This is another piece of educational content on my blog. Whilst I am preparing the manuscript of my book on technological change and renewable energies, my classes are going at their ordinary pace, and so I came to the moment of discussing fiscal policy with my 3rd year Undergraduate students. Thus, here are a few introductory notes to that general topic. As most of you can easily notice, governments have capital. I deliberately use the term ‘capital’ and not ‘money’, as my students have already worked through the fundamentals of monetary policy and they know (I hope) the distinction between money and capital. The scientific way of investigating the phenomenon of a government being able to afford an army consists in asking ‘How do governments have capital?’. The first and most inductive answer to that is: governments have capital in very idiosyncratic, strongly local ways. You can see that your government has capital, when said government spends money, i.e. when it pays wages to its employees and when it buys things. When a road is being built in your neighbourhood, this is your government buying construction output from companies specialized in that sort of heavy stuff. When you pay that delightful visit to your local tax authority, and you explain why you didn’t declare the income from that oil field in Turkmenistan into your annual Personal Income Tax (PIT for friends) statement, it is your government buying the qualified labour of the tax inspector sitting on the other side of the desk, and his or her labour is being purchased in order to extract taxes from your pocket, and those taxes will serve to pay their salary etc. Logical? What? Not quite logical? Well, here you have one of those apparently closed loops in the economic system. There are lots of them, don’t worry.
Anyway, you can know a government by its expenditures, and this is the nominator I used in that Excel file. I put this nominator (the expenditures of the central government) over two distinct denominators in order to understand its relative magnitude. I have prepared, on the grounds of my own, compound database, made of Penn Tables 9.0 (Feenstra et al. 2015), enriched with data from the World Bank, a selective comparison of countries, regarding the share of expenditures, made annually by their central governments, in the stock of fixed capital available in the national economy (machines, buildings etc.), as well as in the stock of money being supplied to said economy, and all that in 2014. Click this link to access the corresponding Excel file. As you do so (cmon, click!), you can see, for example, the central government of Switzerland (the Swiss are a federation, keep that in mind, this is just the central government, not the cantons), with its expenditures making 1,9% of the local stock of fixed capital and just 4% of the money supply. You move up in the ranking, like to France, and you have the French government with its annual expenditures that make 4,9% of the available fixed capital and 16,5% of the national money supply. You move really up the scale, and you get to Armenia, and here, brothers and sisters, you have a nice piece of a government. Its expenditures make 13,2% of the national stock of fixed capital, and 64,8% in the supply of money. You can also use another denominator to measure the relative importance of public expenditures: the Gross Domestic Product. You can find this proportion in different countries by clicking here. Once again, you can see strong differentiation across countries. The first piece of science we have, thus, about the topic of fiscal policy, is that national governments form local, strongly idiosyncratic, institutional environments for the appropriation of capital.
As we have quickly overviewed differences across space, let’s do the same over time. By clicking this particular link you will open an Excel file, which shows the share of the expenditures, made annually by the central, federal government of the United States of America, denominated over three different aggregates: GDP, supply of money, and the stock of fixed capital. You can observe that the latter, namely the share of government spending in the capital stock, changes very little over time. The one in the middle – the proportion between annual expenditures of the central government and the supply of money – varies a little bit more. It is the first column, the share of government spending in the Gross Domestic Product, which displays the greater variance over time. Yet, as I repeat the same analytical procedure in the case of Uganda (you know, click), we can see that, obviously, all countries are not like United States. In Uganda, the share of government spending in the GDP looks quite steady over time, whilst the proportions between said spending and both fixed capital, and money supply, tend to swing wildly. Here, we have the second piece of science: the local, national mechanisms of appropriating capital, on the part of the government, can take the form of participating rather in the current output of the economy (case United States), or, on the other hand, the form of tapping directly into the assets of the economic system (case Uganda). A government can behave like a steady rentier, just sipping the cream from over the milk of current output in the economy, or like an aggressive investor, who comes and goes in the balance sheet of the productive sector.
Now, as we know the possible changes over time and differences between countries, let’s focus on the process of appropriating capital in the government. You can go to the website of the International Monetary Fund and there you can look for the title ‘World Economic Outlook’ . After you have localised it, you can download the latest version of the database, which accompanies that report. As you open the database, you can see each country described with truly broad a range of metrics, and, among them, you can see those:
- General government revenue, consisting of taxes, social contributions, grants receivable, and other revenue. It is being assumed that a financial inflow to the government is really revenue, when it increases the government’s net worth, which is the difference between its assets and liabilities.
- General government total expenditure, which corresponds to the total expense and the net acquisition of nonfinancial assets.
- General government net lending/borrowing, which is simply revenue minus total expenditure. This metric says that the government can either put financial resources at the disposal of other sectors in the economy and non-residents (net lending), or utilize the financial resources generated by other sectors and non-residents (net borrowing).
- General government primary net lending/borrowing Primary net lending/borrowing is net lending (+)/borrowing (?) plus net interest payable/paid (interest expense minus interest revenue).
- General government structural balance, which refers to the general government cyclically adjusted balance. In other words, we can statistically distinguish, in the net lending or borrowing of the government, a slice corresponding to the impact of cyclical phenomena, mostly inflation and real economic growth, although unemployment has two words to say as well.
- General government gross debt, which covers all liabilities of the public sector, which require payment or payments of interest and/or principal by the debtor to the creditor at a date or dates in the future.
- General government net debt, calculated as gross debt minus financial assets corresponding to debt instruments.
So far, I have used the metrics pertaining to central governments. At the International Monetary Fund, they use aggregates corresponding to general governments. Political systems host many distinct pockets of political power, and said pockets can be found in many places outside the central government. You have local governments (like cantons in Switzerland or states in the US), you have peripheral agencies (Finland or Israel have a cartload of these), and you have public funds, like the really big Social Security Fund in Poland. In any country, any government is a heterogeneous structure, which combines four types of fiscal entities, namely: budgetary units, executive agencies, targeted funds, and public-private partnerships. Budgetary units are the building blocks of the strictly spoken administrative structure in the public sector. They are fully financed through the current budget of the government, and fully accountable within one fiscal year. If they have any freedom in spending cash, this freedom is of short range. Public executive agencies follow specific missions ascribed by specific laws distinct from the budget, and from the regulations of fiscal governance. These laws form the legal basis of their existence. The mission of executive agencies usually consists in carrying out long-term tasks connected to large non-wage expenditures, e.g. the distribution of targeted subsidies, or the maintenance of strategic reserves. Executive agencies have more fiscal autonomy than budgetary units: they usually govern some kind of circulating capital untrusted with them by the government. Whilst they receive subsidies from the current budget, they usually do not make the full financial basis of their expenditures. In the same manner, they can retain their current financial surpluses over many fiscal years. The financial link of executive agencies with the current fiscal flows is fluid and changing from one budgetary cycle to another. Targeted public funds are separate public entities in charge of managing specific masses of capital paired with specific public missions to carry out. Just as executive agencies, targeted funds have a separate legal basis of their own. Their specificity consists in quite a strict distinction in their accounts: all the current costs of governance should be covered out of the financial rent of the capital managed, and the possible budgetary subsidies should serve only to back up the financial disbursements directly linked to the mission of the given fund. The distinction between executive agencies and targeted funds may be fluid: some agencies are de facto funds, and some funds are actually agencies. Public-private partnerships are joint ventures, through which private agents are commissioned to carry out specific public missions, in exchange of subsidies, direct payments or specific rights. One of the most obvious examples are contract-based healthcare systems, in which private providers of healthcare services are commissioned to fulfil the constitutional mission of the state to provide for citizens’ health. More subtle schemes are possible, of course. Private agents may provide, with their own financial means, for the creation of some infrastructure commissioned by the government, and their payment is the right to exploit said infrastructure.
The point of all that structural specification is to demonstrate that the broad category of fiscal flows that we use to call “public expenditures” is actually a financial compound. It covers both the expenditures strictly spoken (i.e. current payments for goods and services), and capital outlays that accrue to many different pockets of capital appropriated by public agents in many different ways. Capital accruals have different cycles, ranging from the ultra-short (days or weeks) cycle of consolidated accounting in budgetary units, passing through the mid-range cycle of appropriation in executive agencies and public-private partnerships, up to the frequently many-decade long cycle of capital appropriation in targeted public funds. Each of those pockets of capital makes a unit of economic power, in the hands of some public agents. Each accrual to or from such a capital pocket means a shift up or down in the actual economic power of those agents. Thus, it can be argued that the total stream of financial inflows to public treasury, through current revenues and current borrowing, is congruent with the sum of the strictly spoken public expenditures, and capital accruals in the public sector. Each such accrual corresponds to a pocket of political power in the structure of government.
 Feenstra, Robert C., Robert Inklaar and Marcel P. Timmer (2015), “The Next Generation of the Penn World Table” American Economic Review, 105(10), 3150-3182, available for download at http://www.ggdc.net/pwt