Governor LePage came to the Midcoast region last week to help dedicate American Legion Post 20 in Brunswick. One of his comments caught the attention of my wife.
As quoted by the Bangor Daily News. LePage said, “And I need to apologize to the children because you are going to be inheriting an $18 trillion debt that you’re going to have to pay because of the decisions of us older folks.”
This is a topic we have taken up on several occasions. This is a topic which we call an economic zombie. This is a topic which will never go away as long as Homo sapiens walk the earth.
We do not pass government debt on to our children. Period! End of story!
In fact, this fallacy has a twin, a mirror image which can go along with it. “Look at all of the interest-paying Treasury securities we are passing on to our children. They are going to inherit all of that wealth.”
Isn’t it odd that we frequently hear the former fallacy of the debt load we are passing on, yet we never hear the other side of the fallacy, namely, that we are bequeathing a treasure chest of Treasury notes to our loved ones? Our debt is money we borrow from ourselves and repay ourselves.
Governor LePage is certainly neither the first nor the last to be confused by this economic zombie myth. He is one among legions who misunderstand this topic.
What do we pass on to our children as far as economics is concerned? How can we tell whether economic policies today will help or hinder future generations? Let us examine a simple framework which, when employed, makes even the relatively uninitiated quite an expert in matters of economics.
One of the most important considerations in discussing economics is to start at the beginning. What is an economy? What are the elements of the engine which produce the goods and services we enjoy?
An economy consists of four fundamental factors which, when combined, bring forth the output we consume. These include 1. labor, 2. capital, 3. natural resources, and 4. institutions.
Labor also goes by the name of “human capital” in economic circles. This is undeniably the most important aspect of our economy. Without people nothing happens.
Capital represents all of the factories, infrastructure, equipment, tools, and so forth needed to produce goods and services. In an advanced economy such as ours, which is categorized by high education and high output, the relative contribution of capital versus labor is on the order of 20 to 80. Labor’s contribution is about 80 percent while capital contributes roughly 20 percent.
Natural resources are self-explanatory. As an example of their importance, consider the recent increase in energy production in the US as a result of the so-called “tight oil.” Our energy costs have plunged to levels envied by nearly all advanced countries. Consequently, many energy-intensive industries, such as steel manufacturing, are migrating back to our soil.
Institutions include the rule of law, the quality of government, the financial system, and so forth. The value of these cannot be overstated.
For example, many of the goods and services we enjoy are produced most effectively by the public sector, also known as the government. Also, the strength and agility of our financial sector determines how efficiently our monetary resources move to create optimal investments, as well as to maintain full employment.
Our institutional arrangements can insure labor enjoys a high degree of mobility to relocate in an efficient fashion. The legal structure can insure the enforcement of contracts and ownership of property. High quality regulation can bring innumerable benefits which enable the economy to run with fewer hiccups and road blocks. The list goes on and on.
Now that we have a clearer idea of these four aspects of an economy, we can begin to cut through the haze to see what things really matter and what things do not as far as what we bequeath to our children and grandchildren.
If something we are doing today has very little impact on one of these four areas, it will have very little impact on our economy down the road. Conversely, if policies today impact one or more of these four areas, it will alter the economic future of our society.
For example, some people have lobbied for the privatization of education. How will this effect our economy? The privatization of education will reduce the quantity of education supplied. It will therefore reduce the average literacy and scholastic achievement, and add an even larger divide which separates the education of the poor from the education of the wealthy.
So how does this effect our economy? It has little effect on natural resources. It may or may not have direct effects on our institutions and capital formation, but it will certainly weaken our labor force, the single most important element of our economic machine.
How about a war? That one is easy. Our labor force is reduced through death, and our capital is reduced if the war is on our own soil.
How about a reduction in public spending on infrastructure such a roads, bridges, and transportation networks? These are part of our capital stock. If we burn through these without replacing, improving and constantly modernizing, we will pass on to our children a very poor capital stock.
How about immigration? Economically speaking, this is an addition to our labor force. As such, we are strengthened by the receipt of new workers as long as the population growth does not happen so quickly as to create distortions. The U.S. population growth rate is in no danger of mushrooming out of control.
We have seen a movement in recent years to shrink our government sector down to a minimum point. What would this do? Turning the production of public goods over to the private sector would cause more resources to be used to generate the same products. As such, less capital would be created. It would also weaken our institutional arrangements.
Now we come back to our famous debt myth. Does our national debt/Treasury securities effect our economy?
High debt or low debt, our labor force is what it is. High debt or low debt, our capital stock is what it is. (Although, there are times in which running a government deficit crowds out businesses from borrowing and there are times when running a government deficit can speed up a recovery and set private sector investment and capital formation back on track.)
High debt or low debt, our natural resources are what they are, and high debt or low debt, our institutions are what they are.
So what do we pass on to our posterity? The answer is clear: education and skills, capital, natural resources, and institutions. Strengthening these bestows an economic bequest upon our posterity.
Next week we return to the international currency questions we began a few weeks back.
(Marcus Hutchins, MA, M. Phil, Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)
