Gonzalo Lira: Why Democracies Will Always Go Bankrupt

Thursday, January 13, 2011
Why Democracies Will Always Go Bankrupt
When I was growing up, finance was mother’s milk to me, especially as I was a bit of a math geek. But for my formal education, I was trained—rather rigorously, and in spite of my laziness—as a philosopher and a historian. This odd combination is why I have such a jaundiced view of economics: I don’t find economics particularly intimidating, or even particularly challenging—it’s just finance’s snooty but poor (and slightly daft) older cousin. History’s surprisingly ignorant and blinkered accountant. Philosophy and Math’s lightly retarded, Puritanically rigid, and altogether rather embarrassing spawn.

Now, it’s all good and fine for me to rant about how useless economics is—but these aren’t empty complaints on my part: I can point to a single, specific, monumental failing of economics—a failure in the discipline which pretty much proves my point:

The United States is going bankrupt—and economics cannot explain why.

In fact, a surprisingly large number of economists choose to ignore the problem of America’s looming bankruptcy altogether; or claim there is something called a “structural deficit” (a highfalutin way of pretending that it cannot be fixed, and therefore doesn’t need fixing); or else—as is the case of the fools backing Modern Monetary Theory—they make the claim that all deficits are just debts the government owes itself, so therefore the American government cannot go broke, so therefore—and let’s ring out the QED—the fiscal over-indebtedness is actually not a problem because it doesn’t even actually exist!

They really do claim that. And no, they are not high.

Of course, sovereign over-indebtedness does exist, and it is a problem—a terrible, life-or-death problem: As a lot of historians have pointed out, sovereign bankruptcy presages and ushers the collapse of great nations—often violent collapse. And this is something we want to avoid, no?

Some schools of economic thought recognize that deficits are bad because they lead to bankruptcy, and that therefore fiscal budgets should be balanced so as to avoid them. But they do not explain why this is the case—they have no argument to explain why deficits happen in the first place. That these clever Austrians point to something that has happened before, and therefore infer that it will happen again if similar conditions are met is not an argument—it is an observation, like saying that the sun has risen countless times in the east, so it will likely rise again in the east tomorrow morning.

This is a true observation—but it doesn’t explain why the sun will rise tomorrow in the east. Since the Austrians cannot explain why deficits happen and eventually lead to national bankruptcy, they are simply positing them, much like tenets of a religion. These arguments might appeal more to our experiences in the real world—especially when compared to the a priori drivel of Neo-Keynesians, Monetarists, MMT weenies, and their ilk: Peddlers of arguments as unsound as atonal clamor. But a posteriori arguments based on intuition and “common sense”—gussied up in German though they may be, and attractive though we may find them—are of no help, because they are based on faith, not reason.

If anything has to be taken on faith—if it can’t be analyzed, its premises scrutinized, and the overall argument judged to be sound or unsound—then it’s really no argument at all.

I have the argument that explains why fiscal deficits happen. Moreover, I can explain why fiscal deficits occur in a democracy in a manner which is different from any other sort of regime. My theory can explain why fiscal debts in a democracy grow once they start, and I can explain why this growth in debt inevitably, inexorably leads to the bankruptcy of the democratic regime. Further, I can prove—by sound and valid argumentation—that the United States is going bankrupt right now because of this process.

It’s an overall concept I’ve designated as the Democratic Bankruptcy Paradox: The paradox by which every democracy eventually goes bankrupt—regardless of the people’s will and intention of keeping it from going bankrupt.

That’s why it’s a paradox: The citizens of a democratic state are supposed to control its destiny. They obviously do not want their nation to suffer bankruptcy—yet in spite of their will and intent, democratic states always go bankrupt. Always.

This post will outline my proof of why this is so.

I will first explain the logic of my Democratic Bankruptcy Paradox theory, and how it is derived from a rather recently articulated problem in philosophy called the discursive dilemma, or sometimes the doctrinal dilemma; an aspect of group agency that has been used primarily in legal theory, but which I’ve realized has some fairly interesting—and radical—applications to macro-economics and public finance in representative democracies.

I will then explain how the discursive dilemma, when applied to macro-economics and fiscal policy in a democratic regime, leads to the Democratic Bankruptcy Paradox. It is here that I will prove two general conclusions:

• One: Democracies always act in a fiscally incoherent manner.

• Two: Democracies always go bankrupt—without exception.

Finally, I will show how my Democratic Bankruptcy Paradox theory applies to the American case, and explain why the U.S. governments at the local, State and Federal level spend more than they bring in—even as their citizens uniformly oppose this state of affairs.

So, let’s begin:

The discursive dilemma is a recently formulated paradox in philosophy about how a group’s decisions can be contradictory with the aims of the individual members of the group, to the point of incoherence. Phillip Pettit, Franz Dietrich and Christian List have done a lot of work on the issue of group agency, where the discursive dilemma is discussed; see here for a fairly complete reading list.

As with all paradoxes, an example is the easiest way to understand it—so here’s one:

Suppose there are three of us—you, me and Mary—standing around in the kitchen. Suppose that you and I believe that p is true, while Mary is sure down to her very bones that p is most definitely not true.

Mary is just one person—you and I are two. Therefore, a majority of this group believes p is true.

As I said, Mary doesn’t believe for a second that p is true—instead, she argues very convincingly that r is true. For the purposes of this example, p is completely incompatible with r; not contradictory—rather, incompatible: Symbolically, ¬(p ⋏ r).

Since Mary believes r is true, and p and r are incompatible, you therefore fervently argue with Mary about why r is most definitely not true—if r is true, then p cannot be the case. And you believe that p.

But as I listen to Mary, I come to the conclusion that r might well be true. I don’t believe that p and r are both true—because they are incompatible. I simply believe that r might be the case.

Therefore, a majority of this group believes r is true.

Which allows us to arrive at our paradox: A majority of the group believes p is true, a majority believe that r is true—but none of us as individuals believes that both p and r are true, because as I said before, p and r are incompatible.

However, as a democratic group, we believe that p and r are both true—which is incoherent.

This is the discursive dilemma.

Let me make the example more concrete: I said earlier that you, me and Mary were standing around in the kitchen? Suppose, then, that we have a cup of flour in a bowl on the kitchen table: You think we should add yeast and salt in order to make bread—to which I agree. But Mary thinks we should add eggs and sugar, to make a cake—to which I also agree, as that too sounds yummy.

As a group, the majority is in favor of adding salt and yeast to the flour, while another majority is in favor of adding eggs and sugar to the flour. But even though no individual would conceivably be in favor of adding yeast and salt as well as eggs and sugar to the flour, that is what the group as a whole is in favor of: A majority wants to add yeast and salt to the flour, while simultaneously, a majority wants to add eggs and sugar to the flour.

And that’s just a big old mess. That’s an incoherence in the democratic decision-making process.

So how does this apply to macro-economics in a democracy? It shouldn’t come as a surprise:

You, me and Mary are in the middle of campaigning for our democracy’s budget for next year.

I am campaigning for the Balanced Budget Bill, which requires that our budget be balanced—and all three of us, wholeheartedly and without reservations, agree. So the Balanced Budget Bill sails through.

You are campaigning for the Lower Taxes Bill, which you obviously favor, and to which I also wholeheartedly agree. Therefore, the Lower Taxes Bill has a majority—and it too passes.

However, Mary is campaigning for the More Government Services Bill, to which which I also wholeheartedly agree, creating another majority—and it too passes.

You may say to me, “But your position is contradictory!” But I reply, “Certainly not!”

In fact, I did my civic duty: I listened to all the arguments, and I voted for all the bills. I think we should cut taxes—so when it came to a vote, I voted in favor of the Lower Taxes Bill, which passed. But I also want more government services—so when it came to a vote, I voted in favor of Mary’s More Government Service Bill, which also passed.

And all the while, I’m still in favor of my law, the Balanced Budget Bill, for which I voted.

Thus, as a group, we have an incoherent outcome: The majority of the group believes taxes should be cut—and at the same time, the majority of the group thinks the government should deliver more services to the people. All of the members of the group individually do not want a deficit, but as a group their incoherence leads to a deficit.

This is the democratic fiscal incoherence, a situation unique to democracies.

All democratic regimes eventually reach a state of fiscal incoherence—in fact they reach this state every year, at budget time: A majority of the people want lower taxes while at the same time, a majority of the people want more government services. That is because all people want to pay less and receive more, a self-evident proposition.

A democratic regime has to resolve its fiscal incoherence every time it happens—that is, every year a new budget is proposed. If it doesn’t, it will not be able to operate the following year, as it will not have the money to do so. (This of course is assuming an independent Central Bank that will not money-print away the dilemma.)

If the democracy’s government can only spend such revenue as it actually receives (and there is no Central Bank funkiness), then the electorate will be forced to come to grips with the incoherence of its decisions in the chambers of its parliament or congress: The democratic representatives of the electorate, be they MP’s or Congressmesn, will slug it out—proponents of cutting taxes fighting proponents of more government services—until eventually, a service is cut or a tax is raised, so that the budget is fully covered: This way, the democratic fiscal incoherence is solved, year after year.

The only way a democratic regime can avoid having to resolve its fiscal incoherence is by issuing debt.

Some democratic regimes do not have the credit-worthiness to issue unsecured debt—so issuing debt is simply not a possibility. In fact, all democracies at least initially are constrained from issuing debt because of their circumstances. They are forced to resolve their annual fiscal incoherence—either government spending will be lowered, or taxes raised, but it will be thrashed out and resolved one way or another. No one will lend them the money—so they have no choice.

However, as each successive, successful resolution of the democratic fiscal incoherence takes place, paradoxically, the democratic regime becomes more credit-worthy: The cost of borrowing goes down with each successive, successful resolution of the democracy’s fiscal incoherence.

When it finally reaches the point where credit is so cheap, and the cost of resolving the annual fiscal incoherence—politically, emotionally, practically—is higher than the cost of taking on debt, then a subtle crisis point will arise: The democratic regime will “postpone” the resolution of its fiscal incoherence, and instead take on debt.

This is the tipping point: This is the first step on the path to ruin for a democracy. It’s a subtle moment, but it’s key—the moment when the democracy decides not to resolve its fiscal incoherence, and instead paper over the incoherence by way of debt.

All democracies reach this point. The United States reached it in 1975, when it failed to balance its budget for the first time in peacetime, and never balanced it again.

Once the democratic regime fails to resolve its fiscal incoherence one year and instead covers the shortfall with debt, the democracy enters a debt spiral: The cost of resolving the fiscal incoherence of the electorate is double what it was last year (last year’s cost plus this year’s cost), while the cost of borrowing in order to paper over the fiscal incoherence has likely remained the same, or risen only slight. Therefore, the cost of borrowing the second year is half what it was the first year. And the third year? Assuming the costs of debt haven’t risen significantly, the debt is cheaper still on the third year, when compared to the costs of the accumulating, unresolved fiscal incoherence of the previous years.

This is how every year, the costs of additional debt falls in relation to the cost of resolving the accumulated fiscal incoherence. And this is how it will continue in a democracy, as its debt spirals.

So long as the cost of issuing debt remains lower than the political, financial, personal, social, and emotional costs of resolving the democratic fiscal incoherence, then the deficit will continue (or expand), and the total fiscal debt will grow—because each of the majorities will want more of what it got with each passing year.

This is the problem of unresolved fiscal incoherence: Each majority in a democratic regime becomes accustomed to getting its way, and not reaching a compromise or accomodation with the other majorities that would be necessary, were the fiscal incoherence of the democratic process forced to be resolved.

Thus, the majority which wanted lower taxes expects and demands even lower taxes the next year—while the majority which wanted more government services expects and demands more government services the next year too.

Thus does the debt spiral accelerate. An although no one wants more fiscal debt, the failure or unwillingness to resolve the fiscal incoherence—and the ease of issuing unsecured debt—makes the elimination of fiscal debt in a democracy impossible.

This is exactly the situation happening in the United States today—and it is a natural, inevitable byproduct of not resolving the democratic fiscal incoherence.

In the U.S., majorities wanting lower taxes and more defense spending get their way, while at the same time majorities wanting more government services and entitlements and goverment macro-economic stimulus get their way too—all happening while the overwhelming majority of the population is fervently opposed to deficit spending, which is geometrically adding to the fiscal debt.

This is my Democratic Bankruptcy Paradox theory in action, as applied to macro-economics and fiscal finances in the United States: The democratic state incurs a deficit and fiscal debt which the overwhelming majority of the population do not want—yet are powerless to stop.

(Some might claim that the discursive dilemma as it relates to macro-economics only happens in a democratic state where all of the citizens have an equal vote. This line of argument might conclude that if there was a smaller group of people with decision-making powers, there wouldn’t be this incoherence. The counterargument is, If there were some voters whose vote somehow counted for more, then the Democratic Bankruptcy Paradox would occur again, only this time in this smaller group, with all the same effects; call it the Oligarchic Bankruptcy Paradox. We can regress to smaller and smaller groups—from oligarchy, to technocracy, to committee, to triumvirate—but the Bankruptcy Paradox will always happen, unless there is a single man who decides the issue of fiscal policy—and that man’s name is Dictator.)

As the debt burden in a democracy grows because of the failure to resolve the fiscal incoherence, the total debt inevitably reaches a point where it is unsustainable. People can argue the exact point where fiscal debt becomes unsustainable—100% of GDP, 120% of GDP, or some other figure. But that issue is irrelevant for this discussion—all we have to agree on here is that such a point of over-indebtedness eventually, inevitably happens. I doubt anyone will find this presumption controversial or debatable.

Therefore, once a democracy’s debt reaches a point of unsustainability—either because it cannot borrow more, or it cannot service the debt it already has—the democracy becomes bankrupt.

So as you can see, this always happens, in every democracy: Failure to resolve the yearly fiscal incoherence of the democracy leads it to take on sovereign debt, which leads to a debt spiral, which leads to bankruptcy—every time.

There are several well known outcomes to a nation’s going bankrupt—none of them pleasant, some of them quite awful. Again, a presumption that should not be controversial or debatable: Most of the outcomes of a national bankruptcy are worse than the sacrifices made to avoid bankruptcy. Therefore, national bankrutpcy should be avoided

Now, the solution to this problem—how to avoid national bankruptcy—is quite obvious: Avoid taking on sovereign debt in the first place.

But the problem, as pointed out earlier, is that debt becomes cheaper as a democracy becomes more successful at resolving its fiscal incoherence. In every successful democracy, the point where the cost of taking on debt is less than the cost of resolving its fiscal incoherence will always arrive—it is inescapable. And when that point is reached, people will rationally decide that taking on sovereign debt and kicking the can down the road is a better choice than resolving the fiscal incoherence of the electorate.

This is why democracies will always, in the end, go bankrupt.

This is why the United States is going bankrupt now.

The United States was generally very successful in resolving its fiscal incoherence since the Revolution of 1776 until 1975. Debt was taken on—but only in exceptional cases, almost always war. See the following chart.


As can be readily seen, the periods of large debt occurred during and after the Revolution, the War of 1812, the Civil War, the First World War, the Great Depression, the Second World War.

But then since 1975, the U.S. fiscal debt grew steadily, paused for a bit in the Nineties (when because of political happenstance the contrary aims of the executive and the legislature led to debt reduction)—but then shot the moon. The Congressional Budget Office projects 10% of GDP deficits are in the offing until at least 2013, perhaps until 2016.

My bet is, the 10% of GDP deficits will be even larger in the coming years. And they will not stop in 2013 or 2016—the only thing which will stop the ever-increasing deficits is national bankruptcy. The American democracy cannot prevent this bankruptcy. Bankruptcy is the inevitable, inexorable end.

I hope I have proven why.