2B RED: On public debt, inequality & economic sanctions

Book reviews and musings

As we continue to work our way through the pandemic there are many important economic questions. Some are at the aggregate level — monetary and fiscal policies, asset prices, inflation and the public debt. Others are the benefits and costs of mandates, the impact on business activity and the real costs imposed on so many individuals and families — economic and psychological. But for this column I will have to be selective: I have chosen public debt, inequality and economic sanctions. inequality. Recent books by outstanding scholars address the first two topics.

In Defense of Public Debt

For an up to date, comprehensive and balanced view, it is hard to go past the 2021 book by Barry Eichengreen, Asmaa El-Ganainy, Rui Esteves, and Kris James Mitchener.¹ The publisher describes it as a "dive into the origins, management, and uses and misuses of sovereign debt through the ages". I found fascinating a whole series mini case studies ranging from borrowing by the Greek city-state of Syracuse two thousand years ago; to the default in 1345 by the English King Edward III on loans from Italian bankers to fund war; to the massive accumulation of debt by some Latin American countries. Each case is rich with detail and woven into an overall and consistent analytical perspective. The historical material, occupying over half the book is at once highly readable while reflecting much research and analysis.

At the outset the authors considered they would face an uphill battle to convince readers that profligate spending by governments and the associated debt burdens might ever have real benefits and not only causing harm. Then came Covid and the resultant surge in expenditures on health and propping up the economy led to a surge in public debt. Governments through the ages have borrowed to finance wars, address natural disasters and financial crises. The authors, as their title implies, are unequivocal in their defense of such borrowing.

However, at the same time the authors are very clear about the prerequisites that need to be in place. These include:

• well-functioning liquid, financial markets as "borrowers need willing lenders";

• a political system that has checks on the actions of government;

• a secondary market that allows investors to exit;

• a central bank that can backstop liquidity and provide prudential oversight to ensure the stability of the financial system; and

• a monetary policy that provides credible assurance that the value of their claims on the sovereign will not simply be inflated away.

To these, I would add the need for a system to assess and prioritise public spending so as ensure borrowed funds are invested in productive opportunities, and to minimise waste. It is when these conditions are not met that excessive borrowing can have severe consequences throughout an economy. Such consequences can persist for many years.

Combatting Inequality: Rethinking Government's Role

The recent surge in asset prices and the impact of Covid policies generally has been widely seen as a associated with growing inequality in many countries, not the least in New Zealand. Two of today's outstanding economists, Olivier Blanchard and Dani Rodrik, have edited a volume on inequality that is a "go to" for anyone wanting a rich and detailed coverage of the topic, and what can be done to reduce it.² It is based on papers presented at a 2019 conference held at the Peterson Institute for International Economics. An introductory synoptic view by the editors is followed by 29 chapters by a star-studded line up of scholars.

A key conclusion is that "we need to do something about inequality”, and simply fostering economic growth and removing regulatory barriers will not suffice. The case is made for a more proactive role of the state to close gaps in living standards. The editors provide a useful taxonomy of policies to address inequality. These are arranged by the target group:

• bottom (where poverty reduction is the focus);

• middle (policies to lift the incomes of the middle class); or

• top (reduce the incomes at the top by wealth or inheritance taxes);

and by whether the policy is at the stage of:

• pre-production (e.g. health and education);

• production (e.g. labour market policies); or

• post-production (e.g. transfers and earned income tax credits).

The editors stress that economics alone cannot guide us to the "optimal" policy for each of the 9 cases in their 3x3 matrix. Values and normative judgements are inescapable. Individual chapters address the nature of inequality; its consequences; the political and institutional settings; and provide a wide range of evidence and analysis of potential policies.

Overreliance on Economic Sanctions?

Finally, as I write this post, the Russian “Special Military Operation” in Ukraine continues; and in consequence two countries are being wrecked. As one commentator noted: "For Ukraine this is a tragedy; for Russia it is a catastrophe."

For economists, an interesting question arising from the current conflict is: are economic sanctions effective? In many cases the short answer would appear to be no. There are currently economic sanctions against some 50 countries covering 27% of global GDP. They tend to be implemented sufficiently "softly" — more symbolic than biting — and, like so many regulatory interventions, there is always a seemingly endless supply of creative ways to evade them. Sanctions may also have unintended consequences, and can harm the sanctioning party as well as the sanctioned.

On odd occasions just the threat of sanctions may be enough: the threat by the USA to dump sterling bonds was apparently enough to cool British ardour in the 1956 Suez war.

For a view that leaves no doubt about the futility of sanctions, see the 2020 paper by Richard Hanania at the Cato Institute.³ And from a little further along Massachusetts Avenue, the Foreign Policy program at Brookings hosted a 2020 panel discussion on economic sanctions and their implications for advancing U.S. foreign policy objectives.⁴

Given the speed, severity and coverage of the current round of sanctions, are the chances of success are better than average? Will removing access to financial infrastructure including payment systems, as distinct from just trade embargos, bite much harder? Will the costs imposed on companies in the sanctioning countries prove too much for the sanctions to be politically sustainable? Time will tell, but certainly future scholars studying the efficacy of sanctions will have additional data points.

“Thy rod and thy staff they comfort me”

1. Barry Eichengreen, Asmaa El-Ganainy, Rui Esteves & Kris James Mitchener (2021). In Defense of Public Debt. (New York: Oxford University Press).

2. Olivier Blanchard & Dani Rodrik (2021). Combatting Inequality: Rethinking Government's Role. (Cambridge, Mas.: The MIT Press).

3. Richard Hanania (2020). Ineffective, Immoral, Politically Convenient: America’s Overreliance on Economic Sanctions and What to Do about It. Cato Institute, Policy Analysis No. 884 February 18, 2020.

4. Economic sanctions: Assessing their use and implications for U.S. foreign policy. Panel discussion, Brookings Institution, 27 January 2020.