The social and economic effects of government borrowing

The first public borrowing in the modern sense took place in the early twentieth century due to the financing of the First World War. According to the classics, the budget should be a balanced budget. Modern economists and Keynesians, however, focus on the economic effects of government borrowing and have argued that adjustments should be made according to these economic effects.

Reasons for borrowing for economic reasons

a) Eliminating budget deficits

b) Providing financing for defense expenditures

c) Creating effects that provide and maintain economic balance

d) Financing major investments and reforms

e) Ensuring efficiency in resource allocation and utilization

f) Directing savings to specific investments

g) Providing financing for matured debts

•Effects on Consumption:

a) Contractionary effect

b) Expansionary effect

The effect of government borrowing on development is primarily related to the increase in per capita national income. If borrowing can be directed toward investments, it can have a positive impact on development. In developing countries, external borrowing has a more positive effect on economic development than internal borrowing. Although external debts initially create expansionary effects, they can also have contractionary effects during the repayment period if they are not managed well.

•Inflationary Effects:

•Increase in Money Supply:

Government borrowing can be financed through borrowing from the Central Bank or by selling bonds. If the Central Bank increases the money supply by purchasing government bonds, this can lead to inflation. This is because more money circulating in the market can lead to an increase in demand and, consequently, a rise in prices.

•Increase in Demand:

Public expenditures financed by government borrowing can increase aggregate demand. If this increase in demand exceeds production capacity, inflation may occur due to supply-demand imbalance.

•Expectations:

If market actors believe that government borrowing will lead to inflation, these expectations can trigger inflation by influencing price and wage-setting behaviors.

•Inflation-Reducing or Neutral Effects:

Efficient Use:

If government borrowing is directed toward productive investments (infrastructure, education, etc.), these investments can increase production in the long run, improve the supply-demand balance, and keep inflation under control.

Intergenerational injustice

Borrowing transfers the burden that would otherwise be met by taxes today to future generations. The maturities and areas of use of the borrowing determine this situation.

Effect of borrowing on income distribution

If the government borrows in the capital market at the current interest rate, meaning it does not raise the price of capital as a factor of production, borrowing does not have a distorting effect on income distribution. Conversely, if the government borrows by raising the current interest rate in the capital market, individuals will reduce their consumption expenditures to earn more income, thereby increasing their savings; it is clear that high interest rates will distort income distribution in favor of savers.

Effect of borrowing on income distribution

Considering that taxes are the primary source of financing for government debt, the structure of the tax system becomes important.

In tax practices based on indirect taxes and mostly aimed at consumption, the financing of government debts and interest payments, etc., will generally have negative effects on income distribution because the source of financing will be different from the segment that earns the interest income from government borrowing. In other words, the interest and similar returns of the segments of society capable of lending are being financed by those who are more in need of support in terms of income level.

If the tax system, as a rule, has a structure based on direct taxes and personal tax practices are in the majority, horizontal income distribution will be affected, meaning transfers will occur within the same income group.

The increase in interest payments due to borrowing can lead to problems such as a decrease in social expenditures like health spending in the budget.

The excessive increase in the debt burden of developing countries leads to a loss of control in debt management after a certain point, and the interest rates rising due to the treasury's demand for resources also hinder growth. In an economy contracting as a result of rising interest rates, new instabilities sometimes arise due to maturing external debt payments, which can make the developing country dependent on external debt and hot money. An economy dependent on hot money, which is sensitive to political developments, will disrupt social and economic balances in favor of the rentier class.

Today, the classical fiscal view that borrowing is an extraordinary public revenue seems to have completely lost its effectiveness. In fact, it is observed that, as a result of various political and economic preferences, borrowing is frequently resorted to as a low-cost and easy source, just as if it were an ordinary source of revenue.

One of the primary reasons why borrowing has become a frequently used method of public finance, since the classical economic view, can be attributed to the development of the functions and responsibilities of the public sector. Today, borrowing does not remain merely a tool that serves as a rebalancing instrument according to the economic conjuncture, but also actively contributes to the realization of all other fiscal policy objectives.

The effect of government borrowing on income distribution depends on how the borrowing is managed. If borrowing is directed toward productive investments and social programs, it can improve income distribution. However, if borrowing leads to high interest payments and inflation, it can make income distribution even more unequal.

It is important for the government to manage its borrowing policy carefully, keep the debt burden at a sustainable level, and use borrowing in productive areas. With good debt management, borrowing, which is an effective and practical method for public finance, has significant advantages for individuals and the country's development when used in a timely and appropriate manner; however, when control is lost in debt management, it can create economic and social negatives that are difficult to compensate for.

Prof. Dr. Duran BÜLBÜL