Effect of Government Spending on Indian Economy

By-
Nayan Medhi
Prachurjya Pallab Muchahari
Srinivas Pranab Theja G
Prashant Kumar Yadav
Key Roles of Government
• Provides a well functioning legal and political system
• Plays regulatory role to provide a competitive market.
• Stimulate the economy by increasing the government spending.
• Keep economic inequality in check.
Role of Government in Indian Economy

Agriculture Industrial
Growth Growth

Effective
Infrastructure utilization of
Resources

Taxation and
Subsidy
Indirect Roles
Fiscal Policies
• To control inflation,
• To increase capital formation,
• To maintain equalities of income and wealth;
• To stabilize market
Monetary Policies
The government along with the Central Bank with the help of this policy controls the money market
• International Trade Policy
 Government sources of Income

Tax - Taxes include Income tax,

Corporation tax, and Indirect taxes.

Non Tax- Non-Tax revenue comes from

Public Sector units like income from
Railways or Public sector Banks etc.
 Expenditure or spendings
Government expenditure can be classified into:

Revenues which includes payment of salaries , grants to ministries.

Capital Expenditure which includes formation of assets in the economy.
Government spending vs GDP.

Government spending in India was last recorded at 12.7 percent of GDP in the 2017-18 fiscal year which
ended in March. Government Spending to GDP in India averaged 15.14 percent of GDP from 1970 until
2017, reaching an all time high of 19.42 percent of GDP in 1986 and a record low of 11.81 percent of GDP in
1970.
Budget and budget deficit.
• Before every financial year, Government of India prepares a budget as
a forecast of expenditure. Also known as annual financial statement.
• A budget deficit is an indicator of financial health in which
expenditures exceed revenue. It is the sum of Revenue Account
Deficit and Capital Account Deficit.
• The government tries to fulfil this gap through borrowing which it
does so by issuing bonds or borrowing from the foreign government.
• India recorded a Government Budget deficit equal to 3.50 percent of
the country’s Gross Domestic Product for the financial year ended on
March 2018.
Do deficit matters ?
• The understanding of government spending is not restricted to cost-benefit analysis.
• Government spending boosts growth by injecting purchasing power in the economy.
• Government has the power to improve the situation of economic downturn through
borrowing money. The government can borrow money from the private sector and
return the same through different spending programs.
• Fiscal deficit if kept in a check is not bad. The government in such a scenario can play the
role of creating assets in the economy. These assets in the economy will benefit in the
long term.
• If the deficit is out of control it can pose a problem for the economy. Our Indian economy
is mostly in deficit and in some years it has become uncomfortably high which might lead
to high inflation , high interest rate , high taxes in some cases.
 Impacts of increase in Government Spending
Impacts of Public Expenditure on Aggregate Demand
• Increase in Tax
• Increase in Borrowing

Relationship between government expenditure and public sector spending

• Crowding Out Effect
Evaluation of government spending
Effect of public expenditure on

• Production

• Distribution

• Consumption
Multiplier effect
• Every time there is an injection of new demand into the circular flow there is likely to be a
multiplier effect. This is because an injection of extra income leads to more spending, which
creates more income, and so on. The multiplier effect refers to the increase in final income arising
from any new injection of spending.
• The size of the multiplier depends upon household’s marginal decisions to spend, called the
marginal propensity to consume (mpc), or to save, and called the marginal propensity to
save (mps).
• It is important to remember that when income is spent, this spending becomes someone else’s
income, and so on.
• Marginal propensities show the proportion of extra income allocated to particular activities, such
as investment spending by Indian firms, saving by households, and spending on imports from
abroad.
• For example, if 80% of all new income in a given period of time is spent on Indian products, the
marginal propensity to consume would be 80/100, which is 0.8.
• The following general formula to calculate the multiplier uses marginal propensities, as follows:
1/1-mpc
Conclusion
• There is a high possibility that the rise in taxes will negate the impact of rising government
spending which would leave Aggregate Demand (AD) constant. However, it is possible that the
increased spending and rise in tax could lead to an increase in Country’s GDP.
• In recession, consumers may reduce the spending which leads to an increase in private sector
saving. Therefore a rise in taxes may not reduce the spending as much as usual.
• The increased government spending may lead to multiplier effect. If the government spending
causes the unemployed people to gain jobs then they will have more income to spend which
leads to a further increase in aggregate demand. In these situations of spare capacity in economy,
the government spending may cause bigger final increase in the GDP than the initial injection.
• However, if the economy is at full capacity, then the increase in government spending would tend
to crowd out the private sector leading to a no net increase in Aggregate Demand from changing
from private sector spending to government sector spending.
• Some economists would argue that increasing the government spending through higher taxes
would lead to a more inefficient allocation of resources as governments tend to be less effective
in spending money.