Something of a blogosphere explosion occurred last week. What caused it? A largely correct post by Paul Krugman that had the gist of arguing that the amount of US federal government debt is a misleading indicator of how serious the US debt problem is. Here is my colleague Steve Landburg illuminating and buttressing the point. Many bloggers have since chimed in, including some who dispute that Krugman’s initial claim is right.
I don’t want to summarize the arguments here, you can click through the links, starting with the Krugman one above, then Steve’s and then following the Boudreaux one, to get the economic intuition behind the arguments. I am strongly in the corner of my colleague’s model of whether debt is ipso facto an issue. It’s not, as I think his parable here makes clear. His entirely correct point is that government spending indeed imposes a burden on someone. But from the fact that it is financed with debt says nothing about whether that burden necessarily is imposed on future generations. Current generations have complete control over who the burden of their spending falls upon. What remains unsaid in the debate, but implied, is that the spending indeed can cause harm, and irrespective of whether it is tax financed or debt financed it can cause harm to future generations.
I guess my only quibble with my colleague’s point above is what the term “complete control” means and it is here that I will add my one cent. Assume for simplicity’s sake that all tax collections today and in the future are non-distortionary. It is possible to structure taxes this way, though we are unlikely to see it in practice. What is the problem with transferring resources from some citizens to others? If we ignore prices perhaps nothing. But don’t be a priceless economist. When resources are transferred from Peter to Paul, this will distort the relative prices in an economy from where they would be if Peter had command over the resources himself. And these relative price distortions have ramifications not just for current production and consumption (by others) but also out into the future.
So, if there is a reason to be apoplectic about the level of the public debt, it should be retrospective. It seems to me an indicator that market prices were likely to have been heavily distorted in the past and that the adjustment process in the future of prices getting “more right” is going to be painful. I would note, however, that this position does not follow ipso facto from the fact that governments spend, I suppose one could write down a model where such government spending is price neutral, but again I find that to be an implausible assumption to make.