Week 1 Economic Role of Government.pptx

Public Finance Associate Prof. J. Marire Economics & Economic History Rhodes University Office E17 Email: [email protected] Learning outcomes Be able to discuss the two views of government. Be able to explain the critical perspective on the role of government in the economy. Be able to...

Public Finance Associate Prof. J. Marire Economics & Economic History Rhodes University Office E17 Email: [email protected] Learning outcomes Be able to discuss the two views of government. Be able to explain the critical perspective on the role of government in the economy. Be able to explain the reason why we need government. Be able to explain the four functions of government. Be able to explain, with examples, the four questions public finance explores. 2024-08-13 2 Government Spending Composition and Size 35.00 30.00 Why Mandela-Mbeki Era 25.00 Housing governmen t? How large? Two % of GDP 20.00 Defence Public order views 15.00 Social protection Health about Economic Affairs governmen 10.00 t 5.00 General public services Individualist view (small 0.00 Education government) 1983 1997 1999 2003 2005 2019 2021 1985 1987 1989 1991 1993 1995 2001 2007 2009 2011 2013 2015 2017 Education general public services Collectivist Economic affairs Health view (large social protection public order & safety defence Housing and Community Services government) 2024-08-13 3 Culture, Religion and Recreation Environmental Government Taxation Composition and Size 25.00 Mandela-Mbeki era https://www.you Fuel levy tube.com/watch 20.00 trade ?v=6j3F1wvxnK A excise Tax rebellion in 15.00 Kenya – when Corporate Income Tax % of GDP government becomes too 10.00 big, the tax Value Added Tax burden on the economy will surely cause 5.00 revolt where democratic PAYE voices are not 0.00 repressed too 87 989 991 993 995 997 999 001 003 005 007 009 011 013 015 017 019 021 023 much 19 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2024-08-13 4 paye vat cit trade excise fuel property What is public finance all about? Why study it? The goal of public finance is to understand the proper role of the government in the economy. On the expenditures side of public finance, we ask: What kind of services should the government provide, if any? Why should the government be spending hundreds of billions of dollars to provide health insurance to the uninsured (to cite just one example)? More generally, why is the government the primary provider of goods and services such as highways, education, and transfers to the unemployed? On the revenue side of public finance, we ask: How much should the government tax its citizens, and how should that amount be related to the economic circumstances of those individuals? What kinds of activities should be taxed or be given tax relief in difficult times? What effect do taxes have on the functioning of the economy? 2024-08-13 5 Why do we need government in the economy Market failure (traditional view) (Re)defining and (re)creating the economy Functions of government? Allocative, Stabilisation, regulation, redistribution Two views about government – individualist vs collectivist views 2024-08-13 6 Role of Government: Four Issues… Role of government at the most fundamental level can be defined in terms of FOUR issues Government (re)defines and (re)creates the economy Ideological contests over the role of government tend to hide the role of government in defining and recreating the economy Government drives legal change thereby changing the interests that the state machinery will protect i.e. redistribution of economic advantages The politics and the economy are intricately intertwined such that there is a legal-economic nexus in which both keep co-evolving over time The economy is a social fact i.e. a social construction of economic interactions. For this reason, the most fundamental social process is the definition and creation of socioeconomic reality through legal change The fundamental social process involves two issues selective perception of socioeconomic interests deliberative government choice from a web of conflicting interests what the state must legally support 2024-08-13 7 Role of Government: legal rights & controlling government Legal rights define socioeconomic reality – and legal rights are simply certain interests that government decides to support over and against others – and markets exists because of these rights and the rights operate through the market and the economy as a whole. It follows that those (certain configuration of interests) who want to redefine and recreate the economy must take control of government to change economic performance. Therefore, there will always be fierce contests amongst various interests as to how to redefine, recreate and reconstruct the economy because each social reconstruction results in winners and losers. 2024-08-13 8 Role of Government: Ideologies… How are ideologies involved in the redefinition of the economy and rights? And what are ideologies? Ideologies are systems of beliefs that shape the mental models that ideologues use to understand the socioeconomic reality around them. Ideologies are used to define and legitimise certain partial realities as true domains for government involvement and delegitimise other realities as domains for government involvement. Ideologies are selective in how they construct socioeconomic reality and rights, and lawmakers have a domineering ideology, while lawtakers have a marginalised ideology. Some ideologies favour the status quo and resist legal and policy change, while other ideologies (being of previously marginalised groups) favour legal and policy change Even ideologies that dislike large governments, their agenda requires the 2024-08-13 9 government to uphold and protect their interests (property) and only Role of Government: protection of property only? Market fundamentalists always argue that the government’s role must be limited to the protection of private property. This is an example of how ideology can be used to delegitimise other developmental roles of government But what is property? How does it come into being? Answer: property is the interest the state decides to legally back through its government machinery. Property cannot exist without the government’s definition, creation and construction of socioeconomic reality. Government’s protection of one set of interests as rights is to expose 2024-08-13 10 Role of Government: Causality - is Government the influencing or the influenced variable? Insofar as the government is the protector of interests, the government is both the influencer and the influenced variable Government is the influenced variable because ideologies in favour of certain interests control it to achieve their own ends Government is the influencing variable because the government’s interests legally back determine the economy’s structure, how it works and for whom it works, and its overall performance. The interests the government chooses to support determine the distribution of income and wealth, but the distribution of income and wealth also influences the future evolution of government. Working rules of law determine the distribution and exercise of power, which in turn determine the future evolution of working rules of law Legal rights determine opportunity freedoms, but these freedoms also influence changes in legal rights over time. 2024-08-13 11  Economic ideology and economic role of government: Causality outline Influencing variables Response Economic interests, interest variable Government groups Ideology Government Government Legal rights Economic structure, Legal rights operation & performance Government Distribution of wealth & income Distribution & exercise Working rules of of power law 2024-08-13 12 Four Functions of Government Four conventional functions of government Allocative – through the national budget, taxation, subsidies, expenditure Stabilisation Discretionary vs rule-based fiscal policy Automatic stabilisers Government discretionary spending Redistribution of endowments e.g. income, wealth and opportunities Basic income grants, education funding, social housing, national health insurance etc Regulation Legal and policy changes in different economic spheres e.g. zoning laws, tax laws All and any public finance topics fall in these three functions of government as 2024-08-13 13 indicated The Four Questions of Public Finance Public finance is the study of the role of the government in the economy. This is a very broad definition. This study involves answering the four questions of public finance When should the government intervene in the economy? How might the government intervene? What is the effect of those interventions on economic outcomes? Why do governments choose to intervene in the way that they do? 2024-08-13 14 When Should government intervene in the economy? When there is…. Market failure Public goods (see week 3) Externalities (positive or negative, see week 4) Inequality (redistribution, your NHI financing essay) Incomplete markets Missing markets Information asymmetry in markets 2024-08-13 15 How might the government intervene? Governments have many instruments available for interventions. Taxing or subsidising private transactions – taxing increases the price of the good, while subsidy reduces its price Regulatory changes that permit or restrict certain activities Public provision 2024-08-13 16 What are the effects of alternative intervention? This question requires policymakers to understand the implications of each policy option Empirical public finance provides answers to this question, which involves gathering data and developing statistical models to assess how people and firms might respond to policy interventions. Measurement of the effects of policy interventions will have to control for both DIRECT and INDIRECT effects Direct effects – are effects of government interventions that would be predicted if individuals did not change their behavior in response to the interventions Indirect effects – are effects of government intervention that arise only because individuals change their behavior in response to the interventions e.g. raising taxes on the rich, might lead to them finding new ways of hiding their wealth or taking it to tax havens 2024-08-13 17 Why do governments intervene in the way they do? The government faces the difficult problem of aggregating the preferences of millions of citizens into a coherent set of policy decisions (see Week 2), raising the fourth question of public finance: Why do governments do what they do? Governments face enormous challenges in figuring out what the public wants and how to choose policies that match those wants. Just as there are a host of market failures that can interfere with the welfare-maximizing outcome from the private market, there are a host of government failures that can lead to inappropriate government interventions e.g. rent seeking behaviour, corruption, state capture (week 2). Politicians must desire to design policies that maximize economic efficiency and redistribute resources in a socially preferred manner 2024-08-13 18