Essay, Pages 10 (2480 words)
1.1.1. National debt definition and termsOne might think that defining national debt is easy however it turns out to raise some questions concerning the inclusion of the definition. Debt can be divided to two divisions’ private debt and public debt. The private debt refers to debt that is hold by households and businesses within a country while the public debt, or national debt is the sum of the financial obligations incurred by all government bodies of a country (Meakin, 2018). Literately based on COBUILD Advanced English Dictionary, National debt defined by all the money that the government of the country has borrowed and still owes; also based on Collins English Dictionary, National debt nown as public debt defined by the total outstanding borrowings of a nation’s central government.
Rather many economists defined national debt. National debt or public debt refers to the overall debt that a government owes externally or internally and is a very important element of a county’s financial system (Moffat, 2017).
Also referring to international financial institutions such as IMF, based on IMF DSAx Glossary, public debt is the total financial obligations incurred by all governmental bodies of a nation, thus also known by national debt.The national debt also has several terms such as public interest, public debt, national debt and sovereign debt that all refers to the debt owed by a government (US department of treasury, 2010). Thus in this thesis the term national debt refers to the sololy public debt that owed by government, and all terms public interest, public debt, national debt, government debt and sovereign debt all refers to the same meaning.
1.1.2. National debt benefits and costsPublic debt is inevitable phenomenon of economic growth it can be borrowed internally from domestic investors or externally from foreigners and used to stimulate economy through economic projects and investments that would be beneficial and wealthy for the economy and society and could generate additional surplus if public debt was managed efficiently, meaning that if the economic benefit is able to cover the debt costs (Karazijien— & Sabonien—, 2009). Despite this benefit public debt must be handled with care, since in case of too high debt levels the cost of debt becomes higher than its benefits and starts reducing the GDP. Public debt can be viewed as delaying of taxation so country may choose to borrow instead of rising taxes as means of financing; however borrowing will place higher costs on future generations that could be covered with higher taxes, moreover the economic growth that could be reached from borrowing through injection of investments in the market can be lost thereafter when debt plus its costs should be repaid (Martin, 2009).Moreover studies showed that an increase of public debt could lead to a decrease in private consumption (Berben & Brosens, 2007; Aiyagari & Mcgrattan, 1998). Moreover public debt can be harmful for a country that has financial problems such in developing countries (Ismihan & Ozkan, 2012). Also economists explained the fact that the economic costs of public borrowing on the long term is higher than its economic benefit, thus public borrowing on the short term could reach considerable growth effects, however if public borrowing became as a tradition and became the main source of funding then it inevitably will be harmful (Kellermann, 2007). On the same hand Baum et al. (2012) who find that the short run impact of debt on growth is positive and highly statistically significant, but decreases to around zero and loses significance beyond public debt-to-GDP ratios around 67%. They also find that for high debt-to-GDP ratios (above 95%) additional debt has a negative impact on growth. This evidence is in line with Kumar and Woo (2010) and Checherita and Rother (2010) who also find that only high debt levels (exceeding 90% of GDP) have negative and significant impact on growth.Additional studies revealed that high debt levels burden social expenditures, since government while budgeting will be forced to ensure the higher debt obligations before cutting any social expenditures and this will reduce social wealth (Lora & Olivera, 2007).1.1.3. National debt, internal versus externalPublic debt can be borrowed either internally within the country from domestic banks, financial institutions, other business and interested investors through issuing treasuries dominated in domestic currency; or public debt can be borrowed externally from foreign governments and other parties through euro bonds with certain face value. In both cases debt should be repaid in full based on the debt instrument’s face value plus a specific yield (Interest rate) at a specific time. Both ways whether internally and externally have negative symptoms. Domestic debt gives an opportunity to substitute delay of repayment with better tax rates, social guarantees. It is considered to be safer, since citizens of the country are in debt only with each other so debt issue can resolved much easier. Also high domestic government debt may result in reduced private credit flows. This would mean slower development on private enterprises and other economic initiatives. Consequently it could lead to economic slowdown. This case had been analyzed by Emran & Farazi (2009). Moreover according to Abbas (2007), excess government sector demand for domestic fund tends to push up domestic interest rates. The higher interest rates increase the cost of financing new private investment ” crowding ” out ” and hence limit economic growth. The higher interest rate may also have an adverse effect on the trade balance which is an important parameter of economic growth. Since The government assets become more attractive to foreign investors, so the demand for local currency will increase which tends to push up the price of domestic currency in terms of other currencies, the imports will rise and the exports tend to decline (it became more expensive), hence large trade deficit will ensue which ultimately hinder the economic growth (Blavy, 2006).On the other side External debt holds more risk, since it is hard to negotiate with foreign investors for better terms in case of debt crisis. It also includes additional risks, such as exchange rate risk, if external debt is denominated in foreign currency, however external debt usually has longer terms and lower interest rates but usually refer to a particular project which has to meet specific conditions, meaning restraints for using borrowed funds. Efficient public borrowing planning must be present in order to determine which financial instruments will provide country with most benefits and will result in the least costs possible.Economists studied relation between public debt and economic growth rates, Reinhart and Rogoff (2011) found that there is no strong relation at normal debt rates, however when public debt reaches 90% out of GDP and over, then growth rates are lower 1% than other comparatives. And for emerging countries when debt reaches 60% of GDP, annual growth declines by about 2%; for levels of external debt in excess of 90% of GDP, growth rates are roughly cut in half. Also, Patillo et al. (2011) find that the impact of external debt on growth in a sample of 93 developing economies is negative for levels of external debt in GDP exceeding 35-40%. Clemens et al. (2003) also find the negative relationship, but at a lower threshold (beyond external debt in GDP around 20-25%). Cordella et al. (2005) find that there is a negative marginal relationship between debt and growth at intermediate levels of debt, but not at very low debts level or, surprisingly, very high levels (above 70-80% of GDP). Sclarek (2004) also investigated this link in the sample of developing economies and found the linear negative relationship.All these evidences show the risk of public debt on the economy specially the external debt, thus regardless of the source, public debt should always be controllable.1.1.4. National debt determinants There are many different macroeconomic factors that forces government to increase its National debt. These macroeconomic factors are the main determinants on public debt.Many studies detected the relation between economic growth on public debt.First economic growth is defined as ‘a rise in the total output (goods or services) produced by a country’ (GDP). It is an increase in the capacity of an economy to produce goods and services, compared from one period of time to another (Abbas, 2005). Economic growth can be measured by the percent rate of increase in the gross domestic product (GDP) (Ayres, and Warr, 2006).Schclarek (2004) examined the relationship between debt and growth for 59 developing and 24 industrialized countries with data averaged over each of seven 5-year periods between 1970 and 2002. For developing countries, the results show that there is a negative and significant relationship between total external debt and economic growth. Further, this negative relationship is driven by the incidence of public external debt level and not by private external debt levels. In the case of industrial countries findings reveal that there is not any robust linear or non linear relationship between total external debt and economic growth. These results are in clear contrast with the results for developing countries. For industrial countries higher public debt levels are not associated with lower growth rates. Presbitero (2005) used dynamic panel estimations to examine the relationship between external debt and economic growth in poor countries. The results for a panel 152 developing countries over the period 1977-2002 show a negative linear relationship between external debt and economic growth, and between debt service and investment. The negative effects of external debt on economic growth are due to the crowding out of the public investments. These effects are found to be stronger in the low income countries than in the overall sample creating questions about the major effect that debt has in the world’s poorest economies. Moreover Krugman (2010) argued that low economic growth could lead to high levels of government debt.All these studies shows a controversial negative relation between public debt and economic growth showing that countries facing economic constraints mainly the developing ones are more subjected to an increase in total public debt than countries having healthy economy. However many macroeconomic factors plays a critical role in economic growth and strongly affects it and in relation with national debt, thus for a depth analysis we have to go more deeply to detect the major macroeconomic factors that affects economic growth and in turns could influence national debt. Trade deficit in relation with national debt.Many economists examined the effect of trade deficit on public debt (Demirguc-Kunt and Detragiache, 1997; Reisen, 1998b; Milesi-Ferretti and Razin, 1998; Kaminsky, Lizondo and Reinhart, 1997) all explained the concept that trade deficit specially in developing and lower income countries reflects weaker production and investments which reflects lower GDP, lower economic growth, lower income revenues for the government that could be collected from taxes on productions, lower private savings due to lower productions, high unemployment rates , all forces government to borrow additional debt to stimulate the economy, increase production and investments, create jobs and balance the trade deficit. Freiling, and Robinson’s (2012) also explained that government could go to public debt to stimulate economy when trade deficit gap widen and unemployment rate increase. Pattillo, Poirson, and Ricci (2002) using a large panel data of 93 developing countries over the period 1969″1998 find that up to approximately 160% of debt level external debt- to – export is growth enhancing. Thereafter, it is growth reducing (debt overhang range). Also they found the same impact of external debt on per capita GDP growth for debt levels above 35-40 of GDP as a turnover point.This also reveals that the debt overhang mechanism works through the productivity along with the volume of investment. Later, Pattillo, Poirson, and Ricci (2004) also found that the negative impacts of external debt on growth are transmitted strongly through total factor productivity (TFP) and investment (physical capital accumulation). However, the impact of external debt on human capital accumulation is insignificant. This study shows the importance to keep high levels of investment and productivity within a country to keep high levels of exports over external debt to keep enhancing growth. Unfortunately incase level of exports decrease the level of external debt will increase in proportion to the level of exports thus deteriorate growth. Virtually all developing countries agree that market access for their products (Exports) is the prime instrument to reduce their huge foreign debts by generating trade surplus.(Tambunan and Kadin 2006).Moreover a study emphasized that the nature of exports of the developing countries plays a critical role in the nation’s public debt, the study revealed that developing countries mostly depend of primary commodities in their exports, this high dependence on commodity export is strongly connected with debt problem in two ways. First the world prices of the commodities have been declining for the last four decades. Between the years 1977 and 2001, prices for 41 out of 46 leading commodities declined (after adjustment to general inflation). Second the prices of commodities are subject to sharp fluctuations. This makes them subjected to terms of trade shocks that introduces high levels of uncertainty to their balance of payments, and (indirectly) also impact negatively their fiscal positions, rates of growth, poverty and external debt. (Caliari A. 2005).Bduget deficit:Governments over the world have been financing their budget deficit through debt financing. The debt could be attained through funds from the domestic market or the external market. Reducing the gap between investment and savings is the main reason why the governments borrow (Likita, 2010). Scarce of internal capital formation due to repeated circle of low productivity, low savings and low income are symbols forcing developing nations to request public debt to cover the shortage (Adepoju, Salau, & Obayelu, 2007).Adam and Bevan (2005) find interaction effects between deficits and debt stocks, with high debt stocks exacerbating the adverse consequences of high deficits. In a simple theoretica model integrating the government budget constraint and debt financing, they find that an increase in productive government expenditure, financed out of a rise in the tax rate, will be growth-enhancing only if the level of (domestic) public debt is sufficiently low.Government expenditures:Many literatures and studies found a strong relation between spending and national debt. Mahdavi (2004) has analysed the impacts of debt servicing on public expenditure composition and finds that debt burden adversely affects capital expenditure’ and it invariably changes the spending composition in favour of payments of interest on debt, and nations that have a spending plan in such situation will find no solution other than additional borrowing to cover its expenditures. Moreover Fosu (2007) also argued that expenditure on debt servicing may either shift public expenditure away from social sectors such as health, education and maybe from public investment, which severely affects growth; or may force government to external financing to keep the balance in its social duties. Saint-Paul (1992) and Aizenman et al. (2007) analyze the impact of fiscal policy, proper management of taxes and public spending, in relation with the level of public debt, in endogenous growth models and find a negative relation as well.