When we come to the function of public expenditure, it is evident that it depends overwhelmingly on the structure of public grants that prevails, both in the fiscal system, on the one hand, and in public spending, on the other. These, in turn, depend on the political spirit of the community, as well as on its official political philosophy.
In the 20th century, there has been a strong tendency for the public sector of the economy to expand greatly in virtually all societies. This may perhaps be explained in part as a “superior good” phenomenon, under the assumption that public goods provided by the state are, to some extent, “luxuries” that are in greater demand at higher income levels.
But this view may be overly simplified, since different parts of the public sector obey different principles. National defense, for example, which is essentially part of the economy of public grants, depends on the dynamics of the international system, which obeys a set of principles of its own, with important random elements.
There is some evidence that, within alliances, the expenditures of different countries on national defense follow the general law of public goods. The rich will provide more than the poor, and the strong more than the weak. In any case, the proportion of output devoted to national defense depends only marginally on domestic considerations and is governed largely by perceptions of an international system that is relatively independent of the domestic economy.
This phenomenon is especially striking in the United States, where the proportion of gross national product devoted to national defense has varied from less than 1 percent to 42 percent during the last forty years, and these variations have been hardly related to, or motivated by, anything occurring in the domestic economy.
Civil government expenditures are, of course, more closely related to domestic events, but again in ways that generally reflect “political reality” more than economic reality. The growth of the welfare state in virtually every part of the world, and the increase in public spending on social services and income redistribution, reflect changes in political philosophy more than pressures arising directly from the economy.
The only form of public expenditure that is closely related to events in the economy is countercyclical spending, carried out in response to the development of unemployment or inflation.
Perhaps the most significant element of the economy of public grants is the budget deficit or surplus, rather than total public expenditure. If the state has a deficit, this represents a direct one-way transfer of money from the state to its people, and a direct increase in the liquid assets of private individuals and organizations by approximately the same amount as the deficit.
That is, if the state takes in 100,000,000 dollars during a given period and pays out 110,000,000 dollars, there will be 10,000,000 dollars more in the money stock held by the private sector, provided there is no creation or destruction of money elsewhere in the system.
Another impact of the state is felt through the division of its total payments into grants, or simple transfers, and purchases. For example, in 1970, in the United States, public-sector purchases represented approximately 22 percent of gross national product, while total public-sector payments amounted to more than 29 percent. The difference consists of direct grants from the state to the private sector.
The G in equation 3d represents public-sector purchases, that is, the absorption of output by the state. Public-sector transfers do not appear explicitly in these equations, but they will have a profound effect on both the consumption function and the investment function, 3b or 3c, and will therefore have an important indirect effect on the equilibrium position of the national income system.
The final question is whether the grants element of the economy, once explicitly recognized, can shed any light on the two unresolved problems of the exchange economy mentioned earlier. Much more work is needed before a definitive answer can be given to this question. Nevertheless, a tentative answer may be possible here.
We observe a given set of money prices and wages and first ask: what kind of tensions does this set create within the system? First, it creates what might be called “terms-of-trade tensions.” With any given system of money prices and wages, some people will feel very dissatisfied, some moderately dissatisfied and some satisfied with their existing terms of trade; that is, with what they receive per unit of what they give.
Of course, the terms of trade of each individual, sector and organization depend on the total set of money prices and wages. The magnitude of the tension may depend on the history of the system. Awareness of declining terms of trade is likely to produce greater tension than constant or improving terms of trade.
Consequently, pressures for change will tend to arise from those people and sectors of society that are aware of an unsatisfactory or declining terms-of-trade relationship, or both.
