Edexcel Economics summary 4.5 Role of the state in the macroeconomy A/A*
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4.5 Role of the state in the macroeconomy
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Edexcel Economics summary 4.5 Role of the state in the macroeconomy A/A*
summarised specification points can be used for multiple choice question,4,5,8,10,12,15 and 25 markers
4.5.1 Public expenditure
a) Distinction between capital expenditure, current expenditure and transfer payments
capital expenditure:
refers to spending on fixed assets such as schools, roads, hospitals or aircraft for the air force that are
expected to provide a use over many years (minimum of 1 year).
current expenditure:
refers to spending on goods and services that are used up (consumed) in less than a year. It includes
the salaries of public sector workers such as nurses and teachers, medicines for the health service and
running costs like heat and light for hospitals and schools.
transfer payments:
This comprises the main welfare benefits (called ‘social protection’ in government accounts) such as
the state pension, and benefits for disabled people and those on low incomes.
Transfer payments are excluded from GDP because they are not part of national income; they are not
payments for the output of goods or services.
As the name suggests they are a redistribution of income, from taxpayers in general to the recipients
of the benefits.
They are the single biggest component of public expenditure (approx 30%).
b) Reasons for the changing size and composition of public expenditure in a global context:
Level of income and development
High income, developed economies tend to have higher levels of public spending, both in absolute
terms (the actual amount spent) and as a proportion of GDP, compared to poorer countries.
As a country becomes more developed and living standards rise, people have a higher expectation of
public services, such as healthcare and education, so governments are under pressure to spend more
on these services.
Developed countries also have a much bigger tax base (more people earning more money).
In poorer countries many people live and work in the informal economy, which often does not involve
recorded earnings or spending, so cannot easily be taxed.
Demographic factors
The aging population in many countries (mainly the result of higher development) is starting to put
more pressure on governments to increase public spending, especially on healthcare, social care and
pensions.
The economic cycle
The global recession following the financial crisis in 2007/8 caused big increases in public spending in
many countries, both to support the banking system and as a demand side policy to prevent a bigger
fall in GDP.
But the longer term consequence has been a major fall in public spending (‘austerity’) in many of
those countries; because of concerns over the consequential increase in their national debts spending
has gone down and taxes have risen.
c) The significance of differing levels of public expenditure as a proportion of GDP on:
, o productivity and growth:
Free market economists believe low public spending is better for growth and productivity because it
allows taxes to be low and therefore improve incentives for workers and entrepreneurs.
It is also argued that a lot of public spending is wasteful; private businesses have a stronger incentive
to use resources more efficiently (to increase profits).
Other economists argue increased public spending can increase growth:
Investment in roads and other infrastructure can reduce costs.
Spending on education increases human capital.
Spending on benefits can help people get back into employment.
Spending on healthcare can improve productivity-healthy workers have less time of work.
regional aid can generate run down area.
o living standards:
government spending can have a major impact on raising the incomes of the poorest in society, who
may depend largely on state benefits for their income.
Access to good healthcare and education would also be beyond many families if left to private
provision alone.
The same is true of housing; ‘social housing’ provided by the government at affordable rents gives
families on low incomes access to decent housing.
Government spending also raises living standards for the whole society by providing public goods,
such as street lighting, defence and law and order.
o crowding out:
Free market economists argue that more public spending is likely to reduce private spending- this is
called crowding out.
Crowding out can also happen when the economy is not at full employment. If the government
finances more spending by borrowing, this will drive up interest rates, which will deter investment
spending by businesses. Free market economists believe that private sector investment is usually a
more efficient use of resources.
o Higher public spending does not always result in crowding out:
If the economy is not at full employment (operating inside its production possibility frontier), higher
public spending will lead to higher private spending as well. There will also be multiplier effects.
Higher spending on transfer payments does not reduce private spending; it just redistributes it from
taxpayers to those receiving benefits.
o level of taxation:
Higher public spending has to be paid for, which means higher taxes in the long term.
There are a few exceptions to this; in some oil rich countries where the oil is state owned, export
revenues can be used to finance public services rather than raising taxes.
But there is still an opportunity cost; the oil revenues could be distributed to people to spend as they
wish.
o equality:
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.
4.5.2 Taxation:
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