Theorising public expenditures: welfare theorems, market failures, and the turn from “public finance” to “public economics”

Abstract

Public expenditure theory is a late-comer to the field of public finance, despite laments over the lack of such a theory dating to the late 1800s. This paper documents and attempts to explain this transformation, locating its origins in Richard Musgrave’s normative theory of the public household and the adoption by subsequent thinkers of new developments in welfare theory, which was seen to offer a theoretically sophisticated a vision of the state’s role as a response to the problem of market failure.

Keywords:

• Public expenditure theory
• market failure
• Musgrave
• Bastable
• general equilibrium
• welfare economics

JEL CLASSIFICATION CODES:

• b13
• b20
• d61
• D7
• h0

Acknowledgments

The author wishes to thank Roger Backhouse, Maxime Desmarais-Tremblay, Kevin Hoover, the editors, two anonymous referees, participants in the History of Political Economy workshop at Duke University, the 2023 conference of the European Society for the History of Economic Thought, and the workshop, “From Public Finance to Public Economics,” held at the University of Graz, for instructive comments on earlier versions of this paper. The excellent research assistance of Ziyu Huang is also gratefully acknowledged.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Dome (2006) provides an instructive discussion of the early history of public finance in Britain.

2 The database underpinning the analysis in this paper consists of more than 100 treatises and texts identified from within the literature itself as well as via internet searches targeted at identifying books published with “public finance,” “public economics,” and related terms in their titles. Space limitations preclude a full accounting of these, and particularly those from the pre-1950 literature, in this article, though as a group they inform much of the general commentary.

3 We are referring here, of course, to continental writers such as Adolph Wagner, Emil Sax,, Maffeo Pantaleoni, Ugo Mazzola, Antonio de Viti de Marco, Knut Wicksell, and Erik Lindahl. Musgrave and Peacock (1958) provide a nice set of excerpts from the late nineteenth and early twentieth century continental public finance literature. An overview of this literature can be found in Backhaus and Wagner (2005), while Medema (2005) and the essays in Fausto and De Bonis (2003) provide a discussion of salient aspects of the Italian tradition.

4 Rosen (1997) provides an interesting discussion of changes in the public finance textbook literature over the post-WWII period by comparing Lutz (1947) with Rosen (1995).

5 H.W. Peck (1925) and G.F. Shirras (1924, 27) are notable exceptions here.

6 A brief account of Bastable’s life and career can be found in Boylan and Maloney (2011).

7 Bastable cited Paul Leroy-Beaulieu (1883) as a particularly important offender on this score. As Bastable was aware of the work of Italian public finance scholars, who did much to marry the tax and expenditure sides, it is not clear why he elected to paint the problem with this broad brush.

8 One of the interesting facets of this early literature is the extent to which later authors cited and relied upon the texts written by their predecessors, an indication of the difference between the texts–treatises of this earlier time, which were treated very much as literature in the field, and the modern textbook.

9 Cohn’s “economic analysis of housekeeping has commonalities with the idea of the state as a “public household.” Desmarais-Tremblay (2021) provides a nice discussion of this topic in the context of Richard Musgrave, about whom more below.

10 Bastable’s discussion of Cohn seems to have been cribbed from Plehn’s (1897) text, despite the fact that Cohn’s book had been translated into English by Veblen in 1895.

11 Robert Murray Haig, writing in a 1925 assessment of “Recent Books on Taxation and Finance,” remarked of Findlay Shirras’s (1924) text, which devoted a goodly amount of attention to public finance in India, that it was “perhaps not unfair to characterize it as Bastable served with curry” (Haig 1925, 607).

12 Though Dalton’s marginalist approach to the expenditure question had commonalities the work of Pantaleoni in Italy, Sax in Germany, and Lindahl in Sweden, his discussion of public expenditures in the book made no reference to this literature. That said, he was familiar with at least some of the continental literature, including the Italian tradition, as his “Notes on Books” in public finance makes clear (Dalton 1923, 207–208).

13 Though Pigou lays out these “optimal” expenditure criteria, he does nothing further with them.

14 Like Bastable, Plehn and Adams, Dalton discussion of the functions of government was confined to the then-typical operations of government.

15 There were also several books of “readings” in public finance published during this period, but the space devoted to public expenditures was typically minimal, and even this was basically descriptive rather than theoretical. The exception was Harold Groves’ Viewpoints on Public Finance: A Book of Readings (1947), which included a reprint of Peck’s (1925) chapter on “The General Theory of Public Expenditure.”

16 Landmark works in welfare economics generally during this period include Lange (1942), Lerner (1944), Reder (1947), and Myint (1948).

17 On Samuelson’s development of the theory of public goods, see, e.g., Pickhardt (2006), Desmarais-Tremblay (2017), and Sturn (2010).

18 Hotelling (1938), Lerner (1944), and Meade and Fleming (1944) argued in the affirmative, while Coase (1946) suggested that the efficiency implications were unclear and that multi-part pricing offered a better way forward.

19 Fèvre and Mueller (2023) provide an excellent analysis of the development of public-sector pricing policies in France during this period.

20 Consider, for example, an economy with several monopolists, each of whom is a polluter. Both monopoly and pollution generate inefficiencies. An attempt to eliminate the monopoly and replace it with a more competitive market will reduce the monopoly distortion, but it will also lead to more pollution and thus increase that distortion. A first-best solution is not available here.

21 This continental influence was on evidence already in Musgrave’s essay, “The Voluntary Exchange Theory of Public Economy (1939), which built on the work of Wicksell, Sax, de Viti de Marco, and Lindahl.

22 This public household is at once similar to and different from asserted correspondence between the theory of the individual consumer and the theory of the state highlighted by earlier writers and discussed above. See Desmarais-Tremblay (2021).

23 Johnson (2015) provides a history of the treatment of voluntary exchange theories in public finance.

24 See, e.g., e.g., Buchanan (1960), Due (1963), Herber (1967), Eckstein (1967), Winfrey (1973), Auld and Miller (1975) and, of course, Musgrave and Musgrave (1973). Several writers added a fourth function here, the promotion of economic growth. See, e.g., Herber (1967) and Eckstein (1967).

25 See, e.g., Prest (1960), Rolph and Break (1961), Due (1963), and Eckstein (1964).

26 Johansen’s book, based on lectures he had given in Oslo, was originally published in Norwegian, in two parts, in 1962 and 1964. The English translation appeared in 1965.

27 Previous editions had been titled Government Finance: An Economic Analysis. In 1968, Due changed the title to, Government Finance: Economics of the Public Sector.

28 Head’s book treated welfare theory, collective decision making, public goods, and externalities.

29 Compare, for example, Herber (1967), Due (1968), Fromm and Taubman (1973), Winfrey (1973), Musgrave and Musgrave (1973), and Brown and Jackson (1978). Recognition of what we would now call “public choice” concerns was certainly not new in the public finance literature. See, e.g., Plehn (1897, 22), Adams (1899, 21–23, 147), Hunter (1921, 41), Shultz (1931, 78–112), Kendrick (1951, 70–78), and Poole (1956, 50–51, 54–55). Backhouse and Medema (2012) provide a discussion of the prevalence of these concerns in Cambridge economics.

30 Interestingly, none of these advanced books paid any significant attention to the public choice literature.

31 Though our discussion of this history has ignored the treatment of issues in state and local public finance, we see a similar trend through time there in the reliance on the Tiebout model. On Tiebout, see Singleton (2015).

32 Stiglitz (1986) even went so far as to add specialized chapters on health, defense, and education to those dealing with more general theoretical issues in public expenditure.

33 It is also worth noting that the field’s evolution also brought Anglo-American public finance much closer to the continental perspective that it had ignored in its formative years.

34 In addition to echoing the government activities taken as given in the earlier public finance literature, they also echo key aspects of Pigou’s (1920) welfare economics, which itself has its roots in the work of Henry Sidgwick (O’Donnell 1979; Medema 2007).

35 Thus, for example, chapters on public goods in the more recent treatises and texts barely mention—if at all—the actual government activities that fall under this heading, let alone probe their evolution and extent. Instead, the discussion is confined to conditions for optimal provision, free-riding incentives, and so forth.

36 On the Robbins definition of economics and its gradual diffusion, see Backhouse and Medema (2009).

37 One interesting conjecture here is that the macroeconomic-stabilization policy side of public finance may have helped pave the way for, or legitimize, the normative approach to public expenditure theory. If so, there is a minor associated irony here in that stabilization policy was written out of public finance in the 1970s.