Size Isn’t All That Matters

What's lost in all the talk about America's debt problem.

Debates about government debt, whether in the United States, Japan, the eurozone, or elsewhere, have been missing one fundamental point: The composition of both debt and spending matters just as much as the size. This is such a basic, obvious notion, yet it seems to have eluded many of the politicians, pundits, and credit-raters who have been obsessing about the billions or trillions of dollars that may be spent or saved. In the case of the United States, it is particularly germane.

For American politicians, the big numbers are the ones that invariably get top billing, as they did at U.S. President Barack Obama's Monday-morning press conference on the debt ceiling fight. Yet whether it's $970 billion (the projected deficit after the "fiscal cliff" deal) or $11 trillion (the debt held by the public), these numbers say nothing about how money is borrowed and spent. In Washington, the only difference between good and bad spending is usually 'spending in my district' versus 'spending somewhere else,' as Obama mockingly remarked. It doesn't take much brainpower to see how much important information such a simple, shortsighted distinction omits.

Imagine two people with similar assets and incomes who are both seeking to borrow $100,000 for 10 years. One plans to spend the money on a master's degree that will improve her options in the labor market. The other plans to take a luxurious vacation with his family and buy a pleasure boat. To whom would you charge the higher interest rate? By investing the money in her ability to repay, the first borrower is increasing her credit-worthiness. She should be able to obtain a lower interest rate on the $100,000; she should also be able carry more debt than the other borrower at any given interest rate.

Now imagine that two other people with similar assets and incomes both plan to carry $100,000 in debt for 10 years. One has a fixed interest rate of 3 percent for the entire period. The other has borrowed for two years at 2.5 percent and plans to roll over the debt -- repay and then borrow again -- four times. Which borrower has the bigger risk of default? Since interest rates can fluctuate a lot over the years, and they seem pretty low right now, the long-term borrower probably has the safer strategy.

The lesson is clear: How you borrow and spend can make as much difference to your credit-worthiness as how much. And it's no different for governments. A government that uses borrowing to invest in its economy's future growth -- and hence its ability to repay -- should be able to borrow more than one that doesn't, all other things equal. By the same token, a government that borrows at low, fixed rates for the long term should be able to borrow more than one that constantly rolls over short-term debts.

In the past several years, the national debt of the United States has undergone a tremendous change. Long-term securities -- those with maturities of seven years or more -- have gone from about 30 percent of the debt in 2009 to about 40 percent today. By 2018, according to the Treasury's own estimates, they'll make up 50 percent of the debt, a proportion the Treasury expects to maintain from then onward. The United States is doing what any smart borrower would do: locking in low rates for the long term. As a result, its probability of default for any given level of debt has dropped.

The nature of government spending is undergoing a dramatic shift as well. For a decade, the United States spent roughly $100 billion a year on wars whose value to creditors -- in terms of enhancing the nation's ability to repay its debts -- was not exactly clear. Reducing spending in this area will make the United States more credit-worthy. But even if this spending were simply replaced by programs that invest in the economy -- infrastructure, scientific research, education, health care -- it would still make the United States a less risky borrower.

In fact, there is a powerful argument that the United States can and should borrow more to spend money on these long-term investments. Yet the mere idea of spending more, increasing deficits, and adding to the national debt makes politicians, pundits, and especially credit-raters of all stripes recoil in horror. They do not seem to understand that the United States, despite its national debt growing to about 75 percent of GDP, may actually be a better risk now than it was in, say, the early 1990s.

The markets seem to understand this. Interest rates on Treasury securities have fallen steadily. Of course, the Federal Reserve has been doing its best to keep rates low, and other countries have been in even worse shape fiscally than the United States. But had those been the only important factors, rates on longer-term securities -- 10-year and 30-year debt, for example -- would have recovered more by now.

In the next couple of decades, the United States will indeed have to reduce its budget deficits. Medicare costs and historically low tax rates are likely to be an unsustainable combination. But in the meantime, the nation can do much to improve its credit-worthiness through changes in the composition of its borrowing and spending. Indeed, it already has.

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Daniel Altman

The New Monopolies

Have America's big Internet companies become too powerful?

Twenty-nine years ago, on Jan. 1, 1984, the Bell Telephone Company ceased to exist, having been broken up into smaller firms by the U.S. government. Bell had controlled the American telephone network since its inception, and this control gave it an unfair advantage in selling a variety of goods and services used for communication. Fast-forward to today: If the same were true for a global Internet giant like Facebook or eBay, could consumers still be protected?

Only a few Internet companies have reached a scale that raises questions about competition, but each has at least 100 million customers. So far, legal authorities in the United States and elsewhere have scrutinized them mainly when they have pushed into markets on the fringes of their own business, as in Facebook's attempt to prevent other software from complementing its own system or Google's use of its search engine to influence consumers' purchasing decisions. Last week, the United States decided that Google's behavior did not discourage competition.

But Google is different from Facebook and eBay. The usefulness of Google's search engine depends only indirectly on how many other people are using it; for Facebook and eBay, the network of other users is of central importance and can guarantee customers' loyalty, even when they feel mistreated. Despite this potential drag on competition, however, the companies' market shares in their core lines of business have not come into question.

That's unusual, since they have been completely dominating their markets. Depending on how you measure, Facebook may account for as much as 95 percent of the time Americans spend using online social networks. As of a few years back, eBay had 90 percent of the online auction markets in the United States and Europe. With that market locked up, it's now competing with Amazon for regular retail sales.

A simple reason for the companies' free pass may be that they charge very little or nothing for their services. Facebook's famous pledge "It's free (and always will be)" may help to insulate it from antitrust claims. And indeed, one of economists' primary concerns about dominant firms is that they will gouge consumers, or at least raise prices in a way that pushes some buyers out of the market. But economists also worry that a dominant firm will erect barriers to keep other companies out of its primary market.

The lack of competitors hurts consumers, too, by blocking the introduction of new and potentially better products -- for example, a social networking site that gives users easier control of their content and privacy. Clearly, promising to offer a service for free does not solve this problem. If it finally becomes clear that Facebook's network is so enormous that no other social network can break into the market, then its own business may become a target for regulators.

In Facebook's case, such action may be premature. After all, Friendster and Myspace were apparently strong incumbents before being quickly supplanted. Other companies, like eBay, may not escape so easily. Like Facebook, eBay has an enormous network of registered users, but it does charge for its services. It has not faced any serious competition during most of its existence, and its global presence is growing, with more than three dozen markets so far totaling almost $2 billion in quarterly revenues. The question is whether regulators will see online auction services as a discrete market, rather than just one of many ways of selling stuff.

Sooner or later, a regulator somewhere in the world is bound to take a crack at one or more of these companies on the basis that their networks constitute barriers to competition. If the challenge is successful, the outcome will be very different from what happened to Ma Bell. A case against Facebook in a small country might simply lead the company to stop offering its services there. In the United States or the European Union, that might not be an option.

A company like Facebook cannot simply be carved up into geographical regions or have some services separated from others. Its product is a holistic user experience, and -- if necessary -- it could serve the whole world from a single base of operations. Creating a slew of mini-Facebooks that covered consumers from different states or countries wouldn't remove any barriers, either, since the network and its uniform product would undoubtedly stay intact; dismantling such a popular product would probably end up hurting consumers more than helping them.

What are the alternatives? Governments could try to prevent Facebook from offering new services, in order to give new entrants a fighting chance. A more extreme possibility would be to nationalize the company or turn it into a public trust, forcing it to be run for consumers' benefit. In eBay's case, the solution might be to regulate its prices, as governments already do with utilities like water and electricity.

Yet any remedy that threatened to damage the company's business or its value to shareholders could ultimately be ineffective or even counterproductive. Facebook, eBay, or any other Internet company could just relocate its headquarters to a friendlier regulatory climate, taking thousands of jobs with it -- but with no interruption in its services. After all, the United States and the EU aren't in the business of blocking websites the way China and many Middle Eastern countries do.

It's tough to find a solution that would truly promote competition without destroying the Internet giants' valuable contributions to the global economy. These companies are part of a new species of global business not anticipated by decades-old antitrust legislation or standard theories of industrial organization. Right now, the world doesn't have the right jurisdictions, tools, or even ideas to deal with them. So do we just have to live with their virtual monopolies, whatever prices they decide to charge and whatever services they deign to offer?

Not necessarily. When government fails to act, or can't, consumers still have a choice. In early December, changes to the policy on ownership of photos at Instagram, a Facebook subsidiary, led to outcries among users and in the media. Even though Instagram dropped the changes after three days, thousands of users had already switched to or at least tried other services.

The next step is for consumers to organize themselves so that they can confront potential abuses. If they speak with one voice, the companies will listen and even consult with them before pursuing new strategies. Why? Because the billion-plus Facebook and eBay users aren't just customers -- they're also the companies' most important assets.