164
not surprising. It reflects what economists call the
shortsightedness effect
(?)
: the tendency of
elected political officials to favor projects that generate immediate, highly visible benefits at
the expense of costs that can be cast into the future and are difficult to identify. Legislators
have an incentive to spend money on programs that benefit the voters of their district and
special-interest groups that will help them win re-election. They
do not like to tax because
taxes impose a visible cost on voters. Debt is an alternative to current taxes; it pushes the
visible cost of government into the future. Budget deficits and borrowing allow politicians to
supply voters with immediate benefits without imposing higher taxes. Thus, deficits are a
natural outgrowth of democratic politics unrestrained by commitment to a balanced budget.
Exhibit 20: Greek General Government Deficit or Surplus as a
Share of GDP, 1995–2017
Deficit
2
0
-2
-4
-6
%
-8
-10
-12
-14
-16
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
11
2
0
1
2
2
0
1
3
2
0
1
4
2
0
1
5
2
0
1
6
2
0
1
7
Surplus
The unconstrained political process plays into the hands
of well-organized interest
groups and encourages politicians to increase spending to gain benefits for a few at the expense
165
of many. For example, each member of a legislature has a strong incentive to fight hard for
expenditures beneficial to his or her constituents.
In contrast, there is little incentive for a
legislator to be a spending “watchdog,” for two reasons. First, such a watchdog would incur
the wrath of colleagues because the spending restraint would make it more difficult for them to
deliver special programs for their districts. They would retaliate by providing little support for
spending in the watchdog’s district. Second, and more importantly, the benefits of spending
cuts and deficit reductions that the watchdog is trying to attain (for example, lower taxes) will
accrue equally to voters in the other districts. Thus, even
if the watchdog is successful, the
constituents in his or her district will reap only a small fraction of the benefits.
Perhaps the following illustration will help explain why it is so difficult for the
parliaments of all countries to bring government spending and the budget deficit under control.
The Verkhovna Rada of Ukraine (parliament of Ukraine) has 450 deputies. Suppose these 450
individuals go out to dinner knowing that after the meal each will receive a bill for 1/450th of
the cost. No one feels compelled to order less because his or her restraint will exert little
impact on the total bill. Why not order shrimp for an appetizer, entrées
of steak and lobster,
and a large piece of cheesecake for dessert? After all, the extra spending will add only a few
pennies to each person’s share of the total bill. For example, if one member of the dinner party
orders expensive items that push up the total bill by €45, his share of the cost will be less than
10 cents (1/450th of €45). What a bargain! Of course, he will have to pay extra for the
extravagant orders of the other 449 diners, too.
But that’s true no matter what he orders. The
result is that everyone ends up ordering extravagantly and paying more for extras that provide
little value relative to cost.
(62)
The incentive structure outlined here explains why deficit finance is so attractive to
politicians. During the seven-year period 2008–2015, E.U. members’ deficits
pushed up the
E.U. debt by more than 30 percentage points as a share of GDP. Moreover, the benefits
promised to senior citizens under the social protection programs are far greater than the payroll
tax revenues that provide their financing. These unfunded liabilities are another form of debt.
Social protection represented the largest area of general government expenditure in 2016 in all
E.U. member states (the largest was in Finland—25.6 percent of GDP).
(63)
As the proportion of
the working population shrinks and the number of those retired expands,
(64)
spending on social
166
protection will outstrip the revenues for financing it, further complicating the debt liability of
the federal government.
What will happen if the E.U. member governments do not bring their finances under
control? As a nation’s debt gets larger and larger relative to the size of its economy, there will
be repercussions in credit markets. Extending loans to the government of a country with a large
ratio of debt to GDP is risky.
As a result, the highly indebted government will have to pay
higher interest rates. In turn, the higher interest costs will make it even more difficult for the
government to keep within its budget and keep taxes at reasonable levels.
If the debt continues to rise relative to income, investors will become more and more
reluctant to buy the bonds issued by the country’s treasury. Eventually a financial crisis will
result—either outright default by the government or financing the debt by money creation and
inflation. In either case, there will be a destructive impact on the economy. This has occurred
in other countries such as Greece that have failed to control government finances. No country
is immune to the laws of economics.
It is vitally important for all governments to control their spending and borrowing in
the years ahead. This is unlikely to happen without a change in the political rules to make it
more difficult for politicians to spend more than they are willing to tax. There are several ways
this might be done. The constitution could be amended to require a government to balance its
budget, as Georgia’s government is required to do. Or the current year’s
spending might be
limited to last year’s level of revenues. Proposed constitutional rule changes of this kind would
make it more difficult for legislators to spend unless they were willing to tax or to charge users
for the government services.
