JESSA Q.

BELOY
MSA 202
MANAGERIAL ECONOMICS

Case Study 5.2: State Spending PAGE 216

1. In what areas of public spending do there appear to be increasing

returns?

According to the statistical analysis of return on public spending

of World Bank Group, developing countries like India, China, Indonesia

and Philippines appear to have increasing returns. Each year, its GDP

growth (average real) increases as to the effect of public spending.

2. In what areas of public spending do there appear to be diminishing or

negative returns?

Shown in the table above, the statistical analysis of return on

public spending of World Bank Group, developed countries like United

States, Canada, France, Germany, UK and Japan appear to have

 diminishing or negative returns. Its GDP growth (average real) each year

decreases as to the effect of public spending.

3. Explain the difference between diminishing and negative returns in the

context of public spending, giving examples.

When we say diminishing returns in the context of public

spending, the result of public spending for example, the unemployment

rate decreases and when it reaches the negative (below zero), it then

becomes negative returns. Shown below is an example of diminishing

and negative returns in the context of public spending on education and

its result on employment rate.

4. Explain what is meant by “revenue churning”, giving examples.

A transfer is churned when at least the same level of voter

satisfaction could have been achieved by lowering the voter’s tax burden

by the amount of the transfer. The familiar example of churned transfers

is that of the middle class which is taxed, then give back a significant
 portion of those taxes in the form of social security benefits or

unemployment insurance. Money take from the people in taxes is often

returned to the same people in terms of improving desired infrastructures

– development of transport, schools, medical aids etc.

5. Why do local politicians have little incentive to spend public money

wisely?

Politicians and bureaucrats are in charge of spending money of

the faceless, nameless taxpayer, who has no direct control over how

money is spent. And therefore, they have very little incentive to spend it

wisely. Taxpayer has no direct say in how the money is spent. The

taxpayer can’t cut the government off if he/she doesn’t like how the

money is spent. Since government decision makers are not spending

their own money, and are not directly accountable to anyone whose

money is being spent, they have little incentive to hire qualified workers

and fire unqualified workers, make sure contractors don’t over charge,

economize on purchases, and initiate work on fruitful projects, and cut

off wasteful ones.

Government decision makers have little incentive to spend

taxpayer’s money wisely, but doesn’t mean they lack motivation for other

things. Like everyone else, they are motivated to further their own

personal self-interests, such as their political careers and size of their

bank accounts.

6. Is it possible to talk about an optimal level of public spending? How might

this level be determined?

 A country has certain maximum capacity of GDP production ate

certain conditions. Actual GDP below this maximum GDP level indicates

unemployment.

Here in considered figure gap between a to b witness this. To

mitigate this, there is requirement of money flow in economic system that

gives rise to public spending. Increase in public spending means more

income of household, more purchasing power and more demand,

aggregate demand curve shifts rightward (AD1 to AD4), inflation rate

increased from point a to b, and unemployment reduced from point a to

b. Thus, it is rational to operate between point a to b where a country

has less unemployment maintaining less inflation. This gives

government an optimal level of public spending.

References:

https://www.worldbank.org
http://www.populationcommission.nic.in

http://www.gov.uk/government/topics/public-spending