Thursday, 12 February 2015
Nick Rowe says debt is a burden on future generations.
The economically illiterate, as Nick Rowe rightly points out, think that the national debt is a burden on future generations, and for reasons which are nonsense. However, Nick argues that in fact there IS A REASON for accepting the “burden” argument, but not the one advocated by the above illiterates.
I’ll argue here that in fact Nick’s argument itself is flawed. Nick’s argument is set out here, and I’ve reproduced the essential paragraphs below under the heading “The Rowe theory in his own words”. For other articles where he enlarges on his argument, see here, here, here, and perhaps also elsewhere. (See what you can find by Googling).
Basically I’ll argue that in the real world, the amount of “burden transfer” between generations is determined PURELY BY the size of PENSIONS. As to any burden transfer stemming from national debt, no such transfer is INHERENT TO national debt. That is, a country COULD HAVE a substantial national debt, plus generous pension schemes which are FUNDED and which store up assets in the form of government bonds (i.e. debt). Alternatively, such a country could have equally generous pension arrangements implemented entirely by pay as you go pension schemes, in which case 100% of burden transfer would be attributable to pensions, not the debt.
The basic Nick Rowe argument.
His basic argument is as follows.
Suppose that during a particular decade or two, government borrows from working age people and hands out various government provided goodies to them. Those people are no worse off. Plus assume that government gives bonds to those people.
Assume also that during the retirement years of those people, they sell their bonds to the new generation of working age people. The net effect is that the first generation is better off: it consumes more than it otherwise would have.
Assume also that the above buying and selling of bonds between generations continues for several generations and eventually stops. That means that the FINAL GENERATION loses out: reason is that government has to tax it to buy back the bonds, but the final generation gets nothing in its retirement.
The latter argument is of course valid ASSUMING youngsters in each generation purchase bonds off those in retirement. But why would they do that? There’s only one possible reason: to fund the retirement years of todays youngsters.
Indeed, FUNDED pension schemes (as distinct from unfunded, aka “pay as you go” schemes) do just that. That is, they use the contributions of today’s working age people to purchase various assets including government bonds, and then sell those bonds during the retirement years of today’s working age people to fund the latter’s retirement.
Moreover, it is TOTALLY UNNECESSARY, as intimated above, to actually fund pension schemes. That is, there are pay as you go schemes which have no bonds or assets at all. The biggest pension scheme in the UK is like that. That’s the state pension scheme. And just as in the case of Nick Rowe’s “bond burden transfer” theory, people of working age pay in, and pensioners withdraw money from the scheme.
The amount of inter generational burden transfer is determined SOLELY by the size of pensions. Government bonds CAN PLAY A ROLE in pension schemes, but there is no absolute need for them to do so. Thus there is no inherent “transferring burdens to future generations” characteristic in government debt.
The Rowe theory in his own words.
The government borrows 100 apples from each of cohort A, then gives each person in cohort A a transfer payment of 100 apples. It is exactly as if the government had simply given each person in cohort A an IOU for 100 apples. That IOU is a bond.
So far there is no change in cohort A's consumption of apples.
Cohort A then sells the bonds to the younger members of cohort B. So each person in cohort A gets an extra 110 apples (assume 10% interest per generation), which he eats. Cohort A then dies.
Cohort A is better off. Each member of cohort A eats an extra 110 apples. In present value terms, those extra 110 apples are worth 100 apples at the time the transfer payment is made.
Cohort B eats 110 fewer apples when young, but 121 extra apples when old, and they sell their bonds to cohort C. Although cohort B eats 11 more apples in their lifetimes, the present value of their total consumption of apples is the same. The rate of interest must be high enough to persuade them to eat fewer apples when young and more apples when old, otherwise they wouldn't have bought the bonds from cohort A. So cohort B is not worse off.
But (given my assumption) the debt is rising faster than GDP. The government knows this is unsustainable. It cannot rollover the debt forever, because eventually the next cohort will be unable to buy the bonds from the older cohort. So the government decides to pay off the debt by imposing a tax of 121 apples on each young person in cohort C, which it uses to buy back the bonds from cohort C.
Each member of cohort C eats 121 fewer apples.
Cohort A eats more apples, and cohort C eats fewer apples. It is exactly as if apples travelled back in time, out of the mouths of cohort C into the mouths of cohort A. (With interest subtracted as they travel back in time through the time machine.)
Yes, the national debt is a burden on future generations.