EKN 310

Chapter 1– The Role of the Public Sector in the

economy

Introduction
Public economics studies…

• The impact of the public sector (government) on resource allocation and

distribution.
• The nature, principles and economic consequences of
1. Expenditure
2. Taxation
3. Financing
4. Regulatory actions undertaken by the non-profit making government
sector
• These four areas of decision-making are called Instruments of Fiscal
Policy.
• Public economics analyses the nature and impact of these instruments.

Positive vs Normative economics

Positive economics:

- It studies the nature and consequences of decisions taken.

- Example: If the government raised income tax, what will happen to the
supply of labour in the economy?

Normative economics:

- It focuses on studies of the question, ‘What should the situation be?’

- Example: If the government wants a more even distribution of income,
what type and level of taxation should be introduced?
Instruments of Fiscal Policy
Expenditure, taxation and financing:

• These instruments entail the procurement by the state of private funds and
the spending of these funds.
• These three constitute the direct mobilisation and allocation of scarce
resources.
• Example: Spending of tax income on primary healthcare or borrowing
funds to build an irrigation dam or a highway.

• There are various forms of taxation and expenditure that all have diRerent
economic consequences.
• Taxes on income (income tax) , wealth (property tax) and goods (VAT)
• The choice of a particular tax depends on how govt. wants to change the
distribution of income or wealth in the economy.

NB: Economists have created important guidelines to help the government

decide how to tax and spend money. These guidelines are based on 2 main
ideas…

1. ERiciency (using resources in the best possible way)

2. Equity (being fair)

Regulation:

• Regulation however entails the government enacting a law or oRicial rule

that leads to a diRerent allocation of private resources.
• Aka the law changes how private people or businesses use their own
resources compared to what they would to done without government
intervention.
• The allocation of resources is now influenced indirectly.
• Example: Government forces the manufactures of motor vehicles to install
platinum catalysts in the exhaust pipes of vehicles to reduce the
emissions of carbon monoxide or smoking bans in public areas.
Views of the Roles of Government in the economy
Generally, there are 2 broad views of the roles of govt in the economy:

1) Individualistic view of government

o Sometimes called the mechanistic view
o Recognises the supremacy of the individual and his/her freedom of
choice.
o The test for whether or not a govt should intervene is the
maximisation of individual welfare.
o Government actions are seen as a reflection of individual preferences
(not independent of preferences).
o In this view, the role of government is limited to correcting market
failures.
o This view is closely associated with free-market economies.
o Focuses on eRiciency of resource allocation and economic growth.
2) Public interest view of government
o Also called the collectivist or organic view
o Recognises collective choice and preferences that exist independently
of individual preferences.
o The view sees the goals of society as a separate organism from the
goals of individuals.
o Instead of individual welfare, social welfare should be maximized.
o Focuses on combating poverty and equity issues (notably the
distribution of income as justification for govt. intervention)

In practice, government policies often reflect a combination of these 2 views. The

combination of these 2 views is the model of the developmental state.

3) Developmental State
o Aims to maximized both individual and social interests.
o The strong central government manages the economy by either
creating the right conditions for growth or directly controlling parts of
the economy.
o The government selectively intervenes in markets to promote
development (for example by changing prices).
o Economic success depends on many factors, not just government
policy.
Summary:

Who or What is government

In definition, governments are non-profit making. So their leading motive is not
profit maximization but rather mobilization and allocation of resources

What about other NGOs?

- Government is not the only non-profit sector

- There are also charities, churches and welfare groups that don’t aim to
maximize profit.
- However they can register as public benefit organisations and receive tax
benefits or government funding.
- Even though they are non-profit, they are still not government institutions
and do not fall in the public sector, they are private.

What about State-Owned Enterprises?

- Public enterprises or state-owned enterprises are organisations that are

owned by the government but operate like businesses (e.g. Eskom).
- These organisations sit in a hybrid space between the public and private
sector.
- They are not fully private because they are owned and receive financial
support from the government but they are also not treated as purely
government institutions.
NOTE: universities are classified as part of the public sector.

The Public Sector in SA

Composition of the SA public sector:

The South African Constitution specifies 3 levels or spheres of government:

1. The Central/National government

2. Provincial governments
3. Local authorities/ municipalities

These three all constitute part of the general government.

- The general government thus represents the non-profit activities of the

public sector.
- The allocation of resources is determined by political considerations
and is financed through tax systems and user charges.

The combination of the general government and state-owned enterprises

(Eskom, SABC, Telkom etc) make up the public sector.
Size of the SA public sector:

The size of the government depends on the indicator used. There are a few
diRerent ways to measure the size of the public sector…

1. Taxes (direct & indirect)

§ This measures the tax burden on tax payers
§ It shows the total tax income of the general government as a % of
GDP.
§ In SA (2008-2017), the average tax revenue was 25.4% of GDP.
§ But this is incomplete because government also uses
- non-tax income (dividends, fees, mining leases)
- borrowing (loans)

2. Resource Use (Government expenditure on goods and services)

§ This includes government consumption, government investments
and spending by public enterprises.

3. Total Resource Mobilisation

§ This is the most complete measure to estimate the size of the public
sector.
§ It includes government spending on goods and services PLUS
transfer payments.
§ It incorporates general government and public corporations
§ Transfer payments are money collected by the government but
spent by households or businesses (subsidies, social grants,
interest on debt).

Changes in SA public sector over-time:

The government has generally become more involved in the economy over time
and transfer payments have risen strongly over the past 20 years. A bigger part of
spending now goes to…

- Social grants (helping households)

- Paying interest on government debt
Relationship between Public and Private Sector
The important aspects of this relationship may be identified with reference to the
circular low of income, expenditure and goods and services.

• The government is the supplier of public goods and services. Households

and firms pay for these goods and services through taxes.
• Government uses this tax revenue to acquire factors of production (labour,
capital, land etc).
• Government also uses tax revenue to purchase private good and services
which are then used as inputs to produce more public goods and services.

Government in a mixed economy

- The government buys a lot of goods and services, so it has a big impact on
the economy.
- Some sectors like construction and engineering depend heavily on
government spending.
- When government stops providing a particular good/service, it will be sold
or transferred to a private company instead (called privatisation)

- Sometimes there are public-private partnerships (PPPs).

 - This is where the government decides the quantity and quality of good/
service produced and the private sector produces and delivers the service.
- But private businesses often need public infrastructure (likes roads and
electricity) before they can invest.

- Government spending is needed for economic growth and stability

- But too much spending can cause inflation, reduce private investment
(crowding out) and slow down economic growth.

NOTE:

Government actions impact the economy, but the economy’s performance also
impacts government actions

How government financing aDects the economy

The ways in which the government finances its expenditure also has important
economic consequences, consider the following:

Taxes:

- The type of tax and rates aRect the after-tax distribution of income and
thus individuals’ welfare
- And it aRects the decisions by private businesses regarding the allocation
of resources in the private sector.
- Taxes can either promote or obstruct eRiciency and equity.

Budget imbalances:

- The government has to balance savings (S) and investments (I) as well as
exports (X) and imports (M).
- S = I and X = M
- An imbalance will aRect the economy.

- A budget deficit is when the government spends more than it collects from
tax revenue so G > T
- Therefore they must now borrow money.
- They can borrow money either from domestic savings (Sd) or foreign
savings (Sf).
- This can aRect private investment ( S ≠ I ) or trade (M ≠ X)

- A budget surplus is when the government collects more tax revenue than it
spends so T > G
- This adds savings to the economy.

NOTE:

Leakages = taxes, savings

and imports

Injections = government
spending, investment and
exports