Does (more) (public) debt make a country poorer?
Krugman (and I) believe not. But I follow his subsequent arguments with some skepticism. Let’s follow Krugman’s argument in his first post:
Suppose (to) … pass a constitutional amendment requiring that from now on, each American whose name begins with the letters A through K will receive $5,000 a year from the federal government, with the money to be raised through extra taxes. Does this make America as a whole poorer? We’re just making a transfer from one group (the L through Zs) to another; total income isn’t changed. Now, you could argue that there are indirect costs because raising taxes distorts incentives. But that’s a very different story. OK, you can see what’s coming: a debt inherited from the past is, in effect, simply a rule requiring that one group of people — the people who didn’t inherit bonds from their parents — make a transfer to another group, the people who did. It has distributional effects, but it does not in any direct sense make the country poorer.
So far so good.
Shortly after, some readers ask Krugman if he would answer the same thing if public debt was owned by foreigners. And he writes a new post.
His initial response is, in my mind, excellent again:
Another thought experiment: suppose that for some reason the Chinese and a bunch of domestic investors do an asset swap: the Chinese sell off $500 billion of Treasuries and buy an equal amount of, say, corporate bonds, while the domestic investors do the reverse. Has America become any richer (or any poorer)? Obviously not — as a nation we still owe the same amount to the rest of the world.
What this tells us is that when we’re trying to assess the burden or lack thereof of debt, foreign ownership of government debt doesn’t really matter. What does matter is our net international investment position, the value of the overseas assets owned by all domestic residents minus the value of all domestic assets owned by foreign residents.
Now Krugman goes on to say: “sure, budget deficits can make us poorer as a nation if they lead to bigger trade deficits”. I imagine he has in mind public deficits that raise foreign direct investment and improve the net position of the rest of the world over the USA.
I am not sure to follow him here. Imagine government debt is issued and subscribed by Chinese investors to finance a public invention that will turn out to give great results for the US GDP, a rate of return for example 10 times higher than the cost of debt to repay the Chinese investors: would you say that, given the larger trade deficit, the US are a poorer nation?
He also goes on to show a graph where while recently US public deficits went up the current account (trade) deficit stayed put at low levels. And this is where I really get a bit lost. He seems to argue that this shows that public deficits (so far) have had no bad implications, to the contrary.
However I am not sure of this and I actually believe that this might undo some of Krugman’s usual policy arguments in favor of deficits.
If governments borrow more and the rest of the world does not lend more to the US, the conclusion is that the private sector is pitching in, either by investing less (crowding out) or by saving more (ricardian equivalence). In both cases budget deficits seem to be having either a negative (lower investment) or, at best neutral (higher savings) effect.
Krugman seems to say that in a depressed economy private investments are not crowded out by deficits. Now the US is not very depressed right now and so it is an empirical question if that has occurred or not. But if investments have not gone down because of government deficits, then private savings have gone up as a result and this simply means one thing: some sort of Ricardian equivalence where taxpayers save more when the State saves less. In this case then it is not the way we finance more public spending that matters but what we do with the money we raise (whether with current or future taxes it is irrelevant).
To make a long story short: budget deficits and higher public debts not necessarily hinder prosperity even when held by foreigners and the fact that they do not affect the net external position of a country is not a reason to promote budget deficits as a solution for prosperity.
In both cases, it turns out, what seems to matter for the prosperity of a nation is what we do with the money that (foreign or local) investors give to governments. Or for that matter to every actor, private sector included.
Thank you Lo.