Last Updated 02 Apr 2020

How Effective Would an Increase in Government Spending Be at Promoting Economic Growth?

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How effective would an increase in government spending be at promoting economic growth? Economic growth is best defined as a long-term expansion of the productive potential of the economy. Sustained economic growth should lead higher real living standards and rising employment. Short term growth is measured by the annual % change in real GDP. Government spending is a way of increasing aggregate demand, and if successful can help boost economic growth. Government spending tends to be directed at infrastructure and maintenance, as this not only creates jobs but creates a valuable asset. (AD DIAGRAM) (AS DIAGRAM) DESCRIPTION) Some government spending is necessary for economic growth as if it were zero, enforcing contracts, protecting property and developing infrastructure would be extremely difficult. Another way of putting this is that some government spending is necessary for successfully enforcing the law. There are of course costs to increasing government spending, but there are also many benefits. One cost is that for governments to spend money, they must first take it from someone. This is commonly achieved through taxation, which discourages productive behaviour. A balance must also be made when increasing tax.

This is because an increase in tax means that businesses must either charge more or make smaller profits, so inflation will occur at an increased rate as a by product. Borrowing money is another option, but brings with it interest rates and this money must be paid back. Government spending also has the effect of displacing private-sector activity. Every pound sterling the government spends effectively means one less pound in the productive sector of the economy. There are some ways government spending can have a high rate of return, such as the maintenance of a well-functioning legal system.

Unforunately governments tend not to use resources efficiently. Destructive choices are often made as a result of government spending, often through subsidising economically undesirable programs. Examples of this welfare programs that encourage people not to work, as they prefer not to take the risk of being unable to find a better job, and would rather choose leisure over work. Flood insurance programs encourage construction on flood plains. Government programs likes this reduce economic growth and national output because they promote underutilisation and misallocation of national resources.

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One could argue that government programs that subsidise retirement and housing are bad for the economy as a person will feel that there is not need to set aside income if there are government programs that will finance these for them. Goverment spending also reduces competition. Those working in the private sector are constantly searching for ways to improve their products and reduce the cost in order to stand out from the rest, and this provides competition for others attempting to do the same, and this is a large contributor to innovation.

However government programs are often provided for free, or are subsidised to a certain extent, so reduce the need for competition. This does not mean that there are no positives to increased government spending. If government spending increases there can be many ancillary effects. For example, if a government were to invest in infrastructure jobs would be created in the construction of this building, and then this could be bought for (as an example) office space which would create more jobs as people would need to work in this office.

With these people having jobs they would then inject more money themselves in to the economy through increased consumption. Maintenance is also necessary and increased spending on the matter can have positive effects, such as a rise in value of the area. If an area is left unmaintained the value will quickly depreciate and will negatively affect both those who work in the area, and those who live there. Low value areas often attract crime, which can be a threat to companies and people.

Increasing government spending on education that means that better quality education can be provided to those who can't afford private education and can only be a positive for the future. If more of us are educated well then the opportunity for a successful career increase, although it does not mean that one WILL have a successful career. However by better educating people we can increase the likelihood of long term economic growth for a country.

This will be because better educated people will make better economic choices and have larger positive effects (better paid jobs mean more disposable income to flow back in to the economy, and more tax paid etc). Increases in government spending affects the aggregate demane, and these policies are known as "expansionary fiscal policy". Expansionary fiscal policy is unlikely to affect the long term growth rate of an economy; but it likely to (in the short term) increase aggregate demand, leading to a higher output. Unfortunately there is the side effect of increasing inflation growth rates as well.

The Keynesian view states that the effectiveness of fiscal policy depends upon how close the economy is to full employment. Below a certain point, expansionary fiscal policy will increase output and reduce unemployment without increasing inflation, but as this continues it will eventually increase both output and inflation. At the point of full employment, the Keynesian view states that expasionary fiscal policy will result only in inflation. Many people would argue that the UK cannot afford to increase government spending as taxes are already very high for most people, and we simply can't afford to increase public debt.

If we are to agree that increased government spending will not in the long term boost the economy, then one might argue that our efforts might be directed elsewhere. On the other hand, if we are to follow the Keynesian view we might agree that an increase in fiscal policy might be what we need. Currently unemployment rates are very high in much of the western world, and this would be at the early stages of the model. By increasing fiscal policy we could increase output and reduce employment with little to no inflation. If money were to be invested by the government into our economy there is the possibility that it could go wrong.

This could boil down either to poor handling of the money by the government, or by a negative reaction or both. If the money is spent where it is not needed, such as subsidising the low-end manufacturing industry we could see no increase in real output, as we are no longer able to compete with other parts of the world. However if the money was invested wisely, such as in high-end manufacturing and high-end services, we could see a real benefit. As was mentioned previously, there could be a lack of sufficient reaction to government spending to make it worthwhile.

For example if infrastructure is built, but then nobody purchases it (e. g. it's in an undesirable area or companies can't afford the extra space/manpower). To conclude I think an increase in government spending could be successful at promoting economic growth, although this is likely to only be in the short term. However what is most important is that the money is spent wisely, where it is most needed and can be most beneficial. Too often governmental spending is inefficient (such as the subsidy of food production which led to a food surplus which was donated to Africa, meaning money was wasted).

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