Friday, 17 October 2014
Wren-Lewis and Portes fall for the time travel canard.
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.