One Size Debt Does Not Fit All

Last summer, there was a fake “debt crisis” in the United States. The talk of the town was that the U.S. government had reached its statutory borrowing ceiling; therefore, the government would soon become insolvent. Then, like in a Hollywood melodrama, all of a sudden the crisis ended happily. Or did it? As I write this, a congressional “super committee” announced its failure to agree on debt reduction.

Will the United States ever be able to live happily ever after?

Or the European Union? By the time of this publication, it might be crumbling, Greece first, broke open by the sovereign debt crisis it tried to prevent with its Maastricht Criteria for nations looking to adopt the euro, one of five being that national public debt should not exceed 60 percent of gross domestic product (GDP).

Yet the standard public-debt-over-GDP ratio does not work at all because it has no scientific base. It is not like a baseball cap that claims “one size fits all.”

Without taking the cumulative current account deficit and total national wealth of a certain country into consideration, this ratio is worthless.

Income vs. Wealth

Consider that GDP, or national income, is a “flow” figure, while public debt is a “stock” figure. Flow is measured between two dates and thus should be compared with other flows such as budget size or budget deficits.

But public debt is a cumulative magnitude. If public debt is measured and presented as a percentage of GDP, the timing discrepancy between these two magnitudes will cause interpretation problems. The comparison of GDP growth rate and real interest paid on public debt is much more of a meaningful ratio. Or public debt should be compared with public wealth.

What is public, or national, wealth? Though national income is a household economic term, the term “national wealth” is almost nonexistent in the economic jargon. Probably this is because national wealth is very difficult to define and measure. National income is created by two factors of production: labor (muscle and brain power) and capital (physical and financial assets). Two countries with nearly the same national income may not have the same accumulated capital (national wealth).

Poor countries started to accumulate capital long after Western countries. With their labor-intensive production systems, they have smaller public wealth compared with their national income than the rich countries, with their capital-intensive economic structures.

So for rich countries, with more financial and physical assets relative to their GDP than poor counties, it is natural that their national-debt-over-GDP ratio is higher—and it does not imply that their economies are weaker or, worse, closer to a dangerous macroeconomic imbalance.

Public vs. Public

To understand “public” debt and wealth further, let us try to define the meaning of “public” in the following phrases: public debt, public opinion, public sector, public transportation, public domain, public administration and public toilet. We can easily recognize that “public” has at least two different and somewhat contradictory meanings. It either means the government or the state; or, it means just the people, especially low-income earners, who, in its true sense, are “the public.”

When economists write about “public debt,” which is also known as “government debt” or “national debt,” they mean the debt of the sovereign. As a matter of fact, one definition of public debt is the “debt of the public sector to the private sector (parties).”

Budget surplus is not the only source of cash necessary to lower public debt-to-GDP ratio. The indebted government has two other means of paying back the interest and the principal of the debt. One: the government may have assets that are marketable and can be sold to raise cash. Two: Real interest paid to public debt is negative and there is either insignificant or no budget deficit. This first method of payment has been used by many emerging countries like Turkey when they have experienced financial crises. This had been suggested as a solution for Greece’s debt problem. Finally, the government also has the power to tax the wealth of the public (households and companies) when necessary.

It is obvious that in this case, the taxpayers who pay the debt of the sovereign also receive money because they are the lenders to the government.

The equation assumes, however, that “public debt is also a public asset,” which is only true when the country has no cumulative current account deficit. If there is a cumulative current account deficit, then the taxpaying people of that sovereign will not receive the full amount in the event of full or partial payback of the public debt.

Therefore, the problem of public debt in Germany or Japan, which are both surplus generators, is essentially different from the problem in deficit-generator countries like Greece or Italy—or the United States, for that matter.

Also mind that the bond holders who will receive money are always a minority, while the taxpaying people who do not have meaningful investments in government debt are the majority.

Therefore, in the final analysis of the public debt, even though both the creditors and the debtors are “public/people,” they are not one-to-one the same people. So the real problem is not in the public debt per se, but it is in the income and wealth distribution within that country.

This is why United States had a “Wall Street Spring”—the Occupy Wall Street movement—launched last autumn in New York.

Ege Cansen, WG’66, is a leading business columnist in Turkey and writes for the newspaper Hurriyet.

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