All the brouhaha over the debt ceiling got me to wondering - why do governments borrow money anyway? Of course the trivial answer is that they lack the political cojones to either cut spending or raise taxes, or that it's more self-serving to simply borrow the money rather than having to ask for it. No doubt all true to an extent, but given that at some point the debt has to be paid back from tax revenues (with interest) it would seem to be a self-defeating strategy doomed to failure (when the politicos are out of office, of course). Is this true though - or is there a macro-economic justification for debt?
One justification is that borrowing money helps "smooth the dips and bumps" in an economy. A related justification is that in a growing economy you will have more revenue later to pay back the debt. This could be true if you were borrowing from someone else's economy. However if you are borrowing from your own economy then it makes less sense, since whether you appropriate the money through tax revenue or through borrowing you are still pulling money out of the economy. In a truly global economy where you are trying to maximize the fortunes of everyone then this rationale makes no sense whatsoever. However it does point the way to a possible viable explanation.
Suppose in a closed economy (no borrowing from outside) the government is left with a shortfall of revenue - assume that spending is fixed, they are faced with the choice of either raising taxes or borrowing the money. On the face of it these would seem to be equivalent propositions, as they pull an equal amount of money out of the economy. However since the borrowing is voluntary, the money that is being appropriated is more likely 'excess' wealth - wealth that the individuals who own it don't really need at that time (they can't think of anything better to do with it, like investing in someone's good idea). In this way the borrowing is less harmful to the economy since it is taking wealth from where its not really being used anyway, whereas taxes could take wealth from people that really need it for vital stuff like food, or investing in good ideas.
In this way a constant (though not increasing!) level of government borrowing is good for the macro-economy, by efficiently soaking up unused resources.
I think your model of what government borrowing is doing needs refinement. Borrowing is not taking money out of the economy, in the sense of reducing economic activity. Quite the opposite in fact; government borrowing is normally considered as pumping money into the economy. What the government is doing is taking savings (stored money) and converting it into spending (fluid money). There is some relationship between saving and spending, inasmuch as you can either spend or save the money that you make, but it is not a very tight relationship since saving is the result of accumulated activity over time.
ReplyDeleteSo government borrowing is not taking money out of what is normally considered 'the Economy', i.e. the GDP. Assuming that the money borrowed is spent, it is actually increasing GDP. Where is the money coming from? It is coming from wherever the savers would otherwise have kept it. Under the mattress is pretty rare these days, even the figurative 'under the mattress' of a low interest bank savings account. The money borrowed by government is mostly subtracted from other investments: stocks and company bonds and their derivatives and property. Thus the classic problem with too much government borrowing 'crowding out' private investment. Savings that would otherwise have gone towards supporting a fledgling company go instead into treasury bonds. However, much investment is wasted, going into asset inflation or positional goods such as property. Since government debt in most rich world countries is considered safe but low return (recent crises notwithstanding), the kinds of investment that would first be converted into government bonds tend to be safe assets and property, i.e. not the type that produces actual economic value. Only if government borrowing becomes excessive (an admittedly ill-defined and fluid term) does it start to crowd out useful investment of a type that tends to be higher risk with potentially higher returns.
Long story short, I also think that government borrowing is good, but primarily for the 'evens out the economic cycle' reasons, not for the reason you give here, which I think is flawed.
...assume that spending is fixed... we are not comparing government spending money vs. government not spending money, we are posing the question why borrow the money rather than tax it? Since you have to pay interest on the borrowed money (the interest paid via taxes) it would appear on first blush to be pointless - you could raise the money through taxes and avoid the additional taxes required to pay the interest. Nevertheless I think we are more or less in agreement on the rationale. The gains made by avoiding the penalties of forced appropriation for the principal are greater than the cost of raising taxes to pay the interest.
DeleteI strongly disagree on 'evening out the economic cycle' however - in a closed economy this makes no sense. You are confusing changes in government spending to changes in government borrowing, which are related but separate issues. The ideal government borrowing level is equal to the amount of excess wealth in the economy, regardless of overall economic activity.
I guess it depends on what kind of taxation you are talking about, as the alternative to borrowing. I maybe falsely assumed that you were comparing borrowing to the more common types of taxation, i.e. taxes on production/income or spending. If instead we are comparing borrowing from the stockpile of savings versus taxing those savings (as France does, though it is unusual in that regard) then the difference is probably moot from a macroeconomic perspective, yes. The question then becomes whether it is better for government to tax all savings equally or whether the disincentive and inefficiencies that would create would be greater than the interest cost of voluntary borrowing. I think that brings us back onto the same page, yes? And your proposition is that borrowing is better because each individual saver knows what rate of return he can get on his savings so only those who have nothing better to do with their savings will loan to the government, while those who do have good investments to make will be free to invest the entire sum there, rather than being forced to give some to the government. Right? I think I can agree with that and most economists seem to as well, since, other than France, savings are not generally taxed.
DeleteFrom a pragmatic perspective though, borrowing is indeed used mostly to even out the economic cycle. Government spending should rise and taxation on production/income (as distinct from the proposed tax on savings) should fall when the economy slows, and vice versa. While it would in theory be possible for government to appropriate the necessary amount of saved wealth by levying a tax on savings that varies with need according to the economic cycle, it seems much more politically feasible to simply borrow the money and pay it back later. It would also be possible of course for government itself to save money in the good times (via a sovereign wealth fund) and then draw down that saved fund during downtimes. I'm not sure what the effect of that would be when compared to borrowing and repaying.
ok so I was comparing borrowing versus normal everyday taxation, not anything exotic like taxes on savings. Does this change the point you are making? You have to macro at a sufficiently high level - the government pulls a certain amount of money out of the economy - either through borrowing or taxation (yes, it then spends the money but that is the same in either scenario - the fact that it's government spending the money and not individuals is where the inefficiency/macro-economic loss comes in, which is the same in either case). Theoretically the government has to pay back the money, but they can just borrow the same amount again later to pay the principal, so in practice they can have an eternal balance owed, and the cost is the interest payment. This interest cost is the penalty for borrowing. The gain from borrowing at the macro-economic level has to be higher than the interest for it to make sense. Now of course in practice governments often borrow from someone else's economy. This is a negative for the lender economy and a clear gain for the borrower, since they don't have to pay anything for the principal. In this way governments can 'smooth' the economic cycles of their economy (averaging the cycles globally). However in a global context this no longer applies since the global economy is closed.
DeleteI think the question of spending vs taxation and the effect of both on the economic cycle is a very interesting topic, possibly worthy of a post in it's own right?
This comment has been removed by the author.
ReplyDelete