Pegging their arguments on the still-ongoing
drama relating to sovereign debt in Greece, conservative opinion is making
a case for a reduction of the size of public debt in developed and developing
countries across the world. The latest signatory to the appeal is IMF
chief Dominique Strauss-Kahn who reportedly told an audience at the inaugural
conference of the Soros-funded (Financial Times, 10 April 2010) Institute
for New Economic Thinking that public debt in the advanced economies is
forecast to rise by about 35 percentage points on average, to about 110
per cent of gross domestic product in 2014. In his view: ''Reversing this
increase will be a tremendous challenge – let alone reducing debt to below
pre-crisis levels, which may be needed to leave enough fiscal space to
tackle future crises.''
There are three components to this view. First, that a crisis that had
its core deficit household and corporate budgets and debt-burdened household
and corporate balance sheets has been resolved in ways which substituted
public deficits and debt for private ones. In the event public debt is
seen to have risen to unsustainable levels. Second, that this threatens
widespread sovereign default and weakens the capacity of governments to
deal with fresh problems that may arise in the private sector, necessitating
correction. Finally, that the fear of sovereign default has reduced access
to debt and significantly increased the cost of borrowing for many governments.
Greece, for example, had been facing difficulty in getting adequate subscribers
for its debt issues. And the interest rate at which that debt had to be
incurred had risen sharply. This means that the possibility of dealing
with the debt burden by rolling over debt (or incurring new debt to repay
old ones) and postponing the date of redemption is reducing.
There is an element of truth in this since additional government borrowing
during the crisis was not all aimed at financing a fiscal stimulus. A
part of the build up of public debt amounted to borrowing good money to
throw it away. Governments borrowed to buy up worthless assets from banks
and financial firms that were seen as systemically significant in order
to clean up their balance sheets and keep them solvent. Or they lent against
collateral in the form of such assets at extremely low interest rates.
In the aggregate this amounted to exchanging government paper for toxic
assets in the portfolio of the private sector, and moving those assets
onto the balance sheet of the government. Expecting those assets to yield
the revenues that can help finance debt service commitments would be to
expect too much. If there are no other means to cover these costs, default
on debt is a real possibility.
However, the argument that public debt is a time bomb waiting to burst
is a bit difficult to swallow because there are other options. This argument
amounts to treating public and private debt as being essentially similar.
That is indeed surprising since an important difference between the private
sector-whether households or firms-and the government is that while the
former does not have the option of increasing revenues through taxation,
the latter does. In other words, governments can resort to increased taxation
to mobilise the resources needed to meet their interest and amortisation
commitments and pay their way out of debt. And this should be easier now
since it is widely accepted that a feature of the growth trajectory that
led up to the 2008 crisis was a sharp increase in inequalities resulting
from increased profit and rentier income shares and extremely high executive
compensation. Absorbing a part of this surplus through taxation is both
feasible and justifiable.
Further, when revenues accruing to the state through these means are used
to sustain and expand domestic expenditures and absorption, output increases.
This expands the revenue accruing to the state, making it even easier
to deal with the debt burden. It is for these reasons that debt-financed
government expenditure is seen as an instrument to deal with a downturn
and, therefore, a handy policy tool.
If these differences between the public and private sector are ignored
and private and public debt are treated symmetrically, the assumption
must be that for some reason-ideological or otherwise-taxation, especially
taxation of surplus incomes, is being ruled out as a policy option. Seen
from the point of view of the wealth holders this assumption must make
eminent sense. If the government through its borrowing had converted the
surpluses they had invested in worthless toxic assets into safe government
securities, then to tax those surpluses to finance that borrowing seems
unreasonable from their point of view.
It is this assumption that makes dealing with the public debt delivered
by the process of crisis resolution a challenge. If the debt burden has
to be reduced to forestall sovereign default on the part of governments
that are not permitted to increase revenues through taxation, the immediate
option available is a cutback in expenditures. This cutback cannot of
course include the interest and amortisation payments on debt that are
the problem. So the cuts must fall on capital expenditures that adversely
affect growth. They must involve austerity measures such as a wage freeze
and reduced social security support and spending combined with higher
indirect taxes and reduced subsidies that increase prices and erode real
incomes. They must include reduced employment through retrenchment and
attrition so as to curtail the wage bill. In sum, the debt must be reduced
by taxing directly or indirectly the man on the street rather than the
wealth holder. Unfortunately, this would impose much pain on the people
who are left with the confusing argument that though they have been rescued
from a crisis which was not of their making they have to still bear the
costs that the crisis would have involved. The people may not accept this
argument and take to the streets or dislodge governments that advocate
such policies. This makes resolution through a reduction in expenditures
difficult.
But that is not all. If spending is cutback to deal with the ''problem''
of public debt, then the recession that was overcome by debt-financed
public spending may return. This did happen during the Great Depression
of the 1930s when as a result of the stepped-up federal spending under
the New Deal, an economy that had been contracting for four consecutive
years (1930-33) returned to growth and bounced back sharply. Impressed
with that growth and concerned about deficit spending and public debt,
President Roosevelt cut back on deficit spending triggering a second recession
in May 1937. Realising that this could recur today as well, even those
like Strauss-Khan who speak of the dangers of excessive public debt and
deficit spending are also quick to recognise that the ''global economic
recovery is still sluggish and uneven and needs continued policy support
in many advanced economies.''
If taxes cannot be increased and expenditures cannot be reduced then governments
would indeed find it difficult to meet their debt service commitments
without borrowing more. But this kind of Ponzi finance only scares off
wealth holders who have to buy government bonds and give the government
credit. Credit is difficult to come by and interest rates rise. Sovereign
default is a real possibility, unless, for example, German taxpayers are
persuaded to buy Greek government bonds that private investors reject.
The difficulty in assuring such an outcome is what is leading to the ''public
debt scare''.
This then constitutes the ''challenge''. But some among those raising
this issue, especially financial capitalists, may have larger motives
in mind when raising the scare. The direction in which they would like
this diagnosis to take economic policy is to the other obvious, even if
not necessarily correct, way in which the debt burden can be addressed,
which is by liquidating state assets. It is likely we would soon hear
strident calls for disinvestment and privatisation aimed at generating
the resources needed to retire and reduce public debt. Rather than tax
the surpluses that have accrued with the private sector during the period
of inequalising growth, private wealth holders, who are now reluctant
to hold government paper, would be asked to hold their wealth in real
assets currently owned by the government. This would more than satisfy
private investors as they can diversify their portfolio into real assets
other than commodities or real estate, even while ensuring that the value
of the government securities they hold is as safe as it was originally
presumed to be.
But this is not the best option for the government or the ordinary tax
payer. No private investor would buy government assets unless those assets
promise a return significantly higher than the interest on ''safe'' government
securities. By selling such assets to retire public debt, the government
would, therefore, be giving up a profile of future incomes higher than
the interest to be paid on an equivalent amount of debt. That is irrational
from the point of view of the government and the ordinary taxpayer. But
it is not from the point of view of finance capital.