We all know too well that countries borrow, but should they? To answer this question requires knowing why different sectors borrow. It is not solely to have more money to spend. In the case of government it is to provide services that their citizenry want. In this regard, the government sector differs from the business sector in one significant way. The business sector borrows to make a profit. The government sector does not make a profit. The motivation in the government sector is to meet a request from their citizenry. Governments react like harried parent in a Toy 'r Us at Christmas time. Governments do not evaluate whether they can afford the gift, they just make the purchase and look for a lender to support their extravagance.
The profit factor is key in answering the question of whether governments should borrow. A profit provides the monetary resources to repay a loan. Since a government does make a profit they should not borrow. A government will not have the resources to repay the loan.
I can hear you stammering, but, but .... The fact of the matter is Governments are different from businesses. Borrowing is the vehicle that drives business. Business borrows, because it is just another way to increase their profits and acquire more wealth. Borrowing is central to business activity and one of the primary ways wealth is created in a society. It is not something that should be used by the government sector.
I can hear you arguing that government borrowing is older than business. Originally, government borrowing was for waging wars and capturing territory. This activity (tribute or tax revenue) is the equivalent of profit in the business sector. When a government undertook this risky activity borrowing made sense, because the hope was funds would be generated to repay the lenders. But in the modern world governments rarely seek additional territory to replenish their Treasuries.
Most borrowing by the government sector is for providing things for their citizenry: clean water, roads, good schools, social services, health care, etc. None of these activities when managed by unrestrained government bureaucracies provide a revenue stream sufficient to repay the cost of borrowing. Consequently, they should not be undertaken by the government sector.
You are starting to see the light. Yes, all these activities can be managed by the business sector. Business management is efficient and controlled by market factors that ensure a profit and an ability to repay the loans.
Why do governments undertake to provide all these services? It is simply to ensure their citizens provide tribute or taxes.
Showing posts with label Borrowing. Show all posts
Showing posts with label Borrowing. Show all posts
Friday, April 13, 2012
Wednesday, March 14, 2012
Can Borrowing create Wealth?
Most countries in the developed world are trying to cross a debt high wire. Today, their ability to balance on the wire is essential to the financial stability of the world. How did all these countries get into such precarious positions? Largely, the blame can be assigned to borrowing. Such an obvious assertion does not explain much.
We need to go further back and understand why each country began borrowing. Unfortunately, the answer is simply, because there were lenders willing to loan money. No country evaluated their capacity to repay the loans. Political leaders depended on the lenders to evaluate their country's capacity to repay the loans. This task was done about as competently as the risk evaluations of subprime bonds. In fact, there is a parallel between subprime borrowers and Finance Minister borrowing. Both assumed the willingness of a lender to give them money implied they must have the capacity to repay the loan. In both cases this was a flawed assumption. The lender was not evaluating their capabilities, but only the quality of the collateral in the case of subprime borrowers and the implicit gurantees of repayment in the case of sovereign borrowers. Each evaluation only scratched the surface of what needed to be evaluated.
Risk Managers of subprime lenders did not look at the stability of the entire market. Their focus was only on the specific property. Risk Managers of Sovereign lenders did not look at the competing demands of tax revenues, but only whether a "guarantee" was implied. No one probed into whether the guarantee could be fulfilled. The Global Debt Crisis is largely a result of sloppy lazy work by all sides.
Even so, the negative consequences of this laziness might have been avoided if the borrowers and lenders had made loans that made sense. What is a loan that makes sense? It is a loan that generates sufficient revenue to repay the principle and interest. What kind of loan is that? The simplest example is a toll road that will generate enough income to repay principle and interest. Very few public expenditures meet this standard.
Let's review some of the more common public expenditures that get countries in trouble. All defense borrowing is of this type, but there are others. Surprisingly many of the most egregious examples are the funding of education. Most of the developing countries in the Middle East are using funds from their oil rich brethren to educate their populous. Admirable, but once educated these graduates cannot find jobs. Consequently, the poor countries hire many of them in "make work positions" funded with precious tax revenues insufficient to pay their salaries and meet the principle and interest payments for the colleges and universities funded with borrowed funds. This is a classic example of loading the camel before having a market destination to travel to. Development of the private sector must proceed the education of the employee.
In N Theory the requirement of being able to repay a loan is the Finance Rule. Failure to consider the Finance Rule when making a borrowing or lending decision ends in a Debt Crisis. Escaping from a Debt Crisis after the fact is extremely difficult as we are learning. Every country should make the Finance Rule part of their governing documents.
We need to go further back and understand why each country began borrowing. Unfortunately, the answer is simply, because there were lenders willing to loan money. No country evaluated their capacity to repay the loans. Political leaders depended on the lenders to evaluate their country's capacity to repay the loans. This task was done about as competently as the risk evaluations of subprime bonds. In fact, there is a parallel between subprime borrowers and Finance Minister borrowing. Both assumed the willingness of a lender to give them money implied they must have the capacity to repay the loan. In both cases this was a flawed assumption. The lender was not evaluating their capabilities, but only the quality of the collateral in the case of subprime borrowers and the implicit gurantees of repayment in the case of sovereign borrowers. Each evaluation only scratched the surface of what needed to be evaluated.
Risk Managers of subprime lenders did not look at the stability of the entire market. Their focus was only on the specific property. Risk Managers of Sovereign lenders did not look at the competing demands of tax revenues, but only whether a "guarantee" was implied. No one probed into whether the guarantee could be fulfilled. The Global Debt Crisis is largely a result of sloppy lazy work by all sides.
Even so, the negative consequences of this laziness might have been avoided if the borrowers and lenders had made loans that made sense. What is a loan that makes sense? It is a loan that generates sufficient revenue to repay the principle and interest. What kind of loan is that? The simplest example is a toll road that will generate enough income to repay principle and interest. Very few public expenditures meet this standard.
Let's review some of the more common public expenditures that get countries in trouble. All defense borrowing is of this type, but there are others. Surprisingly many of the most egregious examples are the funding of education. Most of the developing countries in the Middle East are using funds from their oil rich brethren to educate their populous. Admirable, but once educated these graduates cannot find jobs. Consequently, the poor countries hire many of them in "make work positions" funded with precious tax revenues insufficient to pay their salaries and meet the principle and interest payments for the colleges and universities funded with borrowed funds. This is a classic example of loading the camel before having a market destination to travel to. Development of the private sector must proceed the education of the employee.
In N Theory the requirement of being able to repay a loan is the Finance Rule. Failure to consider the Finance Rule when making a borrowing or lending decision ends in a Debt Crisis. Escaping from a Debt Crisis after the fact is extremely difficult as we are learning. Every country should make the Finance Rule part of their governing documents.
Subscribe to:
Posts (Atom)