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Thesis & Antithesis

A critical perspective on energy, international politics & current affairs

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Location: Washington, D.C.

greekdefaultwatch@gmail.com Natural gas consultant by day, blogger on the Greek economy by night. Trained as an economist and political scientist. I believe in common sense and in data, and my aim is to offer insight written in language that is clear and convincing.

05 September 2010

Is Debt Destiny?

The accumulation of debt stands out as the greatest economic challenge facing many developed countries. But the idea that debt is destiny – that a country is “trapped” by debt – is hardly true, and neither is the idea that paying down is extremely painful, if not impossible. In fact, several countries have managed successful fiscal adjustments in relatively short periods, and there is much evidence that these adjustments coincided with (and were aided by) economic growth (see for example, here, here and here). The following graphs are my own attempt to contextualize the story of debt reduction across various countries.

The first graph, from the Congressional Budget Office, shows federal debt held by the public since 1790. As is clear, there are at least four episodes during which the United States has made significant reductions to its debt: from 1790 to 1830 (minus 29.6 percentage points), from 1865 to 1916 (-28.3), from 1919 to 1929 (-18.5), and from 1945 to 1973 (-87.9). Some of these episodes coincided with long-term increases in the standard of living, although these periods also included recessions and times of stagnant incomes.
The second graph shows a similar experience for a much broader set of countries (I have stopped at 2007 before the current recession led to fiscal worsening). Each of these countries managed to make a sustained reduction in gross government debt (the graph above shows net government debt). And each started and ended in very different debt levels suggesting that adjustment was possible for countries with varying initial levels of indebtedness.

In this sample, countries made a fiscal adjustment that was on average 43 percentage points from peak to through and lasted on average 14 years. At one extreme is Ireland which reduced its gross debt from almost 113% of GDP in 1987 to 24.93% of GDP in 2006 (16 years). On the other end is Finland which reduced its debt from 57% in 1996 (debt peaked in 1994) to 34.22% in 2008.
These graphs make clear that debt reduction is possible. The next graph also shows that these adjustments coincided with strong economic growth: on average, these countries grew by 2.65% during their fiscal adjustment periods (real per capita GDP growth). And for all countries save two (Netherlands and Belgium), the growth they experienced after the entered into the process of reducing debt was higher than in the previous five years when debt was either rising or stable.
Of course, there are an enormous number of caveats between what I have written above and saying “therefore a fiscal adjustment for country x in time y is possible.” Nor is it my intention to make this general point. Rather, my goal is to demonstrate (a) that a significant debt reduction is possible, (b) that it can happen during a time when real incomes are rising and (c) that it can be accomplished in the span of a generation or even less.

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