Government Spending in the UK

Government Spending in the UK

As we said at the start of this topic, fiscal policy refers to any policy of the government that involves taxation or government spending. In the last three Learn-Its we looked at taxation. In the final two Learn-Its of this topic we will look at government spending.

Capital expenditure

This includes any spending that adds to the capital stock of the UK. Building new schools and hospitals count (although the wages of teachers and nurses do not) as do new roads and the investment by the government in a new nuclear deterrent.

Current expenditure

Whereas capital expenditure can be seen as 'once-and-for-all' expenditure, current expenditure is recurring. Building a new hospital at a cost of £50 million is an example of a one-off capital expenditure. The wages that will be paid to the nurses and doctors, and the money for drugs and the upkeep of the hospital will all be recurring and are recorded as current expenditure.

Debt interest

All governments around the world have to borrow money at some point. Just as your parents have to pay interest on their mortgage every month, so the government has to pay interest on their debts. See the next Learn-It on the PSNCR (Public Sector Net Cash Requirement) for much more detail.

Transfer payments

You may remember from your work on aggregate demand that government spending counts as an injection into the economy. But not all government spending is 'new' demand in the economy. Any benefit payments and state pensions are known as transfer payments. Although the spending of these benefits will boost the economy, the money raised to pay for these benefits was taken from a taxpayer elsewhere. These transfer payments are not included in the measure of 'G' used in the formula AD = C + I + G + X − M, otherwise they would be counted twice.

General government expenditure

This consists of all capital and current spending (see above). It also includes debt interest.

General government final consumption

This is the current expenditure of the government excluding transfer payments.

Many of the reasons are linked to taxation. The goal of redistributing income is achieved through taxation (particularly progressive income taxes) and government spending (through the payment of benefits to the poor). The same goes for demand management. In times of trouble, Keynesians believe in creating demand in the economy through reducing taxes and/or government spending.

In terms of market failure, government spending can help in terms of labour market failure. Grants can be paid to encourage firms to set up in places of high unemployment. Governments can spend money on training and housing to improve the occupational and geographical mobility of unemployed workers.

For most people, the main reason for government spending is to provide vital services that would otherwise be under consumed in the private sector. Public goods, like defence and the police force, must be provided by the government due to their non-excludability and non-diminishability characteristics. Merit goods, especially health and education, would be provided and consumed if left to private markets, but they would definitely be under consumed. After all, for many voters, the main issues at the time of a General Election (after the success of the economy) are health and education.

The pie chart below shows how the government is planning to spend its tax revenues over the tax year April 2000 to April 2001. Note that they plan to collect £377bn in taxation, so the difference (£6 billion) is know as the budget surplus or the Public Sector Debt Repayment (PSDR). They can use this excess to pay off some of the National Debt, and so reduce future debt interest payments.

Where is the money spent?

Note that all figures have been rounded to the nearest billion (!) and the percentages all represent the proportion of total government expenditure (£371 billion). The figures were adapted from the Guardian of the 22nd March 2000, the day after Gordon Brown announced these projections in the Budget.

The pie chart has been split into segments in order of size, starting at the top and going clockwise. Let's start with the biggest.

Social Security

This includes all benefits, like Jobseekers Allowance (the unemployment benefit), housing benefit and child benefit, to name but a few. By far the biggest element of this £103 billion, though, is the state pension. As this country gets older demographically, governments of all colours are going to have to find a way of cutting these payments without annoying pensioners (tax relief for private pensions?), otherwise this element of government spending could get out of hand. It will take at least a generation for any change to work through the system, and any policy is bound to be expensive in the short to medium term.

The NHS

The NHS

All spending on hospitals, both capital and current. Doctors and nurses salaries form a big part of this budget, as do drugs and new equipment. It should be noted that the government is trying to involve the private sector in the building and running of new hospitals. The government still provides the money, but the private sector (in theory) takes on all the short term risk.

Education

This includes any spending on schools (primary, junior and secondary), colleges and universities. Note that universities do look to the private sector nowadays for further finance since the amount that the government provides per student has fallen in real terms over the last couple of decades.

Debt interest

This is the interest that the government has to pay every year on the National Debt. Given that the UK's total debt is around £330 billion, you can see why this element of annual expenditure is the fourth largest.

The other expenditure areas

The other categories are fairly self-explanatory. The 'all other expenditure' category includes spending on the Common Agricultural Policy (CAP), payments to the European Union, the arts, foreign aid and the money provided to local government.

A historical perspective

At the turn of the century (1900, that is), general government expenditure as a percentage of Gross Domestic Product (GDP) was only about 10%. Now it is now around 40%. So what happened? There are two main reasons. Spending grew enormously during each of the World Wars (up to nearly 50% during the First World War and 60% in the Second World War). Although spending obviously reduced after each of the wars, there was a ratcheting effect, whereby the level of spending after each war was permanently higher than it was beforehand. This was partly due to the reconstruction required, particularly after the Second World War, but also due to the increased expectations in terms of provision of social services.

The second point looks more specifically at government provided services. The post-war Labour government was revolutionary in terms of creating the Welfare State. This was a disaster, though, in terms of government spending. Benefits, state pensions, the NHS and education were all expensive, and have a relatively high-income elasticity of demand. So as the economy grew (the economy's income), the demand for these services grew by a larger percentage. Efforts have been made to cut spending in the last two decades from the peak of 45%-50% of GDP in the 70s, but the cost of this prudence has been (some would say) declining standards of service. The NHS is no longer totally free and the waiting lists are long, university education is no longer free and spending on defence and housing has fallen dramatically.

A final point about the future; Demographically, every developed country in the world is getting older. At the moment, there are two working people for every non-working person (mainly the retired). In thirty years time there will only be 1.5 working people for each non-working person. This means fewer taxpayers relative to benefit receivers. Politicians should be debating these tough questions now: When is the state pension no longer affordable? Will the health service continue to be free at the point of use? Unfortunately, there are not many votes in discussing these realities.

International comparisons

In the previous Learn It, we discussed the fact that, contrary to popular belief, UK taxpayers are not really taxed that highly. Given that the money raised through taxation tends, over the long term, to roughly match the amount that governments spend, it should not be surprising to hear that the UK is also mid-table in the world-spending league.

Our spending levels as a percentage of GDP are consistently below the EU average and roughly in line with the world average (based on OECD - Organisation for Economic Cooperation and Development - countries). The USA is a low spender, with only just over 30% of GDP being spent by the government, and Sweden is an example of a high spending country, with nearly 60% of GDP devoted to government spending in 1998.

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