|
Debt and Democracy
With James Macdonald
Author
Monday, Feb. 3, 2003; 11:30 a.m. ET
Can debt be good for society? Why do governments borrow? What is the connection between political liberty and public credit?
James MacDonald, author of “A Free Nation Deep in Debt,” was online to discuss his book, the
connection between debt and democracy and its long history.
The transcript follows.
Editor's Note: Washingtonpost.com moderators retain editorial control
over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.
New York, N.Y.:
Do you think that third world countries should get debt relief/forgiveness from lenders? Won't this just encourage more borrowing and misspending of funds?
James MacDonald: This is not really part of my specialization. However, just as a personal opinion, I am not much in favor of international lending as currently practiced. Obviously there is a need for investment from developed to less developed countries, but the present system seems to lead almost inevitably to default. If foreign investment flows through the state, it is almost inevitable that much of it will be misdirected (not to mention purloined). After all, very few readers of the Washington Post (even if they are not great admirers of Wall Street) would propose that investment in America should be handled by the federal government. There used to be an old rule of thumb that only one third of international loans to developing went into productive investment – the rest went half into white elephants, and half into Swiss bank accounts. The productive investment was inevitably insufficient to service the entire debt.
There is an interesting parallel from American history. In the early nineteenth century the American states borrowed massively in London to finance development. This led to a wave of defaults in the 1840s that created doubts about the creditworthiness of the whole republic – even though the federal government was not involved. Fortunately, America learnt its lesson, and thereafter international investment flowed almost exclusively to the private sector. Indeed, many states passed constitutional amendments prohibiting the state from borrowing. Personally, I find it hard to believe that the economic development of America (which was highly dependent on imported capital in the nineteenth century) would have proceeded so successfully if foreign investment had continued to flow through the state.
Madison, N.J.:
Why is public debt politically crucial?
James MacDonald: Public debt was historically crucial to the triumph of democracy. If you look deep into history, you find that the most advanced nations were invariably autocracies, not democracies. However, the chink in the armor of the autocracies was that they were not reliable borrowers. Once bond markets were invented (by the city-states of medieval Italy) it became clear that governments that borrowed from their citizens could do so more cheaply that autocracies - because their was no "political" risk. It was this that led to the rise of Great Britain after 1688m and to the final collapse of ancient-regime France. The French Revolution was an admission of political bankruptcy; and it followed the financial bankruptcy 1788 – undoubtedly the most important public bankruptcy in history.
New York, N.Y.:
Why is it that if people in the eighteenth century accepted that public debt and political liberty were related have we moved from this idea?
James MacDonald: I think that the reason is that public borrowing was not ubiquitous, as it is nowadays. It was confined to Europe, and it was apparent that there was a considerable difference between the rates at which countries with some form of representative institutions (such as England) were able to borrow, and those of absolute monarchs. The divide came to a climax with the fall of the ancien regime in 1789, and then with the Napoleonic Wars. Napoleon refused to borrow, and financed himself by taxation and indemnities imposed on conquered countries. England financed itself by borrowing. Since the Anglo-French struggle for supremacy was the big political story of the whole period from 1688-1815, it is not surprising that people focused on the sharp contrast in the styles of public finance used by the two countries.
After 1815, the English model appeared to reign supreme, and was copied elsewhere - so the issue started to blur.
Morristown, N.J.:
Do you think the U.S. deficits and debt are at a problem level?
James MacDonald: I am a historian, rather than a commentator on current affairs; but no, I do not think that current levels of US debt and deficits are dangerous. America is one of the least indebted of western countries. The deficit is far lower than those recorded in the late 80s and early 90s as a percentage of GNP. The projected deficit is under 2% of GNP. In World War II, to use an extreme example, the US borrowed around 25% of GNP a year for several years.
Frederick, Md.:
So, would it be fair to say that -- as a society -- we've made a policy choice that deficits are preferable to taxes?
James MacDonald: This is a fascinating question, in historical terms. Public debt originated in the desire of free citizens to avoid the insult of being taxed at the behest of an autocrat (who most likely owed his power to conquest). Lending money to the state is one way in which the fiscal freedom could be expressed. It just happened to be a very profound development, since it created the bond market. So you could say that lending money to the state is a preferable alternative to being taxed.
This connection is best seen in the city-states of medieval Italy, who were responsible for inventing the bond market.
Medieval Italy is, in some ways, the purest example of the connection between democracy and public credit. In the republics of Florence and Venice, it was the privilege of citizens (but no non-citizens) that their taxes were considered repayable by the state; and in the meantime the state paid them a regular rate of interest (usually 5%). In Florence and Venice, citizens were, by definition, creditors of their states.
The problem was that, in such a situation, there was no incentive to limit the size of the public debt. In theory this did not matter, since the debt was only repayable insofar as the city was able. However, as debt rose, the ability of the city to make interest payments became questionable, and the market value of the debt progressively declined. What was needed was for the citizens to accept at least some direct taxation, so as to support the credit market.
The lesson for the present day is that, yes, it is far nicer to lend money rather than pay taxes. But, in the long term, if one is to enjoy the advantages of being able to borrow affordably, then it is necessary to keep things in proportion.
Re: WWII:
Yes, during WWII the U.S. borrowed enormously. And after it was over we had the world's only large modern functioning economy. Without a similar competitive advantage, is our level of debt a problem?
James MacDonald: You have to remember that, by the end of the war, the US had a national debt that was (briefly) around 130% of GNP. The current debt is around 35% of GNP.
Clearly, the US has a very long way to go before running into serious danger.
On the other hand, the WWII debt was extremely cheap - it cost little over 2% overall. And inflation, although repressed by price controls during the war, took off afterwards. By the end of the Korean War, prices were over 50% higher than in 1945. The debt was, therefore, partly reduced by inflation, which was perhaps necessary at the time, but obviously not ideal. I would certainly not want to suggest that the US could run up a debt of over 100% of GNP without adverse consequences. I am just pointing out that it has got a considerable amount of latitude at the moment.
Alexandria, Va.:
On the other side, is there a problem with having a surplus?
James MacDonald: There is no problem with running a budget surplus - especially if the economy is booming, as it was in the late 90s. However, if you are asking about building up a public surplus as opposed to a public debt, that is another matter.
In a modern economy it would be uncharted territory. The Federal Reserve manipulates the money supply by buying and selling government debt. There would have to be a radical rethink of monetary policy if the government decided to reduce public debt below a certain point - let alone build up a surplus.
Only a few years ago, people were starting to worry about exactly these problems, because it seemed that with the apparently unstoppable 'new economy' the government would soon be entirely out of debt. As you can imagine, such concerns have since evaporated.
Dallas, Tex.:
In the 90s some members of congress wanted to require a balanced federal budget every year even if this meant defaulting on government debts. Was this idea as potentially disastrous as it sounds, or was there a good reason for it?
James MacDonald: As far as I know, nobody actually advocated defaulting on the existing debt, which would certainly have had disastrous consequences.
Flemington, Del.:
Although public debt may be important to democracy, isn't irresponsible borrowing on the part of the government damaging to the nation by the same token? How does one differentiate?
James MacDonald: There are three good reasons to borrow, and one bad one. The good reasons are: to finance a war; to counteract an economic recession; and to finance capital investments.
Public borrowing is bad when it results from the inability of society to agree on the amount and distribution of taxation and spending. It was the sense that the Reagan-era deficits were the result of a sociopolitical stalemate that made many people think that a balanced budget amendment was necessary to force society to resolve its differences of opinion.
James MacDonald: I am afraid that my time has run out. I would like to thank everybody for participating, and the Washington Post for inviting me onto its website. I am sorry that I have not been able to answer all your questions, but I hope that I have at least been able to give at least some interesting information and ideas.
Thank you.
washingtonpost.com:
That wraps up today's show. Thanks to everyone who joined the
discussion.
Stay Tuned to Live Online:
Howard
Kurtz: Media Backtalk, Noon ET
Joel
Achenbach on Space Exploration, Noon ET
Behind
the Screen: Desson Howe, 12:30 p.m. ET
Post
Magazine: 'Performance of Their Lives', 1 p.m. ET
Sports:
The Chat House, 1:30 p.m. ET
Travel
Talk, 2 p.m. ET
Politics:
The Budget & Performance, 2 p.m. ET
Rob
Pegoraro: ISP Directory, 2 p.m. ET
Weather
Warriors: NBC4's Bob Ryan, 2 p.m. ET
Weather
Warriors: WUSA9's Topper Shutt, 3 p.m. ET
Keep up with the latest in news, sports, politics and entertainment with
washingtonpost.com
e-mail newsletters.
Personalize your Post with mywashingtonpost.com.
Get customized news, traffic, weather and more.
| |
© Copyright 2003 The Washington Post Company | 
