More than any other metric, debt has become the definitive political measure of a government’s economic management in many countries around the world.
One reason for this is that debt is supposedly an easy concept to understand because people can relate to it. Unlike growth, inflation or the deficit, people can picture a government owing tonnes of money and immediately think that cannot be a good thing. This has made debt a very politically risky tool.
But are we making too much of an issue out of something which is minor or are we not paying enough attention to a monster which is about to devour us? Is public debt good, bad or is it just an ugly but irrelevant thing?
Global Political Perspective
Debt is a matter on which the right is strong and the left is weak. Why? Because the right has a consistent and simple message on debt – it is bad, it draws money out of investment in the public sector (crowding out), and it leaves a burden for the next generation so let’s “live within our means” and pay it off. But when one asks for more taxes to pay off the debt, the right refuses and would prefer paying off the debt through cuts in public services. One can therefore see that for the right it isn’t so much about the debt than it is about reducing government action in the economy.
The left is weak on the matter of debt for two reasons. It is almost impossible to expunge the misconception that the economy is like a household and therefore public debt is like household debt. Therefore leftist politicians cannot afford to dismiss concerns about debt without being seen as economically irresponsible. Therefore they are left with talking about increasing spending while they’re evasive on saying how they will pay for this without more debt. Secondly, they are wary of pronouncing public debt as good or bad because the truth is that it depends. Many factors are at play. And this lack of a straight pronouncement on debt looks like equivocation and harms the credibility of the left when talking about debt.
Different Shades of Debt
All debt is not created equal. In judging debt one has to look at why it exists, what it is being used for, how much it costs, whether it helps or hurts the economy, who we borrow from and how it is paid back.
Why does debt exist?
If debt exists because too many people are evading tax, then it may be bad. Debt should not be the substitute for a failure of tax policy and revenue collection. See ‘Gov’t borrowing because Ghanaians don’t pay taxes’
What is debt used for?
Is debt being invested in public infrastructure and education? I mean the sectors of an economy which would improve the productivity of the country? If it is then it may be good.
How much does debt cost?
If you have to offer investors a 24% yield before they lend to you, you might want to reconsider. And related to the last point, if your spending on interest payments exceeds your investments in infrastructure and education then you really have a problem in your hands. See Interest payments shoot up by 330% in 4yrs and Gov’t misses interest expense target.
Does debt help or hurt the economy?
Debt serves many purposes in an economy. Government borrowing and spending creates jobs for all the private contractors who would be involved in the projects the debt sponsors. This also creates income for the people who the contractors would spend their money on (crowding in). Government borrowing can increase growth and therefore make the debt as a percentage of GDP insignificant as time goes on. Government borrowing also provides a safe asset for investors to subscribe to instead of chasing risky assets.
But can debt hurt the economy? If government borrowing tempts investors away from investing in potentially profitable private sector business or achieves the same thing by raising general interest rates (since no one will lend to you at a rate lower than the government is borrowing) then it could harm future growth. This is what is referred to as crowding out.
One therefore has to weigh the effect of these two phenomena. If an economy has excess capacity, one can see how government borrowing and spending will grow the GDP and lead to higher incomes and saving, creating more than enough for the private sector to invest. But if the economy is near full employment, then government borrowing will not have a disproportionate impact on GDP growth and the funds may be better left with the private sector.
Who do we borrow from?
There are two sides to this. Firstly if government borrows from people which it should rather be taxing, then it is twice cheated. Not only will the people be evading taxes, they will also be receiving interest on funds they shouldn’t be keeping anyway.
The second perspective is whether debt is domestic or external. Ghana’s domestic debt as at December 2015 was GH¢38.8bn (29.1% of GDP) and external debt as at September of the same year was GH¢54.5bn (40.9% of GDP). When debt is domestic, then government has more control over repayment. It can even allow inflation to eat up the value of the debt. But debt borrowed externally, especially at non-concessionary terms, can quickly become more difficult to service due to a quickly depreciating currency.
One can therefore see that for governments which can borrow in their own currency, there is more stability than for those whose external debt is in other currencies. Attracted by the size of the pool and the low rates, developing countries like Ghana have to consider the rate at which their currency depreciates in chasing external debt.
How is the debt paid back?
Governments pay old debt by issuing new debt. The more an economy grows, the less important the debt is as a portion of GDP. So what is important is the willingness of investors to keep lending to the government, the interest rate at which they are willing to lend and the growth of the economy.
For countries with extremely high debt (like many developed countries) whose interest rates remain low and investors keep queuing for their debt, you can see that they don’t have much of a problem. But a country which is having to offer increasingly higher yields for its debt has a problem.
I have tried to cover as many of the variables as I can in a way which (I hope) does not favour one side but provides perspective on how each specific case can be viewed. I think the various perspectives can be considered when debt is being discussed. And commentators who seek to take one side or the other should be asked, “why?”.
Nobody Understands Debt by Paul Krugman
Why public debt is not like credit card debt by Robert Kuttner
How bad is government debt? by Tejvan Pettinger
The dead hand of austerity; left and right by Simon Wren-Lewis
Crowding-Out and Crowding-In by Mark Thoma
Debt is good by Paul Krugman
The choice between external and domestic debt in financing budget deficits: The case of central and west African countries by Phillipe Beaugrand, Boileau Loko and Montfort Mlachila (IMF Working Paper)
How our national debt hurts our economy by Larry Swedroe
Why the federal budget can’t be managed like a household budget by Helaine Olen
Debt Is Money We Owe To Ourselves by Paul Krugman