'Munibonds' and the national debt
Local authorities are on the verge of issuing bonds in order to raise revenues and make up for further cuts to their government grant.... The "munibonds" will be issued by a new municipal debt agency, and are backed by 48 local councils and the LGA. Scotland will also acquired the powers to issue its own debt in what have been dubbed "kilt-edged bonds".
Why is it such bad news? Shouldn't government be allowed to borrow, for investment, like the rest of us? Few of us could buy a house from our savings: instead we take out a loan. So why should a local authority – or even a country – not borrow to fund its schools, roads and care homes?
I used to read eighteenth-century authors and economists like William Cobbett (of Rural Rides) and Adam Smith (of The Wealth of Nations) and chuckle to myself as they went on and on against the idea of the national debt. Much of the huge rise in prosperity of our times, I supposed, had been built on debt, much of it government debt taken out to fund market-enhancing improvements in roads, bridges, airports, schools, hospitals and housing.
Now I think the Cobbetts and Smiths were right and I was wrong. If we could rely on governments to make rational, objective decisions about the overall benefits and costs of infrastructure finance, then there might be a case for allowing them to borrow for public investment. But we cannot rely on governments to be so dispassionate and high-minded. The very power to borrow is itself too much of a temptation pulling them in the opposite direction. Consider, for example:
(1) It is impossible enough to measure the 'public' benefit of government spending, when there is no such thing as the 'public interest' – only a clash of opposing interests. (Think airports, and the convenience for travellers of extra flights and the distress of local residents over traffic and noise.)
(2) The problem is compounded when it is confused by electoral interests. (As Khruschev noted, "politicians will build a bridge, even where there is no river." All the more so, if there is an election coming up.)
(3) With electoral advantage in mind, it is too easy for those who control the public finances to segue from investment to spending. As Chancellor, Gordon Brown, to his credit, said he would confine borrowing to investment projects. But by his reckoning, anything spent on schools or hospitals was 'investment' for the future – even though much of it was patently simply consumption for today.
Such factors help explain why governments have growth so much, and spend money on so many marginal activities. It is too inviting to spend now, earn the applause of the public, and let the next generation, who do not yet have a vote, foot the bill for it all. Public Choice economists call it 'time shifting'. And in that, of course, the public themselves are complicit. With interest groups, from pensioners to patients, demanding more spending on themselves, and politicians happy to borrow, at little cost to themselves, to provide it, how can we ever expect prudence in the public finances.
It is a draconian answer to say that we should stop government borrowing at all. But actually, the eighteenth century thinkers were right.
Why you might not want to lend your money to the government
The decision to call in part of the War Loan leads to this remarkable figure from FT Alphaville:
The Treasury highlighted that “the nation has paid £1.26bn in total interest on these bonds since 1927″.They sound awful. But in fact the Treasury has been a hands-down winner from the bonds. It issued them in 1927 in exchange for a bunch of maturing First World War bonds it couldn’t easily repay (Winston Churchill was struggling to cope with his disastrous decision to return to the gold standard at the pre-war rate, and the economy was crumbling as a result). Since then inflation has annualised at 4.77 per cent a year, well above the coupon of 4 per cent.
The result has been that in real terms, HM Treasury sold its “Consols” for £100 each, and is buying them back for £1.82 each. The government definitely got the better side of this bargain.
That's the effect of inflation over the long term. Anyone who had £10,000 in those in 1927 would have been considered a rich and wealthy man (a house was perhaps £250 in those days) and today that amount is below the level of savings at which you can still receive certain poverty related benefits. So lending one's money to the government, the same government that can decide what the inflation rate is going to be, might not be the most sensible thing one can ever do.
At which point we can only express surprise at those who tell us today that bonds are how we should all be saving for our pensions. If this is the effect of inflation upon bonds then why on earth would we want to do that? We want, obviously, something that captures some part of the increasing wealth of the society, meaning equities or possibly property. But there really are people out there insisting that pensions savings must be done in bonds, even in gilts. And sadly, one of them was Chancellor at one point: as when Gordon Brown changed the rules about how pension funds could invest.
History tells us that's really not a very sensible way to be doing things despite how convenient it might be to the government.
The national debt is rising. Who will pay the bill?
George Osborne will derive little comfort from today's deficit figures, which show the public sector net borrowing requirement down only £0.3bn between the 2011/12 and 2012/13 financial years, after accounting for one-off effects. This puts borrowing at £120.6bn, after last year's £121bn, and ahead of 2014/15's projected £120bn. Total debt stands at £1.19 trillion, or 75.4 per cent of GDP, the ONS says up from £1.10 trillion, or 71.8 per cent of GDP a year before.
A tired – but apparently necessary, given public misconceptions, fuelled by confusions over the debt/deficit distinction from politicians of all strips – point, is that this shows just how much the debt is still going up despite the Treasury's Plan A. I wouldn't draw from this that austerity is not happening – some budgets are being cut very quickly, and overall spending is expected to fall a significant 2.7 per cent between 2010/11 and 2017/18. But debt is rising very quickly.
The revelation of the spreadsheet errors in Reinhart & Rogoff's influential paper (which said national debts above 90 per cent of GDP could slow growth) means we may have less reason to fear high debt. But we may still have concerns about the redistributive effects of government debt, at least if we've read recently-departed Nobel laureate James Buchanan's work on public finance. Governments borrow to use resources without depriving the taxpayer. But these resources have to come from somewhere (assume full employment or a central bank meeting a nominal target).
Those who buy the gilts, or T-bills, or bunds, pony up the resources now, in return for a better investment opportunity than was available elsewhere. But assuming that households do not act as infinite dynasties, valuing future generations equally to themselves and therefore assuming households do not save now to pay for the inevitable future taxes (i.e. Ricardian Equivalence does not hold) – then future generations will shoulder the burden.
On the one hand, future generations are likely to be much richer than us. This is a trend that has gone on for at least 250 years in the UK, and for shorter periods elsewhere. In some countries it has gone in reverse (spectacularly in Argentina). But on the whole, we can expect future generations to be richer than us. So why shouldn't they shoulder the burden, given their broader shoulders?
This argument is fairly convincing, but it only goes so far. No one would suggest it would be fair to redistribute infinitely toward users of state-provided services and towards bond-buyers, away from future generations. After all, given the secular decline in growth we've seen since the Second World War, they may not be as much more prosperous than us than we are over our parents. As ever in numerical issues, the question may be one of finding the right balance.
