Debt and a deficit of wisdom among governments

In the past debt was treated with greater caution than has become the practice in more recent times; it has become easier to rationalise it away in some segments of our society. 

Financial prudence must be relearned by each succeeding generation. However, difficulties become widespread in the face of ill-advised government policies and economic downturns. No-one is unaffected.

Families are regularly faced with the stark realities of the marketplace, and of life in general. They receive daily invitations to relearn the lessons of the old wisdom. But over the last century the opposite has occurred for governments. Throughout the middle of the 20th century there arose the belief that governments are not faced with the same financial constraints as families.

Not only are governments seen increasingly as eternal beings, but the debts taken on by governments are now seen as less onerous than those borne by families by virtue of the belief that when governments borrow we merely “owe it to ourselves”.

Neither of these beliefs is correct; nor are they benign. While governments can be seen as potentially eternal — with occasional interludes of collapse, overthrow, or realignment — the people who take on the debt are not always the same ones who bear the burden into the future. The debt burden is shifted onto those to be born in future generations.

It can be argued that South Africans of the present generation, through their election of the present government, have approved issuance of new debt and of the excess government spending that made it necessary. But the future generations who bear the persisting burden were not consulted.

Similarly, even in the present the people who buy government debt (the lenders) are not all the same people as those (taxpayers) who bear the current burden of that debt. It is observably false to state that “we owe it to ourselves”. Not all voters will have voted for the present government, nor should it be assumed that they approved of the increased debt. Further, the purchasers of government debt do so voluntarily and benefit directly; the same cannot be said for taxpayers.

When governments take on debt, there are other less obvious burdens. These are related to the reason for taking on the debt in the first place. Governments, or rather the politicians who take the decisions within governments, have an incentive to direct government spending towards their supporters and constituents, but they also have an incentive to reduce the visible burden imposed on those constituents.

People do not like to pay taxes, but they are less likely to notice the burden of debt, which is spread out into the future. Predictably, governments tend to spend more than they are willing or able to pay for now through taxes in the present. When unconstrained by either a constitution or a culture of prudence — or resistant capital markets — governments will run budget deficits.

We must always ask what kind of spending is important enough to justify debt. When a business takes on debt, lenders expect those funds to be invested in productive activities that will generate enough cash flow to cover the debt service, and enough assets to cover some of the losses in case of failure. A government that holds itself to such a prudent model, using debt to finance long-term, genuinely beneficial infrastructure investments (such as roads and bridges), would bring net benefit to its citizens.

Unfortunately, as governments grow in the size and scope of their activities, much of their spending is not investment at all, but rather transfer payments that promote current consumption, and subsidies that draw resources away from productive activities into those that are less productive. As government spending grows, any net benefit soon turns negative, thereby stifling improvements in standards of living. By pushing the main effect of the burden beyond the next election, deficit spending reduces the political cost to politicians who dispense short-term largesse while escaping blame for imposing net long-term financial harm on their citizens.

As debt grows relative to the size of the borrower, whether public or private, the burden and riskiness of the debt service also grow.

With the debt service faced by the national government in SA having grown over the past decade to almost 20% of total tax revenue, citizens have good reason to ask where their taxes really go, and when the fairytale will end.

• Dr Grant, a professor of finance & economics at Cumberland University, Tennessee, is a senior consultant to the Free Market Foundation. He writes in his personal capacity.