A national debt is generated when a government runs a budget deficit for consecutive fiscal years; hence its expenditures (for administration, defense, welfare programs, and so forth) exceed its revenues (taxes). In such cases, the government seeks to finance its deficit by borrowing money either from internal sources or from abroad. The “national debt” is the sum total of all the outstanding obligations (bonds, bills, and notes) issued by the Treasury. Consequently, much of the concern about public deficits arises from their cumulative effect on the national debt.
Nowadays, most countries, regardless of their level of development, face persistent deficits and increasing national debts, which in many economies (such as Latin America, Southeast Asia, and Europe) have reached alarming proportions in relation to their GDP, which is the basis for appraising the size and the safety of national debts. To cite examples, for the United States this ratio is approximately 65 percent; for Italy, 120 percent; for France, 75 percent; and for Belgium, 100 percent. Most contemporary economic policies have as a major target the reduction of the national debt, and most governments follow stabilization policies that reduce their public deficits through cutting their expenditures. But what is the burden of a public deficit and by extension of a national debt?
A major burden of national debt on an economy comes from interest payments, which, however, should not burden an economy if the payment does not involve a leakage of income to foreign holders of the debt (external debt) or if it does not impose severe distortions in the way income is distributed among various groups. In general, as long as growth continues and the debt's relation to GDP remains the same, there is no reason why a national debt cannot increase indefinitely. Is there, then, no burden to a debt? If debt remains a constant fraction of the GDP, we should experience no burden because tax revenues would provide the needed interest. If debt increases, it should still pose no burden as long as the economy grows fast enough to provide the additional tax revenues needed for additional interest.
Critics of budget deficits often argue that the burden of deficits eventually falls on future generations because deficits cause the “crowding-out effect” that results from the intense competition for capital funds between private and public investors. The outcome of this search for funds is an increase in interest rates, which eventually reduces growth in the business sector and the income stream of future generations. Furthermore, the increase in interest rates attracts foreign investors and leads to foreign indebtedness; as a result, the externality of the debt creates increasing leakages from the domestic income stream.
Is the debt too large? Is the deficit a danger to an economy? These questions cannot be answered without taking into consideration many aspects of the economic policy a government is pursuing. Deficits can be useful in promoting growth by generating demand (the Keynesian perspective), or they can be dangerous as they generate excess demand (the monetarist and new classical perspectives). The general consensus among economists and policy makers, however, is that there is no absolute magnitude that separates a useful debt from a dangerous one. A deficit that is mainly incurred to promote public growth-producing services such as education, health, and infrastructure (productive activities) will definitely have an impact on the development process of an economy that is different from a deficit incurred to promote activities such as administration and defense (nonproductive activities). The reason is that growth-promoting state activities generate future income activities and tax revenues to repay the debt, whereas the second case is just a form of income leakage.
SEE ALSO Aggregate Demand; Government; Macroeconomics; Policy, Fiscal
Eisner, Robert. 1994. The Misunderstood Economy: What Counts and How to Count It. Boston: Harvard Business School Press.
Heilbroner, Robert, and Peter Bernstein. 1989. The Debt and the Deficit: False Alarms/Real Possibilities. New York: Norton.
Lipsey, Richard G., Paul N. Courant, and Christopher T. S. Ragan. 1998. Economics, 12th ed. New York: Addison-Wesley.
Persefoni V. Tsaliki
Clive H. Lee
na·tion·al debt • n. the total amount of money that a country's government has borrowed, by various means.