Does Krugman Understand Debt?

U.S. debt is at 100% of GDP, and citizens are worried. Odds are that reducing the debt will be a hot-button topic in the upcoming elections, especially considering that Obama has increased U.S. debt by more than four trillion since he took office.

Keynesian economist Paul Krugman recently wrote an op-ed piece entitled "Nobody Understands Debt." Krugman's bottom line is that although the issue with deficits is not unimportant, there are more important things to worry about than ever-climbing debt. Is he correct that we shouldn't be as worried about debt as we actually are?  

He brings up the point that we don't have to pay off the debt like a family does.  I'll give him that. As long as we're paying interest on the debt, and that our GDP growth exceeds what we owe in debt, it's not an issue. Debt is not inherently a bad thing. 

History of debt-to-GDP ratio is also interesting. Looking at data provided by the International Monetary Fund (IMF), Krugman points out that the United Kingdom's debt had been over 100% for quite some years. Japan reached 203% after World War Two, but was able to pay it off. Even the United States reached 121%, where it eventually reached a low of 32.2% in 1974. Historically speaking, paying off debt that is at ridiculously high amounts in comparison to economic growth is indeed possible. Maybe Krugman is right. 

I also have an alternative idea: Krugman should apply the op-ed title of "Nobody Understands Debt" to himself.

Does Krugman think uttering the words "we owe it [the debt] to ourselves" makes the problem go away? It won't. The trajectory of government spending shows that the problem is only going to get worse, not better, especially considering that more and more Baby Boomers are going to retire and consume more Social Security and Medicare. This is only going to get more burdensome, unless you believe in the Ricardian Equivalence, which Krugman himself calls a "dubious doctrine."

As economist John Cochrane points out, Krugman never asks where the money comes from, which is important. Borrowing is not costless, which is something that Nobel Laureate James M. Buchanan brings up in his work Public Principles of Public Debt. Money doesn't grow on trees, and capital does not come out of thin air. Since the government does not have any money of its own, guess where it has to borrow from? The private sector. Every dollar that gets put in the public sector gets taken away from the private sector. The private sector ultimately creates wealth. Although it's beyond the scope of this blog entry, it should go without saying that a considerably large amount of money that government spends is done so inefficiently (i.e., for every dollar spent by the government, less than a dollar of benefit is derived). 

Krugman is right that we need to get out of the unemployment trap. But if you're under the impression that increased government spending has nothing to do with economic woes, think again. Increased government spending impedes job growth in the short-run and transfers economic burdens in the long-run.