A bit of linguistic trivia may help explain the on-going euro zone crisis. The German word “schuld” means both “debt” and “guilt”. The same is true in Dutch. The dual character of “schuld” may provide some insight into why Austrians, Germans and Dutch voters apparent support their governments’ dysfunctional austerity policies at home and abroad. It provides no help in accounting for the unseemly austerity enthusiasm in Finland (where guilt is “syyllisyys” and debt is “velka”), suggesting that language does not provide a general explanation.
Is German correct, that debt is inseparable from guilt? Actually, no. Like most things in life, debt can be neither a source of guilt nor a vehicle for bliss. Debt has a positive side because it allows businesses, households and governments to do useful and important things that would be impossible without it.
We frequently hear or read, “governments, like households, should not spend more than their incomes”. That old chestnut, much loved by Margaret Thatcher, has a problem. It is nonsense. Households routinely spend more than their incomes. This happens when people take mortgages, buy a car, and send their children to universities, to mention a few examples. Wait, you might say, those are all investments, and there is nothing wrong with debt that finances investments.
Let’s inspect the mortgage example more closely. It finances an asset that substitutes for paying rent. Except in extreme circumstances, the asset is worth more than the mortgage debt. Today a very large number of Americans hold mortgages larger than the value of their houses, but that is not an argument against buying houses on credit. “Negative equity” demonstrates the need for stricter regulation of the mortgage market. It also argues for limits to household borrowing on home equity, which before the 1990s was of little importance.
If we accept mortgages as acceptable household behavior when contracted responsibly, then we also have to accept that public sector borrowing to invest is also acceptable behavior. A house with greater market value than the mortgage that financed it represents a net asset. Similarly, the still functioning investments carried out by the federal government far exceed the US public debt. The federal government has “positive equity”.
You think to yourself, this guy is getting ridiculous. Sure, the massive network of expressways, airports and public buildings may in principle be assets and worth far more
than the federal debt. But a house you can sell. To whom would the federal government sell Kennedy Airport in New York City or the 2500 mile I-40 expressway from North Carolina to southern California? Well, quite a queue of buyers would show up double quick, as the airport privatizations in Britain demonstrated. We do not usually think of these public structures as assets because federal, state and local governments do not in most cases charge us to use them. We can be confident that the Massachusetts Turnpike, which does charge, would attract corporate buyers like bees to honey, eager to snatch up that asset, jack up the tolls and drive home with a tidy profit.
A federally built and owned road is an asset (like a private home), and it could be sold to a private buyer (“privatized”). But, even when the government borrows for a sound purpose, the debt that results represents a burden for future generations, does it not? Actually, no. The present debt does not represent a burden on future generations. How can that be? No future burden because every debt is simultaneously a credit, and every asset also a liability (Accounting 101). A US federal government bond, the form our public debt takes, is an asset for he or she that buys it. Interest payments on the public debt (or any debt) involve an income transfer, not between generations, but between those who pay taxes and those who receive the interest payments funded by those taxes.
Consider the simple, if slightly silly case, in which we distribute the federal debt among households proportionally to the taxes households pay. Each tax paying household receives interest to compensate for the tax that funds the interest. No burden there, on future generations or anyone. The example is not totally silly, because this was close to the situation at the end of World War II, a conflict financed by sales of “war bonds” across income classes.
Even today, over twenty percent of federal bonds can be found in the Social Security Fund (bought by our compulsory contributions), and these pay incomes to the retired. Federal government agencies hold another twenty percent. The interest on this second twenty percent of the debt merely shifts funds from one federal pocket to another. “Off the top”, so to speak, forty percent of the debt involves no burden. More important, the income distribution effect of the interest on that forty percent is progressive (Social Security has been called the largest poverty reduction program in American history). As for the remaining sixty percent, that requires a Heresy column of its own.
Does it follow that governments should only borrow to invest? If so, the federal government currently acts in a very irresponsible manner. The budget deficit subtracting out investment expenditure is about five percent national income. Should we demand that the federal government behave like a responsible household with its finances? Strange as it may seem, that current expenditure deficit does not differ from what households do.
Households frequently, even regularly, borrow (run a deficit) with no intention to invest. An obvious example occurs when the income earners in a household change jobs, with a time lag between the last payment of the old job and the first payment of the new one (which is quite common). Sensible household budget management would not involve selling off the family jewels and more common assets (car, TV, computer) to “tide the family over”. A sensible person would go to a bank and attempt to negotiate a loan to fund the family’s living expenses until the approaching payday. If the hopeful borrower presents the bank functionary with proof of the future employment, chances of getting the loan would be good.
That is exactly what the federal government did during President Obama’s first term. The Global Recession was society’s equivalent of losing a job (or a pay cut). A recovery of the economy represents the equivalent of future employment. The US economy has suffered from many recessions, at least five or six since the end of World War II. In the past it never failed to recover. It will recover this time unless our politicians do something very stupid. Indeed, in the absence of dumb policies, the likelihood of an economic recovery that will generate tax revenue to eliminate the deficit is a virtual certainty.
The 1990s provide a textbook example of, “you’ll wonder where the deficit went”. In 1992, the year before Bill Clinton became president, the federal government budget balance had dropped to almost minus five percent of national income. Steady economic growth for eight consecutive years changed that deficit into a solid surplus of 2.4 percent of national income (see chart). This transubstantiation of deficit into surplus occurred when federal spending increased continuously, from 17.8 percent of GDP in 1991 to 20.6 percent in 2000. Unadjusted for inflation, this percentage rise involved an increase of annual federal expenditure from 1.3 to 1.8 trillion dollars. To counter this, growth generated a doubling of tax revenue from one to two trillion dollars.
What type of dumb, bone-headed policies would prevent a similar recovery now? A good start to blocking a recovery would be a “grand compromise” to increase taxes and reduce federal expenditure. This “compromise”, which might be named “fiscal cliff lite”, would in practice not represent compromise. Rather, it would represent an agreement between the White House and Congress to depress further the American economy. Yes, President, increase the taxes on the rich, and spend all of the new revenue on the rest of us, especially the poor.
The Federal Budget Deficit Goes Away, 1992-2000
John Weeks is the Professor Emeritus University of London & Senior Researcher, Centre for Development Policy & Research, School of Oriental & African Studies