At most of the companies I've run or owned, running at a loss and piling up debt has been a bad thing. In fact, it has been fatal to a few. Governments are now learning the same lesson. Their learning process is, however, so slow that it takes a major crisis to prompt any action—which is often too little too late, and costs way more than taking action earlier.
Who will pull us out of today’s fiscal messes? As always, those among us who see problems as opportunities, and in search of a solution put their creativity and determination to bear. In a word, entrepreneurs. So why not take an entrepreneurial approach to the problem of government debt? Here’s some entrepreneurial thinking on the issue of democracies and debt:
Democracies tend to run up debt for three reasons. First, because we let them. Giving a democracy the right to go into debt (for non-capital items) is like sending your kid off to university with your platinum card and telling him to “be careful.”
Second, economist John Maynard Keynes told the world that deficits are just fine, because they can be used to stimulate economies in recessionary times. The idea is that governments will offset these deficits by running surpluses in expansionary times. But guess what: they rarely do. And we, the electorate, don’t make them. It’s practically in the DNA of a democracy to run deficits and build up debt.
Third, there is almost no “unseen hand of supply and demand” to stop government debt accumulation until it’s too late. If a company runs up too much debt and its management doesn’t apply the brakes, it enters a red zone; its board, shareholders or bank notice, and they take action. And, as Samuel Johnson wrote, “When a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully.” The threat of receivership will do that to an owner-operator (or, equally, to an owner-operator’s spouse). Stakeholders would prefer that focus to come earlier, but at least the prosperity of whole nations isn’t tied to the fortunes of individual businesses.
But we let governments keep borrowing deep into the red zone. We tell ourselves we can borrow our way to wealth. Not so. We support leveraged government investments in targeted economic sectors, ignoring that governments act with the next election in mind and are poor at picking winners to begin with. Worst of all, we tell ourselves that, like some corporations, governments are “too big to fail.” But dozens of countries have defaulted, including Argentina, Mexico and Russia. They (and we) are still here.
The entrepreneurial solution is to bring in consequences earlier. “When do you generally get action from governments? When their bond market blows up,” says Stanley Druckenmiller, legendary Wall Street investor and former fund manager for George Soros.
When Bob Rae was premier of Ontario, I held a Christmas party for the investors in my venture-capital fund at which one of them, a Bay Street moneyman, told me, “Bob Rae got his wake-up call today. He was down in New York and they told him that because of all the deficits he was running, his credit rating was going to be downgraded, his interest rates would go up, and the number of institutions that could take his bonds would shrink overnight.” Merry Christmas, Bob.
Governments all over the world are getting that same message: Greece, Spain, Portugal, Ireland, France, even the mighty U.S. Too bad the situation has to go nuclear before action is taken.
To avoid future debt crises, countries could use independent bodies that not only set the parameters around government spending but penalize those who violate its edicts. Consider the Bank of Canada (or the Federal Reserve in the U.S.). They are run by an appointed board of governors with a singular focus on controlling inflation by managing interest rates. That they are appointed rather than elected depoliticizes monetary policy and puts the focus on the long term.
I propose the same thing on the fiscal side: a Central Bank of the Deficit (CBOD). It would also be appointed for a long period—say, seven years, which approximates the economic cycle—with staggered terms for its individual governors. The CBOD’s sole job would be to determine for any given fiscal year whether the government should run a deficit or a surplus, and the size of same, with the goal of balancing to zero over the course of any seven-year period. (Or, in the case of countries with debt, running a net surplus until that debt is paid down.) The government of the day would then be free to adjust taxation and spending levels to hit the targets set by the CBOD.
And if those targets are missed? The consequences come in nice and early:
1. Hit politicians where it hurts: their pockets. If the predetermined size of any given year’s deficit is exceeded or a surplus target is missed, dock the pay of ministers and their deputies by 20%. Granted, the amount in pay saved hardly offsets the fiscal shortfall, but it sends a strong message and ideally influences behaviour during budget planning and throughout the year. (As an entrepreneurial capitalist, I would also propose a 20% bonus for good performance.)
2. If the politicos miss their targets two years in a row, it triggers an election within 60 days. Yes, elections are expensive. But this cost pales beside the cost of government overspending and cost overruns.
Complex problems get solved through innovative solutions developed and applied by people who are accountable for their actions. It’s the stock-in-trade of entrepreneurs, and it works. Why not apply the same thinking to our country?