Burdenland and Freedonia

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The Quizzical Case of Burdenland and Freedonia:
How the National Debt Effects the Competitive Edge.
By Brad Sharpe-Geisler

A nation with a large national debt must raise sufficient taxes to at least pay the interest on that debt. If all social programs, entitlements, government payroll and military spending were eliminated this would still be left.

Now consider two nations: one with a sizable national debt which we'll call 'Burdenland' and one with no national debt which we'll call 'Freedonia'. Lets assume that they are identical in all other respects. Next, assume that there exists free trade and negligible tariffs between these two nations. These conditions are sufficient to put all the businesses in Burdenland at a competitive disadvantage relative to businesses in Freedonia --reason: The national debt necessitates higher taxes in Burdenland in order to just pay the interest on that debt .

If businesses are taxed, that additional expense will simply be part of the cost of doing business and will ultimately be rolled into the cost to produce the product, thus rendering that product more expensive (less competitive) than the identical product imported from Freedonia. If, on the other hand, the workers are taxed instead of businesses, you will have the same effect because wages will need to be higher which will again ultimately be reflected in the cost of the goods produced. To be competitive, businesses in Burdenland will move their manufacturing operations to Freedonia where costs are lower (lower taxes and/or less expensive labor), but this erodes the tax base and aggravates the problem. The net effect is that an even greater tax burden must be shouldered by the remaining businesses (and workers) which creates an even greater incentive for the remaining Burdenland manufacturers to relocate to Freedonia.

Meanwhile in Freedonia, businesses enjoy undeserved advantages. They can be somewhat less efficient and still out-compete their counterparts in Burdenland. Freedonia undoubtedly enjoys a trade surplus with Burdenland and will thus be in a position to finance Burdenlands debt with its surplus ducats (the unit of currency). What can Burdenland do? At the very least, Burdenlands tax system should not disadvantage its domestic manufacturers in its own market .

Whenever a nation has a net trade deficit, its domestic market is automatically more important to it than all the foreign markets combined for two reasons:

It is the larger market;

It is the primary (if not the only) source of tax revenue.

Lets say Burdenlands taxes add one ducat to the cost of a domestically produced wicket. In order to not, through taxation, create an unfair advantage for any producer, Burdenland should impose a one ducat tariff on wickets imported from Freedonia. Hence, in order to move toward more perfect competition in its own market, Burdenland should impose a tariff on imports sufficient to match the tax burden its debt already imposes on its domestically produced goods. To do otherwise is tantamount to Burdenland subsidizing Freedonia (and the businesses that move their manufacturing to Freedonia) which would be a silly domestic policy because it is neither fair nor in Burdenland's best interests to do so. Would Freedonia respond with a higher tariff of its own? Not likely. A nation with a trade surplus has more to lose than gain by raising tariffs. Would this increase in the tariff hurt the consumer in Burdenland? Not in the slightest. Assuming a balanced budget in either case, when importers begin to pay their fair share for market access, the increase in revenues collected from tariffs will result in a concomitant reduction of other taxes. The consumers net buying power would be unaffected.

Viewed another way: rather than borrow more money from Freedonia to finance its debt, Burdenland would raise tariffs to pay its debt.

Burdenland can forestall higher taxes simply by not paying the interest and allowing the debt to compound and accumulate. This leads to an even greater problem for Burdenland down the road.
A governments duty to its citizens includes not damaging domestic business.

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