempers the will of the current majority.

Public expenditure can be financed through taxes, public debt, money emission, international aid.

Composition

First, public expenditure can be classified in terms of the kind of goods and services bought, also with very general items:

1. capital goods;
2. consumption goods;
3. personnel expenditure.

By contrast, public expenditure in national accounts does not comprehend mere transfers among social groups, as it is the case of pension schemes. Payments of interest on public debt are not comprehended as well.

Second, public expenditure can be classified according to the official body and organization from which budget it is paid, as for example:

1. the central state and its ministries;
2. regional and local authorities;
3. separate public bodies;
4. international organizations.

Here we should note that public expenditure usually does not consolidate state-owned firms. Their capital goods expenditure is added to investment.

Third, public expenditure can be classified according to the macro-function at which it is directed:

1. justice and public order;
2. infrastructure (roads, railways,...);
3. military system;
4. education system;
5. health care;
6. support for the poor, the old, the disadvantaged;
7. support for firms, export and production in general;
8. special policy expenditure (foreign aid, integrated fight against drugs,...).

In different places and over time, those macro-functions have largely changed their level of priority and even the social acceptance of the idea that it is the State that must care of them.

In particular, as a very sketched framework, one may distinguish at least three general models of state to which public expenditure corresponds:

1. the minimal state, where only justice, public order, foreign policy and some other basic functions should be carried out by the state, relying on private initiative for the others;
2. the welfare state, where the State cares about the people's well-being directly, also through expenditure in schooling, health, support for the poor, the old, the disadvantages;
3. the developmental state, where the State takes the responsibility of fostering economic development, also through expenditure in infrastructure, support for firms, export and production in general.

Both the welfare and developmental state include the items of the minimal state. Military expenditure and special policies are common traits of the three models, maybe in different proportions.
Comparing macro-function shares in public expenditure, one can get insights in the kind of state under analysis.

Needless to say, the State does not exert its influence on economy and society through public expenditure only, but also for example through laws.

Determinants

Public expenditure is determined by political will of the leading forces in the state: their priorities, their desired state model, and their interpretation of current economic and political phase. Past choices have relevant impact on public expenditure because of inertia and incrementalism. Bureaucracy may play an important decision role for the actual expenditure.

Sometimes considered as a completely exogenous variable, the public expenditure would thus be fully in the hand of political decision-makers without dependency from the economic context.

Yet, policy makers may turn out to follow an anti-cyclical broad control of public expenditure. Automatic stabilizers may be at work, as with the case of support schemes for unemployment: in this case, higher unemployment and disappointing GDP growth would lead to higher public expenditure through unemployment benefits and financial support to firms.

In a different political and institutional context, public expenditure may, instead, positively respond to state revenues. Higher revenues (and maybe even a public surplus) may lead to higher public expenditure. Symmetrically, if there is an upper limit to public deficit and, because of a recession, tax revenue fall, the State may be forced to cut public expenditure. In this context, public expenditure would turn out to be pro-cyclical.

Impact on other variables

A GDP component as it is, public expenditure has an immediate impact on GDP. An increase of public expenditure rises GDP by the same amount, other things equal. Moreover, since income is an important determinant of consumption, that increase of income will be followed by a rise in consumption: a positive feedback loop has been triggered between consumption and income, exactly as in the case of shocks in export, investment or autonomous consumption.

The full extent of this mechanism will depend, however, by the reactions of the other economic agents. Firms have to decide whether to increase production or prices in response to demand.

Moreover, if consumers interpret the increase in public expenditure as a fall in their disposable income (i.e. after-tax income), consumption may fall accordingly.

Public expenditure is also told to crowd-out investment, possibly through an interest rate increase, further leading, in a floating exchange rate regime, to a currency appreciation. Exports would then be displaced as well.

In more microeconomic terms, public expenditure may be directed to consumer goods and thus substitute families' expenditure, as with the case of health drugs. By contrast, in other cases, as with education, public expenditure may trigger further consumption (books and all the other goods whose consumption depend on culture levels).

Long-term trends

In developed countries, it has always grown, whatever the political orientation of the government. Just the tempo can change. With a few exceptions, only under extremely strong constraints has public expenditure been cut in absolute terms.

Wars are episodes of extremely high public expenditure, followed usually by a return to normality.

Business cycle behaviour

Public expenditure may turn out to be pro-cyclical or anti-cyclical depending on the political and institutional attitude toward public deficit, as we said.

Still, real world data show often little reaction of public expenditure to the cycle. Most cycles show public expenditure as a stabilizing tool just keeping the same dynamics when the rest "goes wrong".

Data

Public expenditure data from 136 countries: a long term time series
Composition of public expenditure (education, health, defence...) - 69 countries in Africa, Asia, America, Europe (1975-1985)
The impact of public expenditure on education results [8 MB]
Data for all the variables in IS-LM model
EU data for all the variables in IS-LM model (Germany, France, Italy, Spain, UK, Switzerland and other 13 European countries)
Total expenditure on health in OECD countries (1960-2000)

Related papers

Health care experience of Kerala (India)

Health care experience of Italy

Towards greener government procurement: a case study

Formal models

An interactive map of how the economy works according to a basic macroeconomic scheme: the IS-LM model