Is High and Increasing Government Debt to GDP a Sign of Malinvestment?
This is a question I have been struggling with since the sovereign debt crisis began. So let me run a little of it by you. This may be half-baked but I would love some comments.
In a perfect world, we would have full employment and resources allocated efficiently in society. In that world, my assumption is that GDP growth, being the highest it could possibly be, the longer-term growth in government debt would be less than the growth in nominal GDP. The country would be operating at full capacity and the tax base would be robust. So government debt-to-GDP should at least remain stable at what even Reinhart and Rogoff would consider a relatively benign level.
The one issue to resolve is Medicare and Social Security. Rising government retiree healthcare and pension costs are largely a function of the inefficiency of the US healthcare system and of political preferences about the allocation of real resources – meaning much of this is political. I would argue that it is ‘inefficient’ to allocate so much of the country’s real resources to these two areas or that having for-profit companies control the non-retiree segment of healthcare provisioning is ‘inefficient.’ But I’ll set this aside for now; I just want to flag it.
Getting back to the large and rising government debt to GDP, you really shouldn’t have government debt-to-GDP rising dramatically if resources are well-allocated. Isn’t this a signpost that says resources have been misallocated/are being misallocated? The question I have is whether it is an ex-post indication. If it is ex-post, it says that the malinvestment occurred in the past and we are only now witnessing the ex-post confirmation.
An ex-post confirmation gives a more benign interpretation to government policy because it doesn’t necessarily indicate that government was ‘responsible’ for the misallocation. After all, hasn’t the capitalist system always had massive boom-busts which increased government debt? Could it be that the private sector simply misallocates capital due to the excess credit growth of irrational exuberance? In my view, government policy was involved in distorting incentives by reducing interest rates and subsidizing some favoured sectors. But that is not the only issue.
So what does that mean about government’s role in a debt deflation regarding jobs?
Marshall Auerback says:
The reason we look at it this way is because the ‘right amount of government spending’ is an economic and political decision that, properly understood, has nothing to do with government finances. The real ‘costs’ of running the government are the real goods and services it consumes- all the labor hours, fuel, electricity, steel, carbon fiber, hard drives, etc. etc. etc. The real cost of the government using all these real goods and services is that those resources would other wise be available for the private sector. So when they government takes those real resources for its own purposes, there are that many fewer real resources left for private sector activity.
How does that interpretation affect how you see government’s role in society when we have a large output gap. It’s not like government is crowding out the private sector right now, is it? Clearly, the private sector isn’t fulfilling its role in creating jobs. Should the government sit back and allow this to continue? And if not, what should it do? Should it institute a payroll tax holiday or apply a federally funded, but locally-administered jobs program in areas with high unemployment? I think both of these ideas have merit.
Update: I failed to mention the socialization of malinvestment onto the government’s balance sheet as a main driver of the recent increase of debt-to-GDP in countries like the US, UK, Spain and Ireland. In each case, government debt-to-GDP was low, but because of property bubbles and banking sector distress, each country has seen the debt-to-GDP increase dramatically. As commenter Olivier points out, this creates a moral hazard and is a major reason I am against bailouts.
Anyway, that’s my thought for the day. I’d appreciate comments.