by One of the ideas raised by the yellow vests is the possibility of a referendum on the cancellation of the public debt. For some, this type of proposal, already heard in Italy, demonstrates the extent of the ‘populist’ danger: how can one possibly imagine not repaying a debt? In reality history shows that it is customary to resort to exceptional solutions when the debt reaches this type of level. However, a referendum would not enable us to solve such a complex problem. There are numerous ways of cancelling a debt, with very different social effects. This is what should be discussed instead of leaving these decisions to others and to the forthcoming crises. To ensure that everyone can make up their minds, I am going to give two sets of information here. The first concerns the present
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One of the ideas raised by the yellow vests is the possibility of a referendum on the cancellation of the public debt. For some, this type of proposal, already heard in Italy, demonstrates the extent of the ‘populist’ danger: how can one possibly imagine not repaying a debt? In reality history shows that it is customary to resort to exceptional solutions when the debt reaches this type of level. However, a referendum would not enable us to solve such a complex problem. There are numerous ways of cancelling a debt, with very different social effects. This is what should be discussed instead of leaving these decisions to others and to the forthcoming crises.
To ensure that everyone can make up their minds, I am going to give two sets of information here. The first concerns the present European regulations; then I will turn to the way in which debts of this size have been dealt with in history.
Let’s begin with the European regulations which are not well known and have generated a certain amount of confusion. Many people continue to refer to the ‘3% rule’ and do not understand why Italy, which was considering a deficit of 2.5% of GDP, before agreeing to a compromise of 2%, has been blacklisted. The explanation is that the Maastricht Treaty (1992) was amended by the new budgetary treaty adopted in 2012. Its real name is the Treaty for Stability, Coordination and Governance (TSCG). This text stipulates that henceforth the deficit must not exceed 0.5% of GDP (Article 3), with the exception however of the countries whose debt is ‘significantly less than 60% of GDP’ in which case the deficit can rise to 1%. Barring ‘exceptional circumstances’ the non-observance of these rules leads to automatic penalties.
We should point out that the deficit targeted by these texts is always the secondary deficit, that is, after payment of interest on the debt. If a country has a debt equal to 100% of GDP and the interest rate in 4% then the interest will be 4% of GDP. To achieve a secondary deficit limited to 0.5%, a primary surplus of 3.5% of GDP is required. In other words, taxpayers will have to pay taxes which are higher than the expenditures benefitting them, with a difference of 3.5% of GDP possibly for decades.
The TSCG approach is not illogical: if we choose not to cancel the debt, and if we have almost zero inflation and limited growth, then only huge primary surpluses can reduce debts in the range of 100% of GDP. However the social and political consequences of this type of choice have to be considered.
Although they have been reduced by the unusually low rates which will perhaps not last forever, at the moment interest payments stand at 2% of GDP in the Euro zone (the average deficit is 1% and the primary surplus 1%). This amounts to over 200 billion Euros per annum, which one can compare for example with the miserable 2 billion per annum invested in the Erasmus programme. This is a possible choice, but are we sure that it is the best one to prepare for the future? If similar amounts were devoted to training and research, then Europe could become the leading pole of innovation at world level, ahead of the United States. In Italy, the interest payments represent 3% of GDP, or 6 times the budget for higher education.
What is certain is that history shows that there are other ways of proceeding. One example often quoted is the big debts of the 20th century. Germany, France and the United Kingdom all found themselves with debts ranging from 200% and 300% of GDP in post-World War Two which have never been repaid. Their debts were written off in a few years by a mix of cancellation pure and simple, inflation and exceptional taxation of private property (which is the same thing as inflation, but is more civilised: the rich can be made to pay more and the middle class protected). The German external debt was frozen by the London Debt Agreement in 1953, and then definitively written off in 1991. This is how Germany and France found themselves with no public debt and able to invest in growth in the years 1950-1960.
However, the most relevant comparison is the Revolution in 1789. The Ancien Régime was unable to force its privileged classes to pay taxes and had accumulated a debt of approximately one year of national income, even a year and a half if the sale of charges and offices (official posts and functions) are included (these were a way for the State to obtain money immediately in exchange for the future revenue to be collected from the population). In 1790, the Assembly obtained the publication of the list of names in the Grand livre des pensions which contained both annuities to courtiers, as well as payments to former senior officials, with payments ten or twenty times higher than the average income, which created a scandal (the comparison with the salary of the President of the National Commission for Public Debate springs to mind). It all ended with the setting up of a somewhat fairer form of taxation and above all, the bankruptcy of two-thirds of those named and a major inflation of the assignats or promissory notes.
In comparison the present situation is both more complex (each country holds a part of the debt of the others) and more simple: we have, with the ECB, an institution which enables us to freeze debts and we could adopt a fairer system of European tax system by finally setting up a sovereign Assembly. But if we continue to explain that it is impossible to make the richest Europeans pay and that only the immobile classes have to pay, then inevitably we run the risk of facing serious rebellions in the future.
PS. On current debt interests and primary surplus in the euro zone, see Economic Bulletin ECB December 2018, p.36, Chart 27, and p.S23-S25. On the schedule of Italian debt interest payments, see Italy Governement Securities, Debt Service (ECB Statistical DataWarehouse)
PS2. On the history of debt in 18th-20th centuries, see for instance Capital in the 21st century, 2014, chapters 3-5; for complete series, see this article published in QJE 2014 and its appendices.