THE excellent Martin Wolf has lots of very sensible things to say about the Reinhart-Rogoff fiasco in his column today. He points out the very real problems in the research that purported to find a change in the nature of the relationship between debt and growth once debt tops 90% of GDP. He notes that the surge in debt levels across the rich world is quite clearly a consequence of abysmal growth related to the crisis. He makes the important point that how and why the debt is incurred matters for growth, and he argues quite rightly that—with the exception of euro-area countries that lost access to markets—the quick pivot to austerity following the crisis was an almost universally bad choice.
For some reason, he chooses to open this sensible column with this:
In 1816, the net public debt of the UK reached 240 per cent of gross domestic product. This was the fiscal legacy of 125 years of war against France. What economic disaster followed this crushing burden of debt? The industrial revolution.
Yet Carmen Reinhart and Kenneth Rogoff of Harvard university argued, in a famous paper, that growth slows sharply when the ratio of public debt to GDP exceeds 90 per cent. The UK’s experience in the 19th century is such a powerful exception, because it marked the beginning of the consistent rises in living standards that characterises the world we live in. The growth of that era is the parent of subsequent sustained growth everywhere...
[T]he UK grew out of its debt. By the early 1860s, debt had already fallen below 90 per cent of GDP.
I understand the point is he trying to make: debt is not destiny. And yet I'm not sure he could have found a more compelling defence of the need for some fiscal vigilance.
Britain in 1816 was a land that had accumulated extraordinary scientific and technical knowledge in the preceding centuries, managed important institutional reforms, and achieved a major expansion in geographic market potential. It had undergone decades of quiet but momentous innovation in production techniques. And it had been building critical infrastructure, including a large network of canals. These factors combined to generate a one-time step change in the growth rate of per capita output.
Mr Wolf links to the indispensable database built by the late Angus Maddison. According to his figures, the average annual growth rate of real per capita GDP was 0.0% between 1801 and 1820. From 1821 to 1860, by contrast, the rate was 1.2%. And that is basically what the British economy has managed since the onset of modern economic growth; from 1820 to now average annual growth in real per capita GDP is 1.4%. Holding all else constant a high level of public debt may be difficult to dispatch and costly to growth. But assume an Industrial Revolution... Shouldn't we have expected massive public debt to impair private investment and constrain economic growth? Perhaps it did, but against the backdrop of a never-before-seen shift in potential output growth it scarcely registered.
An important question: to what extent can we expect a comparable step-change in per capita growth rates to bail the rich world out of its obligations? I am fairly optimistic about prospects for future growth; I think the rich world will maintain historical growth rates in per capita GDP despite significant demographic headwinds. Many others do not, and I think we have to understand current worries about indebtedness within that context.
Mr Wolf isn't necessarily wrong to say that growth is the smart way out of this mess. In the short run, cyclical dynamics have meant that the countries that moved quickly to austerity haven't enjoyed much of a fiscal reward for it. Recession in the euro zone has swelled rather than shrunk debt-to-GDP ratios. It would have been more sensible to let fiscal policy remain accommodative while the private sector deleveraged. Over the longer run a healthy rate of nominal GDP growth would absolutely make reductions in public debt easier.
But while the world might get lucky, it certainly can't count on another explosion in real growth. As a result, the healthy-nominal-GDP route to deleveraging would probably entail a bout of inflation above recent levels. That seems obviously preferable to the current strategy to me but surely wouldn't to everyone. Best to be honest about what the growth solution may entail, rather than promise people an Industrial Revolution.