Economic Effects of Public Debt

Meaning of Public Debt

Public Debt can be defined as a loan taken by the government from its public and foreign countries as well. The government can take loans from the public, financial institutions, banks, business organisations, etc., and from foreign countries as well. Public debts are subject to a fixed interest and are repaid by the government to the creditors after the stipulated period expires.

According to J.K. Mehta, “Public debt is a comparatively modern phenomenon and has come into existence with the development of democratic form of governments in the world.”

Economic Effects of Public Debt

1. Effect on Consumption: Public debt has a contractionary effect on the economy through reduced consumption expenditure. The purchasing power of the customers is reduced due to their contribution towards public debt, making them unable to buy goods and services in the same quantity in which they used to purchase them earlier. It is on account of this that governments all over the world resort to large-scale public borrowings to reduce the impact of inflation. Foreign loans can have a positive impact on domestic consumption. If foreign loans are used for importing those goods and services that are needed by domestic consumers, the result will be increased consumption expenditure and reduced inflationary pressure in the economy.

2. Effect on Private Investment: Public debt leads to less availability of funds for private investors for investment opportunities. Investible funds are limited in the market. If the funds get blocked in public debts, fewer funds will be available to the private sector. Public debt; therefore, impinges directly on the availability of funds to the private sector.

3. Effect on Distribution: Public debts also affect distribution. If the public loans are subscribed by rich people only and the amount so realised is spent by the government on the economic welfare of poor people or low-income groups, the benefit will be a narrowing down of the inequalities and more equal distribution of income between people. However, if the poorer classes have to bear the burden of public debt along with interest payments, the tendency of public debt would increase the inequalities of incomes.

4. Effect on Production: If the people buy government bonds/securities by withdrawing money from their industrial concerns or by selling debentures and shares of industrial concerns or financial institutions and even commercial banks subscribe to government loans out of funds meant for investment, then the investment is adversely affected, leading to adverse effects on production. However, if the government utilises this money in commercial public enterprises, the total investments available for production may not be adversely affected.

5. Public Debts and Credit Control: Public debt also produces some impact on the effectiveness of credit control measures by the Central Bank. It is well known that the main contributors to public loans are the commercial banks, which are required to invest a pre-determined percentage of their investible funds in government loans in exchange for bonds. These government bonds are highly liquid assets that are converted into cash in no time.

6. Effects on Cost of Production: The cost of production of a product depends upon the prices of raw materials and other factors used in production. The state utilises the borrowed money in providing raw materials to the producers at reasonable/concessional rates. The state may also utilise borrowed money in promoting industrial research as well as in providing subsidies to private enterprises.

7. Effects of Foreign Loans on Economy: External borrowing in the economic development of under-developed and developing countries has made possible the import of high-priority goods or capital goods or goods to be used to create, build, and develop capacity for accelerating the rate of growth of the economy.