Debt/GDP and growth

April 26th, 2017 at 11:26 am

I was just on a tax panel this AM with my pal Maya MacGuineas. Maya suggested that high debt levels lead to lower economic growth.

Using Richard Kogan’s data on debt as a share of GDP and real GDP/working-age person (which is closer to productivity growth than GDP growth, but seems like a relevant metric here; you get the same results with GDP/person) back to the beginning of time (1792!), here are two scatterplots.

The first plots debt/GDP against this growth measure and the second plots the change in debt/GDP against the same growth measure. Both are largely random plots.

Source: Kogan et al.


Source: Kogan et al.

To be clear, this is, of course, nothing approaching conclusive evidence that there’s no relationship between debt levels and growth. Establishing that sort of causality would require a lot more than a few scatters; you’d need control variables and a way to partial out “endogeneity,” meaning the mechanical aspects of this relationship. For example, the economy hits a bump, growth falters, and debt begins to rise, say due to offsetting, counter-cyclical fiscal policy. Then growth picks up along with higher debt levels, enforcing a positive correlation.

But I do believe these figures should prevent one from asserting that public debt erodes growth in the US case. At times it may do so, and others, not. Learning more about those dynamics is what we should be doing, IMHO.

Kogan et al stress the key point that “…policymakers can more easily restore the nation’s fiscal health when the economic growth rate exceeds the average interest rate than vice versa.  That’s because, when economic growth rates exceed Treasury interest rates, the burden of existing debt shrinks over time.” That is, g>r is important–you get into debt trouble when your debt (r) grows faster than your economy (g). See, e.g., Greece. In the US case, Kogan et al report that g>r 65% of the time since 1947, by an average 1.3 percentage points.

As I stressed on the panel, I strongly believe one’s views must be dynamic on these issues; one should be what I’ve called a CDSH (cyclical dove, structural hawk). In weak economies, you want your debt/GDP ratio to rise enough to temporarily offset the demand contraction. As the economy moves toward full employment, you want your debt ratio to first stabilize, and then, at full employment, come down. What you don’t want, and I suspect Maya would agree, is ever-rising structural deficits, no matter what’s happening in the economic cycle.

And what you really, really don’t want are big, regressive, wasteful tax cuts that exacerbate the debt for no good reason, while worsening after-tax inequality.

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6 comments in reply to "Debt/GDP and growth"

  1. AngloSaxon says:

    Tax cuts create structural deficits. They need to show guts and gut welfare, government investment programs. Time to tell people the truth.

  2. Mary Beth says:

    I admit up front that I am not an economist. That said I have always wondered, do we need growth year after year? Is the growth we have this year adequate from here on out? It seems that growth is equated with progress, but truly they are not.

  3. William Miller says:

    The whole Trump and GOP policy and argument about the need to cut taxes to create the capital that fuels growth is misguided and false because it ignores what really drives growth. For decades, the growth of the GDP (and the valuation of stocks ) has been much more driven by intangible capital (knowledge in workers created with education, R&D, technology from innovation …) rather than tangible capital as money from profits used for investments in the assets on a balance sheet managed by obsolete financial accounting that also ignores intangible capital in workers . Therefore, government and corporate policy needs to support investments in workers such as training, free college tuition and universal healthcare for workers that would be a much greater driver of GDP growth than cutting taxes. There is no shortage of tangible capital available for corporations to borrow for investments at favorable interest rates. Profits are high but business investment is low and misdirected. Venture and angel capital exist for entrepreneurship now enhanced with crowd funding. Government policy for GDP growth that includes jobs should encourage public and private investments in worker education to create competitive workers. Countries like Germany have government and corporate policies that support intangible capital and specifically worker education in manufacturing with higher paying jobs as a larger percentage of the GDP including worker retention, apprenticeship and training that are large gaps in America. Government policy in America doesn’t adequately recognize intangible capital as the main driver of GDP growth and doesn’t encourage corporations to share profits with workers rather than shareholders as investments in lifelong worker training and wages.

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