Since the Great Depression of the 1930s, the Public Debt of nations has increased manifold. It rose from 53% of GDP to 80% of GDP in advanced countries during 2007-12. The impact of public debt on an economy depends upon a variety of factors- the sources of debt, the use to which it is put, terms and conditions, maturity period and interest rate.
The concept of the burden of public debt has been a source of debate among various economists.
According to Buchanan (1958), the primary real burden of public debt falls onto future generations. Since payment of taxes is a burden in itself, debt financing postpones the levy of taxes to future generations.
Bowen Davis Kopf (1960) argued that public debt reduces the amount available for private consumption by the community at the time borrowed funds are used, and thus it affects the present consumption expenditure.
According to Modigliani’s burden thesis (1961), public debt, whether raised internally or externally, is advantageous to the generation present at the time of increase and will pose a burden on future generations through the reduction in the stock of capital. The gross burden of public debt on future generations can be measured by the interest charged on it. This burden can be reduced if the rise in debt is accompanied by an increase in government expenditure to finance productive capital formation.
Modigliani argues against public debt as it can alter the use of private resources and will displace private investment. Moreover, it can contribute to the rise in income disparities in underdeveloped and developing countries as it benefits the rentier class receiving interest on government bonds. Hence it seems that different economists perceive public debt differently, but there in no unanimity on the definition.
Public borrowings create monetary and real burdens on an economy and its public. In most cases, it leads to the redistribution of resources from more productive to less productive sectors. The public debt tends to increase the disposable income of the present generation and reduction of disposable income for future generations through an increase in taxes to generate funds for debt repayment.
Burden of Internal Debt
● Direct Monetary Burden: In the case of internal debt, there is a transfer of resources from one agent to another, i.e. from the hands of the public to the government. The aggregate position remains the same in this case, as there is no direct monetary burden on the nation as the repayment of debt and the interest involves a transfer of purchasing power within the country.
However, when we take into account the burden imposed on the general public, whenever a government has to pay off its debts, it raises taxes to generate funds. It poses an additional tax burden on the future generation. An increase in taxes can lead to the reduction of disposable income and private consumption expenditure.
● Indirect Monetary Burden: The loans raised by the government lead to the creation of additional demand for goods and services and, in case of supply shortages, can lead to higher prices.
● Direct Real Burden: It refers to the burden borne by society due to the sacrifice of economic welfare and stresses the taxpayers. The public debt is acceptable if it leads to the expansion of productive capacity and a return on it outweighs the cost of the debt. However, a debt incurred to finance unproductive activities can lead to a serious loss of social-economic welfare.
● Indirect Real Burden: Higher taxes imposed by the government reduce disposable income and discourages taxpayers to work hard for higher incomes. A fall in disposable income reduces aggregate demand and thus adversely affects the productive capacity of the economy.
⟹ Inflation: The monetized public debt raised by the government heightens inflationary expectations. The resulting increase in the money supply leads to additional demand and thus creates inflationary pressure in the economy. If the government raises indirect taxes for the purpose of raising funds for debt repayment, it may fuel inflation due to the resulting rise in prices of goods and services, adversely affecting the purchasing power of the poor.
⟹ Unjustified Transfers: The servicing of internal debt in the form of debt repayment and interest payment involves the transfer of income from present to future generations and from active to inactive organizations.
● Effect On Private Investment: Public debt crowds out private investment. Debt servicing involves huge interest payments. Therefore, there is a transfer of resources from the private sector to the government. Lesser funds are available for private capital formation and with the government for development activities such as infrastructure development. The lack of economic infrastructure further discourages private investment, which ultimately affects economic growth.
● Effect On Social Development: Debt servicing implies fewer funds available for socio-economic infrastructure development, especially for social development activities like health, education, sanitation, old age and family welfare, etc.
Burden Of External Debt
During the initial stages, External debt is beneficial for developing countries as it brings with it necessary foreign exchange reserves, helps to bridge the saving-investment gap and brings along technical know-how. Thus, it increases the resources available to the country. But its repayment and servicing create a burden on them, especially when they are already facing payment problems. The recent fall of Greece’s economy is one example in this regard.
● Direct Monetary Burden: External debt involves the transfer of resources/funds from the debtor country to the creditor country and institutions. Higher debt and associated debt servicing imply a greater burden on the debtor country.
● Direct Real Burden: External debt causes loss of economic welfare of the citizens of the debtor country. It has to reserve resources for debt repayment and servicing, which means fewer funds available for domestic consumption. For example, a country earns foreign exchange from the export of its goods and service, which can be utilized for the import of advanced goods and technology. However, in the presence of external debt, it has to create funds out of these reserves for debt repayment.
● Indirect Monetary and Real Burden: Debt servicing involves raising funds through an increase in taxes and a reduction of public expenditure. This, in turn, affects domestic production, consumption and allocation of resources.
● Debt Trap: Countries especially developing and underdeveloped ones, are heavily dependent on external borrowings for their development and nondevelopment programs. Moreover, they find it difficult to service their debt out of their own resources and, in turn, borrow more to repay their loans. This creates a vicious circle where countries get debt trapped.
● Unproductive Foreign Debt: External debt, which is incurred for unproductive purposes, will pose a greater burden and involve greater economic sacrifice on the debtor nation.
● Burden on Foreign Exchange Reserves: As mentioned earlier, servicing external debt requires foreign exchange. During an international crisis, there is often a contagion effect where a crisis in one country easily spreads to other countries. A good amount of foreign exchange reserves provides a cushion against such adverse events. Therefore a country must
maintain a good foreign exchange reserve.
● Domination by Creditor Country: Many times, a creditor country poses restrictions on the debtor country, especially if it is a small underdeveloped one. Thus, external debt might involve domination by the creditor country on the debtor country.
Read More in: Theory of Public Finance
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- Concept of Public Goods, Private Goods, and Merit Goods
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