“There is not a more important and fundamental principle in legislation than that the ways and means ought always to face the public engagements; that our appropriations should ever go hand in hand with our promises.” Current Congressman and future President of the United States James Madison spoke these words in a 1790 speech to Congress during contentious debates about whether the US government should assume the states’ considerable debts.
Madison was seeking to remind Americans that balanced budgets are a basic element of sound public finance. Sadly, this is advice that most contemporary Western governments appear unable to embrace, judging from their public debt levels. There are perfectly legitimate debates about the economic benefits and perils associated with different public debt levels. Nonetheless, the very high public debt carried by many developed nations today and their apparent inability to stabilize—let alone reduce—such debts also reflect particular political challenges that contemporary Western democracies are failing to master.
Advanced Economies Awash in Debt
The most recent warnings about excessive public debt were sounded by the International Monetary Fund in its April 2014 World Economic Outlook report. The report identifies wealthy nations as the primary offenders. Public debt in advanced economies now amounts to 105 percent of GDP; that of the G7 amounts to 120 percent. The comparative figures in 2009, in the immediate aftermath of the global financial crisis, were 79 percent and 89 percent. Public debt in the Eurozone nations alone topped 92 percent of GDP at the end of 2014: the highest since the euro’s introduction. Greece was the worst offender, at 177 percent.
Economists have long argued about public debt’s economic effects. Witness, for example, the ferocious arguments that followed publication of the January 2010 National Bureau of Economic Research paper that suggested that once a country’s public debt exceeds 90 percent of annual GDP, it tends to experience lower growth.
On one level, the subsequent debate was about the linearity of the relationship between debt and growth, and the merits of particular economic predictions based on extrapolations from empirical data. The polemics also arose from longstanding divisions among economists and others concerning the efficacy of public borrowing and government intervention more generally.
Often missing from such discussions, however, is attention to the historical dimension. This tells us that public debt has long had major implications for political order, even for nations’ very stability.
The Dangers of Public Debt
The man who provided America with much of the financial architecture it takes for granted today, Alexander Hamilton, famously described the establishment and successful management of a public debt in his 1790 First Report on Public Credit as a “national blessing.” According to Hamilton, creating a national debt was essential if the United States was to attract foreign capital and become a commercial republic. At the same time, Hamilton considered instituting such a debt as key to forging unity among the hitherto disunited former British colonies. He also saw implications for foreign policy. Britain’s rise to world-leader power status in the eighteenth century, Hamilton held, owed much to its ability to manage its public debt, a task that its major rival, France, had conspicuously failed to accomplish.
In the same report, however, Hamilton insisted that he “ardently wishes to see it incorporated as a fundamental maxim in the system of public credit of the United States that the creation of debt should always be accompanied with the means of extinguishing it.” Furthermore, as noted by his most well-known biographer, Ron Chernow, Hamilton’s warnings about excessive public debt “vastly outnumber his paeans to public debt as a source of liquid capital.” In 1795, for instance, Hamilton described the progressive accumulation of debt as “perhaps the natural disease of all governments. And it is not easy to conceive anything more likely than this to lead to great and convulsive revolutions of Empire.”
Hamilton knew that the French Revolution and the subsequent chaos inflicted upon Europe had been precipitated in part by the Bourbon monarchy’s inability to balance its books. Many modern political crises also have been associated with government failure to manage public debt. The financial meltdown that broke the back of Argentina’s economy between 1998 and 2002, for example, owed much to the growth of its public debt throughout the 1990s and successive governments’ failures to illustrate how they were going to pay it down. Across the Atlantic, the chaos that has engulfed Greece since 2009, culminating in the election to power of the radical-left populist Syriza party this year, owes much to Greece’s public debt predicament.
The damage associated with failure to manage public debt, however, can be more subtle. In 1992, signatories to the Maastricht Treaty agreed that countries seeking admission to the then-proposed single European currency had to meet and maintain a public debt limit of 60 percent of GDP. Today, only 4 out of the Eurozone’s 19 countries are below this limit. Nine—including France, Spain, and Italy—are over or hovering close to 90 percent. In other words, freely undertaken treaty obligations are being ignored as European governments use public debt to address more immediate economic quandaries.
No nation is required to immolate itself to fulfill treaty commitments. That said, violating one’s treaty obligations should be a last resort; if done consistently, such violations seriously erode trust among nations.
Public Debt and the Welfare State
So what are some of the economic concerns that persuade these governments to disregard treaty obligations? After all, public debt crises are hardly new. They are, as historian Niall Ferguson writes, as old as bond markets. Yet, Ferguson adds, they are normally associated with war and revolution. This is not the case with today’s debt challenges. Take, for instance, the United States.
Today, America’s public debt amounts to approximately 105 percent of GDP. Since 20 January 2009, America’s total outstanding public debt has grown from $10.626 trillion to $18.152 trillion as of May 8 this year. Such an increase reflects a consistent disparity between government revenues and expenditures that has long plagued America’s public finances.
Yet despite America’s involvement in two wars and an ongoing struggle against Islamic terrorism over the past fourteen years, it is not military spending that’s driving government expenditures. The spending is overwhelmingly on welfare. In 2013, 49 percent of federal government expenditures was on major entitlements such as Social Security and Medicare, with another 20 percent on income security and other benefits. Just 18 percent was on national defense. One study projects that 85 percent of increases in federal expenditures over the next ten years will be on entitlement programs and public-debt interest payments. If anything, Western European nations face even more ominous challenges in this area, given their bleak demographic outlooks.
There is a major political problem associated with restraining this expansion. This problem was underlined by the German economist Wilhelm Röpke, the intellectual architect of West Germany’s economic liberalization in 1948 and its subsequent rise to become Europe’s economic powerhouse. In a 1958 essay, Röpke observed that there is nothing in the welfare state’s basic conception to set internal limits on its growth. Moreover, if democracy degenerates into politicians competing for votes on the basis of who’s considered better at delivering the most government-provided economic security for the most people, then the welfare state’s continual increase is guaranteed, while the question of how to pay for it becomes a secondary concern.
There’s no dearth of people who regard the present size of public debt in the West as economically untenable and politically dangerous. The problem, however, is that there’s no easy way out.
One option is to default. Many countries have done this in the past. However, this can undermine such nations’ future ability to access capital loans. Defaulting also means that a state dishonors the terms of freely undertaken contracts with other governments and bondholders. Such choices are not without their moral and political problems.
Rather than default, many governments seek outright capital transfers from abroad—i.e., bailouts. But such measures encourage the moral-hazard problem: by shielding people from the consequences of their choices, the chances of mistakes being repeated are enhanced.
Yet another possibility is a currency devaluation, which can help make a nation’s exports cheaper and its imports more expensive. It also, however, involves (1) a risk of increased inflation and (2) accepting that everyone with holdings in that currency will suddenly find the value of their assets reduced. The financially literate can often cope with and even profit from such changes. The less financially educated probably won’t. Is that just?
Recognizing the downsides associated with these options, some governments try restructuring their debts by renegotiating interest rates and payment schedules. Any resulting agreement is usually conditioned by governments promising to implement policies purportedly designed to reduce the debt over time. Sometimes this translates into tax increases. Typically, agreements also involve measures to promote growth, since shrinking public debt is difficult without growth. Such reforms range from diminishing subsidies and liberalizing labor markets to reducing trade barriers and government expenditures.
Most of these measures are hard political sells. Leaving aside the considerable evidence that tax increases have a negative impact on economic growth, no one likes paying higher taxes. Likewise, many interest groups will resist general or specific spending cuts, not to mention reductions in corporate welfare or efforts to lower tariff barriers.
Rhetoric and Reality
But beyond the political dilemma of no easy choices, there is a deeper problem. In the United States, for instance, calls for public expenditure cuts to reduce America’s public debt are regularly articulated by politicians, especially on the conservative side. Rhetorically speaking, this resonates with many Americans, particularly those who claim to be skeptical of government intervention.
One cannot help but wonder, however, whether even many self-described fiscal conservatives are actually willing to embrace real spending cuts as part of any effort to reduce public debt. It is not uncommon, for instance, for legislators to stress their efforts to cut the projected rate of increase in government spending. But that, to put it bluntly, is not a reduction in real spending. It’s simply reducing the pace of increases in government expenditures.
Nor is it hard to find examples of American congressmen and senators who denounce out-of-control spending and excessive public debt but don’t hesitate to lobby for subsidies for politically well-connected businesses located in their electorates. This isn’t surprising. If legislators believe their reelection depends upon their ability to deliver taxpayer dollars to their state or district, and if their electorates consider this part of their representatives’ job, we shouldn’t be shocked at people’s aversion to specific measures designed to diminish public debt.
All of this analysis points to an unpalatable political fact. Unless enough citizens in a democracy are willing to support the difficult choices that enable nations to bring public debt under control, the chances that legislators and governments will do so is small.
Politics, it is often said, is the art of the possible. This may be true, but thinking about the possible is not a blank check for governments, legislators, and citizens to ignore long-term problems. Addressing the West’s public-debt challenge will be difficult. Nevertheless, as Hamilton’s greatest political opponent, Thomas Jefferson, insisted, “we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude.”
Such are the stakes in the West’s public-debt challenge.