High U.S. debt means slower growth, history suggests

McClatchy NewspapersJanuary 11, 2010 

WASHINGTON — A new report that reviewed 200 years of economic data from 44 nations has reached an ominous conclusion for the world's largest economy: Almost without exception, countries that are as highly indebted as the United States is today grow at sub-par rates.

The report, "Growth in a Time of Debt," was written by two respected academic researchers who recently published a thick book on eight centuries of economic crises.

The study by Carmen Reinhart and Kenneth Rogoff — well-regarded economists from the University of Maryland and Harvard University, respectively — found statistical breaks at different points in the relationship between a country's national debt and its gross domestic product. GDP is the broadest measure of a country's trade in goods and services.

When a nation's debt exceeds 60 percent of its GDP, its growth rate slows precipitously, the study found. When that ratio exceeds 90 percent, nations' economies barely grow, and can even contract.

The U.S. national debt is at roughly 84 percent of the country's GDP, and it's projected to cross the authors' 90-percent threshold late this year or early next year.

The implication is stark: The authors don't say that the U.S. economy can't grow briskly despite even higher debt, but if it does, it would be an outlier in roughly 200 years of economic statistics.

"We're racing toward this (90 percent) limit, and maybe it will prove a soft limit for the United States. But not forever," Rogoff said. "I think it is certainly a cautionary tale."

Reinhart and Rogoff published the book "This Time Is Different" last year, which examined how countries repeated mistakes from earlier crises over the past 800 years. Their new paper, presented earlier this month at a conference to review important economic studies, wasn't meant to be a diagnosis of today's U.S. debt picture. Rather it seeks answers about the consequences of mounting debt.

"Outsized deficits and epic bank bailouts may be useful in fighting a downturn, but what is the long-run macroeconomic impact of higher levels of government debt, especially against the backdrop of graying populations and rising social insurance costs?" the pair ask in their report.

Most mainstream economists think that what's been dubbed the Great Recession is ending, and that the U.S. economy will post strong growth in the first half of this year. Much of that growth is coming from government stimulus spending designed to compensate for the drop in private-sector activity.

By midyear, however, much of the spark from this spending is expected to wear off, and Congress already is debating whether to provide additional stimulus money to sustain the recovery.

Fiscal conservatives think that the nation's deep debt argues against any further stimulus spending. Reinhart stressed that she doesn't share that view, saying that the Great Depression taught economists that reducing government spending too soon can plunge the economy back into the doldrums.

"My own view has been that until we are out of this recession and are in recovery, don't jump the gun in removing stimulus too soon," she said. "As soon as we get grounded in our recovery, something really has to give in the fiscal adjustment or you are in a lost decade. High levels of debt and growth don't go hand in hand."

She's referring to Japan in the 1990s and Latin America in the 1980s, when mounting debt led to roughly a decade of stagnant and sub-par growth.

Could that happen to the United States? One reason the authors' data are so troubling is that today's crisis comes against the backdrop of the pending retirement of 75 million baby boomers, born from 1946 to 1964, the first of whom reach official retirement age at the end of this year.

"Surely when we compare to other episodes in history, this is an unusual period for high debt because we're adjusting to this aging population," Rogoff said.

Facing higher government burdens for health and retirement spending, the United States may be forced to choose among cutting promised Medicare and Social Security benefits — which is politically unpalatable, if not impossible — slashing other spending while raising taxes or some combination of both in order to reduce the public debt, which stood at $12.3 trillion on Wednesday.

Another option is to continue borrowing, but as statistics from the Reinhart and Rogoff study show, higher debt levels historically equate to slower growth. It's also unlikely that China and other nations would continue lending to a sluggishly growing, heavily indebted United States without demanding a premium that would be an additional drag on the U.S. economy.

"If the Chinese would lend us money forever in increasing quantities . . . that's very wishful thinking. The United States is not immune to (debt-rating) downgrades, to having its risk premium go up . . . if investors don't see us as willing to tighten our belt," Rogoff said.

Among the findings in "Growth in a Time of Debt":

_ When external debt reaches 60 percent of GDP, it results in a 2 percentage point decline in the annual growth rate. At higher levels than that, growth rates are cut roughly in half.

_ At debt-to-GDP ratios above 90 percent, the result is a 1 percentage point drop in the median (midpoint) growth rate, and average growth falls considerably more.

_ The 90 percent threshold applies similarly to developed and developing nations.

_ To their surprise, the authors found little evidence of a link between inflation and public debt levels for developed nations, although the United States has experienced higher inflation during periods of high debt-to-GDP ratios.

ON THE WEB

National Bureau of Economic Research report, "Growth in a Time of Debt"

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