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Impact Of Government Spending On Economic Growth

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Not All Spending Iscreated Equal

Ohio leaders talk economic impact of military, federal spending locally

While all government spending is associated with extractioncosts and displacement costs, the presence of other costs variesdepending on the structure and operation of each government programor activity. Some programs and activities, such as policeprotection and a well-functioning legal system, actually promoteeconomic growth by facilitating the operation of a market-basedeconomy. Other programs and activities, such as national defense,may yield net benefits because they reduce the likelihood ofexternal threats-a feature that has been called “wealth-maintainingdefense spending.”

However, most government programsfail to generate an adequate rate of return. Many, such as welfareprograms, almost certainly have a negative return and unambiguouslydamage economic performance. Not all government spending, needlessto say, should be dependent on rates of return, but legislatorsshould fully understand that funding programs with money that theprivate sector could use more productively will result in lesseconomic growth.

Academics have found that thecomposition of government spending is often just as important asthe level of government spending.

Boosting The Economy: The Impact Of Us Government Spending Plans

Despite the tragic loss of life and immense challenges brought on by the pandemic, the US economy is making a remarkable recovery. The Biden administrations proposed spending plans will add momentum, raising GDP by more than 5 percent from 2022 to 2024, and will create a lasting impact by increasing productivity and labor force participation.

Accounting For Asymmetry In The Spending Multiplier

To draw possible lessons for fiscal policymaking, we build an economic model that can explain these empirical results. Figure 2 shows how inflation and output are determined in equilibrium in our model economy. The downward sloping blue curve is the aggregate demand curve, which captures the fact that a lower inflation rate allows the central bank to set a lower interest rate, which then leads to a higher level of output. The upward sloping red curve is the aggregate supply curve, which captures how a higher output level tightens the labor market and leads to upward pressures in wages and prices. The economys equilibrium is point A, when aggregate demand equals aggregate supply.

As Figure 2 illustrates, an increase in government purchases shifts the AD curve outward , which leads to a new equilibrium, going from point A to point B. A decrease in government purchases shifts the AD curve inward and the equilibrium would move from point A to point C. The size of the fiscal multiplier is given by the magnitude of the change in output going from the old equilibrium to the new equilibrium. As the figure shows, the convexity of the AS curve results in the output change being smaller when the AD curve shifts outward than when it shifts inward. If the AS curve were a straight line, the output change would be the same in absolute value, regardless of which direction the AD curve shifts.

Figure 2Effects of changes in public spending in model economy

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How Does Public Expenditure Affect The Economy

The budget is the most powerful policy instrument of any government. Without funding, a policy has no potency. In addition, governments are usually one of the biggest organizations in any country in terms of both human and financial resources. Likewise, budget allocations for public services and programs are of public concern because they greatly impact on the lives of citizens. But in the context of the current economic downturn, the size of public sector expenditure is once again under the spotlight.

Other Issues In Fiscal Policy

Does Government Spending Stimulate Economies?

To keep things simple, the previous section omitted three other aspects of fiscal policy: the automatic stabilizing influence of fiscal policy, the multiplier effect, and the propensity to spend or save.

First, fiscal policy exerts an automatic stabilizing effect on the economy, even when the government makes no explicit changes in its tax or spending plans.

When the economy contracts, tax receipts automatically decrease . This effect is magnified by progressive taxation, our system applying higher tax rates to higher incomes. Workers who are laid off or lose their overtime pay automatically fall into a lower tax bracket. Their lower taxes bills will partially offset the effect of their lost income. Similarly, when incomes rise, particularly during inflation, bracket creep pushes people into higher tax brackets. The higher taxes they pay takes money out of their pockets?money they can no longer use to bid prices up even higher.

Government spending also acts as an automatic stabilizer, especially during downturns. The federal government tends to maintain its general level of spending during recessions, which ensures a solid baseline level of demand from the ?G? in C + I + G. Also, programs of unemployment insurance and public assistance help to ease the burden of tough times on households.

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Mediterranean Journal Of Social Sciences

University of Fort Hare, Department of Economics Private Bag x9083. East London, 5200. South Africa

Hlanganipai NgirandeUniversity of Limpopo, Department of Business Management, School of Economics & law Private Bag x1106. Sovenga, 0727. South Africa

Mangena MethodUniversity of Fort Hare, Department of Economics Private Bag x9083. East London, 5200. South Africa

Yewukai RuswaUniversity of Western Cape, Department of Economics and Management Science Robert Sebukwe Road, Bellville 7535, Republic of South Africa

The Theory: Economics Ofgovernment Spending

Economic theory does not automatically generate strong conclusions about the impact of government outlays on economic performance. Indeed, almost every economist would agree that there are circumstances in which lower levels of government spending would enhance economic growth and other circumstances in which higher levels of government spending would be desirable.

If government spending is zero, presumably there will be very little economic growth because enforcing contracts, protecting property, and developing an infrastructure would be very difficult if there were no government at all. In other words, some government spending is necessary for the successful operation of the rule of law. Figure 1 illustrates this point. Economic activity is very low or nonexistent in the absence of government, but it jumps dramatically as core functions of government are financed. This does not mean that government costs nothing, but that the benefits outweigh the costs.

Costs vs. Benefits. Economists will generally agree that government spending becomes a burden at some point, either because government becomes too large or because outlays are misallocated. In such cases, the cost of government exceeds the benefit. The downward sloping portion of the curve in Figure 1 can exist for a number of reasons, including:

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Composition Of Government Expenditure

Governments differ substantially not only in size, but also in priorities

The visualizations above show that governments around the world differ considerably in size, even after controlling for underlying differences in economic activity and population. Here we show that, as one would expect, governments also differ substantially in terms of how they prioritise expenditures.

The visualization shows the share of government expenditure that is specifically allocated to education.

As we can see, there are large and persistent differences, even within developing countries. For example, in 2011 education accounted for about 8% of government spending in the Central African Republic, while it accounted for about 30% in Ghana.

High-income countries spend more on social protection than low-income countries

We have already pointed out that governments in high-income country spend more resources than governments in low-income countries, both in per capita terms, and as share of their national incomes. Here we focus on the social spending component of government expenses, and show that high-income countries also have higher levels of social spending, particularly in the form of transfers.

The proportion of government spending that goes towards social protection varies substantially across OECD countries

How do OECD countries distribute their allocations to social spending?

Employee compensation accounts for a large share of public spending in many low-income countries

Current Use: Final Consumption

How the infrastructure bill may impact economic growth

Government spending on goods and services for current use to directly satisfy individual or collective needs of the members of the community is called government final consumption expenditure It is a purchase from the national accounts “use of income account” for goods and services directly satisfying of individual needs or collective needs of members of the community . GFCE consists of the value of the goods and services produced by the government itself other than own-account capital formation and sales and of purchases by the government of goods and services produced by market producers that are supplied to householdsâwithout any transformationâas “social transfers” in kind.

Government spending or government expenditure can be divided into three primary groups, government consumption, transfer payments, and interest payments.

  • Government consumption are government purchases of goods and services. Examples include road and infrastructure repairs, national defence, schools, healthcare, and government workersâ salaries.
  • Transfer payments are government payments to individuals. Such payments are made without the exchange of good or services, for example Old Age Security payments, Employment Insurance benefits, veteran and civil service pensions, foreign aid, and social assistance payments. Subsidies to businesses are also included in this category.
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    Impact Of Government Spending On The Economy

    There is a high possibility that the rise in taxes will negate the impact of rising government spending which would leave Aggregate Demand unchanged. However, it is possible that increased spending and rise in tax could lead to an increase in GDP.

    In a recession, consumers may reduce spending leading to an increase in private sector saving. Therefore a rise in taxes may not reduce spending as much as usual.

    The increased government spending may create a multiplier effect. If the government spending causes the unemployed to gain jobs then they will have more income to spend leading to a further increase in aggregate demand. In these situations of spare capacity in the economy, the government spending may cause a bigger final increase in GDP than the initial injection.

    However, if the economy is at full capacity, the increase in government spending would tend to crowd out the private sector leading to no net increase in Aggregate demand from switching from private sector spending to government sector spending.

    Some economists would argue increasing government spending through higher taxes would lead to a more inefficient allocation of resources as governments tend to be less effective in spending money.

    Concluding Implications And Future Research Directions

    This study has adopted the auto-regressive distributed lag models to examine the impacts of public spending on economic growth in the context of the Nigerian economy from 1981 to 2017. Our findings support the existence of a long-run relationship between economic growth and public expenditures in Nigeria over the period of the study. The results revealed that both recurrent expenditures of the government and public debt have significant negative impacts on economic growth while capital expenditure of the government has a positive, but insignificant impact on the economic growth of the nation in the long-run. The finding is an indication that real economic growth cannot be sustained by humongous recurrent expenditures and fiscal expansion through debt without fiscal discipline and adequate investment in capital projects considering the level of infrastructural deficit in the country. Our result buttresses the findings of Presbitero that debt and economic growth are significantly and negatively related in developing countries given a certain threshold level which is presently applicable to the Nigerian economy. Further results from the Granger Causality Test reveal that fiscal expansion of the government that is hinged on debt financing is strongly Granger causing public expenditures and domestic investment with the latter also Granger causing real economic growth in Nigeria over the period of our study.

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    Efficiency Of Fiscal Policies: The Expansionary And Contractionary Approaches

    Fiscal policies often come in either of expansionary or contractionary forms when the government wishes to effectively regulate or manage the level of aggregate demand in any economy. The expansionary fiscal policy is applied when the government wishes to stimulate aggregate demand and this is often visible when the government increases expenditures on projects in the various sectors of the economy or when it lowers tax burdens while paving the way for higher disposable income for its citizens in addition to some transfer payments. The major rationale behind this is the multiplier effect which holds that public spending could help to stimulate private spending and tackle the challenges associated with economic recession thereby boosting economic growth as popularly demonstrated by the Keynesian economic school of thought as documented in the attendant literature .

    The Evidence: Government Spending And Economic Performance

    Does Government Spending Affect Economic Growth ...

    Economic theory is important in providing a framework for understanding how the world works, but evidence helps to determine which economic theory is most accurate. This section reviews global comparisons and academic research to ascertain whether government spending helps or hinders economic performance.

    Worldwide Experience. Comparisons between countries help to illustrate the impact of public policy. One of the best indicators is the comparative performance of the United States and Europe. The “old Europe” countries that belong to the European Union tend to have much bigger governments than the United States. While there are a few exceptions, such as Ireland, many European governments have extremely large welfare states.

    As Chart 1 illustrates, government spending consumes almost half of Europe’s economic output-a full one-third higher than the burden of government in the U.S. Not surprisingly, a large government sector is associated with a higher tax burden and more government debt. Bigger government is also associated with sub-par economic performance. Among the more startling comparisons:

    The academic literature certainly does not provide all of the answers. Isolating the precise effects of one type of government policy-such as government spending-on aggregate economic performance is probably impossible. Moreover, the relationship between government spending and economic growth may depend on factors that can change over time.

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    How Government Spending Slows Growth

    …the labor market is the main channel linking these effects of fiscal policy on growth. Higher wages cut into profits, reducing investment, and as a result, economic growth.

    Fiscal expansions sometimes have contractionary effects on the economy, and fiscal contractions may result in economic expansion. To understand why, we need to investigate the effect of fiscal policy on business investment. According to NBER Research Associate Alberto Alesina, Silvia Ardagana, Roberto Perotti, and Fabio Schiantarelli, increases in public spending can hit company profits and thus lead to a reduction in private investment and economic growth. Cuts in public spending, on the other hand, can lead to more private investment, and faster growth.

    In the standard textbook case, fiscal expansion boosts aggregate demand and leads to an economic expansion a fiscal squeeze leads to a slowdown. In Fiscal Policy, Profits, and Investment Alesina and his coauthors push deeper, though, analyzing the experience of a number of OECD countries to explain why these standard predictions do not always hold. Most research into the effect of large fiscal swings on the economy has concentrated on the impact on private consumption. But fiscal expansions and contractions, the researchers say, have a much larger impact on private investment – and this accounts for the larger part of the response in terms of economic growth.

    — Andrew Balls

    Key Roles Of The Government

    The Government has a huge role to play in the economy. Some of its key roles are as follows:

    Provides a well functioning legal and political system:-Any economy facing political or economic turmoil is not conducive to economic growth since it has very little trust in the economy. Moreover, there is uncertainty in the economy and people are also unwilling to invest. The government needs to make sure that there is a stable political environment. Its very important on the part of the government to provide good legal and political framework.

    Lays regulatory role to provide a competitive market:-There should be certain regulations to ensure that the economy does not drift to the monopolistic situation. The government needs to think about trade policies with foreign countries, regulation on natural resources available in our country etc.

    Stimulate the economy by increasing the government spending:-This was one of the philosophies given by one of the renowned economist John Maynard Keynes. He was of the view that governments role is very important when the economy is in recession or depression like situation and the government should increase spending to have a pickup in the economic activity.

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    The High Costs Of Too Much Government Spending

    A man waits at a bus stop that displays the national debt of the United States on June 19, 2020 in … Washington, DC.

    America is engaging in an unprecedented spending spree. The Committee for a Responsible Federal Budget estimates that the infrastructure proposal and the proposed $3.5 trillion reconciliation spending plan will result in $2.9 trillion of additional government borrowing over the next decade. This debt will not solve our problems. America needs more private sector innovation to solve our biggest challengesuplifting the poor, healing the sick, and protecting the planetnot more government spending and top-down regulation.

    If all this proposed spending occurs, the federal debt is likely to hit 109% of GDP by 2031 but could get as high as 125%. This would surpass the debt-to-GDP ratio in the years immediately following World War II.

    Debt as percent of GDP 2019-2031

    Committee for a Responsible Federal Budget

    Too much government spending harms society and individuals in several ways.

    First, it increases the cost of living via subsidies that drive inflation. Government subsidies artificially increase demand. The result is higher prices that disproportionately harmthe working poor and middle class. The companies with subsidized offerings get richer, while these higher prices increase demand for larger subsidies. The cycle repeats, and costs head skyward.

    Can Government Spending Help To Escape Recessions

    Taxation, Government Spending and Economic Growth

    Regis Barnichon, Davide Debortoli, and Christian Matthes

    A key to designing fiscal policy is understanding how government purchases affect economic output overall. Research suggests that expanding government spending is not very effective at stimulating an economy in normal times. However, in deep downturns when monetary policy is constrained at the zero lower bound, public spending is more potent and can become an effective way to escape a recession.

    The health crisis brought on by the COVID-19 pandemic has prompted authorities to force the temporary shutdown of many businesses. Beyond the immediate health concerns, a central worry is the possibility that the temporary freeze in business production has spillover effects that could lower overall demand in the economy and turn the deep downturn into a persistent slump. To prevent such spillover effects, fiscal and monetary authorities around the world have taken extraordinary measures. Early in the pandemic, the goal was to cushion the economic blow imposed by mandated shutdowns. Once there is better control of the pandemic, the debate will shift to ways to ensure a rapid rebound of the economy and avoid long-term damages to economic potential.

    In this context, a popular fiscal tool is to use government purchases of goods and services to stimulate aggregate demand. For instance, about one-third of the U.S. fiscal package enacted in response to the 200809 recession was targeted to boost higher public consumption .

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