Sunday, February 14, 2010

Sovereign debt and Pigouvian Taxes

Sovereign debt , as a potentially crippling fiscal problem world wide, has risen to the forefront over the past few months. Whether it is the US, Europe, Japan or many other developed and developing countries the sovereign debt watch is on.

The major metrics of a pending sovereign debt crisis that have been in vogue for decades used to be applied only to developing countries. Unfortunately this is no longer the case. The Herculian efforts by governments all over the world; the developed in particular; to avoid a repeat of the debilitating depression of the 1930's has forced these countries to increase substantially their fiscal stimulus programs. In a sense the monetary and fiscal policies adopted by the officials of all of these countries have been very successful. A worst case scenario has been avoided.

But as economics has always taught us, There Ain't No Such Thing AS A Free Lunch; TANSTAAFL. Yes we avoided a deep recession and the top officials can pat themselves on the back for this. But maybe not. Is the cure at least as expensive or maybe even more so than the ailment that it saved us from? That is , currently, the $64,000 question or maybe I should say the $64 billion question?:-)

Often, our efforts at prescribing remedies are counter productive because of what is inherent in problem solving. We always seem to target the symptom rather than the disease. As a result we inevitably move from one crisis to the next as a result of the law of unintended consequences.

In our efforts to save the system and to prevent a major economic depression we proceeded to throw money at the problem in order to generate more final demand and thus put more people to work. What we did not stop to consider is the major question of how are we going to pay back all of these funds that we have borrowed? It seems that we did what we always do, shift the burden onto the future generations. The debt will not come due for some decades ,right? Wrong.Well informed individuals know that more debt implies more taxes in the future and so they take corrective by refusing to own the highly risky debt. Once we find out that the debt service is too large and that we cannot keep on rolling the debt unto the future then we will have no choice but to become deadbeats. That is where we are at the moment. The question is which country is going to go under first? Would it be Greece or would it be one of the other PIIGS? How about the UK, or evn Japan or the US? If any of these countries default would they set up a contagion that will devastate all the current international financial sytem as we know it?

Believe it or not there is a potential mechanism that if adopted could go a long way towards addressing the real cause of this issue and not only the surface phenomenon. The solution that I am about to propose is not new, actually,N.G Mankiw wrote about it in 2007.

"The scientists tell us that world temperatures are rising because humans are emitting carbon into the atmosphere. Basic economics tells us that when you tax something, you normally get less of it. So if we want to reduce global emissions of carbon, we need a global carbon tax. ...

The idea of using taxes to fix problems, rather than merely raise government revenue, has a long history. The British economist Arthur Pigou advocated such corrective taxes to deal with pollution in the early 20th century. In his honor, economics textbooks now call them “Pigovian taxes.”...some taxes align private incentives with social costs and move us toward better outcomes."

I would love to see a carbon tax levied not only in the major industrial countries but all over the globe with all the proceeds dedicated to lowering the sovereign debt. Such a tax could be a first step towards internalizing the negative externalities of all the production in the world economy. If that leads to less and more efficient production then all of us will be winners.

Note: Lebanon has already reached the point of no return. The current sovereign debt burden is so large that it will be impossible to avoid a cataclysmic crisis if we do not seek an immediate renegotiation of some of the debt and at least a partial write off. If we do not change course then we will get where we are heading, the financial abyss.


Cpi lebgeorgesabat said...

Yes !...........
I love you Doctor Karam. How right you are.
Do you have time to read my blog on that subject that was written nearly three years ago? Please go to
George Sabat
I also read excerpts of your interview by Executiv Magazine and I love them also.
We are on the same wave length absolutely. The same as with Dr. George Corm and Dr. Charbel Nahas whose views are exactly similar.
What continues to amaze me is why nothing is done about this in Lebanon?
What are we waiting to change this country's fiscal and financial strategy?
What are we waiting to use the extra one and a half billion dollars that we are paying every year in higher interest rates on our debt to finance instead the vital infrastructure projects that our country needs so badly or support private enterprise into developing the agricultural, the industrial and the tourism sectors?
That is the $50 billion dollars question that you so aptly put yourself.

Cpi lebgeorgesabat said...

You wrote and I quote:"The idea of using taxes to fix problems, rather than merely raise government revenue, has a long history"

I wrote two days ago:

"1. The goals of our fiscal strategy

Before considering the reform of our fiscal strategy we should undertake, as a nation, some introspection and self analysis. What do we do best in Lebanon and where do we go wrong?

Our fiscal strategy should be dynamic. It should be aimed at making the most of our national strong points, while seeking to address our handicaps.

As a nation we are doing exceedingly well in the fields of banking and finance, real estate development, and a wise usage of our imported labor force to grow our economy.
In redesigning our fiscal policy we should associate the entrepreneurs who benefit from the current real estate and the financials booms in Lebanon, as well as the large importers and employers of foreign labor. We should ask them to better assume their responsibilities as far as real estate registration taxes, taxes on interest income and the permit fees of the foreign workers are concerned.

On the negative side we are a nation of heavy smokers, compulsory drivers, environmental polluters, and energy wasters.
Through a discriminating use of our tax system, we should encourage the taxpayers to smoke less, use more public transportation means, and contribute to the protection of the environment.
Taxes should also be designed to discourage illegal connections and encourage the private sector to search for a solution to our current energy problems.

Last but not least, the problem of servicing our public debt should be squarely faced at a time when it stands in the way of any substantive fiscal reform and absorbs forty per cent of the entire resources of the State. However this particular subject, because of its complexity, will be better dealt with in a separate section of the National Plan."

Do you think, Dr. Karam, that we have similar views?

ghassan karam said...

Thanks for the link. I have read many of the pots but not all. You are right when you point to the fact that we seem to be on the same page and reading from the same script on the issue of national debt.
It goes without saying that I want to be wrong but all the evidence points towards a head on collision that is waiting to happen especially once one factors in the possibility of a slow down in the real estate speculation, the dependence on remittances and the relatively unstable geopolitical environment. Even if we do work ourway out of this mess the price for the future generations will be exacting.


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