By Luca Di Leo
New research suggests the high and rising debt of the U.S., Japan and Europe will stunt economic growth unless countries act quickly to contain it.
A paper presented Friday by three economists at the Bank for International Settlements finds that debt–be it government or corporate–starts to weigh on growth when it rises close to an economy’s annual output, a predicament currently shared by almost all of the world’s largest advanced economies.
Stephen G. Cecchetti, M.S. Mohanty and Fabrizio Zampolli show that public debt begins to hurt once it rises from a range of between 80% to 100% of gross domestic product. The threshold is above 90% of GDP for corporate debt and around 85% of GDP for household debt, though the economists warn the latter is only their best guess.
The research provides food for thought at the Kansas City Federal Reserve Bank’s annual summer retreat of top global policy makers in Wyoming’s Grand Teton Mountains. The findings are similar to results from a January 2010 paper by economists Carmen Reinhart and Kenneth Rogoff, even though the data set and analysis are different, reinforcing the point that advanced countries hit by the financial crisis now face a big challenge in managing economies loaded with debt.
In 2010, the U.S., Japan, the U.K., France, Italy and Canada all had public-debt levels above 80% of GDP, according to Organization for Economic Cooperation and Development data used in the paper. Germany was the only country in the Group of Seven industrialized nations just under that threshold.
“Countries with high debt must act quickly and decisively to address fiscal problems,” the paper says. “The longer they wait, the bigger the negative impact will be on growth.”
The research shows that in an economy where public debt rises from 80% of GDP to 90% of GDP–or any 10-percentage-point increase beyond that–subsequent average annual growth rates will tend to be more than 1/10 of a percentage point lower than without the debt increase. For corporate debt, the drag on growth kicks in once it increases beyond 90% of GDP and the impact is only half as big.
Asked by Bank of Mexico Governor Agustin Carstens about the optimal rate of debt for growth, BIS economist Cecchetti said he recommends countries keep “substantially” lower level of debt than the thresholds suggested by the paper.
U.S. government debt shot up to 97% of GDP last year from only 58% in 2000. The increase was particularly sharp in recent years, when President Barack Obama boosted spending to fight the financial crisis and recession of 2008 and 2009. Growth has been disappointingly slow since the recovery began around mid-2009 and there are now fears of a new recession.
The U.S. faces an uphill task in keeping its debt under control because Republicans in Congress oppose Obama’s plan to mix spending cuts and tax increases to slash the country’s huge budget deficit. One small positive in the paper: The U.S. has the lowest level of corporate debt among G-7 countries, at 76% of GDP.
A separate paper presented at the Jackson Hole gathering by Harvard economists Katherine Baicker and Amitabh Chandra argues that health-care spending in the U.S. is highly inefficient and, if left unchecked, could lead the world’s largest economy to accumulate more public debt than Greece.
Though all of the largest advanced economies look in bad shape, Japan’s situation seems particularly dire. Public debt is now at a staggering 213% of GDP, from 145% in 2000.
Japanese companies also have the highest level of company debt of the world’s largest economies, at 161% of GDP in 2010, according to the paper from the BIS economists. The Asian country’s anemic growth rates over the last decade lend credence to the research findings.
In Europe, where concerns about a fiscal crisis are forcing countries such as Italy to make aggressive budget cuts, the picture is mixed. Among the euro zone’s three largest economies, Germany is in the best shape with public debt below the danger zone at 77% of GDP and corporate debt equal to total output last year–lower than in Italy and France. Italian Premier Silvio Berlusconi faces the worst problems, with public debt at 129% of GDP in 2010. That ratio was only slightly below Greece’s, which was 132% of GDP last year.