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ECO318 Public Finance Course Notes

4. The growth of the public sector

1. Introduction

Let us begin by taking for granted a large growth in public expenditure as a proportion of output in all western industrialised economies. We shall then concentrate on attempts to explain the growth of the public sector. We need to remind ourselves, however, of the distinction between resource-using public expenditure and transfer payments since some of the theories below are concerned only with resource-using expenditure (that is, public expenditure on goods and services and on domestic fixed capital formation), arguing that the reasons for the growth of transfer payments might be quite different.

2. A classification of theories of public sector growth

Bailey (1995) (p.43) divides models of public expenditure growth into macro models and micro models. In this classification, macro models attempt to account for the long term growth of public expenditure whereas micro models attempt to explain changes in particular components of public expenditure.

2.1 Macro models of the growth of resource-using public expenditure

2.1.1 Wagner's Law

It is customary in discussions of public sector growth to start with Wagner's law. In 1883, Adolph Wagner, a German social scientist, put forward an idea which became known as Wagner's law of increased government activity. The most usual interpretation of this law is that Wagner thought that there would be an inevitable increase in the share of government expenditure in total output, although he did recognise some limits to this increase. Essentially, he was arguing that an expanding government would necessarily accompany social progress and rising incomes. Such a notion, that societies inevitably change according to particular rules, is an example of historical determinism.

In thinking about Wagner's law, one has to understand Wagner's view of the relationship between the state and its citizens - that the state can be seen as existing independently of the individuals in society and has a general responsibility for society as a whole. This contrasts strongly with the standard neo-classical view that the state should merely reflect the views of individual citizens.

Wagner recognised three functions of the state:

(i) providing administration and protection;

(ii) ensuring stability; and

(iii) providing for the economic and social welfare of society as a whole.

According to Wagner, public expenditure on the first of these (which included law and order and defence) would grow because the increasing division of labour would lead to the breakdown of communal relationships, requiring the state to take over functions previously carried out by families and local communities. In the process, administration would become more centralised and administrative units larger.

The increased division of labour would be accompanied by the development of new technological processes which would lead to the growth of monopolies in the private sector. In Wagner's view, private sector monopolies would not adequately take into account the social needs of society as a whole and would therefore need to be replaced by public corporations. Further, if private sector companies became too large, the economy would become unstable because problems for individual companies would become problems for society as a whole. Finally, government would need to expand to provide social benefits and services which Wagner saw as not open to economic evaluation. We could include education and health care under this heading.

The principal criticisms of Wagner's law have concerned his view of history and of the relationship between the state and its citizens. Peacock and Wiseman also queried whether Wagner's ideas could be applied to all societies at all times and suggested that the time pattern of actual public expenditure growth did not fit well with Wagner's law.

2.1.2 Musgrave and...
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