Effects Of Public Debt On Financing Of Social Welfare Programs: Literature Review

Introduction

This chapter entails reviewing of theoretical and empirical literature on the effect of public debt on social welfare programs in Kenya, a conceptual frame work on dependent, independent and intervening variables. The chapter also expounds on the research gap by showing how the study deviates from previous studies reviewed in empirical literature.

Theoretical Review

These are theories which support the research objectives that discuss the effect of public debt on social welfare programs.

Classical View On Burden Of Debt

The concept of debt burden has been an area of intense controversy in public finance by drawing analogy between private and public debt the classical economists considered all public debt as a burden. They postulated that taxes reduced mainly consumption while internal borrowing led to a reduction in private capital formation. To quote Pigou, finance by loans does hit capital and through this, the economic fortunes of future generations somehow more hardly than finance by taxes. As David M.C Wright observes, the financial burden of the national debt is to be measured by the effects of the interest charges and the taxes for interest bear to the national money income is the question of primary importance.

Sometimes the concept of burden is explained in terms of the nation abstinence or pain-cost doctrine and opportunity cost, when a loan is obtained by the government, resources are transferred from private hands to government and those who contribute to government loan abstain from consumption of current income and undergo the pain of abstinence which may be called a burden caused by incurring of public debt. However, the concept of burden based on the notion of abstinent and opportunity cost is not quite acceptable if people contribute to loans voluntarily. When the people voluntarily lend to government it means by investing in government securities, they are moving to a preferred position on the utility surface.

Neo-Classical Theory Of Public Debt

In this theory economics is viewed as a study of the allocation of resources to satisfy human wants. A significant development in the neo-classical economics was the emergence of the welfare theory and it applied utilitarian ideas over the entire range of functions. A.C Pigou is particularly identified with the welfare theory. In his ‘Economics is welfare’ he said that the main motive of economic study is to help in social improvement. The concept of ‘ideal output’ was central. Pigou defined it as that composition of production such that no alternative output which could be obtained by means of re allocation among the various industries of the economy’s resource would by itself achieve ideal output. If and only when a private market relationship departs from ‘ideal output’, then state intervention was justified.

As regards state functions the basic ideology of the neo-classical was that the economic system functions in response to the instructions of the market and ultimately the consumer should be adequate. If this response is inadequate or imperfect then the state should amend or supplement the response in the better interests of the community at large. The state’s role was essentially supplementary and regulatory. Neo-classical economists had a strong adverse attitude towards tariffs, price supports and governmental assistances. They felt that services of the state though of great importance for economic progress did not help development of industries. They adopted the concept of state ‘Neutrality’. It was contended that the state should refrain from distributing the pattern of resource allocation determined by private market. Private market misallocation of economic resources existed where markets were organized on monopolistic rather than competitive lines, then state intervention is justified. Hence a tax on monopoly was favored.

Incase the case of externalities, state subsidies or even public ownership was favored for example education and transport facilities.

Public goods such as roads and telecommunications should be state provided.

The Classical Welfare Economics

The classical welfare economics relates the ideas of Smith, Ricardo and J.S Mill about increasing the wealth of a nation. According to Prof. Myint, the classical view about welfare is largely confined to the production of material wealth. Smith explains real national income of a nation in terms of its physical output which is an index of its economic welfare. The real value of a commodity is its labor price, irksome and disagreeable. It is the division of labor which motivates labor to produce more. Smith associates increase in welfare with a reduction in sacrifice required to produce more commodities. A person’s wealth is measured by the value of a commodity produced by his own labor or his purchasing power over other man’s labor. The more the labor, the more the total output or the hike in real income leading to improvement in welfare. This welfare is a positive function of population growth. According to Smith, the most positive mark of prosperity in any nation is the increase in the number of inhabitants.

Smith believes in the working of the ‘invisible hand’ that is the automatic working of the market. Since every person maximizes his own satisfaction due to automatic working of the economic system, the satisfactions of the whole community are satisfied. Thus, the motive of self interest embodied in the free market system maximizes economic welfare by increasing the physical productivity of labor by adopting new techniques of production

To maximize social welfare, Smith favors the increase in outlay on public works such as highways, canals, bridges and harbors. But he wanted that the greater part of outlay on public works should benefit through toll taxes on their users and the remaining out of local revenue and general revenue

Pigovian Welfare Economics

According to Pigou, welfare resides in aman’s state of mind or consciousness which is made up of satisfactions or utilities. The basis of welfare hence is necessarily the extent to which an individual’s desires are met. Social welfare is regarded as the summation of all individual welfares of a society. Since general welfare is a very wide complicated and impracticable notion. Pigou delimits the range of his study to economic welfare. Pigou therefore defines economic welfare as ‘that part of social welfare that can be brought directly or indirectly into relation with measuring rod of money’. Thus, economic welfare implies the satisfaction of utility derived by an individual from the use of exchangeable goods and services.

Pigou outlined the following welfare conditions; the first condition states that welfare is said to increase when national income increases. Given the same tastes and income distribution, an increase in national income represents an increase in welfare. Pigou contends that in most cases the national income would increase even though the disutility of work also increases. Secondly, for welfare maximization the distribution of the national income is equally important. If national income remains constant, transfers of income from the rich to the poor would improve welfare. According to Pigou such transfers means loss to the wealthy than to poor, as a result the economic position of the latter is raised. This welfare condition is based on the dual Pigou postulates of ‘equal capacity for satisfaction and diminishing marginal utility of income’. Pigou argues that different people derive the same satisfaction out of the same real income and that people now rich are different kinds from the people now poor having in their fundamental nature greater capacities for enjoyment.

Social contract theory

Social refers to set of mutual rights and obligations binding citizens with their state. (Flanagan 1999:135) this comes from a “bargain”, whereby: “one will enjoy the rights and reap benefits of the social order if he/she lives by its rule and fulfils the responsibility of membership.” The normative tendency involves advocating for a contractual approach to social protection(and public policy more broadly). This means promoting a specifically contractual approach to social protection interventions themselves (as in the case of conditional cash transfers) or efforts to locate social protection within more binding sets of relationships and agreements as a means of ensuring political sustainability. This resonates with contemporary social protection debates in international development, particularly in terms of popularity of conditional cash transfers. As the World Bank has noted with reference to the Bolsa Familia program in Brazil “conditional cash transfers provide money directly to poor families via social contract with beneficiaries for example sending children to school regularly or bringing them to heath centers.” (Rawlings and Rubio 2005).

Adopting a social contract perspective to social protection clearly places national governments and their citizens rather than donors at the center of the matter. Donor agencies are generally ill-suited to promoting the types of political changes required to catalyze or strengthen social contracts around social protection in Africa, and their notion might be considered to run counter to the thrust of social contract approach.

Empirical literature

A UN report (1975) suggested that basic aim of social services was to help towards a mutual adjustment of individuals and their social environment. This objective was achieved through the use of techniques and methods which were designed to help individuals, groups and communities to solve their problems of adjustment to changing pattern of society. The current study borrows from the suggestion and aims at showing how this mutual adjustment of the individuals to their social environment has been derailed by inadequate financing of the social welfare programs. According to (Paul Spicker,1988) in a study on principle of social welfare, welfare provision served mainly the physical and material interest of recipients. Interests were linked both with people’s needs which were socially defined, and with what people wanted. If people were mistaken about where their interests lied, their welfare was not served by considering their wants alone. Therefore, social welfare was not simply the sum of individual welfares and one concept could not be derived from the other.Some interest would be held in common, equally, however, there may be conflicts between interests and some may bear costs for the benefits of others. The study links social welfare provision with interests of individuals by serving their physical and material interests. The current study links social welfare provision to economic development. An impact evaluation report of CT-OVC Kenya done by Tomkins et al (2008) showed a reduction in the rate of absenteeism among children in program from 31.3 percent to 11.9 percent. Cash transfers increase the purchasing powers of families as along as they receive the benefit (Soares et al,2008). The study focused on cash transfer for the orphans and vulnerable group and its positive externalities. The current study will include the other social welfare programs such as cash transfer for the elderly, social protection and free education programs.

A policy research project done by (Barriet and Nino-Zarazua,2009) indicated that the focus of social transfer programs on extreme poverty suggested that they could have important effects in reducing persistent poverty and social transfer were emerging as a core component within social protection policies aimed at tackling poverty and vulnerability. The study focuses on reduction of poverty and vulnerability. The current study views social welfare programs as a core component in achieving economic development. (Vincent and Cull, 2009) in a study on impacts of cash transfer across South Africa found out that in addition to promoting food security, social transfers have additional beneficial effects that are wide ranging and extend beyond the direct recipient of the transfer to the wider family. For the recipient there was evidence that suggested that cash transfers promoted self-esteem, social status and empowerment. The study was based in south Africa, it focused on additional benefits of social transfers. The current study is based in Kenya and looks into the financing of the social transfer programs. According to the Ministry of Gender Children and Social Development (MOGCSD, 2011) the need for social grants in Kenya was motivated by extreme and persistent poverty which prevented a larger population of poor people from accessing or benefiting from mainstream development interventions. The study viewed the need for social grants as to reduce extreme poverty. According to the current study, besides reducing extreme poverty the social grants increase the productivity of the citizens leading to a higher GDP thus economic growth. According to (Gaspar and Lustig,2011) social protection played an important role in providing income support and services, redistribution and promoting inclusive growth in countries across the world and the reduction in in income inequality in Latin America was had been attributed to part to the expansion of public transfers. According to the current study public transfers have not been adequate in Kenya so as to reduce the income inequality in the country.

Emily (2013) in a study on cash transfer and its impact on the welfare of the elderly found out that some older persons were found to face challenges of distance which had implications in the cost of accessing the fund. Like wise the fund was found to be sometimes irregular. It was further seen to impact on food security, household asset (livestock), shelter, health, clothing, access to goods and services on credit and ability to join social groups The National Gender Equality Commission (NGEC, 2013) audit on the cash transfer programs for the orphans and vulnerable children (OVC), persons with severe disabilities (PWSD) and the elderly in twenty one sub counties of Kenya reported that on overall the three cash transfer programs had been successful and had remarkable achievements such as improved household food security, retention of children in schools, access to basic health care, formation of social support network and increased self-esteem and dignity among beneficiaries.

Krystle Muthoni (2015) in a study on use of cash transfer programs in progressively addressing poverty and vulnerability revealed that although Kenya had made strides in terms of economic development and improvement of access to education and health care, 45.95 of the population continued to survive on less than $1.25 a day. The studies above have focused on the impact of the social welfare programs such as cash transfer programs and social protection programs on the beneficiaries, that is how their welfare has improved in terms of raising their living standards, access to basic health services and reduction in school absenteeism. However, there is an indication of the financing not being adequate, difficulties among some beneficiaries accessing the fundsand poverty levels still being persistent as in the case of those earning $1.25 per day. The current study borrows from the above study and view public debt as the main limit to adequate financing of the social welfare programs.

Most of the studies that have been done in Kenya on public debt have been on the effects of public debt on economic growth. In order to achieve economic growth,the productivity of the citizens has to be high, without food health, education, high self-esteem, guarantee of income protection through the pension schemes such as NSSF productivity of the citizens will be low thus economic growth is impeded. This implies that with increase in social welfare the productivity of the citizens increases and hence economic growth is achieved. (Shabbir 2005), investigated the impact of external debt on economic growth in 24 developing countries from 1976 to 2003. (Rife-qua and Mustafa,2012) examined the effect of external debt service payments on economic growth in Nigeria. The results from both studies showed that debt servicing negatively affected economic growth and may left less fund available to finance private investment in those countries leading to a crowding out effect. The studies viewed public to have crowded out private investment and negatively affecting economic growth. The current study agrees to public debt negatively affecting economic growth but focused on public debt crowding out social welfare programs. According to (Owino and Mutai 2008), study on the development of public domestic debt in Kenya and its impact on the economy for the period 1996 to 2007, the composition of Kenya’s public debt had shifted in favor of domestic debt while considerable had been made in extending the maturity of the profile of the debt, and diversification of the investor base towards institutional investors and individuals. The significant rise in domestic debt during the period resulted in higher domestic interest payments which presented a significant burden to the budget. The study focused on domestic debt. The current study focuses on the overall public debt to be posing burden on the budget thus less funds being allocated to social welfare programs. Kumar and Woo (2010) in a study on the impact of high public debt on long-run economic growth for a panel of advanced and emerging economies over 1970 to 2007. The study found out that there existed an inverse relationship between initial debt and subsequent growth. The study does not include debt. The current study will incorporate current debt.

Gladys (2017) carried out a study on the effects of national debt on economic growth in Kenya for a period of ten years (2007-2016). The study showed that national debt was negatively related to economic growth in Kenya. The study can be linked with Shabbir, Rife-qua and Mustafa, Kumar and Woo studies which also indicated national debt/public debt to be negatively related to economic growth. The current study differs from the above studies by indicating that public negatively affects social welfare programs. According to (Odongo,2018), unsustainable debt levels were harmful and crowded out development and social programs because huge portions of government revenue were taken away from essential services and used instead to service the debt, Sri Lanka was unable to repay it debt from china and was forced to hand over a strategic port to China. The current study also borrows from the above article and proceeds to provide empirical results on public debt limiting financing of social welfare programs.

Summary of literature review and Research gap

In classical economics the burden of public debt is explained in terms of a nation’s abstinence or pain-cost doctrine and opportunity cost, when a loan is obtained by the government, resources are transferred from private hands to government and those who contribute to government loan abstain from consumption of current income. A.C Pigou in neo-classical theory of public debt postulated that the main motive of economic study is to help in social improvement. The concept of ‘ideal output’ was central, Pigou defined it as the composition of production such that no alternative output which could be obtained by means of re-allocation among the various industries of the economy’s resource would by itself achieve ideal output. If and only if private relationship departed from ‘ideal output’, then state intervention was justified. In order to maximize social welfare, Smith favored the increase in outlay on public works such as highways, canals, bridges and harbors. The main source of finance for outlay on public works would be toll taxes on the users and the remaining from local and general revenue. In Pigovian welfare economics, social welfare is regarded as the summation of all individual welfares of a society. The social contract theory suggested the use of contractual approach to social protection interventions themselves (as in the case of conditional cash transfers) or efforts to locate social protection within more binding sets of relationship and agreements as a mean of ensuring political sustainability. Abraham Maslow proposed a hierarchy of human needs that is applicable to human services model. It consists of the following levels; psychological needs, safety needs, love and belongings and esteem needs.

The previous studies on social welfare programs have shown the social welfare programs to essential in a country as they help in eradicating poverty and vulnerability. (Vincent and cull 2009) found that in addition to promoting food security, social transfers had beneficial effects that are wide ranging and extend beyond the direct recipient of the transfer to wider family. (Emily, 2013) found out that some older persons were found to face challenges of distance which had implications in the cost of accessing the fund and the fund was found to be sometimes irregular. (NGEC,2013) audit on the cash transfer programs for the OVC,PWSD and the elderly reported that the three cash programs had been successful and had remarkable achievements such as improved household food security, retention of children in schools, access to basic health care, formation of social support network and increased self-esteem and dignity among beneficiaries. Krystle Muthoni (2015) revealed that although Kenya had made strides in terms of economic development and improvement of access to education and health care, 45.95% of the population continued to survive on less than $1.25 per day.

The previous studies on public debt indicated public debt had negative effects on economic growth, crowded out private investment and posed a imposed a burden on a country’s budget. Shabbib (2005) and (Rifeqat and Mustafa 2012) studies showed that debt servicing negatively affected economic growth and left less funds available to finance private investment leading to a crowding out effect. (Maana, Owin and Mutai 2008) studies indicated that Kenya’s public debt had shifted in favor of domestic debt while considerable efforts had been made in extending the maturity profile of the debt, and diversification of the investors and individuals. The significant rise in domestic debt during that period resulted in higher domestic interest payments which presented a significant burden on the budget. Kumar and Woo (2010) found that there existed an inverse relationship between initial debt and subsequent growth. Gladys (2017) study showed that the national debt was negatively related to economic growth in Kenya. Odongo (2018) in an article suggested that the unstainable debt levels in Kenya were harmful and crowded out development and social welfare programs because huge portions of government revenue were taken away from essential services and used instead to service the debt. If a country is unable to repay the debt then it faces the risk of losing strategic resources to the creditor such as Sri Lanka which was forced to hand over its port to china. However, Odongo did not proceed to show how the public debt limited the financing of the development and social welfare programs in Kenya that is he did not provide empirical results on his proposal. The current study intends to close the gap, by looking on the composition of public debt in Kenya , the financing of social welfare programs and show how the public debt limits the financing of the programs by diverting large amounts of government revenue to serving the debt and on interest payment thus a crowding out effect on social welfare programs.