OP-ED: Excessive debt is already taking a toll on GDP
Are current U.S. debt levels unsustainable? Will our grandchildren face national bankruptcy? Or does debt not matter, at least not right now? Earlier this year prominent economist Olivier Blanchard caused a stir in fiscal circles when he suggested that current levels of debt may be less worrisome than many experts think. Our new research with Qingliang Fan provides empirical evidence to the contrary with adverse effects already taking a toll on the United States and some other Organization for Economic Cooperation and Development countries.
Despite claims by the debt-level deniers, the negative consequences of high gross debt (106 percent of GDP in 2017) are not waiting for our grandchildren. The effects are here right now — for us. That damage, however, has not been the topic of above-the-fold, front-page headlines about bankruptcy, default on bonds, or even higher interest rates. Instead it flies under the radar in the form of a reduced rate of economic growth. We found that GDP took a hit to the tune of $175 billion in 2017 alone.
While the United States has experienced a period of economic expansion over the past decade, the rate of growth in terms of productivity and GDP has been one of the slowest since 1946, and the rate of growth in debt has been one of the highest. Other OECD countries, such as Italy, Greece, and Japan, have also been among the highest debtors and the slowest growers. All of these countries have rapidly aging populations that produce political pressure to spend more on programs like Social Security and Medicare.
We studied 29 OECD countries from 1994-2014 and found growth for the United States was more than one percentage point per year lower than it would have been at lower debt levels. The lower GDP in 2017 is likely impacted by a shift in government spending away from investments like research and infrastructure, toward programs for an aging population.
Americans were not always debt prone. From the birth of the nation until about 1968, U.S. debt relative to GDP moved up and down with periods of war and peace, without following a definite trend. However, a major transformation occurred around 1968 with U.S. involvement in Vietnam, and since then debt has risen inexorably. The debt doubled from 53 percent of GDP in 2001 to 106 percent in 2017. The United States has now joined Italy, Greece, and Japan among countries with persistent lingering debt.
Without a clear limit to the debt-to-GDP ratio, the United States appears to have no coherent debt policy. And with no real debt policy, policymakers are incentivized to spend more on goods rather than investments. This spending is usually financed through debt rather than increasing taxes. The result has been a large shift from discretionary spending to mandatory spending on entitlement programs.
Based on data from the Office of Management and Budget, the share of government spending on investments decreased from 32 percent in 1962 to 12 percent in 2018. During the same period, the share of the budget devoted to entitlements rose from 28 percent to 70 percent. Fiscal policy is now dominated by policies that redistribute income — particularly toward an aging population – as we see in countries with high indebtedness like Japan, Italy, and Greece.
It’s worth noting that this major change in the way the government spends its money has occurred through the political process, without any increase in interest rates. As government investments are crowded out, slower growth in productivity and GDP is the result.
Many other high-debt and slow-growth nations have responded to this phenomenon by adopting some type of fiscal rule that limits debt, spending or both. Yes, there is a U.S. Congressional Debt Limit, but it’s so easy to increase or suspend that it’s not mandatory or effective in the long-run.
It is time for America to seriously consider implementing a fiscal rule to break our debt addiction. We’re already bearing the high cost of debt, and if nothing is done, that cost will rise.
— Thomas Grennes is emeritus professor of economics at North Carolina State University. Mehmet Caner is professor of economics at North Carolina State University. They are coauthors of new research with Qingliang Fan to be published by the Mercatus Center at George Mason University on “New Evidence on Debt as an Obstacle to U.S. Economic Growth.”