Viewpoint: Why the young should welcome austerity

People protest during a May Day rally in the centre of Barcelona Government austerity measures have been met with protests in many countries - but would young people be wise to encourage politicans to pay-off national debts now to avoid an even more miserable financial future?

Governments should be more honest about the size of their debts and young voters would be wise to get politicians to pay them off as soon as possible, says economic historian Niall Ferguson in the first of his BBC Reith Lectures.

The critics of Western democracy are right to discern that something is amiss with our political institutions. The most obvious symptom of the malaise is the huge debts we have managed to accumulate in recent decades, which - unlike in the past - cannot largely be blamed on wars.

According to the International Monetary Fund, the gross government debt of Greece this year will reach 153% of GDP. For Italy the figure is 123%, for Ireland 113%, for Portugal 112% and for the United States 107%.

Britain's debt is approaching 88%. Japan is the world leader, with a mountain of government debt approaching 236% of GDP - more than triple what it was 20 years ago.

Start Quote

Society is indeed a contract. The state is a partnership not only between those who are living, but between those who are living, those who are dead, and those who are to be born.”

End Quote Edmund Burke Political theorist, writing in 1790

Now, often these debts get discussed as if they themselves are the problem, and the result is a rather sterile argument between proponents of "austerity" and "stimulus".

I want to suggest that they are a consequence of a more profound malfunction.

The heart of the matter is the way public debt allows the current generation of voters to live at the expense of those as yet too young to vote or as yet unborn.

In this regard, the statistics commonly cited as government debt are themselves deeply misleading, for they encompass only the sums owed by governments in the form of bonds.

The rapidly rising quantity of these bonds certainly implies a growing charge on those in employment, now and in the future, since - even if the current low rates of interest enjoyed by the biggest sovereign borrowers persist - the amount of money needed to service the debt must inexorably rise.

Past, Present and Future: Government debt as percentage of GDP

Country 2000 2012 2017

China

16.4

22

10.1

France

57.4

89

84.6

Germany

60.1

78.9

71

Greece

103.4

153.2

136.8

Ireland

37.5

113.1

109.2

Italy

108.5

123.4

118.9

Japan

140.1

235.8

256.6

Portugal

48.4

112.4

109.2

Spain

59.4

79

91.6

United Kingdom

40.9

88.4

86.8

United States

54.8

106.6

113

Source: IMF, April 2012 World Economic Outlook. Figures for 2012 and 2017 are estimates.

But the official debts in the form of bonds do not include the often far larger unfunded liabilities of welfare schemes like - to give the biggest American schemes - Medicare, Medicaid and Social Security.

The most recent estimate for the difference between the net present value of federal government liabilities and the net present value of future federal revenues is $200 trillion, nearly thirteen times the debt as stated by the U.S. Treasury.

Notice that these figures, too, are incomplete, since they omit the unfunded liabilities of state and local governments, which are estimated to be around $38 trillion.

These mind-boggling numbers represent nothing less than a vast claim by the generation currently retired or about to retire on their children and grandchildren, who are obligated by current law to find the money in the future, by submitting either to substantial increases in taxation or to drastic cuts in other forms of public expenditure.

In his Reflections on the Revolution in France, published in 1790, Edmund Burke wrote that the real social contract is not Rousseau's contract between the sovereign and the people or "general will", but the "partnership" between the generations.

"Society," says Burke, "is indeed a contract. The state is a partnership not only between those who are living, but between those who are living, those who are dead, and those who are to be born."

In the enormous inter-generational transfers implied by current fiscal policies we see a shocking and perhaps unparalleled breach of precisely that partnership.

Restoring the social contract

I want to suggest that the biggest challenge facing mature democracies is how to restore the social contract between the generations.

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It is surprisingly easy to win the support of young voters for policies that would ultimately make matters even worse for them”

End Quote Niall Ferguson

But I recognise that the obstacles to doing so are daunting. Not the least of these is that the young find it quite hard to compute their own long-term economic interests.

It is surprisingly easy to win the support of young voters for policies that would ultimately make matters even worse for them, like maintaining defined benefit pensions for public employees.

If young Americans knew what was good for them, they would all be in the Tea Party.

A second problem is that today's Western democracies now play such a large part in redistributing income that politicians who argue for cutting expenditures nearly always run into the well-organised opposition of one or both of two groups: recipients of public sector pay and recipients of government benefits.

The Rule of Law and its Enemies

Niall Ferguson standing in front of a row of police officers in Lima, Peru

Prof Niall Ferguson is an economic historian. He is Laurence A. Tisch Professor of History at Harvard University and senior fellow at Jesus College, Oxford.

For the 2012 Reith Lectures he will explore the role of man-made institutions in driving economic and political change around the world.

The first lecture will broadcast on BBC Radio 4 on Tuesday, 19 June at 09:00 BST and will be repeated on Saturday, 23 June at 22:15 BST

The lectures will also broadcast on the BBC World Service.

Is there a constitutional solution to this problem?

The simplistic answer - which has already been adopted in a number of American states as well as in Germany - is some kind of balanced budget amendment, which would reduce the discretion of lawmakers to engage in deficit spending, much as the practice of giving central banks independence reduced lawmakers' discretion over monetary policy.

The trouble is that the experience of the financial crisis has substantially strengthened the case for using the government deficit as a tool to stimulate the economy in times of recession.

Last year, following a German lead, continental European leaders sought to solve that problem by resolving to limit only their structural deficits, leaving themselves room for manoeuvre for cyclical deficits as and when required.

But the problem with this fiscal compact is that only two eurozone governments are currently below the mandated 0.5% of GDP ceiling - most have structural deficits at least four times too large, and experience suggests that any government that tries seriously to reduce its structural deficit ends up being driven from power.

Conservatism ain't cool

It is perhaps not surprising that a majority of current voters should support policies of intergenerational inequity, especially when older voters are so much more likely to vote than younger voters.

Anti-Capitalist protestor from the Occupy LSX movement at St Paul's Cathedral The Occupy Movement has galvanised young political activists all around the world

But what if the net result of passing the bill for baby-boomers' profligacy is not just unfair to the young - but economically deleterious for everyone?

What if uncertainty about the future is already starting to weigh on the present? It seems as if there are only two possible ways out of this mess.

In the good, but less likely scenario, the proponents of reform succeed, through a heroic effort of leadership, in persuading not only the young but also a significant proportion of their parents and grandparents to vote for a more responsible fiscal policy.

Start Quote

We bay for tougher regulation, though not of ourselves”

End Quote Niall Ferguson

As I have already explained, this is very hard to do. But I believe there is a way of making such leadership more likely to succeed, and that is to alter the way in which governments account for their finances.

The present system is, to put it bluntly, fraudulent. There are no regularly published and accurate official balance sheets. Huge liabilities are simply hidden from view.

Not even the current income and expenditure statements can be relied upon in some countries. No legitimate business could possible carry on in this fashion.

Defining Government Deficit

A government deficit occurs when it spends more money than it receives in income.

Cyclical deficit occurs when the economy weakens during a recession and government income falls because of shrinking tax revenues and increased welfare spending.

When the economy improves, the cyclical deficit turns into a cyclical surplus.

Structural deficit is different from cyclical deficit as it occurs no matter how strong the economy is.

It is debt that has come about as a result of government borrowing. Countries are judged on their ability to pay off this debt on the basis of national debt relative to GDP.

If a country's debt-to-GDP ratio gets too high, investors will worry that the government will default on the debt. However, it is debt governments can try to control through lower borrowing, spending cuts and higher taxes.

The last corporation to publish financial statements this misleading was Enron.

There is, in fact, a better way. Public sector balance sheets can - and should be - drawn up so that the liabilities of governments can be compared with their assets.

That would help clarify the difference between deficits to finance investment and deficits to finance current consumption. Governments should also follow the lead of business and adopt the Generally Accepted Accounting Principles.

And, above all, generational accounts should be prepared on a regular basis to make absolutely clear the inter-generational implications of current policy.

If we do not do these things - if we do not embark on a wholesale reform of government finance - then I am afraid we are going to end up with the bad, but more likely, second scenario.

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Western democracies are going to carry on in their current feckless fashion until, one after another, they follow Greece and the other Mediterranean economies into the fiscal death spiral that begins with a loss of credibility, continues with a rise in borrowing costs, and ends as governments are forced to impose spending cuts and higher taxes at the worst possible moment.

In this scenario, the endgame involves some combination of default and inflation. We all end up as Argentina.

There is, it is true, a third possibility, and that is what we now see in Japan and the United States, and maybe also the United Kingdom.

The debt continues to mount up. But deflationary fears, central bank bond purchases and flight to safety from the rest of the world keeps government borrowing costs down at unprecedented lows.

The trouble with this scenario is that it also implies low to zero growth over decades: a new version of classic economist Adam Smith's stationary state, with economic growth slowing throughout the Western world.

As our economic difficulties have worsened, we voters have struggled to find the appropriate scapegoat.

We blame the politicians whose hard lot it is to bring public finances under control, but we also like to blame bankers and financial markets, as if their reckless lending was to blame for our reckless borrowing.

We bay for tougher regulation, though not of ourselves.

The first of Prof Niall Ferguson's 2012 Reith Lectures will broadcast on BBC Radio 4 on Tuesday, 19 June at 09:00 BST.

Three more lectures will broadcast at the same time on June 26, July 3 and July 10. The programmes will also be broadcast on the BBC World Service and will be available to download.

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