Public Expenditure

Public expenditure is spending made by the government of a country on collective needs and wants such as pension, provision, infrastructure, etc. Until the 19th century, public expenditure was limited as laissez faire philosophies believed that money left in private hands could bring better returns. In the 20th century, John Maynard Keynes argued the role of public expenditure in determining levels of income and distribution in the economy. Since then government expenditures has shown an increasing trend.

In the 17th and the 18th centuries public expenditure was considered as a wastage of money. Thinkers said government should stay with their traditional functions of spending on defence and maintaining law and order.

Importance of Public Expenditure:

Thanks to the macroeconomic theory advanced by J.M. Keynes, the role of public expen­diture in the determination of level of income and its distribution is now well recognised. Keynesian macroeconomics provides a theoretical basis for recent developments in public expenditure programmes in the developed countries.

The public expenditure can be used as a lever to raise aggregate demand and thereby to get the economy out of recession. On the other hand, through variation in public expenditure, aggregate demand can be managed to check inflation in the economy.

Public expenditure can also be used to improve income distribution, to direct the allocation of resources in the desired lines and to influence the composition of national product. In the developing countries also, the role of public expenditure is highly significant.

In the developing countries, the variation in public expenditure is not only to ensure eco­nomic stability but also to generate and accelerate economic growth and to promote employment opportunities. The public expenditure policy in developing countries also plays a useful role in alleviating mass poverty existing in them and to reduce inequalities in income distribution. In what follows, we shall study the types of public expenditure, the causes of growth of public expenditure and its effects on production, distribution and economic growth in both the devel­oped and the developing countries.

Classification of Public Expenditure:

Revenue Expenditure and Capital Expenditure:

Public expenditure has been classified into various categories. Firstly, Government expenditure has been classified into revenue expen­diture and capital expenditure. Revenue expenditure is a current or consumption expenditure incurred on civil administration (i.e., police, jails and judiciary), defence forces, public health and education.

This revenue expenditure is of recurrent type which is incurred year after year. On the other hand, capital expenditure is incurred on building durable assets. It is a non-recurring type of expenditure. Expenditure incurred on building multipurpose river projects, highways, steel plants etc., and buying machinery and equipment is regarded as capital expenditure.

Transfer Payments and Expenditure on Goods and Services. Another useful classifica­tion of public expenditure divides it into transfer payments and non-transfer payments. Transfer payments refer to those kinds of expenditure against which there is no corresponding transfer of real resources (i.e., goods and services) to the Government.

Expenditure incurred on old-age pensions, unemployment allowance, sickness benefits, interest on public debt during a year etc., are examples of transfer payments because the Government does not get any service or goods against them in the particular year.

On the other hand, expenditure incurred on buying or using goods and services is a non-transfer payment as against such an expenditure, the Government receives goods or services. It is therefore called expenditure on goods and services. It may be noted that expenditure on defence, education, health etc., are non-transfer expenditure as in return for these, Government obtains the services of army personnel, teachers, doctors etc., as well as some goods or equipment’s used in these activities.

Investments expenditure is undoubt­edly non-transfer expenditure as through it Government obtains capital goods. It is worthwhile to mention that whereas in case of transfer payments, it is the beneficiaries that decides about the use of resources, in the case of non-transferable type of expenditure, the Government itself decides about the use of real resources, especially whether they are to be used for consumption or investment purposes.

Developmental and Non-Development Expenditure:

Another useful classification of public expenditure rests on whether a particular expenditure by the Government promotes development. All those expenditures of Government which promote economic growth are called developmental expenditure.

Expenditure on irrigation projects, flood control measures, transport and communication, capital formation in agricultural and industrial sectors are de­scribed as developmental. On the other hand, expenditure on defence, civil administration (i.e., police, jails and judiciary), interest on public debt etc., are put into the category of non-development expenditure.

It may be noted that, till recently, expenditure on education and health were regarded as non-developmental type. It has now been realised that the expenditure on education and public health promotes the growth of what is called human capital which promotes economic growth as much as physical capital, if not more. Therefore, these days, expenditure on education, research and health are generally regarded as devel­opmental expenditure.

It is worth noting that division of Government expenditure into developmental or non-de­velopmental is the modern counterpart of the distinction drawn by classical economists between productive and unproductive public expenditure, which has been a subject of great controversy.

For instance, it has been pointed out that even Government expenditure on defence and civil administration helps to maintain conditions in which productive activity can be carried out. It is, therefore, claimed by some that indirectly, expenditure on defence and civil administration is also productive.

Thus, we see that what Government expenditure is developmental or pro­ductive and what non-developmental or unproductive is not based on any objective or fool-proof criteria and is therefore somewhat arbitrary.

Growth of Public Expenditure:

Public expenditure has phenomenally increased all the world over. A pertinent question is what the causes of this phenomenal growth are in public expenditure. It will be useful to discuss this with reference to India. This is because the factors responsible for a large increase in public expenditure over time in India are generally applicable to other countries too. It will be inter­esting to mention here two laws about the growth of public expenditure.

Wagner’s Law of Increasing State Activity:

First, there is Wagner’s Law of Increasing State Activity. According to Wagner, a German economist, there are inherent tendencies for the activities of the Government to increase both extensively and intensively. In other words, ac­cording to this law as an economy develops over time, the activities or functions of the Gov­ernment increase.

With the development of the economy, new functions and activities are undertaken by the Government and old functions are performed more thoroughly. The expansion in the Government functions and activities leads to the increase in public expenditure. Though Wanger based his law on the historical evidence drawn from economic growth of Germany, this applies equally to other countries, both developed and developing ones.

Wiseman-Peacock Hypothesis:

The second hypothesis about the growth of public expen­diture has been put forward by Wiseman and Peacock in their study of public expenditure of U.K. According to this Wiseman-Peacock hypothesis, Government expenditure does not increase at a steady rate continuously but in jerks and step-like manner.

However, in the view of the present author, both these factors, one making for a continuous increase in Government activity and consequently public expenditure as emphasised by Wagner and others like war and depres­sion causing the public expenditure to rise by jerks as emphasised by Wiseman and Peacock have been responsible for the enormous increase in public expenditure. In what follows, we shall explain the factors responsible for growth in public expenditure with special reference to the Indian economy.

1. Defence:

An important factor responsible for public expenditure is the mounting defence expenditure incurred by countries all the world over. It is not only during actual wars that defence expenditure has been rising but even during peace time, the countries have to remain in the state of military preparedness demanding large defence expenditure.

There is arms race going on between countries. A poor country like India has to safeguard its hard earned freedom and this involves a lot of expenditure on building up efficient and adequate armed forces. India is wedged in between two enemies, namely, expansionist China and aggressive Pakistan, which have been strengthening their armed forces.

India had to fight three wars since independence. India has thus to remain in a state of military preparedness. Internally also in view of clash of linguistic, territorial and political interests, lot of expenditure has to be incurred on maintaining internal security.

2. Population Growth and Urbanisation:

Another factor responsible for the increase in public expenditure is the growth in population and urbanisation of the economies. Population has been increasing in almost all countries of the world, though at varying rates.

In India the population has been increasing at an alarming rate since independence. The population of India which was 36 crores in 1951 has now gone upto about 100 crores in 2001. The scale of government activities such as providing education, public health, roads and transport facilities has to increase in harmony with the growth of population. Further, when population increases, more has to be spent on administrative services (police, jails, judiciary etc.) to maintain law and order in the country.

With the progress of the economy and the growth of population, the extent of urbanisation increases. In India, the proportion of urban population to the total population has raised from 11.3 per cent in 1921 to 25.5 per cent in 1991 and to 27.8 per cent in 2001.

As a result of the increasing urbanisation, the existing towns expand and the new ones come up. Urbanisation calls for greater per capita expenditure on social and administrative services. Therefore, the increase in urbanisation in India has tended to increase the government expenditure.

3. Activities of a Welfare State:

The Government activities and functions have been in­creasing due to the change in the nature of State. The modern States are no longer Police States concerned mainly with the maintenance of law and order. They have now become Welfare States.

A Welfare State is one which provides for social insurance of its citizens against old age, sickness, unemployment etc. The modern Governments have therefore to incur a lot of expenditure on social security measures such as old age pensions, unemployment allowances, sickness benefits.

4. Maintaining Economic Stability:

As pointed out by Wagner, state functions increase with the advancement and progress of the economy. In the nineteenth and early twentieth century, the Government followed laissez-fair policy. Now, need for active intervention of the Govern­ment has been increasingly felt.

Thanks to J.M. Keynes whose macroeconomic theory clearly brought out that the working of free-market mechanism does not ensure economic stability at full employment level. According to his theory, lapses from full employment or depressions are caused by deficiency of aggregate demand due to the slackened private investment activity.

In order to compensate for this shortfall in private investment, the Government has to step up its expenditure on public works. The increase in Government expenditure raises aggregate demand manifold through the working of what Keynes has called income multiplier.

This helps to push the economy out of depression and to raise levels of income and employment. Now, this com­pensatory fiscal policy is being followed by all the world over, since achievement of full em­ployment and maintenance of economic stability has become an important objective of the Government.

It is in line with the objective of employment that in India, the Government has taken over several private sick mills and incurs a lot of expenditure on them so that workers employed in them are not rendered unemployed.

Further, the Indian Government, both Central and States, incur a lot of expenditure on relief public works in rural areas when drought and other natural calamities occurs. Besides, a lot of public expenditure is being incurred on special employment schemes to promote employment in the economy.

5. Economic Growth and Development:

The most important factor in developing countries such as ours that has led to a phenomenal increase in public expenditure is the expansion in developmental activities of the Government. In countries like India which have socialistic ten­dencies the public sector plays an important role in promoting economic growth and develop­ment.

Not only public utility services such as water supply, electricity, post and petroleum and transport services have been undertaken by the public sector, but also the Government has invested a huge sum of resources in industrial and agricultural development of the economy.

Several steel plants, multipurpose irrigation projects, fertilizer factories, coal mining, explo­ration and production of oil and petroleum, different kinds of machine-making industries and chemical plants have been started and are being operated in the public sector.

On these a huge amount of expenditure is being incurred by the Government in India. Owing to these developmental activities of the Government in India, the proportion of developmental ex­penditure to the total Government expenditure has greatly increased. In 2003-04, Central Government’s plan expenditure, which is mainly developmental expenditure, was 122.3 thou­sand crores which rose to 137.4 thousand crores in 2004-05.

6. Mounting Debt Service Charges:

The Governments in all developing countries (in­cluding India) has been borrowing heavily in recent years to finance their increasing activities. Not only the debt money has to be paid back when it matures, interest payments have also to be made annually to the creditors.

These debt service charges have resulted in enormous increase in public expenditure. It should be noted that the Government in India has not only been bor­rowing from within the country but also from abroad through foreign aid or commercial loans from private capital markets to finance her development plans. It has been estimated that for the year 1998-99, Rs. 75 thousand crores were spent on the interest payments which went up to Rs. 125.9 crores in 2004-05 by the Central Government.

7. Mounting Expenditure on Subsidies:

Governments, both in the developed and devel­oping countries, incur a lot of expenditure on subsidies to the various sections of population. In India, the Government has been providing subsidies on food, fertilizers, exports and education, and expenditure on them has been increasing at a rapid rate which is the main cause of large fiscal deficit in India.

For example while in 2002-2003, the Central, Government expenditure on subsidies was of the order of Rs. 44.6 thousand crores and for the year 2004-2005 it was estimated to go up to Rs. 46.5 thousand crores.

The expenditure of Central Government’s ex­penditure on subsidies on food, fertilizers, exports now account for about 7 per cent of budget expenditure. While the aim of giving food subsidy is to help the people below the poverty line, the aim of fertilizer subsidy is to promote the growth of agriculture and help small farmers.

8. Anti-Poverty Schemes:

Another important cause of increasing public expenditure in India is huge expenditure which he Government is incurring on employment generating anti- poverty schemes. It has now been realised that economic growth alone will not eradicate poverty, at least in the short run. Therefore, various employment schemes have been started by the Government for the people living below the poverty line.

Prominent among these anti-poverty schemes in India are Jawahar Rozgar Yojna, Prime Minister’s Employment Scheme and Inte­grated Rural Development Scheme (IRDP). Expenditure on these schemes has greatly risen in recent years.

Effects of Public Expenditure on Production and Distribution:

Having studied the causes of large increase in public expenditure, it will be useful to explain the effects of public expenditure on the production and distribution in the economy. Public expenditure, if properly allocated and efficiently used, can have a wholesome effect on the economy.

Public expenditure can augment productive capacity of the economy and improve productivity of its working class. It can also reduce inequalities in income distribution, if properly designed. In the following we shall spell out in detail the impact of public expenditure on production and income distribution in the economy.

Effect of Public Expenditure on Production:

It is generally pointed out that all kinds of expenditure by Government are not productive. For instance, Government expenditure on defence and civil administration (police, jail and ju­diciary) is said to be unproductive for it does not apparently add to the volume of production of the economy.

It is true that public expenditure on defence and civil administration are un­productive directly, but even they can under certain circumstances in an indirect way promote production and employment. This will be made clear a bit later.

Further, the effects of public expenditure on production may be different in the case of a developed economy from that of a developing economy, for the circumstances in them differ a good deal. Let us first take the case of a developed economy.

Effect of Public Expenditure on National Output at Times of Depression:

Developed economies often find themselves in the grip of a depression or recession caused by lack of aggregate effective demand. At certain times in the developed countries effective demand falls due to the decline in private investment.

At times of depression in an industrialised developed economy, there is idle productive capacity on the one hand and unemployed manpower on the other. Under these circumstances, the increase in Government expenditure on public works or any other type of investment or even expenditure on defence and civil administration will lead to the manifold increase in income and employment through the process of multiplier, as has been explained by J.M. Keynes.

However, even in the developing countries such as India are ways in which government expenditure, if judiciously planned, can promote production.

First, if the Government expenditure is incurred on investment projects for capital formation, for instance on building of canals, railways, and other infrastructural facilities, it will expand productive capacity and generate long-term economic growth. Secondly, if public expenditure is directed to scientific research and development (R & D), it will ensure progress in technology and raise productivity or power to produce of workers.

Thirdly, it has now been found that Government expenditure on education and public health helps in building “human capital” which also greatly enhances productivity or power to produce of the people. Against these, it may be pointed out that certain types of Govern­ment expenditure may adversely affect production.

Government expenditure on social insurance like health insurance, unemployment insurance, and old age pensions is said to be of such a type. By insuring against their future and uncertain contingencies like sickness, unemployment and old age, they blunt the edge of the desire to work and save more.

The social security expenditure by the Government makes the people indifferent towards the future and makes them neglect savings. This is bound to affect adversely productive efforts in the present. Because of the future security, people will work less and save less.

However, in our view, if such social security expenditure is kept within proper limits and if it is used to help the really needy and helpless, the adverse effects of social security expenditure on productive efforts and savings may be negligible. Further, Government ex­penditure on social security makes the working people contented and create healthy social environ­ment and industrial peace which is conducive to production.

Apart from augmenting total production, the Government expenditure also affect allocation of resources as between different industries and can divert resources to socially desirable channels. Through subsidies and grants and also through its purchase policy, the Government may succeed in diverting resources to hitherto neglected industries.

Thus, besides raising the level of production, the Government expenditure can influence the pattern of production or composition of output. Like­wise, by diverting resources through subsidies and bounties to the backward regions it can promote growth of output in backward regions.

We thus see that public expenditure, if wisely conducted, can promote production by raising the levels of productivity or powers to produce and save. It can also cause reallocation of resources between industries and regions and exert wholesome influence on the pattern of production work by the Government undertaken through public enterprises.

Effects of Public Expenditure on Distribution:

In the modern times the Government modifies the free working of market mechanism in re­spect of income distribution not only through devising proper tax structure but also through various forms of public expenditure.

Through public expenditure the Government redistributes income in favour of the poor. Too large inequalities in income distribution as produced by the free working of market system are not only socially unjust, but also not conducive to the maximisation of social output. Not all types of public expenditure reduce inequalities in income distribution. The following forms of public expenditure redistribute income in favour of the poor and thus reduce inequalities.

1. Social Security Measures:

Expenditure on unemployment insurance, sickness benefits, old age pensions is some of the social security measures which help the people at times of contingencies. In India only in recent years some State Governments such as those of Haryana, Punjab, Delhi have introduced old age pension scheme. In capitalist countries such as U.S.A., Great Britain the social security system to help the people emerged with the idea of a Welfare State and in these countries Governments spend a large sum of money on the social security system.

2. Expenditure on Subsidies:

Expenditure on various types of subsidies has also a redistributive effect. In India subsidies on food-grain, sugar, kerosene oil, handloom cloth, fertilizers are provided to the people and Government spend a good part of its budget on these subsidies.

Food-grain, sugar, kerosene oil are sold through ration shops (i.e., public distribution system) at prices below the market prices and the difference is borne by the Government as a subsidy. It may be noted that at present benefits of these subsidies are enjoyed not only by the poor but all those who are relatively well off. If the public expenditure on subsidies is to have a real redistributive effect, these subsidies should be targeted to the poor.

3. Expenditure on Social Infrastructure:

Public expenditure by the Government on so­cial infrastructure such as education, health care of the people, housing for the poor also tend to reduce income inequalities. With free or subsidised education, free or highly subsidised health care facilities the poor people’s real income go up.

The modern govern­ment spends a lot of money on schools, colleges, etc., to promote education. In most states in India education upto the middle class is free and for higher levels wards of the poor people are either given free education or charged only low fees.

Similarly, the Governments spend a lot on public hospitals and dispensaries to provide health care to the poor people. Likewise, in many countries poor people are given financial aid by the Government to build houses: In India under Indra Awas Yojna, poor people are being given aid to build their low cost houses.

Expenditure on Anti-Poverty Programmes:

An important step for increasing incomes of the poor people is starting of several employment generating anti-poverty schemes. Prominent among these anti-poverty schemes in India are Jawahar Rozgar Yojna, Employment Assistance Scheme (EAS), Integrated Rural Development Programme (IRDP).

Recently in India, employment guaran­tee scheme under National Rural Employment Guarantee Act (NREGA) has been started which greatly help the rural poor. By generating employment these schemes raise incomes of the poor.

Encouragement to Labour-intensive Industries:

The Indian Government gives various types of subsidies to the cottage and small-scale Industries which adopt labour-intensive technique. Being labour-intensive, the growth of these industries generates a large number of employment opportuni­ties which improve income distribution.

Negative Income Tax to Achieve More Equal Distribution of Income:

Last but not the least, to achieve more equal distribution of income and make a big dent into the poverty problem, a pro­posal which has been recently put forward by some economists in the USA and Great Britain is introduction of negative Income Tax.

Though the name shows it is a tax, but in fact it is a form of expenditure, called transfer expenditure. In this negative income tax scheme, payments are made by the Government to the poor to raise their incomes.

Under this system, the Government has first to define poverty income standard for families of different sizes. Then it makes payment in the form of direct money transfer to bring the incomes of all families upto that standard or at least to close a large part of the gap between their income and poverty income standard.

But the use of public expenditure to reduce inequalities in income distribution has certain bad effects also. The first and foremost evil effect is that it adversely affects incentives to work and save of the people. Thus, when people know that in times of difficulties such as unemployment, old age, sickness, the Government will come to their help they will be less willing to work hard.

The poor would not work more when they know whatever their income, the gap between the minimum in­come and there will be filled by the Government. Likewise, many people save to live comfortably in old age, in periods of sickness. But when all these difficult periods are taken care of by the Govern­ment their willingness to work more and save more will be badly hurt. Thus, expenditure to reduce income inequalities will tend to affect adversely incentives to work, save and invest more. All these discourage production and growth.

It is important to note that redistributive effects of public expenditure must be considered in the light of how it is financed. For example, if redistributive public expenditure is financed through taxation and if the tax system of the country is regressive, it will work against the desirable distribu­tive effects of public expenditure.

For example, if public expenditure is financed through deficit financing, as has been the case in India for several years, it causes inflation in the economy. This inflation hurts the poor most and will therefore cancel out the desired distributive effects of public expenditure. Thus, if reduction in income inequalities has to be achieved not only the pattern of public expenditure, but also method of financing it and the system of taxation has to be suitably designed and adjusted.


We have seen above that, several factors have been working to cause increase in public expenditure in all the economies of the world. Though most of the factors are common operating all the world over, there are some additional factors in developing countries like India which have adopted socialist path to economic development wherein public sector plays a dominant role in the process of socio-economic development. This calls for more rapid growth of public expenditure.

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