Saturday, April 6, 2013

The Grasshopper and the Ant Revisited

Some interesting posts on debt from Antonio Fatas and Noah Smith which I'd recommend to anyone tempted to believe that debt is necessarily a bad thing (also Krugman herehere and here making similar points after David Stockman's rant). Noah Smith's post is headed by a picture of Aesop's fable of the Grasshopper and the Ant, a typical metaphor used by the debt phobic.

Just in case you want the short version, the story is basically that headline debt figures don't tell us that much about their consequences, and we have to consider two important variables: what the debt is actually spent on (Smith), and the ratio of assets to liabilities (Fatas). Put simply, getting into debt to finance consumption probably places a burden (in the form of lower than otherwise consumption) on future generations, but doing it to finance investment all else equal has the opposite effect.

Drawing on Smith's analysis, we can see that the remedy of debt reduction can end up being more damaging than the debt itself. The UK, for instance, has succeeded in cutting its government borrowing only by cutting government investment, which in the current climate means cutting investment in the economy generally (given the private sector's pro-cyclical reluctance to invest). This reduces the productive capacity of the economy in the future, reducing future consumption. In this case then, debt reduction, not debt itself, is what is placing a burden on future generations, since George Osborne is (rightly) preserving the current consumption of the growing elderly population, which constitutes the lion's share of social spending.

Fatas' point about balance sheets is another way of making the same point. Debt corresponds to assets; or as Krugman keeps pointing out, at the level of a whole economy debt is largely money we owe to ourselves. We can see that clearly enough by looking at Germany, whose headline gross debt number is actually pretty high, but whose net external investment position is comfortably in the black. Ignoring the assets that correspond to liabilities is like equating a student loan with credit card debt to pay for a holiday.

So the emphasis on debt is missing the point. It is investment that is important for future generations, not debt. And of course, by squeezing current consumption debt reduction in a recession squeezes current production, reducing the ability to pay off the debt without unnecessary pain. In the periphery countries of the eurozone, unemployment is driving the young - the future productive workers - to migrate, perhaps never to return, whilst the old - who are current consumers, but relatively unproductive - remain. In Aesop's terms, austerity kills the ants, leaving only the Grasshopper, sitting unhappily under a leaking roof. Why are we doing this to ourselves? Well that's for a future post.