Capital in the Twenty-First Century (23 page)

The French monarchy’s inability to modernize its tax system and eliminate the fiscal
privileges of the nobility is well known, as is the ultimate revolutionary resolution,
initiated by the convocation of the Estates General in 1789, that led eventually to
the introduction of a new tax system in 1790–1791. A land tax was imposed on all landowners
and an estate tax on all inherited wealth. In 1797 came what was called the “banqueroute
des deux tiers,” or “two-thirds bankruptcy,” which was in fact a massive default on
two-thirds of the outstanding public debt, compounded by high inflation triggered
by the issuance of assignats (paper money backed by nationalized land). This was how
the debts of the Ancien Régime were ultimately dealt with.
¹¹
The French public debt was thus quickly reduced to a very low level in the first
decades of the nineteenth century (less than 20 percent of national income in 1815).

Britain followed a totally different trajectory. In order to finance its war with
the American revolutionaries as well as its many wars with France in the revolutionary
and Napoleonic eras, the British monarchy chose to borrow without limit. The public
debt consequently rose to 100 percent of national income in the early 1770s and to
nearly 200 percent in the 1810s—10 times France’s debt in the same period. It would
take a century of budget surpluses to gradually reduce Britain’s debt to under 30
percent of national income in the 1910s (see
Figure 3.3
).

What lessons can we draw from this historical experience? First, there is no doubt
that Britain’s high level of public debt enhanced the influence of private wealth
in British society. Britons who had the necessary means lent what the state demanded
without appreciably reducing private investment: the very substantial increase in
public debt in the period 1770–1810 was financed largely by a corresponding increase
in private saving (proving that the propertied class in Britain was indeed prosperous
and that yields on government bonds were attractive), so that national capital remained
stable overall at around seven years of national income throughout the period, whereas
private wealth rose to more than eight years of national income in the 1810s, as net
public capital fell into increasingly negative territory (see
Figure 3.5
).

Hence it is no surprise that wealth is ubiquitous in Jane Austen’s novels: traditional
landlords were joined by unprecedented numbers of government bondholders. (These were
largely the same people, if literary sources count as reliable historical sources.)
The result was an exceptionally high level of overall private wealth. Interest on
British government bonds supplemented land rents as private capital grew to dimensions
never before seen.

Second, it is also quite clear that, all things considered, this very high level of
public debt served the interests of the lenders and their descendants quite well,
at least when compared with what would have happened if the British monarchy had financed
its expenditures by making them pay taxes. From the standpoint of people with the
means to lend to the government, it is obviously far more advantageous to lend to
the state and receive interest on the loan for decades than to pay taxes without compensation.
Furthermore, the fact that the government’s deficits increased the overall demand
for private wealth inevitably increased the return on that wealth, thereby serving
the interests of those whose prosperity depended on the return on their investment
in government bonds.

The central fact—and the essential difference from the twentieth century—is that the
compensation to those who lent to the government was quite high in the nineteenth
century: inflation was virtually zero from 1815 to 1914, and the interest rate on
government bonds was generally around 4–5 percent; in particular, it was significantly
higher than the growth rate. Under such conditions, investing in public debt can be
very good business for wealthy people and their heirs.

Concretely, imagine a government that runs deficits on the order of 5 percent of GDP
every year for twenty years (to pay, say, the wages of a large number of soldiers
from 1795 to 1815) without having to increase taxes by an equivalent amount. After
twenty years, an additional public debt of 100 percent of GDP will have been accumulated.
Suppose that the government does not seek to repay the principal and simply pays the
annual interest due on the debt. If the interest rate is 5 percent, it will have to
pay 5 percent of GDP every year to the owners of this additional public debt, and
must continue to do so until the end of time.

In broad outline, this is what Britain did in the nineteenth century. For an entire
century, from 1815 to 1914, the British budget was always in substantial primary surplus:
in other words, tax revenues always exceeded expenditures by several percent of GDP—an
amount greater, for example, than the total expenditure on education throughout this
period. It was only the growth of Britain’s domestic product and national income (nearly
2.5 percent a year from 1815 to 1914) that ultimately, after a century of penance,
allowed the British to significantly reduce their public debt as a percentage of national
income.
¹²

This historical record is fundamental for a number of reasons. First, it enables us
to understand why nineteenth-century socialists, beginning with Marx, were so wary
of public debt, which they saw—not without a certain perspicacity—as a tool of private
capital.

This concern was all the greater because in those days investors in public debt were
paid handsomely, not only in Britain but also in many other countries, including France.
There was no repeat of the revolutionary bankruptcy of 1797, and the rentiers in Balzac’s
novels do not seem to have worried any more about their government bonds than those
in Jane Austen’s works. Indeed, inflation was as low in France as in Britain in the
period 1815–1914, and interest on government bonds was always paid in a timely manner.
French sovereign debt was a good investment throughout the nineteenth century, and
private investors prospered on the proceeds, just as in Britain. Although the total
outstanding public debt in France was quite limited in 1815, the amount grew over
the next several decades, particularly during the Restoration and July Monarchy (1815–1848),
during which the right to vote was based on a property qualification.

The French government incurred large debts in 1815–1816 to pay for an indemnity to
the occupying forces and then again in 1825 to finance the notorious “émigrés’ billion,”
a sum paid to aristocrats who fled France during the Revolution (to compensate them
for the rather limited redistribution of land that took place in their absence). Under
the Second Empire, financial interests were well served. In the fierce articles that
Marx penned in 1849–1850, published in
The Class Struggle in France,
he took offense at the way Louis-Napoleon Bonaparte’s new minister of finance, Achille
Fould, representing bankers and financiers, peremptorily decided to increase the tax
on drinks in order to pay rentiers their due. Later, after the Franco-Prussian War
of 1870–1871, the French government once again had to borrow from its population to
pay for a transfer of funds to Germany equivalent to approximately 30 percent of national
income.
¹³
In the end, during the period 1880–1914, the French public debt was even higher than
the British: 70 to 80 percent of national income compared with less than 50 percent.
In French novels of the Belle Époque, interest on government bonds figured significantly.
The government paid roughly 2–3 percent of national income in interest every year
(more than the budget for national education), and a very substantial group of people
lived on that interest.
¹⁴

In the twentieth century, a totally different view of public debt emerged, based on
the conviction that debt could serve as an instrument of policy aimed at raising public
spending and redistributing wealth for the benefit of the least well-off members of
society. The difference between these two views is fairly simple: in the nineteenth
century, lenders were handsomely reimbursed, thereby increasing private wealth; in
the twentieth century, debt was drowned by inflation and repaid with money of decreasing
value. In practice, this allowed deficits to be financed by those who had lent money
to the state, and taxes did not have to be raised by an equivalent amount. This “progressive”
view of public debt retains its hold on many minds today, even though inflation has
long since declined to a rate not much above the nineteenth century’s, and the distributional
effects are relatively obscure.

It is interesting to recall that redistribution via inflation was much more significant
in France than in Britain. As noted in
Chapter 2
, French inflation in the period 1913–1950 averaged more than 13 percent a year, which
multiplied prices by a factor of 100. When Proust published
Swann’s Way
in 1913, government bonds seemed as indestructible as the Grand Hotel in Cabourg,
where the novelist spent his summers. By 1950, the purchasing power of those bonds
was a hundredth of what it had been, so that the rentiers of 1913 and their progeny
had virtually nothing left.

What did this mean to the government? Despite a large initial public debt (nearly
80 percent of national income in 1913), and very high deficits in the period 1913–1950,
especially during the war years, by 1950 French public debt once again stood at a
relatively low level (about 30 percent of national income), just as in 1815. In particular,
the enormous deficits of the Liberation were almost immediately canceled out by inflation
above 50 percent per year in the four years 1945–1948, in a highly charged political
climate. In a sense, this was the equivalent of the “two-thirds bankruptcy” of 1797:
past loans were wiped off the books in order to rebuild the country with a low level
of public debt (see
Figure 3.4
).

In Britain, things were done differently: more slowly and with less passion. Between
1913 and 1950, the average rate of inflation was a little more than 3 percent a year,
which meant that prices increased by a factor of 3 (less than one-thirtieth as much
as in France). For British rentiers, this was nevertheless a spoliation of a sort
that would have been unimaginable in the nineteenth century, indeed right up to World
War I. Still, it was hardly sufficient to prevent an enormous accumulation of public
deficits during two world wars: Britain was fully mobilized to pay for the war effort
without undue dependence on the printing press, with the result that by 1950 the country
found itself saddled with a colossal debt, more than 200 percent of GDP, even higher
than in 1815. Only with the inflation of the 1950s (more than 4 percent a year) and
above all of the 1970s (nearly 15 percent a year) did Britain’s debt fall to around
50 percent of GDP (see
Figure 3.3
).

The mechanism of redistribution via inflation is extremely powerful, and it played
a crucial historical role in both Britain and France in the twentieth century. It
nevertheless raises two major problems. First, it is relatively crude in its choice
of targets: among people with some measure of wealth, those who own government bonds
(whether directly or indirectly via bank deposits) are not always the wealthiest:
far from it. Second, the inflation mechanism cannot work indefinitely. Once inflation
becomes permanent, lenders will demand a higher nominal interest rate, and the higher
price will not have the desired effects. Furthermore, high inflation tends to accelerate
constantly, and once the process is under way, its consequences can be difficult to
master: some social groups saw their incomes rise considerably, while others did not.
It was in the late 1970s—a decade marked by a mix of inflation, rising unemployment,
and relative economic stagnation (“stagflation”)—that a new consensus formed around
the idea of low inflation. I will return to this issue later.

This long and tumultuous history of public debt, from the tranquil rentiers of the
eighteenth and nineteenth centuries to the expropriation by inflation of the twentieth
century, has indelibly marked collective memories and representations. The same historical
experiences have also left their mark on economists. For example, when David Ricardo
formulated in 1817 the hypothesis known today as “Ricardian equivalence,” according
to which, under certain conditions, public debt has no effect on the accumulation
of national capital, he was obviously strongly influenced by what he witnessed around
him. At the moment he wrote, British public debt was close to 200 percent of GDP,
yet it seemed not to have dried up the flow of private investment or the accumulation
of capital. The much feared “crowding out” phenomenon had not occurred, and the increase
in public debt seemed to have been financed by an increase in private saving. To be
sure, it does not follow from this that Ricardian equivalence is a universal law,
valid in all times and places. Everything of course depended on the prosperity of
the social group involved (in Ricardo’s day, a minority of Britons with enough wealth
to generate the additional savings required), on the rate of interest that was offered,
and of course on confidence in the government. But it is a fact worth noting that
Ricardo, who had no access to historical time series or measurements of the type indicated
in
Figure 3.3
but who had intimate knowledge of the British capitalism of his time, clearly recognized
that Britain’s gigantic public debt had no apparent impact on national wealth and
simply constituted a claim of one portion of the population on another.
¹⁵

Similarly, when John Maynard Keynes wrote in 1936 about “the euthanasia of the rentier,”
he was also deeply impressed by what he observed around him: the pre–World War I world
of the rentier was collapsing, and there was in fact no other politically acceptable
way out of the economic and budgetary crisis of the day. In particular, Keynes clearly
felt that inflation, which the British were still reluctant to accept because of strong
conservative attachment to the pre-1914 gold standard, would be the simplest though
not necessarily the most just way to reduce the burden of public debt and the influence
of accumulated wealth.