Is Public Debt Really Different from Private Debt?

In his excellent takedown of Paul Krugman (aka the Second-Best Reason to Eliminate the Nobel Prize in Economics), Kyle Smith quotes the Mad Economist’s take on government borrowing:

“People think of debt’s role in the economy as if it were the same as what debt means for an individual: There’s a lot of money you have to pay to someone else. But that’s all wrong; the debt we create is basically money we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.”

This is a piece of nonsense first advanced by the brilliant Abba P. Lerner in the 194os–in discussing debt purely from a net-stimulus perspective–and thoroughly critiqued by James M. Buchanan way back in 1958. That Krugman would claim this as some sort of state-of-the-art analysis is simply pathetic–both as economics and as advocacy.

Don Boudreaux has sketched out the basic Buchanan critique at Cafe Hayek, so I won’t go into that directly. And Nick Rowe provides a nice overview of the broader debate, with lots of links to other recent blog posts on the issue. But there are two related points that I think are frequently overlooked.

The reason it is supreme idiocy to claim that public debt is unlike household debt on the grounds that “we” owe it to “ourselves” is that this argument only holds if the entire nation is viewed as a single entity–i.e. as a household. It is true that borrowing money from your spouse is different from borrowing money from a bank. That’s why people don’t make a point of charging interest on intra-household “loans.” What would be the point?

But if the government borrows today by selling bonds, it obligates one group of households to repay principal plus interest on those bonds to a completely different group of households. And that, my friends, is exactly like you or me borrowing from a bank. It can’t be stated often enough that there is no “we” beyond the household. A state or regional or national economy is simply an artifact of aggregation.

Perhaps the simplest way to see the fallacy in Krugman’s “analysis” is to note that, since the Chinese government is not considered part of the “we” among whom the debt is “owed to ourselves”, even Krugman would argue that the US government’s borrowing from the Chinese government is like a household borrowing from a bank. So somehow it’s supposed to make a difference to me, Joe Taxpayer, if somebody like Warren Buffett sells some of his Treasurys to Hu Jintao–or even to some nice Europeans. But my tax liability for debt service is completely unaffected by this transaction, just as when the bank that gave me my mortgage sells it later on the secondary market.

The one way in which public debt really does differ from private debt is in the way it’s repaid. When I take out a car loan, I base my decision partly on my projected future ability to repay that loan. And if I get tempted to take some time off from working in order to “find myself” on a trek to Tibet, the need to make my car payments will force me either to sell my car to pay off the loan or to reconsider the wisdom of quitting my job.

When the time comes to service government debt, the only options are to cut spending or to raise taxes, neither of which is comparable to selling my car or deciding not to quit my job. In fact, when taxes are raised to pay off public debt, the effect on labor effort is precisely the opposite of the effect of private borrowing. Higher income-tax rates induce people to work and invest less, not more. So it’s actually costlier to repay public debt than to repay private debt, because the cost of repaying public debt includes the “deadweight cost” of taxes. Private borrowing does not.

So the correct answer to the question, “Is public debt really different from private debt?” is:

Yes; it’s worse.

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