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Classification and trends in government expenditure

Introduction Government expenditure is an important influencing factor for the development of the economy. It is one of the major processes which helps in improving the welfare of the people and is a vital aspect of the government’s budget. It is an important tool which can be used by the government for maximizing public satisfaction. It is also helpful in overcoming the inefficiencies of the market system for allocation of resources. In this essay, we shall try to analyze classification of government expenditure by comparing the five-year plans both before the liberalization policies were implemented as well as after liberalization, to understand how the government’s objectives have aligned with the expenditure when planning the budget.
Classification of Government expenditure Government expenditure covers all the heads under which expenditure is incurred – revenue, capital, and loans. Each of these heads can further be sub classified into several different categories. For example expenditure can be classified into non-developmental expenditure and developmental expenditure.
Each classification of government expenditure is closely related to the objectives of the government – economic growth, financial control, price stability etc. In the accounting classification of expenditure we classify all expenses of the government into plan and non-plan, capital and revenue and so on. Capital and revenue classification enables the parliament to exercise financial control over the spending by its individual states and the spending by the center. Similarly the economic classification helps in analyzing the resources that are allocated by the government to the various economic activities which help in the growth of the nation. The cross classification of expenditure which is a mix of both the functional and economic classification, helps in determining the expenditure incurred on consumption and non-consumption of goods and services.
Functional classification According to this classification all expenditure is divided into several sectors. For example Gen. services, social and community services and economic services. Each of these sectors has a hierarchy of major and minor heads and each of these heads have separate expenditures based on their functions. Functional classification provides the necessary facility for monitoring and analyzing expenditure based on the functions which help in aiding the management function.
Economic classification Economic classification refers to the resources allocated by the government to promote economic activities. This classification analyzes the governmental transactions in its activities and records the government’s influence on each sector of the economy.
Cross classification This classification analyzes the government expenditure by both the economic and by functional heads. Under the scheme, functional classification of expenditure can be analyzed according to its economic character and vice versa. The two different classifications hence supplement each other and give a clear picture of the total expenditure or transactions of the government.
Accounting classification Under this classification government expenditure can be analyzed under
Revenue and capital
Developmental and non- developmental
Plan and non-plan
Capital expenditure can be considered to be any expenditure that does not deal with the operating aspects of any function. The benefits of capital expenditure extend over a period of time exceeding one year. A major portion of the expenditure is made at one point of time and the benefits are realized in the future. Hence capital expenditure is intended for creating concrete assets of material character in the economy. Examples include acquisition of assets like land, buildings, etc.
Revenue expenditure is used for the normal running of government departments and various services. In other words, expenditure which does not result in the creation of assets is treated as revenue expenditure or operating expenditure.
Classification of expenditure into developmental and non-developmental can be done on both capital and revenue expenditures. The developmental expenditures are usually incurred on education, medical care, employment, agriculture etc. Non-Developmental expenditure comprises expenditure incurred on items like defense, collection of taxes and duties, Gen. Services etc. Developmental expenditure helps the government in setting quantifiable goals when planning for economic growth. Developmental expenditure is said to be directly related to the promotion of the backward economy while non- developmental expenditure does not. The distinction between developmental and non-developmental expenditure beyond a certain point, gives a distorted picture of the whole government expenditure. For example expenditure on defense, being a non-developmental expense is very important for the safety of the country.
Trends in Government Expenditure The general trend and pattern of public expenditure in India can be best understood by analyzing the five-year plans both before liberalization and after liberalization.
By comparing the total expenditure in 1980-81 and 2001-2002, we can see that the government expenditure from revenues that is financed through current taxation and non-tax revenue is consistently high. Before liberalization, the revenue expenditure was classified into civil expenditure, defense expenditure and grants in aid to states and union territories.
Capital and Revenue Expenditure allocations Capital expenditure of the central government consists of planned expenditure and non-planned expenditure and it is financed out of capital receipts. The capital expenditure consists of:
Loans to states and union territories for financing plan projects, and loans to foreign governments.
Capital expenditure on economic development
Capital expenditure on social and community development
Capital expenditure on defense
Capital expenditure on general services
Fig: Capital and Revenue expenditures before and after liberalization Though the government’s major objective for all the plans starting from 1980-81 has been economic development and the establishment of a welfare state, most of its expenditure has been concentrated on defense as seen in the next table, which compares the expenditure both pre and post liberalization policies.
Fig: Non-Plan expenditures on selected sectors To better understand the difference between the budget and expenditure before the liberalization after the liberalization it would be best to compare the plans just before liberalization and after liberalization.
From the sixth five-year plan, the following can be inferred:
Agriculture was allotted around 30% the total expenditure
Power development was allocated less (10% – 15%). This was due to the assumption that industries had not come up fast and that the use of electric power in rural identification and railway transport system was inadequate. This was taken care of in the seventh plan where allocation for power was around 28% of the total expenditure.
The industries and minerals sector was given low priority at the cost of agriculture. Again in the next two plans, this was rectified to around 24% of the total expenditure.
In transportation and communication, allocation was very high (between 25 and 28%). In the sixth and seventh lands however the allocation reduced. This was again rectified in the eighth plan to around 23%.
Social and miscellaneous services, which include education, health and family planning, housing, labor welfare and welfare of backward class etc. took a boost. These services are very significant for the up-lifting the backward classes.
The Post reform period In the later part of the 1980s, due to the increase in prices of oil, the government was embroiled in huge amounts of debt to and a large interest payment. This resulted in a complete reorganization of the macroeconomic setup. Objectives like reduction of fiscal deficit, depreciation of exchange rate and the restoration of market forces became important. This resulted in a program of macroeconomic stabilization in July 1991. This led to a total change in economic policy of the government leading to liberalization, privatization and globalization.
The table below shows the allocation of resources in the Tenth five year plan.
Fig: Expenditures in the 10th Five-year plan From the above table, we can see that there was a slight improvement in the allocation of resources to social services to about 19% of the total expenditure. This was to improve the human capital, especially by improving literacy. Also the outlay on energy was increased to improve infrastructure constraints.
A more detailed split up of the various sectors is shown in the next table.
Fig: Detailed Split-up of the 10th plan In the 10th five-year plan, as shown in the table above, the main objective was to set at least an 8% growth rate for the state’s economy as compared to the previous plans. In this plan, the main priority of the government was the generation of more wealth.
Inferences and conclusions From this analysis of the pre-and post-liberalization periods, we can see that there is an upward trend in public expenditure. However the heads under which public expenditure was allocated has seen a marked change from agriculture over to industrialization and social welfare. Greater importance has been given to education, health care, housing and social development and other social services. There has also been a growing concern of the need to widen the stage and leakage of funds at the implementation level. According to the RBI, “failure to contain expenditure” has been accepted as a major reason for the fiscal woes of the state governments.
This analysis also proves the Wagner’s theory which predicts that the development of an industrial economy will be accompanied by an increased share of public expenditure in the GNP.

The impact of financial development on economic growth in Japan

The fundamental question in economic growth that has preoccupies researchers is why do countries grow at different rates. The empirical growth literature has come up with numerous explanations of cross-country difference in growth, including factor accumulation, resource endowments, and the degree of macroeconomic stability, educational attainment, institutional development, legal system effectiveness, international trade, and ethnic and religious diversity. The list of possible factors continues to expand, actually without limit.
One critical factor that has begun to receive considerable attention more recently is the role of financial development in the growth process. The important link between financial development and economic growth has been the subject of numerous studies, for many years. More specifically, these researches have highlighted, at the theoretical as well as empirical level, the significance of having a developed financial system to support economic growth. Additionally, recent studies have also addressed this topic from an open economy perspective, and found that financial integration with the global economy like financial deepening can bring about economic benefits. Studying the relationship between financial development and economic growth is a vital one, considering the continuing progress in its financial sector. The focus of study provides support for research work, which have included in its cross country evidence.
The positive link between financial depth, defined broadly as the level of development of financial market, and economic growth is in one sense fairly obvious. That is, more developed countries without exception, have more developed financial markets. Therefore, it would seem that policies to develop the financial sector would be expected to raise economic growth. Indeed, the role of financial development is considered by many to be the key to economic development and growth (Demirguc- Kunt and Levine 1996a).
The general consensus of an ever-increasing number of empirical and theoretical works on economic growth is that a well-developed financial system plays an essential role in fostering a country’s economic growth. We used to see that the development of different aspects of the financial development has different impacts on economic growth. In this study, we focus on Japan. Japan is a good indicator of financial market development in analyzing the relationship with economic growth. Hence, well-developed financial systems could channel financial resources to the most productive use (Goldsmith, 1969).
The notable early works on finance and development along the Schumpeterian lines included Gurley and Shaw (1955), Goldsmith (1969), and Hicks (1969).They argued that the development of a financial system is crucially important in stimulating economic growth. Under-developed financial systems slow down economic growth. The policy implication of this viewpoint is that it is important to formulate policies aimed at expanding the financial system in order to foster growth.
Financial development in developing countries and emerging markets is part of the private sector development strategy to encourage economic growth. A solid and well-functioning financial sector is a powerful engine behind economic growth. It generates local savings, which in turn lead to productive investments in local business. Furthermore, effective banks can channel international streams of private remittances. The financial sector therefore provides the rudiments for income-growth and job creation (Sinha and Macri, 2001).
Financial development has classified as two either of the bank-based type or stock market-based type. It is a crucial policy question on which type of financial development should the government actively promotes to foster the economic growth (Chakraborty, 2008). There are three basic characteristics of financial system that are now regarded as capturing the impact of these five functions on economic growth: i) the level of financial intermediation; ii) the efficiency of financial intermediation; and iii) the composition of financial intermediation. Historically, the role of banks and non-bank financial intermediaries ranging from pension funds to stock market, has been to translate household savings into enterprise investment, monitor investment and allocate funds, and to price and spread risk. Yet, financial intermediation has strong externalities in this context, which are generally positive such as information and liquidity provision but can also be negative in the systemic financial crisis which are endemic to market systems (FitzGerald, 2006).
The Financial sector is all of the wholesale, retail, formal and informal institutions in an economy offering financial services to consumers, businesses and other financial institutions. It consists of financial intermediaries such as (banks, insurance companies, finance companies, and credit unions) and financial markets such as (money markets, stock exchanges, and foreign exchange markets). It can also include money lenders and microfinance institutions. Financial sector development occurs when financial instruments, markets and intermediaries reduce the costs of information gathering, enforcement and transactions in an economy, thereby improving the provision of the five functions. The financial sector can play an important role in reducing risk and vulnerability for private sector firms, individuals and households. It can increase the ability of individuals and households to access basic services like health and education (Odedokun, 1996).
1.2: OVERVIEW OF THE JAPAN’S ECONOMY Japan is the second largest industrial economy in the world. It is the market for about one-sixth of the exports of ASEAN-4 (Indonesia, Malaysia, Philippines and Thailand) and South Korea. Their growth in general and their export growth in particular have to be supported by growth in domestic demand in Japan. Since the bursting of the asset price bubble in 1990, however, the Japanese economy has been in a morbid state.
Figure 1.1: Yearly Growth of Japan Gross Domestic Product (GDP)
Source: Department of Statistic Japan
Since 1990, however, the Japanese economy suddenly has been in recession with GDP growth at an average of 1.7%. As the bubble’s collapsed in 1990, the Japanese economy slumped into the long stagnation in the 1990. To solve this stagnation, the government began to encourage financial reform. In 1992, the financial reform law was approved and financial institutions were allowed to enter into other kinds of financial business by establishing subsidiaries. For example, banks were allowed to engage in securities business through their subsidiaries.
From 1993, the GDP of Japanese economy achieved a high rate of economic growth. The following years, GDP growth quite stable until rapidly drop to 1.8% in 1997 because of financial crises that gripped the region during 1997 and 1998.
Table 1: The financial development index 2008 ranking
Country/Economy Rank Score United states
United kingdom
Japan 4 5.28 Canada
Hong Kong
United Arab Emirates
Source: World Economic Forum (2008)
Table 1 shows the financial development index ranking among countries. According to several authors, they stated that more developed countries have more or better financial development. This is can be proved by United states, United Kingdom, Germany, Japan, Canada, France and most of the developed countries list in a top position The United Stated and United Kingdom takes first and second place in the financial development index (FDI), driven by its strong showing across all different aspects of financial intermediation.
Japan emerged as the highest ranked Asian country (4th) by delivering well-rounded performance in financial development. it is strongest scores are seen with respect to financial intermediation and in particular its highly efficient banks, IPO and M