Debt and a deficit of wisdom

Dr Richard J Grant is Professor of Finance & Economics at Cumberland University, Tennessee & Free Market Foundation Senior Consultant.  

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This article was first published on on 14 February 2022

Debt and a deficit of wisdom

It is not a fairytale that “in the old days” debt was treated with greater caution than has become the practice in more recent times. It is not that the wisdom of Solomon has been lost; rather, it has become easier to rationalize it away in some segments of our society. As they grow older, most individuals – especially those who take on family responsibilities – learn the importance of living within a budget and of treating liabilities with caution.
Debt and the struggle to make ends meet have always been a problem for some families and will continue to plague us to the extent that financial prudence must be relearned in each succeeding generation. Such difficulties become widespread in the face of ill-advised government policies and economic downturns. No one is unaffected.
Families are regularly faced with the stark realities of the marketplace, and of life in general. They receive daily invitations to re-learn lessons of the old wisdom. But over the last century the opposite has occurred for governments. Throughout the middle of the twentieth century, there arose the belief that governments were not faced with the same financial constraints as families. Not only were governments seen increasingly as eternal beings, but the debts taken on by governments were seen as less onerous than those borne by families by virtue of the belief that when governments borrow, we merely “owe it to ourselves.”
Neither of these beliefs is correct; nor are they benign. While governments can be seen as potentially eternal – with occasional interludes of collapse, overthrow, or realignment – the people who take on the debt are not always the same ones who bear the burden into the future. The debt burden is shifted onto those born in future generations. It can be argued that the people of the present generation, through their election of the present government, have approved issuance of the new debt and of the excess government spending that made it necessary. But the future generations who bear the ongoing burden were not consulted.
Similarly, even in the present, the people who buy the government debt (the lenders) are not all the same people as those (taxpayers) who bear the current burden of the debt. It is observably false to state that “we owe it to ourselves.” Not all voters will have voted for the present government, nor should it be assumed that they approved of the increased debt. Further, the purchasers of the government debt do so voluntarily and benefit directly; the same cannot be said for taxpayers.
When governments take on debt, there are other less obvious burdens. These burdens are related to the reason for taking on the debt in the first place. Governments, or rather the politicians who take the decisions within the governments, have an incentive to direct government spending toward their supporters and constituents, but they also have an incentive to reduce the visible burden imposed on those constituents. People do not like to pay taxes, but they are less likely to notice the burden of debt, which is then spread out into the future. Predictably, governments tend to spend more than they are willing or able to pay for now through taxes in the present. When unconstrained by either a constitution or a culture of prudence – or resistant capital markets – governments will run budget deficits.
We must always ask what kind of spending is important enough to justify debt. When a business takes on debt, lenders expect those funds to be invested in productive activities that will generate enough cash flow to cover the debt service, and enough assets to cover some of the losses in case of failure. A government that holds itself to such a prudent model, using debt to finance long-term, genuinely beneficial infrastructure investments (such as roads and bridges), would bring net benefit to its citizens.
Unfortunately, as governments grow in the size and scope of their activities, much of their spending is not investment at all, but rather transfer payments that promote current consumption, and subsidies that draw resources away from productive activities into those that are less productive. As government spending grows, any net benefits soon turn negative, thereby stifling improvements in standards of living. By pushing the main impact of the burden beyond the next election, deficit spending reduces the political cost to politicians who dispense short-term largesse while escaping blame for imposing net long-term financial harm on their citizens.
As debt grows relative to the size of the borrower, whether public or private, the burden and riskiness of the debt service also grow. With the debt service faced by South Africa’s national government having grown over the past decade to almost 20 percent of total tax revenue, citizens have good reason to ask where their taxes really go, and when the fairytales will end.

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