Unit 2 Macro: Government Spending

Government spending (or public spending) and in Britain, it takes up nearly half of our annual GDP. Spending by the public sector can be broken down into three main areas:

1. Transfer Payments: These are welfare payments made available through the social security system including the Jobseekers’ Allowance, Child Benefit, State Pension, Housing Benefit, Income Support and the Working Families Tax Credit. The main aim of transfer payments is to provide a basic floor of income or minimum standard of living for low income households. And they allow the government to change the final distribution of income.

2. Current Government Spending: i.e. spending on state-provided goods & services that are provided on a recurrent basis - for example salaries paid to people working in the NHS and resources for state education and defence. The NHS is the country’s biggest employer with over one million people working within the system!

3. Capital Spending: Capital spending includes infrastructure spending such as new motorways and roads, hospitals, schools and prisons. This investment spending adds to the economy’s capital stock and can have important demand and supply side effects in the long term.

Economic and Social Justifications for Government Spending

1. To provide a socially efficient level of public goods and merit goods and overcome market failure in the provision of these public services

2. To provide a safety-net system of welfare benefits to supplement the incomes of the poorest in society – this is also part of the process of redistributing income and wealth

3. To provide necessary infrastructure via capital spending on transport, education and health facilities – an important component of a country’s long run aggregate supply

4. As a means of managing the level and growth of AD to meet macroeconomic policy objectives such as low inflation and high levels of employment

Fiscal austerity - the Coalition’s plans to cut government spending

The Coalition Government has introduced a policy to halve the size of the budget deficit over the course of the current Parliament. They have launched a programme of fiscal consolidation amounting to £126 billion a year of combined spending cuts and tax rises. Their plans consist of total reductions in spending of £95 billion and a net increase in taxes of £30 billion including a new higher VAT rate of 20%. The “fiscal squeeze” is controversial and has led to an impassioned debate among economists about the best way to control a budget deficit as an economy struggles to lift itself out of recession and sustain a recovery.

Keynesian economists argue that tough deficit reduction policies risk driving the economy into a second recession – known as a double-dip. Reducing spending or raising taxes could hurt an already fragile economy and make the fiscal deficit problem even worse. The government believes that cutting the budget deficit is possible without causing another downturn