Fiscal roots of national power
Business Standard, 13 September 2026
Liberal democracies meander but ultimately win. The twentieth century taught us that free societies out-innovate authoritarian regimes. We tell a story of technological superiority and scientific progress. This is an incomplete picture. The outcome of geopolitical conflict is not pre-ordained. We must understand the institutional foundations of state power.
The resolution of conflict depends on money. Cold wars and hot wars are shaped by the capability of the state to command financial resources. From the Napoleonic wars to the two World Wars and the Cold War, liberal democracies brought more resources to the table. This superiority rested on two pillars. The first was higher economic growth. The second was the capability to borrow. Populist states extract resources through coercion. This mechanism has limitations. Successful liberal democracies borrow from a deep financial system on a voluntary basis. This mechanism scales to staggering magnitudes.
The scale of borrowing wielded by liberal democracies to win the twentieth century was large. In 1914, the UK public debt was 25 per cent of gross domestic product (GDP). By 1919, the UK state had borrowed to push this to 135 per cent. US debt rose from 3 per cent to 33 per cent of GDP over the same period. Between 1937 and 1945, the UK borrowed heavily, taking total debt from 154 per cent to 250 per cent of GDP. The US pushed its debt from 40 per cent to 119 per cent. The populists failed to match this staggering scale of resourcing. Populist regimes force weak financial systems. They lack the institutional machinery to channel private savings into state power.
This phenomenon has older roots. Napoleon Bonaparte was derisive of the UK, calling it a nation of shopkeepers. When his armies conquered Amsterdam, they dismantled its financial centre. The French state lost the capability to borrow. Across the English Channel, William Pitt the Younger built a financial architecture that leveraged the London bond market. Utilising this machinery, the UK borrowed heavily, pushing its debt to 260 per cent of GDP by 1815. Lenders across continental Europe overwhelmingly preferred to buy British government bonds rather than lend to the French state during the Napoleonic Wars. This capital funded the military coalitions that ultimately defeated France. The shopkeepers backed by a bond market bested the pride, machismo and revolutionary zeal.
The capability to borrow constitutes the strategic depth of the state. A capable state runs a tight ship in normal times. It runs primary surpluses, which drop the debt-to-GDP ratio. This creates the fiscal space to act when exceptional events occur. When a crisis arrives, the state surges borrowing. During the pandemic in 2020, the US government expanded its borrowing by 21 per cent of GDP in a single year to finance the state response. This flexibility is the essence of national power.
How does a state achieve this strategic depth? Two conditions are required. First, the baseline level of indebtedness must be low. A state cannot surge borrowing if it is already operating at the limits of its fiscal capacity. Second, the state requires the trust of voluntary lenders worldwide. This trust is not easily acquired. It requires centuries of experience with fair play. Lenders must believe the government will respect property rights, avoid inflationary default, and uphold the rule of law.
In the West today, this mechanism is impaired. We have entered a new Cold War and the geopolitical challenges posed by Russia and China demand a robust response. But the West has limited fiscal space. Debt stands at 121 per cent of GDP in the US, 237 per cent in Japan, 101 per cent in the UK, and 89 per cent in the Euro area. The West possesses a large GDP, but it is weighed down by debt. It is harder to mount the muscular fiscal expansion seen in the twentieth century when faced with hostile populist regimes. This is the deeper cost of the hundred-year journey of establishing large welfare programs in the West.
In India, the project of state building is at an early stage. The Indian state lacks both elements required for strategic depth.
We do not have a large pool of voluntary lenders. The state relies on financial repression. When we strip away captive buyers, voluntary lenders supply perhaps 5 per cent of the borrowing of the Indian state. The financial system is a mechanism for coercive state funding rather than an allocator of capital. That finance cannot check and balance the state hinders the checks and balances against the state: there is a direct connection between the financial repression system and the lack of concern in the Indian state about economic outcomes.
Private capital worries about the Indian state. Public debt management is organised in a crude and coercive way. In modern India it's unthinkable for the Indian state to grab steel from the storage sites of steel companies, but we don't raise an eyebrow when public debt management regularly behaves analogously. The state frequently engages in actions that damage trust. Voluntary lenders demand a predictable legal system where the sovereign can be sued and held to account. They demand norms of behaviour by policy makers, independent courts and regulatory certainty.
The second failure lies in chronic fiscal indiscipline. The Indian state runs primary deficits in normal times. There is no effort to generate a primary surplus of Rs.100 in each budget. Consequently, there is a chronic large debt-to-GDP ratio, which stands at 84.4 per cent. The state operates near the edge of its fiscal constraints during peacetime.
Through these structural failures, the Indian state lacks the strategic depth of having access to vast resources if faced with a special moment. When faced with a crisis such as the pandemic, the Indian state is down to hand wringing: an economic response like that seen in the US is inconceivable. A state that cannot borrow massively when faced with a crisis is a state that cannot defend the nation. Reforming public finance and earning the respect of private lenders are not merely matters of economic efficiency. They are requirements for nation building. A capable state requires low baseline debt and deep institutional trust so that it can have strategic depth of borrowing on a massive scale a few times per century.
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