Cold Hard Wonk

No sentiment but politics

Unintended Consequences

Posted by JJ in Golden Tacks (Wednesday January 31, 2007 at 10:33 pm)

Unsure how to respond to growing inflation and stagnant economies in the 1970s, governments ramped up spending, amassing significant public debt. These liabilities became the rallying cry of a reborn conservatism when the programs they had funded failed to boost the economy.

There was a new wisdom: government should not spend beyond its means. Which, in common understanding, meant that borrowing should be eliminated as a feature of annual budgets.

Which conclusion puts governments in a unique fiscal position. Both individuals and businesses borrow money. Businesses in particular pride themselves on being able to “leverage” their assets by borrowing against them. Where the money borrowed can be profitably invested in other ventures, leverage can be a prudent way of getting more done with fewer resources. Individuals can do the same thing, borrowing against their homes for the money to invest elsewhere. It can be a risky approach, but so long as the benefit from the new investment is at least equal to the cost of borrowing, you’re no worse off.

Governments can have an advantage when it comes to leveraging assets. They can borrow funds at extremely low rates. And while it can be hard to value the benefit from investments in health care or the environment, many public projects, like roads and power generation can be profitably funded by issues of public debt. Some spending on borrowed money can, therefore, be just as effective and sensible for government as it is for private businesses.

But an unreasonably simplistic aversion to deficits continues, ignoring the purpose of intended borrowing. This is why those governments who attempt to leverage do so most often through bond issues tied to the projects in question. It provides additional security for the public, at no greater costs than the political and potentially lengthy delay.

Issues of bonds don’t generally qualify as leverage, since repayment is usually pledged against future income rather than existing assets. In the case of specific infrastructure projects, bonds can qualify as leverage.

Meanwhile, refurbishing assets, the bedrock of genuine leverage, is not so easily accomplished. Rather than incur the costs of renovations (owing in part to negligent maintenance), the Canadian government is preparing to sell buildings.

Is it clear that the cost of leasing back the space and reducing annual financing costs would be less than financing the refurbishing costs? Not necessarily. Is it clear that repaying net debt with the proceeds of such a sale would produce a greater reduction in annual financing costs than using the same proceeds to invest in infrastructure and programs? Not at all. Is it clear that debt repayment would be the public’s preferred choice? Yes.

Which means that years of demanding that the government be run “like a business” have ensured this above all: that it won’t be.

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