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9. ANALYSIS OF PUBLIC EXPENDITURE POLICY 9. ANALYSIS OF PUBLIC EXPENDITURE POLICY

9. 1. Introduction v. Government’s programs are often criticized : Ø Inefficient Ø Mis-targetting 9. 1. Introduction v. Government’s programs are often criticized : Ø Inefficient Ø Mis-targetting Ø Widen income gap between social classes Ø etc v. But, critics are often made without scientific foundation (common sense) v. Scientific framework is important to understand the complexity of government’s program to make critics scientifically acceptable

9. 2. Ten Steps in Analyzing Public Expenditure Policy 1. Identify underlying causes of 9. 2. Ten Steps in Analyzing Public Expenditure Policy 1. Identify underlying causes of government’s intervention 3. Alternative forms of intervention 2. Identify market failures made to justify the intervention 4. Importance of attention on problem of eligibility 5. Respond from private sector 6. Efficiency consequence of the intervention 7. Distributional consequence of the intervention 8. ”Equity-efficiency trade off” 9. Objectives of the public policy 10. Political process underlying the intervention

9. 3. Identify Underlying Causes of the Intervention q. Question as to why the 9. 3. Identify Underlying Causes of the Intervention q. Question as to why the program is needed and who that propose the program? q. For instance , subsidized-rice –for poor program (raskin program) v Monetary crisis unemployment and poverty v Fear of occurrence of lost generation due to hunger implement program that deliver sum amount of subsidized rice monthly to poor family to help them maintain food intake

9. 2. Identify Market Failures Used to Justify the Intervention 9. 2. Identify Market Failures Used to Justify the Intervention

q. Market failures as justification for the government to intervene the economy q Market q. Market failures as justification for the government to intervene the economy q Market failures may relate to inefficiency (imperfect competition, public goods, externality, incomplete market, imperfect information), and injustice (income distribution) and inaccurate welfare judgments by individuals (merit goods or merit bads)

q But, economists are always in agreement about the extent market failures v. Example q But, economists are always in agreement about the extent market failures v. Example Ø Education public goods or private goods? v. Some view it as private goods so that involvement of the government in provision of it must be justified by other arguments beyond market failures

q. Demand of local community for provision of a goods by the government does q. Demand of local community for provision of a goods by the government does not in itself mean the presence of market failures q Demand may emerge as consequence of misunderstood about the market or inability of the government to make market work well q. Therefore, identification of existence of market failures is a crucial step to indentify appropriate scope for the government to intervene

9. 3. Alternative Forms of Intervention 9. 3. Alternative Forms of Intervention

q If market failures have been indentified, there are three possible actions that the q If market failures have been indentified, there are three possible actions that the government can do: v Direct production by the government v Production by private firms with tax or subsidy with the intention to restraint or encourage certain activities v Production by private firms supported by regulation to ensure the firms operate in line with the community’s needs

q. If the government decides to produce by itself, it must be decided how q. If the government decides to produce by itself, it must be decided how to allocate the product to the targeted groups q Three possible ways of distribution: v. Distribution by free of charge v. Distribution at price below cost of production v. Distribution at price equal to cost of production

q If production is by private firms, the government must decide whether: v. Contract q If production is by private firms, the government must decide whether: v. Contract is only for production, while distribution by the government v. Provide subsidy to producers, with the hope they will sold their products at cheaper price to consumers v. Provide subsidy directly to consumers

9. 4. Importance of Attention on Problem of Eligibility 9. 4. Importance of Attention on Problem of Eligibility

q Observe about Raskin Program in Indonesia Who are eligible for Raskin? Need a q Observe about Raskin Program in Indonesia Who are eligible for Raskin? Need a set of criteria to select which families are eligible for Raskin. Criteria can be loose or tight

q If criteria are loose, consequently: ØOnes actually not eligible become involved in enjoying q If criteria are loose, consequently: ØOnes actually not eligible become involved in enjoying Raskin ØWasting public resources q If criteria are tight, consequently: ØOnes actually eligible become not involved in enjoying Raskin ØSaving public resources

9. 5. Respond of Private Sector q Effectiveness of government intervention depends on respond 9. 5. Respond of Private Sector q Effectiveness of government intervention depends on respond from private sector q. Suppose, the government provides BLT to poor families to improve their welfare q. Succeed ? v. If traders increase prices of necessities whenever the poor receive BLT, the intervention will not be effective to reach its objective

9. 6. Efficiency Consequence of the Intervention q For variety of programs, it is 9. 6. Efficiency Consequence of the Intervention q For variety of programs, it is important to distinguish between substitution effect (ES) and income effect (IE) q. Grant IE v See Picture 1 q. Grant ES v Picture 2

Picture 1: EP of Grant to Buy Food for Poor People Ordinary Food Budget Picture 1: EP of Grant to Buy Food for Poor People Ordinary Food Budget line without grant q Both OF and SF increase with the provision of grant Budget line with grant Indif. Curve With grant Indif Curve without grant Staple Food

Picture 2: ES of Subsidized Price Food For Poor People Ordinary Food q OF Picture 2: ES of Subsidized Price Food For Poor People Ordinary Food q OF decline, while SF increase With subsidy Budget line with subsidy Indif Curve without subsidy Indif Curve with subsidy Budget line without subsidy Staple Food

q. Picture 3: Inefficiency due to Food Subsidy Ordinary Food Indifferent Curve B H q. Picture 3: Inefficiency due to Food Subsidy Ordinary Food Indifferent Curve B H E G K F q Initially, consumer’s satisfaction at H and E q If subsidy, consumer will buy E q If grant, Consumer will buy H q It means, for the government is better to give grant than subsidy, since it save budget as high as EG qthus, Subsidy is not efficient A B B” B’ Staple Food

9. 7. Distributional Consequence of the Intervention 9. 7. Distributional Consequence of the Intervention

q It is not always clear who will benefit from government intervention. It is q It is not always clear who will benefit from government intervention. It is possible that benefits are enjoyed by ones that are out of the targeted group. q Observe, for instance, policy that provide subsidized credit to buy house for poor families: ØSubsidized credit demand for house increase Ø Increase in demand price of house increases too Ø Thus, benefit of the credit is enjoyed not by the poor, but developer of houses

q Policy that is intended to help the poor may actually draw them into q Policy that is intended to help the poor may actually draw them into difficulty q. Suppose, the government press land rent down in attempt to make poor farmers who rent in farmland able to improve their family income: Ø As a consequence of declining land rent, farmland for rent declines. Now, landlords prefer to operate their own land with the assistance of hired labor Ø As consequence, it becomes more difficult poor farmers to obtain land to rent in. Accordingly, their income decline as the size of land that they rent declines.

9. 8. ”Equity-Efficiency Trade Off” 9. 8. ”Equity-Efficiency Trade Off”

q This issue is classic one in developing countries, such as Indonesia. q. For q This issue is classic one in developing countries, such as Indonesia. q. For example, use of hand tractors for land preparation of paddy field increases efficiency paddy farms. However, this has been at the cost of decline in income of poor laborers: Ø Tractors replace labor service of the poor workers Ø Landlords become richer as their farm become more efficient Ø But, tractors increase difficulty faced by poor laborers to obtain labor employment. Ø Thus, tractors promote efficiency at the cost of equity

q Provision BLT, Raskin dan Askeskin to poor families as form of income redistribution q Provision BLT, Raskin dan Askeskin to poor families as form of income redistribution program in Indonesia. q. At glance, this program is nice. But, if it is looked from efficiency point of view, it looks not so good. q. This program makes poor people feel good to be poor. As consequence, they feel better to stay unemployed since the government protects them from hunger and sick.

9. 9. Objectives of Public Policies 9. 9. Objectives of Public Policies

q. Objectives of government intervention are often not single, but multiple. q. Objectives may q. Objectives of government intervention are often not single, but multiple. q. Objectives may conflicting one and another (conflicting goals) Ø Example, the case of rice self-sufficient program Ø Its goals are multiple, namely increase of rice production, increase of employment and farmers’ income Ø The question is when production increases, does the price of rice not decline? Ø If rice price decline due to increase of production, will the farmers’ income increase?

q. In addition, goals are not always measurable quantitatively q. As a consequence, performance q. In addition, goals are not always measurable quantitatively q. As a consequence, performance of the program become not evaluable. This opens a way for corruption to take place without any worry for trials.

9. 10. Political Process Underlying the Intervention 9. 10. Political Process Underlying the Intervention

q. Government intervention contains with political interest q. Intervention is often designed to benefit q. Government intervention contains with political interest q. Intervention is often designed to benefit a particular group at the other’s cost ØFor instance, tariff policy on sugar import. ØThis is beneficial to domestic sugar producers, but costly to domestic consumers.

q. Government often uses economic policy to satisfy its constituents by tacit ways in q. Government often uses economic policy to satisfy its constituents by tacit ways in order not invite protest from other groups q. Government intervention may prevail in responding a certain pressure group v. Theory of collective action Ø Small, well-organized group can defeat a large number group which is not well organized Ø Problem of free riders Ø Example, the case of tariff policy on sugar import

9. 11. Daftar Pustaka Stiglitz, Joseph E. 2000. Economics of the Public Sector. New 9. 11. Daftar Pustaka Stiglitz, Joseph E. 2000. Economics of the Public Sector. New York, USA: W. W. Northon and Company. Chapter 10