This article first appeared in the St. Louis Beacon: The continuing debate over government austerity programs recalls John Maynard Keynes observation that “madmen in authority … are distilling their frenzy from some academic scribbler of a few years back.”
Some background. In 2010 two Harvard economists, Carmen Reinhart and Kenneth Rogoff, published an academic paper that examined the relationship between government debt and economic growth. Based on the experience of 44 countries over 200 years, their key and controversial finding was that countries with extremely high levels of government debt — debt in excess of 90 percent of GDP — tended to grow at much slower rates than those with less debt.
Other academics questioned these results and debated them. Many in authority latched on to the now-famous 90-percent level as the underpinning for many austerity programs now in place around the world. Keynes’ madmen in authority did not wait long to begin distilling academic research into policy.
Such quick action is fraught with danger. Scientific research proceeds by debunking existing ideas. This winnowing of ideas through replication and re-examination leads to a better understanding of how the world works. It is no different in economics. Just recently, three economists at the University of Massachusetts published a paper revisiting the Reinhart and Rogoff results. These researchers — Thomas Herndon, Michael Ash and Robert Pollin — used Reinhart and Rogoff’s data and found that the latter’s dire forecast was wrong. After correcting some spreadsheet coding errors and including countries that had been previously excluded, the Herndon results showed that countries with debt-to-GDP ratios higher than 90 percent do not, on average, suffer negative economic growth. Rather, the average growth rate for countries in this region is positive though quite small.
This new finding has been accepted as fact by another cadre of policymakers, who apparently believe that there is no level of government spending that is too harmful to the economy. Led by Paul Krugman, the New York Times columnist and Nobel Prize recipient, the new results rekindled calls for greater government spending to trigger economic activity in the United States and in Europe.
The problem is that such calls still ignore the story being told by the “new” set of facts.
Let’s take the evidence presented in the Herndon study as given. Namely, countries with debt-to-GDP ratios in excess of 90 percent, on average, had economic growth rates of only slight more than 2 percent. In contrast, countries with a debt load between 30 and 60 percent (the average for the United States over the past four decades is about 40 percent) average growth rates slightly greater than 3 percent.
Slowing economic growth by what appears to be such a small number — specifically from 3.2 percent to 2.2 percent — still has significant, negative consequences on future standards of living. Consider the following calculations. Median U.S. household income in 2012 was $52,762. If the economy grows at a 3.2 percent rate over the next 20 years, median household income increases to a little over $97,000. But, if the growth rate of the economy averages 2.2 percent, median household income increases to a much smaller value, a little more than $81,000. That small change in the growth rate associated with higher government debt results in a much lower standard of living.
What’s the likelihood of being in the high-debt group? The Congressional Budget Office predicts that, if current policies are followed, the debt-to-GDP ratio will swell to 93 percent in 2022 and to almost 200 percent by 2037. This well-publicized run-up in debt comes from changing demographics and the maintenance of social programs, such as Social Security and Medicare.
Serious reform, which thus far is lacking, is necessary to keep U.S. government debt from surpassing and staying above our total production of goods and services.
Using the “corrected” numbers shows that a sustained, high level of government debt has a significant economic cost. Controlling the deficit and the attendant increase in the debt remains a serious issue for economists and policy makers alike.
Rik Hafer is a distinguished research professor in the Department of Economics and Finance at Southern Illinois University Edwardsville and a scholar at the Show-Me Institute.