Government spending

Government spending, or public expenditure, involves the use of money by a government to meet collective or individual needs. It is a fundamental part of a nation's economy and is measured as a major component of gross domestic product (GDP). This spending covers a wide range of public goods and services. These include healthcare, education subsidies, pensions, and emergency services. It also funds infrastructure like roads and dams.

Economists divide government spending into two primary categories. The first is government final consumption expenditure. This refers to the acquisition of goods and services for current use to satisfy immediate community needs. The second is government investment, also called gross capital formation. This involves spending intended to create future benefits, such as research or building infrastructure. Together, these two types of spending represent how a government manages its resources to serve the public.

To understand how spending works, one must look at how governments obtain money. Governments are classified by their level of monetary sovereignty. Currency-issuers are governments that issue their own currency. They have an infinite fiscal capacity in principle because they can issue as much money as they need. However, they face real-world constraints like inflation. Inflation is a rise in prices that can happen if too much money is issued. In contrast, currency-users do not control the currency they use. They must raise revenue through taxes or fees before they can spend.

When a sovereign government spends money, it must sometimes manage the removal of purchasing power from the economy. This is done through taxes, custom duties, or various fees, such as national park entry fees. Governments may also sell or lease natural resources. If a government chooses to borrow money temporarily, it issues securities. In exchange for this borrowed money, the government must pay interest. These financial choices are central to how a nation manages its wealth and its debt.

Historically, the role of government spending has changed significantly. Before the 19th century, many followed laissez-faire philosophies. This idea suggested that governments should stay out of economic affairs. However, in the 20th century, economist John Maynard Keynes changed this view. He argued that public expenditure is pivotal for determining income levels and economic distribution. Keynesian economics suggests that increasing spending can raise aggregate demand. This helps the economy recover more quickly from recessions.

To ensure spending is responsible, experts use specific rules called "canons of public expenditure." Economist George Findlay Shirras established four important canons. The Canon of Benefit states that spending should bring the greatest social benefits. The Canon of Economy requires that spending be productive and efficient. The Canon of Sanction means spending must be approved by an appropriate authority. Finally, the Canon of Surplus suggests that public revenue should exceed expenditure to avoid a deficit. Other principles include the Canon of Elasticity, which allows spending to change based on the period, and the Canon of Equitable Distribution, which aims to minimize inequalities.

Governments also use fiscal policy to stabilize the macroeconomic business cycle. Fiscal policy uses spending and taxation to influence the economy. There are two main types: expansionary and contractionary. Expansionary fiscal policy involves increasing spending or decreasing taxes to stimulate a slow economy. This can help increase employment. Contractionary fiscal policy involves decreasing spending or increasing taxes to cool down an economy during a boom. This helps reduce inflationary pressures.

Stabilization can happen in two ways: automatic or discretionary. Automatic stabilization occurs through existing policies like unemployment insurance. These change automatically without new laws. Discretionary stabilization requires the government to pass new laws to change spending or taxes. Some economists worry about "crowding out." This theory suggests that government deficit spending might reduce the capital available for private investment. However, other views suggest that deficit spending actually increases liquidity in the banking system. This shows how complex and vital government spending is to the global financial system.