 Effects of Public Expenditure On Economy

Production Distribution

1. Effects on Production

The effect of public expenditure on production can be examined with reference to its
effects on ability & willingness to work, save & invest and on diversion of resources.

1. Ability to work, save and invest : Socially desirable public expenditure increases
community's productive capacity. Expenditure on education, health, communication,
increases people's productivity at work and therefore their incomes. With rise in income
savings also increase and this in turn has a beneficial effect on investment and capital
formation.

2. Willingness to work, save and invest : Public expenditure, sometimes, brings

adverse effects on people's willingness to work and save. Government expenditure on
social security facilities may bring such unfavourable effects. For e.g. Government
spends a considerable portion of its income towards provision of social security benefits
such as unemployment allowances old age pension, insurance benefits, sickness benefit,
medical benefit, etc. Such benefits reduce the desire to work. In other words they act as
disincentive to work.

3. Effect on allocation of resources among different industries & trade : Many a times
the government expenditure proves to be an effective instrument to encourage investment
on a particular industry. For e.g. If government decides to promote exports, it provides
benefits like subsidies, tax benefits to attract investment towards such industry. Similarly
government can also promote a particular region by providing various incentives for
those who make investment in that region.
2. Effects on Distribution

The primary aim of the government is to maximise social benefit through public
expenditure. The objective of maximum social welfare can be achieved only when the inequality
of income is removed or minimised. Government expenditure is very useful to fulfill this goal.
Government collects excess income of the rich through income tax and sales tax on luxuries. The
funds thus mobilised are directed towards welfare programmes to promote the standard of poor
and weaker section. Thus public expenditure helps to achieve the objective of equal distribution
of income.

Expenditure on social security & subsidies to poor are aimed at increasing their real
income & purchasing power. Public expenditure on education, communication, health has a
positive impact on productivity of the weaker section of society, thereby increasing their income
earning capacity.

3. Effects on Consumption

Public expenditure enables redistribution of income in favour of poor. It improves the

capacity of the poor to consume. Thus public expenditure promotes consumption and thereby
other economic activities. The government expenditure on welfare programmes like free
education, health care and housing certainly improves the standard of the poor people. It also
promotes their capacity to consume and save.

4. Effects on Economic Stability

Economic instability takes the form of depression, recession and inflation. Public
expenditure is used as a mechanism to control instability. The modern economist Keynes
advocated public expenditure as a better device to raise effective demand & to get out of
depression. Public expenditure is also useful in controlling inflation & deflation. Expansion of
Public expenditure during deflation & reduction of public expenditure during inflation control
money supply & bring price stability.
5. Effects on Economic Growth

The goals of planning are effectively realised only through government expenditure. The
government allocates funds for the growth of various sectors like agriculture, industry, transport,
communications, education, energy, health, exports, imports, with a view to achieve impressive
growth.

Government expenditure has been very helpful in maintaining balanced economic growth.
Government takes keen interest to allocate more resources for development of backward regions.
Such efforts reduces regional inequality and promotes balanced economic growth.

 Impact of Government Spending: Industry based

Analysis
Now that we know the importance of Government spending, let’s understand how it
impacts particular industries or sectors. The government propels the growth in an industry by
either increasing it’s spending in it or supporting it in the forms of subsidies, lower interest rate
for investments etc. Here is an analysis on some of the key industries of the economy.

Infrastructure- Infrastructure sector (accounts for 26.7% of India’s industrial output) is

the backbone of any economy and is necessary for the successful functioning of a
country. The government introduces projects for development of road, highways,
railways, aviation etc. The government has set aside $ 475 billion in its 11th Five Year
Plan (2007-2012) for investment in infrastructure. With the increasing presence of
private players in this sector, companies like Reliance Infra, GMR Infra, Punj Lloyd
etc stand to gain from this. The economy stands to gain from these projects irrespective
of whether they are undertaken by govt. or given to the private sector because
a) Infrastructure development is essential for the growth of the country & economy
b) Industries like cement, steel, copper, coal etc stand to gain from it as the product of
these industries would act as a raw material for infrastructure activities

Power Sector – A growing economy and rising population has led to an exponential rise
in demand for power in India. The power sector is largely dependent on the government
plans & projects it undertakes. In the 11th Five Year Plan the target is to add 78,700
MW of power during 2007-2012. The impact of government spending has a spiral
effect. Expenditure on Power Sector not only augments the growth of power companies
like NTPC, Power Grid Corporation etc. but also gives impetus to heavy engineering
industries like BHEL, L&T etc which provide inputs to companies from Power Sector.
The chain does not stop here. The rise in demand for engineering industry increases the
demand for industries providing raw materials to them in turn, and the wheel of
development starts rolling.

Sectors dependent on subsidies: Oil is a key raw material for most of the industries.
Government gives huge subsidies to Oil Marketing Companies like IOC, HPCL, and
BPCL for selling petroleum products at a subsidized rate. This makes it almost
impossible for private players to compete with these state-owned companies. That is the
reason why Reliance had to close down all its petrol pumps in 2008. But the government
cannot continue to provide subsidy forever. Infact, it has already started the
deregulation process and petrol has been deregulated. In the short term the oil
companies like IOC, HPCL, BPCL stand to gain from this move but in the long term
they might face increased competition because private players would now be able to
compete with them.
Similarly, fertilizer industry is also highly dependent on the government subsidies.
Even today, more than 50% of population is dependent on the agricultural sector.
Fertilizer being the key raw material for agricultural sector, the government has
continued to increase its subsidy to the farmers. The total fertilizer subsidy has increased
from Rs. 13800 cr. in 2000-01 to Rs. 75849 cr. in 2008-09.

Other sectors like Automobile, logistics, textile etc also gain from government spending.
Over the last 10 years the government’s expenditure on transportation has increased from
Rs. 7740 cr. in 1999-00 to Rs. 31213 cr. in 2009-10. Due to large infrastructure
requirements, it is expected that construction of roads, highways, airports, ports etc.
will continue. Sectors like automobiles and logistics business stands to gain from this.
Companies like Tata Motors, Ashok Leyland, Container Corporation of India etc. have
benefited heavily from this and have shown good growth in the commercial vehicle
segment over the years.
Similarly, the textile sector has also benefitted since the introduction of schemes like
Technology Upgradation Fund (TUF) Scheme. The textile companies have availed the
benefits and have started using advanced technology of production to increase their
productivity.
  Public expenditure on education in comparison to
India's total government expenditure and GDP
Detailed data on public expenditure on education, in comparison to the total
expenditure of the government.Analysing the data by looking at it in graphical form, throws up
some interesting points.

Figure 1: Public expenditure on education as a percentage of GDP (blue) and as a

percentage of expenditure on all sectors together.

Figure 2: Public expenditure on education (green), on all sectors (blue) and India's GDP
(red).
Note: All figures above are in crores of rupees. A crore equals 10,000,000 (ten million)

The government's education expenditure as a percentage of GDP (blue line in Figure 1) has
never ever risen above 4.3% of GDP, despite the target of 6% having been set as far back as
1968 by the Kothari Commission. Looking at Figure 2 above, the GDP (red line) seems to be
rising at a much much faster pace than the government's education expenditure (green line) to be
able to reach the 6% target. Finding the money to bridge this gap will be quite a challenge.
Though the 6% target finds mention in the manifestos of all parties, I've not seen any mention in
any of the manifestos on how they plan to raise the funds to be able to meet this target.

Using 2001-02 figures, public expenditure on education was Rs. 84,179 Crores (at 4.02% of
GDP). So to have achieved the 6% target, we would have had to spend Rs. 125,641 crores, an
additional Rs. 41,461 crores over what was spent, about a 50% increase. The GDP has been
growing much faster over the past 2 years than before, so it will be so much harder to achieve the
6% target.

But the public expenditure on education as a percentage of government expenditure across all
sectors (red line in Figure 1 above) has been as high as 14.6% and averages 13.5% over the past
few years. (It would be interesting to find out what fraction of government expenditure across all
sectors goes towards interest payments, salaries and pensions, defence and other major
expenditure heads, to put the education spending in perspective.)