Letter from Lhasa, number 106. (Neck 2008): Sustainability of Public Debt
by Roberto Abraham Scaruffi
Neck, R., and J.-E. Sturm [editors], Sustainability of Public Debt, MIT Press, Cambridge, MA, USA, 2008.
(Neck 2008).
Reinhard Neck,
Jan-Egbert Sturm
17 authors discuss, in 9 chapters, different contexts from the point of view of the sustainability of public debt.
“The starting point in the formal discussion of the requirements for debt sustainability is the government's budget constraint, which requires that current spending on goods and services plus the cost of servicing current debt equals current tax revenues plus the issuance of new debt.” (Neck 2008, 1. Sustainability of Public Debt: Introduction and Overview, by Reinhard Neck and Jan-Egbert Sturm, p. 5-6)
“(...) the debt ratio will increase indefinitely if the real interest rate exceeds real GDP growth unless the primary budgets is in sufficient surplus. In this approach, the interest rate and the GDP growth rate are taken as exogenous.
“Making the evaluation of fiscal policy sustainability dependent on the preceding conditions might be of little practical use. Bohn (1995) shows that policies that are sustainable in a certain world may no longer be so in case of uncertainty. Hence, while ex post evaluation of fiscal sustainability is rather straightforward, ex ante evaluation of current or planned fiscal policies in not trivial. The literature has thus proposed a large number of methods and indicators for the evaluation of fiscal policy. This volume extends the existing literature and applies its methods to actual fiscal policies.”
(Neck 2008, 1. Sustainability of Public Debt: Introduction and Overview, by Reinhard Neck and Jan-Egbert Sturm, p. 7)
“(...) The entire concept of public debt sustainability shifts policymakers' and citizens' attention toward the long run, which, owing to political constraints and to the (probably “pseudo”) Keynesian legacy, often tends to be neglected in the actual political process. Although it is true that in a world of fully informed rational agents with perfect foresight, there will never be unsustainable government debt development because nobody will lend money to a government that is going to repudiate, in the actual economic environment of imperfect information and other market failures and, not the least, government failures, this is no longer true.” (Neck 2008, 1. Sustainability of Public Debt: Introduction and Overview, by Reinhard Neck and Jan-Egbert Sturm, p. 10)
The authors seem here to have forgotten to underline that economists, as well as economic journalists and other opinion makers, can be and are actually easily buyable and bought, both for selling, as sustainable, policies are not and for selling, as unsustainable, policies eventually could be sustainable. Provoked collapses are automatically self-[pseudo-]evidence of some inevitability as well as delayed collapses may be self-[pseudo-]evidence that “we could not know” just catastrophes eventually verify. Since markets, at whatever their level, are “law and order” creation, their manipulation depends on force-military relationships. A public debt may be unsustainable for Argentina, while an even worse one, may become sustainable for the USA. And it is actually right that be such. A market actor with real military strength may not be considered at the same level of beggars of the world market. Call that “credibility”/“non-credibility” or “brute force”/“weakness”, the actual terms of how reality works are not changed.
Force relations, and connected propaganda apparatuses, equally count in other aspects, for example in printing or coining money, or simply creating it as an accounting value, in relevant quantities as a way for facing expenditures. What is accepted from a world power would have driven whatever other country/State to a rapid bankruptcy.
Chapter 2 discusses the USA. “The real series shows that debt growth from 1950 to 1980 was entirely nominal, whereas the post-1980 debt growth was real.” (Neck 2008, 2. The Sustainability of Fiscal Policy in the United States, by Henning Bohr, p. 17)
In the USA, there is a “central role of wars in the build-up of debt. Five major wars – the America War of Independence, the Spanish-American War, the American Civil War, World War I, and World War II – were largely deficit-financed. This explains the high debt-to-GDP ratio in 1791 and the sharp increase in in 1812-1816, 1861-1866, 1916-1919, and 1941-1946. The debt-to-GDP ratio generally declined during peacetime periods, with the exception of the Great Depression/New Deal era (1929-1939), the 1980s, and the post-2001 period. One might even interpret the 1980s as a hot phase in the cold war and the post-2001 period as the war on terror, which would leave the Great Depression as the sole episode of peacetime increase in the debt-to-GDP ratio.” (Neck 2008, 2. The Sustainability of Fiscal Policy in the United States, by Henning Bohr, p. 17-18)
“In summary, for the last two hundred plus years the U.S. Government has been able to rely on economic growth to keep its debt-to-GDP ration from rising. Most of the time, the United States has had no need to run primary surpluses, and indeed, it did not run primary surpluses on average. Much of the sustainability literature, in contrast, starts from the premise that primary surpluses are necessary to keep public debt from growing exponentially.” (Neck 2008, 2. The Sustainability of Fiscal Policy in the United States, by Henning Bohr, p. 22)
The definition of ad hoc sustainability given in chapter 2 is: “A fiscal policy satisfies ad hoc sustainability, if it is on a trajectory that the present value of expected future primary surpluses equals the initial debt.” (Neck 2008, 2. The Sustainability of Fiscal Policy in the United States, by Henning Bohr, p. 22)
“A disturbing feature of ad hoc sustainability is the apparent disconnection from practical politics. While political debates about sustainability are mostly about bounds on debt-to-GDP and/or deficit-to-GDP ratios, much of the academic literature has focused on real fiscal series and treats nonstationary debt-to-GDP ratios as unproblematic.” (Neck 2008, 2. The Sustainability of Fiscal Policy in the United States, by Henning Bohr, p. 25)
“(...) which fiscal policies are sustainable? The basic economic answer is that an agent's ability to borrow is constrained by other agents' willingness to lend. The question concerning which policies are sustainable is therefore a general equilibrium question, a question of who the government's potential lenders are and what determines their behavior. Different assumptions about lenders lead to different conclusions about the set of sustainable policies.”(Neck 2008, 2. The Sustainability of Fiscal Policy in the United States, by Henning Bohr, p. 30)
There are different formal conditions of sustainability: “These differences reflect an economic intuition that is fundamental for an understanding of budget constraints under uncertainty . The key point is the distinction between uncertainty about specific debt securities and uncertainty about the future path of total public debt.” (Neck 2008, 2. The Sustainability of Fiscal Policy in the United States, by Henning Bohr, p. 31)
The formal analysis of chapter 2 concludes that the US public debt is sustainable. However, it is evidenced that public debt should not be confused with the gross federal debt which is different entity, considerably greater than public debt, including intragovernmental obligations to social security and other trust funds.
Chapter 3 (Neck 2008, 3. The Sustainability and Determinants of Italian Public Deficits before and after Maastricht by Emma Galli and Fabio Padovano) is dedicated to the Italian public debt. The authors remember that in its 145 years history, only 30 years saw the Italian public debt inferior to 60% GDP, and this thanks to hyperinflations collapsing it. It was 39% of GDP in 1948 and remained below 60% until 1974. Continuously growing more than GDP, it reached 126% in 1994. The authors do not notice that not casually that maximum was reached in the couple of years of the Great Purge that de facto collapsed the 1944-48 political and Constitutional system.
The analysis of this chapter concludes that the determinants of the Italian public deficits have not changed with the Maastricht treaty. What considerably changed has been the way fiscal policy reacts to these determinants. Internal and external institutional constraints “have always been the main condition for Italian public finances to be in equilibrium. Our analysis also suggests that the sensitivity of Italian budget deficits to these institutional constraints has increased since 1991. The recent weakening of the Stability and Growth Pact is therefore not good news for the sustainability of Italian public finances.” (Neck 2008, 3. The Sustainability and Determinants of Italian Public Deficits before and after Maastricht by Emma Galli and Fabio Padovano, p. 78). It is the depiction of a [neo-]colonial area.
Chapter 4, which discusses Holland, concludes that successful fiscal adjustment in the Netherlands “were quite gradual and successful adjustments often relied on tax increases. Still, during the final two decades of the previous century, government spending as share of GDP declined substantially, and this was realized to some extent by cutting transfers.” (Neck 2008, 4. Policy Adjustments and Sustainability of Public Finances in the Netherlands by Jakob de Haan, Jan-Egbert Sturm, and Olaf de Groot, p 102)
In the mid-2000s Austria, 2% GDP federal budget deficit and lower income tax rates were presented as a way for combating unemployment and enhancing growth. More generally, there is a problem of sustainability of this, as well as of whatever other policy, in the specific context. The formal analysis carried on in Chapter 5 concludes that “from the early 1960s until 1974 the debt-to-GDP ratio was stable at around 10-12 percent, while from 1975 to 2003 it increased at an average annual rate of about 2.5 percentage points, culminating at a more than 60 percent in the last few years. Since 1995, the ratio has been rather stable again.” (Neck 2008, 5. The Long Shadow of “Austrokeynesianism”? Public Debt Sustainability in Austria by Reinhard Neck and Gottfried Haber, p. 128)
Chapter 6 reviews different aspects about a revision of the SGP (the Stability and Growth Pact). (Neck 2008, 6. The Stability Pact Pains: A Forward-Looking Assessment of the Reform Debate by Marco Buti, Sylvester Eijffinger, and Daniel Franco, p. 131-160) It is nearly impossible efficient governance on confederal bases, without adequate institutions.
Chapter 7, the Danish experience is interesting for remembering that not all Statism are equal and that they are not necessarily “corrupted”. Frequently they are. Finally, it depends on specific contests. Formal laws and rules do not magically change the brains and behaviours of different populations. What works in north Europe does not necessarily works it its south.
Denmark has a large public sector providing services on a universal base. The tax burden is around 50% of GDP. Public debt, already reduced from 81% of GDP in 1993 to 46% in 2003 will be further contracted. Demographic and other factors may easy alter delicate equilibria, although Denmark credibly managed and is managing its Statist model. (Neck 2008, 7. The Welfare State and Strategies toward Fiscal Sustainability in Denmark by Torben M. Andersen, Svend E. Hougaard Jensen, and Lars Haagen Pedersen, p. 161-192)
Chapter 8 is a depiction of British successful fiscal policies and their comparison with the Euro area. The essay is played around the binomial represented from monetary policies and fiscal policies, and the consequent kinds of leadership.
“The hypothesis in this chapter is that the United Kingdom's improved performance is due to the fact that fiscal policy leads an independent monetary policy. This leadership derives from the fact that fiscal policies typically have long-run targets (sustainability, low debt), are not easily reversible (public services, social equality), and do not stabilize well if efficiency is to be maintained. Nevertheless, there are also automatic stabilizers in any fiscal policy framework, implying that monetary policy must condition itself on the fiscal stance at each point. That automatically puts the latter in a follower's role. That is all to the good, however, because it allows the economy to secure the benefits of an independent monetary policy but also to enjoy a certain measure of coordination between the two sets of policymakers – discretionary/automatic fiscal policies on one side, and active monetary policies on the other.” (Neck 2008, 8. Post-Thatcher Fiscal Strategies in the United Kingdom: An Interpretation by Andrew Hughes Hallett, p. 195)
“To draw a sharp distinction between actively managed long-run policies, and short-run stabilization efforts restricted to the automatic stabilizers is of course the strategic policy prescription of Taylor (2000). Marring that with an activist monetary policy directed at cyclical stabilization, but based on an independent Bank of England and a monetary policy committee with instrument (but not target) independence, appears to have been the distinctive U.K. feature. It implies a leadership role for fiscal policy that allows fiscal and monetary policies to be better coordinated – but without either losing their ability to act independently.
“In short, Britain appears to have adopted a Stackelberg solution that lies somewhere between the discretionary (but Pareto-superior) cooperative solution and the fully independent (but noncooperative) solution. Nonetheless, by forcing the focus onto long-run objectives, to the exclusion of the short term, this setup has imposed a degree of precommitment (and potential for electoral punishment) on fiscal policy because governments naturally wish to lead. But the regime remains noncooperative so that there is no incentive to renege on earlier plans in the absence of changes in information. Thus the policies and their intended outcomes will be sustained by the government of the day.”
(Neck 2008, 8. Post-Thatcher Fiscal Strategies in the United Kingdom: An Interpretation by Andrew Hughes Hallett, p. 193-194)
According the author, British fiscal policy had been more successful than the Euro area one, producing “lower debt, more stable incomes, and employment but without any additional inflation.” (Neck 2008, 8. Post-Thatcher Fiscal Strategies in the United Kingdom: An Interpretation by Andrew Hughes Hallett, p. 195)
Relatively to monetary and fiscal policies, there are different kinds of leadership: “More generally, leadership implies complementarity between policy instruments in the leader's reaction function but conflicts (competition) between them in the follower's responses. A weak form of leadership also allows for independence between instruments in the leader's policy rules. Thus monetary leadership would imply some complementarity (or independence) in the Tailor rule, but conflicts in the fiscal responses. And fiscal leadership would mean complementarity or independence in the fiscal rule, but conflicts in the monetary responses.” (Neck 2008, 8. Post-Thatcher Fiscal Strategies in the United Kingdom: An Interpretation by Andrew Hughes Hallett, p. 201). The Taylor rule is the response in nominal interest rate to divergences of actual inflation rates from target inflation rates, and to divergences of actual GDP from potential GDP.
The author finds evidence of a possible fiscal leadership and no suggestion of monetary leadership, in the UK, and of a possible weak monetary leadership in the Eurozone. In the Eurozone, he finds a situation of conflict between instruments of monetary policy and the same conflict in the fiscal policy reactions. The advantages of fiscal leadership are that “fiscal leadership eliminates an inflationary bias and results in lower inflation. Fiscal leadership also yields higher taxes and more income redistribution.” (Neck 2008, 8. Post-Thatcher Fiscal Strategies in the United Kingdom: An Interpretation by Andrew Hughes Hallett, p. 212)
In the conclusions, the author underlines that: “Fiscal leadership leads to improved outcomes because it implies a degree of coordination and reduced conflicts between institutions, without the central bank having to lose its ability to act independently.” He evidences also “that the important property for monetary policy is instrument independence. Given that, target independence brings few additional gains and may have the effect of undoing the complementarity between fiscal and monetary policies.
“(...) The United Kingdom appears, both from its institutional structure and the available empirical evidence, to have adopted this leadership framework since 1997. This is perhaps the main reason for the country's improved performance both in terms of outcomes and in making more effective use of her fiscal and monetary instruments.
“(...) the incentive to adopt fiscal leadership is clear from the theoretical results. Confirmation of those results then comes from the outcomes. The leadership with separation model predicts improvements in growth, inflation, or income distribution of the order of 1 percent of GDP. And that is exactly what we have observed since 2000. In addition, the leadership framework requires less precise information on the strategic and institutional parameters than do other strategies.”
(Neck 2008, 8. Post-Thatcher Fiscal Strategies in the United Kingdom: An Interpretation by Andrew Hughes Hallett, p. 215-216)
The last chapter, the ninth, concerns Switzerland. Budgetary questions are discussed in the institutional frame of federal (actually confederal, in Switzerland) institutions. (Neck 2008, 9. On the Effectiveness of Debt Brakes: The Swiss Experience by Lars P. Feld and Gebhard Kirchgässner, p. 223-255)
Neck, R., and J.-E. Sturm [editors], Sustainability of Public Debt, MIT Press, Cambridge, MA, USA, 2008.
