Column | The public debt is not free

Now that the interest rates of public debt in the advanced economies are at a minimum in several decades, some important economists argue that almost all can af

Column | The public debt is not free

Now that the interest rates of public debt in the advanced economies are at a minimum in several decades, some important economists argue that almost all can afford a gradual increase of the debt to levels similar to those of Japan (more than 150% of GDP even according to conservative estimates) without worrying too much about the long-term consequences. But although the proponents of increased indebtedness may have reason, they tend to underestimate or overlook everything that can go wrong.

First and foremost, the new vision of debt underestimates the risks to other holders of rights in the tax collection (for example, pensioners, who can be imagined as holders of subordinated debt in the welfare State of the TWENTY-first century). In the end, almost all social security systems are a form of debt, in the sense that the Government takes us out money now with the promise to pay it back with interest when we are old. And for Governments, this debt is “subordinated”, is immense in relation to the debt market “privileged” added about that.

In fact, the Governments of the countries of the OECD are paying an average of 8% of GDP in old-age pensions, which comes to a staggering 16% in the case of Italy and Greece. From a point of view, actuarial, part of the tax collection future reserved for the payment of pensions exceeds several times the destined to the payment of debt, despite the fact that many countries have tried a gradual adjustment of pensions, as did Europe during the financial crisis, and more recently Mexico and Brazil in response to economic pressures. Unfortunately, the slow growth and the aging population imply that there is still much to be done.

so even though it may seem that Governments are able to borrow much more without having to pay an interest rate considerably higher than that in the market, the risks and real costs are hidden. Economists Alan Auerbach and Laurence Kotlikoff have made a similar approach in a number of research articles back in the nineties.

A problem, perhaps more fundamental, is that the extreme confidence with which today we look at a possible increase of the debt is based on the implicit assumption that the next crisis will look like 2008, when there was a huge drop of interest rates on public debt. But there are historical reasons to think that it is a course dangerous. It could happen, for example, that the trigger for the next wave of crisis is a sudden realization that climate change is advancing much faster than was thought, requiring Governments to stop the engine of capitalism and, at the same time, to allocate huge sums to preventative and remedial measures, (not to speak of dealing with climate refugees). And the next worldwide conflagration can be a cyber war, with unforeseen effects on the growth and interest rates.

in Addition, an experiment of borrowing a large scale may cause a corresponding change in the mood of the markets (in line with the criticism made by the Nobel prize winner in Economics, Robert Lucas, when he said that the great changes of policies can be counterproductive due to large changes in expectations). And to be honest, any realistic assessment of the economic risks present in the global scope, you must take into account that the largest economy of the world is in a situation of political paralysis, with a style that's impulsive decision making that leaves it ill-prepared to cope with a crisis other than the usual if it were to occur.

The conclusion is that there are no guarantees that the next global crisis to reduce the types of interest.

None of the arguments preceding supposed to deny that there are good reasons to invest now in infrastructure projects (and education) very cost-effective in the long term will far outweigh outweigh the costs. While Governments comply with the management criteria of debt is reasonable, balancing the risk and the cost at the time of choosing the maturity, the very low current interest rates offer the greatest opportunities.

But to assert that the State may now make a benefit free by issuing debt (similar to that obtained with the issuance of currency) is an exaggeration dangerous. If you are looking for is a public policy of inequality reduction, the only long-term sustainable solution involves an increase in taxes to those who earn more; the debt is not a short cut magical to give to the poor without taking away from the rich.

it Is true that in many advanced economies the real interest rate (after deducting inflation) of the public debt today is lower than the real rate of economic growth. So it is assumed that Governments can borrow much more without having to increase taxes. In the end, while revenues grow faster than the stock of public debt, a simple arithmetic shows that the ratio between debt and GDP (income) will reduce with time.

But things are not so simple. Interest rates are so low is due in part to that around the world investors are hungry for assets that are “safe” to continue paying even if it produces a big slowdown, or economic catastrophe. But can they really the Governments to provide that security free-of-charge, when there is the risk that in the next systemic crisis important there is a rise in interest rates? A recent study by the International Monetary Fund on a sample of 55 countries over the past 200 years found that, although the economic growth was superior to the interests of the public debt, almost half of the times, that data is not a good thermometer of the capacity of the countries studied, to cope with an escalation of interest rates during a crisis.

And above all, what is the guarantee investors that they will be the first in charge in the next crisis, as happened in 2008? How will the u.s. Government put Wall Street ahead of Main Street and to honor debts to China before the obligations to the pensioners?

The use of debt is an important tool of modern economies, but it is never an option risk free for the Governments; that is why the debts should be contracted and managed with prudence, even when the cost of debt is predominantly at a minimum.

Kenneth Rogoff, former chief economist of the IMF, is a professor of Economics and Public Policy at Harvard University.

© Project Syndicate 1995-2019.

Translation of Esteban Flamini.

Date Of Update: 26 December 2019, 08:00