The public debt: A serious problem or a delusion?

Dhaka,  Wed,  20 September 2017
Published : 13 Oct 2016, 21:30:49

The public debt: A serious problem or a delusion?

Muhammad Mahmood
There is sense of total despair in developed countries on the levels of public debt if one listens to politicians, policy planners and public servants. This issue now completely dominates the public discourse on public finance. So much so that they are abusing the national budget like a household budget. The metaphor is not lost to the public and they (public) are scared stiff. They are scared about their children and grandchildren's future.  The suggestion is that the current generation is living their lives irresponsibly by living far beyond their means. Obviously the debt levels in these countries have skyrocketed since the Global Financial Crisis (GFC) as a consequence to rescue banks (by socialising losses and privatising profits) and to jumpstart these economies. The problem was further exacerbated by the collapse of tax revenue due to the slowing down of domestic economic activity and deteriorating global economic outlook.

There are divergent views on public debt levels and their sustainability from economic and financial management perspectives. It is estimated that public debt/gross domestic product (GDP) ratio has shot up from 53 per cent to 80 per cent from 2007 to 2012 in most countries of the Organisation for Economic Cooperation and Development (OECD). The current conventional wisdom dictates that a public debt/GDP ratio above 60 per cent is unsustainable. This magic number 60 per cent churned out by the International Monetary Fund (IMF) and other similar multilateral organisations has always baffled this writer and still remains a mystery to him how they have come to this magic number. There is a strong hint that crossing this redline will threaten fiscal stability. 

Now all of them crossed that redline. Under such circumstances the IMF, of course, has an off-the-shelf prescription: impose austerity (cutting government expenditure and sell public assets and deregulate) and pay it down (primarily paying back the banks) as is now happening in Greece with a public debt/GDP ratio of 188.2 per cent in 2015. These cuts in public expenditure are also accompanied by tax cuts for higher income groups. These policies are canvassed by governments as tough choices and are based on principles of fairness. 

Oddly enough such austerity measures are claimed to engender economic growth and resilient fiscal rules settings. Where is the fairness in this exercise in welfare spending cuts along with tax cuts is beyond any reasoning. There is a strong tendency to demonise public debt by politicians to push back the frontier of state and its ability to undertake any economic activity. A recent study in the USA reveals that an average US citizen has no influence on public policy; rather the influence entirely comes from large corporations and Wall Street.

The simple fact is governments are not households. The government can borrow from itself and do not have to pay off the debt before it retires because countries do not retire. A government that spends more than its revenue receipts ought to borrow to bridge the gap. Does that mean living beyond our means? What does this phrase mean is also a mystery to this writer. 

The idea that public borrowing harms the economy has no basis in economics. The issue we should look at is whether the economy has any excess capacity and this is quite often reflected in unemployment which can be utilised to expand economic activity. Under such circumstances any fiscal deficit will not only stimulate spending without exerting any upward pressure on interest rates or inflation and add to increased tax collection (including consumption taxes). In 2015, Japan had the highest public debt/GDP ratio at 232.5 per cent among OECD (Organisation for Economic Co-operation and Development) countries, and Italy had 147.4 per cent but none of these countries experienced any spiralling inflation or higher interest rates as the conventional wisdom dictates that's what is going to happen with burgeoning public debt. 

In effect exactly the opposite is happening in Japan - a country now grappling with deflation and negative interest rates. Curiously enough it is deflation not inflation that is causing the higher public debt/GDP ratio to rise in Japan. The one way to decrease this ratio in Japan to inflate the economy however modest that might be and this in turn will raise nominal GDP causing the ratio to decline.

However, there is a caveat -- we have to look at the composition of debt instead of just focusing the aggregate levels of debt. What matters are not how much is borrowed but how it is spent. In most cases public borrowing is undertaken to invest in public infrastructure such as road, highways, railways, bridges, hospitals, schools etc. All these add to our standard of living but more importantly help to gain economic efficiency. If we do not build roads, hospitals, schools etc., today paid for by the government, we leave behind dilapidated infrastructure marked by grossly overcrowded and slowly decaying  roads, public transport, schools and hospitals  for the future generation but with a lower burden of public debt. 

Is that what we want? Governments also borrow during economic downturns for transfer spending or after a great natural disaster. Such borrowings enables a government to "smooth out consumption" which contributes to increased economic activity and increased tax revenue through consumption taxes.

If we continue to allow politicians and public policy planners to demonise public debt, we will leave behind a rather very sad world for our future generations. We are time and again told or continually reminded by politicians that we will be leaving this debt burden to the future generations. This simply implies that higher levels of public debt will have to be paid by higher taxes in the future. 

As far as domestic debt is concerned, it can always be paid off by printing money which only a sovereign state can do. Furthermore, so long nominal GDP increases more than interest payment liability per annum, the debt liability itself will continue to decline. The core issue is to enable the economy to grow. There is no empirical evidence to suggest that public debt causes slowdown in economic growth. 

In essence the present generation will largely pay for a better equipped, educated and healthier future generations. The current obsession about public debt/GDP ratio misses the basic point that fiscal policy has a significant role in promoting economic growth. More importantly simply looking at public debt/GDP ratio can be a trap. While governments tell us that we owe so many billions of dollars as if there is nothing to show for such spending. This is just politicians game playing to lead us to believe in their version of events. The alternative is very clear where we allow public infrastructure to deteriorate to the level experienced by low tax developing countries.

The writer is an independent economic and political analyst.

Editor : A.H.M Moazzem Hossain
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