Everyone expects the government to build roads, highways, bridges, ports, schools, universities, hospitals and many more; and then to hire people to work and manage them. Yet, we seem less keen on the huge amounts of funds that the government would need to raise to support such high spending. In other words, we expect the government to spend and make things right when the private sector doesn’t, or when the private sector normally can’t or fails to.

Historically, empires generated revenues through mining, acquiring new lands and their fortunes, as well as taxation. The world is not too different nowadays, except now; sectors can be privatised or jointly managed with the government, i.e. Public-Private Partnerships. The cash then raised by governments is used to pay salaries to government employees; current spending, and to invest in projects like transportation, power generation, etc. which is referred to as capital spending. Why do you think people start protesting when governments decide to curb their spending?

In the broad definition of GDP, four main components exist: consumption, investments, net exports, and government spending. For any economy at any given time; all four are important. The state that governs the economy, however; has direct control over its spending only and indirect influence over the rest using different tactics. Lower income taxes result in higher disposable incomes which trigger consumption, lower tax rates spur foreign direct investments, competitive exchange rates promote exports, and the government makes sure that friction between these four is kept at minimum. Besides that, when the former three do not achieve desired levels, governments increase their spending to make up for that. The challenge remains in whether or not this spending is channelled into appropriate sectors to stem growth. That is, spending on a one-time off infrastructure project creates jobs temporarily, if the project wasn’t outsourced, but the construction of hospitals and schools is more long-term thinking. The costs of government spending are closely related to the sources of funding, be it taxes or otherwise.

Even though many believe that markets do correct themselves if left on their own, that is not entirely true. And it’s not true either that governments are out of harm’s way. To the surprise of not too many nowadays, governments do fail as well. In the recent events that took place in Cyprus, a tax imposed on bank deposits to secure a bailout is, plainly put, weird. Consumption will be hit by unemployment and lost tourism, investors will be wary about putting their money into banks, and reduced economic activity will keep this rolling for some time. To be precise; inefficient spending.