Debt sustainability has emerged as one of the key issues of the day and one that brings the different poles of the rich world together: the United States, European economies and Japan are all struggling with the problem of how to cut public debt. There are few better accounts of current thinking on this matter than the recent report published by the International Centre for Money and Banking Studies (ICMB), run by Charles Wyplosz.
Written by some of the world’s leading economists (Wyplosz, Eichengreen etc.), the report gives a simple explanation for today’s problems: individuals prefer to free ride on goods rather than to pay the full cost for them. Given half a chance, even when from a collective perspective this is not rational, individuals will shirk from paying for something themselves. The result is that in the provision of public goods, governments have been forced to borrow in order to meet public expectations. The authors of the report call this the common pool problem.
In a telling graph (p49), the authors show that the problem has tended to be manageable in when GDP growth is strong. As both the US and Europe exited from the post-war Golden Age of national Keynesianism in the 1970s, governments turned to borrowing in order to make up the gap between transfer payments and tax revenues. The authors cite the cases of Germany and the Netherlands: in Germany, the ratio of spending on transfers and subsidies rose by 9.5% of GDP between 1970 and 1995 whilst total revenues rose by 6.1%; in the Netherlands, transfers and subsidies rose by 7.1% of GDP, total revenues only by 5.6%.
The report identifies four ways of reducing public debts: default, inflation, cutting spending/raising taxes and growth. It does not consider defaulting as a serious policy option and dismisses the chance of advanced economies experiencing a sudden spurt in GDP growth. This latter point is striking: only those economies catching up are likely to experience high growth levels, they claim. After that, when you are close to the technology frontier, it’s all low growth (pp56-59). That leaves only inflation and restrictive fiscal policy as serious policy options. Inflating away the debt they argue is unlikely in Europe’s case given the ECB’s stringent price stability mandate. The only option left is the one that hurts people most: cutting government spending or raising taxes.
The authors argue that the better option is to cut spending since raising taxes only lays the basis for more spending later on. The report then outlines the institutional fixes that are needed in order to undertake spending cuts. There are many different solutions proposed here, each tailored to fit with the national political system in question (presidential, parliamentary etc.). However, what the institutional reforms all have in common is that they seek to distance decision-making and implementation over government spending from political discretion. Politicians must either have their hands tied or be disinvested of responsibility for spending decisions. In the case of the Eurozone, the authors suggest that the European Commission should be given the powers to judge whether a country’s institutional framework is appropriate for the goal of reducing public debt. Countries that fail to win the Commission’s support would find that its debt is no longer accepted as collateral by the European Central Bank in money market operations.
It is difficult to know what is most chilling about the report: its skepticism regarding the growth prospects for advanced industrial economies or its willingness to curtail democratic procedures in the name of eliminating “deficit bias”. Either way, its recommendations fit well with the prevailing wisdom in national capitals. In Italy and Greece, national democracy has given way to technocratic administrations charged with implementing government spending cuts in the face of massive public opposition. In the Eurozone, the focus is on monitoring government spending and beefing up sanctions to be imposed on those members unwilling to curtail their debt. Outside of the Eurozone, in the UK and in the US, more inflationary policies are considered. There, however, the focus is still primarily on reducing spending.
What is most striking about the report is its starting point. In explaining the crisis, there is no reference to the international economy or to domestic politics as such. Today’s problems are not put in any historical context or tied to any particular decisions or set of interests. No mention of global imbalances. No mention of financialization. Instead, their explanation is one that holds across all time and all societies: the selfish irrationality of individuals and how that translates into dysfunctional representative institutions. Under those assumptions, capitalism can only be saved from itself if the running of it is given up to technocrats.
This gets the problem the wrong way round: since the 1970s, we have seen a steady accretion of political power away from majoritarian institutions. We have seen the birth of what some call “the regulatory state”. Political discretion has shrunk and yet advanced industrial economies today face severe public debt crises. To blame individual selfishness and the difficulty of properly pricing collective goods in a democracy is too easy. It shifts the blame away from capitalism and puts it squarely on the shoulders of ordinary people. Compelling reading for the ICMB’s audience perhaps; less so for the rest of us.