During the 2008-2009 Great Recession, many governments rushed to come up with monetary and fiscal policies that shield the economy from falling further. Such policies included lowering the interest rates and offering bonds for firms that were on the brink of collapse. Without these government interventions, it could be very hard for markets to hold in bad economic times. And hence, we can say that the state plays a crucial role in economic growth and development.
We are living in a world where natural resources are scarce, where the human needs that depend on them are unlimited. As such, it is only when we can find a system of sharing and allocating these resources effectively that we can have sustainable development. Traditionally, these were social and communal roles, but now the state has taken it over, in addition to their legislative and other roles. The government is the main aspect of the public sector, which ensures the proper allocation and distribution of public resources. Pay attention to institutions like schools, healthcare facilities, social welfare, and social security, and you will notice the main role of the state in the economic activities of a country.
And this is where public finance comes in – to study the financial planning of a government. Every government has to adopt a specific approach to increase its resources to meet its endless and increasing expenditure demands. For students of economics, public finance is one of the areas of study you need t focus your energy on. It will teach about the income and expenditure of public authorities in regard to the utilization of tax funds by providing public goods.
The government is mandated with ensuring the proper allocation of resources. It uses its authority for regulations and law to ensure that everyone follows a certain behaviour pattern for the good of everyone else. The economic theory highlights that humans are rational decisional makers who will choose something based on its highest benefits in their lives. Other consumer models like deontology and Kantianism suggest that people should always strive to do good, no matter the conditions. Every human being is related to one another, which creates the social foundation of modern economies. Consider markets; for instance, the relationship between consumers and suppliers is what keeps everything moving forward. Any changes from either side can have a great impact on the whole system.
Public finance is one of those ways through which the government ensures accountability for the resources they allocate. It has everything to do with public wealth and other aspects of economic development.
Understanding public finance
Public finance can be best understood as a subject of finance and economics. It aims to offer an insight into the role of the government in an economy. As stated above, the government is mandated with managing revenues, expenditure, and a debt load of a nation. Public and quasi-public organizations form parties that make these functions a possibility. Public finance is a subject that revolves around taxation effect, public expenditure and borrowing, and deficit financing within an economy. Both developed and developing economies are faced with the issues of overpopulation and scarcity of resources, which call for government interventions at any given time. Therefore, public finance enables the state to evaluate government expenditure and revenue, contributing to economic growth.
Three factors determine the scope of public finance, including:
– Allocation of resources
– Income distribution
– Macroeconomic stability
Management of public finance, its components, and its significance is among the aspects that make studying public finance more effective. Professor Otto Eckstein, a renowned economist, states that public finance is nothing but “a study revealing the effect of the budget on the growth, stability, equity and efficiency of an economy.
Components of Public finance
Public finance seeks to determine how taxes and other forms of public revenues are used in regard to the growth and development of an economy. It is founded on the following three components.
Economic efficiency
What is the value of certain resources to an economy, and how can they be used to meet the specific needs of a nation? Economists need to understand such information to come up with fiscal and monetary policies that take the economy forward. Economic efficiency is the standard they use to achieve this evaluation. Efficiency can be achieved using a general formula of ratios and their generated results. You need to understand the difference between technical efficiency and economic efficiency, which comes from the relationship of values people place on material possession. In technical efficiency, values may be subjective from individual to individual. What one person sees as most important in their life may not be the same way another person looks at the same thing. Economic efficiency seeks to get rid of waste, providing as much value as possible. Therefore, we can say that economic efficiency is a more collective term standing for what everyone else will find valuable. On the other hand, technical efficiency seeks to maximize value by sacrificing everything that is needed to create the best initiative.
Distribution of income
How much wealth and income does a nation have divided by its total population? This question is answered using income distribution. In this case, it is vital to understand the difference between wealth and income. Wealth is the physical possession a population has and their financial assets. It is what people see as tangible assets, which can be translated into financial benefits. Income is the net intake of a population exactly calculated over a specified period of time. Every government collects data and information on their subjects’ wealth and income, using it to answer a variety of political, social, and economic questions.
Understanding how much wealth people have is a standard measure for positive economic growth. It would be very hard to know where a nation is if it did not have such information. Political, social, and economic problems rely on this information as the foundation of making informed decisions.
Macroeconomic Stabilization
A country can grow economically by establishing trade partnerships and good relations with other states. This process is achieved through macroeconomic stabilization, which can be viewed as the process through which the stabilization and growth of an economy are monitored. The process applies fiscal and monetary policies, laws, and regulations. Achieving a stabilized macroeconomic environment opens doors to more investment opportunities, allowing many people to run their businesses effectively. It therefore acts are the foundation and pillar of economic growth. Without this, the economy is doomed to fail, and it will take a lot of effort to bring it back on track.
The government is expected to balance budgeting, domestic commerce, banking operations, international trade, and governing institutions. All these are factors that determine and contribute to economic growth and development. There is much need to manage the market, ensuring that interest rates, business cycles, and demand are steady within an economy. Only then can the ongoing macroeconomic stabilization and optimal levels of economic efficiency can be achieved.
Significance of public finance
Public finance is, without a doubt, a pillar of economic growth. With the increasing population and limited resources, there is a need for accountability in everything that is distributed or shared by the government. When citizens pay their taxes, they need to know that their money is being used for a good cause, and that is where public finance comes enters the picture. Even though it seems to lean more toward accountancy, public finance is majorly a subject of economic development.
Hence, the main role of public finance is accountability. When the Great Recession hit, policymakers came up quickly with policies to boost the economy, while economists built different models to explain what was happening and what could be done to reverse the situation. Everything that happened came down to reviewing certain actions that could improve the current situation. Above all, public finance was there to give a clear guideline on the resources needed and how they could be distributed.
Apart from this, public finance is also important in the following areas:
Constant economic growth
Economic growth is one of the main aims of any government. There is no economy that can be said to be fully developed, as even those seen as such keep growing. This means every economy is on a constant growth path, and they will keep going.
However, constant economic growth is something else. It cannot be assured because many unforeseen things happen just when the economy seems to be picking, returning it back low. However, this does not mean positive economic growth cannot be measured and assured. Besides, economic growth involves so much more than just wealth and income.
The government relies on taxes, public debt, expenditure, and many other similar aspects to ensure consistency. These tools are used whenever necessary to boost both the demand and supply of goods and services. Markets have to be monitored and regulated to ensure they don’t overuse the resources or overprice their goods. This is the role of the government and one of the factors that keeps a steady rise in the economy. Even with economic shocks, it is much easier to rise from a fall where public finance is well maintained than the opposite.
Pricing
Inflation and deflation are among the biggest threats to economic growth and development. When the prices of goods are too high, there is a low demand, which means household expenditure goes down. Data has shown that household consumption is a key determinant of any nation’s GDP. Hence, it is crucial to keep it on the high side.
Public finance has been used effectively as an essential tool the government uses to overcome these challenges. When there is inflation, it minimizes the indirect taxes and expenditures while maximizing direct tax and capital expenditure. Doing this creates a good balance between what is coming in and what is going out in the national treasury. This policy is reversed in the case of deflation.
A balance in the Economy
Economic balance is crucial in maintaining a certain status of a given nation. For this to happen, there is a need to maintain financial stability, where proper utilization of fiscal tools is among the most popular steps many governments take. It is common for the government to levy a high tax to raise the internal public debt used in repaying foreign debt. This procedure is reversed when there is a recession when taxes are lowered, and the interest rates. Every step is taken according to the current situation’s demands, ensuring there is a balance in the economy.
Distribution of resources
Even distribution of public resources is a necessary step in ensuring all people are satisfied. The limited resources we have may not be enough for everyone to get as they desire, which is why it’s important to have a system of ensuring there is at least something for everyone. Revenue and expenditure are the most common tools governments use to reduce disparity in an economy. When there is a high discrepancy, the government is sure to levy high taxes on income and valuable assets from wealthy people. The capital raised from this is used to support disabled people living in that economy. The government may use various schemes, including subsidies, allowances, and different benefits, to achieve this goal.
Proportional development
When the economy begins to outgrow, the government must wipe out the gap between the agricultural and industrial sectors. These are the two main sectors that ensure proper economic growth and development. Their role is, without a doubt, something to admire, and they have to be well-balanced. The government must ensure resources are distributed in a balance through these sectors enabling sustainable growth and development. The government may be required to direct funds towards the personal interest of people living in rural areas where a lot of farming takes place.
Evolution of infostructure
The government generates revenues through taxation and other means, which are invested in the planning and development of the evolving infrastructure. Hence, there are balanced socio-economic reforms and infrastructural growth. The government needs revenues and expenditure for this.
Apart from it being an important subject of study in modern economics, public finance serves a great purpose in any economy. As we have seen through its significance, students can use their knowledge to create a better environment for growth and development.