Carlo Clericetti – Italy: Debt Mystification

Is debt really our biggest problem? Are we placing a burden on our children and future generations? The answer to both questions is a clear “no”, without a shadow of a doubt. Unfortunately, the European rules, now thankfully suspended, were drawn up from this mistaken perspective, and there is also the risk that we may want to return to something similar. That would be a bad move. In the meantime, some economists and many pundits should stop talking nonsense.

Carlo Clericetti is an Italian journalist. In the past he has directed “Affari & Finanza”, a weekly supplement published by “La Repubblica”, and web portals. Currently he  blogs for “La Repubblica”, for his personal website “Blogging in the wind”, and writes for other websites on economy and politics.

Cross-posted from MicroMega

Translated and edited by BRAVE NEW EUROPE

Not a day goes by that we don’t hear some economist on television blaming us for “passing on the enormous burden of the national debt to our children”. Commentators and pundits of all kinds repeat in chorus: the public debt is a monster that we have created, that continually threatens to devour us and bankrupt the state. It is our primary problem, the most dramatic, the most important. Our forces and our efforts must first and foremost aimed at reducing it, at any cost. At the cost of cutting the welfare state? Of course. At the cost of leaving a few million people out of work? What can you do… At the cost of having, in one of the richest countries in the world, a few million families in poverty? That’s the way of the world.

And yet: at the cost of imposing a wealth tax? Never! At the cost of raising taxes on the wealthiest ? Don’t joke, taxes must be reduced. But then it is not ‘at all costs’: only at certain costs.

But back to the “burden on future generations” nonsense. Let us assume for the moment that all our public debt is held by Italians. For the son of the dustman who will find himself with an indebted state, there will be the daughter of the lawyer who will inherit the government bonds bought by her father with his savings, i.e. she will inherit a debt. The relationship between the two is the interest that the state pays on the debt. The dustman’s son has no government bonds, so he is left empty-handed; the lawyer’s daughter, on the other hand, will have an income thanks to the coupons on the bonds bought by her father. She will not mind the fact that the state has gone into debt, thus providing her father with an opportunity to make his savings pay off. As we can see, we cannot reason with Trilussa’s average (Trilussa was a Roman poet, and one of his most famous poem says about averages: “If you eat two chickens and I none, the average says that we ate a chicken each”. The same if you say “Everyone who is born in Italy has a debt of a thousand euros”).

But then, does debt benefit the rich and harm the poor? Again, it depends. If that debt has been used to build roads, schools and hospitals, the dustman’s son will not receive interest but will have a range of services that he would not otherwise have had. And maybe that money has also been used to keep his father’s job, allowing him to live a decent life. Maybe some of that money has been used to create public enterprises, or to facilitate the life of private ones (e.g. by helping them to modernise). And in that case part of the legacy is to live in a healthier economy than it would otherwise have been.

So is debt always a good thing? No, if it is done to secure the support of clientele or to give bonuses to the already wealthy (who then, perhaps, with that money will buy government bonds, from which they will collect interest…). In short, public debt has redistributive effects, i.e. it shifts wealth from certain categories to others, but it is very difficult to determine who loses and who gains, which also depends on what and how many services the state provides, how the tax system is designed, etc. It certainly does not benefit one generation to the detriment of another, as Luigi Einaudi already noted:

“Much of the moral condemnation hurled by austere politicians against the public debt is due to the conviction of the immorality of enjoying the benefits of spending by us alive today and leaving the bill to our distant grandchildren. Posterity is involved; but in a way quite different from that imagined by the commonly held belief among the populace that the national debt is a trick to make grandchildren pay for the expenses incurred by the living. Unfortunately for the living, there is no way to make people who are yet to be born pay for any expense, large or small, private or public. (from “Myths and paradoxes of tax justice”).

A lesson forgotten? No, not by those who know about economics. This is a very recent tweet by Vitor Constâncio, former vice-president of the ECB:

“Domestic debt is debt held by residents. In the future when bonds are redeemed, members of the future generation will pay the taxes (if the debt is not rolled over) but other members of that generation receive the money of the redeemed bonds. It is not a burden on the generation”.

This image has an empty alt attribute; its file name is Constancio-Tweet.jpg

But we have assumed that all the debt is held by Italians, while about one third is in the hands of foreign investors. So the interest on that part, which has to be covered by the taxes we pay, ends up in hands outside the country. Of course, we should consider that a part of those securities – it is difficult to establish the size – belongs to Italians. If I buy a Luxembourg mutual fund or a Credit Agricole or Merrill Lynch managed fund, there are also government bonds in there, which I therefore indirectly own. But let’s leave that aside. What counts is Italy’s net international position, which is one of the most important parameters taken into account internationally to assess the sustainability of a nation’s debt.

Just as foreigners buy our securities, so there are Italians who buy foreign securities, thus collecting their interest covered by the taxes of citizens of other states. The country’s net financial position is the balance between the assets held by foreigners in Italy (i.e. including our public debt securities) and the assets held abroad by Italians. According to the most recent data (third quarter 2020) the balance of Italy has become positive after many years (it has not happened since the 80’s), for 3.1 billion, as can be seen from the Bankitalia data (tab. 8 A). Therefore, against a foreign debt, there is a slightly higher credit towards foreign countries.

This means that the public debt is not the dramatic problem that many people describe; and, as we have already seen, it is not correct to say that it is a burden that we leave on the shoulders of our children.

But if you can take on debt without thinking too much about it, is there no problem? Of course not, that would be too easy. For someone to lend you money they must have a reasonable certainty that you will pay them back at maturity, so don’t overdo it. And where is the limit of exaggeration? There is no magic number, no Piave’s line beyond which you are heading for disaster. It depends on various factors, for example the ability to produce goods that are in demand on the international market. In the long term, the crucial factor is that nominal growth (i.e. including inflation) exceeds the cost of servicing the debt, even if only slightly. This has not been the case for us for some years, and this is the real problem.

But budgetary policy is not indifferent to growth. It must be possible to use the budget in an anti-cyclical way. In other words, when things are going well – the economy is growing, foreign demand is “pulling” – you can skimp on public spending, but when there is stagnation or recession the state must spend, even if this means ending the year with a deficit that will increase public debt and even if the latter is already considered high. We have seen proof to the contrary in recent years. In particular with the Monti government, which inherited the effects of a very major fiscal plans launched by the previous Berlusconi government (forced by the famous letter from the ECB and the Commission) and then added its own. In spite of spending cuts and tax increases, the debt-to-GDP ratio has risen sharply, because fiscal policy has slowed down the denominator of the ratio, i.e. GDP. Spending cuts, when the economy is already suffering, not only do not help to reduce that ratio, they make it worse.

Of course, there are other important collateral conditions. The bureaucracy must work, as must civil justice. There has to be a central bank that keeps speculation in check, which the ECB is doing now and has not always done in the past. And expenditure does not all have the same effect on growth: Renzi’s €80 (The Renzi government decided on a salary increase of 80 euros for those earning €8000 (not lower) to €26000 € and only to employees, excluding self-employed and pensioners), for example, has less of a long term effect than the safety of school buildings. But if the ‘macro’ picture is missing, it is almost useless to discuss the quality of spending.

European Union rules, all focused on reducing debt through restrictive budget policies, have done very serious damage. And just as much damage has been done by the widespread – but mistaken – beliefs about public debt and deficit spending. It took a catastrophe like the pandemic to expose the egregious damage this has caused, but the temptation to return to the old song as soon as possible is far from over. Perhaps it has something to do with the fact that, even in these years of crisis, the rich have become richer. If the wrong ideas suit someone, it is very difficult to change them.

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