In any country in the world, most citizens tend to want more social/welfare programs from their governments. When politicians are running in local or national elections, they become particularly sensitive to the pressure from groups advocating their pet social/welfare programs. It is quite natural for politicians in any democracy to cater to the citizens’ wishes, hoping to ingratiate themselves to the voters. All is good except for the problem of paying for the programs, or more specifically, who will pay for the programs.
Politicians have several options for how to finance social/welfare programs. The first option is to collect more taxes and pay for the programs. This is what most western European democracies have chosen to do. The downside is that general economic activities tend to be dampened by high taxes. This is also likely to trigger a vicious cycle wherein the government would have to raise tax rates even higher to pay for existing programs and the ever-rising tax rates would in turn choke economic activities further. The government’s share of GDP would also rise to a very high level, as the cycle keeps on turning over many years. In France, for instance, the government’s share is greater than 50 percent of its GDP. Margaret Thatcher of the U.K., for one, was keenly aware of the peril of this financing scheme and the underlying socialist policies.
The second option is to borrow money by selling government bonds, which is a much more palatable choice for politicians than raising taxes. For example, in Japan and the U.S. the bonds are sold primarily to the next generation of domestic citizens. In particular, the U.S. government sells its bonds (i.e., the national debt) primarily to the U.S. social security fund, and of late, to the Federal Reserve banks, its central bank. In Greece, the bonds were sold to foreign banks. No matter who buys government bonds, a rising government debt relative to the GDP is not a good thing for taxpayers who will eventually have to settle the debt ― either pay up the borrowing, or default on the debt, or devalue the debt obligation through inflation. Taxpayers in Greece are looking at austerity as far as their eyes can see into the future. Japan and the U.S. are essentially playing a huge Ponzi game in which the government pays the current beneficiaries with borrowed funds from the next generation of taxpayers. The sobering news is that the governments may run out of money when it is the next generation’s turn to collect benefits.
The third option is to print more money to pay for government spending. This simple option has a very limited life span before the scheme blows up. Zimbabwe is the latest example, where hyperinflation completely destroyed the national economy, but it perhaps won’t be the last. The fourth, and the only prudent option is to limit the growth of social/welfare programs. If the local or national economy cannot afford a certain proposed program, the politicians ought not to commence with it. This, however, is easier said than done. Most politicians are not far-sighted leaders of their society, but are ordinary people who must weigh personal benefits and the costs of doing certain things.
Politicians have to weigh on one hand their public responsibility of doing the right and prudent thing for the long-term interests of citizens and the nation, and on the other, their personal losses if they oppose a new social/welfare program. Since the top priority of most politicians anywhere in the world is to get elected and reelected, prudence over public finance is often outweighed by the fear of getting rejected by the voters for their opposition to a new program. Some unscrupulous politicians may even choose to advocate new social/welfare programs knowing that any new program would be popular among most voters. These politicians in fact are bribing voters with the taxpayers’ own money. In short, a new social/welfare program is likely to be adopted in a democracy and the number of these programs is likely to explode regardless of the economy’s ability to pay for them. This prospect raises a fundamental question: Does democracy eventually ruin the economy?
Aside from the economic consequences of new or expensive social/welfare programs, there is a basic moral issue involved in expanding the programs. Under the principle of fairness, those who are paying for the social/welfare program should have a final say. What would happen to society if a majority of its citizens want a particular program, but they are not the ones paying for it? What would happen if a minority of the citizens does not want the program, yet they are the ones who are required to pay? What would happen to society if the required-to-pay citizens are heirs of national debt who are still too young, or yet unborn, to have a voice over a welfare program? What will be the moral consequences of such an unfair political process if it is left unchecked?
How should a democratic society ensure in general that the non-paying citizens do not bully the required-to-pay citizens? The U.S., for one, seems to be headed to plutocracy by moving away from its democratic political precepts. The most reasonable persons would agree that democracy is not an overrated concept, and that citizens ought to live in a society where everyone has a political voice. What then is the needed change to political orders to ensure that social/welfare programs in particular are adopted judiciously? The question is how to make democracy compatible with a thriving economy. My answer is that democracy needs a division between the power to propose social/welfare programs and the power to decide on new programs. An entity composed of apolitical economic/financial professionals should have the exclusive authority to propose new programs and politicians should only have the power to either accept or reject.
Thoughtful politicians may welcome this proposal. They fear in their hearts that an unbridled democracy is indeed on a straight track to governmental insolvency, not unlike today’s Greece. For them an independent entity responsible for presenting new social/ welfare program to political debates is a convenient political vehicle that applies urgently needed restraints on the excesses of democracy. Clearly, some politicians would not like their power to propose new social/welfare programs be forfeited. The proposed division of power, however, is akin to the present criminal justice system under which only prosecutors have the authority to bring criminal suspects to a trial. If these politicians are willing to live in a society where no one can be both a prosecutor and a judge at the same time, they should also accept a system wherein someone proposing a new program is not the same one that will decide on the proposal.
For the citizens, trusting faceless economic/financial professionals as opposed to friendly and popular politicians is not necessarily a bad thing. Not many citizens would want their friendly politicians to perform a medical procedure on them; not many citizens should want their popular politicians to perform an economic/financial analysis either. Besides, citizens in most democracies in the world are already familiar with the proposed division of power: politicians representing the citizens select and oversee the professional managers of the central bank who are then entrusted with managing the money supply and interest rates.
The only remaining issue in implementing the proposal presented here is how to ensure the economic/financial professionals will remain apolitical and committed to the highest level of professionalism. However difficult it might be for society to find a batch of apolitical economic/financial professionals, it will be still far easier to do that, than to find a bunch of politicians who are financially prudent enough, or politically brave enough, to keep national finances solvent and the economy thriving in a democracy.
By Ken Choie
Ken Choie is professor of finance at Sejong University in Seoul. Formerly, he was a portfolio manager at UBS in New York. He earned his Ph.D. in economics & finance from the University of Michigan. He can be reached at kchoie@aol.com. ― Ed.
