Abstract: With the modernization of public finance, public debt has promoted economic development and social service provision and acts as an important financial vehicle to regulate the economy. To fulfill the role of finance to promote innovation and common prosperity, China needs to use public debt more actively and appropriately. Public finance and debt play a crucial role in solving elderly care problems and promoting intergenerational equality. While achieving policy objectives with public debt, it’s important to reduce the potential adverse effects of public debt and maintain debt sustainability. The positive role of public debt in promoting economic growth, social service provision, and equality deserves our attention, especially when viewed dynamically. If the increased debt now enhances future economic growth by promoting fertility and improving public services, the debt will become more sustainable.
Since 2022, the CICC Global Institute has launched a quarterly macroeconomic seminar series, inviting domestic and international academics and policymakers to engage in in-depth discussions on major macroeconomic and policy issues over the medium to long term. The first seminar, held on March 26, 2022, focused on financial policy and government debt in a changing economy, with Barry Eichengreen as the keynote speaker, which became an opportunity for the CICC Global Institute to collaborate on the translation and introduction of his new book In Defense of Public Debt.
In Defense of Public Debt reviews the origins of government debt and the development of the mechanism from a historical perspective, including the history of sovereign debt and defaults, the construction of debt servicing and enforcement, and the rise of the modern financial market. Based on the above organization, this book focuses on the positive effects of public debt.
With the modernization of public finance, public debt has promoted economic development and social service provision and acts as an important financial vehicle to regulate the economy. In a downward economic cycle or when the economy encounters major shocks, it is possible to promote aggregate demand growth by reducing taxes and increasing transfers through raising debt. For example, in response to an unseen pandemic in the past century, governments increased debt to support affected enterprises and individuals, which manifested the function of social insurance and helped prevent the economy from going into “shock” and undermining growth potential.
Furthermore, the authors of this book also point out how governments provide social insurance and transfer payments through debt, such as investing in school buildings, libraries, and hospitals, and financing workers’ compensation, unemployment, and pension insurance, enabling society to adapt to the functioning result of the market economy. In other words, governments are not only the night watchmen of the market but also the mediators of the outcome of economic distribution. Public debt expansion enables most people to benefit from economic growth, which is enlightening for solving China’s realistic problems.
Currently, China is in a new stage of development, and high-quality development requires innovation to promote economic growth and achieve shared prosperity, calling for an increase in financial transfer payments. Expenditure on public services and security, such as education and healthcare, is a significant aspect of helping low-income groups, reducing the risk of class solidification, and promoting fairness, especially as the equalization of public services reduces urban-rural and regional disparities. Meanwhile, in an increasingly critical knowledge-based economy, increased investment in intangible assets such as research and development (R&D) has positive spillover effects on private enterprises and enhances overall productivity; investment in childcare and early education is conducive to enhancing the skills, competitiveness, and productivity of the future labor force.
The role of public policies in a market economy can be categorized into two types: first, public policies regulate the behaviors of market players in competition through laws, rules, and policies. Second, the government directly provides products and services, such as national defense, research and development, and public services. The first refers to the role of the aforementioned policies in market distribution; the second is a financial role through taxes and debt issuance, which is a secondary distribution. An important function of finance is regulating income distribution. Finance can also act as an automatic stabilizer and counter-cyclical adjustment. Therefore, to fulfill the role of finance to promote innovation and common prosperity, China needs to use public debt more actively and appropriately.
Take China’s current relatively prominent aging problem as an example. Public finance and debt play a crucial role in solving elderly care problems and promoting intergenerational equality. Elderly care is relevant not only to the elderly but also to the young. The pension mechanism is, in essence, a financial arrangement concerning multiple generations, namely, the participation of the elderly, through their ownership of assets and equity, in the distribution of “cakes” produced by young people. One of the most popular global mechanisms for financial arrangements for the elderly is the government-led and socially coordinated pay-as-you-go system, such as China’s social security system. However, almost all countries facing the aging problem have a social security gap for the simple reason that aging leads to an increase in the number of people receiving elderly care security but a decrease in the number of people contributing to it.
How can we bridge the social security gap for the elderly under the pay-as-you-go system? This is a problem faced by countries like China, the United States, Europe, and Japan.
There are two ways to bridge the gap, and they have different macroeconomic implications. The first is a financial subsidy, namely, to expand the fiscal deficit and public debt to close the gap in pension payments. This approach promotes consumption and economic growth and brings upward pressure on prices. It lowers financial asset valuations but improves corporate earnings. The second is the increase in social security contributions or the reduction in social security conditions. This approach is detrimental to consumption, leads to a downward spiral in the economy and prices, and deteriorates corporate earnings but supports financial asset valuations.
The different ways of responding to the social security funding gap also have important implications for income distribution. First, a socially coordinated pension system is inherently similar to transfer payments and is conducive to narrowing the income gap. The larger the gap is, the stronger its function of regulating income distribution is. That is to say, reducing the gap by increasing contributions or lowering pension expenditures may lead to a decline in the effectiveness of social security in regulating income distribution.
To put it another way, from the perspective of the impact of funding sources, increasing social security contributions is mandatory and will generally reduce the disposable income of residents, causing a greater impact on low- and middle-income households. However, the purchase of government bonds is voluntary, generally by institutions and wealthy households. Therefore, closing the social security gap by expanding the fiscal deficit and public debt helps close the income gap, while increasing social security contributions widens it.
Overall, from the perspective of economic growth and equality promotion, narrowing the social security gap through financial expansion seems to be a relatively favorable way. This is in line with the book’s conclusion, and thus the results of a functioning market economy become more acceptable to most people.
Of course, recognizing the positive effects of public debt is by no means blind to its potential harm. The book also points out that governments’ inappropriate use of public debt may lead to adverse consequences, such as delaying financial reforms, over-indebtedness, and even the “crowding out” of productive investment from the private sector.
A common concern about government debt is that it is too large, unsustainable, and detrimental to long-term economic development, which explains some people’s pessimistic view about public debt. Therefore, while public debt is actively used to achieve policy objectives, it is also significant to reduce its potential negative impacts and maintain debt sustainability.
For example, when narrowing the social security gap through the expansion of public debt, debt sustainability can be considered through the lens of intergenerational distribution. In China and European and American countries facing aging problems, a growing social security gap has become the biggest argument against the current financial expansion. However, government debt is different from private sector debt in that the government can maintain an orderly roll of debt through taxation or money printing. To put it simply, bonds issued by the government are assets of the current generation and liabilities of the next, and an increase in public debt is equivalent to redistribution between generations. Therefore, the key to assessing whether the expansion of public debt is sustainable is whether it is fair to increase the burden of debt servicing on the next generation. We can think of two ways to maintain intergenerational balance.
First, through technological progress. Technology in 20 or 30 years may solve today’s debt problem, which means that the cake is made bigger, and the distribution between the two generations is no longer a zero-sum game, so the expansion of public debt is relatively sustainable.
If technological progress is insufficient, the second way is through inflation. In other words, the government prints money to dilute its debt, leading to a rise in inflation and interest rates and a fall in financial asset valuations. In this way, while the older generation benefits from the distribution through social security, the value of its financial asset holdings falls, giving way to the next generation, and debt sustainability is likewise assured. Notably, social security is beneficial to the lower- and middle-income classes, whereas the fall in the value of financial assets mainly affects the affluent. In this sense, a balanced approach that relies on public debt expansion helps reduce the gap between the rich and the poor and is also sustainable.
To summarize the above discussion on debt sustainability, a comprehensive macro perspective is to compare the interest rate on the national debt (i), which is the cost of funds in finance, and the economic growth rate (g), which represents the growth of the tax base. If i < g, the given debt size will converge in the future, or the debt is dynamically effective. Historical experience shows that for most countries, the cost of finance is less than the economic growth rate, and China is no exception. Meanwhile, studies show that the return on capital (R), which is the sum of the interest rate of national debt (i) and the risk premium, is greater than the economic growth rate (g), leading to a decrease in the share of labor income, which is an important reason for the widening of the income gap [1].
Government debt can be efficiency-enhancing and equity-friendly if it promotes long-term economic growth while reducing the risk premium for society.
Similar to the previous discussion, a more obvious example is that the government sector increases public goods that the market cannot provide effectively, such as education, healthcare, and basic research. In the face of an aging population, the public sector increases debt to encourage childbearing and reduce the burden of childcare. In this way, more children become part of the labor force 20 years later, bringing economic growth that can repay the debt.
Another example is related to reducing the potential adverse effects of public debt, that is, to reduce risk premiums and abnormally high rates of return on capital based on the regulation of financial mechanisms. For instance, the issuance rates of China’s municipal investment company bonds are generally higher than those of national and local bonds. Converting implicit government debt to explicit can effectively reduce financing costs and promote efficiency and equality.
In conclusion, the positive role of public debt in promoting economic growth, social service provision, and equality deserves our attention, especially when viewed dynamically. If the increased debt now enhances future economic growth by promoting fertility and improving public services, the debt will become more sustainable.
The historical experiences and issues about public debt in this book are relevant to China’s current realities. It is hoped that the translation and publication of this book will stimulate thinking on public debt and contribute to the discussion of related public policies.
Note：[1] Piketty, T. (2014). Capital in the twenty-first century. Harvard University Press.
This is the author’s foreword to the Chinese version of the book In Defense of Public Debt. The views expressed herewith are the author’s own and do not represent those of CF40 or other organizations.
