Election Economic Misconceptions (5) Debt is Always Bad

Listening to many politicians, I get the impression that they believe that debt is the great evil of our time. However, debt is not always bad. Borrowing can sometimes be useful. The important distinction is between productive borrowing and unproductive borrowing.

A household that gets into serious debt to fund consumption is foolish. However, getting a mortgage to buy a house might be sensible, if the long-term benefits outweigh the interest costs.

People establishing a business will need to have some savings to get started, but most businesses will need to take on debt to develop to their full potential. Borrowing to purchase productive plant or capital equipment makes sense if the extra production will cover the interest costs.

A government is different from a business, as it does not sell what it produces. It does not have a savings account that it can draw on to fund infrastructure projects. A government’s only source of income is taxation, and if it has taken money from businesses and households, it has a responsibility to use it straight away. Saving up for many years to build a new power station would upset the people whose money the government has taken.

If the development of an economy needs capital equipment or infrastructure developments, it makes sense for the government to borrow money to fund them, provided the extra production outweighs the interest costs. During the 1950s and 1960s, the New Zealand government built a series of Hydro Electric Power Stations on the Waitaki River in the South Island. These assets have brought massive benefits to the economy.

Rather than treating debt as a great evil, politicians would be better off discussing what types of assets and infrastructure the economy needs. They should decide which of these can be provided by businesses and which would be better provided by the government. They should be assessing which infrastructure projects would be sufficiently productive to cover the interest costs of the required debt.

Government borrowing to build infrastructure or investment in capital equipment that would make the economy more productive makes sense, as the economic benefits easily cover the interest costs. The government that does not borrow to build infrastructure is holding back the development of the nation. Too much debt can be a problem, but debt in itself is not bad.

The New Zealand economy is currently underdeveloped, so increasing productive debt to fund infrastructure and capital assets might be a sensible policy. I would like to see more discussion about the quality of debt, and less about the volume of debt.