Role of Deficit Financing in Mobilization of Resources

Role of Deficit Financing in Mobilization of Resources:

After making strenuous efforts to raise as many resources as possible through taxation, borrowing, and external finance, there may still remain a gap between available receipts and the total investment expenditure necessary for repaid economic advancement. The Government of an underdeveloped country may, therefore, have to adopt the device of deficit financing as a last resort, since it is difficult to raise the required resources through moral sources of revenue. Again, due to low levels of income and high propensity to consume, aggregate savings in the economy are low. Investment through such voluntary savings is inadequate as compared to national requirements, due to low levels of production, incomes, and savings, and thus investment again, cannot increase sufficiently. It is, therefore, necessary to break such a “Vicious circle of poverty” in these economies. Since sufficient investment is not coming forth from the private sector, the government has to bear the responsibility of initiating a process of economic advancement by undertaking a considerable amount of investment. Hence, deficit financing is advocated for the implementation of development projects.

Deficit financing may be used for the development of economic and social overheads such as the construction of roads, railways, power projects, schools, hospitals, etc. By providing socially useful capital, deficit financing is able to break bottlenecks and structural rigidities and thereby increase productivity. Moreover, the fiscal apparatus in underdeveloped countries is neither efficient nor can it be easily made so as to provide savings needed for capital formation. Hence, deficit financing has resorted so as to obtain the required resources for the implementation of development projects.

Limitations: The process of economic advancement, facilitated by the use of deficit financing is, however, not a smooth one. The investment outlay is mainly undertaken for increasing capital formation in the economy and there is a great time lag between investment and realization of the production of consumption goods. But, in the meantime, due to increased spending by the government, the money supply with the public increases, and an imbalance is created between the demand and supply of consumption goods. If, therefore, certain counteracting measures are not undertaken, there is a great danger of the emergence of inflation, as a result of deficit financing. Price inflation may lead to cost as well as wage inflation. When prices rise more rapidly than the incomes of some groups in the community, their consumption in real terms is diminished. Again, rising prices reduce the real income of the consumers, thus, lowering consumption in real terms. Thus, deficit financing may undermine the very purpose of economic development for which it is taken.

The device of deficit financing has been opposed by several writers on the ground that in the context of economic development, it is undesirable owing to the danger of inflation associated with it. In most of the discussions, it is referred to as an inflationary way of financing the development process. However, even after admitting the possibility of such a catastrophe, it is erroneous to associate deficit financing with inflation at all times. It is possible to render the quantum of deficit financing non-inflationary if proper safeguards are taken and resources are taken in that direction.

Moreover, there are several degrees of inflation, and deficit financing can be condemned only if it leads to inflation of a spinal type and not when there is only mild inflation. Since mild inflation in the economy is considered conducive to the growth of the economy. Deficit financing undertaken for the purpose of creating useful capital goods, even if it leads to mild inflation at certain stages is ultimately self-destructive. Deficit financing may however generate inflationary forces when it is resorted to for employing labor for capital formation only, i.e., construction of buildings and roads, etc. It is used for increasing the output of consumer goods, it will not be inflationary as the additionally created purchasing power will be matched by an increased amount of such goods.

It may now be concluded that deficit financing should not be resorted to beyond the point at which it becomes seriously inflationary. The policy of managed deficit financing in contrast with that of an unlimited and reckless one is certainly not dangerous but is necessary and helpful in the process of economic development.

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