MacroPolis

A play with four actors about hidden liabilities and the green economy

The corporate sector Let us think of a factory that makes widgets that consumers like to buy. The management of the factory then sees an opportunity to buy a new piece of equipment, a machine, that can double widget production once it is operational.

This machine lasts for many years and is expensive, so management calculates the cost of borrowing to buy this machine, against the added value, the higher profits, that this machine can help deliver in the future.

The purchase of this machine is an “investment.” Investments can, but do not have to be, financed with debt (e.g. a loan). As investment brings higher income in the future, the debt (e.g. to a bank) can be serviced with timely principal and interest payments. Since this is a “durable” piece of equipment lasting many years, the rate of using up this machine in production is called “depreciation” and the charge for this is called “consumption of fixed capital.”

The owners of our imaginary factory purchase the machine and add it to the “capital stock” on the asset side of the company’s balance sheet. In the beginning, the liabilities go up by the amount of new debt that they have taken on board to pay for this machine. The net worth, or wealth, of the shareholders is not immediately affected (assets and debt are both higher now; it is a so-called “balance-sheet lengthening” operation, in accounting terms). 

Then, as the machine begins to operate, the assets get written down every year by the amount of depreciation of the machine, and the debt is reduced by the amount of annual amortization of the debt. If this machine causes revenues to increase faster than operating expenses and the interest on the debt, then a “profit” results and the surplus accumulates over time in bigger cash assets on the balance sheet. The company’s net worth increases—this is how growth makes investors wealthier over time.

Now let us also assume that the factory, with its new high volume machine, uses as one of the inputs a nonrenewable resource—something that we can take from the earth but we cannot  put it back or increase or make a replacement for it as we used it up in production. The depletion of this nonrenewable resource is not in any balance sheet. Because it is not recorded, we do not see that its quantity is gradually depleted­­—this can take many years.

The second actor is the government. Many nonrenewable resources, as it happens, are administered by governments because they are the stewards of resources in their country. Crude oil is an example of a nonrenewable natural resource (there are many more). What government of an oil producing country has a balance sheet that shows that when the country sells the oil, it is selling the country’s net worth? (The “oil deposits” make up a great share of the net worth of the country as a whole.) If readers are aware of any, please let us know.

The proceeds of the oil sales are recorded as “revenue” in the budget and this money gets spent mostly on government consumption. The true economic net worth of the state is rapidly eroded because assets are being sold, and often, in addition to depleting the resources of the country,  debts are being accumulated to pay for additional (over-)spending. The average citizen does not see any of this, because oil receipts are recorded in the budget as “revenue” so it seems that there is no deficit. Yet the net worth of the government (the collective net worth of all the citizens) is steadily dropping, which means that, yes, there is a deficit.

Let’s return to our widget producing company. Production proceeds and the company does well and is admired for many years in a row. Nevertheless, the production causes the emissions of certain residues, some of which are toxic or harmful to the environment in which we all live. The company deposits the residues in a terrain behind the factory, or buries them in the ground in a landfill, and some of it gets released into the air, or, in some countries, it gets simply dumped into the river. These residues are really “negative value added” or a “loss,” but often this does not get recorded because the production of the toxic residue is not costed. That would cause much lower profits and it would not look good on a corporate balance sheet.

The third actor is Nature. The “collective balance sheet” of humanity neither records correctly the drawdown of nonrenewable resources, nor the production of harmful residues of our insatiable consumption. But the innate balance sheet of Nature records all of it. In the “true” balance sheet where everything is visible, depletion of assets and the buildup of hidden liabilities are all recorded and the effects on Nature itself, and economies that live in it, accumulate over time.

Last but not least, we have the household sector. A respected employee of our factory has a family with kids. He (or she) has bought a big house with an equally big mortgage. The head of the household pays the interest every month, and the mortgage is a no-amortization mortgage (for a while), so the family enjoys a high level of consumption. Since the factory is doing well and wages are gradually going up, the family decides to buy a large SUV, also on credit.

The house is beautiful, the big car is luxurious, and the standard of living is high, but there is one drawback—the trash service in town is unreliable, so the family dumps the trash on a vacant lot at some distance from the house. This trash accumulates over time. Again, the hidden liability of accumulating trash is not recorded anywhere on a private balance sheet. Once more, Nature absorbs the destruction of net worth on its “true” balance sheet over time.

The town is in a country with vigorous political debates. There are two types of politicians—the Populists and the Contemplatives. The Populists are in the majority; the Contemplatives don’t command as much attention. The Populists appeal to emotions, the Contemplatives appeal to reason. But because reason is more difficult than emotion, the Populists almost always win the elections, and, therefore, they are in the majority most of the time.

Nature is a force to be reckoned with. She seems infinitely patient and accepting, but sometimes she gets a peptic upsurge and bites back. And so it happens that the town discovers that slowly but surely, the natural resources are beginning to be drawn down, as pointed out by quiet and unassuming scientists. Moreover, doctors are having a hunch that increased illness is related to the toxins and residues from the  disposals and garbage that has not been properly treated, and for which no-one has ever had to pay adequately. The toxins have been leaking into the drinking water and evaporating into the air. Trace elements are gradually being encountered in the livers of animals and in the tissue of plants. People are now starting to realize intuitively that there are, in fact, substantial “hidden liabilities” that have never been accounted for in our economic models. Nature is gently pointing out that something is amiss.

The parents of our happy family, with high consumption and standard of living, impress upon the children that all is well, because of all the “investments” that have been made. As a result, they explain, the kids will be much richer than the parents and they can easily pay off all the debt that is being accumulated.

The government is not a silent participant in this development. The Populists proclaim that something needs to be done for the sustainability of the economy. Suddenly, there is alarm. They launch a plan for “green investments” to clean up the toxic waste and the garbage dump. Since these are called “investments,” they quiet everyone down, including that it does not have to be paid for. These can be financed by issuing more debt. After all, the Golden Rule of economics is that consumption needs to be paid for, but investment can be financed.

Thus, the hidden liabilities (debts) that were never paid for are now being funded with …. more debt. The alternative would be to pay for the cleanup of the environment with taxes (e.g. a steep carbon tax) on all consumers who have never incorporated the “hidden liabilities” in their voracious consumption patterns in the first place. But that idea does not win any votes, so to be elected, political representatives convince the people that cleaning up the environment is an “investment” and you don’t need to pay for it at all. This is the new “Green economy.”[1] The kids and the Contemplatives are a bit uneasy, but they are in the minority (if only we had “true” balance sheets, including in government).

In the debates about reforming the European Stability and Growth Pact (SGP), seemingly all political leaders have decided that the Green Economy does not need to be paid for—you simply borrow yourself into sustainability. The race is on how to relax the deficit and debt rules under the SGP—"increasing flexibility to finance the Green Economy,” this is called. Who could ever be against it?   

*Bob Traa is a macroeconomist and author of "The Macroeconomy of Greece: Odysseus' Plan for the Long Journey Back to Debt Sustainability" published in 2020. Jens Bastian is senior policy advisor at ELIAMEP.