State assets and the importance of being earnest

Robert Peston's column today got me thinking on a tangent.

If the state incurs liabilities (let's say while rescuing banks), there are a few ways it can pay them off.

One is by selling assets that it acquires along with the liabilities. For example, if it acquires a 70% stake in Royal Bank of Scotland, it can sell it into the private sector for (let's say) £20 billion. This might offset some or all of the liabilities it has covered.

Another is by increasing taxes. In one sense, this is exactly the same as selling assets: it takes money from the private sector into the public sector. The difference is in the distribution. When selling assets, the money comes from those people who choose to buy the assets. When taxing, the money can come from whoever you like.

A third is by walking away. After all, the state's liabilities are unenforceable except by the state itself. Thus the state can simply ignore its liabilities (as Argentina did a few years ago, and most developed economies have done at some point in history). This does reduce its ability to raise money in future, because its credibility is reduced; and it may result in confiscation of foreign assets too. In general the state loses some ability to influence future behaviour in return for current gain.

A fourth is by printing money. This is a bit like a blend between defaulting and increasing taxes. By increasing the amount of money in the economy, the value of existing money is diminished (and existing money is just another liability of the government); and the spending power of the money in savers' pockets is diminished, so this is essentially a tax on savers.

But ultimately this is a matter of how the state wants to be perceived and what the value of that perception is. If a country wants to be regarded as a low-tax economy, it is better off selling assets. If a country wants to have a strong balance sheet, maybe it should raise taxes and keep its assets. If it wants to strengthen its asset sheet and pretend to have low taxes, it can print money. And if it wants to maintain the value of its currency it should avoid printing money and reduce its debts through other means.

Ultimately though, as you might imagine if you know the Coase theorem and Modigliani-Miller, the difference between these methods don't matter much in terms of the solvency of the state. The state has ultimate control over the productive power of its population and can meet its debts in whatever way it wants.

The real issue is that some of these methods have an influence on behaviour, because they affect the distribution of resources between people. So mechanisms which provide incentives for productive behaviour are good; mechanisms which encourage the creation of public goods with a high return are good; if there is a conflict between these goals, we try to evaluate the return of each and choose the best option.

The main reasons for the state to behave in line with its own rules are: to demonstrate its adherence to the rule of law; and to make its future behaviour predictable. This both sets a good example for its citizens and enables people to maximise their welfare over a long future time period. It's all about creating credibility; being able to give its word and stand behind it. This we might call being earnest. Even though you could be laid-back about things, there is a value in having rules.

Of course you can choose what those rules are - within reason and if they appear to be logical - and governments frequently do this, when they set their central bank policy, pass a constitutional amendment relating to tax, or impose a capitalisation requirement on their country's banks. As long as you can convince people that what you are doing is a legitimate and sensible continuation of what you did before, they'll broadly continue to trust you - and accept your money.

So while it might be controversial to say that taxation, privatisation, default and printing money are all the same, they are more similar than you might think. A simple sleight of hand transforms one into the other - if you can pull it off with a trustworthy smile on your face.


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