Chapter 1_Public economics.pdf - *Public economics...

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Unformatted text preview: *Public economics 3D *Chapter 1: The public sector in the economy *Introduction -Recall that in a world of scarcity—more specifically economics—we study the way in which society chooses to allocate its resources in order to satisfy a multitude of needs and wants. -In public economics, however, we study the impact of the public (government) sector on resource allocation and distribution. -Why is there a public sector? @: The part of national economy providing basic goods or services that are either not, or cannot be, provided by the private sector. -How does one determine resource allocation? @: In a mixed economy (like South Africa), the balance between the supply of and the demand for resources is pursued through either the m ​ arket system​or p ​ olitical system. -In the ​market system​, prices are the equilibrating mechanism in the interplay between supply and demand, which in turn, are determined/influenced by factors such as the preferences and income of consumers (demand), the costs of inputs and prevailing technology (supply), etc. -Put another way, a ​market system​ is the network of buyers, sellers and other actors that come together to trade in a given product or service. -The participants in a ​market system​ include: Direct market players – producers, buyers and consumers who drive economic activity in the market. -Needs that cannot be or are not satisfied via the market system are channelled through the political process. -The equilibrating mechanism between supply and demand in a political based on democratic principles is the ballot box, and the ‘price’ is the tax that people pay. 1 -Restated, a ​political system​ is a system of politics and government. It is usually compared to the legal system, economic system, cultural system, and other social systems. 1 -A large portion of South Africa’s total resource use is channelled through the political process. -Public sector plays an important role in the economic development. -How? @: Employment; Rural Development; National Income; Capital formation; Foreign Exchange Earnings; Social Order; & Government Revenue *The study field of public economics -Public economics, is the study of the nature, principles and economic consequences of expenditure, taxation, financing, and the regulatory actions undertaken by the non-profit making government sector of the economy. -This area of economics is concerned with examining the interface between private and public economic activities as well as looking at how government policy and economic policy in particular impact the economy as a whole. -Public economics is a branch of the field of economics focused on studying the public sector and examining the ways it interacts with the private sector. -In order to understand this definition, we first note that economic policy entails the application by government institutions of measures (instruments) that are designed to influence economic behaviour in order to achieve certain outcomes. 2 -Besides various macroeconomic goals , many sectoral and microeconomic goals are also pursued, with the ultimate objective being to improve the material well-being of people. -Therefore, Public economics focuses on answering two types of questions: 1. How do government policies affect the economy? 1 In South Africa the main fiscal challenge, therefore, is to find ways through which the recent gains in fiscal solvency can be consolidated. 2 Economic growth, BoP stability, Price stability, equitable distribution of income, etc. 2 2. How should policies be designed to maximize welfare? ~Instruments of fiscal policy -Turning now to the elements of our definition of public economics, note firstly that the main 3 areas of decision-making are expenditure, taxation, financing and regulation. -The use of these instruments constitutes the direct mobilisation and allocation of resources. -Economists have developed several important fiscal criteria on which economic decisions in the public sector are or should be based and that may be applied when recommendations on taxes or expenditure allocations are formulated. -These governing criteria are derived from two (2) concepts of efficiency and equity. -Economic efficiency occurs when a society obtains the largest possible amount of output from its limited resources. -Equity occurs if a society distributes its economic resources fairly among its people. -'Fiscal Policy' = Government spending policies that influence macroeconomic conditions. Through fiscal policy, regulators attempt to improve unemployment rates, control inflation, stabilize business cycles and influence interest rates in an effort to control the economy. -Some of the major instruments of fiscal policy are as follows: A. Budget B. Taxation C. Public Expenditure D. Public Works E. Public Debt. F. Regulation. -Economics uses two types of analysis: positive (1) and normative (2). 3 These “elements” are also called the instruments of fiscal policy. 3 1. Positive economics is defined as the "what is"/fact of economics - focuses on the description and explanation of phenomena, as well as their casual relationships. For example: "The unemployment rate in South Africa is higher than that in the United States”. 2. Normative economics focuses on the "what ought to be”/opinion - is a branch of economics that expresses value or normative judgments about economic fairness. For example, "The price of milk should be R6 a litre to give dairy farmers a higher living standard and to save the family farm”. -Therefore, the study of the nature and economic consequences of decisions falls in the realm of positive economics, posing questions such as the following: -If a take step ​a ​(for example, raising income tax), what will happen to step ​b (for example, the supply of labour in the economy)? -The development criteria, on the other hand, has to do with normative economics, focusing on what ought to be. For example, if I want ​d (for example, a more even distribution of income), what should step c​ ​be (in other words, what type and level of taxation should be introduced)? -Public economics enters the realm of normative economics when we consider diverse questions such as the rationale for the state involvement in the economy and how political decisions should be taken (in other words, what kind of voting system should be used) to ensure efficiency and equity in the allocation of resources. ~The role of government -Generally, two (2) broad views of the role of government in the economy are encountered. -The first, which recognises the supremacy of the individual and his or her freedom of choice, is 4 known as the individualistic view of government. -Government action is seen as a reflection of individual preferences and government institutions have no role independent of these preferences. 4 Sometimes also called the mechanistic view. 4 5 -The other view is called the public interest or collectivist view. -One is indeed likely to find a combination of policies emanating from both views. -The ANC government propagates this model, although many features of South African society arguably do not fit this model. *The public sector in South Africa ~Composition of the public sector -There are three (3) tiers/levels or spheres of government, namely: 1. The central (or national) government (see inner rectangle in figure) -Consists of all the national government departments. -When the various extra-budgetary institutions are added (NRF, Universities, National Health Laboratory Service), we refer to the combination as the Consolidated National Government instead of just Central Government. 2 and 3. Provincial governments and 278 local authorities (or municipalities) 5 Sometimes also referred to as the organic view. 5 -Together with central government, the general departments of provinces and local authorities as well as certain business enterprises such as the trade departments (for water, electricity, transport, etc) of local governments are constituent components of the general government. -For the most part, general government thus represents the non-profit activities of the public sector. -The next category of public entities (see outermost rectangle in figure) consists of financial and non-financial public enterprises (also referred to as state-owned enterprises or companies) such as Eskom, PetroSA, the South African Broadcasting Corporation (SABC), Telkom, Transnet, etc. -To summarise: we refer to the three (3) tiers of government as general government, and the combination of general government and public corporations as the public sector. ~Size of the public sector -The size of the public sector differs according to the indicator used. -If we are interested in the size of the burden that government imposes on taxpayers, we may use the total tax income of the general government as an indicator and express it as a percentage of GDP (direct). 6 6 -We may also use non-tax income (indirect). -We will obtain a more accurate picture by looking at government expenditure. -As a consequence, we identify two (2) aggregate indicators. -The first of these aggregate indicators is the total amount of resource use by government (in other words, the final demand of goods and services or exhaustive expenditure of government) in any year. -But even this is not the complete picture. -Not all government expenditure is in the form final demand for goods and services. 7 -The government also makes transfer payments to targeted beneficiaries or entities outside the public sector. -If we add interest payments and transfers to the household, business and foreign sector, we obtain an accurate picture of the extent of resource mobilisation by government, our second aggregate indicator of the size of government. ~The relationship between the public and the private sectors 6 Such as dividend and property income, mining leases and administrative fees. 7 Subsidies, current transfers and interest on public debt. 7 -Government is a supplier of public goods and services. Household and businesses pay for these goods and services through taxes (and user charges). Government then uses this revenue to acquire factors of production as well as to purchase private goods and services (as intermediate inputs), all of which are used in order to produce public goods and services. -The way in which government finances its expenditure also has important economic consequences. The kind of taxes used and the rates levied influence the after-tax distribution of income and thus the well-being (utility) of individuals as well as the decisions by private businesses regarding the allocation of resources in the private sector. The tax system can promote or obstruct efficiency and equity. -If there is a budget imbalance (surplus or deficit), the government exercises an influence on the balance between saving (S) and investment (I) or on the balance of payments (in other words, the balance between exports [X] and imports [M]) -This is shown in figure 1.3 (see textbook) -In national accounting terms, a budget imbalance (that is, G is not equal to T) is reflected in either an imbalance between private investment (I) and saving (S), that is, S does not equal I (that is an internal imbalance) or an imbalance between imports (M) and exports (X), that is M does not equal X (that is an external or balance of payments disequilibrium or a combination of both). -If there is a budget deficit, for example, tax revenue (T) is less than government expenditure (G), the government has to borrow money. The size of its deficit and the way in which it is financed is very important for macroeconomic stability, depending on one's view of the impact of budget deficit on the economy. Government borrowing occurs via the financial markets and represent the use of either domestic or foreign savings. -In the case of a budget surplus, the government supplements the supply of savings in the economy. -While the government can influence the course of economy, it is also extensively affected by what happens in the economy. In an economic recession, for instance, government revenue falls or grows at a slower rate. This may impair its ability to provide public services, especially if its debt or budget deficit is already relatively high. Government also bears the brunt of its own decisions via 8 their adverse effect on the economy, such as when high budget deficits result in higher interest rates, thereby increasing the government’s interest bill. 9 ...
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