Tuesday, April 12, 2011

Pat Toomey's plan for the Republican BATNA

U.S. government debt, backed with the "full faith and credit" of the nation, is the standard for risk-free returns.  Any local government, company or person that wants to borrow money pays a higher rate of interest than the federal government because it's assumed that the chance of a federal default is virtually zero.

There is, however, a fairly straightforward way that the U.S. could, in theory, default.  Since the federal budget runs at a deficit, we need to keep borrowing money to pay our bills.  This means that we have to increase our absolute debt level, and there's a legal limit -- the debt ceiling.  Once the debt hits that level we can't borrow more unless Congress passes legislation to increase the ceiling.

What would this mean?  In simple terms, the U.S. wouldn't be able to pay its bills and we would default on a number of obligations, including our debt obligations.  Even if resolved quickly this would likely attach a significant risk premium to our government borrowings which would do serious damage to our economy and make the budget deficit worse.

So far Congress has always increased the debt ceiling as needed but recent years have seen an occasional game of chicken being played, with politicians threatening to vote against an increase unless certain demands are met.  Most recently, some members of the Tea Party have demanded major cuts in spending in exchange for allowing the ceiling to rise.  Although the "grownups" of each party have kept these revolts from getting serious, the specter of a debt default is scary enough to have attracted efforts to prevent it in a more structural way.

Pat Toomey (R-Pennsylvania) has proposed an interesting way to reduce the damage that would be done by a failure to raise the debt ceiling.  He has put forward legislation that would prioritize debt service payments in the event that the debt ceiling was not increased.  As Toomey points out, tax revenues are more than sufficient to pay our debt service obligations provided only that they are prioritized under law and this would reduce the damage done by a failure to increase the ceiling.  Think of it as changing a game of chicken from being played in airplanes (with each pilot having all their loved ones on board) to being played in cars -- maybe even cars that are only going ten or fifteen miles an hour, with the drivers wearing their seat belts and having air bags.

The bill has fifteen co-sponsors in the Senate -- all Republican.  Democrats have attacked it on a number of fronts.  Why is this a partisan issue?

Of course there are political reasons for Democrats to attack any Republican proposal (and vice versa).  Accusing Republicans of putting the financial class ahead of social security recipients or putting China first grabs headlines and can be seen as part of the understandable (although unfortunate) attempts each party makes to delegitimize the other in the eyes of the electorate.  It's also quite possible that there are legitimate disagreements over whether bondholders should be the top priority among government obligations in the event that the debt ceiling weren't increased.  But let's assume for the moment that these factors aren't in play.  Specifically, let's assume that there's broad support for Toomey's logic -- failure to meet our obligations to bondholders, even for a matter of hours or days, would be catastrophic.  The Full Faith and Credit act would therefore seem like a reasonable way to reduce the risk of a catastrophe.  Why then might Democrats still oppose it?

Remember the concept of BATNA -- a party's best alternative to negotiated agreement.  Whenever our national debt approaches the ceiling, a negotiation takes place but it's a negotiation in which the BATNA is catastrophe.  Republicans will demand spending cuts, tax cuts or specific reforms and will saber-rattle about blocking an increase in the debt ceiling but that's not really a credible threat because it would be a disaster, both for the nation and for the party that caused the default.

Toomey's plan changes that.  The game of chicken is now being played in slow-moving cars rather than airplanes and the Republican threat not to increase the debt ceiling becomes a lot more credible.  The Republican BATNA would be improved substantially so their demands become much harder for Democrats to resist.

Toomey and his co-sponsors know this, of course.  In fact, Toomey gives away that half of the plan in the op-ed that introduced the plan:
If we do not raise it, the government's tax revenue will enable us to fund roughly two-thirds of projected expenditures, including interest payments. Without the ability to borrow the other third, spending cuts would be sudden and severe: Projects would be postponed, some vendor payments would be delayed, certain programs would be suspended, and many government employees might be furloughed. Default would easily be avoided, but these cuts would certainly be disruptive. That's why I hope we can avoid this scenario.
But it would be even worse simply to raise the debt ceiling without regaining control of federal spending. The recent surge in spending, both in absolute dollars and as a percentage of our GDP, has driven us to record deficits and an explosion of debt. The growth in discretionary spending has been the most dramatic, but in the future mandatory entitlement spending will be the deficit driver. Congress must address both in order to put the government back on a sustainable fiscal path.
The vote on whether to raise the debt ceiling—and, if so, by how much—is our best opportunity to insist that any increase in our nation's debt be coupled with concrete steps toward fiscal sanity. Congress should make increasing our debt contingent on immediate cuts in spending and effective reforms of the spending process that helped get us into this mess.
While Toomey "hopes" Congress could avoid failure to agree on an increase to the debt ceiling, he makes clear both that such failure would be acceptable (assuming his bill is enacted into law) and would be superior to any agreement that didn't include clear measures to reduce spending.  In negotiation terms, his plan would shift the negotiation from one in which neither party has an acceptable BATNA (and thus attempts to capture value are both risky and likely ineffective) to one in which only the Democrats would find failure to make a deal unacceptable.

That's a pretty attractive prospect for Republicans; small wonder they're the only ones who support the plan.

Toomey's plan is a great example of a broader strategic concept.  Your BATNA is rarely static and you can often improve your negotiating position simply by improving your BATNA (or by worsening the BATNA of the other party or parties).  If you're asking for a raise or promotion at work you're better off if you have an attractive offer from another firm than if your BATNA is simply to quit or start looking.  If you're negotiating with a potential buyer for your house you're better off if you already have a solid offer from someone else.  An improved BATNA makes it easier for you to walk away which, in turn, makes it much harder for those you're negotiating with to take a hard line against your interests.


  1. But, which *should* be more important for Democrats, (1) protecting the full faith and credit of the United States, or (2) increasing their bargaining power by threatening catastrophe?

    A bit of symmetry might be useful here. Suppose that the law already were that debt payments were prioritized ahead of other spending, and Democrats proposed to repeal that provision, so that a failure to increase the debt ceiling would become more catastrophic. This is exactly the reverse situation of that you describe above, and therefore, your argument would imply that Democrats should support it and Republicans should oppose it, for exactly the reasons you state.

    But, one might ask the question, is creating the potential for catastrophe, as a bargaining tactic, really what they should be doing?

  2. It depends on what you mean by 'should be doing'.

    If we assume that what is best for the leader of any political party is to increase their influence without making the country implode, lowering BATNA across the board seems like a good idea.

    Now, if instead the good of the country is your main priority, then risking a catastrophe is definitely not something you'll look for, but your strategy will be trumped by someone else who puts their influence first, unless you find a way to lower their BATNA without lowering yours: Convince the electorate that any budgeting problem is definitely your opponent's fault.

  3. David,

    My post was not meant to argue that Democrats should oppose the Toomey plan but rather to explore why they might. I'm the last person to argue that the public good isn't always the same as the interest of any particular politician!

    That said, I don't think it's clear-cut. Suppose you're a Democrat who honestly believes the following:

    1. Failure to increase the debt ceiling is still a disaster even with Toomey's plan in place.
    2. Current Republican fiscal policy would be disastrous.
    3. If the Toomey plan was put into effect, Republicans would only raise the debt ceiling if Democrats capitulated on all or most major aspects of fiscal policy.

    In that case it's not unreasonable to prefer a scenario in which there's a very small chance of a huge disaster, since the alternative is a guaranteed lesser disaster.

    Let's follow your symmetry. Suppose the law did prioritize debt payments and as a result the Democrats regularly found themselves in a position of being forced to pass policies they considered damaging to the nation because the alternative was suspension of a third of government programs. It would be high-risk but not crazy for them to make failure to pass the debt ceiling more damaging in order to prevent that tactic from being used.

  4. If "small wonder they're the only ones who support the plan" means, "I am not surprised that no Democrats support the plan," then I think it should be a bit surprising if NO Democrats think that reducing the adverse consequences is more important than enhancing their leverage in a game of high-stakes brinksmanship. Perhaps it's only not surprising in this era of hyperpartisanship.

    By the way, your posting also doesn't really explain why this "modified default" might be more acceptable to Republicans than to Democrats. You seem to sort of take that for granted. Maybe it's because you think Republicans care less about whether government functions, or functions well, than Democrats do. But I'm not entirely sure. If the plan makes the consequences of failure to raise the debt limit more palatable to both parties, equally, then in your analysis it wouldn't increase the Republicans' bargaining power, right?

  5. My assumption is that a party that wants massive cuts in government spending is far less averse to the government being forced to cut spending by an inability to borrow. Certainly the rhetoric and actions of each party seem consistent with that. Whether that's how they should look at it is an interesting question, but beyond the scope of this post.