We are sailing our economy through uncharted waters. Moreover, these waters are not the serene southern Pacific seen by early European explorers. Rather, they are treacherous ones replete with rocks, shoals, unknown currents where howling storms can spring out of nowhere.
When facing such unknowns, sailors must ensure that compass and radar are accurate and trustworthy.
Applying that metaphor to our economic situation means using economic insights best supported by theory and history.
Unfortunately, not all policy makers understand these concepts, nor do influential political commentators. That showed in comments by the New York Times’ David Brooks on the May 28 PBS Newshour. As a nominally conservative pundit, he assessed Biden administration economic proposals by saying: “it has been a truism that if your debt passes 100 percent of GDP, your nation is going to be in trouble.”
That assertion simply is false.
The issue isn’t whether increasing a nation’s debt relative to the value of its output is good or not. In general, it is not. However, there are many circumstances where it nevertheless is the option. The issue is whether theory and history lead most economists and policy makers to believe in some fixed point, like 100 percent, where a rising debt-to-output ratio suddenly flips a switch and economic “trouble” begins.
Brooks is one of the national commentators I most admire. Informed, insightful, articulate and humane, he is a moderate with sterling conservative credentials. He worked for William F. Buckley, the Hoover Institute and the Wall Street Journal. He is strong on philosophy, sociology and even developments in neuro-science. Economics is his weak point. He really isn’t up on the research of the last 50 years, nor does he seem to follow broad current debates within the discipline.
A “truism” something evident on its face and universally accepted. The sun rises in the east, water flows downhill, ice cream tastes good, pancreatic cancer often is fatal, all are truisms.
There are truisms among economists: Market signals from supply and demand often allocate resources efficiently; sometimes markets “fail;” international trade isn’t zero-sum, it usually makes both trading nations better off; emissions taxes should be a first choice for controlling pollution.
However, the idea that the value of a nation’s debt passing 100 percent of the value of one year’s output must harm its economy is not a truism. It never has been. Indeed finding 51 percent of economists who believe this would be hard now and at any time in the past. In 40 years of college teaching, I never encountered this in a textbook.
Yes, individual economists have made that argument, most famously Carmen Reinhart and Kenneth Rogoff, whose 2010 non-peer-reviewed paper in the American Economic Review argued that when a nation’s “gross external debt reaches 60 percent of GDP, its annual growth declined by two percent,” and “in excess of 90 percent” GDP growth was “roughly cut in half.” That paper probably is the source underlying Brooks’ statements. But it was highly controversial among economists and sharply rebutted. It certainly has never been a truism or even a bare consensus.
Their paper pained me. Just as Brooks is a pundit I highly respect, Rogoff is one of the economists I most highly admire. But it is a bad paper based on very flawed assumptions and methods, including logical errors warned against in every intro economics or statistics text ever published.
The researchers tabulated data about debt and output levels from dozens of countries over long periods of time, for some centuries rather than decades. The countries were sorted into categories or “buckets,” but there was no consideration of the size of the nation, debt owed abroad versus domestically, the absolute level of taxation or government spending, exchange rate systems or several other relevant factors.
There was an initial kerfuffle when other researchers discovered an error in the spreadsheet omitting some key years for New Zealand. The authors corrected this and asserted their conclusions stood. Yet there was little debate about whether the experience of a tiny nation like New Zealand, then tied to Britain in an economic commonwealth system, had any bearing on what might happen to the United States or Japan or Germany or any other country 60 years later in very different circumstances.
In the end, the research was a set of not-very-comparable data about widely differing countries that, on average, showed some negative correlation of debt with output. However, intro statistics and economics texts always warn new students that “correlation is not causation.”
Moreover, there was huge variation around the averages. Examples of countries that performed very well with high levels of debt are common. Moreover, in myriad cases countries with debts well below these thresholds got into deep problems.
Some successes are salient. Remember that no one really tabulated GDP until the late 1940s, so numbers for earlier periods are estimates, often rough ones. But in 1815, England came out of 25 years of war with debt-to-GDP ration of around 240 percent. The 1800s were the period of greatest output and income growth in British history. Our nation had debt of some 110 to 125 percent of GDP at the end of World War II, depending on metric used, and the succeeding 1950s and 1960s decades saw output growth rates higher than any succeeding decade.
All this may seem a minor point of dispute among a few scholars. It is not. Ideas have consequences. The flawed Reinhart-Rogoff article was used to justify “the Paul Ryan budgets” that emphasized spending limits as the U.S. economy remained hung over from the financial binge of the 2000s. It has been cited in other nations, particularly by Germany in the European Union, in calls for austerity.
We face an economic mess with deep roots, We steadfastly refused to deal with problems in federal finances for 35 years. We cut tax rates so that the proportion of national income paid in general taxes is well below levels prevailing in past, including the 1950s or 1990s. We have eaten our seed corn by failing to keep up and improve infrastructure or provide health care more efficiently. There is much room for debate on many aspects of Biden’s plans, but let’s discard the threat of tripping some catastrophic debt-to-output trigger.
St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
Real World Economics: Flawed logic in GDP-debt debate - TwinCities.com-Pioneer Press
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