What other factors contribute to the debt problem

Reference no: EM133373742

Case Study: Debt is Good! Debt is Bad!

Leveraging, borrowing, and using other people's money can be powerful wealth-creating tools if used properly, but devastating if things go wrong. Countries like people or companies borrow from time to time when they need to outlay sums that they do not have enough of to undertake major projects without having to use their own resources.

Many persons are leveraging daily and are not even aware of it. Acquiring a house is one of the costliest items most people buy, and few have the full outlay to purchase it for cash. To make it easier and faster to own a home, financial institutions created mortgage loan funding. This is in fact leveraging. How does it work? Leverage is the use of borrowed funds combined with one's own.

Governments are not much different from private sector borrowers. With limited resources, they contend with society's demand for infrastructure. It is this demand and the inadequacy of cash funds that pushes governments to borrow. Those who borrow have to pay the piper. In the financial world, the payment is interest. The level of interest paid is dependent on the creditworthiness of the borrower. Creditworthiness is the measure of creditability to service debt.

Real estate investors have benefitted tremendously from leveraging. They buy property on a mortgage and soon after their equity goes up a fair degree, they borrow more and acquire more property. This approach can multiply an investor's wealth considerably. Governments, however, are not mainly in the business of profit-making, but the same principle applies to them. By borrowing, governments can further the development of infrastructure by repaying the loan from future revenues. If used prudently, the approach can be extremely beneficial to a country. The problem is that governments come and go and with them good and bad management. This is where things can go awfully wrong. Most politicians are popular persons and are not necessarily trained in the art of finance. The major thrust of policy tends to be socially oriented than economically prudent which leads many countries into a long-term debt trap as governments often run large fiscal deficits over many years.

When governments' fiscal operations are in deficit, economic shocks which lead to revenue shortfalls make servicing the debt more difficult. In such instances, careful and judicious management is necessary. Unlike the private sector, politicians answer to different constituencies. They who face the electorates regularly can be put out of office if the populace is dissatisfied. This factor alone encourages governments to err on the side of popularity as opposed to prudence, which in several instances has led to chronic economic debt complications. This is what has happened to Jamaica and is the reason for the astronomical debt and financial constraints. (Excerpt from The Investors' Choice, Cover Story, November 2004.)

Questions:

1. In reference to the article, what are the major causes of indebtedness

2. Based on discussions in class, as well as your own research, what other factors contribute to the debt problem being experienced in the Caribbean?

3. 3. According to the article, when is debt good, and when is it bad?

4. How is the incidence of such high levels of indebtedness likely to impact the region's economic development prospects?

Reference no: EM133373742

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