Tuesday, May 1, 2012

More of Robert Murphy on Government Debt

Robert Murphy, the brilliant Austrian school economist, has written another post on whether government debt can burden future generations.  I have dissented from his view in the past.  His answer is that future generations are burdened.

My view on the subject is one that Murphy previously held (according to some of his more recent writings).  I believe that future generations are burdened only in the sense that there is less savings and capital investment that future generations will benefit from.  We are relatively wealthy today with houses, cars, televisions, refrigerators, plentiful food, etc. because of the capital investment that has taken place in previous history, especially in the last couple of hundred years.

In Murphy's latest piece on this subject, he uses an example of someone buying what is essentially a government bond in 2012 and then being able to cash in on it in 2112.  The government declares that the debt will be paid off in one hundred years using the taxpayers of the country.

First, this is assuming that there is no default, whether through inflation or outright repudiation.  The taxpayers in one hundred years could simply refuse to pay up.

Second, the country as a whole won't be any poorer in one hundred years, even without a default.  It will just be a redistribution of wealth, which is exactly what happens in 2012.  It is the person buying the government bonds in 2012 who is transferring wealth to the government.  In 2112, wealth may or may not be transferred again, depending on whether the taxpayers are willing to pay up and also depending on the level of previous inflation.

Let's go back to the basics and pretend we have a tropical island with four people living there.  There is Al, Bob, and Chris, along with George the government.  George wants to throw himself a party.  He wants to feast on three big fish for the night.  He does not want to order a confiscation of one fish from each citizen.  Instead, he issues debt.  He asks someone to loan him three fish and they will be paid back in the future through the fish catching of all of the citizens.  Whether or not he offers additional interest is irrelevant to this discussion.

Bob decides to take the three fish that he just caught and to loan them to George.  He is now Bob the bond holder.  Meanwhile, George the government has his feast.

In one year, Bob the bond holder tries to cash in on his previous loan.  At that point, there are two possible scenarios.  George the government may be afraid of Al and Chris if he tries to confiscate their fish.  It might be easier for George to default on his debt and stiff Bob.  The other scenario is that George wants to keep his parties going and he wants to be able to issue more debt in the future.  In this case, he confiscates fish from Al and Chris (and maybe even Bob) to pay off Bob.

In the first scenario, it is obvious that future generations were not burdened (even though it is still Al and Chris and not their children).  The only person who lost was Bob, but his loss occurred when he made the loan.  He may have realized his loss a year later, but his actual loss was at the time of the loan.

In the second scenario, Al and Chris were burdened a year later.  Their fish were confiscated to pay for the previous excesses of George.  But here is the key thing.  A year later, the island as a whole was not worse off.  There was simply a redistribution of fish from Al and Chris, to Bob.  The only way the island as a whole may be worse off is because of the lack of previous capital investment.  A year ago, when Bob made the loan, if George hadn't made his loan and had his feast, then Bob would have had three extra fish.  He might have spent an extra day building nets and fishing rods or even shelters, knowing that he had three extra fish to feed on during that time.  But since he gave up his three fish, he did not have the extra opportunity for savings and capital investment.

In conclusion, I believe that government debt is harmful in the present.  It is also harmful in the future because there is less opportunity for capital investment and future wealth generation.  However, I would not say that government debt is a burden on future generations, at least on the whole.  It could cause a redistribution of wealth if the taxpayers are willing to pay the bond holders, but this in itself would not make society poorer as a whole.  There would still be the same number of fish to eat.

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