Different dimensions of debt

Frank Stilwell

Politicians in this neoliberal era are wont to boast of their commitment to the reduction of debt. Peter Costello is now talking of zero debt for the Commonwealth government, thereby effectively eradicating the market for Australian government bonds. Meanwhile, other forms of debt - for housing and credit card purchases - are rising rapidly, apparently with the government's blessing. And the foreign debt continues to pump up the nation's current account deficit, widely regarded as a critical flaw in the performance of the national economy.

Many Australian people are understandably confused by all this. Is debt a problem or not? As a first step to sorting out the issues it is useful to distinguish the different dimensions of debt: personal debt, corporate debt, public debt and foreign debt.

Personal debt

Personal indebtedness typically arises when individuals spend on making purchases in advance of getting the income that would permit them to do so outright. Housing is the obvious example. Those who have not 'chosen their parents (or grandparents) wisely' nearly always need to obtain mortgage finance to purchase a home. The overall level of housing debt has climbed as house prices have escalated in recent years. Credit card debt is also escalating. The total personal debt in Australia now stands at $590 billion, rising by $22 billion in the three months to June 2002 - half of the increase being housing debt.

Whether incurring personal debt is wise depends on a variety of factors. Take the case of a carpenter or other tradesperson, borrowing money to buy good tools or a vehicle, for example. Those purchases enable the carpenter to earn income, to then pay off the interest and eventually, if work is plentiful, repay the principal. Debt in these circumstances is a sensible economic strategy. Indebtedness to finance one's education has a similar logic, as witnessed by the failure of HECS to deter most students from undertaking university study. As for housing debt, people need to make decisions about the relative advantages of rental and purchase, depending on their individual circumstances, interest rates and assessments of future housing price trends and expected future income streams. In other words, whether debt for these purposes is 'good' or 'bad' depends on complex judgements that properly vary from individual to individual.

In practice, the main social concern arising from personal debt is the interest rate burden, which is much higher for credit card debt than housing debt, of course. Going into debt to finance expenditures which have little prospect of generating income is particularly hazardous. Financing addictions to drugs or gambling in this manner is a major social problem. Having to borrow more to repay interest on past borrowings constitutes a disastrous outcome - a 'debt trap'.

Whether personal debt is wise or unwise for individuals, there is no doubt that it is central to the functioning of the economy. The buoyancy of the housing market depends on it. So, more generally, does the capitalist system as a whole. High and rising consumption spending is needed to absorb the economy's vast capacity to produce goods and services. The economic growth process is driven by commercial advertising and substantially financed by debt. It is a process that is enormously wasteful of resources and is not ecologically sustainable. This is the essence of modern capitalism. Peter Costello is not about to challenge that!

This is an era of rampant consumerism in which material aspirations are rising more rapidly than current incomes. It seems that (unlike Sydney Morning Herald commentator Ross Gittins) the people are not aware of the social-psychological evidence that more material possessions do not reliably create happiness! Personal debt has become an integral part of the spiral of want-satisfaction and want-creation, for better or worse.

Corporate debt

Debt incurred by Australian businesses is the second major category of debt. Somewhat similar considerations apply. For individual firms, going into debt may be quite sensible, but some significant macroeconomic consequences may follow.

Any proprietor wishing to expand his or her business more rapidly than is possible simply out of past profits, must consider how to get the finance to do so. Equity finance is one option, but it is one that is often beyond the reach of small businesses for whom the issue of shares incurs too many administrative costs. Equity finance may also lead to a significant loss of the proprietor's control too, depending on whether shareholdings are dispersed or concentrated. Debt is the principal alternative. This may simply involve getting a loan from a bank or, for bigger businesses, the issue of corporate bonds. Such loan finance requires the commitment to make interest payments, whereas equity finance leaves the business with more flexibility about the level at which future dividend payments, if any, will be set.

So choosing between debt and equity finance is a matter of complex judgement. The balance between the two is known as 'gearing'. The gearing ratio (debt to equity) rose dramatically in Australia in the 1980s, which eventually made many businesses vulnerable because of their higher expenditure commitments as interest rates climbed towards the end of the decade. The gearing ratio levelled off in the 1990s but it generally rises with economic growth. It has a major impact on the demand for investible funds and can therefore affect the determinants of interest rates as well as the profitability of businesses. But Treasurer Costello is saying nothing about this either. In a capitalist economy, neoliberals generally adopt a laissez faire position on matters of corporate finance. The pervasive belief is that 'business knows best'.

Of course, whether businesses really do know what is best in practice is far from axiomatic. Sometimes the funds raised through loans (or equity) are unwisely used, even from a narrow profitability perspective. Where the emphasis is on using corporate debt to finance acquisitions, speculative ventures and other financial legerdemain, there may be no productive economic contribution at all.

From a social perspective, the question of 'externalities' also arises. The external effects of private investment decisions may be positive, as where debt finance leads to productive innovations of benefit to the national economy and society, including job creation and export success. On the other hand, externalities may be negative, as in situations where environmental degradation results. Corporate debt is not just a private matter: working people's livelihood and the quality of life depend on how wisely or otherwise it is managed. To adapt the standard cliché (with a touch of irony), there can be no general presumption that 'what is good for BHP-Billiton is good for Australia'.

Public debt

The third debt item is government debt, and this is what is now in the spotlight. Peter Costello's suggestion that it should be reduced to zero is the culmination of a decade of political rhetoric - and a corresponding practical commitment - to debt reduction. Public sector debt, by inference, is a burden on the nation. Indeed, it may be but, like personal and corporate debt, whether public borrowing is wise or unwise depends on the purposes for which the debt is used. There is an added social dimension too because of the essentially collective character of governmental expenditures, whether financed by debt or otherwise.

Governments can finance their expenditure either by taxes or by borrowing, and usually do so by a mixture of the two. The latter has more obvious logic when the form of expenditure involves capital investment, rather than spending on, say, social security payments. In other words, forms of expenditure which enhance the nation's infrastructure, and from which future generations can benefit, are appropriately financed by public debt. That, at least, is the conventional wisdom which neoliberal ideology and practices challenge.

Of course, government borrowing involves a cost - the interest payments on government bonds, for example. That is usually said to be the main reason for seeking debt reduction. But whether the interest constitutes a 'burden' depends upon how it compares with the social benefits arising from the government spending. As in the case of the carpenter's personal debt, the interest payments are not a net burden if the future income-generating capacity is enhanced.

A supplementary concern about public debt is the alleged 'crowding out' effect. Neoliberals say this arises because government borrowing competes with other corporate claimants on the relatively fixed pool of investible funds, thereby driving up interest rates, which leads to less private sector investment. Evidence to support the existence of any such 'crowding out' effect is inconclusive. In practice, there is stronger evidence of 'crowding in' because government spending (for example, on building roads, schools or hospitals) creates additional investment opportunities for the private sector (for example, for road, school or hospital construction companies).

So, as with personal and corporate debt, there are complex arguments about the 'good' and 'bad' aspects of public borrowing. The alternatives always need to be considered. Would financing public investment through higher taxes rather than debt be a better alternative? That option deserves serious consideration. However, it currently seems to have few supporters, as a result of the seemingly widespread belief that higher taxes are a political 'no-no'. But if that option is eliminated, reduced government borrowing means lower capital expenditure. So the deterioration in public infrastructure - in the quality of 'public goods' in general - is a direct consequence of the commitment to debt reduction. Thus the ultimate 'logic' of the neoliberal program is the hollowing out of the public sphere of the economy and society.

Foreign debt

Foreign debt is different. It is a fourth category of debt that cuts across the other three. It is best regarded as a 'slice' through personal, corporate and government debt, rather than an additional type of debt. Thus, to the extent that borrowings by individuals, corporations and governments cause increased indebtedness to individuals, corporations and governments overseas, they add to foreign debt. The overseas borrowings are partly offset by Australian lending overseas, leaving a net foreign debt of currently about $330 billion, roughly equivalent to the total value of goods and services produced in Australia in half a year. The ratio of foreign debt to GDP in Australia is mid-range among the OECD nations. Most of the debt is corporate debt.

The Australian economy has always relied on capital inflow, whether through direct foreign investment or loans. Indeed, it is hard to imagine how the nation could have experienced the capitalist economic development that it has had otherwise. This is not to say that we should be relaxed about this being a permanent state of affairs. In the current era the nation would have the capacity to reduce dependence on capital inflow, if the vast pool of savings in superannuation funds were to be more effectively channelled into productive investment in Australian industry. The creation of a National Investment Fund for that purpose warrants serious consideration. Treasurer Costello will have no truck with any such 'socialist' policy, of course, and even the ALP seems hesitant to embrace it. But mobilising domestic savings for productive investment is the best way to reduce reliance on capital inflow. Meanwhile, over 20 per cent of the super funds continue to be invested overseas, making the need to rely on capital inflow correspondingly greater.

The main problem with foreign debt is the outflow of interest payments that an increased foreign debt generates. For the last two decades this outflow of 'net income' has been the biggest item in the nation's current account deficit. To the extent that this current account deficit constrains the growth of the national economy, that is problematic. It is doubly problematic if it drives economic policy. It has commonly done so, leading governments trying to rein in the deficit to induce recession through their domestic fiscal and monetary policies. Such was the case with the notorious 'recession we had to have' a little over a decade ago. The current government seems to have no idea about how to cope with the situation. The so-called 'twin deficits' thesis, postulating a direct link between the government's budget deficit and the current account deficit, has been discredited. A systematic interventionist industry policy seems politically out of the question. Control of capital flows has been deregulated. So the current account deficit is left to take its own course.

These macroeconomic matters are important consequences of foreign debt, notwithstanding some elements of arbitrariness in how national estimates of debt and deficits are made in an era when 'globalisation' undermines the coherence and integrity of 'national economies'. But these concerns are largely independent of public debt. The foreign debt and the public debt are quite distinct matters, contrary to widespread misunderstanding. This is not to say that there cannot be a link - historically, the individual state governments have been significant contributors to foreign borrowings. However, the lion's share of foreign debt in recent years has been associated with the corporate sector. It is the pattern of corporate borrowing, including the choice between domestic and foreign sources according to the prevailing market interest rates, that is crucial. Government policy regarding reductions in the overall level of public debt is not a major determinant of the outcomes, unless there is a direct and reliable connection between the size of public debt, the level of domestic interest rates and the propensity of corporations to borrow locally rather than from overseas.

Conclusion

Debt matters. It is multidimensional. Each dimension - personal, corporate, public and foreign - involves complex judgements about the desirability or otherwise of incurring particular forms of indebtedness, particularly focusing on the purposes for which the borrowed funds are used and what alternative sources of finance are available.

The different dimensions of debt are also interdependent. How wisely consumers and corporations make decisions about the levels and forms of their indebtedness has significant ramifications for government and its policies of public sector debt management. The capitalist system as a whole is permeated by debt and, as the stewards of the system, governments are necessarily central to its administration. The current government evidently sees no inconsistency in facilitating the growth of consumer debt while warning of the 'burden' of public debt.

From a collective societal viewpoint, judgements need to be made about the broader economic, social and environmental consequences of particular forms of debt-financed expenditures. To reduce all this complexity to a simplistic assertion of the inherent desirability of 'zero public debt' is laughable. Well, it would be laughable if it wasn't so damned serious.


Frank Stilwell is Professor of Political Economy, University of Sydney and a member of the Evatt Foundation's Executive Committee. This is a revised version of his introduction to the Evatt Foundation's Breakfast Seminar - Who's afraid of public debt? - at the Southern Cross Hotel, Sydney, 19 November 2002.


See also:

Suggested citation
Stilwell, Frank, 'Different dimensions of debt', Evatt Journal, Vol. 2, No. 8, December 2002.<http://evatt.org.au/papers/different-dimensions-debt.html>