PUBLIC ECONOMICS Manuela Samek Lodovici LIUC msamekirsonline it

PUBLIC ECONOMICS Manuela Samek Lodovici – LIUC (msamek@irsonline. it) James Wickham – Trinity College Dublin

Aim of the course To examine the role of the public sector in modern economies n To provide an understanding of the economic rationale for government intervention, n To discuss the effects of government’s actions in terms of efficiency and equity n

Course outline The course is organised into the following units: 1 - An introduction to public economics: the economic roles of government, the rationale and limits of public intervention according to economic theory, its effects in relation to efficiency and equity trade offs; 2 - Public expenditures: basic theory and application to some expenditure programmes, i. e. welfare policies, education policies, employment policies, health care policies; 3 - Taxation: microeconomic and redistributive effects of fiscal policy and of the structure of taxation. 4 – Welfare states and inequalities (Prof. Wickham) References: n Lecture Slides n Textbooks on Public Economics : Ø E. Stiglitz, Economics of the public sector, W. W. Norton & Company, 3 rd edition, 2000, chapters 3, 4, 5, 6, 7, 8, 9, 10, 14, 15, 16, 17, 19, 20, 26; or Ø J. Gruber, Public Finance and Public Policy, 2007. Chapters 2, 5, 6, 7, 11, 12, 13, 14, 17, 18, 19, 20 Ø in alternative other textbooks in the library , such as A. L. Hillman, Public Finance and Public Policy, Cambridge, 2003. n Optional readings will be mentioned in the course Examination 2 hours written examination at the end of the course; optional: short paper (4 -5 pages) and eventual oral presentation on one/two articles (+ 0 -2 points on the grade of the written exam). The list of articles will be available by early November, short papers to be handed in by December 21.

1. Introduction to public economics n Ø Ø Public intervention is widespread and largely influence our daily life: The government provides goods and services (health, assistance, education, defence, environment, infrastructures, etc. ), it defines the rules for socio economic behaviour (legal structure and property rights, environmental regulation and protection of natural resources, safety regulations, employment regulations, etc. ) it ensures a stable economic environment; it finances its activities with taxation and this affects the agents’ decisions on labour demand supply and on consumption.

The ratio public Deficit/GDP in the EU = (TOTAL REVENUES – TOTAL EXPENDITURES)/GDP Source: EC and Eurostat 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Austria -4. 2 -4. 9 -5. 6 -3. 9 -1. 8 -2. 3 -2. 2 -1. 5 0. 3 -0. 2 -1. 1 -1. 3 Belgium -7. 3 -5. 0 -4. 3 -3. 8 -2. 0 -0. 7 -0. 4 0. 2 0. 6 0. 1 0. 4 0. 1 Germany -3. 1 -2. 4 -3. 3 -3. 4 -2. 7 -2. 2 -1. 5 1. 3 -2. 8 -3. 7 -3. 8 -3. 7 Greece -13. 4 -9. 4 -10. 2 -7. 4 -4. 0 -2. 5 -1. 8 -4. 1 -3. 6 -4. 1 -5. 2 -6. 1 Finland -7. 3 -5. 7 -3. 2 -1. 5 2. 2 7. 1 5. 2 4. 3 2. 5 2. 1 France -6. 0 -5. 5 -4. 1 -3. 0 -2. 7 -1. 8 -1. 4 -1. 5 -3. 2 -4. 2 -3. 7 Ireland -2. 7 -2. 0 -2. 1 -0. 1 1. 1 2. 4 4. 4 0. 9 -0. 4 0. 2 1. 3 Italy* 10. 3 -9. 3 -7. 6 -7. 1 -2. 7 -2. 8 -1. 7 -0. 8 -3. 1 -2. 9 -3. 4 Luxembourg 1. 5 2. 7 2. 1 1. 9 3. 2 3. 7 6. 0 6. 2 2. 3 0. 5 -1. 1 Netherlands -2. 8 -3. 5 -4. 2 -1. 8 -1. 1 -0. 8 0. 7 2. 2 -0. 1 -1. 9 -3. 2 -2. 5 Portugal -8. 9 -6. 6 -4. 5 -4. 0 -3. 0 -2. 6 -2. 8 -4. 4 -2. 7 -2. 9 Spain : : : -4. 9 -3. 2 -3. 0 -1. 2 -0. 9 -0. 5 -0. 3 Euro-zone (12 countries) : : : -4. 3 -2. 6 -2. 2 -1. 3 0. 1 -1. 7 -2. 4 -2. 8 -2. 7 -4. 9 -3. 6 -3. 1 -2. 2 -0. 8 0. 4 0. 9 1. 6 -0. 4 -3. 8 -4. 6 -4. 4 United States

2) Ratio Public Debt/GDP 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Austria 60. 5 63. 4 67. 9 67. 6 63. 8 64. 2 66. 5 67. 0 67. 1 66. 7 65. 4 65. 2 Belgium 137. 9 135. 9 134 130. 2 124. 8 119. 6 114. 8 109. 1 108 105. 4 100 95. 6 Finland 55. 9 58 57. 1 54. 1 48. 6 47 44. 6 43. 8 42. 5 45. 3 45. 1 France 45. 3 48. 4 54. 6 57. 1 59. 3 59. 5 58. 5 56. 8 57 59 63. 9 65. 6 Germany 46. 9 49. 3 57 59. 8 61 60. 9 61. 2 60. 2 59. 4 60. 9 64. 2 66 Greece 110. 1 107. 9 108. 7 111. 3 108. 2 105. 8 105. 2 114. 0 114. 8 112. 2 109. 3 110. 5 Ireland 95. 1 89. 6 81. 8 73. 3 64. 5 53. 8 48. 6 38. 3 35. 8 32. 6 32 29. 9 Italy 118. 7 124. 8 124. 3 123. 1 120. 5 116. 7 115. 5 111. 2 110. 7 108 106. 6 Luxembou rg 6. 8 6. 3 6. 7 7. 2 6. 8 6. 3 5. 9 5. 5 7. 2 7. 5 7. 1 7. 5 Netherlan ds 79. 3 76. 4 77. 2 75. 2 69. 9 66. 8 63. 1 55. 9 52. 6 54. 3 55. 7 Portugal 59. 1 62. 1 64. 3 62. 9 59. 1 55 54. 3 53. 3 55. 9 58. 5 60. 1 61. 9 Spain 58. 4 61. 1 63. 9 68. 1 66. 6 64. 6 63. 1 61. 1 57. 8 55 51. 4 48. 9 Euro-zone (12 countries) 66. 2 68. 9 73. 6 75. 2 74. 9 74. 2 72. 7 70. 4 69. 6 69. 5 70. 8 71. 3 United States 75. 4 74. 6 74. 2 73. 4 70. 9 67. 7 64. 1 58. 2 57. 9 60. 2 62. 5 63. 4 Japan 74. 9 79. 7 87. 1 93. 9 100. 3 112. 2 125. 7 134. 1 142. 3 149. 5 157. 6 164

Fundamentals of public economics n Public economics studies: the role of the government in market economies, the rationale of its intervention and the economic and social effects in terms of the efficiency and equity trade offs. n MAIN QUESTIONS: Ø When should the government intervene in the economy (should the government intervene more or less than it does? ) How might the government intervene (should it intervene differently? ) What are the effects of public intervention? How social choices are made? Ø Ø Ø

When should the government intervene in the economy? Roles and instruments of Government intervention n Ø Ø Ø q The public sector has different roles in market economies: Allocation of resources (efficiency goal) Income (re)Distribution (equity goal) Stabilisation fo the economic cycle these roles interact with each other

When and how to intervene/1 Allocation role (efficiency) n Ø Ø Ø The ALLOCATION ROLE is to provide efficiently (increasing the size of the pie) goods and services when the market is not able to produce them efficiently (market failures) through: The production of public goods or the public financing of private provision: i. e. all those goods and services which are not produced (or would be produced inefficiently) by the market, due to market failures; The regulation of market activities to support market competition (property rights, legal system, restrictions ) Taxes and subsidies which change the market price of goods/services

When and how to intervene/2 Redistributive role n Ø Ø Ø The aim is to foster equity correcting the distribution of resources resulting from market mechanisms by shifting resources from some groups in society to others and/or by changing initial endowments through: Monetary transfers (such as welfare benefits to support the income of the poor or the unemployed) Transfers in kind (provisions of public services such as education, health services, social services) Taxes/subsidies (for example with progressive taxation or exemptions)

When and how to intervene/3 Stabilisation role n Ø Ø Smoothing over the business cycle and external shocks, supporting full employment and controlling inflation through: Fiscal policy (transfers and taxation, automatic stabilizers, public expenditures) Support to productive activities

What are the effects of government intervention: The analysis of government failures v v Ø Ø Behind public intervention in modern market economies is the need to correct actual or perceived market failures (efficiency goal) and to ensure and equitable distribution of resources (equity goal) However government intervention may also produce negative direct and/or indirect effects (government failures) due to: Limited information Limited control on private markets responses to public intervention Limited control over the public bureaucracy Limitations imposed by the political process

What are the effects of public intervention n Need to consider direct and indirect effects of public intervention on individuals and markets: Ø Direct effects are those expected assuming that the behaviour of economic agents do not change as a consequence of government intervention Ø Indirect effects are those that arise because agents change their behaviour in response of the intervention (for example increasing taxation may reduce labour supply) § Difficult to measure impacts and especially to establish causation (see Gruber ch. 3 if interested)

How decisions are taken? The analysis of social choices n n n Political economy studies how the political decision making process produces decisions that affect individuals and the economy This part of public economics analyses how socially desiderable goals are chosen Socially desiderable goals relate to: - the capacity to support socio-economic growth - the capacity to guarantee adequate living conditions to citizens - the capacity to guarantee equality in opportunities for all

Key economic questions in public economics q Ø Ø Efficiency: What is produced, how it is produced and how much it is produced (public vs private goods/services): given available resources make the pie as large as possible Equity For whom it should be produced and who should pay for it: distribute the pie in the most equitable way How are decisions taken? Trade offs: an efficient outcome could be not equitable an equitable outcome could be inefficient

Theoretical tools needed for Public Economics (Stiglitz ch. 3, 5; Gruber ch. 2) n Consumer theory (constrained utility maximization) n Production theory n Equilibrium and social welfare theory