Do High Levels of Public Debt Stifle Economic Performance?
dominicfitches
Apr 28, 2022
15 min read
Covid-19 had an unprecedented effect on global economies. Levels of public debt soared as economies scrambled to uphold standards of living throughout stringent lockdowns, with economic performance plummeting due to large parts of the economy becoming inactive due to public health measures. Prior to Covid-19, one of the most heated debates in economics was around the impact of public debt on economic performance, a consequence of the previous global economic crisis in 2008. There is significant discussion and disagreement within the academic community as to whether high levels of public debt have an impact (Pescatori, Sandri and Simon, 2014). With over half of the G20 having a debt to GDP ratio of over 90% (Statista, 2021), including the world’s largest economy (The United States), it is a particularly pertinent issue for the global economy. If high levels of public debt does stifle economic performance, then we can expect half of the world’s largest economies to have their economic performance ‘stifled’.
Before we examine the issue in greater detail, we must firstly define what we mean by high levels of public debt, and how we measure economic performance. Much of the literature focuses on critiquing Reinhart and Rogoff’s contributions to the debate in the wake of the financial crisis. In their 2010 working paper ‘Growth in a Time of Debt’, Reinhart and Rogoff examine the effect of public debt on GDP growth at a debt to GDP ratio of 60%, and a higher ratio of 90%. Kumar and Woo (2010) also study the impacts of a 90% debt to GDP ratio, as does Caner, Grennes and Köhler-Geib (2010), Minea and Parent (2012) and Checherita-Westephal and Rother (2012). With such a high volume of important contributions to the subject all considering a 90% debt to GDP ratio to be high, it seems an appropriate definition for this essay to use, with a 90% public debt to GDP ratio being considered a high level of public debt. Secondly, we must define what we mean by economic performance, and explain how this can be ‘stifled’. All the aforementioned papers have used GDP growth as their key economic performance indicator, and this essay will continue with using GDP growth, also referred to as economic growth, in assessing whether high levels of public debt stifle economic performance. It is important that the distinction is made between high levels of public debt directly stifling performance (GDP growth) in a directly causational manner, and an indirect relationship. For example, as many G20 economies such as the UK, US, France and Japan experienced sharp rises in their debt to GDP ratio, they also concurrently enacted large scale austerity programmes, which is also ‘stifles’ and slows economic growth (Krugman, 2015). This essay will therefore examine whether public debt stifles economic performance, and if so, the extent to which that is as a result of high levels of public debt itself, or whether it can be attributed to the austerity programmes seen in the wake of the financial crisis.
Traditional Keynesian theory suggests that in a time of recession, fiscal expansion is necessary, despite potentially high levels of public debt (Keynes, 1937). Through spending induced economic growth, debt to GDP ratios can be significantly reduced, preventing high debt levels from stifling economic growth. On the other hand, the neoliberal thinking seen predominantly as a result of Friedman’s rejection of Keynesianism lead to the increasingly proposed view that austerity (Farnsworth and Irving, 2018) is necessary to reduce levels of public debt, otherwise growth will be hindered in the long term. This was then developed into a theory of ‘expansionary fiscal contraction’, advocated by Giavazzi and Pagano (1990), which states that through a fiscal contraction (aiming to combat high levels of public debt), long term economic growth can be achieved. Most of the subsequent literature follows one of the aforementioned views, with Herndon, Ash and Pollin (2014) being in the Keynesian camp, and Reinhart and Rogoff (2010) following Giavazzi and Pagano’s school of thought.
Much of the recent literature regarding the relationship between public debt and economic growth stems from Reinhart and Rogoff’s (2010) paper, titled ‘Growth in a Time of Debt’, in which the central argument is that when debt reaches 90% of GDP, economic growth is halved. A significant strand of literature has examined and hotly debated this claim, with the central argument made by Reinhart and Rogoff being perpetuated by influential policymakers such as Paul Ryan (Leader of the House of Representatives in America) and George Osborne, the British Chancellor of the Exchequer (Pollin and Ash, 2013). It is difficult to overstate the impact of Reinhart and Rogoff’s research, forming the basis for austerity policies throughout Europe and America. Other contributions from Eberrhardt and Presbitero (2015) note that ‘whatever the form of the debt-growth relationship, it differs between countries’. This is a vitally important addition to the literature, highlighting that whilst high levels of public debt may stifle growth in one country, they may not in another, due to the fact that the debt-growth relationship is significantly altered depending on the country in which it is studied. Similarly to Reinhart and Rogoff (2010), Kumar and Woo (2010) also note a slowdown in economic growth with rising levels of public debt, as does Cochrane (2011). However, Kumar and Woo (2010) explain that there is only a 0.2% fall in economic growth for a 10% rise in public debt, and that this is ‘even smaller in advanced economies’, although if an economy has a debt to GDP ratio of around 90%, there is an ‘element of non-linearity’, and growth is hindered by 0.4%. In parallel to Kumar and Woo (2010), Schclarek (2005) indicates that the inverse relationship between debt and economic growth only applies to developing countries, not advanced economies. Furthering the argument, Cecchetti, Mohanty and Zampoli (2010) describe the thought of debt to GDP ratios of over 100% as ‘frightening’. Whilst their contributions were made in 2010, one wonders what they make describe Japan’s current 256% debt to GDP ratio as. Checherita-Westephal and Rother (2012) assert that at a 90% debt to GDP ratio long term growth ‘certainly falls’, postulating that the ratio at which growth is stifled may actually be lower, at around 70-80%. Conversely, Ostry et.al., (2010) consider the fact the relationship may be inverse, with low levels of economic growth being a primary cause of high debt, as opposed to the other way around. Furthermore, Ostry et.al., (2010) also suggests that debt doesn’t inherently stifle growth, and the argument that it is possible to sustain high levels of debt whilst eliciting economic growth naturally to reduce debt to GDP ratios. Additionally, Panizza and Presbitero (2013) suggest that whether high levels of public debt impact economic growth or not depends on several factors, such as ‘institutional quality’, ‘how and why’ debt has been accumulated, and the size of the public sector. This is a valuable contribution adding weight to Eberrhardt and Presbitero’s (2015) comments that the debt to GDP ratio is varying from country to country.
Much of this criticism towards the idea that growth is either possible during times of high debt, or not stifled by high debt, comes from the neoliberalist views seen as a response to high levels of public debt during the 1970s (Konzelmann, 2014)
Whilst swathes of the literature adds to Reinhart and Rogoff’s (2010) research, there is also however significant criticism. Herndon, Ash and Pollin (2014) provide a retort to Reinhart and Rogoff’s (2010) assertion that the average growth of an economy with a greater than 90% debt to GDP ratio is -0.1%. Showing that through ‘exclusion of data, coding errors and inappropriate weighting of statistics’, there was a ‘serious miscalculation’ which led to an incorrect conclusion as to the nature of the debt to growth relationship. Herndon, Ash and Pollin (2014) correct the alleged mistakes, stating that for countries with a debt to GDP ratio of over 90% growth is in fact 2.2% on average, which is ‘not dramatically different’ to countries with lower debt to GDP ratios, with their paper ‘totally refuting’ the negative impacts on growth of the 90% debt GDP ratio. Additionally, Nerisisyan and Wray (2010) also question the impact on growth, maintaining that for advanced economies there is no inverse relationship between debt and growth. Minea and Parent (2012) also refute averment that 90% is the level at which growth becomes actively stifled by debt, instead suggesting that this figure is closer to 115%.
Kharroubi and Aghion (2008) also note that rising debt levels ‘constrain the rational avenues’ for fiscal policy to take, perpetuating that high debt causes austerity based policies, which in turn constrains growth. Panizza and Presbitero (2013) suggest that high levels of public debt only has a negative impact on economic growth when contractionary fiscal policy is implemented. There are significant volumes of literature backing the assertion that austerity policies (caused by high levels of public debt) stifles economic growth (Blyth, 2013), (Schui, 2014), (Krugman, 2015), (Skidelsky, 2015). However, it is also questionable amongst similar circles within the literature whether austerity is a necessary policy measure to combat rising levels of public debt. If a debt to GDP ratio is rising, governments are able to reduce the levels of debt via austerity policies, however stimulus packages can increase GDP, therefore reducing the ratio (Ostry et.al., 2010), (Blyth, 2013). It appears from the literature that high levels of public debt does in fact stifle economic growth, especially at high debt to GDP ratios of over 90%. However, there are significant question marks as to whether this is intrinsic, or due to policies associated with debt reduction such as austerity, which inherently stifles growth. The only certainty when it comes to debt to GDP ratios and economic growth is that there are wide ranging disagreements within the literature and wider economic community, and no consensus. Whilst the literature does lean towards suggesting that a high debt to GDP (of 90% plus) ratio does stifle economic growth, there are contrasting arguments, and no clear consensus.
According to the assertions made by Reinhart and Rogoff (2010), a country with consistently high public debt over a medium-term period of 10 years should see negative economic growth, with public debt significantly stifling economic growth. Singapore is an ideal case study to test this theory, with a debt to GDP ratio of consistently over 90%, and in most years pushing over 100%. We will study the period between global recessions, 2010-2019, where external shocks are more limited. Some academics have described a debt to GDP ratio of over 100% as ‘frightening’ (Cecchetti, Mohanty and Zampoli, 2010), with Reinhart and Rogoff (2010) forecasting this would mean a fall in GDP over the period. Kumar and Woo (2010) suggest that there would also be declining levels of economic growth. Therefore, according to much of the literature studied, we can ‘certainly’ (Checherita-Westephal and Rother, 2012) expect the high debt, advanced economy of Singapore to contract between 2010 and 2019. This is not the case, as illustrated below. We do however see a decline in economic growth over the period, in line with the predictions made by Kumar and Woo (2010), although we cannot prove that this is a direct result of high levels of public debt.
Figure 1, below, illustrates the raw datapoints for Singapore during this period in terms of debt to GDP and economic growth, with data taken from the World Bank (2020) and CEIC (2021).
Figure 1
Year
Debt to GDP %
Economic Growth %
2010
98
14.5
2011
101
6.3
2012
104
4.4
2013
108
4.8
2014
96
3.9
2015
97
2.9
2016
103
3.3
2017
107
4.5
2018
108
3.5
2019
111
1.4
Figures 2 and 3, obtained from the same dataset (World Bank, 2020), (CEIC, 2021) illustrate the data graphically.
Figure 2Figure 3
We can immediately see that Singapore does not experience negative economic growth over this 10 year period as predicted by Reinhart and Rogoff (2010), but in fact has an average economic growth of over 4% during this period, placing Singapore more in line with the results seen by Herndon, Ash and Pollin (2014). This high level of growth is observed whilst the country has a debt to GDP ratio of above the 90% level considered to be a hinderance to economic growth, with the ratio increasing for the last 5 years studied. Singapore provides proof that public debt doesn’t ‘stifle’ economic growth, and that it is possible for high levels of economic growth to occur with high and rising levels of public debt. Furthermore, Singapore’s GDP growth rate actually outpaces the global economic growth rate during this time period (World Bank, 2022b), further disproving the assertion that high levels of public debt stifle economic growth over the long term. There is a distinct lack of link to prove that debt is stifling growth in the case of Singapore. However, Singapore does also add weight to the ‘expansionary fiscal contraction’ proposal made by Giavazzi and Pagano (1990), with austerity policies being a part of Singapore’s economy in the decade after the 2008 financial crash. Whilst this data does provide evidence that an economy can expand via austerity, and that austerity is not a predeterminant for low or negative economic growth, it does however also negate the assertion that high levels of public debt ‘stifles’ economic growth. On the other hand, Blyth (2013) and House et.al., (2017) illustrate the negative effects of austerity on economic growth, and we do observe a decline in Singapore’s economic growth over the period studied.
In another case study, the world’s largest economy, America also sheds doubt on Reinhart and Rogoff’s (2010) results, providing further weight to Herndon, Ash and Pollin’s (2014) data. America has consistently high levels of public debt, a cause for political concern over the size of their deficit (Krugman, 2012), with a debt to GDP ratio increasing for 94% to 106.8% in the same period studied with Singapore, a ratio considered to be a high level of public debt which may stifle economic growth. Between 2010 and 2019, America posted an average of 2.12% in economic growth (Statista, 2020), very close to the 2% figure proposed for developed economies by Herndon, Ash and Pollin (2014). Being able to post consistent growth whilst maintaining such a high level of public debt further emphasises the view that public debt does not explicitly stifle economic growth, at least not by the margins proposed by Reinhart and Rogoff (2010), and that with a comparatively expansionary fiscal programme (Burton, 2016), evidence that ‘expansionary fiscal contraction’ policies is not necessary to reduce debt and induce growth. Chudik et.al., (2017) suggest that the debt to GDP ratio itself is not important, but in fact the ‘debt trajectory’, providing a theory as to why both the US and Singapore were able to achieve growth at a time of high debt, and supporting Giavazzi and Pagano’s (1990) expansionary fiscal contraction theory for Singapore.
We cannot however discount all of the literature which suggests that public debt stifles economic growth, and that ‘expansionary fiscal contraction’ is necessary for economies with high levels of debt in order to achieve growth. Kumar and Woo’s (2010) study highlights some applicable points, stating that growth decreases by 0.4% per 10% debt to GDP ratio increase (0.2% for more advanced economies). This can be directly applied to both Singapore and the US, who do see marginal declines in their economic growth at the same time debt as a percentage of GDP rises. It is entirely possible that high debt does have a small stifling impact on economic growth to the tune of 0.4% as Kumar and Woo (2010) suggest, as opposed to the larger contractions proposed by Reinhart and Rogoff (2010). However to assume so based on purely the data aforementioned would be inappropriate, and multiple other factors could be influences on the slowdowns seen in growth. Examples include trade wars in the case of the US (Waugh, 2019) or rising wages reducing commercial profits in Singapore (Giap, Duong, Xiao, 2017), as well as Chinese growth slowdown spillover effects (Dizioli et.al., 2016).
Another potential reason for the decline in economic growth witnessed in the US and Singapore between 2010 and 2019 is due to austerity policies having a greater than anticipated impact upon fiscal multipliers. Keynes (1936) outlines how an initial increase in government spending can have a proportionally larger effect on GDP growth depending on the size of the multiplier effect. The same is true in reverse, when austerity policies cause a reduction in spending, we can see a proportionally larger fall in GDP growth. Spilimbergo et.al., (2009) demonstrate that the negative fiscal multiplier is around 0.3 for tax increases, and 0.3 to 1.5 depending on the time of spending cut implemented. Therefore, with many G20 economies undertaking austerity policies (Kurgman, 2015), (Whiteside and McBride, 2021), we can expect to see a decline in economic growth as a result of these policies, highlighting that it is not in fact public debt that is the primary cause of stifled economic growth, but in fact austerity. Blanchard and Leigh (2013) provide further weight to this argument, proving across a 26 country study that the negative fiscal multiplier is ‘substantially above 1’, although this does differ between the countries studied. The austerity policies implemented in the aftermath of the 2008 financial crash cast doubt on the effectiveness of the expansionary fiscal contraction theories from Giavazzi and Pagano (1990), proving that fiscal contraction in most cases is not expansionary (Blyth, 2013). Furthermore, the negative effects on growth seen as a result of fiscal contraction are certainly ‘stifling’, highlighting that it is in fact austerity rather than high levels of debt as the main stifling force constraining economic growth. Kharroubi and Aghion (2008) suggest that high levels of public debt restricted policymakers in their decision making, leading to austerity, meaning in an indirect way high debt could stifle growth via the mechanism of fiscal retrenchment. However, this view is hotly disputed by Blyth (2013) and especially Krugman (2015), who both imply that policy makers did have a choice and were not forced into pursuing austerity policies. Cherif and Hasanov (2012) also imply that despite high levels of debt, economic growth can be induced as a means of reducing the debt to GDP ratio.
This paper has highlighted the extreme difficulty in proving that high levels of public debt are directly causational in stifling public debt. Whilst it may be theoretically possible, or even probable, proving a direct cause and effect of high levels of public debt reducing economic growth is challenging. This is as a result of the fact that whilst a significant proportion of G20 countries do have high levels of public debt above the 90% threshold suggested by Reinhart and Rogoff (2010), many also have enacted fiscally contractionary policies over the last decade (Blyth, 2013), (House et.al., 2017), (Whiteside and McBride, 2021), to which declining levels of economic growth could be attributed. Additionally, alongside theory, the case studies of the US and Singapore have further illustrated that economic growth can be achieved, and is not stifled by, high levels of public debt. Furthermore, Eberrhardt and Presbitero’s (2015) study highlights the differences between each individual country’s debt growth relationship. This is particularly important, highlighting the lack of a directly comparable cross-country inverse relationship. It should be noted that as we emerge from the aftermath of the Covid-19 pandemic, further studies on the debt growth relationship will shed further light on whether debt does truly stifle economic growth, with debt having ballooned significantly in advanced economies during the pandemic, and with austerity policies less likely to be followed in many countries compared to 10 years ago for political reasons. For now however, we can see no direct stifling of economic growth in an economy from high levels of public debt, with declines in economic growth likely being attributed more directly to other sources such as austerity.
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