Friday, 15 July 2011

The economy can’t grow with debt

A point made by Carmen M. Reinhart and Kenneth S. Rogoff in an article at Bloomberg.

Public debt in advanced countries is reaching levels not seen since the end of World War II and thus asking: Is this level of debt a problem? seems sensible.

Reinhart and Rogoff write,
Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP.
and they continue,
Several studies of financial crises show that interest rates seldom indicate problems long in advance. In fact, we should probably be particularly concerned today because a growing share of advanced country debt is held by official creditors whose current willingness to forego short-term returns doesn’t guarantee there will be a captive audience for debt in perpetuity.

Those who would point to low servicing costs should remember that market interest rates can change like the weather. Debt levels, by contrast, can’t be brought down quickly. Even though politicians everywhere like to argue that their country will expand its way out of debt, our historical research suggests that growth alone is rarely enough to achieve that with the debt levels we are experiencing today.
And for the big question: At what point does indebtedness become a problem? Reinhart and Rogoff argue,
In our study “Growth in a Time of Debt,” we found relatively little association between public liabilities and growth for debt levels of less than 90 percent of GDP. But burdens above 90 percent are associated with 1 percent lower median growth.
Reinhart and Rogoff's conclusions are based on a data set of public debt covering 44 countries for up to 200 years. The annual data set incorporates more than 3,700 observations spanning a wide range of political and historical circumstances, legal structures and monetary regimes.

They end by saying,
Those who remain unconvinced that rising debt levels pose a risk to growth should ask themselves why, historically, levels of debt of more than 90 percent of GDP are relatively rare and those exceeding 120 percent are extremely rare [...]. Is it because generations of politicians failed to realize that they could have kept spending without risk? Or, more likely, is it because at some point, even advanced economies hit a ceiling where the pressure of rising borrowing costs forces policy makers to increase tax rates and cut government spending, sometimes precipitously, and sometimes in conjunction with inflation and financial repression (which is also a tax)?

Even absent high interest rates, as Japan highlights, debt overhangs are a hindrance to growth.
The relationship between growth, inflation and debt, no doubt, merits further study; it is a question that cannot be settled with mere rhetoric, no matter how superficially convincing.

In the meantime, historical experience and early examination of new data suggest the need to be cautious about surrendering to “this-time-is-different” syndrome and decreeing that surging government debt isn’t as significant a problem in the present as it was in the past.
Now, just what is New Zealand's level of debt? According to this site New Zealand's public debt: 25.5% of GDP (2010 est.). There is of course the issue of what exactly is being measured here. But while debt is rising this estimate is well below the 90% mark noted above.

For comparison, this webpage ranks countries by public debt as a percentage of GDP, (source: CIA World Factbook - unless otherwise noted, information in this page is accurate as of January 1, 2009, so the figures are a couple of years old.). Japan comes in first at 194.4%, Zimbabwe second at 189.9% and Lebanon is third at 188%. At the other end of the list is Luxembourg at 2.6%. Australia is at 15.2%.

1 comment:

The Arthurian said...

Hello. Next-Blog brought me here.

The blind man who judged the elephant by its tail thought it was like a snake.

Reinhart and Rogoff perform "more than 3,700 observations" of the elephant's tail, but none of the great body of the beast. None on private debt.