The Cause of the Crisis Matters

I begin by asking a naive question: Why are all the Western liberal democracies so indebted?⁸ Aren't these countries, I ask, the wealthiest societies in the history of civilization? If ever there were economies that could support themselves without recourse to massive borrowing, aren't these the ones? What gives?

A financial crisis can arise from a variety of causes, but the principal cause is a sovereign debt burden beyond what can be borne by the wealth of the society without causing social instability. Sovereign indebtedness can arise directly from government overborrowing, or it can arise indirectly, via (for example) guarantees of bank deposits or mortgage debt, or via government bailouts of private financial institutions.

But the important question is not simply how the indebtedness arises, but why. Imagine, as a hypothetical situation, that a country has incurred a huge external debt in order to fund significant infrastructure expansion. Presumably, this is really an investment in future growth, which should enable the country to repay the debt easily.

Suppose instead that a country has incurred its debt as a result of ongoing societal demands for current spending beyond what can be supported by the country's budget. Or imagine that private borrowers in the country have incurred massive debts to buy, for example, bigger houses. To bail out the foolish lenders to these foolish borrowers—after all, no one wants another global banking crisis—the country has to bail out the lenders, effectively transferring private borrowing into sovereign debt.

This hapless country is now faced with the problem of discharging a vast debt that is still growing, because the societal demands are still there. The situation, in other words, seems to be completely hopeless. Even if the country can somehow find the means of discharging its huge existing debt, that debt will simply rebuild itself unless something can be done about the spending demands that are responsible for the debt, or unless additional sources of revenue can be found to support the spending demands.

As a thought experiment, let's adopt the postulate that, in the advanced Western democracies, social norms have evolved to require minimum standards of living that exceed the ability of even those wealthy countries to pay. In other words, social goods that even a few decades ago would have been deemed unattainable by the great mass of the populace are now considered to be inalienable rights of all: access to universal health care (and damn the cost!), a dignified retirement and old age (whether I have saved my money or not), education through the baccalaureate degree, freedom from hunger, home ownership, and so on. These are “rights” about which there has grown up a broad consensus—indeed, anyone who espouses a reduction in these rights is usually perceived as a barbarian.

Thus there is, I am positing as part of this thought experiment, a very serious disconnect between what the citizens in Western societies believe they are owed by their governments and what those governments can actually afford to deliver. Let's step back a few hundred years and see how we've managed to get ourselves into this position.