By Jeremy Smith (with a hint of irony in his soul)
Over the last few years, we have been told time and again that a public debt-to-GDP ratio that goes beyond 90% is dangerous, and leads to slower economic activity. The main source for this thesis, which has been accorded the status of fact, is a paper by Carmen Reinhart and Kenneth Rogoff entitled “Growth in a time of debt”, published in early 2010.
By extraordinary coincidence, on the very day that blogger Rortybomb uncovered curious discrepancies in the data used by Reinhart and Rogoff, casting much doubt on the correctness of the thesis, PRIME are proud to announce the results of our own in-depth research (fieldwork took place this evening), covering the experience of the UK from 1949 to 2011. Our findings? A bit radical, really.. A period of public debt-to-GDP ratio of over 90% is associated, on average, with a higher level of annual increase of GDP than is the case for periods with a debt-to-GDP ratio under 90%.
What’s the evidence and methodology for this somewhat surprising set of findings?
Our researchers (well, me actually), took the IMF data for annual UK public debt-to-GDP ratios available here. Then we took data on annual increases in GDP from the ONS database, available from here (see column BU) starting in 1949, and ending with 2011. Using our complex model (i.e. adding up) we found that for 18 years, from 1949 to 1966, debt to GDP ratios were above 90%. If one adds up the ONS annual increases and divides by the number of years, the average annual GDP increase over these 18 years when the ratio was over 90% is 3.19%.
We then looked at the periods when the debt-to-GDP ratio was between 60 and 90%. There are two periods totalling 9 years, from 1967 to 1972, and recently from 2009 to 2011. The average rate of GDP increase for these 9 years of 60 – 90% is 1.93%.
Finally, we looked at the rest of the period in question, when the debt-to-GDP ratio was between 30 and 60%. This was from 1973 to 2008, covering 36 years. For this period of 30 – 60%, the average annual GDP increase is 2.60%.
So our conclusion is that the UK economy grew more rapidly, in real terms, at a time when – for 18 years covered by this study – it had a high debt-to-GDP ratio, and still managed to reduce that ratio almost year by year. The 36 years when the debt-to-GDP ratio was between 30 and 60% achieved the next best rate of annual GDP growth, but also saw the crises and recessions of 1991 and 2008/9. The worst rate of growth was during the 2 periods when debt-to-GDP was between 60 and 90%.
Ah yes, time for some charts. First, a nice simple one showing the evolution of the UK debt to GDP ratio.
Source: IMF. Vertical axis = debt-to-GDP ratio
Second, a chart that shows the annual increase (with a few nasty decreases in the era of liberalisation) in GDP, colour-coded for the relevant debt to GDP ratio band.
Source: ONS, IMF
2 Responses
Great stuff Jeremy. I think, though, there’s a case to be made for the liberalisation of finance being started earlier, than 1979, in 1971 with Anthony Barber’s “Competition & Credit Control” system (dubbed ‘all competition & no control’) which lifted controls over:creation of credit and the rate of interest for short & long-term loans, safe & risky loans and which led to an explosion in credit creation & rising borrowing costs. In the same year Nixon unilaterally dismantled Bretton Woods.
Thanks David.. point taken on liberalisation, though I did say “in particular” from 1979!