SOVEREIGN BORROWING
AND THE PRINCIPLES OF BUDGETARY LAW
Contribution by Professor Rolf Knieper*
(Article Reference: Document No.1, Chapter 6, February 1992)

There is now unanimous agreement in principle within the international community that there is a common responsibility for the development of mankind. Even though the meaning of the term "development" is vague and even though it is not universally agreed that there is a "right" to development, nevertheless it may justly be said that the development efforts of the developing countries and the support given to these efforts by bilateral, regional and multilateral agencies are not based on merely moral or ethical considerations. They correspond to what may fairly be described as legal standards and obligations - virtual "law of development".

Secondly, one can agree that the World Bank's view (as stated in its report on Sub-Saharan Africa, 1989) is correct and that responsibility for Africa's economic crisis is shared by donor agencies and foreign advisers, along with the African governments themselves.

Thirdly, the State has certain inalienable functions in the matter of public expenditure and public revenue which must be exercised for the sake of the common good. However, in the modem interdependent world economy the common good can no longer be defined in purely national terms.

It is to the light of these considerations that public expenditure, public revenue and public debt in developing countries have to be discussed.

Let us now elaborate on the laws of public expenditure, public revenue, public debts or budgetary deficits in the developing countries.

Public expenditure "constitutes the dispensation by the State on non-market criteria of economic resources which it has acquired from firms and households" (D. Heald, Public Expenditure, Its Defence and Reform, 1987, p. 10). It includes such recurrent operating costs to the Government as provisions for police, judiciary, military, diplomatic services, central banks or statistical services, the bulk of expenditure being wages and salaries. It further includes the costs of social and economic infrastructures like schools, clinics, posts, highways, bridges, power stations and water supply. To this is to be added, from time to time, investment in productive activities, or as the World Bank likes to say parastatals, which can range from mining companies to state banks and agro-industrial firms (cf. A. Seidman, An Economics Textbook for Africa, 1980 p. 290 s; K. Griffin, Alternative Strategies for Economic Development, 1987, p. 236 ss.) and we have to add of course the costs of reimbursement of existing debt that for the time being cripples any state policy.

Apparently, neither lawyers nor economists have succeeded so far in developing objective criteria justifying all these activities. It has been equally impossible to draw an objective line between public and private expenditure. Both questions have been the subject of political controversy and have opposed political parties and moral philosophers as basic issues of principle. For the same reason, categorizations have changed over time. What was private yesterday can become public today; what was deemed of highest necessity yesterday might be considered superfluous tomorrow. However, this is only true for specific expenditures. No one would dispute the fact that modern societies could not survive without public expenditure, without any state activity at all.

The following quotation of Adam Smith - which best summarizes the essential points - will help us grasp the problem in its essence and link it to the next point: "The third and last duty of the sovereign or commonwealth is that of erecting and maintaining those public institutions and those public works which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expenses to any individual or small number of individuals, and which it therefore cannot be expected that any individual or small number of individuals should erect or maintain. The performance of this duty requires very different degrees of expense in the different periods of society" (A. Smith, the Wealth of Nations, Book V. Clip. I. Part Three). Smith goes on to give the examples of roads, bridges, harbours and the like ? all expenditures which can be found in any project list of any development agency. At the end he adds a "certain expense which is requisite for the support of the dignity of the sovereign".

We find here two decisive criteria for public expenditure, advantageous to the society and not profitable to individuals. From there, Smith concludes and we cannot but agree, that these expenditures have to be "defrayed by the general contribution of the whole society, all the different members contributing, as nearly as possible, in proportion to their respective abilities" (Book V Chp I. Conclusion).

These observations and reflections, written some two hundred years ago, are of more than historical interest. In fact, they give a clue to a better understanding of the ongoing debt crisis of developing countries which goes far beyond current allegations of bad management or corruption, although these facts cannot be denied. They even justify the prediction that the mere forgiving of the existing debt would not solve the problem, which is of a structural nature.

In order to explain what is meant, the following example will be used, which might seem to be far fetched. When the Security Council decided that Iraq should be driven out of Kuwait and when it authorized allied forces to do so, the United States found that they could not finance this unforeseen military venture through their tax revenues or by increasing the budget deficit, which is already the highest in the world. The US budgetary legislation stood against the contracting of further (foreign) debt. The US argued that what they did was deemed necessary by the international community, that it was under all aspects a public expenditure, that it could not be financed by one national budget for structural reasons, so that other national public revenues should contribute to finance their expenses. That was accepted by several countries like Japan, Saudi-Arabia and Germany, which in turn used tax and other public revenues to do so. It did not occur to anyone that these contributions, to a task that was defined as being in the common interest in an interdependent world, should be made in the form of loans. It was paid as grants to the US budget, stirring later and almost inevitably, discussions as to the justification of cost estimates.

Does this example apply to the debt problem of African countries and how?

A crucial point in the reasoning of Adam Smith is that certain expenditures are by definition public because they will not generate profits on private capital and will not generate funds which could be used to reimburse credits. By definition, reimbursement from the proceeds of this specific expenditure is excluded. It has to be financed by general contributions, by public revenues accrued from taxes, duties and the like, which are defined by their compulsory nature, outside any individual consideration. If in a given period of time public revenues are not sufficient to meet all public expenditures which have been judged necessary, the gap might be bridged by deficit spending, by credits. These are contracted in the expectation of a future rise in public revenues.

Most national budgetary laws set ceilings as to the percentage of debt against tax revenue. They might vary from zero to thirty percent, but they never allow for a total financing of public investment, let alone recurrent administrative costs, with borrowed money. Experience as well as theoretical considerations tell that a 100 percent debt?financing strategy must lead to a failure of reimbursement. Some states such as the US have even introduced legislation which ask for a balanced budget although this has not led to any significant success. Nonetheless, such laws have been the basis for the demand by the US Government to have the Gulf War co-financed by other States.

To a growing extent, public investment in developing countries is financed by international public funds, coming from development agencies. In some countries, even a part of recurrent costs is financed in this way. The picture gets even bleaker when technical assistance is added to recurrent costs. Equally growing is the recourse to credit as opposed to grants to meet such costs, these credits being often extended on concessional terms.

It is worth noting that the World Bank had modified its criteria of acceptability of credit financing with changing circumstances. While suggesting in 1962 that a maximum prudent debt service ratio would be 7%, it stepped up this ratio to 10% in the late 1960s and now uses 30%. And lending still goes on.

Going back to Adam Smith and to the above conclusions, it seems obvious that there are third world debts that cannot be paid, even if loans were managed in the most effective way and corruption did not exist. This is partly due to the fact that development has not taken place the way its actors expected it to happen, one of several consequences being that public revenue in developing States rose much less than anyone expected. As was stated above, responsibility for this state of affairs is shared.

This is the situation today. Now what can be done to remedy it?

Austerity programmes encourage cuts in expenditures in order to increase revenues and the introduction of ceilings to debt/revenue ratios. This is the normal procedure of stand-by arrangements and structural adjustments. These approaches have to be looked at in the context of development requirements. If it is accepted that there is an international obligation to enhance the well?being and development of all human beings as it is expressed in the Declaration on the Right to Development, and if it is admitted that developing countries have to effect public expenditure which is out of proportion with their potential to raise public revenue, and if the gap is too wide to be bridged by loans, which are not going to be reimbursed, then the international community should finance this gap through grants at least to the same extent to which it financed the Gulf War. Apparently, there are many questions open to debate: What is an indispensable public expenditure? Is it only physical infrastructure like roads and posts? Does it equally include social infrastructure like access to health, clean water, public education? What type of infrastructure has to be developed.) What is a tolerable proportion of recurrent costs, public investment and military spending? What activity can be left to the private sector and what does privatization mean?

All these questions need answers. Since there are no fixed or objective criteria, they can only be found through trial and error and by introducing procedures which allow for an open discussion, where all opinions can be voiced. Answers should not be the monopoly of any single monolithic power. The authority to negotiate and sign credit and expenditure agreements should be checked by independent political bodies and the power to ratify them should not belong to the same entity. These procedural considerations apply, of course, to the national borrower.

It would be unrealistic and counter productive not to add an international dimension to these procedures under the pretext of national sovereignty, since the latter has de facto become more and more obsolete. Orderly procedures should be introduced, that allow for interaction among different actors, national and international, which cooperate in the definition and financing of development policies. The ongoing distinction between traditional budgetary policies on the national level and negotiations in the framework of international law with multilateral agencies is questionable. The dialogue concerning indispensable expenditure needs, the rate of coverage by public revenues and the tolerable rate of credit financing has to be carried on in a more complex setting which has to be worked out. Once all actors have agreed upon the facts and figures and if, as a result of agreements, there remains a financing gap, then this gap has to be bridged by grants since loans could not be reimbursed anyway. Existing debt should be treated the same way: If, following, ex?post?evaluation it becomes apparent that it has been contracted under unrealistic assumptions, it should be forgiven for structural adjustment reasons.

* Professor Rolf Knieper (Germany) - Prior to and after being a Legal Adviser to the Government of the Central African Republic from 1981 to 1988, and to the Government of Chad from 1978 to 1979, Professor Knieper has taught Civil and Economic Law at the University of Bremen since 1972. Professor Knieper also was a visiting scholar at Harvard Law school in 1971 to 1972. Born in 1941, Professor Knieper obtained a doctorate from the University of Frankfurt in 1966. Besides writing a book on the Limits of National Sovereignty and Development, Professor Knieper has contributed extensively to literature in his field and has made a major contribution to the adoption of a new Investment and a new Forestry Code by the National Assembly of the Central African Republic in 1988 and 1989.

(The above author profile was written in February 1992)