Low growth leads to high debt, not the other way round

Charts of the day.

Two big holes have been left by the revelation of serious flaws in the Reinhart-Rogoff paper on austerity. The first is that the concept of a criticality at high levels of debt has been demolished. The original paper showed a massive drop in growth rates for countries with debt to GDP ratios over 90 per cent; that simply does not hold anymore. Insofar as the paper shows any negative association, it is linear – the step from 60 to 70 per cent is no more dangerous than the step from 85 to 95 per cent.

But there's also now an absence of notable economists claiming that high debt ratios cause low growth. In Reinhart and Rogoff's initial response to Herndon, Ash, and Pollin's paper, the authors point out that "we are very careful in all our papers to speak of 'association' and not 'causality'". That's true, but they have also not been shy about endorsing suggestions that there is an element of causality involved – and their paper has been widely misinterpreted as showing as such.

However, Arindrajit Dube presents pretty compelling evidence that the causality lies in the direction everyone but the austerians expected it to: slow growth causes high debt to GDP ratios, not the other way round. It's as simple as two charts:

 

The first image shows the correlation between the debt to GDP ratio in any given year, and the growth in the three years after it. Really low debt comes before high growth rates – but for nearly every other level of debt, the average growth in the next three years is 3 per cent.

Looking backwards, though presents a very different picture. There's strong linear relationship between low growth in the past and high debt-to-GDP ratios now.

And that's not surprising! As Dube writes:

One reason is just algebraic. The ratio has a numerator (debt) and denominator (GDP): any fall in GDP will mechanically boost the ratio. Even if GDP growth doesn’t become negative, continuous growth in debt coupled with a GDP growth slowdown will also lead to a rise in the debt-to-GDP ratio.

Besides, there is also a less mechanical story. A recession leads to increased spending through automatic stabilizers such as unemployment insurance. And governments usually finance these using greater borrowing, as undergraduate macro-economics textbooks tell us governments should do. This is what happened in the U.S. during the past recession.

The easiest way to cut the debt – in the only measure which matters, which is it in relation to the size of the economy – is to increase growth, at least back to the long-term trend. Going at it from the opposite direction, and cutting the debt in the hope it will bring growth back, is a recipe for disaster.

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

Getty
Show Hide image

Leader: Trump's dangerous nation

From North Korea to Virginia, the US increasingly resembles a rogue state.

When Donald Trump was elected as US president, some optimistically suggested that the White House would have a civilising effect on the erratic tycoon. Under the influence of his more experienced colleagues, they argued, he would gradually absorb the norms of international diplomacy.

After seven months, these hopes have been exposed as delusional. On 8 August, he responded to North Korea’s increasing nuclear capabilities by threatening “fire and fury like the world has never seen”. Three days later, he casually floated possible military action against Venezuela. Finally, on 12 August, he responded to a white supremacist rally in Virginia by condemning violence on “many sides” (only criticising the far right specifically after two days of outrage).

Even by Mr Trump’s low standards, it was an embarrassing week. Rather than normalising the president, elected office has merely inflated his self-regard. The consequences for the US and the world could be momentous.

North Korea’s reported acquisition of a nuclear warhead small enough to fit on an intercontinental missile (and potentially reach the US) demanded a serious response. Mr Trump’s apocalyptic rhetoric was not it. His off-the-cuff remarks implied that the US could launch a pre-emptive strike against North Korea, leading various officials to “clarify” the US position. Kim Jong-un’s regime is rational enough to avoid a pre-emptive strike that would invite a devastating retaliation. However, there remains a risk that it misreads Mr Trump’s intentions and rushes to action.

Although the US should uphold the principle of nuclear deterrence, it must also, in good faith, pursue a diplomatic solution. The week before Mr Trump’s remarks, the US secretary of state, Rex Tillerson, rightly ruled out “regime change” and held out the possibility of “a dialogue”.

The North Korean regime is typically depicted as crazed, but its pursuit of nuclear weapons rests on rational foundations. The project is designed to guarantee its survival and to strengthen its bargaining hand. As such, it must be given incentives to pursue a different path.

Mr Trump’s bellicose language overshadowed the successful agreement of new UN sanctions against North Korea (targeting a third of its $3bn exports). Should these prove insufficient, the US should resume the six-party talks of the mid-2000s and even consider direct negotiations.

A failure of diplomacy could be fatal. In his recent book Destined for War, the Harvard historian Graham Allison warns that the US and China could fall prey to “Thucydides’s trap”. According to this rule, dating from the clash between Athens and Sparta, war typically results when a dominant power is challenged by an ascendent rival. North Korea, Mr Bew writes, could provide the spark for a new “great power conflict” between the US and China.

Nuclear standoffs require immense patience, resourcefulness and tact – all qualities in which Mr Trump is lacking. Though the thought likely never passed his mind, his threats to North Korea and Venezuela provide those countries with a new justification for internal repression.

Under Mr Trump’s leadership, the US is becoming an ever more fraught, polarised nation. It was no accident that the violent events in Charlottesville, Virginia, culminating in the death of the 32-year-old Heather Heyer, took place under his presidency. Mr Trump’s victory empowered every racist, misogynist and bigot in the land. It was doubtless this intimate connection that prevented him from immediately condemning the white supremacists. To denounce them is, in effect, to denounce himself.

The US hardly has an unblemished history. It has been guilty of reckless, immoral interventions in Vietnam, Latin America and Iraq. But never has it been led by a man so heedless of international and domestic norms. Those Republicans who enabled Mr Trump’s rise and preserve him in office must do so no longer. There is a heightened responsibility, too, on the US’s allies to challenge, rather than to indulge, the president. The Brexiteers have allowed dreams of a future US-UK trade deal to impair their morality.

Under Mr Trump, the US increasingly resembles a breed it once denounced: a rogue state. His former rival Hillary Clinton’s past warning that “a man you can bait with a tweet is not a man we can trust with nuclear weapons” now appears alarmingly prescient.

This article first appeared in the 17 August 2017 issue of the New Statesman, Trump goes nuclear