Living within your means is so inconvenient

by Russ Roberts on May 30, 2012

in Budget Issues, Debt and Deficits, Financial Markets

Mr. Micawber in David Copperfield was onto something:

“My other piece of advice, Copperfield,” said Mr. Micawber, “you know. Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. The blossom is blighted, the leaf is withered, the God of day goes down upon the dreary scene, and—and in short you are for ever floored. As I am!”

And here is Adam Smith in The Theory of Moral Sentiments:

What can he added to the happiness of the man who is in health, who is out of debt, and has a clear conscience?

In short, it’s a good idea to spend less than you take in. Debt leads to misery. But wiser men than Dickens and Smith argued that what is best for the individual need not be best for the nation. In fact, we have heard over and over again that in fact, debt is good for a nation with an economy that is struggling. The fruits of this view are all around us. The latest news comes from Europe. The Wall Street Journal reports:

The 17 countries that use the euro should consider setting up a “banking union” that allows them to share the burden of bank failures, the European Union’s executive arm said Wednesday in a report on the currency union’s crisis-fighting efforts.

To further stop expensive bank bailouts from pulling down governments’ own finances, allowing the euro zone’s new rescue fund to directly boost the capital of banks “might be envisaged,” the European Commission said.

At the moment, any financial aid to prop up struggling banks would have to be requested by the firms’ own government, pushing up its debt and deficit burden. The fear is that even if the government gets the required bank aid from the bailout fund, it would damage its efforts to raise money from the bond markets to finance the rest of its operations.

In other words, it’s unpleasant to live within your means. Yes it is, especially when you’ve gotten out of the habit, especially when you have special friends who are hungry.

But a banking union just makes the problem worse. Not today, maybe. But certainly tomorrow. What makes government action attractive is the opportunity for the body politic to pool its money to achieve things that individuals cannot achieve on their own. This idea ignores the possibility of voluntary collective action. But more importantly, the romance of this idea ignores the reality that inevitably, politicians are spending other people’s money. One of the simplest and deepest ideas of Milton Friedman is that people don’t spend other people’s money very carefully, especially when they are spending it on other people.

Creating a banking union to “share the burden of bank failures” makes the “other people’s money” problem worse–it pushes the consequences of irresponsibility further from those who are irresponsible. It’s an attempt to lower the cost of a bank failure. But when you lower the cost of something you get more of it.

I am reminded of this piece I wrote long ago about the dangers of pooling resources and detaching consequences from choices. We all have a desire to live in that world, the world of the free lunch, the world where I pay little or nothing for a poor choice or an extravagant one. But that world cannot exist without the financial help of someone else. And eventually, the money or the patience of the financier runs out.

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