Saturday, 18 October 2014
My article yesterday on the above topic was not well thought out. But I still don’t think that funding public investment via government borrowing rather than via tax has any significant implications for inter-generational fairness. Let’s run through the arguments.
The obvious and superficial attraction of funding via borrowing is that future generations (who benefit from public investments) have to pay interest on the debt and/or have to repay that debt.
One answer the latter point is the “time travel” argument set out in my article yesterday.
And an answer to the latter time travel argument, set out by Nick Rowe is that time travel is in fact possible in the following sense (assuming I’ve got Nick right). Assume a public investment is made during the working life of a particular generation (let’s call it generation 1). Assume also that government funds the investment via borrowing. Generation 1 undoubtedly suffers a standard of living hit as a result. However, that hit can be nullified if during the retirement years of generation 1, generation 2 has to buy government bonds off generation 1. That obviously helps fund the retirement of generation 1.
Likewise, generation 3 can be made to buy the bonds off generation 2 in the retirement years of generation 2. And clearly that works: that is, it transfers the burden of making a public investment to future generations.
However the big problem with the latter “generation” argument is that it is highly artificial. That is, when governments make public investments funded by borrowing, they don’t in practice set up the above nice clean and simple “succeeding generation” system.
That is, the real world is in practice far more messy. For example, government debt tends to be held by the rich who far from SELLING government bonds to their descendants, simply GIVE it to those descendants. Second, government debt is in practice bought by and held by a variety of actors apart from pension funds, e.g. foreigners, banks and so on. And the latter have a variety of reasons for buying or selling government debt that have nothing to do with inter-generational fairness. Third, the assumption in the above “generation” scenario that government makes public investments in a particular year and none at all for the next ten or twenty years is unrealistic.
The reality is that governments spend very roughly the same amount on public investments every year. And that point alone means that it doesn’t make much difference as far as inter-generational fairness goes, whether public sector investments are funded via borrowing or tax.
And a fourth and final complicating factor is that the population ALREADY HAS approximately the pension set up it wants. That is, in as far as pensions are investment based rather than pay as you go, the above generation 1, 2, 3 etc won’t be very interested in a new facility that enables younger generations to buy bonds or other assets off preceding generations. Put that another way, if the above “clean and simple” system WERE SET UP, it would to a large extent just displace EXISTING SYSTEMS for “making the next generation pay”.
Friday, 17 October 2014
According to an article to today’s Financial Times by Martin Wolf, Simon Wren-Lewis and Jonathan Portes believe in the old canard that public investment should be paid for out of borrowing rather than tax. One superficially attractive argument for borrowing is that if investment is paid for out of tax, then the CURRENT generation bears the burden, whereas if investment is paid for out of borrowing, then future generations (who benefit from the investment) have to contribute to paying back the loan, thus those who benefit from the investment contribute towards its funding.
For the naive, that’s a thoroughly sensible and reasonable point, isn't it? In fact the idea is nonsense and for reasons set out below.
Incidentally, I haven’t been through the Wren-Lewis / Portes paper line by line, but I HAVE SKIMMED thru it, and Martin Wolf seems to be correct to attribute the “make future generations pay” idea to Wren-Lewis and Portes, far as I can see.
The flaw in the above “make future generations pay” argument actually has nothing to do with economics. The argument actually breaks the laws of PHYSICS, and for the following very simple reasons. (Incidentally, I’ll initially assume a closed economy: that’s one that does not trade with or have any dealings with other countries.)
If a bridge is built in 2014, the LABOUR REQUIRED to build it must be expended in 2014. Put that another way, if a bridge is built in 2014, there is just no way that labour expended on bridge building in 2015 or 2016 can contribute to the bridge built in 2014. That would involve time travel. In short, as far as labour goes, the CURRENT GENERATION foots the entire bill. That is, the current generation has to abstain from devoting person hours to producing consumption goodies, and instead, devote person hours to building bridges.
As to MATERIALS for the bridge, obviously it’s possible in 2014 to use steel produced in 2013 or 2012. That’s time travel of a sort. But that’s time travel in the opposite direction to the one advocated by Wren-Lewis and Portes.
Put that another way, it’s not physically possible to build a bridge in 2014 using steel produced in 2015 or 2025. I.e. you just can’t use steel in 2014 which does not exist in 2014.
To put all that another way, if a bridge IS FUNDED via borrowing, all that happens is that government induces a set of individuals to abstain from consumption in 2014 by borrowing money off them. Those individuals (or their descendants who inherit the relevant government debt) are then repaid by taxpayers at some point in the future.
But note that those payments are simply payments from one set of individuals within a country to another set of individuals in particular years (e.g. 2014, 2054 or whatever). That is, there is no NET SACRIFICE by the country as a whole in for example 2054 when taxpayers pay £Xmillion to holders of government debt.
There is just one exception to the above argument, and that occurs where a country borrows from abroad (as indeed was pointed out by a namesake of mine Richard Musgrave in the American Economic Review in 1939).
Obviously (to put it illustratively) if steel for a bridge is supplied by foreigners and they defer payment for the steel, and labour is provided by a foreign construction firm and they too defer payment, then the country where the bridge is built gets a bridge initially at no charge, while payment for the bridge is made by those living in the future.
However, on the simplifying assumption that every country funds roughly the same amount of investment out of borrowing (from domestic creditors and foreign creditors), then the above “foreign creditor” point becomes irrelevant. That is if debts owed by country X to country Y are cancelled out by debts running the other way, the “foreigner” point is irrelevant.
In any case the latter “domestic / foreign” distinction does not appear in the Wren-Lewis / Portes paper, far as I can see.
Numerous popular myths.
Incidentally, the above is just one of several popular myths that I’ve demolished over and over on this blog. But of course the problem with superficially attractive ideas is that people fall for them over and over and over and over. Thus they have to be rebutted over and over and over and over (witness Richard Musgrave’s demolition of the idea in 1939).
It’s desperately frustrating having to explain the bleedin obvious, because there are loads of more abstruse and complicated ideas I’d like to discuss. Unfortunately, those abstruse ideas are way beyond the comprehension of 99.9% of the population, thus they just never get considered or discussed.
If you have the choice of spending a few hours writing a book and spending a few hours helping a neighbour put out a fire in their house, obviously the book goes by the board.
If you’re a cynic, you might enjoy the first few sentences and the last two sentences of this article by Chris Giles in the Financial Times recently.
First few sentences:
“Take your pick: Britain’s choice in next year’s election is between forgetfulness and deceit. The opposition Labour leader cannot remember the importance of Britain’s budget deficit; the Conservative prime minister pretends it will be easy to run a budget surplus and cut taxes. So absurd are both positions on the UK’s public finances that a few facts need to permeate the debate.”
Last two sentences:
“When the new government opens the books after the election and the truth comes out, voters will think their new rulers are a bunch of liars who were willing to say anything to get elected. They would be right.”
Thursday, 16 October 2014
But his reasons are unnecessarily complicated. See here. (A tweet by Stephanie Kelton drew my attention to the latter article).
There is actually a far simpler reason why near permanent deficits are inevitable which I’ve been banging on about for years on this blog (e.g. see para starting “First..” here.) The reason is thus (in green).
The national debt and monetary base lose value in real terms thanks to inflation. Thus if the debt and base are to remain constant relative to GDP (which in the very long term they do, more or less) then they have to be topped up regularly. And there is ONLY ONE WAY of topping them up, and that’s via a deficit.
Moreover, that is compounded by real economic growth. That if the economy grows in real terms at X% a year, and if the debt and base are to remain constant relative to real GDP, then even more topping up, i.e. deficit is needed. In fact if inflation is at the 2% target, and growth is 2% and if the debt and base are say 50% of GDP, then the deficit well need to be 2% of GDP (50% x (2%+2%)).
The above of course assumes a more or less constant desire for savings: i.e. if there is a sudden RISE IN the desire to save (e.g. up to Japanese levels), then the deficit would have to be significantly increased).
And that’s it.
Simple enough isn't it? But the strange thing is that no one (far as I know) gets it.
And that all confirms my suspicion that if anyone produced a nice simple E=MC2 style solution for economic problems, professional economists far from welcoming that would run a mile. Professional economists DO NOT WANT simple solutions for economic problems: that tends to put them out of work. Or as Upton Sinclair put it, "It is difficult to get a man to understand something, when his salary depends upon his not understanding it."
Ambrose Evans-Pritchard suggests as much in a Telegraph article entitled “World economy so damaged it may need permanent QE”.
Evans-Pritchard is clued up, but he doesn’t distinguish between QEing government bonds and other assets, which is a significant omission from his article.
I have no objections to continuing to QE, and up the point where there is no government debt left: i.e. all government debt is replaced with base money. Indeed both Milton Friedman and Warren Mosler argued for the abolition of government debt ANYWAY, i.e. quite apart from that being a way of imparting stimulus. (See para starting “Under the proposal..” in Friedman’s paper and the 2nd last para of Mosler’s article.)
As to taking QE even further, and having the central bank buy up loads of OTHER ASSETS (including your car and house) that’s pointless, isn't it? Granted market monetarists believe in having the central bank buy up just about everything, but that just proves market monetarists have lost the plot. (See comment by Scott Sumner (leading market monetarist) here for what I think is a total “loss of plot”.)
We’ve had “permanent QE” for at least a century!
A further reason for not getting excited about permanent QE is that we’ve had permanent QE, at least on a small scale, for decades if not a century or more, and for the following reasons.
QE (where it consists of the central bank buying government debt rather than other assets) has the effect of increasing the monetary base, as pointed out above. Indeed that’s the only way the base can be increased under the present set up (i.e. unless you give the Treasury the right to print it’s own money). But the monetary base has to be increased (in nominal and real terms) every year ANYWAY, assuming the monetary base is to stay constant relative to GDP, which over the long term it does. Ergo we’ve had “permanent QE” for a long time.
What if stimulus is needed given no government debt?
That all raises the question as to what to do if having disposed of all government debt, stimulus is still needed. Well that’s easy: the solution has been spelled out by Positive Money and advocates of Modern Monetary Theory. The solution is to continue printing base money and spending it (and/or cutting taxes) till the average household has a sufficient stock of money or net financial assets that it is induced to spend at a rate that brings full employment. Plus Milton Friedman said exactly that in the above mentioned paper of his.