Opinion Leaders' Digest 99-08
Date: Mar 5, 1999
Author : Keon Young Yoon, Professor, Yonsei Univ.

Concern Over The Government Debt

Rapidly Increasing Government Debt

Since the rescue financial package from the IMF at the end of 1997, the government debt is literally snowballing rapidly. At the end of 1997, the so-called net government debt, which refers to the sum of government bonds, borrowings, contracts resulting in treasury obligation and government loans, stood only at the 12.1% of the GNP. Even when we add government guaranteed bonds, the total is amounted to 63.6 trillion won and it is only 15.3% of the GNP. This ratio was very small in comparison to the corresponding ratio in other advanced capitalist countries. Considering the size of our economy, the small proportion of government debt prior to the financial crisis was largely due to the fact that the government had maintained, for a long period of time, a conservative financial management, following the principle of "expenditure within the revenues."

However, in the process of overcoming the economic crisis which began at the end of 1997, the government took responsibility for various debts, such as government bonds, loans from the IMF and the IBRD, issuance of exchange equalization fund, payment guarantee for the deposits and foreign debt incurred by financial institutions, and guarantee for bonds issued by Deposit Insurance Corporation and Korea Asset Management Corporation. The debt increased rapidly. The government announced that government debt, including payment guarantees, will reach 200 trillion won, that is, 45 % of the GNP, at the end of this year. However, there is a great possibility that the scale of government debt may exceed the announced 200 trillion level, since the restructuring of financial sector and clearing-off of non-performing loans are not completed yet and there will be more non-performing loans in the process of corporate restructuring. It is notable in this context that the scale of non-performing loans, held by financial institutions, turned out to be much larger than it was known at the beginning of 1998 when the government drew up plans to use the public fund of 64 trillion for the restructuring of financial institutions. As shown in the process of disposing the KIA group or in the so-called Big Deal, i.e., business exchange process and industrial restructuring, it is certain that the size of fiscal burden for the government in the process of overcoming the economic crisis will be much larger than expected. If the government is going to spend money actively in the public works and social infrastructure projects in order to boost the economy and provide subsidies to the unemployed while trying to dispose the non-performing loans of the financial sector and achieve corporate restructuring rapidly and thoroughly, the government debt will go over 60 percent of the GNP without much resistance.

Large Scale Government Debt and National Economy

From the viewpoint of national economy, it is fortunate that the government, faced with the economic crisis, could pour a big sum of money into the financial sector and take positive policies in order to support the livelihood of the unemployed. If the government was not able to provide funds for the restructuring of financial sectors and unemployment subsidies after the beginning of the economic crisis, the socio-economic sacrifice of people would have been much greater. In this regard, the long-standing conservative management of budget before the economic crisis should be appreciated.

The increase of the government debt leads naturally to the increase of taxpayers' burden. Though the share of burden between the present generation and the future generation will vary according to the fiscal policy, the government debt should be paid from the taxpayers' pocket in any case. To grasp the issue more precisely, we need to take note of two things. First, the increase of the government debt does not directly leads to the net increase of taxpayers' burden. For example, when Korea Asset Management Corporation takes over non- performing loans of financial institutions with the fund made by issuing government guaranteed bond or when Deposit Insurance Corporation participates in the increase of capital, new assets are being acquired. So, the net government debt increases only so much as the difference between the acquired value and the asset value. Second, when the government guarantees the payment of loans borrowed by financial institutions or the payment of bonds issued by the Korea Asset Management Corporation or Deposit Insurance Company, the net taxpayers' burden calculated before the real transaction should be the amount of guaranteed debt multiplied by the probability that the government should actually pay. This amount is remarkably smaller than the guaranteed amount.

It is also very important that economic activities are distorted when the government debt is large and when a tax rate is high and a tax burden is heavy. When the taxes on the incomes or consumption are excessively high, people lose the motives to work hard or they lose interest in saving and investments. As the tax rates go up, the motives to evade the taxation also increases and, as a result, it is likely that tax burdens are shared unfairly and the moral duties to pay tax become lax. The government which has to make funds to pay principal and interests may find it difficult to provide proper public services. Furthermore, since it is not politically popular to increase the tax rate, the government may look for alternative sources of revenue. What worries us in this score is that the government may be more interested in making funds through the increased issuance of money and may neglect the price stability in order to reduce the actual burden of government debt.

Tasks of the Government Debt Management

We can not say that it is wrong for the government to pour a large amount of public funds and guarantee the payments for financial institutions and deposits relying on the government reliability in order to overcome the economic crisis. On the contrary, for the past one year, the role of the fiscal policy in the process of overcoming the crisis should be assessed successful. In the economic crisis, the government resorted to the active fiscal policy and this was made possible due to the financial leeway accumulated during the period of the conservative fiscal policy.

However, the government capability to pay debt is an intangible asset which can not be reused till replenished once it is depleted. In the process of overcoming the crisis, the additional capability to take debt burdens has been reduced to a substantial degree and the policy options in the fiscal management are narrowed and the adaptability of the government in the possible future crisis is reduced to the same degree.

The narrowing of fiscal policy leeway means the reduction of domestic and international flexibility of Korean economy which is almost completely open to commodity markets and international capital market. Another problem is that the adaptability of the government to the sudden fiscal demands is also reduced. In the case of Korea which has to take into account the unexpected direction and speed of changes in the North and South relations, the reduction of fiscal policy flexibility is a really important matter of concern. It is also crucial that the government takes preparatory steps in such a way that the rapid increase of the government debt does not escalate the large-scale fiscal deficits of social safety net funds, such as National Pension Fund, Public Employee Pension Fund and Private School Pension Fund. However, we are not saying that the government should take unreasonable measures to manage a surplus budget, trying to reduce the government debt as drastic as it can. Though the wound of the economic crisis would not be fully healed completely in two or three years, the growth potential of Korean economy has not been lost. So, it is necessary to approach the issue of the government debt from a long-term perspective. From the long-term perspective, what matters is not the absolute size of the government debt, but the proper management of the ratio of the government debt to the national economy.

The management of the government debt is not a simple choice between financial deficit and financial surplus. For example, if the government can not produce sufficient surplus when an interest rate is higher than a growth rate, the ratio of the government debt to the GNP constantly increases. But, even if the relatively small financial deficit is produced, the ratio of the government debt to the GNP may be lowered when the growth rate is higher than the interest rate. Considering the importance of the high growth rate in the management of the government debt, we should be cautious not to reduce the investments unreasonably in education, science and technology, information industry, social overhead capital in the name of rapid reduction of the absolute amount of the government debt. It is important to realize that the task of managing the government debt requires a comprehensive approach, taking into account the relationship among financial deficit, government debt, interest rate and growth rate.

Fiscal Policy For Tomorrow

The financial policy played an important role in the process of dealing with the economic crisis. Yet, the rapid increase of the government debt also produced several side-effects. Of particular concern are the sharp reduction of flexibility in the fiscal management and the decline of the government adaptability to crisis. To deal with these problems, it is necessary for the government to make efforts to reduce the ratio of the government debt to the GNP. Both the excessively tight financial policy which aims to reduce the government debt rapidly and the loose financial policy which does not show interest in reducing the government debt are risky. It is important to manage the financial policy from the long-term perspective in such a way that the government debt does not grow too much in relation to the size of the economy.

Reasonable management of the government finance should be approached not only in terms of the total size, but also from the microscopic perspective. It is needless to say that the government should set a priority in a rational manner and reduce the waste and inefficiency in the management of budget. Restructuring of financial sector and corporations which will last for a while should faithfully follow the market principle and self-responsibility principle. The unnecessary increase of public burden for the benefit of special interest groups should be prevented. When people believe that the financial policy is clear, fair and efficient, they will be willing to carry the heavy burden as if they are light.

(The view expressed here is the author's personal view. It is not the official view of the CFE.)