Theories of Public Expenditure
Public expenditure is one of the important subject matters of public finance. Public expenditure studies about the expenditure incurred by an authority or a government. Today, the scope of public expenditure increased largely since all the economies of the world are focusing on development, growth, welfare, safety etc. Therefore public expenditure can be considered as a vital tool of a government to ensure and boost the process of development of a country. Anyway, with regarding to the public expenditure, there are three important theories. They are
i) Adolf Wagner’s Hypothesis
ii) Peacock and Wiseman Hypothesis, and
iii) Colin Clark’s Critical Limit Hypothesis.
Each of the theories and its idea are briefly explained below.
i) Adolf Wagner’s’ Hypothesis
Adolf Wagner introduced his hypothesis with connecting to the public expenditure. His idea is also known as ‘Wagner’s Growth of Public Expenditure’. He published his book titled “Law of the Increase of State Activities”. In his hypothesis, he analyzes the relationship between public expenditure and growth of an economy. It can be explained with the help of a diagram as showing below.
According to Wagner, there is a fundamental cause and effect relationship between economic growth with respect to the growth in public expenditure. In the figure, real per capita income or growth is represented on the ‘x’ axis and changes in public expenditure on ‘y’ axis. There will be a positive and direct relationship between these two variables. In short, higher public expenditure automatically increases the function of the state. This will gradually lead to higher economic growth.
There are many reasons for increasing the trend of public expenditure like planning, modernization, higher social demand, industrial development etc.
ii) Peacock and Wiseman Hypothesis
Peacock and Wiseman hypothesis in public expenditure is based on their empirical study conducted in United Kingdom, during the period 1890 to 1955. Here also like Adolf Wagner, these economists talks about the relationship between growth of an economy and public expenditure. But there is wide difference between these two theories. Here, Peacock and Wiseman says that, public expenditure will increase with respect to the growth of an economy. But the growing trend will not as like in the Adolf Wagner’s theory. Further, it will be in a step like manner. The hypothesis can be explained with the help of a diagram as showing below.
In the figure, real per capita income or growth rate is represented on ‘x’ axis and public expenditure on ‘y’ axis. According to this hypothesis, there are three basic effects in an economy which can see in the growing path of a country. They are
a) Displacement effect
b) Inspection effect, and
c) Concentration effect.
a) Displacement effect: Every economy challenges many social disturbances in different periods. Social disturbances may question the economic stability. Some of the social disturbances are war, natural calamities, political instabilities etc. In such cases government requires huge public expenditure to restructure the economy. In simple words, displacement effect is the increasing of public expenditure due to social disturbances. So, the economy will change its current position in public finance. Point ‘D’ in the figure represents displacement effect.
b) Inspection effect: Once an economy experienced displacement effect, new and higher public expenditure will came in to existence. Along with the raise in public expenditure, government also undertakes some improvements in public revenue by adjusting tax. This will lead to a new equilibrium in public finance, which will be greater than the previous equilibrium level. Point ‘I’ in the figure represents inspection effect.
c) Concentration effect: after the displacement effect, the economy will follow a new equilibrium level in the public finance. Concentration effect refers that, this condition will follow until a new social and economical displacement arises.
In short, according to Peacock and Wiseman, an economy can grow after experiencing social disturbances. Such economic challenges will promote the authority to increase its expenditure. This will resulted in the growth of an economy.
iii) Colin Clark’s Critical Limit Hypothesis
Colin Clark’s idea on public expenditure is associated with the idea of tax tolerance. He says that, public expenditure should not exceed more than 25 percentage of the total expenditure since it may create inflation even in the balanced budget. Further, higher public expenditure will increase the income of the people. Which may tending to reduce production because of fear on higher tax payment among people. In fact, Colin Clark highlighted the precautions for public expenditure.
Public expenditure theories are dealing with the role of public expenditure for the economic growth and development. As mentioned above, there are three basic theories in public expenditure. Each of them agreed with the necessity of public expenditure to enter a country in to the path of development.