Home   »  Issues  »  Rights in Crisis  »  Fiscal Fallacies

Fiscal Fallacies: 8 Myths about the 'Age of Austerity'

Myth #3: But deficits are problematic. Just like individual households and companies, governments must live within their means.

Just as families and firms need to live within their means to avoid the scourge of financial condemnation, so too—this misplaced assumption goes—must governments be constrained in the same way as the rest of us. Relying on borrowing to spend too easily opens the door to insurmountable levels of debt and even government default, with very real human and economic consequences. Living better today, this myth asserts, should not come at the expense of our children tomorrow.

Did you know?

Public deficit financing, in fact, is not at all like individual household or company debt. As elegant as it sounds, national governments don’t have the same types of financial constraints as households or companies. The simple analogy between sovereign governments on the one hand, and households and companies on the other is based on some misunderstandings about how modern monetary policies generally work.

First of all, government creditors cannot simply break up governments and sell their assets to recover any losses, as other types of creditors can. This means at the end of the day a government almost always has the upper-hand in debt negotiations. Second, businesses and households obviously do not control the money supply—an authority we vest only in sovereign States, and in some cases groups of States like the EU. And lastly, several common-place flexible financing practices of modern central banks are simply unavailable to family and business planners. They can and often do “create” money at their central banks, for example, use this money to buy bonds from their finance ministries, and in turn those ministries use the money from the bond sales to finance their deficits. The interest that is paid to the central banks which purchased the bonds is then refunded to the finance ministry at the end of the year, thereby generating resources for governments to use to finance their deficits. This approach has long been widely used by Japan, the US and many other countries. While common among most modern central banks, this type of flexible financing by national governments is something that individual households and companies obviously cannot do.

Deficit financing in moderation is, in fact, a standard and important economic policy tool which has allowed governments worldwide the ability to maximize resources and invest in current and future human and economic potential. Like any tool, there are certainly risks of abuse. Excessive deficit financing can burden governments and their people with unsustainable levels of debt which eat up space in national budgets which could be better used to invest in economic, social or infrastructure programs. Prolonged deficit financing can also produce inflation when an economy is operating at or near full capacity or employment. The risk of inflation, however, is very low during economic slumps when there is a large amount of underused capacity in the economy (factories sitting idle, investment capital not being used by companies, etc.), high levels of unemployment, and general deterioration in the productive and human potential in the economy.

The two most important factors to successful, sustainable and equitable deficit financing is the interest rate at which governments borrow, and the purposes for which the deficit spending is used. First, on interest rates. The main way governments borrow money is by selling bonds to be repaid at a later date. Debt servicing in the future is not a problem as long as interest rates on borrowing remain low. Some of the wealthiest nations of the world, with the highest standards of living, often go for decades at a time servicing very large national debts. Belgium’s outstanding national debt, for example, is valued at almost 100 percent of its GDP, and Japan, the global leader today in deficit spending, currently has a debt-to-GDP-ratio of 226 percent. Yet these remain strong economies with high standards of living, and relatively low interest rates. While there is some evidence that countries with high debt grow slowly, new empirical studies show that this is far from a causal phenomenon. It may well be that slow growth causes high debt.

Secondly successful and sustainable deficit financing often improves future economic productivity, and therefore more than pays for itself over time through increased tax revenues. You see, not all deficits are created equal. High levels of deficits developed to invest in long-lasting social, economic and cultural assets in one place are not the same as deficits incurred to no end in another. The real issue determining the sustainability of a country’s debt, in other words, is the end-use of government expenditure. Government borrowing is sustainable if it is used to finance investment, and if the rate of return on such investment is greater than the interest rate payable. Therefore, debt used sensibly and productively over the long term to create things of increasing value into the future (especially investments in human and other productive assets) can boost productivity and growth.

Deficit hawks like to argue that the pain inflicted by austerity measures in the short-term will provide real long-term gains by controlling deficits and instilling confidence in financial markets. They argue that future generations should not suffer from our current government largesse. But this myth misses a key part of the picture. The social, economic and political well-being of future generations depends on the type of society, economy, and government which we build now—one which has progressively invested in essential educational, health, housing and decent work programs, or one which is permanently under-resourced, under-capitalized, and crippled by the downward spiral of deepening deteriorations of physical, technological and, perhaps most importantly, human capabilities.

Human rights responses

If governments engage in deficit spending to achieve higher levels of decent, well-paid employment, equitable economic growth and thus increased tax revenues over the longer run, and do so at affordable interest rates, then there is no reason why the actual level of deficit spending (as a per cent of GDP) should in itself be a problem. Targeted, transparent and accountable deficit financing in this respect shouldn’t be seen as shameful, but taken for what it is: an essential tool in maximizing the resources available for the fulfillment of human rights. In one way, then, governments are like households—they need to weigh both sides of their balance sheet. Deficit financing creates liabilities and assets. The real question is what you get for what you spend. Governments which borrow to invest in programs with a real return in social, environmental or economic terms are doing a service to their people, just like a family who takes out a loan to put their child through school or pay for a life-saving medical procedure. Generating resources to efficiently and equitably invest in people—through education, healthcare, social services and other fundamental human rights—and the environment can boost the overall human, economic and ecological assets of the economy, essential for both increased productivity and human dignity.

This briefing can be accessed in pdf format here.