“The ordinary expence of the greater part of modern governments in time of peace being equal or nearly equal to their ordinary revenue, when war comes [governments] are both unwilling and unable to increase their revenue in proportion to the increase of their expence.” (WN, V.iii.37; my emphasis)

I concluded my previous post with the following words: “… Smith identifies yet another method of government borrowing — one that occupies a ‘middle place” between temporary ‘anticipations’ and ‘perpetual funding’.” (WN, V.iii.29) What is this intermediate method? According to Adam Smith, “These are, that of borrowing upon annuities for terms of years, and that of borrowing upon annuities for lives.” (V.iii.29) In a word: bonds or what Smith calls “annuities”.

As an aside, Smith concludes that “[i]n France a much greater proportion of the public debts consists in annuities for lives than in England.” (V.iii.34) Why are lifetime annuities more popular than long-term annuities in France than in England? For Smith, this difference in public finance “arises altogether from the different views and interests of the lenders” in both countries. More specifically, according to Smith, investors in England are shrewd merchants who value liquidity, and long-term annuities are easier to resell than lifetime annuities:

“In England, the seat of government being in the greatest mercantile city in the world, the merchants are generally the people who advance money to government. By advancing it they do not mean to diminish, but, on the contrary, to increase their mercantile capitals, and unless they expected to sell with some profit their share in the subscription for a new loan, they never would subscribe. But if by advancing their money they were to purchase, instead of perpetual annuities, annuities for lives only, whether their own or those of other people, they would not always be so likely to sell them with a profit. Annuities upon their own lives they would always sell with loss, because no man will give for an annuity upon the life of another, whose age and state of health are nearly the same with his own, the same price which he would give for one upon his own. An annuity upon the life of a third person, indeed, is, no doubt, of equal value to the buyer and the seller; but its real value begins to diminish from the moment it is granted, and continues to do so more and more as long as it subsists. It can never, therefore, make so convenient a transferable stock as a perpetual annuity, of which the real value may be supposed always the same, or very nearly the same.” (V.iii.35)

In France, however, the market for public debt is different, for many investors consist of wealthy bachelors who have less need for liquidity and who instead prefer the soundness and dependability of receiving a dependable stream of payments during their lifetimes:

“In France, the seat of government not being in a great mercantile city, merchants do not make so great a proportion of the people who advance money to government. The people concerned in the finances, the farmers general, the receivers of the taxes which are not in farm, the court bankers, &c. make the greater part of those who advance their money in all public exigencies. Such people are commonly men of mean birth, but of great wealth, and frequently of great pride. They are too proud to marry their equals, and women of quality disdain to marry them. They frequently resolve, therefore, to live bachelors, and having neither any families of their own, nor much regard for those of their relations, whom they are not always very fond of acknowledging, they desire only to live in splendour during their own time, and are not unwilling that their fortune should end with themselves. The number of rich people, besides, who are either averse to marry, or whose condition of life renders it either improper or inconvenient for them to do so, is much greater in France than in England. To such people, who have little or no care for posterity, nothing can be more convenient than to exchange their capital for a revenue which is to last just as long, and no longer, than they wish it to do.” (V.iii.36)

Although one might be tempted to dismiss Smith’s analysis here as anachronistic or out-of-date, the Scottish scholar quickly redeems himself. After comparing and contrasting the markets for public debt in England and France, Smith poses a deeper and more timeless question: why do government overborrow in the first place? Why does public spending always end up exceeding the amount of public revenue collected via taxes? In a word, Smith’s answer is war: “when war comes,” politicians are “unwilling” to increase taxes “for fear of offending the people”:

“The ordinary expence of the greater part of modern governments in time of peace being equal or nearly equal to their ordinary revenue, when war comes they are both unwilling and unable to increase their revenue in proportion to the increase of their expence. They are unwilling for fear of offending the people, who, by so great and so sudden an increase of taxes, would soon be disgusted with the war; and they are unable from not well knowing what taxes would be sufficient to produce the revenue wanted. The facility of borrowing delivers them from the embarrassment which this fear and inability would otherwise occasion. By means of borrowing they are enabled, with a very moderate increase of taxes, to raise, from year to year, money sufficient for carrying on the war, and by the practice of perpetually funding they are enabled, with the smallest possible increase of taxes, to raise annually the largest possible sum of money. In great empires the people who live in the capital, and in the provinces remote from the scene of action, feel, many of them, scarce any inconveniency from the war; but enjoy, at their ease, the amusement of reading in the newspapers the exploits of their own fleets and armies. To them this amusement compensates the small difference between the taxes which they pay on account of the war, and those which they had been accustomed to pay in time of peace. They are commonly dissatisfied with the return of peace, which puts an end to their amusement, and to a thousand visionary hopes of conquest and national glory from a longer continuance of the war.” (V.iii.37; my emphasis)

But what happens after these wars end? How will the government be able to repay all the money it has borrowed to subsidize its wars and other overseas entanglements? I will address this key question in my next post.