Economic history indicates two possible scenarios resulting
from high government debt.
Unfortunately, it is only the negative one which is generally
remembered. The alternative positive
result occurred, for example, in the post 1939-45 war period in the UK (and the
US). This indicated that, in suitable
economic conditions, what are now considered to be unacceptably high budget
deficits and government debt levels can actually lay the basis for sustained
economic growth.
Both of these countries had government debts of over 100% of
their GDP in the late 1940s, but this was followed by one of the most sustained
economic booms either country has experienced before or since. In the US the Federal debt alone (excluding
state or local government debt) reached over 120% of GDP in 1946[1]
and in the UK Government debt peaked at nearly 250%3 at around the
same time. However, the sustained
economic boom of the 1950s and 1960s meant that these levels of debt were
sustainable, could be accommodated and were eventually repaid.
In the US the Federal Government debt had fallen to below
50% of GDP by 1964 as the economy had grown so consistently, although the
actual dollar amount of the debt had grown by over 15% over the intervening
years2.
In the UK, Government debt rose in during the second world
war to a peak of around 250% of GDP in the late 1940s[2].
This would currently be considered a catastrophic level of debt, but
again proved to be sustainable. Despite
consistent budget deficits of around 3% of GDP in the 1950s and 1960s, the UK
Government debt had fallen to only 50% of GDP by 1975 and has remained around
that level over the subsequent thirty years.
The steady and consistent decline in the level of debt
relative to the GDP in the three decades after the end of the Second World War
reflected a number of factors working in the same direction3. It was not because the governments had a
surplus to pay off their debt. The
following graph shows that most of this time there was a budget deficit:
UK Government Deficit as percentage of GDP:
Clark, Tom and Dilnot, Andrew,
Measuring the UK Fiscal Stance Since the Second World War, The Institute For
Fiscal Studies, Briefing Note No. 26
Reasons the UK Government debt proved to be sustainable and
reduced to 40%:
First, the very high level of the initial debt ratio meant
that significant borrowing would have been required to maintain it at this
level, given that national income growth was positive.
Second, post-war inflation persistently turned out to be
higher than anticipated. Little inflation was factored into interest rates when
Government bonds were sold in the middle of the last century. So the Government
benefited from low effective interest rates on its debt.
In the 1950s, prices trended upwards, and this increased
inflation accelerated during the 1960s. As a result, the real value of the
(cash-denominated) stock of debt eroded.
Finally,
real economic growth in these years was fairly consistently high by historical
standards, so the relative importance of a fixed stock of debt to national
income tended to decline rapidly.
·
UK & US governments benefited from low real interest rates on
its debt
–Global south faced high interest rates
·
Inflation eroded the stock of debt
–Devaluation increased local cost of debt
·
Real economic growth was high by historical standards, so debt to
national income ratio declined
–Global south suffered a fall in national incomes
·
UK and US faced the opposite economic environment to the global
south
In the
case of both the US and the UK, governments borrowing linked to investment in
public services and infrastructure had helped to lay the basis for one of the
most consistent periods of economic growth these countries have ever seen. Thus demonstrating that, in certain
circumstances at least, relatively high levels of government borrowing can be
beneficial for the national economy.
The
historic economic experience of Britain also supports the view that government
dept can be good. For most of the century between 1750 and 1850 and for much of
the 20th century, periods associated with industrialisation and sustained
economic growth, the UK national debt was above 100% of its national income.
The
macro-economic demand for a balanced budget is also contradicted by the
experience of developing countries during the decades immediately after the end
of the Second World War. Thus, for example, research by two academics at Oxford
University (Adam and Bevan, 2005[3]) shows an association
between maximum economic growth and a government budget deficit of around 1.5%
of GDP. In particular, they conclude that ‘deficits may be growth-enhancing if
financed by limited seigniorage (printing of money). These results come from
their study of 45 developing countries over the 30 years from 1945.
Unfortunately,
the experience of many developing countries over more recent decades has been
less successful. Their governments borrowed heavily in the late 1970s and then
suffered from the twin effects of a substantial increase in the rate of
interest levied on these debts and a world economic slow down in the early
1980s which reduced the value of their exports.
Around the
same time, in the late 1970s and early 1980s the United States raised interest
rates to nearly 20% in a battle to throttle back its persistent inflation[4].
The real (inflation adjusted) interest rates paid by developing countries
increased from minus four per cent in 1975 to almost plus four per cent a
decade later[5].
The rapid
increase in world interest rates in the early 1980s on top of the oil price
rises, led to a world economic recession.
As a result most developing countries faced a reduced demand for their
exports whilst having to pay higher prices for their imports coupled with much
higher interest rates on their government debts.
As UNCTAD describes the effect on sub-Saharan Africa:
From just over $11 billion in 1970, Africa had
accumulated over $120 billion of external debt in the midst of the external
shocks of the early 1980s. Total external debt then worsened significantly
during the period of structural adjustment in the 1980s and early 1990s,
reaching a peak of about $340 billion in 1995[6].
The United Nations Food and Agricultural Organisation[7] estimated in 2005 that
if commodity prices had maintained the same real value as in 1980, developing
countries would be earning an additional $112bn in annual export revenues,
which was double the current level of their aid receipts. Putting it another way,
between 1970 and 1997 changes in the terms of trade cost non-oil producing
African states (excluding South Africa) a total of 119% of their annual GDP,
according to the World Bank[8]. External debt grew by 106% of GDP over the
same period. So all the external debt of
African countries at the end of the twentieth century could be explained by
falling prices for their exports and increasing prices of imports – both
changes over which their governments had little or no control.
Thus the actual impact of government budget deficits and the
resulting debt are not as simple as the advocates of fiscal responsibility
would have us believe. In certain
situations, government debt at levels far in excess of levels which are currently
regarded as prudent may have had a beneficial effect on the economy and have
proved to be sustainable.
[1]
Office of Management and Budget (2007) Historical Tables Budget of the United
States Government - Fiscal Year 2008, page 126, http://www.whitehouse.gov/omb/budget/fy2007/pdf/hist.pdf
(17 September 2008)
[2]
Clark, T and Dilnot, A, (2002) Measuring The UK Fiscal
Stance Since the Second World War, Briefing Note No. 26, London, The Institute For Fiscal Studies
[3]
Adam, C.S. and Bevan, D.L. (2005). Fiscal
deficits and growth in developing countries, Journal of Public Economics,
No. 89, pages 571–97
[4]
Stiglitz, Joseph (2006) Making Globalisation
Work (page 220)
[5]
Bond, Patrick (2006) Looting Africa,
Zed Press (page 13)
[6]
UNCTAD (2004) Debt Sustainability: Oasis
or Mirage (page 5)
[7]
FAO (2005), The State of Agricultural
Commodity Markets 2004, UN Food and Agricultural Organisation
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