PUBLIC SPENDING AND PRIVATE SERVICES: MACROECONOMIC ASPECTS

RECENT decades have seen substantial increases in public consumption and transfer payments by governments in many countries, financed by higher taxation. What effects have these changes had? It is often argued that these developments affect market-production of services adversely: high marginal tax rates may shift the production of some services from markets to households, while government provision of highly subsidized services to households ("public consumption") may shift some service production away both from markets and households to the public sector. However, such assertions are usually based on partial equilibrium analyses of households and firms. We wish to see whether, or rather under what conditions, they also hold in general equilibrium or disequilibrium. A general (dis)equilibrium framework also allows one to study the consequences for aggregate private sector employment, unemployment, the budget surplus, the external trade balance and the welfare of households. To explore these issues, we set up a simple general (dis)equilibrium model (in Section 2). A higher income tax rate is assumed to finance either larger tranfers (Section 3) or freely provided services to households (Section 4). The private sector produces two goods, one of which is traded internationally at an exogenous price. The other is a non-traded service, the price of which adjusts to clear the market for it. The domestic labour market, however, is assumed not to clear: there is unemployment. Key features of our model include a detailed treatment of household production of services; the effects of "public consumption " for household behaviour; and the differential response of employed and unemployed house-holds, as only the latter type of household is "income-constrained " in its demand for goods and services. In this paper, labour is internationally immobile, but can move between sectors. Capital is internationally immobile and sector-specific. In the interests of simplicity, there is no explicit role for monetary or financial variables in the model. 2. The model The model incorporates a household sector, a production sector for a tradeable good and a production sector for a non-traded good. It als