What’s it: Government capital expenditure refers to spending to create long-term assets in the economy. An example is money spent on building infrastructures such as roads, railways, and ports. Unlike government current expenditures, they are productive investments to generate long-term benefits. Meanwhile, current expenditure is for operations or routine activities such as personnel and office equipment.
Capital expenditure is vital for increasing the productive capacity of the economy. For example, building physical infrastructure will reduce logistics costs and encourage increased economic activity in the future while creating jobs and income in the short term. Likewise, investment in non-physical infrastructure such as education will encourage higher quality human capital, contributing to long-term economic growth.
In addition, in certain sectors, investment by the government is deemed necessary to provide vital goods and services efficiently. But on the other hand, leaving it to the private sector through competition may not be efficient. That’s because certain industries like power only need one supplier to achieve significant economies of scale to lower prices.
What are examples of government capital expenditures?
Government capital expenditures can vary widely. But, to be sure, they aim to create long-term assets and benefits. An example is spending on infrastructure such as:
In addition, spending on equipment and machinery – including for defense purposes – is another example.
Then, in general, spending on infrastructure is divided into two categories:
- Physical infrastructure such as roads, telecommunications, and buildings. These investments are vital for facilitating and encouraging economic activity.
- Non-physical or intangible infrastructure such as education, training, and research investment. This investment is essential, for example, to improve human capital.
Why are government capital expenditures so important?
There are several other reasons why government capital expenditure is important. First, government capital expenditure is productive spending. They provide long-term benefits. For example, it will increase the productive capacity of the economy. In other words, such investments contribute to an increase in the economy’s output in the future. So, the economy can produce more in the future.
Second, creating jobs for households is another reason why government capital expenditure is important. For example, infrastructure projects create jobs for households, especially construction workers. In addition, they also create jobs for supporting industries as their demand increases.
Third, like government current expenditures, capital expenditures also increase the demand for goods and services in the economy. As a result, governments usually increase their allocations to stimulate economic growth. For example, during a sluggish economy, the government takes an expansionary fiscal policy by launching infrastructure projects. These projects create jobs for households. In addition, they also increase the demand for goods and services in related industries. Ultimately, they create income for households, pushing their consumption up.
Fourth, capital expenditure is vital to stimulate private sector economic activity. For example, better roads improve the transportation of goods and people. Logistics costs are down. They all contribute to an increase in business activity. In addition, improved infrastructure will attract private investment and drive sustainable economic growth in the long term.
How are government capital expenditures financed?
In the government budget, taxes are the main source of financing. In addition, there are other sources such as contributions from state-owned enterprises, funds from privatization, and grants. If spending is insufficient to cover spending, the government takes debt, usually by issuing debt securities.
Capital investment by the government can be through the central government and local governments. In addition, it may be through state-owned companies, which are authorized to provide public services such as electricity, toll roads, and railways.
Certain infrastructure investments may be too expensive to finance through the fiscal budget. So, finally, the government invited the private sector to get involved. This scheme is known as Public-Private Partnership (PPP).
How PPP works can vary widely. For example, the private sector bears construction and capital financing during construction under a build-transfer scheme. Then, they hand over the assets built to the government with compensation according to the agreement.
There is another build-operate-transfer scheme. This is similar to the build-transfer scheme, where the private sector is responsible for the development and financing of capital. However, instead of directly handing it over to the government, the private sector operates and manages the assets built for a set period to recover investment costs and generate returns. After that, they hand over the assets to the government.
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- Transfer Payments: Importance, Types, and Criticism