Public Debt

Public Debt: Concept

The practice of raising public debt by the state to finance government expenditure started only since 19th. Century. But the royalties used to borrow on their personal goodwill even since ancient times. These days government borrowing has been almost a normal method of financing government expenditure.

J.L.Hansen, “Public debt is the debt owned by a government to people and institutions within its own borders and/or to foreign creditors.”
Philip E. Taylor, "Government debt arises out of borrowing by the treasury from banks, business organizations and individuals. The debt is in the form of promises by the treasury to pay back the holders of these promises a principal sum and interest on the principal."
Public debt is raised internally by floating the securities like bonds and treasury bills, and overdrafts from the central bank. Externally, it is raised from foreign individuals and organizations, donor governments and international financial institutions. Normally, government borrowing is voluntary in nature, but sometimes it may be coercive or with some influence.

Generally, the classical economists were against public debt. They strongly believed on the laissez-faire policy, and so favored minimum size of the government as far as possible to them. Government borrowings is mostly unproductive, inflationary and burdensome. However, they approved debt financing in the productive projects called as the self-liquidating projects. According to Musgrave, "The self-liquidating projects may be defined as investment on public enterprises that provide a fee or sales income sufficient to serve the debt incurred in their financing. It can be defined in a broader way as expenditure on projects that increase future income and the tax-base. Such projects permit serving of the debt incurred in their financing without requiring an increase in the future level of tax-rates.”

The Keynesian view after the 1930’s Great Depression advocated the need for the use of public financial operations as fiscal policy for maintaining economic stability. To them borrowing may not necessarily be unproductive, inflationary and burdensome always. It is accepted as the best option in a period of depression, and to some extent even to control inflation. According to Lerner,,government should borrow only when it wants to make people hold more bonds in place of money. The desirability or otherwise of public borrowing should be judged in terms of its effects on aggregate demand and the economic situation.

The modern view is concerned about its importance in raising and mobilization of financial resources, its management, and relationship with the monetary policy. It has been accepted that debt financing beyond the limit is certain to invite severe economic problems.

Need for Public Debt

Borrowing by the state has been a normal method to finance public expenditure in both the developed and developing countries. In different situations or for different purposes public debt is raised.
  1. To manage current budget deficit: Governments do not have large accumulated reserves or cash balances to meet any current budget deficits. Normally, it is said that the regular expenditure should be financed from revenue sources. But due to many reasons sometimes income from revenue sources may not be sufficient to meet even the regular expenditure as required. Besides, the unexpected emergencies like fire, floods, famines earthquakes and other natural disasters necessitates a large amount of government expenditure for rescue and relief works. In such situation governments are compelled to borrow.
  2. To meet war expenses: Borrowing to finance wars is in practice since ancient times. In modern times, the cost of warfare has been tremendously increased with the development in war technology and techniques. In a situation of war, income from revenue sources will not be sufficient to meet war expenses. Besides, in such situation, economic activities generally decreases leading to low level of national income and low yield from taxation sources. In such situation it is not desirable to increase rate of taxes beyond desirable limits which may create serious socio-economic and even political problems in the country. So, it is better and convenient for government to borrow in a warfare situation.
  3. To maintain economic stability: The idea of compensatory finance and functional finance has recognized the importance of borrowings to maintain economic stability. In a situation of depression. Government is to increase its expenditure, mainly by borrowings, to increase effective demand in the economy. To control inflation, government is to borrow out of the peoples’ fund which is likely to be used for increasing consumption expenditure. At the same time, the borrowed money is to be invested on production of goods and services by itself or private sector, Besides, government may borrow from external sources to manage trade deficit.
  4. To promote the rate of economic growth: One of the main constraints in the process of economic growth in the developing countries is lack of sufficient investment resources. To exploit or utilize the potentiality of natural and human resources, it is necessary to make a significant investments on them. For this, the savings of individuals and private corporate bodies can be increased voluntarily by borrowings with attractive monetary benefits. Borrowing from banking and financial institutions including central bank, is needed for productive use of unused or idle resources. Besides, borrowing from external sources in a wise way and effective investments helps in increasing productive capacity of the economy and national production.
  5. To manage the problem of Balance of Payments: In a situation of deficit in the balance of payments, government may borrow from external sources for funding the import requirements.

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