With much of the global economy apparently trapped in along and painful austerity-induced slump, it is time to admit that the trap isentirely of our own making. We have constructed it from unfortunate habits ofthought about how to handle spiraling public debt.
People developed these habits on the basis of theexperiences of their families and friends: when in debt trouble, one must cutspending and pass through a period of austerity until the burden (debt relativeto income) is reduced. That means no meals out for a while, no new cars, and nonew clothes. It seems like common sense – even moral virtue – to respond thisway.
But, while that approach to debt works well for a singlehousehold in trouble, it does not work well for an entire economy, for thespending cuts only worsen the problem. This is the paradox of thrift:belt-tightening causes people to lose their jobs, because other people are notbuying what they produce, so their debt burden rises rather than falls.
There is a way out of this trap, but only if we tilt thediscussion about how to lower the debt/GDP ratio away from austerity – highertaxes and lower spending – toward debt-friendly stimulus: increasing taxes evenmore and raising governmentexpenditure in the same proportion. That way, the debt/GDP ratio declinesbecause the denominator (economic output) increases, not because the numerator(the total the government has borrowed) declines.
This kind of enlightened stimulus runs into strongprejudices. For starters, people tend to think of taxes as a loathsomeinfringement on their freedom, as if petty bureaucrats will inevitably squander the increasedrevenue on useless and ineffective government employees and programs. But theadditional work done does not necessarily involve only government employees,and citizens can have some voice in how the expenditure is directed.
People also believe that tax increases cannot realisticallybe purely temporaryexpedients in an economic crisis, and that they must be regarded as an openingwedge that should be avoided at all costs. History shows, however, that taxincreases, if expressly designated as temporary, are indeed reversed later.That is what happens after major wars, for example.
We need to consider such issues in trying to understandwhy, for example, Italian voters last month rejected the sober economist MarioMonti, who forced austerity on them, notably by raising property taxes.Italians are in the habit of thinking that tax increases necessarily go only topaying off rich investors, rather than to paying for government services likebetter roads and schools.
Keynesian stimulus policy is habitually described as deficit spending,not tax-financed spending. Stimulus by tax cuts might almost seem to be builton deception, for its effect on consumption and investment expenditure seems torequire individuals to forget that they will be taxed later for public spendingtoday, when the government repays the debt with interest. If individuals wererational and well informed, they might conclude that they should not spendmore, despite tax cuts, since the cuts are not real.
We do not need to rely on such tricks to stimulate theeconomy and reduce the ratio of debt to income. The fundamental economicproblem that currently troubles much of the world is insufficient demand.Businesses are not investing enough in new plants and equipment, or adding jobs,largely because people are not spending enough – or are not expected to spendenough in the future – to keep the economy going at full tilt.
Debt-friendly stimulus might be regarded as nothing morethan a collective decisionby all of us to spend more to jump-start the economy. It has nothing to do with taking on debtor tricking people about future taxes. If left to individual decisions, peoplewould not spend more on consumption, but maybe we can vote for a governmentthat will compel us all to do that collectively, thereby creating enough demandto put the economy on aneven keel in short order.
Simply put, Keynesian stimulus does not necessarily entailmore government debt, as popular discourse seems continually to assume. Rather,stimulus is about collective decisions to get aggregate spending back on track.Because it is a collective decision, the spending naturally involves differentkinds of consumption than we would make individually – say, better highways,rather than more dinners out. But that should be okay, especially if we allhave jobs.
Balanced-budget stimulus was first advocated in the early1940’s by William Salant, an economist in President Franklin Roosevelt’sadministration, and by Paul Samuelson, then a young economics professor at theMassachusetts Institute of Technology. They argued that, because any governmentstimulus implies higher taxes sooner or later, the increase might as well comeimmediately. For the average person, the higher taxes do not mean lowerafter-tax income, because the stimulus will have the immediate effect ofraising incomes. And no one is deceived.
Many believe that balanced-budget stimulus – tax increasesat a time of economic distress – is politically impossible. After all, FrenchPresident François Hollande retreated under immense political pressure from hiscampaign promises to implement debt-friendly stimulus. But, given the shortageof good alternatives, we must not assume that bad habits of thought can neverbe broken, and we should keep the possibility of more enlightened policyconstantly in mind.
Some form of debt-friendly stimulus might ultimately appealto voters if they could be convinced that raising taxes does not necessarilymean hardship or increased centralization of decision-making. If and whenpeople understand that it means the same average level of take-home pay aftertaxes, plus the benefits of more jobs and of the products of additionalgovernment expenditure (such as new highways), they may well wonder why theyever tried stimulus any other way.