“…to pursue common interests of individuals living in a community” - David Hume
Provision of indivisible and non-excludable goods. Thus should be financed through the collective action of the beneficiary good.
Coase: The externalities can be resolved in a smaller group by voluntary action (through bargaining and coordination), assuming the property rights are clearly defined.
Problem with voluntary action to resolve spillovers is the coordination and transaction costs.
In a large community with diverse preferences, rational, self-interested individuals will not act in the interest of the common group.
Non-excludable nature of the group gives rise to free-riding behavior
Public finance: Public goods (jointness in supply and infeasibility of exclusion)
Feng Yu-Hsiang’s example
Due to the bandits, the people were unsure about their own future (whether they will live tomorrow or not) and thus lost their incentive to accumulate wealth
The bandits were overthrown by this warlord and people were promised security for life and right to living at a small cost (a portion of their salary)
The situation just shifted from anarchy to dictatorship. The nature and quality of the growth was determined by the dictator
Even though the basic public good was being provided (protection of life and property of the people), it didn’t promote encompassing growth as the goal was private profits
The dictator didn’t undertake redistribution
2.2 Public Finance and Public Choice: Contrasting views on the state
Public Finance: the government performs actions necessary for encompassing growth
Provide social goods with externalities.
Redistribute income.
It provides meritorious goods.
Provide fair competition.
Public Choice: the government is not maximizing public welfare
It’s maximizing its own welfare
Constrain freedom of the people
Normative view of state activity
Government is a Benevolent social guardian requiring to expand their sphere of influence
Adam Smith: Core functions are
Defense
Protection of life and property
Administration
Justice
Large public works
Adolf Wagner: As democratic and progressive nations industrialize the share in the national economy of public spending increases faster than the increase in income. This rise is due to
Increased social activites of the state
Higher administrative and protective actions
Increase in welfare functions
Peacock and Wiseman: “Displacement effect” hypothesis explains the step-like increase in public expenditure-GNP shares (ratio) during war and depressions
The ‘tolerable burden of taxation’ increases during wars and depressions (social upheavals).
It continues to stay like that even after the social upheaval has ended. People are okay to continue to pay that level of taxes.
This allows the government to implement public spending programs that weren’t possible before due to lack of taxation before.
Lord Keynes:
In his End of Laissez Faire, advocated for the expanded role of the state
General Theory of Employment, Interest and Money (1936) speaks about the government maintaining full employment even when interest rates and wages show downward stickiness.
The expanded role of the state may lead to autarchy.
Due to economic planning, individuals lose their freedom to determine their economic future. They get reduced to mere “tools of the state”.
This loss of freedom may result to loss of political freedom
2.3 Types of Market Failure and Government Intervention
The State can get into the provision of the core functions without any controversy. This includes providing/ensuring
Life and property protection
Property rights
Enforcement of contracts
However, the government should not get into the production of the inputs required to provide the aforementioned. Rather it should buy them from the market and provide it to the people.
The State should also ensure fair competition in the market by
Disseminating information properly (transparency)
Promoting market competition
Creating markets where they do not exist
Ensure effective regulation without getting into the production process. Why?
Certain services (industries) have declining marginal cost over large volumes of output.
To prevent giving any industry or firm a monopoly status. (e.g. Electricity, telecoms, railways, airlines)
Even private sectors can provide many of these services due to improvements in tech. In such a case the State should ensure fair competition through regulation.
Incomplete marketsmissing or incomplete in developing countries
Rural markets are not connected so farmers have very little option about when and where to sell their produce and at what rate. They are forced to immediately sell their produce to clear off their debts from money-lenders.
Lack of credit and insurance market
Extreme volatility in prices
Accessibility of loans and reasonable interest rates
Pure public good vs private groups. There is a group in between (Gray area)
Determined by aggregating individual choices (Samuelson’s model) or by voting (Musgrave’s construct)
“Merit goods” lie in between and people want it to be provided by the government (called so since they are meritorious to the people)
Market fails here because individual do not gauge the costs and benefits in the social context.
Markets do not distribute wealth and income equally. Thus government intervention is imperative to redistribute income to a socially desired state.
But what is equal? This question poses as a challenge. The ‘proper’ state of distribution is assumed to exist and there is a tax-transfer mechanism for achieving it.
‘Equality’ can be subjected to different interpretations. Interpersonal comparisons of welfare.
How to make distributional changes?
Budgetary policy
Minimum wage legislation
Price fixation and controls
Subsidization policy and tariff policy
Tax-transfer policy is far superior as it involves minimum interference in resource allocation.
The type of intervention is decided by the kind of market failure:
Provision of public goods, merit goods and redistribution require budgetary policies.
Ensuring competition, environmental protection etc. require effective regulation.
Intervention should not replace but strengthen the market.
2.4 Indian Development Strategy and Role of the State
Objective of the fiscal policy was to raise the level of saving (to finance increasing levels of investments required to accelerate the growth of the economy).
Wasn’t effective to achieve the intended task. Though the public sector experienced significant expansion, public savings and required resources for investments couldn’t be generated.
A considerable portion of the public spending was financed from borrowing, leading to large deficits and debt (and also inflation).
Import substitution lead to inefficient production systems with low-quality, high priced, non-standardized products supplied to the consumers.
Poverty
Public finance policies did not provide competitive levels of infra required to raise econ activity to…
Generate productive employment
Empower workforce with required human capital (education, skill dev and healthcare)
doubt P.21 The strategy was unviable… Markets to function (Second last paragraph ending)
Most prices are still determined by government fiat rather than the market mechanism
Attempts to privatize unprofitable and non-strategic sectors have met with limited success.