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Theories of Public Expenditure

Updated on July 31, 2017
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IRSHAD CV has been a student in Economics. Now he is doing Masters in Economics. He completed B.A. Economics from the University of Calicut.

Introduction

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 theory 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 tell us about the relationship between growth of an economy and public expenditure. But there is wide difference between these two theories. Here, Peacock and Wiseman quotes that public expenditure will increase with respect to the growth of an economy. But the growing trend will not be 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 will also undertake 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 be 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 tends to reduce production because of fear on higher tax payment among people. In fact, Colin Clark highlighted the precautions for public expenditure.

Conclusion

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 push a country in to the path of development.

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      mohamed ahmed 3 weeks ago

      let me ask you this question

      Explain the peacock wise man hypothesis of the growing public expenditure. How is it deferent from Colin Clark Hypothesis?

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      p@s 8 months ago

      Sir add pictures

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      Paul economist 8 months ago

      Thanks I think also public expenditure may move tight closely with its restrictions because of its negative effects like inflation..

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      melkie munye 3 years ago

      I think public expenditure is very important for one country economic development but it uses properly and effectively ,mostly for developing countries

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      Author

      IRSHAD CV 3 years ago from India, Kerala

      Thanks Blossom SB for sharing your argument...

      I think richer class acquire higher education. Along with that their attitudes must change towards the social responsibility. A kind of moral ideology (essential) among richer people will help the economy to grow and develop more.

    • BlossomSB profile image

      Bronwen Scott-Branagan 3 years ago from Victoria, Australia

      Yes, countries cannot grow and develop without public expenditure - the only problem is that it needs to be balanced as most of the public does not like paying taxes, only using the results of the expenditure.

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