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.
First, even if these government debts are “just” an ex-post confirmation of private malinvestment, the fact governments socialize private losses is obviously huge moral hazard that will fuel further private malinvestment down the road. So it’s far from “benign.” But wait, the government set low interest rates fueling bubbles in the first place, so no, they’re at the root of private malinvestment too (or at least amplify it from normal business cycle busts to huge systemic crises).
Second, GDP components are not fungible into each other as some are productive and support real savings (private production) while others are consumptive (yes it’s a word!) and destroy savings. If all you have is debt-driven consumer and government consumption, you can’t have real sustained job growth.
Make believe jobs are not a substitute for real productive ones, and paying people to sit around is destroying savings. The government should get out of the way, let the private sector wash up its sins, and stop confusing finance with the economy.
Maybe you’re starting to intuit how to get out of your chartalist funk. Good! Here’s what’s wrong with it: the private sector has absolutely no desire to have “net savings” to fund the government. That’s looking at things backwards: yes the government needs net private savings or foreign loans to run a deficit! The private sector can save and loan within itself. So what if there’s no “net saving” out of it? That’s the profligate government’s problem, not the private sector’s. You want to open a restaurant, I loan you $100K, you get your funding, I put my savings at work, we’re happy, see no government involved and no “net private savings” necessary. Money and jobs are created via private savings, productive output, and reasonable leverage.
Olivier, I’ll leave the rest of the comment for others but I agree with your comment about socializing losses. Somehow, I forgot how to work that in to the post. But, the increased debt to GDP can be seen as a socialization of malinvestment onto the government’s balance sheet. I agree with that 100%. It does create a moral hazard and is the biggest problem I have with stimulus as a panacea for excessive private sector debt.
Watch what happens in Ireland because that is the country where the socialization has been the greatest. They have destroyed the government’s finances by socializing the banks’ losses and if they double dip, it will get worse.
Edward, you discuss financial sector balances quite a bit in your discussions of MMT and related topics. Perhaps this current discussion would be tightened with a view toward another accounting identity: The Savings-Investment identity.
Investment (I) = Private Savings (P) + Government Savings (G) + Foreign Investment (FI).
Netting the three factors, it appears to me the problem going forward will be maintaining investment. Long term, productive investment allocation is what creates wealth in the society.
I’m curious what you and the MMT folks think about the above identity, and whether government countercyclical policies would cause Investment to deteriorate.
Here’s a different thought:
I agree that in a near perfect world, you should have near full employment. But let’s think about this. In any given population, there are needs – to travel, to eat, to sleep in a shelter of sorts and store one’s belongings (nowadays, mostly crap), to clothe oneself, etc…
Well, in the past 40, if not 100 years, technological advances have progressed such that a fraction of the people working to provide these necessities are needed as they were in the past. In the 1930s, for instance, 25-30% of the population lived on a farm. Today, 2-3% do that and produce more food (not always good or real) than ever before.
Same with manufacturing. Whereas it took 300K people in that past to produce a certain amount of steel – today it only takes 75K. Robotics, near free energy sources, and other technological improvements have significantly increased productivity.
So… what if we don’t need that many people working? Let’s look at the most recent era of “full employment.” What did many people do other than work in the Ponzi system we recently created? And this doesn’t just go to the direct employees of Finance, Insurance, and Real Estate (FIRE) -but to their support staffs – paralegals, legal secretaries, title companies, and to ancillary services – eDiscovery providers, Copying and printing services, ad agencies, graphic designers, and to the next in line: the restaurants and shops all these people frequented, the travelling – airline industry, etc… Think of all the consequences. It’s enormous.
What if the only reason we had full employment was due to the fact that we overshot on the production of necessities, and created a fictitious, debt driven economy (FIRE) that was unsustainable – or at least overexaggerated in size? Just to keep people working?
We may have become the victims of efficiency gains thru technological advancements. And to increase some arbitrary level of “growth” we have to continue the Ponzi debt based system until it can no longer continue and collapses spectacularly.
That’s my opinion. Either we learn to live with what we need, and accept high levels of unemployment, or we will not only misallocate capital, but non-renewable resources as well. And instead of sharing the resources of this planet and living less of a materialistic culture for the sake of unnecessary and unsustainable growth, we will blow each other up because we all prefer to drive that Mercedes and live in a McMansion – and we all know, only a certain percentage of us can do that.
Sorry to get off topic, but I wanted to address the concept of acceptable employment levels – and if this paradigm/goal we have of 5% unemployment, weekends off, two weeks vacation… is a realistic one, or one we created.
In other words, there are x amount of things and services a society needs in a given year. How can we say that it must take 95% of the population, working 5 days a week, 50 weeks a year to satisfy those needs?
Maybe we should let the housing market collapse to reasonable price levels. Maybe many people only need to work for half the year. Maybe only one breadwinner is needed to raise a family again. Let’s take advantage of these productivity gains to improve the quality of our lives.
Who says we have to build up the “FIRE” sector?
For years now the neo-liberals have been eschewing the use of
counter-cyclical fiscal policy and as the dominance of inflation-targetting monetary
policy was made concrete, fiscal policy was assigned a passive role. Monetary
policy was given predominance, which in turn resulted in the Fed acting as
a serial bubble blower. That in turn created the conditions for the
massive growth in our “FIRE” sector. With this ideology prevailing, it is
little wonder that governments ran down their capacity to implement large-scale
infrastructure projects and instead of engineers who build things, we got
financial engineers who designed financial Frankenstein products.
Your argument could have been made at any point in history: “We don’t
need people doing buggy whips and horse carriages now that we’ve got cars, so
why force them to do ‘unnecessary labour’?”
Government departments used to have large planning capacities and projects
would be thought out in advance and would be ready – well-designed and
costed – for when the fiscal tap had to be turned on. In general, the
evaluations that have been done over the years point to these projects being well
implemented and providing enduring benefits. I can think of many projects
around the world that have been completed as part of a fiscal
counter-stabilisation program which now provide huge financial and non-pecuniary benefits.
So there is no inherent flaw in the “Keynesian” approach to large-scale
infrastructure programs being used as a primary platform for providing fiscal
stimulus to an ailing economy.
Why is it always assumed that jobs emanating from the public sector are
always “low quality”? Do you think the world needs a bunch more staff at
Wal-Mart, versus more nurses or teachers? You don’t think a medium-term
public investment in sustainable energy and education is fully supportable?
In a message dated 6/11/2010 8:41:33 A.M. Mountain Daylight Time,
writes:
Marshall, I agree that we shouldn’t reflate the FIRE sector, but I also believe that as it eventually crashes, the devastation to employment levels will be immense.
As for government projects, yes there are many that have outlasted their initial purposes yet still benefit humanity. But I guess I have a different view of government over the long term. All economic theories become entrapped by an oligarchy – whether it is communism or capitalism. And then the misallocation ensues.
The Walmart staff jobs are symptoms of monetarism hijacked, in my view. Would they have existed if FIRE didn’t get so bloated? If money was not managed for the benfit of elites and FIRE, there would have still been a lot of mom and pops today. When my father emigrated here over 40 years ago, the town he settled in was full of independent businesses where the owners lived in the same town. Today, you have massive retail and restaurant chains anchored in Wall Street because of a massive bubble that began in the 1980s. This I attribute to fiat debt based money that needs to constantly expand. And those that are closest to the money spigots, own and control everything today.
As for gov’t sponsored energy jobs – I agree that is needed. I believe in Peak Oil and the private sector will not be sufficient to make up for energy issues down the road. But I’m also realistic. There are only so many energy jobs out there. If you create a program for windmills, you will be laying off coal miners – it’s a wash. Why do people see alt energy as a long term panacea? I believe in alt energy, but for different reasons.
Agree that devastation to employment levels will be immense. Hence, the Job Guarantee proposal. What do you want to do? Let the whole thing crash and do nothing?
Marshall – it looks like we share some values, it’s the policies that we disagree on.
I’m not saying that government should not play a role. But I would prefer other policies as well. Fair trade, for instance. When we trade with nations with no unions, no child labor laws, lax environmental laws – we lose and we end up importing their poverty. We lose because we want a clean environment for our children.
We also need a monetary system that does not accumulate in the hands of a few rentiers. Private banks create money that in the long run consolidates businesses in fewer hands. I want to see main street rise again. I want to see every community have family businesses that are passed down for generations, where the wealthy are dispersed and live in the community they work and invest in. Today we have gated communities of rent-seeking FIRE economy thugs centralized in wealthy suburb towns. They do nothing for society in general; they are just good at playing the Ponzi Casino game. And society celebrates these people! What a case of Stockholm Syndrome!
And yes, I’m an Austrian and prefer a gold standard. When money is easily replicated, it’s value diminishes. It is easier to gamble with money backed by nothing, than with real money backed by gold.
In a message dated 6/11/2010 3:11:53 P.M. Mountain Daylight Time,
writes:
Marshall – it looks like we share some values, it’s the policies that we
disagree on.
I’m not saying that government should not play a role. But I would prefer
other policies as well. Fair trade, for instance. When we trade with
nations with no unions, no child labor laws, lax environmental laws – we lose
and we end up importing their poverty. We lose because we want a clean
environment for our children.
DON’T DISAGREE. THAT’S WHY WE HAVE NATIONAL GOVERNMENT STANDARDS. TO
PREVENT THIS RACE TO THE BOTTOM. BUT I DON’T SEE THAT BEING FUNDAMENTALLY
ANTITHETICAL TO WHAT I’VE PROPOSED.
We also need a monetary system that does not accumulate in the hands of a
few rentiers. Private banks create money that in the long run consolidates
businesses in fewer hands. I want to see main street rise again. I want
to see every community have family businesses that are passed down for
generations, where the wealthy are dispersed and live in the community they
work and invest in. Today we have gated communities of rent-seeking FIRE
economy thugs centralized in wealthy suburb towns. They do nothing for society
in general; they are just good at playing the Ponzi Casino game. And
society celebrates these people! What a case of Stockholm Syndrome!
AGREE WITH YOU, AS DOES RANDY WRAY. WE ALSO WANT TO ELIMINATE MONEY
MARKET CAPITALISM. AGAIN, UNSURE AN EXTREME FORM OF LIBERTARIANISM ACHIEVES
THAT GOAL. KEYNES ALSO SAID HIS GOAL IN LIFE WAS TO ‘EUTHANISE THE ECONOMIC
RENTIERS’. THE ONLY WAY TO CALIBRATE THE WORHT OF FISCAL INTERVENTIONS IS
TO ESTIMATE OUTCOMES SUCH AS “HOW MANY JOBS WERE SAVED”. THIS IS THE RIGHT
PRIORITY. IN FOCUSING ON LARGELY IRRELEVANT CONSIDERATIONS LIKE THE SIZE
OF THE BUDGET DEFICT (WHICH IS NOTHING MORE THAN AN ACCOUNTING IDENTITY), WE
ARE DISPLAYED A WARPED SENSE OF POLICY PRIORITIES.
And yes, I’m an Austrian and prefer a gold standard. When money is easily
replicated, it’s value diminishes. It is easier to gamble with money
backed by nothing, than with real money backed by gold.
I THINK YOU’D BETTER RE-READ YOUR HISTORY. IT SEEMS TO ME THAT WE HAD
SOME PRETTY NASTY DEPRESSIONS UNDER A GOLD STANDARD, AS WELL AS THE SAME KINDS
OF POLITICAL CORRUPTION AMONGST THE RENTIER CLASS. WHY DO AUSTRIANS
IGNORE THIS ASPECT OF HISTORY AND IMPLY THAT THIS WAS A ‘GOLDEN’ AGE OF ECONOMIC
GROWTH? IT’S A COMPLETE HISTORICAL FABRICATION, OR DELUSION AT BEST. YOU
CAN PREVENT PROPER GAMBLING WITH OTHER PEOPLE’S MONEY IF YOU HAVE A PROPER
REGULATORY APPARATUS IN PLACE, BUT AGAIN, THIS SEEMS TO RUN UP AGAINST THE
LIBERTARIAN GOAL FOR ‘SELF REGULATION’ AND ‘FREEDOM’.
Link to comment: https://disq.us/dwaww
I try not to comment too much during the day, but this is a very well-phrased and considered question. Having no formal training in economics, I’ll try to stay in plain English.
High ratio of public debt to GDP is clearly not good, and “malinvestment” is a great concept to throw at it. Why is public debt too high? 4 key reasons.
1. Public sector spending on less-productive things
2. Bringing private sector debts onto public balance sheet.
3. Insufficient revenue streams for government (taxes too low).
4. People squander money on inutile crap
Lets go at them in order.
1. Public sector spending on less-productive things
Which ones?
a. Ill-considered wars / foreign policy. On 9/12/2001 or thereabouts, we should have been thinking “where’s the most bang for our buck?” A big chunk of the world hated us, we should have sought to mitigate that by putting $N billion into public health projects in the Islamic world. Water quality in Bangladesh, etc. But no, we put Wolfowitz in the driver’s seat and set off on poorly thought out adventures.
b. Yes, entitlements. Big mess to sort out. Mortality curves have changed dramatically over the years, people need to work longer, etc.
c. Higher efficacy in other government expenditures. Real performance metrics and ability to have flexible workforce.
2. Private sector debts brought onto public balance sheet.
This is a largely a theological question. Lending was crazy, people were borrowing insanely, consuming insanely. The “new normal”, Grantham’s “7 lean years,” and bondmarket vigilantism will generally constrain this going forward.
3. Taxes have been too low. The W. Bush tax cuts were always ill-considered. The fiscal situation was good under Clinton, why was it messed with. The supply side hypothesis has never been empirically validated.
4. Between borrowing and low taxes, people felt like they were richer than they were and invested too much money in foolish luxury consumption: McMansions, SUVs, seared ahi tuna in every pot. The marginal returns on a swimming pool are nil. Society as a whole does not benefit over time. These things crumble and return to dust, or, as was the case in Russia, are nationalized and broken up into disfunctional multi-family housing. Take the Mansion Walk in Newport and glory in the marvels of the robber baron days. Think about the future of Steve Cohen and Eddy Lambert’s digs in Greenwich. Go read Chekhov.
“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?”
Your question as quoted (and also the title of the post, “high and increasing government debt…”) includes two components (and I believe separating them is key to answering your question): the LEVEL of government debt and the RATE OF CHANGE of government debt.
I think a rapid RATE OF CHANGE of government debt usually indicates a growing or bursting bubble in the private sector, which likely implies some “malinvestment”.
However the LEVEL of government debt may not tell us much except a rough gauge of the desired cumulative financial savings of the non-government sector. Demographics likely come into play here, and probably also relative asset values in other areas (stocks, real estate, etc). I’m not sure that the level itself can tell you too much about how productive government deficits have been…. you’d need other measures of society’s well-being to gauge that.
Also just to be clear, even most econoblogosphere advocates of running high enough government deficits (Randall Wray, other MMTers, etc) are against using them to socialize private sector asset value losses.
Clearly, the private sector isn’t fulfilling its role in creating jobs. Should the government sit back and allow this to continue?
————————–
Wages need to fall before hiring workers becomes profitable. Private debts need to be liquidated so competent managers can take over the businesses. So long as we pretend the economy operates in some “equilibrium” and that the previous crisis was just some random aberration from it, how can we expect the private sector to adapt to new market environments?
The US has lost competitiveness in the global marketplace. So has much of Europe. Falling wages and falling asset prices will first entice people to save and then entice savers to invest in productive capital equipment/human capital.
Government is attempting to make up the difference by building bridges. But eventually government spending runs into the law of diminishing returns, we are left with the debt servicing (higher taxes), and the private sector will not have adapted to a new global economic order.
A perfect recipe for underperformance and stagnation.
Maybe it’s not wages that need to fall but commercial real estate prices? Think for a moment how many uneconomic business models today become economic tomorrow if CRE prices were, say, cut in half? A 50% reduction in a lease goes a long way in opening outlets for hiring.
Don’t think the banks will go for that one though I’m afraid.
Either way, deflation is the cure. And I’m not really interested in what banks “will go for.” If they won’t mark their assets to market values after being told to do so, they can be closed for fraudulent accounting.
Disagree. Deflation is not the cure, it’s the death march. Monetary inflation is the cure as it forces debt deleveraging without promoting nominal asset price deflation.
@ Marshall (I couldn’t reply to your last comment – looks like the comment string ends)
The term “recession” did not exist in the 1800s. Thus, they were all “depressions”. Recession is a fiat money era construct to make us feel better. But look at a government debt to gdp chart from that era. Quite the opposite of today. But I will allow, that much of it was due to technological advances that in my mind, relatively speaking, were more significant than today’s advances – at least for that era, and for creating work. As I said before and I’ll elaborate, the first wave of industrialization created a need for labor and a consuming class. The second wave of industrialization required higher technological based efficiencies, outsourcing, etc, that dampened the need for labor.
Recessions are needed to re-align output with demand. To clear out the underbrush of malinvestment, much like a forest fire. Monetarists and modern Keynesians fight recessions with loose money and debt, and in the end, create an usupportable super bubble of malinvestments, that upon collapse, makes all other recessions seem miniscule.
But I don’t want to compare the 1800s, or the guilded age, with today. The technological advances and lack of workplace regulations and monopoly regs, etc… were much different. Two different eras.
Gold is still relevant on another basis. It is the ultimate extinguisher of debt. I follow Antal Fekete, and believe in much of what he says. I have also read up on John Exter. But that’s another topic…
Correct.
Gold is not a panacea. It merely keeps in check the inflationism that distorts the structure of production by encouraging asset accumulation and near-term consumption as opposed to saving and investment in capital goods.
Only rabid Rothbardians argue that anarcho-capitalism under a gold standard eliminates the business cycle altogether. I admit that they could be correct. But I doubt it. Far more likely is that we would have regularly occurring liquidations of malinvestment that are localized in certain areas of the economy, but do not spread systemically into major crises. Much like the Depression of ’20-’21.
Self-conscious investment implies assessing potential projects on a risk-reward basis. I don’t know if one can fairly say that there’s absolutely a good or bad investment; they need to be assessed comparatively. There are (or were) always better and worse investments. The term “malinvestment” therefore implies the presence of better alternatives, now or in the past.
Is it useful to specify how much better or worse we could have invested? (It’s always obvious in hindsight that one could have made better investments. Do we need a relatively objective litmus test of some kind to help us distinguish between garden-variety second-guessing and truly poor judgment?)
1. About a trillion dollars on war.
2. About a trillion dollars on bailouts/rescue package due to a massive financial conspiracy involving dodgy mortgage lending and securitization, with spill over into the real economy and resulting in debt deflation.
If you want to call that malinvestment, I’d agree. I’d call it something else, myself.
So would I. “Last days of the Roman Empire” springs to mind.