Phantoms in the Dark Part 2

 In the Nick Rowe blog post I linked to in the previous blog post, he outlines the views of the economic world this way:

“There are 4 possible positions to take on the debt. One of them doesn't make sense; the other 3 do. Which of those 3 is right is an empirical question.

Here are the 4 positions. I gave each one a name. I made up the quotes.

1. Abba Lerner. 'The national debt is not a first-order burden on future generations. We owe it to ourselves. The sum of the IOU's must equal the sum of the UOMe's. You can't make real goods and services travel back in time, out of the mouths of our grandkids and into our mouths. The possible second-order exceptions are: if we owe it to foreigners; the disincentive effects of distortionary future taxes; the lower marginal product of future labour if the future capital stock is smaller.'

2. James Buchanan/uneducated person on the street. 'The national debt is a burden on future generations of taxpayers. Foreigners are basically irrelevant. Any second order effects of distortionary taxes and lower capital stock are over and above that first order effects of the taxes themselves.'

3. Robert Barro/Ricardian Equivalence. 'The national debt is not a burden on future taxpayers (except for the deadweight costs of distortionary taxation) but only because ordinary people take steps to fully offset the burden on future generations by increasing private saving to offset government dissaving and increasing bequests to their heirs to offset the debt burden.'

4. Samuelson 1958. 'If the rate of interest on government bonds is forever less than the growth rate of the economy, the government can run a sustainable Ponzi finance of deficits, where it rolls over the debt plus interest forever and never needs to increase taxes, so there is no burden on future generations.'

I personally was taught 1 as an undergraduate. And I believed in 1 until about 1980, when I spent some time reading Buchanan and Barro arguing with each other. And I worked 4 into my own beliefs soon after.

And now, I believe 1 is false. The truth is some sort of mixture of 2,3, and 4. What precise mixture of 2,3,4 is true is an empirical question. My prior is one third-one third-one third.”

 

So, from the quote above, the answer from the world of economics to the question “does the debt burden future generations” is “no”, “yes”, “it would if all the valiant people didn’t sacrifice themselves to prevent it”, and “we’ll be ok if we can keep up with the payments”.  

Well that’s helpful, isn’t it?

I agree with Rowe when he says that three of these make sense and one doesn’t, but I don’t agree with him about which one doesn’t.   I think the first and second views are both largely correct even though they seem to be opposites---I’ll explain below---and I think the fourth is self evidently true, although I don’t think the use of the word “Ponzi” is appropriate here since the universe of players is not finite.   

But the third makes no sense at all to me.   I’ll explain more in a later post, but just as a first practical point I’ll observe that no one I know behaves like that.  No one bases their current savings/consumption decisions on what taxes might be in twenty years.  Not even people with doctorates in economics who are brave enough to hazard a wild guess about future tax rates behave like that, largely because they all know that no matter how good they are their guess about things that far away is likely to be wrong.  But to the average person who does not study economics the future debt, while it may be a scary phantom in the woods that grabs their vote, is a distant abstraction in daily life.  It doesn’t change the fact that they need a new dishwasher.  So even if it worked theoretically (and I don't think it does) it would not describe a real process that exists in the real world.

At the end of his post he adds this:

“But my brain just can't figure it out, yet. Maybe some of you younger, keener, brighter, people could work on this?”

I’m pretty sure I’m not any younger than Nick Rowe, and I certainly can’t claim to be brighter, but maybe if I explain how I see this it will spark something that will lead him, or someone, to some kind of progress in this long debate.

So to start, let me say that I think the people in the four views above are talking past each other, talking about different things using different conceptual tools. 

In view number 1 Abba Lerner is talking about physical stuff, the real economy, houses and trucks and grapes, not accounting or finance.  Lerner does get into finance---functional finance, which is really fun (no, really!), and which I’ll describe in a day or two in very rudimentary form as a treat for those who haven’t heard of it before---but the concept in Rowe’s quote is about physical things, and makes the point I started with several blog posts ago: we can’t eat the carrots from future gardens, so as long as we continue to invest and educate our children and all the rest of the things that will impact future productive capacity, we can’t grab their things and consume them now.  They, in the future, will divide up among themselves the same amount of stuff whether we have a federal debt at that time or not.  The idea that “we owe it to ourselves” means that we shift the right to consume among the people who are around in that future period, but the loss to some is a gain to others, so on the whole, as a country, we have not lost anything.

In view number 2 Buchanan is talking about the inner life of people: he’s saying that the amount of material satisfaction, or for econ people utility, can change from one period to another, or even within a period, even if the amount of stuff available for consumption doesn’t.  This is a discussion of personal choice, and of a utility burden rather than a financial burden.  It’s entirely possible to concede that the amount of stuff is unaffected by debt, but to argue that the burden in terms of utility falls completely on the later group---and in some places Buchanan does exactly that, in a very simple way.  He points out that in the first time period, when some people purchase government debt, they do so voluntarily so they must be happier buying the bonds than they would have been if they had bought consumption goods instead.  In the first period, the bond buyers are better off, in terms of their satisfaction with what they buy.  But in the second period the bonds must be paid off by taxing the population, which is a direct loss to each of the taxpayers.   So the people in the first period are more satisfied with life, while the people in the second are less satisfied with life.

Views 3 and 4 both seem to me to be talking about finance, that is, not about the amount of physical stuff available or about how satisfied we are consuming them, but about how and when we pay for them. 

As I said before, I think 3 is a puffy concoction created solely to support a contention that the government has no impact on the real world, a contention which is completely and obviously false. It does have the virtue that it gets a bit beyond finance alone and talks about human reactions to financial events, which is to say that it gets into actual economic behavior, but the assertion it makes about how humans react seems wholly unreal.  Sorry, I don’t mean to be harsh, but that’s how it looks to me.  But I’ll expand on that later, and readers can savage me at their whim. 

View 4 is just a basic statement of good investment: if your returns are greater than the cost of borrowing, you come out ahead.

It’s late, and dinner is calling, so I’ll continue tomorrow.  But tomorrow I’ll look first at a variation that isn’t really listed above: crowding out.  That’s the assertion that government borrowing displaces private investment, so in the end it has to reduce future productive capacity, and future consumption.  And I’ll start with the most boneheaded possible version, the assertion that savings equals investment as an accounting identity, so there's no way around it:  when government deficits go up investment must go down.

Some very good economists have said things like this.  And it’s completely, incredibly wrong.