The second assertion which underpins the idea of what fiscal sustainability looks like is that high sovereign debt is a problem which needs to be addressed. I have been wondering why this is so widely accepted because it does not make any sense to me at all.
The first stumbling block for me is how sovereign debt is defined. Everywhere I look I see it expressed as a percentage of GDP. How does that make any sense? Debt is a fixed quantity: GDP is a dynamic thing (what I have previously rather clumsily described as a "dependent variable"). Or, to put it in terms that economists use, debt is a stock and GDP is a flow. I was under the impression that you can only compare like with like and this does not seem to do that
I tried to think about it in terms we can all understand: the most obvious example is a mortgage. If I borrow money to buy a house the lender will apply some similar metric in calculating what he will let me have: that is, he will look at my income and he will advance some multiple of that income, presumably based on what he thinks I will be able to repay. What is immediately clear is that the lender's view is not based on anything very much: I say that because in the past the amount was fixed at 2.5 times income: more recently it is 4 or even 5 times income. That is quite a difference and it is not at all obvious what changed in the real world. Was there some scientific research which showed that people can service much higher levels of debt than was previously thought? Did lenders just get braver? Did borrowers suddenly decide that they would rather spend a lot more of their money on housing and shift their expenditure from other things happily? Who knows? It hardly matters in this context. The point is that if we are to think about economies as if they were households, which is very common these days, then the closest analogy we have suggests that there is no real basis for what is sustainable: it shifts a great deal from time to time and for no very clear reason
But one might argue that there are limits on that: Whether the upper limit is 2.5 times income or 5 times income, there is perhaps general agreement that 10 times income is too high and is not sustainable. And perhaps that is also true of the debt to gdp ratio for national economies? If that is the case then what is that limit? If we stretch the analogy with household debt it would seem sensible to say that it cannot be lower than 2.5 times national income: for which gdp is the proxy. So 250%? apparently not. Though that is not considered excessive for households it is wholly unacceptable for governments. Why is that? It is curious how keen we are to draw analogies with households in some contexts but we have a fit of the vapours if they are applied consistently. I have not seen any real explanation of that, though there may be one.
The same happens if you consider acceptable levels of debt for the private sector. Very few big corporations limit themselves to levels of debt which are considered appropriate for households; still less for governments. Starbucks famously made no profit at all in the uk for about 10 years. So it had no income, if we take the analogy with households, yet it is entirely funded by debt. Admittedly the loans are extended by group companies ( a bit as if your auntie had lent the money rather than a bank) but since these are supposed to be "arm's length" transactions we would expect some similar unease about extending credit to a company with no income at all: but we don't. That is probably not a fair comparison because it is essentially a scam to avoid tax: but it makes you wonder nonetheless. Why are governments uniquely subject to criticism for having debt, and why now?
Why now is a good question too: maybe there is an answer in the history? Perhaps there is evidence that high debt leads to collapse in the case of government because of some real difference in the way government finance operates? After all we know that a government is nothing at all like a household really.
Well that does not seem to be true either. For the UK, at least, debt has been above 80% of GDP for most of the last 300 years. It was particularly indebted for the century 1750-1850: a time when the industrial revolution happened and which is considered to be one of the most successful periods in British economic history. It was also very heavily indebted in the 20 years after the second world war with no obvious adverse effects. In none of these periods was there a risk of sovereign default nor any hint of such an outcome.
http://www.guardian.co.uk/commentisfree/20...oke?INTCMP=SRCHNor is it true if you focus on more recent times. The idea that high debt leads to a reduction in GDP is widely held and it seems that this is the intellectual underpinning for the focus on debt at present. It is largely defended on the basis of a paper produced by two highly respected economists called Reinhart and Rogoff in 2010. That is perhaps the answer to the question "why now", though in fact the concern about public debt precedes this paper on generally ideological grounds, I think
www.nber.org/papers/w15639.pdfThe authors claimed to have found that debt levels higher than 90% of GDP have a strong adverse effect on economic growth. As economic growth is the grail that is a very significant finding for the conduct of economic policy and it is the justification for measures to reduce the public debt, and therefore the austerity and attendant impoverishment of people all over the developed world
It is therefore shocking to find that his paper has been found to be flawed in very fundamental ways. Despite the authors' attempts to defend its conclusions it is not possible to accept their findings at all, given the major errors contained in it. These criticisms have been widely reported and are outlined here
http://www.nextnewdeal.net/rortybomb/resea...rDQo2L4.twitterIn short: the authors made a mistake in an excel spreadsheet so that in calculating an average they omitted 5 rows of data. They also excluded data from three countries which had debt levels above 90% of GDP and simultaneously had strong growth. In addition they weighted the contributions of countries in an odd way. All three errors tended to distort the figures in the same direction: which is unfortunate, to say the least
The main point is that there is no evidence that high debt has a dampening effect on GDP, as Reinhart and Rogoff claimed. In fact further analysis by yet another economist demonstrates that the causation runs in the opposite direction
http://www.nextnewdeal.net/rortybomb/guest...rowth-time-debtThat is pretty much what I would expect because of the automatic stabilisers (the economists term for the simple fact that in a recession public spending rises because of unemployment payments etc) and because it is the definition of a recession that economic activity falls. So you necessarily have a higher number divided by a lower number. The author shows that a high ratio is good predictor of the past and a lousy predictor of the future: which supports the view that a high ratio is caused by low growth in the years preceding the high ratio under consideration.
PRIME has also done some work on this after the debunking of Reinhart and Rogoff's paper, looking at the post war period in the UK
www.primeeconomics.org/?p=1785#more-1785They refrain from drawing the conclusion that a high debt to GDP ratio is beneficial ( a restraint which is in stark contrast to the approach of those who use such research in support of austerity) but it is tempting to at least consider that possibility: one would need to consider what the spending was for, presumably, since public spending supports demand through social security payments and infrastructure spending, arguably: but does not have those effects if it is given to banks for them to sit on.
A blunter critique is contained here, and is also worth a look. It is by Randy Wray who is a leading light in MMT circles. I like their refreshingly direct approach to all this (also seen in Bill Mitchell's blog) and their genuine attempt to explain what they are talking about in language we can all understand.
http://www.economonitor.com/lrwray/2013/04...sults-are-crap/In fact many people criticised Rienhart and Rogoff when it was first produced: but without the data they could be safely ignored: which brings me back to the original point and is also touched on in last link. That author has the touching belief that this will have an impact in the policy world and I hope he is right. But I doubt it, at least for the UK. The austerity is not an honest response to an economic theory which is likely to be altered when the theory is shown to be false: it is an ideological attack on the role of the government in favour of private profit. The paper was handy in giving a figleaf of justification for that: but it was not the reason they adopted the policy and it will not be a reason for ditching it either.
