Here’s the second of the promised two long posts on the burden of public debt. I see now that I will likely burden future readers with a third long-ish post on this topic.
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Steve Landsburg summarizes nicely his take on the debate – sparked by Paul Krugman’s blog posts and recent NYT column – on whether or not government debt held by citizens of country A is a burden to country A whose taxpayers in the future will have to pay to retire this debt.
While I might word differently a few of Steve’s 16 points – especially his point #1 – I agree substantially with all that he writes in his latest post on this matter. Steve’s post confirms my earlier belief that much of the recent discussion between him, Bob Murphy, Nick Rowe, and myself involved a lot of talking past each other.
But unlike Steve I’m not convinced that Krugman likely would agree with Steve’s latest post. (At 3:55pm EST today I checked Krugman’s blog and he has yet to respond to Steve or, more generally, to contribute much to this debate beyond his earlier claims that “talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay money to other children.”)
Why does it matter what Krugman thinks? Apart from his hugely influential role in today’s economic-policy debates, it was Krugman who re-launched this debate with his recent posts and his January 2nd column. And his explanation of his position strikes me as rendering his position much more akin to that of mid-20th-century Keynesian economists who asserted that public debt “owed to ourselves” is not a burden to “us” because receipts of repayments on matured debt, or of interest on outstanding debt, by some members of “us” largely cancel the increased tax payments, by others of “us,” used to fund these repayments and payments. So, collectively “us” is not much burdened by internally held debt.
I obviously don’t know for certain what Krugman thinks, but – as I said in this previous post – his statements about the feather-light burden of internally held debt combine with his full-throttle Keynesian advocacy of deficit spending to make his position on this matter at least appear to be awfully similar to the position of the ‘don’t-worry-’cause-we-owe-it-to-ourselves’ economists who Buchanan (and, if I recall, also William Vickrey, among some others) challenged a half-century ago.
Reinforcement of this suspicion about Krugman’s analyses of the burden of public debt is found in his explicit denial that a government budget can be analogized usefully to a family budget. Explicit denial of the appropriateness of this analogy was a central feature of the “new orthodoxy” that Buchanan exposed as faulty.
Further reinforcement of this suspicion is supplied by the very fact that Krugman missed Steve’s point about the irrelevance of the nationality of the holders of government debt. Krugman’s repeated emphasis that “we owe it to ourselves” seems to me to be crucial to the point he is trying to make. His repeated mention that debt owed ‘to ourselves’ is not a burden “because it is money we owe to ourselves” strikes me as being compelling evidence that he sees in the pattern of debt ownership a key determinant of how burdensome is any given amount of public debt.
So Krugman, after all, does indeed appear to espouse the fallacy that Buchanan exposed. To explain why this espousal matters, it’s worth quoting again the Buchanan and Richard Wagner passage that I quoted in an earlier post (emphasis added):
The Keynesian advocates failed to see that, if their theory of debt burden is correct, the benefits of public spending are always available without cost merely by resort to borrowing, and without regard to the phase of the economic cycle. If there is no transfer of cost onto taxpayers in future periods (whether these be the same or different from current taxpayers), and if bond purchasers voluntarily transfer funds to government in exchange for promises of future interest and amortization payments, there is no cost to anyone in society at the time public spending is carried out. Only the benefits of such spending remain. The economic analogue to the perpetual motion machine would have been found.
Thus we see the significance of the fact that a scholar of Paul Krugman’s stature is today proclaiming that the burden of the public debt is zero or negligible if we owe that debt to ourselves. Krugman’s “new new orthodoxy” – like the mid-20th-century “new orthodoxy” – dangerously portrays deficit financing as supplying a free lunch.
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It’s true that if a switch to deficit financing and away from financing exclusively out of current tax receipts has no effect on government’s budget (either in its size or its pattern), then we need not worry. Deficit financing changes nothing real of any significance. But why, then, bother with the “we owe it to ourselves” line?
If you assume that changing the method of financing leaves unchanged the level and pattern of government spending, and accompany this assumption with talk of “we owe it to ourselves,” then you must think that, in fact, something real is affected insofar as “we owe it to ourselves,” namely, the cost of a given level and pattern of government spending. You must believe that “we owe it to ourselves” matters (else why mention it?), and that it matters precisely because owing it to ourselves reduces, possibly to near-zero, “our” cost of any given level of spending.
But if it’s true that owing government debt to ourselves reduces the burden of the debt (used to finance any given level and pattern of government spending), then the assumption that the level and pattern of government spending is invariant with respect to financing methods is unjustified. Why would, and why should, government not spend more and differently if the cost of that spending is reduced by being financed more with debt that “we owe to ourselves” than with either current tax revenues or with debt owed to foreigners?
It was precisely this implication of the “we owe it to ourselves” line that Buchanan sought to counter. Deficit financing does allow the cost of current spending to be foisted on to others. As Buchanan says in a 1964 article entitled “Public Debt, Cost Theory, and the Fiscal Illusion” (reprinted on pages 150-163 here):
The essence of public debt, as a financing institution, is that it allows the objective cost of currently financed expenditure projects to be postponed in time. For the taxpayer, public debt delays the necessity of transferring command over resource services to the treasury.
Deficit financing, therefore, gives people today stronger incentives to increase government spending. The essence of the problem, then, is that deficit financing encourages more wasteful consumption (through government spending) today than would occur in the absence of such financing. And that unfortunate encouragement is made only worse if well-known scholars insist on the truth of – and if people therefore fall for – the canard that the burden of the public debt is minuscule if “we owe it to ourselves.”
If people are misled by credentialed economists into thinking that there’s a free lunch when there isn’t, government will spend more wastefully than if this myth is tossed onto the trash-heap of dangerous ideas, where it belongs.
