As EU tries to lay one spectre to rest another could come back to haunt it

Tackling the spectre of debt with fiscal consolidation could raise the spectre of revolution.

The map of Europe is featured on the face of a two Euro coin seen in this photo illustration taken in Rome, December 3, 2011. Standard & Poor's has warned it may carry out an unprecedented mass downgrade of euro zone countries, including Germany and France, if EU leaders fail to deliver a convincing agreement on how to solve the region's debt crisis in a summit on Friday. Photo illustration taken December 3, 2011.     REUTERS/Tony Gentile (ITALY - Tags: BUSINESS) *** Local Caption ***  TGN108_EUROZONE_1206_11.JPG
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Europe is now haunted by the spectre of debt. To exorcise the demon, European leaders are putting their economies through the wringer.

It doesn't seem to help. Their economies are still tumbling, and the debt is growing. The credit ratings agency Standard & Poor's has downgraded the sovereign-debt ratings of nine euro-zone countries, including France. The UK is likely to follow.

To anyone not blinded by folly, the explanation for the downgradings is obvious. If you deliberately aim to shrink your GDP, your debt-to-GDP ratio is bound to grow. The only way to cut your debt (other than by default) is to grow your economy.

Fear of debt is rooted in human nature; so the extinction of it as a policy aim seems right to the average citizen. To be in debt can produce anxiety if one is uncertain whether one will be able to repay.

This anxiety is readily transferred to national debt . How, people ask, will governments repay all of the hundreds of billions of dollars they owe? As the British prime minister David Cameron put it: "Government debt is the same as credit-card debt; it's got to be paid back."

The next step readily follows - to repay, or at least reduce, the national debt, the government must eliminate its budget deficit, because the excess of spending over revenue continually adds to the national debt. If the government fails to act, the debt will become, in today's jargon, "unsustainable".

Again, an analogy with household debt suggests itself. My death does not extinguish my debt, reasons the sensible citizen. My creditors will have the first claim on my estate - everything that I wanted to leave to my children. Similarly, a debt left unpaid too long by a government is a burden on future generations.

That is why deficit reduction is now at the centre of many governments' fiscal policy. A government with a "credible" plan for "fiscal consolidation" supposedly is less likely to default on its debt or leave it on the back-burner.

This will, it is thought, enable the government to borrow money more cheaply, in turn lowering interest rates for private borrowers, which should boost economic activity. So fiscal consolidation is the royal road to economic recovery.

This, the official doctrine of many developed countries today, contains at least five major fallacies, which pass largely unnoticed, because the narrative is so plausible.

First, governments, unlike private individuals, do not have to "repay" debts. A government of a country with its own central bank and its own currency can simply continue to borrow by printing the money lent to it. This is not true of countries in the euro zone. But their governments do not have to repay their debts, either. If their (foreign) creditors put too much pressure on them, they default. Default is bad but life goes on much as before.

Second, deliberately cutting the deficit is not the best way for a government to balance its books. Deficit reduction in a depressed economy is the road not to recovery, but to contraction, because it means cutting the national income on which the government's revenues depend. This will make it harder, not easier, for it to cut the deficit. The UK already must borrow £112 billion (Dh640.7bn) more than it had planned when it announced its deficit-reduction plan in June 2010.

Third, the national debt is not a net burden on future generations.

Even if it gives rise to future tax liabilities (and some of it will), these will be transfers from taxpayers to bond holders. This may have disagreeable consequences. But trying to reduce it now will be a net burden on future generations: income will be lowered immediately, profits will fall, pension funds will be diminished, investment projects will be cancelled or postponed, and houses, hospitals, and schools will not be built. Future generations will be deprived of assets.

Fourth, there is no connection between the size of national debt and the price that a government must pay to finance it.

The interest rates that Japan, the US, the UK, and Germany pay on their national debt are equally low, despite vast differences in their debt levels and fiscal policies.

Finally, low borrowing costs for governments do not automatically reduce the cost of capital for the private sector.

The powers of old Europe have entered into an alliance to exorcise the spectre of national debt. But statesmen who aim to liquidate the debt should recall another famous spectre - the spectre of revolution.

Robert Skidelsky, a member of the British House of Lords, is professor emeritus of political economy at Warwick University

* Project Syndicate