Tuesday, 15 July 2014

Investing in the Future

Imagine two countries, A and B. Neither has any kind of public education system, and neither has any money to spare to start one. The government of A decides to borrow $100M a year at 3% interest to fund free public education until the end of elementary school while the government of B decides to run a balanced budget and offer no public education.

Fifty years later A has $5B in debt and is paying $150M a year to finance it. They are actually paying more to service their debt than it would cost to simply run the education system that the debt was meant to run.

Which country do think is better off?

Having two generations of literate people with basic numeracy skills is probably going to mean that A is far more prosperous. Government revenues are going to be much higher, and they will probably be able to service that $5B debt without difficulty. B is probably stagnant and in about the same state it was fifty years earlier. Obviously there are more factors that go into the prosperity of a country than a public education system, but people seem to agree that public education is so massively productive that we should expect going into debt to run it is a good investment.

Similarly, it is probably uncontroversial that a government would be well advised to go into debt if necessary to build roads. Since humanity discovered how to make good bridges those are probably a good idea too. Since humanity discovered electricity, energy infrastructure is probably a good investment.

All of these things are insanely obvious. The return on investment is through the roof. We are asking whether it is wise to borrow at 3% to fund an investment that pays 10%, 15%, or even more. The right answer is to borrow as much as they will let you to invest as much as you can. What's more, if the investment continues to pay that much and the interest to finance it continues to be so low, you should never, ever pay back the debt. Just keep borrowing more.

So when people talk about high government debts and deficits I shake my head. The problem isn't debt or deficit, the problem is making investments that don't pay for themselves. If the government is borrowing to do things that aren't terribly wise things to do then a mistake is being made.

But if the government is cutting very useful services to pay down the debt, it's likely a bigger mistake is being made. Borrowing at 3% to invest at 1% is pretty dumb. Paying back debt at 3% by taking the money out of an investment at 10% is a lot dumber. Austerity is failing and increasing deficits all over Europe and the reason why is as simple as this: those services that are being cut to reduce deficits paid out more than the interest on the debt. They should continue to be run at a deficit forever. This isn't a complex or radical theory, it's just obvious.

The issue of not trusting governments to spend money wisely is a real one. Governments may be starting programs that have no measurable benefit at all or that actively do harm. So they should stop doing those things, not cut spending for the sake of balancing the budget.

A balanced budget is no promise of good decision making. Countries could cut education to pay for foreign wars or cut infrastructure spending to pay for subsidies to already profitable companies. In fact they do just that all the time. Governments don't have to worry about their finances in at all the same terms that people or even large corporations do. Good investments should be made, bad ones should not. Deficit and debt are vanity projects for very wealthy nations.

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