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The politics of deficits, surpluses, borrowing and debt - Essay Example

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The politics of deficits, surpluses, borrowing and debt

While a strong relationship exists how sound and well-functioning financial markets impact economic growth, Beck et al raise a critical question: 'How did some countries develop well-functioning financial systems, while others did not Why do some countries have particular laws and enforcement mechanisms that support the operation of free, competitive financial markets, while others do not' (2001, p.2). Particularly, why do some countries post huge budget surplus amounts while other states suffer prolonged effects of massive budget deficits
According to Petersen (1999), governments face the fundamental issue of using credit and raising funds in the present that will be repaid in the future with interest, a cost just like any other economic choice. Governments usually borrow in order to finance deficits (easier than to raise taxes), stabilize the economy in the short term and invest in productive infrastructure and economy upskilling in the long-term. Foreign borrowing allows a country to invest and consume beyond the limits of current domestic production and, in effect, finance capital formation not only by mobilizing domestic savings but also by tapping savings from capital surplus countries (Narayanan 2002). Petersen notes that national governments face more options in this regard because it has control over the money supply as well as the operation of the banking system and credit markets than its local counterparts but argues that the more open that national economies have developed, "the more even those options are curbed by the workings of the international economy" (Petersen 1999). That is, governments today are faced with more complex borrowing options as the global economy for savings has become more complicated over time.
Debt Government Management: Changing the Legal System and the "Other" Costs of Borrowing
Economies found with adequate savings, stable political systems, and sound financial institutions and good growth prospects tend to enjoy lower cost of borrowing. According to Lane and Tornell (1997, p.2), "two common characteristics of developing countries that have grown slowly in the last several decades are the absence of strong legal and political institutions and the presence of multiple powerful groups in society". The importance of improved budget systems across all governments, Petersen (1999) quotes, must be seen as a crucial part of a strategy in developing better public sector reform. Storkey (2001, p.9) cites Ireland, New Zealand, Sweden and the United Kingdom as the countries that have set the highest standards in sovereign debt management because of these countries' approach to sovereign debt management and their track record over the past 10-15 years, which has become the benchmark for other countries to follow. He also adds that governments in the OECD countries over the past 10-15 years took measures in addressing problems on sovereign debt management such as the limited understanding of a government's risk preferences and its tolerance to risk by establishing an autonomous debt management office or ...Show more

Summary

According to Beck et al (2001, p.2), much of the work done in monetary economics indicates that well-functioning financial intermediaries and markets promote long-run economic growth. They further that particular legal codes, contract enforcement mechanisms, and information disclosure systems influence financial development and hence economic growth, as shown by researches done on cross-country level [King and Levine 1993a,b; Levine and Zervos 1998; LaPorta, Lopez-de-Silanes, and Shleifer 2000], as well as by firm-level studies [Demirguc-Kunt and Maksimovic 1998, 1999]…
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