p Ever since the Great Depression of 1929-1933 the centre of emphasis in the theories and practices of economic regulation has gradually been shifted from measures of monetary policy to operations in the sphere of public finance. This is a reflection of definite structural changes in the development of the capitalist economy. Expansion of the economic functions of the government and the effecting of numerous state-monopoly measures presupposed a sharp rise in the share of the national income going into the channels of public finance. After a number of unsuccessful attempts to eliminate the Great Depression of the 1930s with the help of the policy of cheap money, faith in the possibility of influencing the course of economic growth through monetary policy was undermined. Keynesian concepts of economic regulation, widely disseminated during this period, were assigned a decisive part in operations in the sphere of government finances.

p In the post-war period the discussion on the choice (and/or proper combination) of individual forms and methods of economic policy flared up with fresh force in Western economic literature. Today in almost all these discussions the financial operations of the state are regarded as a direct and efficient instrument and, in the opinion of some opponents of financial regulation, even “excessively powerful" (from viewpoint of the general proponents of the private enterprise economy) for influencing the economy. Of late, 109 budget policy has been attracting the particular attention of Western theoreticians in connection with mounting military expenditures and the need for financing an ever wider range of government measures to stimulate economic growth, accelerate the development of many sectors of economy and so on.

p A solution to a major question of financial theory, the optimal size of government consumption, has always been closely linked with the dominant general economic concept. Since the days of Adam Smith and David Ricardo an adverse attitude to big government spending has been quite firmly entrenched in Western economic literature. Exponents of the classical political economy emphasised the unproductive nature of government spending and assumed that in ordinary conditions it must be kept down to a minimum.

p The extensive spread of the microeconomic marginalistic theories, which imparted a universal nature to elementary relations of the purchase and sale of goods, also left a definite imprint on the development of financial science. The gradual ousting of the methods of study employed by classical political economy and the wide introduction of the apparatus of .microeconomic analysis ushered in a new approach to the problem of government spending.

p The category of “services” the government renders to the individual is gradually assuming a central place in financial theory. The demand for these “services” is presented, according to the new financial concept, not by society as a single political and economic entity but by every member of society; in this connection the demand for governmental services from the very beginning is considered an individual demand. The relations between the consumer of government services and the state are analysed in accordance with the partial equilibrium method. Since government expenditures represent simply a specific form of goods, the nature of government spending is determined solely by the composition of the effective demand of the population.

p This concept gained dominant positions in Western financial literature at the end of the 19th and early 20th centuries. It was most consistently expounded in Germany by Friedrich von Wieser; Austria, Emil Sax; Italy, Maffeo 110 Pantaleoni and dc Viti de Marco; and in the Scandinavian countries, by K. Wicksell and Erik Lindahl. The proponents of this concept see, as one of its major advantages, that it makes possible the linking of the theory of public spending and taxation. Budget appropriations and taxes become one and the same act of exchange, the purchase and sale effected between the private buyer and the government.

p The central role in this transaction is played by the subjective evaluations of the utility of governmental spending, on the one hand, and the similarly subjectively evaluated burden of tax payments, on the other. Thus in their relations with the state, consumers are guided by the same principles as in buying other commodities in the market: they buy the services only so long as the marginal utility of these services still exceeds the marginal disutility ( subjective burden) of the paid taxes. If the further development of the transaction proves disadvantageous for the taxpayer he refuses to shoulder the additional expenses of the state. Given such a premise, the precondition for the optimum financial activity of the government is the equal valuation by every consumer of the marginal utility of government services and the marginal utility of the money paid in the form of taxes. Provided this condition is observed the sum of the budget expenditure can ensure the maximum utility of the services from the point of view of the population.  [110•1 

p With such an approach, the financial activity of the state does not enter into contradiction with the processes of price formation on other markets: on the contrary, it fully meets the requirements of commercial accounting and forms an important component of the entire market mechanism.

p In the financial literature of Anglo-Saxon countries, “most of their ideas about the subject, and even their prejudices,” as John Maynard Keynes pointed out, “are traceable to the contact they have enjoyed with the writings and lectures of the two economists who have chiefly influenced Cambridge thought for the past fifty years, Dr. 111 Marshall and Professor Pigou."  [111•1  After the publication of the Principles of Economics by A. Marshall and especially Economics of Welfare by A. Pigou, the academic theory began to link the financial activity of the state above all with the effect which Marshall designated as “external economy or diseconomy".

p The substance of this effect can be expressed as follows: in real economic life the production (or consumption) of one or another commodity within the bounds of one firm often exerts an essential influence on the nature of production functions of other firms (or correspondingly on the utility of commodities purchased by other consumers). In conditions of the dominance of private property such an interdependence inevitably assumes the form of an external economy (or diseconomy). The existence of this effect can undermine the conditions of “normal” competition. From this follows, as assumed by the proponents of these concepts, the need for financing governmental activity aimed at regulating the “external” conditions of production and consumption.

In modern economic literature we can find the most diverse schemes in which the financial operations of the state are deduced from the existence of one or another externality as well as numerous interpretations of government spending which link it first of all with the sociopolitical functions of the state. Any attempt to classify all these schemes and describe their approach to the question of the optimal level of government spending would lead us far beyond the bounds of the present chapter. Therefore we shall confine ourselves to a brief discussion of one of the presently most widespread and influential theories—the socalled “pure theory of public finance".