4.5.1 - Public expenditure

Types of Public Expenditure

The first distinction to get secure is between capital expenditure, current expenditure, and transfer payments. Students often lose marks by treating all three as if they were the same thing.

Capital expenditure creates or improves assets that raise future productive potential. Building a new road, railway, school, hospital wing, or digital network is capital spending because the benefit lasts beyond the current year. This is why economists often link capital expenditure to long-run growth: it adds to infrastructure and can make private-sector production easier and cheaper.

Current expenditure is the day-to-day cost of running the public sector. It includes paying teachers, nurses, doctors, civil servants, buying medicines and textbooks, heating buildings, and maintaining existing services. It supports current output rather than creating a new long-lived asset. When economists focus specifically on the government's direct use of labour and services, they may use the term general government final consumption.

Interest paid on the national debt is often grouped within current spending totals, but it is better thought of as a financial obligation than as spending on newly produced goods or services.

Transfer payments are different again.

Examples include state pensions, unemployment benefits, housing support, and tax credits. These payments redistribute income, but they do not directly create current output. If the government pays a nurse, it receives labour services in return, so that is current expenditure. If it pays a pensioner, nothing is produced in return, so that is a transfer payment. That is why transfer payments count as public expenditure but not as government purchases of output in GDP.

In the UK, the biggest areas of spending typically include pensions, welfare, healthcare, and education. That makes it a useful case for seeing the categories together: NHS wages and day-to-day running costs are mainly current expenditure, a new hospital building is capital expenditure, and state pensions are transfer payments.

Why Size and Composition Change

Public expenditure as a share of GDP varies between countries and over time because both economic conditions and political choices change.

One reason is national income and development. Lower-income countries often collect less tax because incomes are lower, the tax base is smaller, and tax administration is weaker. That usually limits how much the state can spend. Higher-income economies can raise more revenue and their citizens often demand more healthcare, education, transport, and social protection as incomes rise. Some public services may also be income elastic, with an income elasticity of demand above one: as societies get richer, they want not just more healthcare and education, but better-quality versions of them. Spending on them then grows faster than income, so public expenditure rises as a share of GDP, a pattern known as Wagner's law.

Politics matters too. Different countries make different choices about the role of the state. Many European economies have traditionally accepted higher taxation and higher public provision than the United States. In 2023, for example, general government spending was about 57% of GDP in France, compared with around 45% in the UK and under 40% in the United States. That is not just an economic difference; it reflects attitudes toward redistribution, welfare, and how much people want the government rather than the market to provide.

Economic shocks can also change public expenditure quickly. During the 2008-09 financial crisis, governments increased spending to support banks and demand, while automatic stabilisers pushed up welfare spending as unemployment rose. In the UK, the period after 2010 is often used as an application of austerity, where governments tried to slow or reduce the growth of public expenditure in order to cut the budget deficit. The COVID-19 pandemic was an even larger shock: UK public spending jumped from about 40% of GDP in 2019-20 to around half of GDP in 2020-21, as the government paid for the furlough scheme, business support and emergency health spending. Remember that the ratio has two parts: in a recession, public expenditure as a share of GDP also rises simply because GDP falls.

Demography changes the composition of spending as well as the total. An ageing population tends to push up pensions, healthcare, and social care because more people are retired and older households usually need more medical treatment and support. This is one reason ageing societies in Europe and Japan face persistent upward pressure on public spending.

How Public Expenditure Can Help

The Keynesian or interventionist case for public expenditure is that well-targeted spending can raise both living standards and long-run growth.

Capital expenditure on infrastructure can lift productivity by reducing business costs and delays. Better roads, rail links, ports, broadband, and energy networks make it easier for firms to move goods, communicate, recruit labour, and invest. Public spending on education and healthcare builds human capital, so workers are more skilled, healthier, and more productive. Spending on research, training, and infrastructure may also correct market failure because the private sector can underinvest when benefits spill over to others.