Lesson 2: PUBLIC FINANCE AND POLICY

Introduction to Public Policy

Policies are broad precedent settings decisions that guide or substitute for repetitive
managerial decisions.

Government expenditures are financed mainly by taxes. Malawi taxpayers give up

more of their income each year to support government activities than they do to
satisfy their desires for such basic items as food, clothing, and shelter. Taxes collected
by governments in Malawi are: income tax corporate tax, custom duty, Surtax. Fees
charges etc.

Citizens benefit from the many goods and services made available by governments,
but they also pay the costs of these services. There are different views about what
governments should and should not be doing in part because individual valuations of
the benefits received from government differ. There are also disagreements because
of variation in the amount of taxes and other costs each of us pay…

PUBLIC POLICY

Policies are broad precedent – setting decision that guide or substitute for repetitive
or time sensitive managerial decision making. Sometimes are called standard
operating procedures.

Government create policies that guide, preauthorise the thinking, decisions, actions of
operating managers and their subordinates in implementing the business strategy.

An example of a directing and nature of policies might be:

A requirement that manager have purchase request for items costing K5 million co-
signed by the controller

Creating Policies that Empower

Policies communicate guidelines to decisions. They are designed to control decision

while defining allowable discretion, within which operational personnel can execute
business activities,

They do this in several ways:

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 i. Policies establish indirect control over independent action by clear stating how
this is to be done.
ii. Policies promote uniformity handling of similar activities. This facilitates the
coordination of work tasks and help reduce friction arising from favouritism,
discrimination and the disparate handling of common functions
iii. Policies ensure quick decision- standardising answers.
iv. Policies institutionalise basic aspects of organisation behaviour – minimise
conflicting practices and establish consistent pattern of actions.
v. Polices reduce uncertainty in repetitive and day to day decision making thereby
providing a necessary foundation for coordinated, efficient efforts and freeing
operating personnel to act.
vi. Policies offer predetermined answer to routine problems.
vii. Policies afford managers a mechanism for avoiding a mechanism for avoiding
hasty and ill-conceived decisions.
viii. Policies counter resistance to or rejection of chosen strategy by organisation
members. When major strategic changes are undertaken, unambiguous
operating policies clarify what is expected and facilities acceptance particularly
when operating managers participates in policy development.

The Government and Distribution of income

The government is interested in the distribution of income for four main reasons.

1 Fairness: especially in the richer western economics, people’s social conscience will
not tolerate “poverty in the midst of plenty”. Yet private giving though charitable
institutions are irregular, unreliable and inadequate in dealing with the relative size
of the problem of inequality in a” caring society”
2 Cross inequality of income is divisive of society and disruptive of economic life e.g.
through strikes for higher salary.
3 The distribution of income affects the broad macro variables e.g. savings through
taxation yield which government has to take into account in formulating
stabilization policies.
4 The extent to which the government is successful in the stabilization policies will, in
its turn, affect income distribution e.g. unemployment and raising prices. The

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 government, therefore, has moral obligation to compensate for any failure on its
part, by providing unemployment benefit and indexing social security benefits in
line with inflation

Government objective and policies

To achieve economic growth and control inflation the macroeconomic policies used by
the government are:

 Influencing overall demand in the economy (aggregate demand) via

 Monetary policy: government policies on money supply, monetary supply
system; interest rates, exchange rates and the availability of credit.
 Fiscal policy government policies on taxation; public financing; borrowing
and public spending.
 Influencing overall supply in the economy ( aggregate supply) via supply side
policies

Monetary policy

Interest rates – the price of money- are a target of monetary policy, if government
considers that there is a direct relationship between interest rate and the level of
expenditure in the economy or between interest rates and the rate of inflation.

Effects of a rise in interest rates

 The price of borrowing in the economy will rise

o If companies see the rise as permanent, rates of return on investment will
become less attractive and investment plans may be curtailed. Spending will
fall; corporate profits will fall as a result of higher interest payment. Companies
will reduce inventory levels as the cost of having money tied up rises.
o Households will reduce or postpone consumption in order to reduce borrowing
and should become less willing to borrow for house purchase. Spending will fall.
 The exchange rate for Malawi kwacha will be higher than it would otherwise
be. This will keep the cost of imports higher.
 There reduction in spending and investment will reduce aggregate demand in
the economy.

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Fiscal Policy

This is government’s policy on government spending; taxation and borrowing.

Spending the government spends money at national and local level to provide goods
and service, such as health service, public education, police force, roads public
buildings and to pay its administrative work force. It may also perhaps provide finance
to encourage investment by private industry for example by means of grants.
Increased government spending increases the size of the economy.

Taxation; Expenditure must be financed and the government must have income. Most
government income comes from taxation; some income is obtained from direct
charges to users of government services market fees and road tax. Increase in
taxation without increase spending reduces size of the economy.

Borrowing the government must borrow the amount by which its expenditure exceeds
its income (budget deficit)

Fiscal policy refers to action by the government to spend money or to collect money in
taxes, with the purpose of influencing the condition of the national economy.

A government might intervene in the economy by:

a) Spending more money and financing the expenditure by borrowing

b) Collecting more in taxes without increasing spending Collecting more in taxes in
order to increase spending thus diverting income from one part of the economy
to another.

Fiscal policy could be used as an instrument of demand management. Government

spending and taxation levels could be used to eliminate an inflationary gap or
deflationary gap in the economy.

A reduction in taxation would give households a larger income and so domestic

consumption (c) would rise. Conversely an increase in taxation would reduce domestic
consumption. Extra government spending (G) should create a multiplier effect on
nation income although public sector spending might lead to “crowding out” of private
sector investment because of higher rates of interest in the capital market.

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Macroeconomic Problems

The business and finance operate in an environment. The general environment covers
all the Political, Legal, economic, social /Cultural, ecological and Technological (PESTEL)
influences in the country a business operates in.

There are two economic environments that affect the Government and business.

The macroeconomic environment in which all government and business have to

operate which incorporate:

 National influence the business cycle government policies (e.g. fiscal and
monetary)
 Global influence internationalised of trade influence of regional economic
groups such as EU, globalised markets. Regional integration of Infrastructures
such as Transport, Energy. Data Transmission and telecommunication, Financial
markets and direct investment, Public health
.

The microeconomic environment of the particular business which basically involves

looking at market (or price) mechanism.

1. Macroeconomic is concerned with the study of the whole economy; problems arise
when the economy suffers from high unemployment, inflation or a balance of
payments deficit. Therefore, government sets its self-certain macroeconomic
objectives.
 Low unemployment
 Low inflation
 A balance of payment surplus
 Economic growth

Recession is when output and employment are falling in the economy. This is when
the trade cycle.

Booms in the Economy

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A boom is when output and employment in the economy are rising. This is peak of
trade cycle.

 A boom increase spending on imports, causing balance of payment problems.

 Once high levels of employment have been reached, output cannot be increases
any further and the boom causes inflation.

Slumps in the Economy

A slump is when output and employment in the economy are falling. This is the
bottom of the trade cycle.

 A slump reduces spending on imports. Thus improving the balance of payment.

 Reduced total spending lowers inflationary pressure.

Trade Cycle

The trade or business cycle refers to regular movements in the economy between
booms and slumps.

Government Macroeconomic Policies

Below are some of the policies government can use to try to get full employment,
stable prices etc.

Macroeconomic policies

POLICY DESCRIPTION

Fiscal Changes in government expenditure and taxation

Monetary Changes in money supply and interest rates

Price and incomes legal and voluntary limits on price and wage increase

Regional Measures to help depressed areas within the country

Industrial Government planning of industry

Commercial tariffs, exchange control or free trade

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Exchange rates Encouraging a depreciation or appreciation of kwacha.

Elements of Public finance

a) Public Expenditure
The Government at a national and local level and through the nationalisation
industries spends money.
Government expenditure has the following purpose:
 To provide public goods and services such as health services, public education,
security, roads, public buildings etc. and to pay its administrative workforce.
 To alleviate poverty
 To provide payments to certain members of society such as pensioners etc.
 On a small scale, perhaps, to provide finance to encourage investment by
private industry e.g. by means of grants.

Services that Government provide

What would it be like to live in a nation without government? There would be no
system of courts to administer justice. Provision of national defence and homeland
security would be difficult or disorganized with no central government to maintain and
supply the armed forces. You could forget about such programs. How would police and
fire protection be provided? Driving on roads and over bridges that we take for
granted could also be a problem because virtually all the highways, streets, and other
public transportation infrastructure we use every day are supplied and maintained by
governments or their agencies. There would be no publicly funded secondary schools.
Higher education, which is heavily subsidized by government, also would be in trouble.
Our system of health care depends on government programs to pay the medical bills
of many of the poor. Institutions ranging from medical schools to public clinics and
hospitals would have their operations impaired without government support.

THE ALLOCATION OF RESOURCES BETWEEN GOVERNMENT AND PRIVATE USE

Government provision of goods and services requires labour, equipment, buildings,
and land. The real cost of government goods and services are the value of private
goods and services that must be sacrificed when resources are transferred to
government use. Citizens pay taxes, their capacity to purchase goods and services for
their own exclusive use (such as automobiles, clothing, housing, cameras, and dining
out) is reduced. Resources that are thereby diverted from private use are purchased or
otherwise obtained by government.

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Taxes also have indirect costs because they distort choices.
- Taxes affect prices of goods and services and the incentive to work, save, and
allocate expenditures among goods and services.
- Taxes impair the operation of the economy by inducing individuals to make
choices based not only on the benefits and costs of their actions but also on the
tax advantages or disadvantages of their decisions.
- The distortion in resource use and loss in output that results from the effect of
taxes on incentives is also part of the cost of government activity.
- The resources governments obtain are used to provide citizens with goods and
services, such as roads, police and fire protection, and national defence.

These government goods and services are shared by all; they cannot be used by any
one citizen exclusively. Other goods and services provided by government are limited
in availability to certain groups, such as the aged or children, as with public primary
and secondary schooling.

Private goods and services are those items, such as food and clothing that are made
available for sale in markets. Government goods and services, such as roads,
schooling, and fire protection, usually are not sold in markets.

Public money is the money that government gets from taxes, fees, charges, grants,
loans, donations and spends on provision of public services.

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