Public Debt and Economic Growth

After reading this article you will learn about the role of public debt in economic growth of a country.

Economic growth necessitate monetization of an increasing propor­tion of economic activities and larger volume of financial transac­tions. This in turn results in an increase in financial requirements of the economy.

When economic growth gets accelerated, internal re­sources became insufficient to meet the diversified economic activi­ties. As a result government resorts to public borrowing to finance the growing economic activities.

In this context, Gurley and Shaw and the Radcliff Sayers Com­mittee, assigned an important role of public debt in the economy of a country. The Gurley and Shaw thesis underlines the fact that physi­cal growth of an economy is not sustainable without a correspond­ing financial growth.

Public debt forms the superstructure of the fi­nancial system. Hence for a healthy and strong growth of the finan­cial system, a corresponding growth of the public debt of the nation is imperative. The Radcliff Committee emphasized the role of public debt as a powerful tool in the credit and monetary regulations of the economy.

During the process of economic growth, larger proportion of eco­nomic activities gets monetized. It means that when economic activi­ties like production, consumption, distribution trade etc. grows; it necessitates a corresponding growth in the financial transactions of the economy. This may in turn change the composition of the finan­cial structure of the economy.

The credit structure of an economy consists of two components – inside money and outside money. The loans and financial claims against the private sector of the economy are termed as inside money. Whereas outside money refers to the financial claims against the government sector.

It is to be remem­bered that the large variety of government loans create a conducive atmosphere for the healthy development of financial markets and financial institutions of the economy.

As the economy grows, there will took place a proliferation of banking and non-banking financial intermediaries. These credit institutions contribute towards the or­derly development of financial institutions and for the mobilization and channelization of fragmented savings of the community into fruitful productive activities.

These institutions also facilitate the develop­ment of the credit structure of the economy by adding their own debt obligations to the system. Inadequacy of capital resources is the most important factor retarding the economic development of developing economies. The scarcity of capital can be remedied through saving and investment.

However, since these economies are caught up in a vicious circle of poverty, augmentation capital resources through increased saving domestically is practically difficult. As an alternative measure to mobilize the required capital, the governments of these economies resort to public borrowing.

For instance, public borrowing can be used for the development of capital goods sector or for the expan­sion of social overhead capital, which is a highly productive investment, facilitating speedy economic growth.

Public borrowing in this context can be divided into two parts:

(a) Borrowing from the market proper, and

(b) Borrowing from the central bank.

These different types of borrowings produce different effect upon the economy. If the mobi­lization is done through market borrowing, the net effect on saving and capital accumulation depends upon the source of such borrow­ing.

If the public, subscribe loans floated by reducing their consump­tion, it will lead to a net increase in the speed of saving and capital accumulation.

On the other hand if the mobilization is done through borrowing from the central bank, it is equivalent of printing currency. This may generate an upward rise in prices. However, this is a dan­gerous process of borrowing. Governments always prefer mobiliza­tion of capital through market borrowing. In all the cases purpose of borrowing is most important.

If the loans are used for enhancing the productivity of the economy, leading to an increased supply of goods, inflationary forces can be controlled. Thereby the government can overcome the evil effect of public debt.