Economic Growth in the Age of Debt

“The Financial World According to Inya” Column,
by Inya Ivkovic, MA

What is the relationship between government expansion and economic growth? It is a positively correlated one, almost symbiotic. If an economy is growing, its government is expanding, and vice versa. Governments need economic growth to finance their spending without inconveniencing taxpayers. In other words, economic growth makes for many happy customers.

For example, if an economy grows at an average annualized rate of 2.5%, it can double in size in a single generation, and, as a by-product, the government ends up with bonus revenues year after year without having to raise taxes. If the U.S. economy hadn’t grown in the 20th century as it did, we would never have had the state of well-being we have now. And if we cannot generate such growth in the 21st century, we will never have succeeded in sustaining the state of well-being achieved during the last century.

Surviving the financial meltdown of the 2008/2009 Great Recession, world governments need to rely on their respective economies more than ever. Why? Because most of them have never been in so much debt. How much more in debt? The worst-case scenario is seeing a number of developed economies in twice as much in debt compared to the pre-2008 levels. Is paying off debt with debt an option? It shouldn’t be at this point. If yet another band-aid debt solution is applied, we could end up in a long-term period of economic stagnation.

Not all debt is created equal. When analyzing a country’s debt, there are two kinds: 1) public or government debt; and 2) national debt, both public and private, expressed as a percentage of the country’s gross domestic product (GDP). For example, in Japan, the national debt is expressed as 200% of the country’s GDP. However, Japan’s national debt is mostly limited to its borders and thus is the easiest debt for any government to manage. In contrast, Japan’s external debt is comparably smaller, at only 40% of its GDP.

A scary debt situation is what the U.S. economy and government find themselves. The U.S. gross external debt currently exceeds 90% of its GDP, which is also the point, many economists believe, where reasonable rates of economic growth simply cease to exist.

Making matters worse is the fact that the U.S. is not alone in this debt mess. Many emerging European economies are suffocating under gross external debt equaling 100% or more of their respective GDPs. Worse yet, many developed European economies are barely breathing under the debt burden of 200% of their GDP.

Just to show you how dangerous having too much debt is, research shows that, from 1790 to 2009, the U.S. economy grew at an average rate of four percent, while enjoying the so-called “low debt” environment of having national debt at about 60% its GDP. But the moment the national debt exceeded 90% of the U.S. GDP and entered “high debt” territory, the U.S. economy shrank at an average annualized rate of 1.8%.

I have very little confidence in the current recovery. The global debt situation seems like it’s being ignored, probably because no government is yet ready to admit that what is ahead of us is an extended period of snail-pace, debt-induced, economic growth, and, in some instances, even negative growth. I would prefer to be told the truth and be prepared for what’s ahead. But at a time when governments are facing pressures for more social spending, telling the truth may equate to committing political suicide.