The Burning Platform

According to the International Monetary Fund, the gross government debt of   Greece this year will reach 153 per cent of GDP. For Italy the figure is   123, for Ireland 113, for Portugal 112 and for the United States 107.

Britain’s debt is approaching 88 per cent. Japan – a special case as the first   non-Western country to adopt Western institutions – is the world leader,   with a mountain of government debt approaching 236 per cent of GDP, more   than triple what it was 20 years ago.

Often these debts get discussed as if they themselves were the problem, and   the result is a rather sterile argument between proponents of “austerity”   and “stimulus”. I want to suggest that they are a consequence of a more   profound malaise.

The heart of the matter is the way public debt allows the current generation   of voters to live at the expense of those as yet too young to vote or as yet   unborn. In this regard, the statistics commonly cited as government debt are   themselves deeply misleading, for they encompass only the sums owed by   governments in the form of bonds.

The rapidly rising quantity of these bonds certainly implies a growing charge   on those in employment, now and in the future, since – even if the current   low rates of interest enjoyed by the biggest sovereign borrowers persist –   the amount of money needed to service the debt must inexorably rise.

But the official debts in the form of bonds do not include the often far   larger unfunded liabilities of welfare schemes like – to give the biggest   American programmes – Medicare, Medicaid and Social Security.

The most recent estimate for the difference between the net present value of   federal government liabilities and the net present value of future federal   revenues is $200 trillion, nearly 13 times the debt as stated by the US   Treasury. Notice that these figures, too, are incomplete, since they omit   the unfunded liabilities of state and local governments, which are estimated   to be around $38 trillion.

These mind-boggling numbers represent nothing less than a vast claim by the   generation currently retired or about to retire on their children and   grandchildren, who are obligated by current law to find the money in the   future, by submitting either to substantial increases in taxation or to   drastic cuts in other forms of public expenditure.

To illustrate the magnitude of the problem, the economist Laurence Kotlikoff   calculates that to eliminate the federal government’s fiscal gap would   require either an immediate 64 per cent increase in all federal taxes or an   immediate 40 per cent cut in all federal expenditures.

When Kotlikoff compiled his “generational accounts” for the United Kingdom   more than 12 years ago, he estimated (on what proved to be the correct   assumption that the then government would increase welfare and health care   spending) that there would need to be a 31 per cent increase in income tax   revenues and a 46 per cent increase in National Insurance revenues to close   the fiscal gap.

In his Reflections on the Revolution in France (1790), Edmund Burke wrote that   the real social contract is not Jean-Jacques Rousseau’s contract between the   sovereign and the people or “general will”, but the “partnership” between   the generations. He writes: “SOCIETY is indeed a contract… The state … is …   a partnership not only between those who are living, but between those   who are living, those who are dead, and those who are to be born.” In the   enormous intergenerational transfers implied by current fiscal policies we   see a shocking and perhaps unparalleled breach of precisely that   partnership, so brilliantly described by Burke.

I want to suggest that the biggest challenge facing mature democracies is how   to restore the social contract between the generations. But I recognise that   the obstacles to doing so are daunting. Not the least of these is that the   young find it quite hard to compute their own long-term economic interests.

It is surprisingly easy to win the support of young voters for policies that   would ultimately make matters even worse for them, like maintaining defined   benefit pensions for public employees. If young Americans knew what was good   for them, they would all be in the Tea Party.

A second problem is that today’s Western democracies now play such a large   part in redistributing income that politicians who argue for cutting   expenditures nearly always run into the well-organised opposition of one or   both of two groups: recipients of public sector pay and recipients of   government benefits.

Is there a constitutional solution to this problem? The simplistic answer –   which has already been adopted in a number of American states as well as in   Germany – is some kind of balanced-budget amendment, which would reduce the   discretion of lawmakers to engage in deficit spending, much as the practice   of giving central banks independence reduced lawmakers’ discretion over   monetary policy.

The trouble is that the experience of the financial crisis has substantially   strengthened the case for using government deficit as a tool to stimulate   the economy in times of recession.

Last year, following a German lead, continental European leaders sought to   solve that problem by resolving to limit only their structural deficits,   leaving themselves room for manoeuvre for cyclical deficits as and when   required. But the problem with this “fiscal compact” is that only two   eurozone governments are currently below the mandated 0.5 per cent of GDP   ceiling; most have structural deficits at least four times too large, and   experience suggests that any government that tries seriously to reduce its   structural deficit ends up being driven from power.

It is perhaps not surprising that a majority of current voters should support   policies of intergenerational inequity, especially when older voters are so   much more likely to vote than younger voters.

But what if the net result of passing the bill for baby boomers’ profligacy is   not just unfair to the young but economically deleterious for everyone? What   if uncertainty about the future is already starting to weigh on the present?   As Carmen Reinhart and Ken Rogoff have suggested, it is hard to believe that   developed country growth rates will be unaffected by mountains of debt in   excess of 90 per cent of GDP.

It seems as if there are only two possible ways out of this mess. In the good   but less likely scenario, the proponents of reform succeed, through a heroic   effort of leadership, in persuading not only the young but also a   significant proportion of their parents and grandparents to vote for a more   responsible fiscal policy. As I have already explained, this is very hard to   do. But I believe there is a way of making such leadership more likely to   succeed, and that is to alter the way in which governments account for their   finances.

The present system is, to put it bluntly, fraudulent. There are no regularly   published and accurate official balance sheets. Huge liabilities are simply   hidden from view. Not even the current income and expenditure statements can   be relied upon. No legitimate business could possible carry on in this   fashion.

Public sector balance sheets can and should be drawn up so that the   liabilities of governments can be compared with their assets. That would   help clarify the difference between deficits to finance investment and   deficits to finance current consumption.

Governments should also follow the lead of business and adopt the Generally   Accepted Accounting Principles. And, above all, generational accounts should   be prepared on a regular basis to make absolutely clear the   intergenerational implications of current policy.

If we do not do these things then I am afraid we are going to end up with the   bad, but more likely, second scenario. Western democracies are going to   carry on in their current feckless fashion until, one after another, they   follow Greece and other Mediterranean economies into the fiscal death spiral   that begins with a loss of credibility, continues with a rise in borrowing   costs, and ends as governments are forced to impose spending cuts and higher   taxes at the worst possible moment.

There is, it is true, a third possibility, and that is what we now see in   Japan and the United States, maybe also the United Kingdom. The debt   continues to mount up. But deflationary fears, central bank bond purchases   and flight to safety from the rest of the world keeps government borrowing   costs down to unprecedented lows. The trouble with this scenario is that it   also implies low to zero growth over decades.

As our economic difficulties have worsened, we voters have struggled to find   the appropriate scapegoat. We blame the politicians whose hard lot it is to   bring public finances under control. But we also like to blame bankers and   financial markets, as if their reckless lending was to blame for our   reckless borrowing. We bay for tougher regulation, though not of ourselves.

This is an edited extract from the first of Prof Niall Ferguson’s four   Reith Lectures, to be broadcast today on Radio 4 at 9am