Graeber on Sectoral Balances

I touched on this a few times before, but here’s David Graeber on sectoral balances and flows (excerpt):

Britain is heading for another 2008 crash: here’s why
David Graeber

British public life has always been riddled with taboos, and nowhere is this more true than in the realm of economics. You can say anything you like about sex nowadays, but the moment the topic turns to fiscal policy, there are endless things that everyone knows, that are even written up in textbooks and scholarly articles, but no one is supposed to talk about in public. It’s a real problem. Because of these taboos, it’s impossible to talk about the real reasons for the 2008 crash, and this makes it almost certain something like it will happen again.

I’d like to talk today about the greatest taboo of all. Let’s call it the Peter-Paul principle: the less the government is in debt, the more everybody else is. I call it this because it’s based on very simple mathematics. Say there are 40 poker chips. Peter holds half, Paul the other. Obviously if Peter gets 10 more, Paul has 10 less. Now look at this: it’s a diagram of the balance between the public and private sectors in our economy:

Notice how the pattern is symmetrical? The top is an exact mirror of the bottom. This is what’s called an “accounting identity”. One goes up, the other must, necessarily, go down. What this means is that if the government declares “we must act responsibly and pay back the national debt” and runs a budget surplus, then it (the public sector) is taking more money in taxes out of the private sector than it’s paying back in. That money has to come from somewhere. So if the government runs a surplus, the private sector goes into deficit. If the government reduces its debt, everyone else has to go into debt in exactly that proportion in order to balance their own budgets.

The chips are redistributed. This is not a theory. Just simple maths....

Prof Graeber says quite a bit more, in full keeping with his activist/socialist background (he was one of the key early figures in the Occupy Wall Street movement). But ignoring all that, what he lays out here is absolutely correct – the accounting identity always holds, such that a deficit in one sector must necessarily involve a surplus in another sector and vice versa. If the government runs a budget surplus, the private sector must run a deficit, and if the government runs a deficit, the private sector must run a surplus. If you want a less politicised treatment of the idea of sectoral imbalances, try Richard Koo (here and here).

Of course, real life isn’t quite that simple. For starters, operationalising accounting identities (i.e. identifying how policy can work in this framework towards the desired outcome) is no small matter. In this case though, there are multiple channels in how this could actually happen. For example, a shift from a government deficit to a government surplus reduces government debt, which causes long term interest rates to fall and induces the private sector to take on more debt. Another avenue is that when government reduces their net spending, households and corporations must increase theirs to maintain the economy in full employment equilibrium (i.e. maintaining the standard of living).

Secondly, nothing in the sectoral view says anything about whether the economy actually does stay at full employment output (incidentally, this is the biggest problem I have with this whole idea). We could have both the private sector and public sectors running a surplus, implying higher unemployment, output below potential and lower consumer welfare. Conversely, we could also have all sectors running deficits, implying output above potential and accelerating inflation. Nothing in the accounting identity says that the economy stays at full potential output, and it says even less about economic growth and development.

Again, there’s not too much difficulty overcoming this objection. There is an underlying, unspoken assumption involved here that we also have an activist central bank willing and able to adjust monetary policy to maintain the economy at the desired output and employment level consistent with stable inflation.

My third caveat is more damaging to his thesis – the sectoral balances approach (in Prof Graeber’s formulation) completely ignores the external sector. It’s possible, though exceedingly rare, for both public and private sectors to run surpluses and have the economy at full employment output with stable prices, if the economy as a whole is also running a sufficiently large surplus relative to other countries. So there’s nothing that says that a government can’t shift from a deficit to a surplus while avoiding the private sector falling into deficit, as long as the country maintains an external surplus.

But, the inexorable logic of accounting identities and sectoral balances also transcends national boundaries – there is no way, in aggregate, for the world as a whole to achieve a surplus (unless we’re trading with Mars). Every external surplus must be counterbalanced by a deficit somewhere else. External balances must always and everywhere sum to zero, whatever happens to internal balances within any individual economy. For a country to run a consistent current account surplus, another country must be willing to run a consistent current account deficit.

In other words, living within one’s means always requires someone else to live beyond theirs. This is true whether we’re looking at a closed economy as Graeber describes it, or an open one as I talk about here.