The Great Debt Experiment

The Great Debt Experiment

Does public debt work only when the citizenry values so highly what the debt will buy that they're willing to give up private or consumer goods for the duration? And then only if, when the debt-funded emergency or project is over, they are willing to give the public project up before they return to funding the private goodies?

This Foreign Policy article posits that the U.S. and Great Britain recovered quickly from WWII debt levels because their people drastically cut down on private debt while the war debt was ballooning. When the war was over, there was a painful re-tooling process, but wartime production was shifted over to meet a pent-up consumer demand. In contrast, recent decades have witnessed an explosion of public debt, not for temporary war emergencies or even long-term infrastructure like railroads, but for long-term unfunded pension and healthcare programs, even while consumer debt kept on expanding to fund larger houses, cars, and gadgets:

The heyday of Keynesian economics came to an end in the stagflation of the 1970s. But curiously, budget deficits actually grew after Keynesianism fell from favor -- not only in the United States, but throughout the Western world. The explanation lies partly in a covert acceptance of deficit spending even by governments nominally hostile to Keynesian doctrine, but also in part in the increasing pressures on public spending created by the second ingredient in the great debt experiment: unfunded long-term financial promises to voters.

The post-war era witnessed not only the triumph of Keynesian economics, but also the establishment of public pensions throughout the Western world. Almost all these pension plans were set up on a pay-as-you-go basis that provided high rates of return to the first generation of pensioners (which, perhaps not coincidentally, was the generation that voted them into existence) at the cost of an unfunded commitment to later generations. Public pension plans are the biggest element in the off-balance-sheet obligations of states, which also include unfunded health-insurance liabilities and the 2008 guarantees to the banking system. In most countries these "implicit" public debts dwarf their traditional obligations traded in the bond market. In the United States, the total long-term commitments for Social Security, public sector pensions, and Medicare have been estimated at over 300 percent of GDP on the basis of current policies.

The author appears queasy about the recent revolt against Keynesian policies by both lenders and voters, which is leading to brand-new austerity measures in nearly every developed country. Although he protests that no one can predict what will come of this about-face, he acknowledges that something had to give:

The markets have highlighted a fundamental shortcoming in Keynes's ideas: He assumed that governments would always be able to borrow. If they cannot, then Keynesian economics is dead in the water.