LECTURE 1

INTRODUCTION TO PUBLIC FINANCE AND THE ROLE OF GOVERNMENT

 WHAT IS PUBLIC FINANCE?
• Public finance is the field of economics that studies
government activities and the alternative means of
financing government expenditures.
• Learn about the economic basis for government activities.
Microeconomic functions of government, the way
government affects the allocation of resources and the
distribution of income.
• A crucial objectives of the analysis is to understand the
impact of government expenditures, regulations, taxes
and borrowing on incentives to work, invest and spend
income.
• Governments are organizations formed to exercise
authority over the actions of people who live together in
a society and to provide and finance essential services
• Many citizens and resources are employed in the
production of government services.
• Individual pay taxes and in many cases, are recipients of
income finances by those taxes such as the pensions,
unemployment benefits and subsidies.
• The extent to which individuals have the right to
participate in decisions that determine what governments
do varies from society to society.
 ALTERNATIVE VIEWS OF GOVERNMENT
A. Organic View
• The individual significance only as part of the
community and the good of the individual is
defined with respect to the good of the
whole
• The goals of the society are set by the state.
B. Mechanistic View
• Government is a contrivance created by individuals
to better achieve their goals
• Government is a trust, and the officers of the
government are trustees; and both the trust and
the trustees are created for the benefit of the
people – Henry Clay (1829)
• Government should protect the society from the
violence and invasion of other independent
societies and protect as far as possible every
member of the society from injustice or
oppression of every other member of it. (Adam
Smith)
THE ALLOCATION OF RESOURCES BETWEEN
GOVERNMENT AND PRIVATE USE
• The production-possibility curve shows alternative combinations of
government goods and services and private goods and services that can be
produced in an economy.
• The curve assumes that productive resources and technology are given.
• An increase in government goods from OG1 to OG2 requires a sacrifice of
X1X2 units of private goods per year.
• For example: suppose that individuals demand more environmental protection
services. To make these services available, governments might raise taxes paid
by firms that pollute the air or water or they could enact more stringent
regulations that prevent pollution. The new regulations or taxes are likely to
increase costs of production for business firms, causing the prices of products
produced by these firms to increase and the quantities demanded in the
marketplace by consumers to decline. The new policies will result in improved
environmental quality—a government-supplied good—but will also require
that households sacrifice consumption of private goods and services to pay for
the cleaner environment.
CIRCULAR FLOW IN THE MIXED ECONOMY (1)

• The upper and lower loops represent transactions between

households and business firms in markets. Households use the
income they earn from the sale of productive services to purchase
the outputs of business firms.
• The inner loop represents transactions between the households and
government and between business firms and government.
Governments purchase productive services from households and
outputs of business firms.
• These purchases are financed with taxes, fees and charges levied on
persons and firms and the inputs acquired are used to provide
government services and transfers.
 CIRCULAR FLOW IN THE MIXED ECONOMY (2)
• Government purchases are those that require
productive resources (land, labour and capital) to be
diverted from private use by individuals and
corporations so that such resources can be used by
the government.
• Example: national defence services and
collection/disposal of garbage.
• The bulk of government purchases are consumption
expenditures that use resources to satisfy current
needs.
• Gross investment by government is expenditure for
new capital such as roads, equipment and structure.
• Government expenditures that redistribute
purchasing power among citizens are call government
transfer payment.
• Constitute a source of income support to recipients
who are not required to provide any service in
return for the income received.
• They are not payments made in exchange for
productive services.
• Example: Bantuan Keluarga Malaysia, unemployment
insurance and social security pension benefits.
 TOOLS OF ANALYSIS

• Positive and normative analyses are the two common analytical tools to
evaluate the efficiency of public policies.
• Particularly, the positive analysis is an approach to establish cause-and-
effect relationship among economic variables or government policies.
• The normative analysis, on the other hand, can not only determine the
effects of government policies, but also whether or not they produce
results that are good as intended.
 TOOLS OF POSITIVE ANALYSIS (1)
• One important purpose of empirical work in public finance is to estimate the causal relationship between a government
policy and its outcomes/consequences. Economic theory is a useful starting point for analysing the impact of government
impact. The positive theory makes no presuppositions about what is good or bad or what should be accomplished. It
merely formulates hypotheses of the “If … then” statement. In the example, if wage tax increases, then …
• Example 1 - Imagine that Roger earns wage rate of $10. Now the government imposes a tax on earnings of 20%. Then,
Roger’s after-net or net wage is $8. Now, let’s look at the causal relationship between this government policy (income tax)
and its outcome.
• The wage tax lowers the effective price of leisure. Before the tax, consumption of an hour of leisure cost Rogers $10.
Under the tax, the net wage is lower, and an hour of leisure costs him only $8. Since leisure has become cheaper, he will
tend to work less.This is called the substitution effect.
• Another effect occurs simultaneously when the tax is imposed. If Roger works the same number of hours after the tax, he
receives only $8 while before it was $10. Because the tax makes Roger poorer, it induces him to work more. This is called
the income effect.
• In this example, knowing the impact of tax reductions (cause or if) on labour supply (effect or then) is of major interest in
the positive analysis.
 TOOLS OF POSITIVE ANALYSIS (2)

• Example 2 - A positive analysis of the impact of a proposal to widen a road can be used to predict how the
road will benefit users by reducing the time and money costs involved in getting between two locations.
• Example 3 - The impact of a food subsidy to low-income persons can be utilized to estimate the effect of
the subsidy on the price of food and the quantity available to the recipients.
• One way to conduct the positive analysis is through econometrics.
• Econometrics is the use of statistical analysis of economic data in order to estimate causal relationship.
• We can use regression analysis, for instance, to estimate the relationship between two variables (in the
example, tax rate and economic growth), ceteris paribus.
 TOOLS OF NORMATIVE ANALYSIS (1)

• This tool assesses whether a government policy has achieved the intended
objective, normally is a good objective.
• Theoretically, the government policy is said effective if it achieves Pareto
efficient.
• Pareto efficiency is an allocation at which the only way to make one
person better off is to make another person worse off. That is, the policy
reaches its highest potential.
 TOOLS OF NORMATIVE ANALYSIS (2)

• Inefficiencies may occur for two general reasons – market power and nonexistence of markets.
• If some individuals or firms are price makers (they have the power to affect prices), then the
allocation of resources might be inefficient. Why? A firm with market power may be able to raise
price above marginal cost by supplying less output than a competitor would.
• Another type of inefficiency that may arise due to the nonexistence of a market is an externality.
For example, suppose your roommate smokes, polluting the air and making you worse off.
However, there is no market for clean air that forces him to pay for it. The price system fails to
provide correct signals about the opportunity cost of a commodity.
PUBLIC FINANCE: MALAYSIA’S CASE
 WHAT IS FISCAL POLICY?

• Fiscal policy is the means by which a

government adjusts its spending levels
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and tax rates to monitor and influence a sights/what-is-fiscal-policy/
nation's economy.
• It is the sister strategy to monetary policy
through which a central bank influences a
nation's money supply.
• These two policies are used in various
combinations to direct a country's economic
goals.
FISCAL REGULATORY FRAMEWORK
Debt Acts and Rules

• MGII stands for Malaysian Government Investment Issue and is a form of marketable
government debt securities issued by the Government of Malaysia to raise funds
from the domestic capital market to finance the Government’s development
expenditure. MGII is Islamic securities issued in compliance with Shariah
requirements and is an alternative debt instrument for the Government.
• Malaysian Islamic Treasury Bills (MITB) – short-term securities, based on Islamic
principles, issued by BNM. MITBs are usually issued on a weekly basis with
maturities of 10-year.
• Malaysian Government Securities (MGS) – is coupon-bearing, long-term bonds issued
by the Government to raise funds for development expenditures. They are the most
actively traded bonds. The BNM regularly issues 3-year, 5-year, 7-year and 10-year
MGS as benchmark securities for the development of a benchmark yield curve. I
addition, 15-year and 20-year have been issued to lengthen the yield curve.
• Malaysian Treasury Bills (MTB) – Short-term securities issued by BNM for the
government’s working capital requirements. It is issued with original maturities of 3-
month and 6-month and 1-year.
• Government Investment Issues (GII) – long-term non-interest bearing Government
securities based on Islamic principles issued by the Government of Malaysia for
funding developmental expenditure. GII are issued through competitive auction by
BNM on behalf of the Government. Funds are used for developmental expenditures.
GIIs are issued with original maturities of 3-year and 5-year, 7-year and 10-year.
FEDERAL GOVERNMENT FINANCIAL POSITION, 2020 - 2022
• 2021 Budget: Fiscal deficit to
reduce to 5.4% of GDP based on
assumption of steady economic
recovery in the 2nd half of 2020
and spillover to 2021
• However, the emergence of new
COVID-19 variants, which is
more virulent and contagious,
poses big challenges to the
Government in protecting the
rakyat, businesses and economy.
• Consequently, the Government
re-imposed the MCOs and
announced additional assistance
and stimulus packages to ease the
burden of the rakyat and
businesses.
 FEDERAL GOVERNMENT OVERALL AND PRIMARY
BALANCE

Source: Ministry of Finance, Malaysia

 FEDERAL GOVERNMENT REVENUE, OE AND CURRENT
BALANCE

Source: Ministry of Finance, Malaysia

 FEDERAL GOVERNMENT MEDIUM-TERM FISCAL FRAMEWORK

Source: Ministry of Finance, Malaysia

 FEDERAL GOVERNMENT REVENUE, 2020 - 2022

Source: Ministry of Finance, Malaysia

 PETROLEUM-RELATED AND NON-PETROLEUM
REVENUE (% OF TOTAL REVENUE)

Source: Ministry of Finance, Malaysia

 REVENUE AS PERCENTAGE OF GDP

Source: Ministry of Finance, Malaysia

 FEDERAL GOVERNMENT OPERATING EXPENDITURE BY
COMPONENT, 2020 - 2022

Source: Ministry of Finance, Malaysia

 FEDERAL GOVERNMENT DEVELOPMENT EXPENDITURE BY
SECTOR, 2020 - 2022

Source: Ministry of Finance, Malaysia

DEBT LEGISLATIVE GUIDELINES
 FEDERAL GOVERNMENT FINANCING, 2020 - 2021

Source: Ministry of Finance, Malaysia

 FEDERAL GOVERNMENT DEBT BY
INSTRUMENT, 2020 - 2021

Source: Ministry of Finance, Malaysia

 FEDERAL GOVERNMENT DEBT COMPOSITION

Source: Ministry of Finance, Malaysia

 FEDERAL GOVERNMENT DEBT AND LIABILITIES
EXPOSURE, 2020 - 2021

Source: Ministry of Finance, Malaysia

 COMMITTED GUARANTEES, 2020 - 2021

Source: Ministry of Finance, Malaysia

 OUTSTANDING LOAN GUARANTEES

Source: Ministry of Finance, Malaysia

 CONSOLIDATED PUBLIC SECTOR FINANCIAL
POSITION, 2020 - 2022

Source: Ministry of Finance, Malaysia

 CONSOLIDATED STATE GOVERNMENTS’ FINANCIAL
POSITION, 2020 - 2021

Source: Ministry of Finance, Malaysia

 NFPCS’ FINANCIAL POSITION, 2020 - 2021
NFPCs’ Assets and Liabilities (End-2020)

Source: Ministry of Finance, Malaysia