Introduction / Motivation

Johannes Spinnewijn

London School of Economics

Lecture Notes for Ec426

1 / 18

Topics & Question in Public Economics

Classical division in Public Economics:

Taxation: How does and should government raise revenues?Spending: How does and should government spend revenues?

Same fundamental questions for both topics:

When and how should the government intervene?How do government policies affect economic behavior?

2 / 18

Why care about government interventions?

Government expenditures average close to 50 percent ofnational income in OECD countries.

stakes are extremely large because of broad scope of policiesgovernment is largest employer in many countries (ex. UKNHS)

Contentious debate on the appropriate role of government insociety

evidence on increasing inequality / austerity governments aftercrisisgovernment expenditures have increased as a percentage ofnational income throughout the 20th centurygovernment expenditures have shifted towards social securityand health insurance in particular

3 / 18

UK Government in the 20th CenturyGovernment expenditures as a percentage of national income

Source: IFS; Crawford et al., A Survey of Public Spending in the UK, IFS

Briefing Note no. 43, September 2009

4 / 18

International Comparison of Total Spending,1960-2001

Source: Gruber’s Textbook

5 / 18

Distribution of UK Government Spending

Rule-of-thumb: 20% on Pensions, 20% on Health, 20% on SI &Welfare, 15% on Education.

Source: IFS 2008-2009. Alternative source:http://www.ukpublicspending.co.uk/

6 / 18

Social Security Spending as a Share of NationalIncome, 1949 to 2011

Source: 1949—50 to 2007—08 from ONS series ANLY; 2008—09 to 2010—11

from HM Treasury, Budget 2009.

7 / 18

NHS Spending as a Share of National Income, 1949to 2011

Source: 1949—50 to 2007—08 from Offi ce of Health Economics; 2008—09 to

2010—11 uses plans for NHS England from HM Treasury, Budget 2009

8 / 18

Change in Distribution of US Gov. spending, 1960vs. 2014

Source: Gruber’s Textbook

9 / 18

International Comparison of Social ExpendituresShare of GDP, 2007 vs. peak vs. 2014

Source: OECD

10 / 18

First Part focuses on Social Insurance

SI is the biggest and most rapidly growing part of governmentexpenditures in many countries. Generosity of SI (i.e.replacement of lost income) differs significantly amongcountries.

Some (US) vocabulary:

Social Insurance = transfers based on events such asunemployment, disability, retirement or health.

Welfare = means-tested transfers such as poverty alleviation,housing benefits.

11 / 18

Main Questions in Social Insurance

1 What type of insurance system maximizes social welfare?

2 Why have social (as opposed to private, or any) insurance?

12 / 18

Why have social insurance?

General motivation for insurance: pool risks of risk-averseindividuals

Unemployment Ins: risk of involuntary unemployment

Disability Ins (& Worker’s Compensation): risk ofinjuries/disabilities

Health Ins: risk of health shocks

Social security annuity: risk of outliving your wealth

But why is government intervention needed to provide thisinsurance?

we established First and Second Welfare Theorem, so whyshould we care when 50 million Americans have no healthinsurance?

13 / 18

Why have social insurance?

Typical answer is market failure due to asymmetric information

private information about actions leads to moral hazard;increase in coverage increases the probability that the riskoccurs

private information about risks leads to adverse selection;higher risk types are more likely to buy insurance

Does this provide a rational for government intervention?

in case of adverse selection it does; government has advantageover private insurers that it can mandate insurance

if governments intervene for other reasons, understanding howinterventions affect selection and incentives is essential foroptimal design

14 / 18

What else can explain government interventions?Other Market Failures

externalities, aggregate risks, redistribution, imperfectcompetition,...

Behavioral failures

people make mistakes, do not internalize the true impact oftheir actions on themselves

Trade-off between costs and benefits of governmentintervention

1 information: how does government aggregate information onpreferences and technology to choose optimal production andallocation?

2 politicians not necessarily a benevolent planner in reality; faceincentive constraints themselves

3 why does govt. know better what’s desirable for you (e.g.wearing a seatbelt, not smoking, saving more)

15 / 18

Outline

1 Unemployment Insurance (& Moral Hazard) [1-2 Lectures]

2 Health Insurance (& Adverse Selection) [1-2 Lectures]

3 Social Security [1 Lecture]

4 Education [1 Lecture]

5 Behavioral Public Economics [1 Lecture]

6 Optimal Taxation [3 Lectures]

16 / 18

Approach

Integration of theory with empirical evidence to derivequantitative predictions about policy

theoretical analysis of core issues

empirical analysis of direct and indirect effects

institutional framework (incomplete)

Behavioral public economics: focus on non-standard decisionmakers where relevant

Critical about question; why government?

17 / 18

Logistics

Slides and reading list posted in advance on Frank’s website

Background textbooks:

Public Finance and Public Policy by GruberHandbook of Public Economics (recent Vol. 5 in particular)

Contact:

Email: j.spinnewijn@lse.ac.ukOffi ce hours: Tuesday 4 - 5 (32LIF 3.24)

18 / 18