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Responding to Steve Landsburg on Government Debt

Summary:
Steve graciously commented on my recent talk from Mises U, in which I rehashed the Great Debt Debate of 2012. (Steve left a comment here and here.) Below, I will respond to Steve’s points individually. But before doing that, let me give an analogy. ================== A HYPOTHETICAL DEBATE ON GUNS PAUL: It’s impossible for handguns to hurt our grandkids, so long as they are wearing bulletproof vests. BOB: What the heck are you talking about? I could shoot the grandkid in the head. Dead. STEVE: Well no, actually it would be the bullet that would cause the actual pain there; the handgun is incidental. Indeed, I could kill someone with a rifle or indeed any device that accelerated a bullet. Furthermore, a handgun without bullets can’t hurt our grandkids. So Bob, you

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Steve graciously commented on my recent talk from Mises U, in which I rehashed the Great Debt Debate of 2012. (Steve left a comment here and here.) Below, I will respond to Steve’s points individually. But before doing that, let me give an analogy.

==================

A HYPOTHETICAL DEBATE ON GUNS

PAUL: It’s impossible for handguns to hurt our grandkids, so long as they are wearing bulletproof vests.

BOB: What the heck are you talking about? I could shoot the grandkid in the head. Dead.

STEVE: Well no, actually it would be the bullet that would cause the actual pain there; the handgun is incidental. Indeed, I could kill someone with a rifle or indeed any device that accelerated a bullet. Furthermore, a handgun without bullets can’t hurt our grandkids. So Bob, you are actually wrong on this, and Paul is right.

==================

AN ACTUAL DEBATE ON GOVERNMENT DEBT

PAUL: It’s impossible for debt to hurt our grandkids, so long as they hold the Treasuries.

BOB: What the heck are you talking about? We could have overlapping generations like this. Utility up for earlier generations and down for later ones.

STEVE: Well no, actually it would be the taxes that would cause the actual pain there; the debt is incidental. Indeed, I could cause utility movements with simple transfer payments. If the government ran up big debts today but never taxed anybody to pay the interest or principal, clearly our grandkids would not be harmed in the way you think. So Bob, you are actually wrong on this, and Paul is right.

=================

Now on to Steve’s specifics, with his words in italics and mine in normal text:

Your chart and your presentation are very clear and engaging (as one expects from Bob Murphy). Also, a big thumbs-up on the beard. 

I always liked Steve.

1) Your chart does not display the effect of govt borrowing; it displays the effect of a Social Security system (with old people receiving transfers of various amounts in various generations). If you financed exactly the same system through taxation, you’d get exactly the same results. In year 1, we tax Young Bob 3 apples and give them to Old Al. In year 2, we tax Young Christy 6 apples and give them to Old Bob. Et cetera.

All of the effects you’re illustrating would have been exactly the same if you’d financed all the transfers by taxation instead of borrowing. It’s the transfers that are having all the real effects.

Your particular assumptions lead to different sized transfers in different years. But any pattern of transfers you care to specify can be achieved equally well by appropriate timed borrowing or similarly timed taxation.

See my analogy above.

There is no doubt that Krugman thought it was our grandkids owning the bonds that made all the difference. This is why I was so frustrated with Steve at the time of the debate. Steve was making a series of correct statements showing how government financing was a red herring, but in that framework, “we owe it to ourselves” is still a non sequitur. And yet that was literally the mantra of Abba Lerner, and it was explicitly adopted by Krugman and Dean Baker.

That’s all Nick Rowe and I were doing with our simplistic thought experiments. We were trying to show as simply as possible that Lerner and Krugman were simply mistaken when they argued that “we owe it to ourselves” therefore meant government debt (and yes the taxation to service it) couldn’t hurt our grandkids to our benefit.

I myself believed this at first. Then I realized Nick was right. (Don Boudreaux was right too, but it was Nick’s specific numerical examples that made me realize I was wrong.) Dean Baker himself later admitted that theoretically his original position was wrong, and switched to an empirical defense. To my knowledge, Krugman never realized the problem.

2) You’ve assumed a 100% interest rate. This means that in each year, people adjust their bond purchases until, at the margin, they consider two apples in old age a perfect substitute for one apple in their youth.

Therefore:

Al is a winner.

Bob is neither a winner nor a loser. (He gains 6 “old age” apples, which exactly compensates him for his loss of 3 “youth” apples.)

Christy is neither a winner nor a loser.

Dave is neither a winner nor a loser.

Eddy is neither a winner nor a loser.

Frank, George, and the rest are losers — because they get taxed. The bottom line is that you hurt people by taxing them. Again, this would be true with or without the borrowing program.

I didn’t go back to check this, but I *think* you said Bob, Christy, Dave and Eddy were winners. If so, I think that’s a mistake.

No, in the very simple example I sketched out, there is no private borrowing. I specified actual utility functions and so the Excel sheet told me who had more or less utility, relative to the consume-your-endowment baseline.

In a more general framework, yes we have to allow for private credit markets, but even there the government can improve the utility to lenders by offering a higher interest rate (relative to default risk) than the market. I will do more work on this once I see how far things have been taken in the literature.

(Steve anticipates a bunch of these subtleties in the following, but I don’t see how it overturns my position:)

3) Your simplifying assumptions mask the most interesting (to me) issues. Namely: Because the govt is essentially doing people’s saving for them, they face a reduced incentive to save on their own. This isn’t an issue in your model because they can’t save without the govt anyway. But in the real world, this means people will engage in less private saving, so there will be less investment (and in fact suboptimal investment) which hurts
all generations going forward above and beyond what your chart shows.
(This is the essence of Martin Feldstein’s calculations of the social cost
of Social Security.) But once again, this effect will be exactly the
same whether you finance your program through taxes or through borrowing.

I should add, though it’s a second-order effect, that some borrowing is inframarginal, so the govt, by making borrowing possible, can make some people better off. For example, we know that the last apple Bob borrows is, for him, a perfect substitute for 1/2 a present apple (otherwise he’d borrow more). But his first and second borrowed apples might be worth more to him than 1/2 a present apple apiece. So Bob can be a winner here, though I think this is a relatively minor point in the context of the issues you’re trying to get at. (Or maybe it’s a major point, if I haven’t fully understood your purpose.)

Robert Murphy
Robert Patrick Murphy (born 23 May 1976) is an American economist, consultant and author. He is an economist with the Institute for Energy Research (IER) specializing in climate change and a research fellow with the Independent Institute, He was a senior fellow in business and economic studies at the Pacific Research Institute, and he is an associated scholar at the Ludwig von Mises Institute. In addition to economic subjects, Murphy writes about, and has presented an online video class in, anarcho-capitalism on the Mises Institute website. Murphy also has written in support of Intelligent Design theory and expressed skepticism of biological evolution.

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