1.

Indonesia is an emerging middle-income country and Cyprus is a high-income

country. In 2016, Indonesia’s government expenditure as a proportion of GDP was
16%. In Cyprus, public expenditure as a proportion of GDP was 38%. Which one of
the following is the most likely explanation for this?
a. Cyprus is experiencing lower economic growth than Indonesia.
b. Levels of taxation are higher in Cyprus than in Indonesia.
c. GDP in Cyprus is lower than in Indonesia.
d. Citizens in Indonesia have a lower demand for public sector goods and
services, compared to citizens in Cyprus.

2. Read the above extracts and answer the following.

a. In 1990, social protection spending by the South Korean government was
2.3% of GDP. Using this information and FIgure 4, calculate the proportion of
government spending on social protection in 1990.
Government spending as a percentage of GDP was 21.4%.( 2.3/21.4)x100

b. Explain what is meant by the phrase ‘current expenditure’

Current expenditure is government spending on transfer payments, interest
payments, and other general government consumption in the short-run.
Between 2003 and 2014, current expenditure by the Senegalese government
increased by 5% in proportion to GDP. This increase in current expenditure is
due to wage increases in the public sector, meaning the government in
Senegal is spending more on the wages of civil servants.

c. With reference to Figure 4 and Extract B, analyse the likely effect of differing
levels of public expenditure, as a proportion of GDP, on levels of taxation.
Public expenditure is the total government spending on public services. In
Senegal, public expenditure rose from 21% to 28% of GDP between 2003
and 2014. This increases the level of taxation of the Senegalese population.
Increases in public expenditure are due to government objectives of
improving infrastructure or human capital to promote economic growth,
therefore increased capital expenditure would lead to long run increase in
taxation. However, increased levels of public expenditure may not imply equal
increases in tax revenue. In 2014, the amount of borrowing by the public
sector reached a deficit of 5.2% of GDP. This means that public expenditure
is exceeding tax revenue and current expenditure is being paid for by
borrowing rather than solely tax revenue.

d. With reference to the information provided, examine the likely reasons for the
changes in the size and pattern of public expenditure between 1990 and 2015
in South Korea.
Reasons for changes in public expenditure? Changing demographics,
incomes
Public expenditure is government spending on public services. Increased
incomes likely increased the size of South Korea’s public expenditure. In
1999, minimum income was guaranteed for the poor in South Korea.
Considering the Asian Tigers whose economies grew exponentially
throughout the 80s and 90s, the average income for a South Korean
 increased, therefore the government received more tax revenue from direct
taxes, therefore they could afford to spend more on welfare benefits for lower
income households. Another factor is demographic change. In 2008, South
Korea introduced a universal basic pension and insurance scheme providing
long term care for the elderly. South Korea’s low birth rate means it has an
ageing population, therefore the country has to spend more on healthcare
and the provision of welfare for the elderly who compose an increasing
proportion of the population. Therefore government spending in South Korea
has largely increased due to demographic changes and higher household
income.

e. With reference to the information provided, discuss the likely economic effects
of an increase in public spending as a proportion of GDP on countries such
as Indonesia, Taiwan, Thailand, South Korea, and Senegal.

Economic effects of increasing public spending: Crowding out, crowding in,

productivity
Public spending is government expenditure on public goods and services.
With increased public spending there would be increased productivity and
efficiency in the economy. Senegal increased public spending as a proportion
of GDP from 21% in 2003 to 28% in 2014. This increase in spending on
healthcare, education, and infrastructure would set off a positive multiplier
effect, improving the human capital within the economy, and transportation
networks, therefore increasing the overall productivity of the Senegalese
economy. Although financing with debt can be risky since borrowing in the
public sector reached a deficit of 5.2% of GDP, in the long run these debts
would be compensated for by the growth promoted by dynamic efficiency,
assuming these investments are correctly managed.

In Senegal, the private sector would become more competitive due to the
improved human capital and infrastructure. The magnitude of this is
significant due to economic growth in the region rising from 2.8 per cent to 7
per cent in 2017. However, since Senegal is a developing country, it may not
have a sufficient tax base in order to fund the increased public expenditure.
Assuming oil supplies remain constant in the long run for Senegal then they
may be able to fund this expenditure from nationalised oil rather than just
taxes.

In contrast, the Asian Tiger countries may experience crowding in due to

increased public expenditure. This is shown by the following diagram.
Crowding in is where an increase in public expenditure leads to an increase in
private sector spending as opposed to being proportional when an economy
is at full employment. In 2001 Taiwan opened state benefits for the
unemployed, and Indonesia also expanded its own welfare state in 2011
providing healthcare and insurance to 240 million citizens. This increase in
spending would increase the productive potential of the economy, therefore
shifting the production possibility frontier right, hence increasing private sector
and public sector spending.
 An increase in productive potential for the Asian Tiger economies signals long
run stability of employment rates which will increase living standards for the
population of the region. However, if stagnant birth rates do not improve in the
long run, then these countries may lack the funds in order to finance the
welfare state and the provision of healthcare.

3. From 1996 to 2016, Poland’s public expenditure as a proportion of GDP fell from
51% to 41%. Evaluate the possible reasons for a fall in the level of public
expenditure, as a proportion of GDP, for an economy.

Public expenditure is government spending on public goods and services. It can be

divided into two categories: Current expenditures are the day-to-day expenses of the
government such as transfer payments, debt interests, and other government
consumption. In contrast, capital expenditure consists of long run investments, such
as the improvement of infrastructure and the provision of education. In 1996 Poland’s
public expenditure was 51% whereas in 2016 it fell to 41%.

The composition of spending over time may be an important reason for the fall in
Poland’s public expenditure. In 1996, Poland had a stagnant economy, therefore the
state attempted to promote economic growth and improve living standards by
increasing public capital expenditure in order to create long run dynamic efficiency.
Poland lacked a tax base in order to finance this therefore the public capital
expenditure was financed by loans. With the improvement of human capital within the
economy, the improvement of infrastructure, Polish firms would become more
efficient and there would likely be economic growth. Therefore over time the Polish
government would be able to dedicate more proportion of funds to the provision of
the welfare state rather than public investment. Therefore overall public expenditure
would decrease in Poland as a proportion of total GDP due to increased economic
growth and less capital expenditure.

However, this may not be a significant factor considering the debt crisis Poland
suffered throughout the 2000s, which would have likely led to a larger proportion of
expenditure being dedicated towards debt interests which would increase spending
in proportion to GDP. The magnitude of this is limited however, especially
considering the exponential growth experienced by the Polish economy due to the
aforementioned dynamic efficiency.
Another significant factor may be changes in governance. Over time different
governments in power will have different views about the presence and size of the
welfare state, and will therefore change policy accordingly, creating legislation such
as contractionary fiscal policy. Considering Poland’s increasing tendency towards a
right-leaning government, the presence of the welfare state is minimised by this
ideology therefore this would be an explanation for the decrease in public spending
to 41%.

Although this is a significant contribution, this cannot be the only factor since Poland
still suffers from high unemployment rates which would maintain public expenditure
high. Furthermore, the change over 20 years is extremely drastic therefore the
presence of political ideology may not be as significant as long run economic cycles
such as recession.

In contrast, age distribution of a population is likely a more significant factor. If Poland

has a rising or stable birth rate, then government spending on healthcare and
pension funds would decrease due to the lack of an elderly population to provide for,
meaning there are less ‘sunk costs’ of expenditure with no corresponding output,
therefore overall government spending would decrease and pension funds may also
experience cuts due to lack of demand. With a larger working population, the
productive potential of the economy would increase as shown by the following
diagram. There is a decrease in public spending from Q2 to Q1 and an increase in
private spending from P1 to P2. This would occur because increased employment
would lead to decreased welfare spending.

This actively illustrates that demographic changes are more significant than
governance changes and composition of spending. Although the production
possibility frontier is assuming the economy is at full employment which is
contradictory, the fact that the majority of current expenditure is often on the welfare
state implies that demographic changes have a strong impact on public expenditure.
However, this may still be limited by the fact that a constant or rising birth rate may
lead to expenditure increases due to healthcare and education costs rising in the
long run to accommodate an increasing population.

Lastly, changing incomes may also be a contributing factor. With increased

household incomes and lower income households ascending the income ladder, the
government pays less in welfare benefits due to the high employment within the
economy, therefore the extent of government spending decreases. Considering the
rising or stable employment we may also assume that there is increasing economic
growth, therefore even if public expenditure remains constant it would decrease in
proportion to GDP if there is increased economic growth.

This may also be an accurate assessment of the decrease in government spending

relative to GDP considering the aforementioned capital investment throughout the
late 90s and early 2000s which would promote economic growth in the region,
therefore making public expenditure smaller relative to the growing value of output in
the economy.
Overall the principal factors contributing to decreased public expenditure in Poland
are changing demographics and incomes of the population. Although government
policy and the composition of expenditure are also significant factors, in the long run
demographic changes correspond directly with the nature of spending due to birth
rates and population growth, while income changes lead to increased living
standards and a lack of demand for a welfare state.