HAS EXCESSIVE PUBLIC DEBT SLOWED WORLD GROWTH?
Anthony J. Makin Director APEC Study Centre Griffith University Australia 4222
[email protected]
1. Introduction World economic growth since the 2008-10 North Atlantic banking crisis has fallen well short of precrisis rates, with the result that unemployment in many advanced countries, especially Europe, remains high, while poverty reduction in emerging economies has slowed markedly. Over this time very high public debt has defined the post-crisis macroeconomic landscape, yet its dampening influence on world economic activity has been largely ignored. To proponents of the huge co-ordinated G20 fiscal stimulus that was supposed to shield the real side of the world economy from the crisis, the continued economic slowdown some seven years after the event - despite prolonged monetary easing in major advanced economies - remains a macroeconomic mystery. Yet the world growth stall is no mystery at all if seen as the lasting legacy of the huge 2008-10 worldwide fiscal expansion promoted by the IMF and implemented by the G20 which has failed to deliver as originally expected. The fiscal response to the crisis was based on crude closed economy Keynesian theory found in most macroeconomic textbooks. This well-known theory directly links increased national expenditure to higher national output and hence employment. Yet it ignores the impact of higher government spending on the availability of funds for investment and abstracts from subsequent adverse expectations and confidence effects that elevated public debt levels stemming from sizeable budget deficits have on household and business behaviour, and hence overall macroeconomic performance. Though implementing co-ordinated fiscal stimulus regardless of individual countries’ circumstances was challenged at the time (Kirchner 2009, Makin 2010), the simple Keynesian view prevailed that it was necessary to bolster aggregate demand and that, by implication resultant budget deficits and rising public debt were subordinate to this goal. Since then, fiscal policy thinking has vacillated between support for consolidation and further stimulus, most recently under the guise of additional infrastructure spending. For instance, at the last G20 Summit in Brisbane, even though many useful policies to spur economic growth from the supply side were agreed, G20 governments on advice 1
from officials also committed to spend more on infrastructure, without acknowledging this would raise public debt levels even more. This paper contends that worldwide fiscal excess, as embodied in heightened public debt levels, is central to understanding why global growth has been sub-optimal since the transatlantic crisis. It is structured as follows. Section 2 canvasses recent trends in economic growth, fiscal activity and public debt, comparing the relative performance of advanced and emerging economies. Section 3 interprets these trends with reference to a number of theoretical perspectives. Section 4 summarises and draws policy conclusions.
2. World Economic Growth and Fiscal Activity since the Transatlantic Financial Crisis In the five years before the 2009-10 financial crisis average world economic growth was close to 5 per cent per year, but has since averaged only 3 per cent. See Figure 1. Growth in advanced economies post-crisis has been a mere 1.5 percent on average compared to 2.3 per cent pre-crisis, whereas in emerging and developing countries it has been 5.1 percent compared to 6.4 percent precrisis. This means that the average growth rate in advanced economies has fallen well over 40 percent, but by less than half that, by 20 per cent, in the rest of the world.1 Figure 1 - World Economic Growth, per cent averages 7 6 5 4 3
2003-07
2
2011-15
1 0
GDP World
GDP
GDP
Advanced economies Emerging market and developing economies
Source: IMF World Economic Outlook There are several reasons for this growth deceleration. First, creeping trade protectionism post crisis via opaque means, such as countervailing duties and anti-dumping action, has been a brake on international trade, a traditional driver of world growth (see World Bank 2015 for related discussion).
1
Here all world economies are included, although in what follows the focus shifts to the fiscal experience of G20 advanced and G20 emerging economies which account for around 85 percent of global GDP.
2
Second, China’s pre-crisis growth rate of around proved unsustainable, especially in light of the world trade slowdown and post crisis strains on its financial system. Third, commercial banks in advanced economies ceased to lend as freely as they did pre-crisis due to increased financial regulation and greater risk aversion, which has impeded private investment. Finally, due to discretionary fiscal stimulus, recession-related revenue shrinkage and bank bailouts, public debt levels escalated sharply in most advanced economies, notably the US, UK, the Southern European economies and Japan, with deleterious consequences. This global phenomenon has received far less attention than it deserves and is the primary focus of what follows. Figure 2 shows the extent to which budget balances deteriorated during the crisis period, with significantly larger deficits experienced by G20 advanced economies on average than by G20 emerging economies which had hitherto been in surplus. The average budget deficits of G20 advanced and emerging market and middle income economies (hereafter simply ‘emerging economies’) still remain higher than before the crisis which implies the stock of public debt continues to rise globally. Figure 2 - General Government Overall Balance (as a percentage of GDP) 2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2 0 -2 -4 -6 -8 -10 -12 G20 Advanced
G20 Emerging
Source: IMF Fiscal Monitor G20 budget deficits post-crisis reflect revenue growth routinely falling short of public expenditure growth. While revenue as a share of GDP in G20 economies as a whole has remained relatively stable since the crisis, it is characteristically less in emerging economies, currently by around 7 per cent. See Figure 3.
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Figure 3 - General Government Revenue (as a percentage of GDP) 40 35 30 25 20 15 10 5 0 2006
2007
2008
2009
2010
G20 Advanced
2011
2012
2013
2014
2015
G20 Emerging
Source: IMF Fiscal Monitor Government expenditure spiked notably more in advanced economies than in emerging economies in response to the crisis. See Figure 4. It remains around 9 percent higher as a share of GDP in G20 advanced economies on average than in G20 emerging economies reflecting a structural expansion of the state in advanced economies since the 1960s, beyond providing public goods that private markets would not normally provide, such as national defence, law and order, education, basic research, health services, and social welfare for the most deserving. See Tanzi (2011) for related discussion. Over the entire period under scrutiny public spending has also risen in emerging economies, by more than 5 per cent, and largely accounts for the average budget turnaround from surplus to deficit for these economies over this time. Figure 4 - General Government Expenditure (as a percentage of GDP) 50 45 40 35 30 25 20 15 10 5 0 2006
2007
2008
2009
2010
G20 Advanced
2011
2012
2013
G20 Emerging
Source: IMF Fiscal Monitor
4
2014
2015
The need to fund persistent post crisis budget deficits has significantly increased public debt worldwide. In gross terms public debt stands at over 110 percent of GDP for advanced G20 economies, although is significantly less at over 80 per cent in net terms.2 Both gross and net debt are considerably lower for emerging economies at over 40 and 20 per cent respectively and notably have not grown as a share of GDP, as is the case for the advanced economies. See Figures 5 and 6. Figure 5 - General Government Gross Debt (as a percentage of GDP) 140 120 100 80 60 40 20 0 2006
2007
2008
2009
2010
G20 Advanced
2011
2012
2013
2014
2015
G20 Emerging
Source: IMF Fiscal Monitor Figure 6 - General Government Net Debt (as a percentage of GDP) 90 80 70 60 50 40 30 20 10 0 2006
2007
2008
2009
2010
G20 Advanced
2011
2012
2013
2014
2015
G20 Emerging
Source: IMF Fiscal Monitor
2
Net public debt is defined by the IMF as gross public debt minus financial assets corresponding to debt instruments such as gold, SDRs, currency, deposits, debt securities, loans, insurance, and pension schemes.
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Advanced economies whose public debt grew fastest post crisis include the PIIGS (Portugal, Ireland, Italy, Greece, and Spain), Australia, France, the United Kingdom, the United States and Japan whose staggering 245 per cent debt to GDP ratio contributes significantly to the 100 per cent group average. Fiscal excess in response to transatlantic crisis contributed to public debt crises that erupted in a number of these economies, especially Greece and other Southern European economies. Meanwhile, bank bailouts played a major role in blowing out public debt in Ireland, the United States and the United Kingdom. Yet some advanced economies, for example Norway and Switzerland, managed to reduce public debt, while levels in Germany and Sweden, remained much the same as before the crisis. In G20 emerging economies public debt as a proportion of GDP has on average been remarkably stable in contrast to the spike that occurred in advanced economies, post crisis. Whereas gross debt for G20 advanced economies rose from around 80 percent to 106 percent between 2008 and 2015, for G20 emerging economies on average it only rose from 38 percent to 42 percent reflecting comparable average rises in Asia, Europe and Latin America. However, this masks a sharp increase in China’s debt from 32 percent to 50 percent, while some other large emerging economies, notably India, Philippines, Indonesia and Saudi Arabia actually experienced falls in gross debt measured relative to GDP. Interestingly, net debt for G20 emerging economies on average actually fell slightly from 25 percent in 2008 to 23 percent in 2015. When comparing public debt levels across countries it is important to bear in mind that it not only matters how quickly public debt grows, but what public debt finances. In economies where government borrowing has funded productive activity over a lengthy period, a higher debt level could be less worrisome than for economies with relatively lower debt that has been incurred to fund unproductive activity that is unmatched by any public asset entries in the government balance sheet.
How High Public Debt Stymies Economic Growth: Theory and Evidence All theoretical counterarguments to Keynes’s (1936) fiscal theory depend in one way or another on the negative repercussions that budget deficits and unproductive public debt have on the wider economy. In the classic loanable funds approach, fiscal stimulus crowds out private investment because the take up of public debt instruments, including by commercial banks, diverts funds from more productive private sector use. Consistent with this approach, government bonds account for a much larger share of assets in investment portfolios and on banks’ balance sheets post-crisis. At the same time, the prospect of increased taxation to repay higher public debt crowds out household consumption from a Ricardian perspective, whereas in highly open economies foreign take up of bonds issued to fund budget deficits appreciates nominal and real exchange rates according to the Mundell-Fleming approach, which worsens competitiveness, thereby crowding out net exports. Hence, in theory, short run fiscal multipliers should be small or zero according to each of these different perspectives.
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On the contrary according to the crude Keynesian justification for the large internationally coordinated fiscal stimulus in 2008-10 increased government spending was expected to spur world aggregate demand, and therefore output, by a multiplied amount. When fiscally induced domestic spending raises national output (and hence employment) by more than the fiscal stimulus, multipliers are greater than unity and stimulus is considered effective. In addition to the above theoretical arguments, a classic practical argument against fiscal activism is that budgetary policy exacerbates rather than smooths business cycles due to recognition, implementation and operational lags. There is now an extensive literature on the value of fiscal multipliers estimated using numerous empirical techniques that has yielded very mixed results ranging from negative to positive values (for a survey see Auerbach et al 2010). Several recent studies estimate values less than unity in the short term (for example Barro and Redlick 2011, and Clemens and Miran 2012) which implies some crowding out of other forms of spending. However, most studies pay little, if any, regard to the future implications of meeting the budget constraint via tax increases. When taking the future consequences of closing budget deficits to repay public debt into account, multipliers can become significantly negative in the long run, offsetting any possible positive short run multiplier effect (Mountford and Uhlig 2009, and Guest and Makin 2013). This lesson has been insufficiently recognised by international policymakers, including the IMF (2014). On the other hand there is a relatively small recent literature focusing explicitly on the crowding out effects of fiscal stimulus, either of investment from the loanable funds perspective, of consumption from a Ricardian perspective or of net exports from a Mundell-Fleming perspective. Early studies on Ricardian effects by Bernheim (1987), Masson et al (1998), Loayza et al (2000) found that up to 0.7 of the change in fiscal balances was eventually offset by increased private saving. The fiscal multiplier depends on a Keynesian short run consumption function which relates household spending to short run income. Alternatively, studies related to the forward looking Ricardian perspective but based on the permanent income theory of consumption (Friedman 1956) have found the saving offset was almost complete in response to falls in public saving (see Taylor 2009 for the United States and Makin and Narayan 2011 for Australia). Meanwhile, recent empirical studies have validated the predictions of the Mundell-Fleming by showing that increased budget deficits under floating exchange rates crowd out net exports, implying higher external deficits (see Ilzetzli et al 2013, and Makin and Narayan 2014). There is another far more straightforward way of gauging the sign of fiscal multipliers with reference to the public debt to GDP ratios. If short run multipliers are positive, the denominator in the public debt to GDP ratio should rise faster than the stimulus-induced rise in public debt affecting the numerator. Hence, other things equal, public debt to GDP ratios should fall for economies that implement large scale fiscal stimulus of the kind put in place by the G20 in response to the crisis. This can be illustrated with a numerical example.
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First consider the numerator of the public debt to GDP ratio, Dt . Fiscal stimulus of say $10 billion in period t would add equivalently to the budget deficit and hence to the stock of public debt in the next period, Dt 1 . For example, if Dt was $80 billion, Dt 1 would therefore be $90 billion. If GDP in period t , Yt , was $100 billion, the initial public debt to GDP ratio
Dt would be 80 percent.3 What Yt
should happen however to GDP, the denominator, following fiscal stimulus if there is a short run
Yt 1 Yt 2. Dt 1 Dt
fiscal multiplier greater than unity? Let’s say the value of this multiplier is 2, that is This implies that Yt 1 should rise by $20 billion to $120 billion. Hence,
Dt 1 90 , or 75 per cent, a Yt 1 120
significant fall from the 80 per cent in the previous period. In other words, fiscal multipliers imply public debt to GDP ratios if initially above 50 percent should decrease following fiscal stimulus, and the higher the intial debt ratio and the larger the multiplier, the larger that decrease should be. Yet, as the above Figures 5 and 6 illustrate, the opposite occurred in the wake of the worldwide fiscal stimulus applied in 2008-10, most noticeably in G20 advanced economies where fiscal stimulus was much greater. In other words, despite major fiscal stimulus in advanced economies, public debt to GDP ratios kept rising when simple Keynesian theory suggests they should have fallen. Is Infrastructure Spending Any Different? Fiscal austerity is the antonym to fiscal stimulus, and is generally perceived as having a negative macroeconomic impact. But macro-economically, there is harmful fiscal austerity and beneficial fiscal austerity. The former includes over-reliance on various forms of tax, most notably income taxes and cutting productive public spending. Taxation has actually risen since the crisis as a proportion of GDP in most G20 advanced economies, especially in Europe contributing to the region’s barely positive growth. Beneficial austerity on the other hand can involve cutting unproductive government programs, including spending overlap between the different tiers of government that can generate additional national saving, thereby improving the availability of funds for private investment. It can also mean improving the efficiency of the tax system, and improving compliance with existing tax laws. At the Brisbane G20 the focus was on improving economies’ supply side performance to boost productivity and hence economic growth, as well as a commitment to increase infrastructure spending. Infrastructure influences an economy’s aggregate demand and supply sides by increasing demand through investment, while simultaneously adding to the capital stock. Crude Keynesian theory suggests any form of government spending always boosts the economic activity, irrespective of its intrinsic worth, while any cut in government spending reduces it. On the contrary the quality, not quantity, of government spending helps determine economic growth and hence living standards in the long run.
3
This was the actual average value of the gross public debt to GDP ratio for G20 advanced economies in 2006.
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More government spending on infrastructure without regard to its productivity is risky if it manifests as spending on public works, such as 'roads and bridges to nowhere' that fail on cost-benefit grounds. Japan, number-two economy in the world after the United States until 2010, now numberthree after China, provides a case study on how over-reliance on infrastructure, rather than undertaking necessary domestic structural reform and fostering international trade, can prolong sub-optimal economic growth. Public debt has to rise further to fund extra infrastructure spending and there is a further risk that servicing infrastructure-related debt will become burdensome as monetary policies around the world are tightened and interest rates rise. Importantly for financially open economies like Australia extra infrastructure also adds to the economy’s foreign borrowing requirement. Accordingly, infrastructure spending has to yield a return greater than foreign borrowing costs as a condition for it to raise national income (see Makin 2015). Conversely, increased government consumption and unproductive spending of the kind witnessed since the crisis reduces national income defined net of income paid abroad. This is contrary to Keynesian textbook thinking and implies such spending has a negative multiplier. As a corollary, cutting government consumption can spur national income and yields a positive multiplier for countries reliant on foreign borrowing. Conclusion This paper has examined the relationship between the public debt legacy of the global financial crisis and sluggish world economic growth. In summary, slower world growth since the crisis has evidently been associated with markedly higher public debt levels, especially in advanced economies. In fact, the slowdown in economic growth in advanced economies has on average been twice as bad as that of the emerging economies, at the same time as advanced economies’ budget deficits and public debt levels as a share of GDP have been more than twice as high. Numerous theoretical perspectives suggest budget deficits and increased public debt can contribute to subsequent macroeconomic weakness and help explain why the world economy has failed to return to pre-crisis growth, contrary to the assumption the IMF and the G20 made during the fiscal pump priming of 2008-10. Ongoing budget deficits divert funds from more productive use and raise uncertainty about how they will be repaired. Meanwhile, the public debt legacy of the sizeable fiscal stimulus from the time of the crisis continues to retard economic growth as it represents a future tax obligation affecting household consumption and business investment. At the same time, the inclination of governments to reduce budget deficits by raising taxes rather than trimming unproductive spending, such as industry assistance, has compounded the public debt drag on global growth. Fiscal austerity in the form of reduced government spending cannot be blamed for the post crisis global slowdown. Indeed, it is a myth that governments in advanced economies have practised fiscal austerity post-crisis by cutting spending because in the advanced economies (except for Greece, Iceland, Ireland, New Zealand and the United States) public spending by all levels of government as a proportion of GDP is higher now than it was pre-crisis.
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