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Good debt and Bad debt Mainstream discussion pits austerity against increasing debt: if someone says that government should spend on capital projects to help get us out of recession, John Humphreys or one of his clones will adopt a tone of astonishment and trounce the proposer of this scandalous doctrine with ‘What! Take on more debt? How can you solve the problem of too much debt by adding to it? The proposer can do little but retreat into silence and lick his wounds, because to explain the fallacy behind this response needs more time to explain than is available on a mews programme. I want to argue that the austerity/profligacy dichotomy, which we have been fed ad nauseam, is the wrong way to look at debt and to pose another dichotomy: good and bad debt. I shall argue that there is nothing wrong with debt as such – whether it is good or bad depends on what it finances. I shall deal with government debt only, but holds for private debt too. But first let us tackle the Osborne proposition that we must bring the debt down or face, if not bankruptcy, certainly cripplingly higher borrowing costs, which will, of course, increase debt further. A country that controls its own currency and issues debt in that currency cannot go bankrupt, so that allegation is pure hot air. But Osborne still maintains that it is his austerity policy that has kept interest rates on government debt down, by demonstrating his determination to the market. The truth is, no-one knows the point at which the market would baulk at further UK borrowing without a substantial rise in interest rates. But there is an alternative explanation of current low rates: the fact that the BoE has been buying up vast amounts of gilts. This is certainly a factor in keeping interest rates down and may be decisive. Furthermore, there is some evidence that before QE became so extensive, markets were more attentive to the deflationary effect of austerity on the UK economy than any fiscal probity. Finally, even if it were true that the markets want to see the debt reduced, it cannot be reduced by austerity in the middle of a recession. This is because the government is not like us: we can reduce our debt by spending less, but when they spend less and/or tax more, incomes fall, the private sector cuts back output and employment, benefit costs rise and the tax take falls. A rise in output and employment is necessary if the debt ratio is to come down. Let’s also look at the scale of debt. Yes in recent years it has grown substantially, but in the larger scale of things, the present level of debt is not huge. [slide] Of course the high levels of debt that you see in the early part of the last century is war debt, and the debt ratio fell through the ‘golden years’ of growth, largely because of the growth of GDP. In 2007-8 we faced the largest financial crisis since the 1930s, if not larger, and it is still going on. A rise in public debt to forestall financial collapse was, in the view of all but the most extreme free marketeers, necessary, and again most agree that deficit spending was absolutely justified to prevent the collapse of the real economy repeating the experience of the 1930s. This crisis was huge: it has the dimensions of a war. So Keynes’s remark1 is pertinent; ‘If only I we could tackle the problems of peace with the same energy and wholeheartedness as we tackle those of war! Defence is old-established as a proper object for the State, whereas economic well-being is still a parvenu.’ 1 The Policy of Government Storage of Food-Stuffs and Raw Materials, EJ Sept 1938, p 454. To get economic activity to rise in a recession, where liquidity is being hoarded by the banks and the private sector is trying to pay down its debt, it is important for government to stimulate the economy. Good debt is debt that pays for itself. Perhaps the best debt – or at least good debt that is easiest to understand, is created by loans for productive purposes, preferably capital, which, once it is installed and working, will produce goods that earn a profit sufficient to pay off the debt. The economy ends up with an improved capacity and the debt is repaid. If banks lend for this kind of activity, there is no need for the money supply to rise continuously. Growth can be supported by a ‘revolving fund’ of debt that is constantly being issued and repaid. Bad debt is generated by loans for unproductive purposes: purchases of existing assets, which inflates their prices, or consumption, which only brings consumption forward in time. Some of this is necessary (house purchase and occasional large consumption items), but this kind of debt does nothing to generate income and should be kept within moderate bounds. Really bad debt finances purely financial transactions, which generate no wealth or income except to those who act fastest. If these loans generate leverage, the gains can go on for longer, but the system will become unsustainable, as we have seen. I have started with examples of individual debt contracts. But when government (or any other entity that bulks large in the economy) borrows to invest productively, not only does the investment itself generate income to pay off the debt but the expenditure will stimulate the rest of the economy to expand. This secondary effect is known as the multiplier, and because of it, we don’t have to wait for the debt to be repaid from the proceeds of the specific project it financed: because the expenditure stimulates the rest of the economy, tax revenue will rise and unemployment benefits decrease with the economic expansion. Osborne denies this mechanism. At the beginning of the austerity programme he maintained the opposite: that the private sector, once relieved of government oppression, would rush in and fill the vacuum left by falling government expenditure. In effect, he maintained that the multiplier was negative: that the private sector would grow to replace the cuts in public expenditure. Many academics long thought the multiplier to be low, not much more than one, but the IMF has recently revised its estimates upward. At the moment, of course, a high multiplier is working against the economy, as it works in the downward direction too, amplifying cuts in public expenditure. Be clear, however, that this multiplier only works for direct public expenditure on the economy, not for benefits or interest payments. These are transfer payments, payments amongst ourselves. If they have an effect on the level of economic activity, it is because the effect on spending of the group that pays and the group that receives is different. So, once again, if government expands debt in order to stimulate the economy, it ought to use the proceeds for those expenditures that have multiplier effects, not to make further transfer payments except where these are dictated in the short to medium term by contractual or statutory obligations (interest payments, benefits, pensions). This is a point even most economists don’t understand: they tend to lump all government expenditure together or, at best, take interest payments out (what is left is called the primary deficit). The multiplier effect does rely on the private sector responding to a government stimulus. The trouble is that, after nearly 70 years of peace, it is difficult for the private sector to find good investment opportunities, except in areas of rapid technical change. The long period of capital accumulation means that the expected rate of return on many investment projects will have declined. Corporations have turned to generating ‘bubbles’; from which they can extract rent rather than contributing to economic welfare by producing things that people want and need. Yet there are many things that need doing, not least re-tooling our infrastructure and processes toward a greener future. We know, while apparently government does not, that we cannot return to Business as Usual. If there is a shortage of profitable opportunities which are also genuinely socially useful, it follows that there are only two routes to a viable future: either people reject the corporate solution in favour of local initiatives or government, which can in principle take a long view and distinguish mere profitability from social usefulness,2 must take the lead. But this they show no taste for doing: they are as saturated as the rest of us in the neoliberal rhetoric that would leave all economic decisions, including banking, to the private sector, and despite the private sector’s recent evident and miserable failures they appear actually to believe it. Or are they just walking away from problems they ought to address? – playing the role of the Cowardly State?3 Should they decide to take on the mantle of the Courageous State, the issue they must face is that debt is good or bad depending on what it is used for. It is always a good idea to spend money wisely, but with the present constraint of enhanced market sensitivity it is imperative. Spending money wisely means that there is a need to think through what sort of economy – and indeed ecology and society – we want and obtain support for this vision. Keynes is understood by those who haven’t read him as recommending wasteful expenditure, ‘digging holes in the ground’, to boost employment in a slump. This was a piece of bitter irony, used to lambast Treasury officials for judging proposed expenditures strictly on whether they would turn a profit and disregarding the social utility of the improvements that could be brought about by a partial subsidy. What he actually said was that instead of some wholly wasteful expenditure, like digging holes in the ground, it ‘would … be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, [digging holes] would be better than nothing.’4 The Courageous State will need to resurrect active industrial and regional policy. ‘Picking winners’ has to come back on the table, at least in very broad-brush terms. Amongst the weapons they might use to re-shape the economy is credit guidance to the banks. This policy was followed during the Second World War and continued into the 1960s. Very general instructions were issued to the banks – credit for speculation was forbidden and personal lending was severely restricted; exports and productive investment in some industries were given priority. Present policies of subsidising loft insulation and the like are very much to the point but need to go further. There should be no squeamishness about increasing debt for such purposes – it should pay for itself in fairly short order though its boost to the construction industry and through the multiplier to the rest of the economy. 2 They routinely fail to make this distinction. See Keynes’s complaint that profit is their only criterion (GT p. 129). Today (24 April 2013) it was announced that even the arts should show a profit or lose government funding! 3 Richard Murphy, The Courageous State 4 General Theory, p 129. The gains from some types of public expenditure are less easily measurable because those gains are indirect, eg health, education and the arts. At the moment, government is so besotted with the idea of profit that we are told that even the arts must show a profit! The government needs to think more broadly about the economy in terms of ecology and society if it is to spend wisely, but if it does that, debt is nothing to fear. This optimistic view of debt cannot be shared by those in the Eurozone, for they have no control over the currency in which their debt is promised. We are dependent on market sentiment, but they are far more trapped.