Authored by Mark Spitznagel, originally posted at Project Syndicate,
As Detroit begins to sort through the ill-begotten public liabilities that have driven it to bankruptcy, an important opportunity is at hand to revitalize the city that was once the epicenter of American entrepreneurship and manufacturing, while setting an example for other municipal governments that appear to be headed toward a similar fate. Here is an “Austrian moment” in the making, a potential libertarian awakening guided by the market-oriented, non-interventionist principles of the Austrian school of economics.
For years, Detroit’s expenditures vastly exceeded its revenues. With the tax base eroding, owing to a declining population and diminishing private-sector jobs, efforts to boost revenue by raising taxes would have been futile. (Detroit’s 2012 income-tax rate of 2.45% and its property taxes, which are among the country’s highest, are inexplicable, given the inadequacy of basic public services.) In this context, Detroit’s “Ponzi”-like fiscal situation would have continued to deteriorate, with no options other than to borrow more.
But, as long as investors were willing to purchase risky bonds, neither politicians nor unions would admit how unsustainable Detroit’s situation was. With the Federal Reserve’s near-zero interest-rate policy and purchases of trillions of dollars in long-term securities driving demand for such bonds, Detroit’s leaders were able to delay public-sector reform for far too long (a situation that is frighteningly similar to the federal government’s today). Detroit’s bankruptcy is thus exactly what the financial system needs.
Before any tears are shed for the bondholders, it is important to consider the fundamental differences between private and public debt. Private debt is an inter-temporal, contract-based exchange between two entities: the debtor, who needs capital, and the creditor, who is willing to provide that capital in exchange for a sufficient rate of return.
When it comes to public debt, however, creditors receive returns not from the governments to which they have lent money, but from taxpayers, who may be reluctant to cover the costs incurred by a contract to which they never really agreed. Given that the people who borrow and disburse government funds (typically, as in Detroit’s case, an entrenched political elite) are rarely the ones from whom revenues are later collected, public debt does not entail a willing inter-temporal exchange.
As the Austrian-school economist Murray Rothbard pointed out more than two decades ago, deficit spending and public debt represent “a growing and intolerable burden on the society and economy,” given that they transfer “resources from the productive [private sector] to the parasitic, counterproductive public sector.” Detroit’s predicament clearly demonstrates the need to reduce this burden, even if that means enduring a painful adjustment period.
In fact, public debt and deficit spending can be compared to a forest that has become choked with overgrowth, giving the false – and, ultimately, damaging – impression of an abundance of resources. In the forest, natural correcting mechanisms, such as small wildfires, might be suppressed by external actors with an interest in preserving the illusion of plenty, regardless of its potential consequences.
Likewise, rather than allow market forces to correct the problems of mounting public debt and deficit spending, policymakers manipulate interest rates to create excess liquidity and encourage investors to chase yield in a risky environment. Such interventions support unhealthy, distorted, and destabilizing growth, causing the debt burden to grow and, eventually, triggering systemic collapse.
The good news is that, as Rothbard noted, such a collapse “is the ‘recovery’ process,” and, “far from being an evil scourge, is the necessary and beneficial return,” whether in a forest or an economy, to “optimum efficiency.” Given this, purging Detroit’s balance sheet (specifically, the disproportionate unfunded liabilities that have plunged it deep into the red) is the best – maybe even the only – available path to renewal. The long-term benefits would more than offset the short-term costs.
Detroit can correct its past public-sector ineptitude and abuses by unleashing the private sector’s vast potential, rooted in the metropolitan region’s vibrant entrepreneurial and manufacturing culture, skilled workforce, and a robust technology base nurtured by world-class institutions like the University of Michigan. The city’s position on an important border crossing and access to an enormous fresh-water supply from the Great Lakes, not to mention the business community’s unrelenting support, enhance its prospects further. (In fact, in the wider metropolitan region, the private sector is realizing its potential even today, despite the barriers that Detroit’s dysfunctional public sector has erected.)
The time has come to free Detroit’s entrepreneurial spirit from the legacy of government mismanagement. Guided by the Austrian school’s libertarian principles, Detroit can transform itself from an example of municipal failure into a symbol of restoration and source of economic dynamism, the likes of which the US has never seen.