Public Finance Proposal : Final Project

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Public Finance Proposal Part I: Cost-Benefit Analysis

Heather R. Johnson

University of Phoenix

Public Finance MPA/553

Instructor Jackie Lester

July 20, 2021

Public Finance Proposal Part I: Cost-Benefit Analysis

Counties all over the globe incur debt through borrowing. Although debt may be considered to be bad in some instances, often, it is crucial the countries borrow money to finance crucial development projects and programs. Borrowing is especially vital for emerging countries because they have limited resources and financial power to cater to their needs (Berg et al., 2012). More so, these countries must borrow to compensate for the needed revenue that cannot be obtained via taxation. Despite the importance of borrowing, when debts are accumulated to unmanageable levels, the burden of repaying them can overwhelm the finances of a country. Wyplosz (2011) notes that the elevated debt of many emerging countries over the years has raised concerns over their abilities to sustain their debt levels. Consequently, the issue of debt sustainability in emerging countries is crucial because having sustainable debt implies that a government will adequately meet its future and present payment obligations without going into default or getting exceptional financial assistance. In this context, this paper carries out a cost-benefit analysis of the issue of debt sustainability in emerging countries.

For starters, having some debt is beneficial for an emerging country. Debt allows a country to raise money to supplement the revenue it collects through taxation and fund essential development projects. Even though there are other techniques of mobilizing financing like enhancing the country’s business environment, lowering corruption, improving the country’s spending efficiency, and raising the country’s domestic revenue, all these take a lot of time to materialize (Hakura, 2020). For an emerging country, limited resources imply that getting loans is the most realistic way of fast-tracking development projects. Nevertheless, debts are only beneficial if they are sustainable in a manner that they do not jeopardize a country’s stability and growth. Debt, which is not sustainable, can result in debt distress such that a country fails to fulfill its financial obligations and require debt restriction (Hakura, 2020). In some situations, a country that defaults its loans can disqualify it from accessing various markets, incur higher borrowing costs in the future, and harm its overall investments and growth.

To check for debt sustainability, major lending institutions such as the International Monetary Fund (IMF) and the World Bank utilize the Debt Sustainability Framework (DSF) to measure the borrowing and lending decisions surrounding emerging countries (Guzman & Heymann, 2015). This framework gauges the financing needs of an emerging country and its ability to repay the borrowed funds. It is crucial to note that this framework is not rigid but is fluid and customized based on country-specific circumstances. This is beneficial in ensuring that debt sustainability is measured accurately to suit the needs of a given country. There are two major models used to check for debt sustainability under the DSF. First, there is the Market-Access Debt Sustainability Model, which is utilized to emerging market economies with the ability to easily access the global capital markets (Guzman & Heymann, 2015). Second, there is the Low-Income Country Debt Sustainability Model, which assesses countries that face huge problems to meet their development objectives (Guzman & Heymann, 2015). The cost of implementing these models before giving out a loan is worth it because it ensures both the lender and the borrower are able to fulfill their obligations in the foreseeable future without any major problems.

This analysis will be crucial in making decisions regarding public expenditures. From the analysis, it is clear that debt is necessary for emerging countries to develop their infrastructures and enhance their financial strength. However, the debts have to be sustainable if these benefits are to be realized. Public expenditures have to be structured in a way that ensures the spending on each project will lead to the long-term growth of the country. More so, each expenditure has to yield tangible benefits for the country. This will be vital in ensuring that the country generates the necessary income it requires to pay off its debts. If the loans are used for unnecessary public expenditures, then the debts will not be sustainable leading to undesirable outcomes for the emerging countries.

Economic theory played a significant role when conducting research on this project. According to Levy, Levy, and Solomon (2000), the assumption of economic theory is that consumers and investors are efficient and rational individuals such that they make the best choices for themselves. However, Levy, Levy, and Solomon (2000) acknowledge that pertinent research suggests that the behavior of investors is quite complex in the context of the behaviors that many economic theories assume. Hence, when analyzing the costs and benefits of debt sustainability, it is crucial to research how the actions of the consumers and investors in the borrowing country will influence the government’s ability to repay off its loans in a reasonable manner. An example of an economic theory that influenced this cost-benefit analysis is the Circular Flow, as depicted in figure 1.

Figure 1: Circular Flow

This economic theory depicts the interactions between firms and households in the implementation of development projects financed through loans. If the projects are essential to the community and are managed efficiently, then the flow of services, goods, and money will be ideal leading to a steady supply of revenue to pay off loans.

In conclusion, this paper has conducted a cost-benefit analysis of the issue of debt sustainability in emerging countries. It has been deduced that even though there are other techniques of mobilizing financing like enhancing the country’s business environment, lowering corruption, improving the country’s spending efficiency, and raising the country’s domestic revenue, all these take a lot of time to materialize. Hence, having some debt is beneficial for an emerging country. Debt allows a country to raise money to supplement the revenue it collects through taxation and fund essential development projects. However, it is crucial that a country facilitates debt sustainability so that it develops economically in a feasible way without hurting its future credit status.

References

Berg, M. A., Portillo, R., Buffie, M. E. F., Pattillo, M. C. A., & Zanna, L. F. (2012). Public investment, growth, and debt sustainability: Putting together the pieces. International Monetary Fund.

Guzman, M., & Heymann, D. (2015). The IMF debt sustainability analysis: Issues and problems. Journal of Globalization and Development, 6(2), 387-404.

Hakura, D. (2020). What is debt sustainability? International Monetary Fund. https://www.imf.org/external/pubs/ft/fandd/2020/09/what-is-debt-sustainability-basics.htm

Levy, M., Levy, H., & Solomon, S. (2000). Inefficient choices and investors’ irrationality: Microscopic simulation of financial markets. San Diego: Academic Press.

Wyplosz, C. (2011). Debt sustainability assessment: Mission impossible. Review of Economics and Institutions, 2(3), 37.