Consulting by RPM || Free Advice Blog

Quick Clarification on the Great Debt Debate

My trip to NY has messed me up vis-a-vis my “day job” and so I can’t go nuts on the debt debate the way Nick Rowe is (here, here, here, and here). I hope later in the week to offer two more posts, one for the lay reader, and the other for professional economists. It is obvious to me that a lot of people in this debate “still don’t get it.”

The reason I am so confident that I am seeing the divisions more clearly than most, is that I would have agreed with Dean Baker and Paul Krugman two years ago. In fact, I actually wrote up exactly their perspective in both The Politically Incorrect Guide to Capitalism and Lessons for the Young Economist. So this isn’t an ideological issue. In those outlets, my point wasn’t to say, “Government debt is innocuous.” Rather, my point was to say, “The way government debt hurts future generations is through crowding out of private sector investment in the present, meaning our grandchildren inherit fewer tractors and other capital goods.” I now realize that I was wrong for thinking this, and it was Nick Rowe (last year when we had this debate) who freed me from my error.

This time around, when Scott Sumner says he doesn’t see what the big deal is, or Steve Landsburg thinks that Krugman has it almost, but not quite, right, I am pretty sure what’s going on is that Scott and Steve have always thought about this stuff the proper way. It’s somewhat similar to the arguments they use about income vs. consumption taxes, and so it doesn’t surprise me that they have always thought about intergenerational consumption paths and financing options in a correct way.

But Dean Baker and Paul Krugman have been thinking about it the wrong way. That is why they keep focusing (erroneously) on whether the future government debt is held by foreigners vs. Americans. To Landsburg, this is some inexplicable tic on Krugman’s part. Landsburg knows that the ownership of the debt is irrelevant if you are thinking about it properly. So when Krugman says (paraphrasing), “The debt won’t hurt our grandkids so long as foreigners don’t own the Treasuries,” Landsburg just hears, “The debt won’t hurt out grandkids” and gives Krugman a high-five.

Let me be more specific, because it was just today that I realized more precisely why everybody is having such a hard time figuring out who is saying what:

==> Dean Baker and Paul Krugman have been arguing that today’s deficits don’t impoverish our grandkids, so long as the future taxes on our grandkids needed to finance the larger debt are used to give money to some of our grandkids (the bondholders at that time).

==> Steve Landsburg (and I think Scott Sumner, Gene Callahan, Noahpinion, Daniel Kuehn, and maybe some others) have been pointing out that today’s deficits per se don’t make our grandkids poorer. Rather, it’s the taxes that the government will levy on our grandkids, that will make them worse off, in gross terms. (Perhaps these gross harms from the future taxation will be offset by benefits in the form of more bridges, universities, or avoided invasions from Martians. But the higher taxes necessary to finance today’s deficits will definitely be a gross burden on our grandkids.)

==> Nick Rowe and I have been pointing out that the above two camps are NOT “basically saying the same thing.” Go read the two arrows above if it’s not jumping out at you. Reading quickly, they sound similar, but they are vastly different statements.

Part of the problem with this is that the people pushing the “we owe it to ourselves so it’s not a burden” fallacy, are bringing up all sorts of other arguments too. Thus, since some of their other arguments are plausible, it muddies the debate and people aren’t getting the narrow (yet crucial) point that Nick Rowe and I have been patiently making for more than a year now.

To see that we’re not inventing strawmen, look: Here is Dean Baker himself summarizing–as late as Friday, October 12, after Nick Rowe and Brad DeLong went head-to-head–what his position has been:

I saw that Nick Rowe was unhappy that I was saying that the government debt is not a burden to future generations since they will also own the debt as an asset. I had planned to write a response, but I see that Brad DeLong got there first. I would agree with pretty much everything Brad said. The burden of the debt only exists if there is reason to believe that debt is somehow displacing investment in private capital, which is certainly not true at present. [Bold added.]

So Nick Rowe and I continue our valiant crusade, because the part I put in bold above–which Dean Baker himself summarized as his contribution to this whole debate–is TOTALLY WRONG. It’s precisely because Dean Baker continues to write false statements like the above, that Nick Rowe keeps generating very simplistic counterexamples to show why Dean Baker is totally wrong when he keeps saying stuff like this. When the critic asks Nick, “Why don’t you have capital in your model?” Nick’s obvious response is, “Because Dean Baker thinks the debt is only a burden with crowding out. So I’m showing him an example of a debt burden where there is no capital at all! Aaaaaagh!”