ECONOMIC

THE

RESEARCH INSTITUTE

Public Debt and Economic Development

by

EDWARDNEVIN

December, 1962 Paper No. II.

73 LOWER BAGGOT STREET, DUBLIN 2.

THE ECONOMIC

E X E C U T I V E

RESEARCHINSTITUTE

BOARD I961-62- ~ "

J. J. MCELLmOT% M.A., LL.D.President of the Institute.

G. O’BRIEN, D.LITT., LITT.D.Chairman of. the Executive Board.

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%\-

C. S. ANDREWS, B.COMM., D.ECON.SC.,Chairman, Coras Iompair ]~ireann.

J. P. BEDDY, M.COMM., D.ECON.SC.,Chairman and Managing Director, The Industrial Credit Company Ltd.

R. D. C. BLACK, PH.D.Professor,. Department of Economics,. The QuEen’s Univemity, Belfast.

J. BUSTEEDi M.COMM,Professor, Department of Economics, University College, Cork.

G. A. DUNCAN, S.F.T.C.D.,Professor of Political Economy, Trinity College, Dublin.

R. C. GEARY~ D.SC., D.ECON.SC.,Director of the ~Institute.

W. A. HONOHAN, M.^., F.LA.,Secretary, Department of Social Welfare.

M. D. MCCARTtlY, M.A., PH.D.,Director, Central Statistics Office.

J. F. MEm~AN, M.A.; B~L.,Professor of Political Economy,~University College, Dublin.

C. K. ]~SIILL, B.A., D.SC.,Joint Managing Director, Arthur Guinness Son & Company (Dublin) Ltd.

¯ ¯ . . .... -.

; - _ .’.

, ¯F

D. N~3’IN,

ResarchOfficer, Irish Congress of Trad~ Unions., : ..’ .. /J} -"- :¯. / f~, :: ,

L. O’BuAcIIALLA, M.COMM., ....Professor, Department of Economics, University College, Galway.

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Cople~ of thla paper may be obtained from The E6on¢~mie and¯Social Research in~titute, 4 Burl~nEtan Road.

Dublin4 ...... price 28p a copy

G~ALD WILSON,

Governor, Bank of Ireland, Dublin.

T. K. WHITAKERi M.SC. (ECON.), D.ECON.SC.,Secretary, Depa.rtment of Finance.

J. C. TONCE,Federation of Irish Industries,

T. WALSH, D.SC.,Director, An Foras Talfintais.

Public Debt and Economic Development

Public Debt and Economic Development

by EDWARD NEVIN*

I. The role of tile public debt

Until the Keynesian revolution in economicthought, an increasing public debt was regarded bymost commentators as one of the evils of war andas an indicator of fiscal and economic folly in timesof peace. The Irish Banking Commission wastherefore very much in the prevailing stream ofinternational thought on this subject when it tooka:gr’ave view in 1938 of the growth of Ireland’spublic debt since 1924; the magnitude of this maybe seen from Table I. It led the Commission tothe firm conclusion that

Our considered view is that no increase whatever beyondthe existing volume of net dead-weight debt should bepermitted, and that volume should be reduced from yearto year at such rate as general financial circumstancespermit,t

As may be seen from Table I, their hope that thepublic debt would decline was in vain. Certainlyduring the decade 1935-45 the expansion wasrelatively modest, and the debt in fact declinedsubstantially in relation to the national income.Thereafter, however, the increase in th.e debt tookon gigantic proportions: between 1945 and 1953it nearly trebled, and between 1983 and 1961 it roseby a further 89 per cent. By 1961 it was more thantwice as large in relation to the national income as ithad been in 1935 ; the rise in the net annual debtcharge (interest payments, management expensesand sinking funds) was a little less pronounced--from 2"o per cent. of the national income in 1935to 3"7 per cent. in 1961.2

Even from a rigorously orthodox point of view,however, tlm position is not as bad in reality asthese figures might suggest. In the first place, aproportion of the gross debt (unfortunately ofunknown magnitude) rests in the hands of thegovernment itself or in those of agencies under its

*The author of this paper is a Senior Research Officer ofThe Economic Research Institute. The paper has beenaccepted for publication by the Institute. The author isresponsible for the contents of the paper including the viewsexpressed therein.

1Reports of the Connnission of Inquiry into Banking, Currencyand Credit (P. 2628), Stationery Office, Dublin 1938, Chap. X,para. 489, PP. 305-6.

~In 1961-2 the net debt service showed an increase ofx2 per cent. ; the estimates for I96Z-3 predict an increase of~3 per cent. in the gross debt charge.

control--as backing to the currency issue, forexample--so that the net debt outstanding issmaller than the gross total. Secondly, a substantialgrowth has naturally occurred in the assets held bythe government in the acquisition of which muchof the debt was originally issued. At March 31st,1961, for example (excluding double reckoning)these amounted to some £221 million,a

On the other hand, the debt total shown does notinclude contingent liabilities or guarantees; theseexcluding the capitalised value of housing loansubsidies-included in the debt totals shown inTable 1--amounted to about £84 million in March1961.a

Obviously these facts need to be borne in mindwhen the growth of the total gross debt is beingconsidered. It is perhaps worth noting also thatthe marked increase in the gross debt during recentyears has not been attended by the calamitousresults sometimes believed to follow from govern-ment borrowing as a matter of necessity. As thedata in the Appendix Table show, by Europeanstandards Ireland has not experienced art especiallymarked rise of prices, its money sUpply is notparticularly large in relation to national income, andits official reserves abroad continue to be relativelyhigh.

The present paper therefore seeks to summarisethe trend of recent thinking in relation to the publicdebt, and especially the change in attitudes towardsits functions in a growing economy. Traditionaleconomic and fiscal theory tended to apply similarprinciples to both private and public indebtedness,but a deeper understanding of the role of govern-ment in economic development in more recent dayshas done much to change this. It is true that in thepast few years a resurgence of rico-laissez-faireeconomic doctrines has had some effect, in thisparticular context as in others, of clouding thedistinction between private and social good whichanalytical welfare economics had previously suc-ceeded in establishing. Nevertheless there stillremains wide acceptance of the proposition that to

°Statistical Abstract of Ireland, 196i (Pr. 5984), StationeryOffice, Dublin I961, Table 258, p, 27o.

4Ibid., Tables 258-9, pp. 27o-1.

z

TABLE I : THE PUBLIC DEBT OF IRELAND, 1924-61

19241928193519451953196o1961

Totalgross debt

outstanding£000

Annualdebt charge

(net)~000

Nationalincome

Total debtas ~/o ofnational

£nm. income

x 2 3 4

n.a.161"7149"2277’1439’6540"0582"0

n.a.

17"2

38’432"758"783"583 "8

Net debt charge as ~/o of

I3,91827,88357,3039o,661

258,05745I,O14487,952

1451,4o53,0353,5338,800

19,2OO

21,47I

National Totalincome debt

5 6

n.a. 1"o

0"9 5 "o2’o 5’3I’3 3"92 ’o 3 "43 "6 4"33 "7 4 "4

Sources: Cols. 1-2 : Data supplied by Department of Finance. The debt totals include the State liability element ofLand Bonds and the capitalised value of housing loan subsidies but excludeaccrued interest on Savings Certificates, andelements of double-counting. Debt charge totals refer to net charges provided in both Central Fund and Supply Services. Thedata refer to fiscal years ending on March 3ISt in the 3’ears succeeding those shown except for 1924 and i928, which refer tofiscal years 1923124 and i927128 respectively.

Col. 3 : For 1925-35, Reports of the Commission of Inquiry into Banking, Currency and Credits, (P. 2628), StationeryOffice, Dublin 1938, Ch. X, paras. 482-4 pp. 3Ol-2 and Appx. 7, Table XXXV, p. 45z. For 1945-61, Statistical Abstract andEconomic Statistics, 1962.

treat private and public finance as closely analogousis at best dangerous and at worst positivelydisastrous.5 The cconomic role of governmentcannot be defined in terms identical with thoseapplicable to individual components of the economy.Similarly, the choice of government between currentand capital finance for any given expenditureproject cannot be governed solely by the criteriaappropriate for a private enterprise; the publicdebt cannot validly be treated as no more thanprivate debt writ large.6

Along with the awareness of the special positionof government in the economy has developed agreater appreciation of the complex role played bythe public debt in arty financial system. It is notonly the criteria by which expenditure is judgedwhich may differ between government and theremainder of ttie economy ; the place of the publicdebt itself in the asset-structure of a developingsociety is of crucial significance, quite apart fromthe effects of the expenditure which its issue mayhave permitted or prevented. The size, structure,terms and distribution of the debt itself all playa critical role in the operation of a country’sfinancial structure--the currency, the bankingsystem, savings and financial institutions, andindeed the budgetary policies of individual citizens.

~The error involved is, of course, the:error of composition--i.e. the assumption that what is true of persons or enterprisesacting individually is necessarily true of them acting collectively.Expositions of the point can be found in any elementarytext ; for reasons of space its acceptance has to be taken forgranted here. ¯

alt is perhaps necessary to emphasise that this paragraphcontains no suggestion whatever that govermnent expenditureis inherently or necessarily beneficial. Spending by govern-ments may be wise or wasteful, just as spending by privatepersons or enterprises may be wise Or wasteful. This paperts concerned, however, with the means of raising funds, notwith the details of how those funds are spent. Obviously adiscussion of the one Cannot always avoid reference to the other,but nevertheless the principles of government expenditure arenot the prim:try issue here.

Any assessment of the role of the public debt ineconomic development must therefore considerthree separate, although obviously inter-related,aspects; first, its part in the financing of centralgovernment expenditures themselves ; secondly, itsrole in the indirect financing of expenditures on thepart of semi-government or private agencies ; and,finally, the asset-effect of the public debt in theencouragement or control of the finance of projectsin the private sector. The discussion which followswill consider each of these three aspects in turn ingeneral terms; wherever possible, however, thegeneral conclusions will be related to the particularcase of Ireland.

2. The debt and government expenditureIn principle, the same basic considerations are

applicable to the public debt in economies at .’illstages of economic growth. In the more highlydeveloped economies, however, governments Oftenfind themselves concentrating more on the stabilitythan on the expansion of the economy, whether thatstability is in terms of a constant national productor of a rate of growth in the national product.Accordingly, in such economies the macro-econ0microle of public finance may tend to be the ratherpassive one of compensating for oscillations in theprivate sector; tile government’s own commitmentsare, for the large part, fairly regular current ex-penditures continuing from year to year. In such asituation the role Of government--and therefore ofthe public debt--may often be a relatively marginal,or neutral, one.7

The position may be different, however, in asociety which feels that its existing rate of economic

~This refers only to the macro-economic aspects of fiscalpolicy, of course. It is not to suggest fl)r a moment that thefunctions of public finance are unimportant in, say, thewelfare or public utility fields.

growth is substantially below what is both desirableand feasible, and where the acceleration of suchgrowth takes precedence over the maintenance ofstability in policy formulation. It seems reasonablethat this category should be taken to include Irelandfor present purposes. By definition, in this type ofsituation the private sector cannot be left as the soledeterminant of the overall pace of economic activity,precisely because the existing rate of growth isinadequate by the standards which the society hasset itself. Of necessity, therefore, the governmenthas to take upon itself the responsibility for stimula-ting the rate of economic expatision. It may dothis in one of two ways : by means involving noexpenditure on its own part--controls, tarifflegislation, exhortation, etc.--or by expenditures ofa capital or current nature. With the former set ofmeasures this essay will not be concerned, sincethey have little bearing on the question of publicdebt.s The latter is in any case likely to be ofdominant importance in reality.

The range of expenditures for which governmentis responsible will naturally vary from country tocountry according to existing states of development,industrial patterns, political attitudes and so on.(The fact that many countries in Europe andAmerica have been involved in two world warsduring the present century, for example, is obviouslyrelevant to their public debt totals.) Further, thecomparative importance of government interventionin different economies is exceedingly difficult,, if notimpossible, to measure. If the relationship betweengovernment expenditure and national income is

8Although, as is argued below, it should not be inferred thatthe public debt is of importance only when its absolute volumeis changed : adjustments in its structure of distribution mayalso have important effects.

taken as a very rough guide, however, the datapresented in Table II may be of some interest. Theyindicate that by international standards the relativeimportance of central government expenditures isdistinctly on the high side in Ireland. As a propor-tion of the national income they are larger in onlytwo of the thirteen European countries listed--Austria and the United Kingdom--and NewZealand is the only one of the thirteen non-European countries shown in which the proportionexceeds the Irish figure.° In only two of the twenty-six countries--Belglum and the United Kingdom--is the public debt as large in relation to the nationalincome as in Ireland, and the accumulation of wardebt previously mentioned is obviously of relevancehere. The actual content of such governmentexpenditures is not material to the present discussionhowever.1° The relevant point is that, whether theyare current or capital in nature, they have to befinanced in some way.

It is appropriate to examine first a situation inwhich it is considered that the resources necessaryfor a government’s economic development expendi-tures must be found internally. This is, of course,the most important situation in practice. In theparticular ease of Ireland, for example, governmentexternal capital transactions during the years1956-6o represented a net inflow of only some£Ii million, at a time when its overall net capital

DAlthough impossible to verify statistically, it seems likelythat the comparison would become even more striking ifallowance could be made for the role of semi-governmentagencies in the economy.

x8See footnote (6) page 2, There’seems no reason, in a paperof this kind, why one should not assume that a society knowswhat it is doing when it chooses to spend some of its incomecolleetively--i.e., in the form of government expenditure--rather than individually.

TnBt, n II : CENTRAL GOVERNMENT EXPENDITURE AND PUBLIC DEBT AS A PERCENTAGE OF NATIONALINCOME i96o

Total central Total centralCOUNTRY government Gross COUNTRY government Gross

expenditure public debt expenditure public debt

x. Europe 2. OtherAustria 35’6 18’9 Australia 2I’IBelgium

32"529’4 88’6 *Brazil 13’I 7’6

Denmark 2x’2 24"7 Canada 2I’2 76’9France 26’7 39’5 Ceylon 3o’8Germany (F.R.)

39’420’4 12’2 Costa Riea 16’2 2I°0

Greece 23’0 15"5 Ghana I6’2Ireland 33’9 80’5 Guatemala 16’3Italy 27’5 *India 13’INetherlands

37’3 38"724"8 54’8 Japan 16’3

Norway4’5

12’8 38’9 Mexico 8’7 4’8"Sweden 28.5 36’4 New Zealand 37’3Switzerland

75’98.3 I8’9 Philippines 11’7 22’1

United Kingdom 38’4[

136"9 United States 18’5 69’3

’1959.Source : Statistical Yearbook 1961, United Nations, New York 1962 (62-XVII-I), Table 163, pp. 486-7, and Table t75,

PP. 537-593. The data for government expenditure refer in all cases to the period nearest to the calendar year 196o, exceptfor Brazil and India, when they refer to I959. The debt ratio shown for Ireland differs somewhat from that given in Table Ipage 2 because of small discrepancies between the U,N. totals for both public debt and national income and the official figuresused for the purposes of Table I.

liabilities (excluding contingencies and guarantees)roseby £46 million,n To secure resources in anycountry, of course, government has to lexT taxationand/or expand the public debt--including in thislatter category an expansion of the currency or inbank borrowing.

The subject of taxation of various kinds is a verylarge and complex one, and little will be said onthe matter here. It is widely be!ieved that in almostevery economy there are serious, if undefinable,practical limits to the extent to which taxation canbe raised without injurious effects on its growth.Where unemployed or underemployed resourcesexist, indeed, it can be argued that the use oftaxation to finance expenditure may result in thepositive wastage of resources, partly throughdisincentive effects on the propensity to invest andpartly through a " dampening " of the raultiplier.In a fully-employed economy these latter effects maybe in themselves desirable, and popular discussiontends to concentrate on the adverse effects ofrelatively high taxation on the incentive to work, onthe one hand, and on the incentive to save, on theother.

The fact of the matter is, however, that thevalidity of this type of argument cannot be satis-factorily established, either empirically or ona priori grounds. The collection of factual data onthe effects of taxation is immensely difficult and hasseldom produced unambiguous findings. Analyti-cally, it is obvious that taxation must have substitu-tion effects and income effects which operate inopposite directions, the one discouraging work (orsaving) because its net reward is lower, the otherencouraging it because the taxpayer is poorer, aneffect which is especially likely amongst primaryproducers. In any ease it is manifestly unlikely thattaxation will have the same effects whatever itsform--whether proportional or poll taxes, andwhether imposed on income, capital or expenditure,x2

Nevertheless, so far as the direct role of the debtin financing expenditure from internal resources isconcerned, the case in its favour is largely identifiedwith the case against the use of taxation, debatableand ambiguous as the latter may be. The moreserious that case is believed to be, the stronger the

xlStatistical Abstract of Ireland, 196I, Table 252, p. 264,¯ Table 258, p. 27o. It is of course true that capital may be

borrowed externally in an indirect way if internal debt issues,new or existing, are taken up by foreign investors. The balance

",of payments statistics do not enable an estimate to be made ofExternal private transactions in the Irish public debt, but thestatistics of applications for National Loans during 1957-61given in the annual report of the Central Bank of Ireland forthe. year ending 3ist March, 1962 (Statistical Appendix,Table XV.2, p, 65) indicate that applications for loan issuesfrom outside the State amounted to some £9"6 million, orabout x3 per cent. of all applications.

t2These issues are thoroughly explored in A. R. Prest,Public Finance in theory and practice, Weidenfeld and Nicolson,London x96o, Chap. 4, PP. 70-9°.

4

case for the use of debt issues. (The question of thelimits to the expansion of the public debt is discussedat a later stage.) It is important to remember, ~i~course, that some of the disincentive effectsattributed to taxation may well be associated Withdebt issues. Expansion of the money supply, forexample, may significantly affect propensities tosave or to work through its influence on the generalprice level; similarly, the same propensities willreact to a rise in interest rates, or fall in capitalvalues, resulting from an increase in the stock oflong-term bonds in the market.

Given all this, it remains true to say that debtissues can be judged as an alternative to increasedtaxation. Unfortunately, as has just been emphasised,there is no general agreement as to what, if any, isthe critical level beyond which taxation cannot risewithout causing serious damage to an economythrough its effects on incentives to work and save.It is widely believed in Ireland, for example, thatthe level of taxation in the country is too high, bysome undefined standard. The comparison withother fairly small European countries shown inTable III would not appear to substantiate thisview. The average level of direct taxation in Irelandis in fact unusually low, while the incidence of totalcentral government taxation would certainly notseem to be particularly high by contemporaryEuropean standards.

TAnLE III: THE INCIDENCE OF TAXATION, x96o

Country

AustriaBelgiumDenmarkIrelandNetherlandsSweden

Taxes on incomeand wealth as % of

national income

lO’49"38"97"8

16"611"3

Total CentralGovernmenttax revenue

% of nationalincome

29"523 "321 "9

23 "427 ’42I"7

Source : Statistical Yearbook, 1961, United Nations, New,York 1962, Tables 163 and 175.

The comparison cannot begin to claim con-clusiveness, however, even apart from all theseanalytical uncertainties attaching to the relationshipbetween taxation and incentives. In the first place,it takes no account of local government taxation ;nor can it measure the taxation implicit in arelatively high domestic price-level resulting fromtariff protection. Both of these elements mightreasonably be expected to be of greater significancein Ireland than in most other European countries.Secondly, a low average level of taxation--especiallydirect taxation--might still be consistent with highmarginal rates of taxation on particular strategically-important sections of the community, if its incidence

was not even through society. Thirdly, a rate oftaxation which is tolerable for a country at onestage of economic development, or with an extensivesystem of (say) social services, may be unduly highfor another country whose economic development orgeneral circumstances are different or even for thesame country at a lower or higher stage of develop-ment. The question of whether the level of taxationin a particular country, such as Ireland, is above orbelow the critical point at which further increasesbecome inadvisable must therefore remain in thereahn of opinion.

When external resources are sought for develop-ment the case for the public debt naturally becomesa positive one. Except in the virtually extinctsituation of an imperial power with colonialterritories which it is prepared to exploit--usingthis word in its dispassionate, technical sense--itis not possible for an economy to secure resourcesfrom overseas by taxation. If an external con-tribution to development is thought necessaryor desirable, therefore, foreign debt becomes animportant device of economic policy ; the questionof its possible limits is again left on one side forthe moment.

All this goes to confirm the inadequacy of theview that an economy experiencing rapid growthin its pub.lic debt in time of peace is necessarilydoomed to disaster. An individual whose indebted-ness increases pari passu with his income mayindeed often be headed for trouble. The positionof a government in a growing economy is almostthe reverse. Unlike an individual, a governmentmust have regard to the national income, ratherthan its own, and whereas an individual’s indebted-ness can be offset against his income or wealth insome meaningful sense, the process becomesmeaningless if translated to the public debt ownedin the greater part by the community itself. Indeedan increasing public debt may be a prerequisite forthe proper contribution of a government to thegrowth of its economy--evidence of a responsible,not irresponsible, administration.

3. Structure of tile debt

In most pre-Keynesian fiscal analysis, the publicdebt was treated o11 much the same lines as privatedebt: except for short-term " floating debt" toeven out annual revenue and expenditure flows,its issue would have been regarded as theoreticallyjustifiable for productive capital purposes but nototherwise, while its optimum maturity would havebeen regarded as dependent on the period overwhich the net revenue from the underlyingcapitalassets was expected to repay their cost. There isobviously an element of sound commonsenseunderlying this view; no prudent enterprise will

burden itself with a stream of future interestpayments, and ultimate capital repayment, withouta reasonable expectation that its income would besimultaneously increased in order to meet thesecommitments. Nevertheless, for two reasons, ina government of a developing economy this type ofattitude would be manifestly inadequate.

In the first place, there is no real justification forthe complete identification of public debt withlong-term capital expenditure. It will be arguedin a later section that the issue of debt may berequired even though no necessity exists to financeany government expenditure on goods and services.This type of consideration apart, however, it is stillincorrect to assume that the issue of debt is justifiedif the proceeds are used for capital expenditure butnot otherwise. The task of government in economicdevelopment is to determine the volume of resourceswhich, over a given period, are to be devoted tospecified purposes. These may well be of a capitalnature--roads, harbours, airports, schools and soon. Equally, they may be of a current nature theprovision of educational facilities, expenditure onagricultural extension services, the prevention anderadication of disease, etc. The development of aneconomy knows no rigid distinction between currentand capital,la

It is scarcely necessary to add, of course,-thatthe expenditure should be worthwhile and efficientlyapplied, but this dictum holds whether the expendi-ture itself, or its financing, is of a current or a capitalnature. The question of what criteria are adoptedfor determining the merits of government expendi-tures is in itself a highly complex one.1~ Assumingfor present purposes that the government hasdetermined the shape and size of its developmentprogramme, the next task is to decide What volumeof resources it will be necessary to divert fromprivate use--capital as well as current--in order tofulfil this programme, having due regard to ad-ditional resources becoming available from higherproductivity or the activisation of under-utilisedcapacity in the economy; and having regard alsoto resources which it is possible and desirable toobtain from abroad.

The second consideration which necessitates aclear distinction between a private enterprise andgovernment in the matter of debt policy is, of course,that for the former the debt charge represents areduction in its disposable income whereas for thecommunity as a whole the annual service of internalpublic debt represents a redistribution of the national

X3This point is developed at some length by David Walker,The allocation of public funds for social development, TheEconomic Research Institute, Paper No. 8, Dublin, SeptemberI96z.

x4See Prest, op. cir., Ch. 3, PP" 60-64’

5

income, not a reduction of it.Is In assessing thebalance between current use of resources and futureincome flows, therefore, private enterprises andgovernment are in fundamentally different positions.

This of course raises the issue of the " burden "of the public debt; Classical doctrines on thismatter were undoubtedly confused and frequentlyerroneous.Is It does not follow, however, that theconcept of a burden of debt is entirely devoid ofmeaning. Recent analysis, in clarifying this issue,has tended to restore to the forefront, in particular,the old classical doctrine that if, and to the extentthat, issues of public debt result in correspondingreductions in private capital formation then theflow of income to "future generations " will besmaller. The magnitude of this reduction willbe measured by the difference between the annualyield on the expenditure financed through publicborrowing and the yield which would have beenobtained from tile private investment which thatborrowing disp’aced. It can be argued that thisdifference can validly be regarded as the " burden"of the public debt on future generations.Iv

This argument supposes that, in contrast totaxation, public borrowing will reduce privatecapital formation, rather than current consumption.Obviously this is by no means necessarily the case,but it is nevertheless plausible. In a fully-employedeconomy the government can secure additionalresources only by withdrawing them from theprivate sector; it can be assumed likely thatadditional taxation will withdraw resources mainlyfrom private consumption, whereas additionalborrowing (by raising interest rates, etc.) willwithdraw them mainly from private investment.

Certainly, in reaching its decision regarding debtpolicy, a government must have regard to theeffects which its borrowingmay have on privateinvestment, and consider how far such effects areacceptable.

How serious a consideration this would be inreality will naturally depend on the country con-cerned and on its current situation. It is difficultto conceive of it playing a significant role in contem-porai-y Ireland, for example. In the first place, it is

if’It should perhaps be stressed that this sentence is not tObe taken as implying that because it is a mere transfer, theservice of the public debt is unimportant. An annual debtcharge carries implications for both the level of taxation andthe distribution of income, both of which do matter.

16See R. A. Musgrave, The Theory of Public Finance,McGraw-Hill, New York, i959, Ch.:23.

17This is an extremely truncated summary. Of a complexand not entirely uneontroversial analysis. The view whichit seeks to summarise is most clearly set out by F.Modigliani, "Long-run implications of alternative fiscalpolicies and the burden of the National Debt," Economic

ffournal, Vol. LXXI, No. 284, December, 1961, pp. 73o-755.See also J. M. Buchanan, Public Principles of Public Debt,Irwin, Homewood, Illinois, 1958 and " Easy budgets andtight money ", Lloyd’s Bank Rovfow~ No 64, April, I962,pp. 17-3o.

6, ,~,

not convincing to think of a country experiencingcontinuous and substantial emigration as fully-employed; additional public capital expenditi!remight well generate noticeable balance-of-paymentseffects, but there is no obvious reason for believingthat it would necessarily cause a correspondingreduction in private capital formation. Similarly,the Irish monetary system is so open vls-~-vt’s theUnited Kingdom that the effects of public borrowingon internal monetary conditions would surely beunimportant in comparison with the influence ofcontemporaneous British monetary developments.Finally, the statistics scarcely support .the view thataggregate capital funds in Ireland are so limited insupply that any additional public borrowing wouldreduce private borrowing to an equal extent. In1951 and 1955, it is true, externally-held fundsfell substantially in response to the severelyadverse balance-of-payments situation of thoseyears; between December, I955 and March, 1962,however, official and banking external assets roseby some £3° million and, fis the Appendix Tableshows, by Europeanstandards Ireland is singularlycomfortably-off in the matter of official externalreserves. Such evidence as is available also suggeststhat the value of private external security holdingshas risen in recent ye~irs; by contrast, new issuesof marketable securitiesl within Ireland by industryand commerce averaged the ludicrous total of £o.9million a year from 1955-6o.Is These are notthesymptoms of an economy experiencing, or borderingon, capital scarcity.

The effect of increased public debt cannot beassessed, however, only in terms of its impact onprivate capital formation through higher interestrates. An increase in the debt will raise the totalof net assets in the hands of the private sector, and ifit is assumed~as seems reasonable that a rise intheratio of assets to income will tend to reduce thepropensity to save, the final effect on privateinvestment will be a matter of great complexity. Itis conceivable that a reduction of private investmentcaused by the initial debt issue may be offsetin subsequent periods by the repercussions onaggregate demand of its asset-effect. Much willalso depend on the form which the debt issue takes;if it comprises a mixture of money and (relatively)long-term securities it is not possible to say ona priori grounds whether the overall net effect onprivate capital formation will be positive ornegative.1D

Having considered these various factors in the

¯ XSFor all these official data see Statistical Abstract of Ireland,1961, Tables 253-4, p. 265. The report of the Central Bankof Ireland for the year etaded 3ISt March, 1962, gives anaverage of £1"3 million for new issues by industry andcommerce during I95I-6r (Statistical Appendix, Table XV,p. 64.)

19Or, all this see Musgrave, op. tit., Ch. 2z, pp. 55o-3.

~’ABLE IV: PUBLIC DEBT AND THE INFLATIONARY GAP, x954-6I

I. G.N.P. at current market prices2. G.N.P. at previous year’s prices

3. Inflationary gap(I--Z)4. Net government borrowing (ai

£ million....... .

1954 x955 I956 1957 1958 I959 196o x96x

529 552 56I 583 I 599 [ "635 I 662 1532 539 543 568 559 626 665 ~

--3 I X31 I8 I I5 I 40] 9 I --3I IZ3II 25 I 3x ] 30 I 2z

t3x I 39[ 45

(a) Money raised by creation of debt less issues for debt redemption, to March 3Ist of year succeeding that shown.

Sources : Based on data in Statistical Abstract of Ireland, 1961 (Pr. 5984), Stationery Office, Dublin 196I, Tables 245and 255-6, pp. 26I and 266-7, Report of the Central Bank of Irelandjfor the year ended 3Ist March 1962, Statistical Appendix,Table XVI, p. 66 and Economic Statistics (Pr. 65o9), Stationery Office, Dublin 1962, Appendix, Tables i2(a) and i2(b), p. 27.

situation, the authorities of any country must arriveat a final judgement concerning the manner inwhich the available resources are to be divertedfrom private use (assuming an initial state of fullemployment) in order to ensure that total demand--public and private--is neither too great nor too smallin relation to tile capacity of the economy. Theymust determine how much it is possible anddesirable to extract by means of taxation, bearingin mind all they know about tile prospectiverelation of current incomes and the flow of goodslikely to be available to meet them, and the factthat increased borrowing now usually implies aclaim on future tax revenue for its annual serviceand possibly repayment. Havi)lg decided the properlevel of current taxation, the necessary volume ofdebt issue or retirement is determined as a residual.(This, of course, is in the context of financinggovernment expenditure only; other factors, to bediscussed below, will also enter into the formulationof debt policy as a whole.)

It follows from all this that there need be nocorrelation between debt issue over a particularperiod and government capital expenditure over thesame period. It may be that the proceeds ofborrowing are used to finance current expenditureif a relatively low level of taxation is consideredappropriate; conversely, taxes on current incomemay be used to finance capital formation or debtretirement if a high rate of taxation is needed. Ingeneral, there is no way in which the proceeds ofdebt issue can be linked with any particularexpenditure. The spending needs of the govern-ment, in other words, cannot be the sole determinantof the volume of the public debt ; rather it is thelevel of taxation necessary to maintain equilibriumor achieve a desired rate of growth in the economy,the level of government expenditure naturally beingan important element in the existing and prospectivestate of that economy.

How far has recent public debt policy in Irelandbeen linked with stability considerations only ?A firm answer to this question is scarcely possible

because of the complexity of the factors enteringinto debt operations, but the data shown in Table IVmay nevertheless be of some interest in this context.The measurement of the " inflationary gap " thereattempted is inevitably a crude one but it probablygives some impression of the orders of magnitudeinvolved. If so, it would be difficult to argue thatthere has been any necessary connection in recentyears between public debt policy and the overallpressure on resources of the kind indicated in theprevious paragraph. Debt issues were positive in allthe eight years shown, despite the considerablevariation in the pressure of demand on availableresources. Indeed, the relative constancy of centralgovernment borrowing during these years suggeststhat the predominant influences on debt operationshave not been what might be called Keynesianmacro-economic considerations. The analysiscannot be conclusive. A good deal turns, forexample, on the distribution of the debt, as well asits volume; an increase in the total outstandingcould conceivably be associated with a decline inthe holdings of the private sector. There appear tobe no detailed data available on the distribution ofthe Irish public debt, however, so that the aggregatefigures shown in Table IV cannot be qualified bydistributive criteria.

A second factor separating the structure of thepublic debt from the pattern of governmentexpenditure is the special responsibility of govern-ment in relation to the asset needs of the economy.A private enterprise is normally governed in itsborrowing policy by the nature of its expenditureplans ; ordinary considerations of cost-minimisationusually prevent it from issuing long-term debt tofinance essentially short-term expenditures, whilecommon prudence usually prevents it from usingshort-term borrowings to finance long-run capitalformation. For at least four reasons, however,governments are not in a comparable position.

First, governments are by definition obliged toconsider the indirect social costs and benefits oftheir actions as well as their direct monetary

consequences. Secondly, their debt, unlike that ofprivate enterprises, is widely utilised in the moderneconomy and, indeed, usually forms the foundationof the asset-structure of the currency, banking andfinancial systems. Changes in its size and structure,therefore, have widespread consequences which donot arise in the Case of private enterprises.

Thirdly, the scale on which governments operate,and the scope of their policy horizons, are so muchgreater than those of a private enterprise as tointroduce a difference of kind rather than of degree.In particular, the sources from which govermnentsdraw short-term funds are so dispersed that with-drawals in one direction are frequently offset bydeposits in another, a collection of nominallyshort-term loans cart thus become a semi-permanentsource of finance. Irish Exchequer Bills, for example,are nominally very short,term liabilities, but thevolume outstanding has remained well over £Izmillion between March I957 and March I96z.Com,ersely, the market in government debt is oftenso extensive that the authorities may be able tooperate in it and secure the redemption of long-termdebt long before nominal maturity if they so desire.

Finally, a government, unlike any other agency inthe economy, has not only mandatory taxing powersbut also ultimate control over the monetary unitand the currency supply, the very basis of the entirecredit system. (The special relationship of the Irishcurrency to the British pound sterling renders thisgeneralisation subject to perhaps more qualificationthan would be the case with most other currencies,but its basic validity remains nevertheless.) Unlikeprivate agencies, therefore, it need never find itselfunable to service or redeem its own debt in thelegally-enforceable currency of the country. Thisis not to say that this power is never subject toserious practical limitations, or that dangers maynot be associated with either increases of taxationor expansion of the money supply to meet debtobligations. The power is there, however, givingthe government both opportunities and respon-sibilities not present for any other agency in theeconomic system.

For all these reasons, then, the assumption ofa rigid connecting-link between type of borrowingand use of funds is inappropriate in the context ofthe public debt. Further, the considerations set outin the preceding paragraphs indicate the alternativebasis on which public debt policy can be formulated--namely, the requirements of the asset-structure ofthe economy as a whole, rather than the simplerelationship between expenditure and tax revenues.

In its narrowest sense such a policy could beinterpreted to mean "tailoring " the debt, to usethe American expression, so as to minimise its cost.By issuing the type of secl~rjties demanded by

particular groups, that is to say, the rate of interestcould be held at the lowest feasible level, andcertainly at a lower level than would be needed if,say, long-term securities were issued when investiblefunds were held predominantly by investors seeking

¯ short-term outlets. This interpretation of theconcept would be unduly narrow, however, in anyeconomy where the minimisation of debt costs isregarded as an inadequate Criterion for governmentpolicy. In such a context the word" requirements "cannot necessarily be interpreted to mean "desires";the requirements of a particular sector, as conceivedby the government, may conflict with--or even beopposed to--the desires of that sector as conceivedby itself.

An example may make this clear. Suppose thatan economy is growing less rapidly than physicallypossible because of a chronic unemployment orunder-employment of some of its resources. Insuch a situation a government might choose tofinance some of its current expenditure not bymeans of taxation (which would reduce aggregatedemand), but by the expansion of the very short-term end of the public debt--that is, the currencysupply or indebtedness to the central bank. Thiscould have the effect of reducing interest rates,expanding the volume of commercial bank credit,and generating additional demand to bring idleresources into activity,z° Here the policy of shapingdebt policy to meet the requirements of the economy-in the widest sense of the word--would involvelittle or no debt cost.

Suppose, however, that the opposite situationprevailed--i.e., that the pressure of demand uponavailable resources was excessive, With a consequentthreat to the stability of the economy and thebalance of payments. If in such a situation debtpolicy is to be used to support and reinforce taxpolicy, it would involve the aggressive replacementof short-term debt by long-term securities, eventhough investors’ preferences might well lie in theopposite direction. The aim of such a policywould be to raise interest rates and reduce theliquidity of the private sector ; this would be therequirement of the economy as a whole as seen bythe monetary authorities. The policy would probablynot coincide with the desires of the investing world,and it would certainly not minimise the interestcharges on the public debt.

It may be of some relevance to examine recentdebt policy in Ireland in the light of this considera-tion. The statistics are shown in Table V. Sincethe period as a whole was an inflationary one,

~°This would be the happy theoretical sequence. In reality,immobility of the factors concerned might result in a failureof output to expand, so that a mere inflation of the price levelresults; again, the balance of payments might worsenintglerably. But all this, of course, is another story.

TABLE V: THE STRUCTURE OF THE IRISH GROSS PUBLIC DEBT, 1955--62"

£ million

Year ended March 31st Change

I. Floating debt2. Marketable securities :

(a) Repayable in under 5 years(b) Repayable in 5-I5 years(c) Repayable in over 15 years

TOTAL

3. " Small " savings4. Other internal debt

TOTAL INTERNAL DEBT

5. U.S. Debt

TOTAL GROSS DEBT

1955

84’6

7’661"462"1

215.6

18"330"5

264"4

4o’6

3o5"o

1958 1962

lO9"9 151"1

6"9 5’994’7 96’659"1 112.o

270"7 365.6

30"0 46"236’7 49’7

337"4 461"5

4.0.2 38’4

377"6 499"9

1955/58

+25"3

0.7+33"3

3.o

+55"1

+II"7+ 6’2

+73"0

-- o.4

+72"6

1958/62

+ 41"2

1"0-{- 1"9+ 52’9

+ 94"9

+ 16"2+ I3"o

+124"1

-- 1"8

+122"3

1955/62

+ 66"5

1.7+ 35"2+ 49"9

+15o"o

+ 27’9+ 19’2

+I97"1

-- 2’2

+194"9

*Excludes capitalised liabilities in respect of subsidies on housing and sanitary services loans (£42 million in 1962).Source : Statistical Abstract of Ireland, 1960 (Pr. 5492), Table 25I, p. 268 and Statistical Abstract of Ireland 1961

(Pr. 5984), Table 258, p. 27o, and Tables in connection with the Financial Statement, 1962 (Pr. 6493), Table XI, p. 14.

equilibrium policy as such21 would have implieda lengthening of the debt structure in an effort toreduce the liquidity of the economy. It will beseen that the actual drift of the debt structure duringI955158 was in the opposite direction, partly, ofcourse, through the re-classification of outstandingdebt with the passage of time. Of the increase ofabout £73 million in the gross debt betweenMarch 1955 and March 1958, floating debt andrelatively liquid " small savings" securities to-gether accounted for £37 million. The longest-term marketable security issue actually fell by £3million. During 1958/61, however, the changetended to be in the opposite direction, since roughlya half of the increase in the total debt occurred inmarketable securities having a maturity of over15 years. Over the period as a whole, however, theliquidity of the debt structure has been somewhatincreased rather than diminished.

There is another sense in which the policy of" tailoring " the debt differs from one of simplyminimising debt charges. Different groups ofinvestors seek different types of security. Fundsmay be available for short-term investment, forexample, which would in no circumstances be usedto purchase long-term assets--even if an activemarket existed in them, which is not Mways thecase. If the appropriate type of security is notforthcoming, such fimds will lie sterile, or perhapsbe remitted to foreign money markets; in eithercase they are lost to tbe internal development of

21The proviso is important, since growth policy as suchmight have implied an opposite course, and policy as a wholecould involve a delicate balancing of advantages. It is alsoworth recalling the obvious fact that the type of debt whicha government can sell is not entirely within its own control.

the economy. In these circumstances a soundpublic debt policy would result in an expansion ofthe money supply or the issue of short term securitiesirrespective of the extent or nature of the govern-ment’s financing problem at that particular moment.In this way a circulating flow of short-term fundsmay be mobilised for investment ; the interest costmay be lower than would result from conventionaldebt policy.

In other cases, however, the opposite will be true.Some groups of investors--insurance companies andpension funds are important examples--need long-term securities for their proper operation. If suchsecurities are not forthcoming, the flow of fundsinto internal development may again be hampered.In this case, debt policy may involve the issue oflong-term securities against short-run expenditures ;the interest cost of the debt will be raised.

In its broadest sense, then, the shaping of debtpolicy on the basis of the asset-requirements,o’(theeconomy as a whole, rather tllan on the basis ofthe use made of the proceeds, may or may not resultin the reduction of the debt cost as commonlyunderstood. This must be a relatively minorconsideration, however; of infinitely greater im-portance is the fact that tile public debt can beemployed positively in the development of theeconomy, both in the sense of contributing towardsequilibrium in the balance of real resources and inthe sense of assisting the financial flows of theeconomy to attain the closest possible integrationwith its physical development needs.

It must be recognised that a debt policy restingon this basis is not without its risks. A well-tailoreddebt facilitates the movement of funds into it;

it must therefore ipso facto facilitate the movementof funds out of it, a process which might well occurat an awkward moment from the government’spoint of view. This is merely to say, however, thata policy for growth will always involve risks ; it isalways safer--at least apparently--to stand still.One reaction is therefore that of negative caution--to do nothing which is not safe. The alternative isto become reconciled to the fact that if policy is tobe positive and energetic it may well have to beenergetic in both directions. That a movementonce started may subsequently need to be checked,or even reversed, is not a self-evident justificationfor preferring not to embark on the movement atall.22

4. Special selling featuresAt this point it may be worthwhile to mention

briefly some of the special conditions which may beattached to public debt issues in order to attractand retain both domestic and external investors.Tailoring the debt, in the ordinary sense of maturitydates and interest rates, may not in itself be sufficientif the aim is to attract not merely funds alreadyseeking investment--wh0se owners are often alreadyfavourably disposed towards government securities--but also fimds which would otherwise find outletseither internally in directions which are undesirablefrom the point of view of sound economic develop-

’ ment, or in external investments or even iu " con-spicuous consumption" expenditure.2a In economieswith sophisticated structures of financial institutionsthis problem will usually be a marginal one; inothers, however, it can attain serious dimensionsand the public debt can have a major role to playin connection with it.

A long-established device in this context is theconcession of tax remission on interest payments.For external lenders, indeed, it is a virtuallyindispensable feature; justification in this case isnot difficult, however, since the beneficiary, beinga citizen of another country, will normally be taxedon the interest payments by his own fiscal authorities.Justification is also not difficult in the case of smallinvestors ; frequently their.p’rofound reluctance tocome into contact with the machinery of tax collec-tion-and the relatively trivial revenues which can

’21~ace the Radcliffe Committee which appears to haveargued 1hat measures which would remedy a slump shouldnot be adopted if they would complicate the problem ofcontrolling a future boom--Report of the Committee on the~t,orking of the monetary system, Cmd. 827, H.M.S.O. London,1959, para. 49o, p. 175.

23Two examples are hoards of " precious " metals (seeMeasures for the economic development of under-developedcountries, United Nations, New York. 1951, Chap. VI) andProfessor Arthur Lewis’ pyramids (W. A. Lewis, The theoryof economic growth, Allen & Unwin, London, I955, Chap. V,p. 236).

I0 ’~’

be collected from them at high administrative cost--make a de jure recognition of a de facto situation oftax exemption a worthwhile psychological weaponhaving little real cost. It is difficult to extend thejustification much beyond such special cases,however. The practice of tax exemption to specialgroups of rentiers is not easily reconciled with socialjustice ; further, it is in effect a concealed subsidyon official borrowing rates which may distort thepattern of the economy’s capital charges. Thepayment of a sufficiently high interest rate couldpresumably exert an "equal attraction for theinvestor and would have the importa.nt advantageof accurately reflecting the true cost of capital tothe borrower.

Much the same is true of the technique ofoffering issues at a price below their redemptionvalue, which is used extensively in many countriesand which involves a tax-free capital gain. Likeincome-tax-exemption, it amounts to a concealedsubsidy, having the effect of holding the apparentinterest cost below its true level, and it confers afiscal privilege on a particular section of society.

A third possibility which has been much discussedin recent years is the linking of the interest paymentson, and maturity value of, public debt issues to thegeneral price-level (or to gold) so as to preservetheir real value. Inflation is undoubtedly a majorenemy of the acceptability of the public debt as artinvestment, and a psychological situation may bereached in which debt issues to the general publicbecome impossible without some stich concession.94

In anything short of so desperate a situation,however, there is general agreement that this is adevice to be avoided. It is one more weak link inthe chain of forces restraining inflation, an animalnever far removed in a growing economy; it isone more claim on revenue which must increase asprices rise but which is unlikely in practice todiminish if prices fail; above all, it is a clearadmission of the expectation of defeat by the oneagency in the economy which has both the powerand the responsibility for combating inflation.

A much stronger argument can be made out,however, for linking public debt issue terms withthe growth of productivity--~for example, real outputper head. The problem of establishing acceptablestatistical indicators is not an easy one, but theadvantages of the technique could be substantial.An argument can be made out on grounds of socialjustice for extending to a government’s creditorssome guarantee of a share in the improved standard

~4France may have provided an example of this in recentyears : see H. Brochier, " L’Evolution de la Dette Publiqueen France depuis I945 ", Public Finance, Vol. XVI, No: r,1961, pp. 5o-77. The figures quoted earlier of externalapplications for National Loans indicate that there is nodanger of this situation developing in Ireland.

of living of society as whole.2~ More prosaically,in a growing economy the prudent investor will seek" growth" assets, and if the public debt cannotoffer growth, he may well look elsewhere ; howeverhigh the rate offered currently by public debt issues,he may still prefer an asset whose yield can growpari passu with the national output as a whole.Finally, the technique represents an announcementby the authorities of the probability, not of inflation,but of continued econothic growth; the psycho-logical effect of this would be of value in promotingthat growth itself.

Fourthly, the offer of attractive redemption terms,especially to the small investor, may have consider-able practical effect. Just as the erosion of valuesthrough inflation can weaken the attraction ofgovernment securities for investors--as opposed tospeculative operators having little interest in long-term holding--so the same effect can result froman instability of market values which robs theinvestor of the assurance that his resources aresubstantially recoverable in an emergency. It isnot difficult to conceive of a system whereby, forexample, specified amounts of a security could besubmitted for redemption by the authorities withina guaranteed, but progressively widening, range ofprices regardless of current market quotations.This would give a valuable concession to the smallinvestor without simultaneously opening the doorto abuse by the professional and institutionalinvestor. Whatever the technique employed, theassurance of liquidity to the genuine investor isimportant ; experience shows that such an assurancemakes the public debt not merely more attractiveto buy but also more attractive to hold. In Irelandthis principle is already embodied in the SavingsCertificate. There may be scope for a more extensiveand, so to speak, more aggressive application ofthis type of provisiorl; it is relevant to observe thatover the six years 1956-61 net sales of SavingsCertificates amounted to only £8.5 million whentotal personal savings amounted to well over £200milliom9.6

Finally the introduction of a lottery element mayhave its part to play in the mobilisation of funds

2aThis is debatable, of course. If regard is had to the strictThomistic doctrine on interest--basically indistinguishable, asKeynes himself once wrote, from the Keynesian liquidity-preference theory--interest is related .to the sacrifice ofconvenience, ete.--htcrum cessans and dammtm emergens in thescholastic terminology--by the lender, not the use to whichborrowed funds are actually put. The crucial question istherefore whether the lucrum cessans refers only to the situationprevailing at the time of the loan or whether it can validly beextended to cover the changing expectations which (as eventsprove) rising productivity would have generated through thelife of the loan.

26Statistical Abstract of lreland, 1961, Table 247, P. 261and Tables 255-6, pp. 266-7, ~¥nancial Statement, 1962,T,~ble XI and Economic Statistics, 1962, AppenSix Table 13.Sales of Savings Certificates relate to fiscal years commencingin the years mentioned.

through the public debt. For investment, ascontrasted with the outright purchase of an ordinaryprivate or state lottery, it is necessary that the prizesshould be paid from the fund normally set aside tomeet interest payments. This inevitably means thatthey will be of a smaller amount th,~n those paid bythe usual type of lottery in which, once finished, thedocument purchased by the individual ceases tohave value. The experience of the United Kingdomsuggests that this may be an almost fatal defect;there are some signs that this may also prove to bethe case in Ireland, since the net sales of Prize Bondsllave fallen from £6.8 million in 1957-58 to £2.2million in 196o-61 and £2.4 million in 1961-62.9.7

In a different type of society, however, the devicemight have a more substantial role to play.

There are many ways, therefore~and the fore-going paragraphs are in no sense exhaustive--inwhich the public debt can be employed as a policyinstrument appealing to and influencing manysections of the community. The traditional conceptof the debt as a private pasture confined to banksand obscure trustees has little relationship to itsmany-sided and complex role in the moderneconomy, a role as all-pervading as that of govern-ment itself.

5. The finance of government agenciesThe foregoing has been concerned only with the

debt in relation to its most direct and obvious role~the channelling of purchasing power to governmentitself, either for the finance of its own expenditureor for the maintenance of a proper balance betweenaggregate demand and aggregate supply over theeconomy as a whole.

Important though this function is, the role of thepublic debt cannot be regarded as ending there,especially in the context of a growing economy.Economic growth may involve substantial outlaysby the central government itself even in relativelylaissez-faire type societies; during 1954-6o, forexample, " general government " and " governmententerprises " accounted for nearly 25 per cent. oftotal domestic fixed capital formation in Ireland.2s

More often, however, the development and pro-motion of productive enterprises will rest on otheragencies--p~iblic boards subject to varying degreesof official control or privately-owned enterprises ofall types. The growth of such enterprises, whether

~Financial Statement, 1962, Table XI, Finance Accountsfor the year ending March 31st, 1961, (Pr. 6Io7) and StatisticalAbstract qf Ireland, 1960. Net sales were also £a-z million in1958-59, but this was duc to a fall in issues which was to beexpected after the large first-blush issue of £7 3 million(gross) in 1957-58. The significant fact is that while saleshave fallen, repayments have steadily risen.

~SYearbook of National Accounts Statistcis, 1061. (62.xvii.2), United Nations, New York I962, Table 5, P. 134. Thetext assumes that Ireland can be termed a laissez-faire society.As was shown earlier, on some definitions this is debatable, tosay the least.

II

semi-public or wholly private, will naturally dependon many factors, but the availability of adequatefinance on reasonable terms will be not the leastamong them.

If such finance is forthcoming, no special problemexists and development will proceed if the othernecessary components are available. In manyeconomies, however, it is not forthcoming insufficient magnitude, even--paradoxically enough--in countries where capital funds are, in aggregate,adequate to meet existing demands. Economicdevelopment can be held back precisely because theordinary mechanism of profit-attraction is notstrong enough to overcome the prevailing resistancesto investment in particular sectors. Profit-outcomesmay be necessarily especially uncertain, or may.have to be accepted on an unusually long-runbasis ; the liquidity of investments in local enter-prises may be relatively low; conventional typesof collateral security may not be available ; enter-prises may tend to be small-scale. Some or all ofthese factors are obviously of significant importancein Ireland, for example ; an analysis of death-dutystatistics suggests that, of total private holdings ofcorporate securities in Ireland amounting inx953-55 to some £zzz million, no less than £ioomillion, or about 45 per cent., were held in foreignenterprises,a°

In view of this, it may prove necessary in somecases for government itself to shoulder some of therisks, and absorb some of the illiquidity, involvedin investment. It can do this by ,~llowing thepublic debt to be used as a means of reconcilingthe need for liquidity on the part of the borrower,on the one hand, and the need for long-term capitalby investing enterprises, on the other. Onlygovernment may be able to under-write, on acollective basis, the risks inherent in economicdevelopment which private lenders cannot beexpected to bear in connection with individualenterprises. (For a government concerned with thelong-run interests of the economy as a whole,indeed, many of the risks associated with particularenterprises can safely and reasonably be expectedto cancel out,) It is well-known, of course, that theuse of government funds in productive and tradingenterprises is not without its own dangers; ex-perience suggests that the availability of publiccapital often results in a softening of attitudestowards realistic pricing or the continuous pursuitof efficiency.3° The possible abuse of an instrument

~gSee my study The ownership of personal property in Ireland,The Economic Research Institute, Paper No. I, October, 1961,Appendix II, Table E, p. 22. The same data actually suggestthat for later years the value of privately held foreign corporatestocks is substantiallyin excess of that of holdings of Irishcorporate stocks.

~°One is reminded of the Italian proverb--Public funds arelike holy water: everyone helps himself freely.

I2

is hardly an adequate justification, however, for theneglect of the instrument itself.

It follows, then, in principle at any rate, that~the’

public debt has an important function as a channelfor development funds ; by means of it, risks canbe reduced and liquidity increased. The funds maybe transmitted via the debt directly to major publicprojects or industries. For private enterprises it ismore probable (and, for the reason mentioned atthe end of the previous paragraph, frequentlymore advisable) that they will be transmittedindirectly through semi-private institutions engagedin development finance Agricultural Credit Cor-porations, industrial promotion bodies, agencies forproviding credit to small-scale enterprises, and soon. Ireland provides an unusually clear example ofthe public debt, being used in this way. OnMarch 3ist ~96z the assets which could be offsetagainst the Irish public debt included £r9I millionExchequer advances to various public agencies--the most important of which was local government--and a further £41 million held in the form of sharesof various state-sponsored development agencies)1

One important aspect of this function of thedebt is that it may help to overcome a familiarproblem in many economies--the presence of ademand for capital funds by industrial and agri-cultural enterprises and a concentration of thesupply of investible funds amongst institutionssuch as banks, insurance companies or pensionfunds which do not regard long-term investmentin such enterprises as part of their legitimatebusiness. The role of the public debt in all theserespects is thus in a sense passive and indirect;nevertheless, it can be of crucial importance.

6. The creation of capital markets

There is one other function of the public debtin the finance of development which deserves briefmention. It has been argued that the debt may"channel funds directly from the private sector tothe government, and that it may also channel fundsfl’om the private sector into public or semi-publicagencies--and thus back again into other parts ofthe private sector where the demand for capitalexists. There is a further possibility, however:the debt may be used to facilitate the flow of fundswithin the private sector so as to promote develop-ment, and without the intervention of officialagencies in the use of funds.

It is generally agreed that the existence of strongand active markets in both short-term and long-term capital is very much in the interests of develop-ment, ~ince such markets encourage the movementof funds from the various points at which they

31Financlal Statement, 196~, Table XI, p. 14.

emerge to the sectors where they can be bestutilised. It is often the case, however, that suchmarkets are imperfect in the technical sense orlimited in their coverage; the result may be thatfunds urgently needed for internal developmentmay be lost overseas or absorbed into less urgentconsumption for lack of suitable security outlets ormarketing facilities. Although Ireland possesseslong-established and reputable stock exchanges, forexample, these considerations are by no meansirrelevant for it. Reference was made earlier to theextremely small volume of private new issues whichoccur in the domestic capital market, and it is knownthat the market in existing securities is a narrow andfar from highly active one.

What then is the role of the public debt in thedevelopment or improvement of such markets? Intheir earlier stages it may well be a critical one. Thehabit of investment in general, and the use of asecurities market in particular, will become wide-spread only if a regular supply of suitable securitiesis available to the investing public and if a reasonabledegree of marketability is attached to them. Theformer requirement links up with what was saidearlier in connection with the tailoring of the debt.But rather more may be involved, since investorswill develop the habit of portfolio investment onlyif the right quantity, as well as type, of securities areavailable. The use of short-term government debtas a regular outlet for funds, for example, will notbecome established if the volume available fluctuatesviolently through the year ; comparable considera-tions apply to medium and long-term investment.Another factor is thus added to the already complexproblem of determining the optimum volume ofdebt. Issues or retirements may be required notonly by the state of government finances or thebalance of aggregate demand in the economy butalso by the needs of a stable financial market.

The maintenance of marketability is equallyimportant. Investors acquire the habit of portfolioinvestment only if securities are reasonably liquidas well as regularly available. So far as short-termdebt is concerned, this may imply a willingness onthe part of the authorities to provide generousre-discount facilities, either directly or through thebanking system,a2 For medium and long-term debtit implies an acceptance by the authorities of theneed to be constantly operating in the market fortheir own securities with a view to assisting themaintenance of marketability at a level of priceswhich does not oscillate so violently as to makeportfolio investment a dangerous business for theordinary investor. The horizons of the government

S2For examples, see P. G. Foussek, Foreign central banking :the instruments on monetary policy, Federal Reserve Bank ofNew York, New York, 1957, Chap. IV.

in formulating overall debt policy are accordinglywidened yet again.

Where security markets are well established, andthe habit of portfolio investment is common,however, one would expect the relative importanceof the public debt in this context to decline. Therewill always be a need for a fairly stable market ingovernment securities, but as security marketsbecome familiar one would expect them to widen.If the buying and selling of government debt iscommonplace, similar activity is likely to developin the debt of semi-public bodies, and, in time, insecurities issued by private corporate borrowers. Astable government bond market, for example, oftenprovides a firm basis for the portfolios of banks,insurance companies, investment trusts, and so on,from which they can venture into more speculativeinvestment. Thus a regular efficient channel isestablished between various groups of investorswithin the economy and all enterprises, public andprivate, seeking new capital.

7. The limits of the public debtThe ends which the public debt may be asked to

serve are therefore several. In a developing economythe authorities may consequently find themselvesfaced with the question of how far they may safelyproceed with an expansion of the debt in order toattain those ends. What limits--other than thosewhich may be imposed by statute--exist to such anexpansion ?

First, there may be, psychologically speaking, amaximum beyond which public opinion is notprepared to see the debt, or particular elements ofit, go; expansion past this point may lead to abreakdown of confidence in the stability of thefinancial System in general and of the currency inparticular, with all the consequences which couldfollow from this. The precise position of this barrierwill be to some extent variable through measuresto increase the public understanding of the role andsignificance of the debt in the modern economy;it will doubtless vary between internal and externalinvestors; it will vary over time. Reference wasmade earlier to the strong feelings expressed by theBanking Commission in connection with the sizeof the Irish public debt then outstanding. The factthat no comparable fears are expressed nowadays,despite the enormous expansion which has occurredin the debt, is a demonstration of how public opinioncan evolve in such matters over a comparativelyshort period. Nevertheless, at any given moment itmay form an ultimate barrier which the authoritieshave to accept. Fortunately it is unlikely that manygovernments will need to operate close to thatbarrier in the ordinary course of economic policy.

Secondly, and probably of more relevance, there

I3

may be a less absolute and clearly-defined limitbeyond which the debt can be placed without sharplyincreasing difficulties of a monetary kind. Theoperative factors here are not the dangers of a crisisof confidence but the less explosive ones of, on theone hand, a relatively low propensity to save, or, onthe other hand, a relatively low preference forgovernment debt as opposed to other availableinvestment outlets. The former would imply that atany moment of time the sale of assets to the publiccould take place only with increasing difficulty--i.e. sharply rising interest rates--as their volumeincreased. The magnitude of this problem will ofcourse vary from country to country, but theavailable evidence does not suggest that governmentneed labour under any very marked disadvantage inIreland in the matter of the general propensity tosave. National income statistics suggest that overthe years i954-60 the propensity to save of privatehouseholds was 6’5 per cent. in Ireland, which,While’smaller than, the comparable ratio in Denmark;the Netherlands or Belgium, (7’6, lO’3 and ix.7 percent. respectively) was higher than :in otherEuropean countries such as Sweden (6.0 ¯percent.)or the United Kingdom (3"3 per cent.).a3

On the other hand, there may be a lower ¯inclina-tion:to hold government securities in Ireland thanelsewhere; estate-duty statistics indicate’that notonly are securities generally less favoured as apersonal asset in Ireland than elsewhere--in 1953-55they amounted to 52 per cent. of gross personaltyin Ireland compared with 59 per cent. in Britainand 62 per cent. in the Six Courities--but govern-ment securities are relatively less popular, amountingin I953-55 to’ only 14 per cent. of total security

holdings in:Ir61and compared with 24 per cent. inBritain and 36 per cent. in the Six Counties.a~

The potential scope for government action toshlft the limits imposed by these factors is obviouslymuch greater than when dealing with the state ofconfidence. Measures at government’s disposal willinclude higher interest rates, better tailoring ofissues, more generous re-disc0unt or redemptionfacilities or even, in the case of domestic institu-tional investors moral or legislative pressure. Howfar such measures can or should be carried, ofcourse, is a matter which 0nly the governmentconcerned in each case can judge in the light of thesituation in which it finds itself.

Finally there is the question of the increasing" burden " of the debt. Considering first internally-issued debt, reference was made earlier to the fact

~a Yearbook of National Accounts Statistics, 1961, UnitedNations.

34See my study The ownership of personal property in Ireland,Table IV, p. x3. This probably explains the rather high yield(by European standards) on Irish government bonds seeAppendix Table, col. 5. ’

] 4 ’ iN

that the concept of the burden of the public debtis an extremely vague, not to say iUusory, one,Nevertheless, a rising debt means, other thingsbeing equal, an increasing debt charge and a levelof taxation which rises accordingly. Conceivably,the public debt could reach a level at which thetaxation necessary for its servicing represented Iooper cent. of the national income. Without prejudgingthe question of the precise effects of high rates oftaxation~by no means a simple issue, as wasemphasised earlier it can be assumed that such astate of affairs xvould give rise to some concern.

How serious a problem is this ? If one postulatesa constantly-increasing debt within a static nationalincome it could obviously become very seriousindeed. In a celebrated article, Domara5 hasdemonstrated that from an initial situation in whichthe public debt amounted to $800 billion and thenational income to $13o¯ billion, the seryice chargeson a debt Hsing by 6 .per cent. per annum wouldrepresent 2o per cent. of the national income after175 years and 25 per cent. after 250 years. Such asitu~iii0n would have no relevance in a discussionof debt policy in a growing economy, however, sincethe whole purpose of the increased debt is to preventa constancy in the national income. With anyreasonable ¯-rate of growth in the economy, theburden of even a steadily increasing debt can becomea minor consideration. Domar has shown that in aneconomy with a steadily expanding income, thecharge on the debt rising at 6 per cent. annually--mentioned in the example above--would ultimatelysettle down to a constant and relatively smallproportion of income.

It may be of some interest to examine this latterpoint in more detail. During 1959-61, the annualdebt charge in Ireland rose by an average of 9"6 perCent. and national income by an average of 6"3 percent.aG In Table gI the net debt charge of 196o is

TABLE VI : DEBT CHARGE AND NATIONAL INCOME,IRELAND, 196o-2ooo

~96ox97oi98ox99o2000

Projectednet debtcharge

£m.

19"245"4

lOTS254"2601"5

Ratio to national income assumingannual growth rates of

4% 6%

3"6 3"65"7 4’79"I 6’2

14’6 8’223"3 lO’8

8%

3"63"6 ’3"63.63"6

~SE. D. Domar, " The burden of the debt and the nationalincome,’! American Economic Review, Vol. XXXIV, No. 4,December I944, reprinted in Readings in Fiscal Policy,American Economic Association, Allen & Unwin, Londonx955. ¯

a6Debt charge figures are the gross totals shown in the Reportof the Central Bank of Ireland, 1962, Statistical Appendix,Table XVI, p. 66. Since the public debt is a monetary entity,it is the national income in current prices which is relevant here.

projected forwards on the assumption of a continuedannual rise of 9 per cent. Obviously its relationshipto the national income will depend on whether

national income (at current prices) rises more orless rapidly than this. Table VI shows the per-centages which would apply after 4° years atdifferent assumed rates of growth. At the growthrate nearest to that of recent experience (6 per cent,)a debt charge rising continuously at 9 per cent.would amount to 6 per cent. of the national incomeafter 2o years and about I x per cent after 4° years.Whether such a proportion is " too high " in somesense naturally depends on the importance attachedto rising tax rates (assuming all other expendituresrelatively unchanged) in comparison with theadvantages envisaged by the attthorities in ex-panding the debt in this fashion. It would be hardto argue, however, that such a proportion would beinnately disastrous.

The limits applicable to externally-issued debt areobviously much more real and significant. The mostimportant consideration is naturally that the capitalinflow should lead to a growth of national incomewhich is more than sufficient to absorb the additionaldebt burden. The problem of foreign exchangeavailability is raised, however, as well as that ofgrowth itself. If the proceeds of external borrowingdo not result, directly or indirectly, in an increaseof exports or reduction of imports during the life-time of the issue, the servicing of the debt mightgenerate balance-of-payments problems of somemagnitude.37 If such problems subsequently inspiredeflationary policies for the economy as a whole, itis conceivable that the overall rate of economicdevelopment will prove to be slower as a result ofexternal borrowing than it would have been withoutit. At the same time, it is not always easy to assessthe effects of particular projects on the balance-of-payments, especially when there is no obviousconnection between them ; how, for example, is theeffect of a hydro-electric generating station onexports to be measured ? It is easier to formulatethe balance-of-payments limitation in general termsthan to define its exact incidence in practice. Never-theless it is clear that with a reasonably productiveuse of foreign capital, external debt need cause noinsoluble problems ; it can be shown, indeed, thatunder quite reasonable assumptions with regard to

production and consumption functions the likeli-hood of a country being able to service foreign debtis greater if the foreign capital inflow is large thanif it is small.3s

3~And a fortiori if the proceeds are used on projects whichresult in an increase of imports over and above those involvedin the original capital installations.

aSSee G. M. Alter, " The servicing of foreign capitalinflows by under-developed countries," Economic Developmentfor Latin America, (Eds. Ellis and Wallich), Macmillan,London, I96x, Chap. 6, pp. I39-I6o.

In any event, the problem does not seem likelyto attain serious proportions for Ireland. As wasshown in Table V, external debt in the usual senseof the word amounted in i962 to less than £4°million or about 9 per cent. of the total ; althoughno detailed estimates of the distribution of holdingsof the Irish debt are available, it seems unlikely thatexternal holdings of internally-issued debt wouldexceed £2o million.39 Against this can be set theholdings by Irish residents of British and otherforeign government securities which were put atabout £36 million for persons alone in 1953-554°All this is reflected in the balance-of-payments data,which show Ireland as a net creditor on investmentincome account in recent years to the tune of some£iz or £13 million a yearfl1

8. ConclusionThe complexity of the role of the public debt

in the developing economy makes an adequatesummary of the argument rather difficult. Never-theless it is perhaps worth stressing that thetraditional, and obvious, function of the debt inchannelling purchasing power to the governmentitself clearly remains of tremendous importance.This is true whether the proceeds of debt issuesare used directly in the finance of pre-determinedgovernment expenditures or whether they are usedin the broader task of ensuring that those expendi-tures, together with those proposed by the privatesector, are consistent witha reasonable equilibriumof aggregate demand and aggregate supply and/oran adequate rate of growth over the economy as awhole. Similar considerations apply to debt issueson behalf of government agencies, local govern-ments or nationalised industries.

The second broad task of the public debt is toassist in the finance of development projects byprivate enterprises. The obvious role of the debthere is to act as a medium through which funds arepassed from personal or institutional savers toindividual enterprises via development banks andcredit agencies. A less obvious, and longer-term,role is to encourage the development of activesecurity markets and the growth of the habit ofportfolio investment, so that the flow of funds fromsavers to enterprises, in the non-government sector,is ultimately established directly.

Thirdly, the debt has an important role instimulating savings and in encouraging their usefulapplication within the economy, thus preventingtheir loss in hoards or external leakages. Here the

aDSce The ownership o/personal property in Ireland, p. I I.4°Ibid., Table VIII, p. x7.41£i5 million in i961--Economic Statistics (Pr. 6509).

Stationery Office, Dublin, I962, Appendix, Table 2, p. x7,Note also the relatively high level of Ireland’s official externalassets shown in the Appendix Table.

~5

emphasis must be on the form of borrowing, ratherthan On the disposition of the proceeds. The debtmust be designed primarily to meet the needs ofpotential lenders, not the requirements of theofficial borrowers.

In all these ways, then, the public debt bearsupon the finance of development, influencing notonly the total volume of the funds available tofinance capital formation but also the pattern oftheir disposal. Within the limits imposed by theneed to maintain public confidence and externalequilibrium, the authorities possess in the publicdebt a development instrument of considerablepower. The main emphasis in its application willnaturally vary according to the state of the economyconcerned. In the earliest stages of growthits directrole in financing official and semi-official develop-

ment expenditures will probably predominate; asthe economy develops, its task in the encourage-ment of finance for the non-government sector willincrease in importance; at the highest stage ofdevelopment, when direct government expenditureshave retired somewhat into the background as a

determinant of the rate of expansion, the overallcontrolling powers of the debt in the context ofmonetary policy may come to the fore.

The evidence discussed at various stages of thispaper suggest that the growth of the Irish publicdebt is largely classifiable under the first of theseheadings, but in recent years debt policy in Irelandhas clearly moved more towards the second. The" State Debt Balance Sheet " presented in theFinancial Statement indicates that by March 1962some 4° per cent. of the accumulated gross debtwas accounted for by repayable advances and shares,and a further 3z per cent. by various voted capitalservices. Budget deficits had accounted for littlemore than io per cent. of the total.42 At all stages,however, both for growing economies in general andfor Ireland in particular, the public debt, prudentlybut imaginatively managed, remains a complex,far-ranging and powerful instrument of policy inthe maintenance of a. steady and he~althy growth inthe whole ecdnomic system.

4°’Financial Statement, 1962, (Pr. 6493), Stationery Office,Dublin, I962, Table XII, p. I5.

APPENDIX TABLE: MONETARY INDICATORS, I961

Prices Money supply : Yield on Per caput

Country i953 = ioo ~/oof national Official Foreignincome

GovernmentBonds Reserves

Retail prices ’ Wholesale prices % $

I 2 3 4 5 6

IRELAND I21 II4 34"4 6’zo xx9Austria I22 xI5 29"6 n.a. I17

Belgium III io2 50"7 4"39 18o

Denmark I22 xo7 33"0 6’22 55France ~38 x32 47 "o 5"o6 64Germany (F.R.) ii4 lO5 zz’5 6"oo I2I

Greece 134 19"Z B.a. 30135Italy ix8 99 48"z 5’x4 69

Netherlands 123 I02 34"6 4"Ol 147

Norway i24 H3 31"o 4 69 77Portugal io9 I02 ¯ 76"4 3"7z 76Spain ~56 43 "3 n.a. Z8

~55Sweden i27 113 20"3 4"55 89

Switzerland IIO I0I 63"z 2’98 504

Turkey 236 246 I2"3 4"55 8

United Kingdom x25 x16 29"I 5"91 63

Sources : Statistical Yearbook 1961, United Nations, New York 1962 (SY) and Monthly Bulletin of Statistics, UnitedNations, New York,August 1962, (MBS).

Col. z--SY, Table x6z and MBS, Table 48, except that the index for Denmark between 1953 and I958 was taken fromTwelfth Annual Economic Review, O.E.E.C. Paris I96I, Statistical Appendix, Table 51. The series refer to all items.

Col. 3--MBS, Table 46. Series relate to general wholesale prices except for Austria (Basic materials) and UnitedKingdom (Finished products).

Col. 4--MBS, Tables 49 and 5I. Series show total money supply mid-I96I, as per cent. of x96o national income. Thenational income figure used for Sweden is that of gross national product at factor cost.

Col. 5--MBS, Table 54. Yields are these on government bonds with 12 or more years to maturity at December 1961

Col. 6----MBS, Tables x and 52. Data relate to December 196I.

16 "r

THE ECONOMIC RESEARCH INSTITUTE

Publication Series :

1. The Ownership of Personal Property in IrelandEdward Nevin

2. Short Term Economic Forecasting and its Application inIreland

Alfred Kuehn

3. The Irish Tariff and The E.E.C. : ,,1 Factual SurveyEdward Nevin

4: Demand Relationships for IrelandC. E. V. I.~ser

5. Local Government Finance in Ireland : A Preliminary SurveyDavid Walker

6. Prospects of the Irish Economy in 1962Alfred Kuehn

7. The Irish Woollen and Worsted Industry, 1946-59 : /1 Studyin Statistical Method

R. C. Geary

8. The ~11location of Public Funds for Social DevelopmentDavid Walker

9. The Irish Price Level : A Comparative Study

Edward Nevin

10. Inland Transport in Ireland : /1 Factual SurveyD. J. Reynolds

11. Public Debt and Economic DevelopmentEdward Nevin

Reprint Series :

1. Commentary on "" Europe’s Future in Figures"R.C. Geary