Forewarning: This blog is generally about monetary theory. This post is going to be unusually loaded in political content, because this stuff is required to lay down the foundation of the framework that explains why using fiscal policy to regulate the price-level is a horrendous idea. Moreover, I do not have a background or any formal training in political science, so for all I know I’m repeating other people’s work: as usual, I make no claim of originality.
Democracy is, by nature, imperfect. Without a strong constitution, it’s a dictatorship of the 51%. Here are a couple of extreme examples that illustrate the shortcomings of a pure majority rule:
- If 51% of the population has blue eyes while 49% has brown-eyes, the blue-eyed people could in theory vote to enslave the brown-eyed folks and take all their wealth
- The 51% poorer can vote to take a huge share of wealth from the top 49%
In practice it’s difficult for a 51% majority to impose such outrageous will on 49% (because the oppressed would become violent and it would be too costly to keep them under control) but once you get in the sub-15% range you’re in business. The blacks, the jews, the unskilled unemployed (think minimum wage law), the gay, have all gotten screwed by a democratic majority.
As a minority, your vote basically doesn’t count because voting is a winner-takes-all game. Therefore when things get untenable, the only thing left to do is to with vote with your feet–and that’s assuming you’re even allowed to do that (think East Germany).
Politicians get away with retarded policies because there’s a great deal of friction which prevent folks from voting with their feet:
- There needs to exist a better place than the one you’re in now and that place has to be willing to take you in.
- There’s a big cost to moving, selling your house, moving your stuff, possibly having to learn a new language, uprooting the family, etc.
When politicians want to get away with even more retarded policies, they have to increase the friction for getting out by forcibly locking people in or through propaganda.
Seasteads are a mean to reduce these frictions to their practical minimum. Essentially the idea is to build floating cities outside the jurisdiction of the majority-controlled land where minorities could flourish, new political systems could be experimented with, and the liberty to vote with your feet would create ideal conditions for the betterment of political systems through competitive pressures.
- The availability of alternative seasteads is only limited by the resources we devote to build them and the surface of the sea
- The cost to move is basically that of towing your entire floating house from one city to another
The Seasteading Institude is working to make Seasteads a reality under the leadership of none other than Patri Friedman (Milton’s grandson). While watching the Seasteads evolve will provide very interesting data not to mention an opportunity–for a handful of people–to live free of the majority’s oppression, we don’t have to wait until they’re actually built to use them for the purpose of analysis: every political proposition should be evaluated in terms of how it would perform in a world with a large number of seasteads.
Let me try to describe this analysis in semi-formal terms:
Definitions: An competitive political environmentis a world where a large number of seasteads exist, new ones are built all the time, and they continuously experiment with every possible variation of all the possible political systems. In this world, moving between seasteads is costless. Some fraction of the political systems will manage to sustain for meaningful length of time without major modifications to the rulesets: we’ll call those stable political systems.
The “Seastead test” for a political system: what would happen to a seastead implementing this political ruleset in a competitive political environment?
(Yes, this is a vague question)
Now, this is still a monetary theory blog, so let’s use this to analyse what we’re interested in: deficit spending. The question we’re asking is: What would happen to a seastead in a competitive political environment if it were to issue debt to pay benefits to its residents?
To keep things separate and simple, we’ll assume no redistribution and no foreign bond purchases: for instance, there are 1,000 people on the seastead, all of them produce the same output, pay 10% of it in taxes, receive 20% of it in benefits, and “save” the remaining 10% in bonds.
Note that they don’t consume any more than if they were paying 20% in taxes and saving 0% in bonds so the cliché of “living beyond their means” doesn’t apply here. The only difference is purely financial.
Risk adjusted real yields on the government bonds must be in-line with those in the rest of the world so we’ll assume our seastead is small enough to be a pure price taker on that. As the debt grows larger (at the rate of 10% per year), the real interest cost as a fraction of tax revenue also gets bigger.
Let’s now assume that one of the residents decides to move to another seastead for an exogenous reason. Now all of the sudden, the 999 remaining residents are paying interest to themselves, plus 1/999th of the interest the leaver receives. Since we’re in a competitive political environment, there exists somewhere a stable seastead identical to this one except that it decided to keep a balanced budget and charge 20% taxes to its residents.
In that alternative seastead, residents get to spend 80% of their income plus get the remaining 20% in public services. In their current seastead, they also get to spend 80% of their income but only receive 20% minus the share of interest paid to the leaver in public service. Instantly, all 999 remaining residents move to that other seastead and the original seastead is left with tons of debt and nobody to pay taxes. A default is now the only option before the seastead can be salvaged and used again–this means that the system was unstable.
This is the part where MMT proponents sing their chorus: “If the bonds are denominated in domestic currency, solvency is never the issue, inflation is”. Fine, so the seastead inflates its currency into oblivion–it makes no difference: the bonds are worthless either way. MMT comes back again: “if inflation is too high, raise taxes”. Well, there’s no one left to pay any taxes. “Seize the houses of the residents, it doesn’t matter who owns them”. The houses have already been towed away.
“But your seastead example is not realistic, in a real country people and capital can’t just float away”. Yes in the real world things will happen much more slowly and much less visibly. People and capital will trickle out. More importantly we’ll never see the capital that would have come and never did, the investments that would have been made but never were. Any political system that takes advantage of the frictions-to-voting-with-your-feet which exist in the real world, but not in a competitive political environment, is oppressing its people and I reject it, not because it violates some economic welfare optimality condition, but simply on ethical grounds.
Of course if the agents in this example were “more” rational, they would have seen this coming from miles away and would have never agreed to purchase the bonds after some point. What point? The point where the value of the common parts of the seastead started to exceed the value of the debt, in other words, when the seastead government became negative equity. That’s because at that point, the cost of building a new seastead, or of renting an existing one, is going to be equivalent to servicing the interest on that debt. This leads to the following conclusion on fiscal policy:
A government should always maintain stable value for its public equity (value of public assets minus public debt)
This is not a balanced budget condition: if the seastead government invests into a wind turbine meaning it no longer needs to pay electricity to the private sector to power the public facility, it’s ok for it to issue debt up to the value of the turbine: the residents are indifferent between paying taxes to service the interest of that debt or paying taxes to pay an electricity bill in an alternative seastead.
Governments can, and should, issue debt when they make investments. Governments should never use debt to pay benefits.