Wednesday, August 26, 2009

The Debt Fallacy

One fear that seems to be constantly iterated about Obama's stimulus package (or, for that matter, any equivalent package anywhere else in the world) is the fear that running large budget deficits will saddle the nation with levels of debt that will take generations to pay-off. These fears are sensible in their way, but they also fail to appreciate the function of stimulus spending and why deficit spending - under certain conditions - represents a perfectly acceptable economic strategy.

What triggered this post was a piece I just saw on BBC news, which suggested that Obama's stimulus package would cost around $9 trillion, or - as the reporter rather sensationally pointed out - around $30,000 for every man, woman and child in the US. A scary figure, to be sure, and for that reason I can understand the reaction of the man they then interviewed on the street: "What I want to know is where they're getting the money from... well, I mean apart from the taxpayers!". These two factors - the stupefying amount of money involved and the pernicious belief (happily peddled by Republicans) that public spending requires saddling individual tax-payers with commensurate levels of debt - have conspired to create an opposition to stimulus spending based more on a visceral fear of large numbers than on sound economic reasoning.

Let's use an analogy to make the issues a bit easier to grasp. Say the father - in a family of four - decides to take out a loan of $100,000, paying interest at a rate of 5% per annum, to invest in some company. According to the logic of the anti-stimulus fear-mongers, this man has just saddled every man woman and child in his household with $25,000 of debt, effectively appropriating earnings or future earnings from his wife and children ("the taxpayers" and the "future taxpayers") without their permission. This is the picture that the fear-mongers want to paint on a much broader economic scale, but the analogy raises 2 important points:

1) The father isn't taking money from the other members of his family, it's coming from an external bank.

and

2) The family may now be $100,000 in debt, but it is not $100,000 poorer - note the difference! In fact, at the moment the loan is taken out, the assets ($100,000 cash) equal the liabilities ($100,000 repayments owed), so in undertaking the debt the family is - to begin with, at least - absolutely no worse off financially than it was before undertaking the debt. If the man invests in a company and sees returns on that investment that exceed the interest payments, then in the long-run he will actually profit by going into debt!

Now the analogy isn't perfect (as I'll explain) but it does have some important corollaries for the economy at large:

1) Governments don't fund deficit spending by taking from taxpayers, they fund it by borrowing from banks (both domestic and foreign). Now the distinction between public government and private citizen in a democracy is admittedly somewhat blurred, but not so blurred as to render sensible the arguments raised by the fear-mongers about the government "thieving" from the taxpayers to fund deficit spending.

and

2) The government is not simply taking out debts and throwing away the money (in which case, every man, woman and child would be out of pocket by $30,000) it's taking the money and investing it in domestic production. If the return on this investment is consistently greater than the interest owed, then the short-term debts may pay for themselves in long-run economic growth. Just as the current generation of Americans can profit from the economic investments made during the New Deal without owing the government a cent, far from being saddled with debt, today's children may actually be in a position to profit tomorrow from the investments that the government makes today.

In other words, the two main fears about stimulus spending - that the money is coming from the tax-payers and that the levels of debt owed are fixed - are actually untrue. These fears fail to take into account that investments made with these deficits will be generating economic growth (no-one can seriously deny that) that will, over time, be used to pay the debt off. If the revenue generated by these investments exceeds the debt undertaken plus interest (admittedly this is a big "if" and something very hard to accurately measure: how much economic growth can be pinned on the stimulus, how much can be pinned on other factors?) then the deficit pays for itself in the long-run. Unless the stimulus package fails to stimulate any growth at all, then the idea that children are walking around today with a $30,000 debt that they'll have to pay-off when they start earning is just blatantly false.

The other factor that the fear-mongers fail to take into account concern the economic costs of doing nothing (or, at least, doing substantially less). An economic retraction which causes business closure, unemployment and depressed spending and investment will itself cost countless billions in growth forgone, only - in contrast to a debt that can be repaid over time - this is a loss than can never be recouped. Even if we presume that the stimulus package is somewhat unsuccessful, and is unable to generate returns on investment large enough to avoid saddling future generations with debt, it's far too simple to say that these future generations are therefore necessarily worse off. For instance, is it better for these children to mature into an economy that is able to provide opportunities at the cost of public debt, or is it better for them to mature into an economy gutted by a long, deep recession without the burden of public debt? Even in the more pessimistic scenarios, the moral dangers of running large deficits are not quite so clear cut.

Now this is an idealised portrait and I hope I haven't given the impression that it's all quite so easy. It's a complex issue and one that exists far beyond my purview as an economic undergrad. But it is precisely this complexity which requires us to identify the facile nature of anti-stimulus movement for what it is, namely a movement propagated more out of ignorance (largely excusable - as I said, superficially the numbers are scary) and personal ideology (less excusable) than out of concern for the tenets of economic policy.

2 comments:

BeyondBankrupt said...

Never take for granted your debts and try to prioritize them first. Create a debt management plan with your creditors so that you can fairly settle your obligation.

___________________
Avoiding, Understanding and Surviving Bankruptcy

Anonymous said...

I did a search on debt fallacy and came across your blog... I think it's a great analysis, thank you. As an American in one of the worst economic markets (Flint, Michigan), I am inundated with this fear-mongering about the debt. Grass-roots organizers (aka "tea partiers") are storming local municipal meetings and protesting taxes of any form, putting a stop to exactly the kind of spending we need right now. We are laying off public safety workers, halting infrastructure projects, even turning away free grant money that would update lighting and buildings to be more energy efficient. In my locality, they've even elected someone to government who admittedly wants to tear down government.

Unfortunately, there's no reasoning with this sort of mentality, and the eloquence of your piece would no doubt be lost. But I do take comfort in having new ways of arguing. Thanks!