Role of Public Debt in Economic Development

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Role of public debt in Economic development. How public debt can be good and how it can be a bad thing for an economy. A developing economy has to tap all possible sources to mobilize sufficient financial resources for the implementation of its e

Role of Public Debt in Economic Development

A developing economy has to tap all possible sources to mobilize sufficient financial resources for the implementation of its economic development plans. It has to utilize revenue surplus for the purpose, seek external aid, and pitch up its level of taxation and resort to public borrowing in addition. But taxation and public borrowing are the two major instruments of resource mobilization.

Public borrowing has an important advantage over taxation. Taxation beyond a certain limit tends to affect economic activity adversely owing to its disincentive effect. There is no such danger in public borrowing. It does not have any unfavorable repercussions on economic activity by being disincentive, partly because of its voluntary nature and partly because of expectation of return and repayment.

The classical theory frowned upon public borrowing. It was thought that the government use of resources was less productive than in private hands. But the classical reasoning was based on the assumptions of full employment, inelasticity of money supply and unproductiveness of public expenditure. These assumptions, we know, are not valid.

Public borrowing for financing fruitful investment produces supplementary, creative capability in the financial system which or else would not have been achievable. It is utilized as a device to organize reserves which, in an under-developed economy, would otherwise have gone into hoards or invested in jewelry or real estate. Public debt would divert the flow of resources into the right channels. Thus, in an under-developed economy, public borrowing, if prudently managed and skillfully operated, can become a powerful instrument of economic development.

Growth and composition of public debt provide the monetary authorities with assets which they can manipulate to give effect to a monetary policy considered desirable in the context of economic development. Thus, monetary policy, which is considered essential for achieving objectives of economic policy, becomes virtually related to public debt management.

There are two significant ways in which the regimes of under­developed nations raise reserves via public loans; (a) market borrow­ing, and (b) non-market borrowing.

The loans may be voluntary or forced. Most of the types of public loans are voluntary. But if the voluntary loans do not prove sufficient for the purpose, forced loans become necessary and are resorted to: Important examples of forced loans familiar in India are Compulsory Deposit Scheme and Annuity Deposit Scheme.

Compulsory loans have a special advantage in the context of an inflationary situation and are superior to voluntary public borrowing. They sterilize funds, whereas voluntary public loans result in the creation of readily cashable bonds which would be monetized to increase liquid assets in the community which produce an inflationary effect. Also, lower rate of interest can be paid on compulsory loans thus reducing the cost of public debt. But a continuous policy of compulsory borrowing may arouse public resentment. Compulsory loans may be more suitable for financing specific projects which benefit specific regions or specific groups who may, therefore, be called upon to subscribe. Normally, it is the voluntary public borrowing programme which should be chiefly relied upon.

The Dangers of Debt

Too many times, a country will consider that debt is a good thing, but this just rolls the debt to the next year, year after year. It is just pushing the debt load to future generations. This causes the national debt to rise to dangerous levels. Other countries might buy a country’s debt, like in the United States selling treasury bills to U.S. citizens and many other countries.

Currently, the problem is keeping interest rates are artificially low rates, which its citizens. But sooner or later, interest rates will have to rise, and the debt will increase, possibly dramatically.

Selling bonds is one way to pay for city, county, state and country projects, but once again, there is interest that has to be paid on those bonds, and sooner or later, those bonds come due, and they have to be paid off to the bond holder.

Bonds can certainly be a great way to pay for a project, like a new highway, bridge or many other types of projects that can help a city. But once again, they have to be paid off sooner or later. And investors understand that if there were to be a default, they are out most if not all of their lent money to the owners of those bonds.