Debt by David Barrows

Introduction

Personal and public debts are contentious issues. Emotions with respect to debt can be very strong. There may, as well, be religious connotation. What are the emotional issues of having a debt obligation? Have we borrowed for consumption or for purposes of productive investment? The emotional issues complicate the scientific exploration of appropriate levels of private and public debt obligations.

The first section examines the philosophical and ethical considerations with respect to national debt. We present a robust discussion of growth theory and the implications for national debt. Functional finance and modern monetary Theory (MMT) provide an important framework for the analysis of national debt. The applicability of functional finance and MMT depends upon the competitiveness structure of the economy (and society).

The Philosophy of Debt

Analysis of the public debt has two components, scientific and emotional. The emotional component is based upon perceptions with respect to the role of the state. On the one hand, the state is seen as an extension of the “family or community". In this context the state is benign, friendly and helpful. The alternative viewpoint portrays the stateas distant with dominating- dictatorial tendencies. In the public administration literature this behavior is identified as public choice theory. In economics it is called economic rent.

The argument that government, like households, must 'tighten its belt' as a necessary policy response to higher indebtedness is based upon a number of logical fallacies:

· Ad populum

· Affirming the consequent

· Composition

· Non sequitur

Two Harvard philosophers debated the configuration of a just society in the context of inequality. John Rawls was a proponent of contemporary liberalism. Citizens do not deserve to be born into a rich or poor family or to be born more or less gifted than others. The initial distribution of natural assets is undeserved. Wealth creation is a cooperative enterprise, and all social goods are to be distributed equally. Wealth and power would be distributed equally except where inequalities work to the advantage of all. Rawls theory of justice is within the social contract tradition of Locke, Rousseau and Kant. (Rawls)

Robert Nozick believed in the minimal state. In this philosophical approach legitimate use of power by the state is limited to preventing fraud or the use of force. It does not include the power to tax or to confiscate property. Taxation by the state to finance projects other than protection violates individual rights to decide how one's property is disposed of. Taxation without consent is equivalent to forced labor. Socialism and liberalism redistribute wealth to achieve social justice. This imposes the redistribution of goods which ignores the history of how goods have come to be produced and distributed through trade, labor, purchases, gifts, etc. To take those goods away from people would be unjust, as long as the initial acquisition of the goods was just (e.g., one's own labor, inheritance). The state has the obligation to protect property and to punish those who violate property rights. (Nozick)

We enjoy inequality in inherited attributes. Cristiano Ronaldo is a Portuguese professional soccer player with a net worth of $460 million. Ronaldo earns a base salary of $64 million. Off the field he earns an additional $40 million from endorsements. He is 34 years of age. He kicks a ball. Is that fair? How much should he be paid for kicking a ball? How will this value be determined? (Ronaldo)Jeff Bezos established Amazon on July 5, 1994. Amazon has created market value of over $ 1 Trillion for shareholders, and has created 750,000 jobs. Bezos is worth $100 billion. Is that fair? What is a better number and why? (Bezso)  In Economics 101 we learn that the marginal value of labour is the marginal product of labor multiplied by the value of the items produced. Why is that not applicable here?

Empirically the elimination of inequality is impossible. In 1573, Tusser observed: “A foole and his monie be soone at debate, which after with sorrow repents him too late “This is the earliest known version of the proverb: A fool and his money are soon parted. (Tusser)

The numbers do not work. The Pareto distribution is a power-lawprobability distribution that is used to describe a number of social, scientific, geophysical and actuarial observations. With respect to the distribution of wealth in a society, the fitted trend indicates that a large portion of wealth is held by a small fraction of the population. This Pareto distribution has become known as the Pareto Principle, or 80-20 rule. This rule states that 80% of the wealth of a society is, generally, held by 20% of its population.

In a recent interview Thomas Piketty addressed a number of issues related to inequality:

Q: “Are western societies more unequal than they were in 1918?
The levels of inequality we see today are much, much lower than what they were a century ago...I’m an optimist. The story I tell is a story of learning, of progress in the long term. Today we have a much better balance of the rights of owners, workers, consumers and local government. That represents a complete transformation in our notion of property, and it was combined with increased access to health and education. The present regime of free circulation of capital, set up in the 1980s and 90s encourages evasion. It prevents poor countries from developing a fair tax system, which in turn undermines their ability to build a social state.

Powerful shocks like pandemics, wars or financial crashes have an impact on society, but the nature of that impact depends on the theories people hold about history, society, the balance of power – in a word, ideology – which varies from place to place. It always takes major social and political mobilization to move societies in the direction of equality”. (Piketty)

Ethical Issues

It can be argued that if the duty to pay a debt is ethical, then the ‘ought toimply can’ rule applies: we cannot be morally obliged to do what it is not in our power to do. Thus any obligation to pay is limited by capacity to pay. Ethically, the obligation to pay a debt may shrink to the obligation to pay what can reasonably be required. However, one person’s debt reduction is another person’s asset loss. There is context-dependency in the relationship of trust, expectation and obligation implied by the language of ‘credit’ itself.

The ancient world exhibited a pattern of high interest loans to subsistence farmers in times of crisis (war, drought etc), leading to loss of possessions (and thus earning-potential) and the sale of family members into various forms of slavery. This behaviour led to periodic amnesties (such as the Biblical Jubilee) where debts were cancelled and slaves returned to their families. This behaviour was not simply as a matter of justice, but undertaken in order to prevent revolution.  In the fourth century BC, Dionysus of Syracuse borrowed from citizens but “repaid” the loan only by debasing the coinage.

In the pre-commercial feudal era, princes, landlords, and clerics owned estates or sanctuaries that generated income, not unlike a personal business, but by command-and-control operations, with tribute paid by tenant farmers or serfs, in return for military protection. Government funds in the feudal era also derived from conquest and war, the sale of offices, titles, and indulgences, or by debasing coins at the mint. Prior to the Renaissance monarchs, princes, and popes borrowed on their own account, pledging personal income and estates as security. They often reneged on their debts. Creditors, initially lured by the prospect of large financial gains, given their privileged proximity to political power, more often than not were mistreated, whether by defaults, interest reductions, confiscations, or bodily harm.

Governments in ancient and medieval times required funding, as do modern states, but they did not borrow publically in the sense of drawing funds from a wide populace and making it ultimately responsible for servicing the debt as a form of deferred taxes. Private borrowing existed since recorded history and preceded the development of public borrowing by many centuries. Eventually, public borrowing became common, but initially involved loans in kind (commodities) not money, for shorter rather than longer periods, and for war or idiosyncratic purposes rather than as a permanent funding source. In ancient and medieval times no debt instruments existed. Sovereign obligation emerged in the late seventeenth century, when the rule of law, security of contract, and parliamentary checks on monarchical power was implemented

Out of this experience – the exploitation of the poor in forcing them to borrow to survive a crisis beyond their control   – emerged the ancient condemnation of usury, from the criticisms of Aristotle to the censures of medieval church councils, Judaism and Islam. Here there is very limited evidence for the common utility of the institution of debt, and thus limited grounds for any absolute moral obligation to pay in full all interest-based loans. As a result there is an important distinction between the usury of productive debt and the illegitimacy of extractive and forced debt. This reasoning implies that debt as an institution is morally ambivalent. Clearly there is a good, mutually beneficial, set of debt-related practices. But we cannot insist on an absolute obligation to pay debts, without considering the quality and effects of all debt-related activity in society at large.

Eventually Aquinas provided a qualified defense of lending, which coincided with the origin and growth of modern, private banking and lending, starting in Italy and spreading quickly to Spain and Holland.  With the Protestant Reformation came a defense of usury by Martin Luther. The Industrial Revolution led to the defense of usury by Jeremy Bentham and his contemporaries in the 18th century (Smith, Ricardo, Say and Mill).They argued that the common good is served by the productive activities of entrepreneurs, who require start-up capital that must be borrowed.