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High Debt Threatens Economic Growth

Posted By Salim Furth, Ph.D On February 25, 2013 @ 11:29 am In Featured | Comments Disabled

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Photo credit: Newscom

Economic scholars have recently shown how high government debt has a negative effect on long-term economic growth.

Government debt crowds out private investment, slowing the growth of gross domestic product (GDP) and wages. The consensus is that “debt drag” gets worse as debt rises. Like piling bricks on a sled, each new annual deficit adds to the weight of the existing debt.

In one study [2], Manmohan Kumar and Jaejoon Woo of the International Monetary Fund (IMF) find that high-debt economies grew 1.3 percentage points slower than their low-debt counterparts. The negative effects of debt builds steadily as debt grows from low (below 30 percent of GDP) to high (above 90 percent).

Over a decade, a difference of 1.3 percentage points of growth would be $11,000 more—or less—every year per family in the U.S. That’s enough to send the kids to a state college or move to a nicer neighborhood.

Kumar and Woo find that higher debt leads to slower capital accumulation. This confirms economic theory: When savings are invested in government bonds, they cannot also be invested in productive capital. Since capital augments labor productivity and wages, lower capital accumulation leads to lower wages.

The U.S. has rapidly accumulated debt in the past five years. Using the IMF’s measure of federal, state, and local debt, U.S. debt has zoomed from 48 percent of GDP in 2007 to 84 percent in 2012.

In another study [3], Stephen Cecchetti, Madhusudan Mohanty, and Fabrizio Zampolli of the Bank for International Settlements use an econometric technique to identify the cutoff point after which high debt is particularly damaging to growth: 84 percent.

It is appropriate that Washington is consumed this year with debates about the growth of debt and whether to constrain federal spending. We stand at the 84 percent threshold, and we may either lurch ahead into a future where high debt and low growth are facts of life for a generation or hold back and allow our economy to grow faster than our debts.

Read more about the research and data on U.S. government debt here [4].


Article printed from The Foundry: Conservative Policy News from The Heritage Foundation: http://blog.heritage.org

URL to article: http://blog.heritage.org/2013/02/25/high-debt-threatens-economic-growth/

URLs in this post:

[1] Image: http://blog.heritage.org/wp-content/uploads/debt_piggybanks.jpg

[2] one study: http://www.imf.org/external/pubs/ft/wp/2010/wp10174.pdf

[3] another study: http://www.bis.org/publ/work352.pdf

[4] here: http://www.heritage.org/research/reports/2013/02/how-a-high-national-debt-impacts-the-economy

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