What do governments spend money on?

Governments spend money on a wide variety of things, and this has considerable implications for both the size and the shape of the state. For example, if a government decides to fund universal health care, this will significantly increase government expenditure because you’re suddenly spending money on something that you weren’t spending money on before. Moreover, as health care costs in most countries over the last 50 years have tended to rise above the rate of inflation, the government may also be committing itself to increased expenditure in the future. Actually, it’s a bit more complicated than that, as in a democracy, the promise of providing effective health care may well affect who gets elected to form the government.

So what governments spend money on doesn’t just affect the country but also, reflexively, affects the government.

The first governments spent very little money on anything. This was the so-called laissez-faire phase of government. People were expected to provide for themselves, for their own old age, for their health care, and the state was limited to providing services which were universally applicable, such as defence and the rule of law. In the Victorian era, this changed, as concerns that the poor were living in squalid conditions led to sanitation and public housing. Otto von Bismarck, the first chancellor of Germany, introduced pensions, in part to safeguard the state. As he said, “Whoever has a pension to look forward to in his old age is much more contented and easily taken care of than the man who has no prospect of any.”

From these sentiments the welfare state rose and grew in many Western countries. However, in the last quarter of the 20th century, a different view became prevalent, particularly in Anglo-Saxon countries, that the state had become too big and inefficient. In the classic public administration model, the purpose of state bureaucracy was to administer agreed policy fairly. This new view suggested that what was more important was efficiency and value for money. Governments in countries such as the UK and New Zealand had political objectives to roll back the state and to limit government expenditure. More recently, and particularly in response to the financial crisis, there’s some evidence that governments have been forced by market failures in the private sector to embrace a larger role.

Additional regulation, the nationalisation of failing banks and financial institutions, as well as increased spending on health care and defence, hint at an increased role for government. The success of countries in developing industries with the aid of state support, for example, South Korea in the case of shipbuilding or the United Arab Emirates in air transportation, has encouraged nations to think about what they can do to foster development, rather than leaving it to the invisible hand of the market. Different countries have tended to draw different lessons from these observations and cases, but a number of researchers have suggested that the state may have a greater role in the future than it has at the present.

So what sort of things do governments do? Well, governments can spend their money in four ways. They can provide a good or service themselves. For example, most governments tend to keep defence in-house. They can subsidise provision, and this is an approach which has been taken with agriculture in both Europe and North America, where governments offer agreed prices for agricultural products. Governments can produce goods. This is slightly different to provision, as the production of these goods occurs at arm’s length from government, away from political control and possibly by a private company. These goods, such as electricity or water, are then charged for by usage.

Finally, government can regulate by procedures or legislation, and this is what happens, for example, in the area of health and safety. In a defining article in 1997, the World Bank

classified government activity into two categories: addressing market failure on the one hand and improving equity within nations on the other. For these two categories, they defined the bare minimum that governments would do. They then defined an intermediate level and then, finally, the kinds of things that activist governments would do. So for example, ensuring defence and a functional legal system was regarded as the bare minimum to prevent market failure. Similarly, disaster relief and anti-poverty programmes were the minimum that governments could do to improve equity. Moving up to the intermediate level, governments could protect the environment, enforce anti-trust legislation, or offer health insurance or pensions, and that would prevent market failure.

They could offer unemployment insurance or family allowances, and that would be to improve equity. More interventionist governments might try and foster particular markets to build up industrial capacity. Or they might even resort to redistributing assets to produce a fairer society. In short, therefore, governments spend the money they obtain in a wide variety of ways. To help understand how this impacts on nations, it’s necessary to pay close attention to the state’s developmental trajectory, as well as the prevailing social, political, and economic conditions.