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.
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