• Why do governments exist?• What are the objectives of governments?• What are the results of our system of government?• How are governments constrained?

Chapter 2

Fundamental of the Public Finance

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Learning Objectives

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Differences between private and public sectorMarket failureExistence of governmentCategories of resourcesExternalitiesPrivatizationGovernment production of private goodsPolitical science

Differences of public & private SectorLevels of differences

Organizational level => Cost efficacy/efficiencyToo many formal processesRed tape (rules, regulations, procedures)Power braches (legislative, executive, judicial)

Managerial levelDecision-making process (centralize vs. decentralize)Conflict resolution (positive vs. negative)

Employee levelCollective or social value basedEconomic reward on firm or individual based

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Differences of public & private Sector

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Market FailureWhat is market failure? (QD < QS or QD > QS)

Causes of market failureImperfect competitionSmall number of producers Small number of consumersPoor judgment of individual consumer on their own

welfareExternality effects

Solution to market failureGovernments exist to provide valuable services that

businesses or individuals are unwilling or unable to provide independently.

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Existence of government

Why Do Governments Exist?Governments make rules for marketsGovernments enforce rulesGovernments provide public goods

Market failureImperfect competition

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Categories of ResourcesPRIVATE GOODS

• Food

• Clothing

• TV Sets

• Cellphones(alternate use, exclusion feasible)

TOLL GOODS

• Turnpikes (tool roads)

• Toll bridges

• Motion pictures/cinema

• Parks(Joint use, exclusion feasible)

COMMON-POOL RESOURCES

• Irrigation system

• Fishing grounds

• Libraries

• Timber, coal(alternate use, exclusion not feasible)

PUBLIC GOODS

• National defense

• System of justice

• Vector control

• Free-to-air TV, Fresh-air(Joint use, exclusion not feasible)

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Categories of resources

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Externalities

What is Externalities? pollution, noisy, traffic jam, ...

Externality existence:Market failuresPolicy failures Institutional failures

Dimensions of externalities:Negative effects: e. g. industrial waste vs. water pollutionPositive effect: e. g. well education vs. firm productivityProduction externalities: e.g. factory waste dumped the river.Consumption externalities: e.g. smoking, music noise.

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Policies toward externalities

Policy toward externality problemGovernment intervention:

Tax policyExternality taxProduction taxConsumption tax

Output-reduction subsidy policyLevel of pollution estimated

Standard on pollution or outputCommand and control approach

o Quota of production to restrict output

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Privatization

What privatization is Methods of privatizationTypes of privatizationBenefits and Costs of privatizationAdvantages and disadvantages

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What is privatization?

Private firms need their customers in order to survive – state industries do not.

Financed through taxation, state operations are largely independent of consumer choices.

• “The transfer of public assets, operations or activities to private enterprise”.

Margaret Thatcher once remarked: “The public controls the private sector, but nobody controls the public sector”.

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Consider University education:Nationalization implies public good

Assumes a constituent policy:Equity before efficiency no one pays the cost, but everyone is better off

Privatization implies private goodAssumes a distributive policy:

Everyone pays the cost, benefits flow to only a fewTherefore, efficiency-based, user-pays model

Includes higher-tuition Academic-based/merit funding only

Some observations on privatization

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Methods of privatization

There are four main methods of privatization:Share issue privatization (SIP) - selling shares on the

stock market.Asset sale privatization - selling an entire organization

(or part of it) to a strategic investor, usually by auction.Voucher privatization - distributing shares of ownership

to all citizens, usually for free or at a very low price.Privatization from below - Start-up of new private

businesses in formerly socialist countries.

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Liquidation: gov’t sale of a state-owned firm to the private sector.

Part Liquidation: PPWSAWhole Liquidation: rubber plantation, Cambodia

Subsidization: gov’t provision of grants to non-profit orgs for public service, for example: informal education. ...

Franchising: to a private company exclusively to provide a region with a certain service, e. g. monopoly rights

Contracting out: gov’t retention of responsibility but hiring a private contractorPetroleum and office supply for gov’t institutionsTax collection, custom clearance services

Types of privatization

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Costs and benefits of privatization

Benefits of Privatization: One-time cash injection to gov’t revenuesIncreased efficiency Reduce cost of public service deliveryImprovement of accountabilityRetain and enlarge employment for workersMarket capitalization for publicly traded

company

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Costs of privatization:Loss of annual government revenue Loss of ‘guaranteed’ jobs Loss of government influence in market

outcomes (Public Interest) Loss of government control over provision of

public goods and services to market

Costs and benefits of privatization

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Advantages of Privatization

To Government:Reduces the operating costs of governmentRaises proceeds to reduce the debtReduces future calls on government expenditureTurns losses into tax revenuesReduces lobbying pressures on politicians

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Advantages of Privatization

To the Private Sector:Stimulates development of private enterprisesHelps create a competitive environment which in

turn increases efficiencies and reduces costsCould provide a basis for an export industry

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Government production of private goods

Government production of public goods:Defense, justice, social order, ...

Government production of private goods: Postal services Telecommunications Water harbors, and Electricity

Rationale: Market failure – lack of competition with natural monopoly

Problem: inefficiency, subsidy issues, intervention of politician.

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Political Science

What is political science?Definitions

APSA (American Political Science Association)Wikipedia, the free encyclopediaAristotle –the study of the state or government

(politics, system, behavior)Why study political science?

Difference between liberal and conservativeDifferences between capitalism, socialism, and

communism

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Political Science

Difference between liberal and conservative:Conservatism:

Definition (preservation and opposed radical changes)Characteristics

Liberalism:Definitions (freedom, preference of changes, private

property and limited roles of government in economy)Characteristics

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Political Science

Differences between capitalism, socialism, & communismCapitalism:

private ownership, market economy ... ownership, benefits, freedom of choice, competition, pricing

Socialism: social ownership, common ownership, state ownership, ...co-operative management of economy, co-operative enterpriseplanning economy, roles of the state

Communism:common or collective ownership, no social classesall means of production are of the government or state

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End of Chapter 2

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Thank you!