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Pros and cons of high and low government debt

 
Tags: Macroeconomics | Government debt | GDP | Standard of living | Oil | USA | Japan | Greece | Russia | Analytics
 

In Russia, they are very proud of the low public debt. And they laugh at the United States, which has the opposite.

The high sovereign debt of the United States of America is a popular horror story of Russian television and a powerful Internet meme. What are you constantly grumbling, look at how bad they are - the US is over credited, and his high standard of living is based on credit money only, and very soon this bubble will finally burst.

US national debt meme

Typical meme about US government debt

During last two decades there is opposite situation in Russia. Soviet debts have been fully paid, there are no requirements to ask money in IMF as in 1990s. Instead, huge stabilization funds have been accumulated. They should support the country in the event of a difficult macroeconomic situation - in other words, when oil prices fall. The following table clearly illustrates that if the Russian economy has problems with something, then it’s definitely not with public debt (not all countries are listed):

Location Country Debt / GDP
1 Japan 234.18%
2 Greece 181.78%
3 Sudan 176.02%
4 Venezuela 172.08%
5 Lebanon 160.57%
6 Italy 127.51%
7 Eritrea 127.34%
8 Barbados 127.31%
9 Cape Verde 126.66%
10 Portugal 117.54%
11 Mozambique 116.60%
12 United States of America 109.45%
13 Singapore 108.79%
14 Gambia 105.17%
15 Republic of the Congo 105.01%
16 Bahrain 102.01%
17 Belgium 99.08%
18 France 96.20%
19 Bhutan 96.05%
20 Yemen 95.83%
30 United Kingdom 85.92%
31 Canada 83.81%
33 Ukraine 76.86%
39 Zimbabwe 72.64%
50 Pakistan 67.44%
51 India 67.29%
63 Finland 59.56%
79 Germany 55.75%
81 Armenia 55.58%
85 China 54.44%
97 Belarus 49.93%
115 CARs 44.37%
116 Georgia 44.09%
117 Honduras 44.08%
118 Rwanda 43.12%
124 Switzerland 41.10%
125 Australia 41.05%
151 Kuwait 32.42%
170 Kazakhstan 23.14%
171 Bulgaria 22.86%
172 Luxembourg 22.80%
173 New Zealand 22.69%
174 Uzbekistan 20.65%
175 Micronesia 20.55%
176 Russia 19.48%
177 United Arab Emirates 19.35%
178 Solomon Islands 16.41%
179 DR Congo 13.31%
180 Botstvan 12.84%
181 Estonia 8.12%
182 Afghanistan 6.32%
183 Brunei 2.46%

This table says better than any boring theories that leverage has little effect on living standards. Among the largest debtors are both economically successful Japan and the USA, as well as the poorest Sudan and the Gambia. Among countries with low borrowing, both prosperous Switzerland and Luxembourg, as well as poor Micronesia and Rwanda. And two African countries, whose capitals are separated only by the river of the same name (the Republic of the Congo and the Democratic Republic of the Congo) - have a diametrically different credit load, but are equally poor.

Why is a large government debt not scary

High borrowing does not mean that the country is doing badly. Economically successful countries usually have the opportunity to borrow at a relatively low rate (since the risk that they will not repay the debt is minimal). So if the percentage is low, then why not take advantage of it?

A classic example just the United States of America. The largest world economy not only occupies the lowest rates, but also controls the most important world currency - the dollar - which means that in the event of a serious threat to its solvency, it can reasonably print the currency. Behind this debt is a strong economy - US companies lead in capitalization and are leaders in their markets.

In the corporate world, large and successful companies are rarely financed only at the expense of their shareholders. Moreover, it is believed that a certain level of borrowed capital is even useful - interest payments on it are usually lower than dividend payments to shareholders, and companies have more funds left for development. Even in personal finances, a mortgage can solve the problem of lack of housing, not only faster, but also cheaper (we analyzed, in which cases) than trying to save necessary money using a bank deposit. The same laws apply at the macro level too.

Therefore, you should not be surprised at the high debt in countries such as the UK, France, Canada. If you look at the debt / GDP ratio in the EU countries (relatively prosperous), then this indicator will be on average higher than in other regions of the world.

Why is a large goverment debt scary

But the higher the level of debt, the more risky the economy. In a critical case, all taxes collected are primarily directed to the repayment of interest on debt, and own social programs are financed on residual money.

The modern Russian economic and political elite is almost entirely from the 1990s. At poor 1990s, many of those who today determine the most important economic decisions were on the approaches to the highest echelons of power. And they are too familiar with the situation when “there is no money”, but somehow you need to solve problems and hold on in your chairs. Miners knocking helmets on Red Square, banks closed from lack of money, inefficient enterprises without working capital are all horror stories not only for the population, but also for the authorities.

Such an economic collapse is fraught with much greater risks than any politically colored protests of young people.

Greece was in a similar situation in the 2010s - it is still one of the world's largest debtors. During long time this country took debt at low rates, forging and falsifying its own statistical reporting. In fact, the local economy did not have powerful competitive industries, high-tech products were purchased mainly in Germany and other European countries, and government spending was greatly overpriced by populist governments. The global crisis that began in 2008 brought down the country's income from tourism, the main bastion of the local economy. It instantly became clear that the country could not service the accumulated huge debt - Greece began to expect bankruptcy and all related consequences, including unemployment and impoverishment of the population.

In such situations, the country usually becomes a hostage to the IMF and other international lenders. But like any lender, these organizations are usually very concerned about the return of funds, rather than saving the debtor. They require governments primarily to cut budget spending. International lenders did not help Russia in the late 1990s. Government bonds default and rouble devaluation have restarted the economy, while negotiations with the IMF only waste time. The country was saved by rising oil prices and economic reforms. Greece’s problems have still not been resolved - high local debt has left the front pages of newspapers, but a weak economy has not gone away. In a similar scenario, the interaction between the IMF and Ukraine is developing right now.

When should I borrow, and when not?

How to borrow like the US and not like Greece?

The question is very important. External debt can significantly help the economy. Borrowed funds must be invested in the economy, and thus create competitive advantages. These can be large infrastructure projects, investments in new technologies and human capital. The most important thing is that at the output a product is created that will be competitive in the world market and will bring income to local enterprises and the economy.

It makes no sense to build bridges and roads, if this does not help the economy in any way, it will not increase revenues or reduce costs. The population quickly eats up the money spent, and they won’t learn how to earn money (in the worst case scenario, the beneficiaries will be a narrow layer of elites who will quickly withdraw money from the country).

It makes sense to build roads if, due to this, the country gains access to large mineral deposits or can become a major transport hub. Or if it reduces the cost of delivering key national goods to world markets - which means it will improve price competitiveness. Or, on the whole, it contributes to the growth of economic cohesion in the regions of the country, which means that due to specialization the average size of enterprises will increase, labor productivity will increase, and the unit cost of production will decrease. Summarizing, state should borrow when, due to this, a technological advantage can be created. To get ahead of more conservative competitors, developing on their own money, to occupy new markets and begin to quickly receive benefits from emerging technologies. This usually assumes that the country raises funds for the long term and invests them in fixed assets and human capital.

Borrowing money to cover current expenses is a bad idea

Compare two simple examples. A successful and promising young man who takes a mortgage or a education loan at low rates in order to start earning even more as quickly as possible. And a tormented poor man who constantly borrow in non-bank credit organizations at high rate to find money before next salary payment. Which of them is more attractive and interesting for you? As for a business partner, as for a husband? At the state level, absolutely the same logic works.

If there are no new interesting technologies on the horizon, then it is hardly worth borrowing. In this light, the example of Japan is extremely interesting - at the moment the world's largest debtor. Destroyed after the Second World War, the country performed an economic miracle in the 60-70s of the last century. She made it due to the fact that she was able to achieve a competitive advantage in the then advanced industry - car manufacturing. The Japanese invented "lean manufacturing" and were able to conquer the American car market with their economical compact cars - the price of the cars themselves and the cost of maintenance differed favorably from their American competitors, with the same high quality.

But in the early 1990s, after rapid growth, the country began to gradually sink into a recession, and in the car market, neighbors from South Korea began to catch up with it. To save the situation and stimulate production, the government decided to sharply reduce taxes. At the same time, government spending was not reduced, and the missing funds were raised through the placement of debt. However, the economic situation has not changed at all - the declining tax base slightly improved the competitiveness of Japanese products, but in the absence of new technological ideas, this was not enough. Of course, Japan is borrowed at a very low rate, and its economy is not a dummy (unlike Greece), but the growth of external debt only added problems to the country.

If we talk about Russia, then its idea of ​​having low debt is absolutely sound and reasonable in the chosen economic model. Domestic doctrine proceeds from the volatility of oil prices as the main source of income for both the federal budget and the country as a whole. What to do with a large external debt, if suddenly oil prices fall? There will be no funds paid and everything will end with a new default. In general, it is not surprising that in the table above, in the last places there are many oil exporters - the United Arab Emirates, Brunei, Russia, Kuwait (there are exceptions too). Countries with more stable incomes, on average, can afford a higher level of debt - likewise, an employee of a large enterprise or a government official usually takes a bolder loan than a representative of a small business. Not because one has higher incomes than another, but because the potential variability of these incomes is different.

And a definite answer, whether it is worth borrowing or not, as always, is not present - each case is individual and requires a separate study.

Why do some countries, cities or companies achieve economic success, while others are in poverty? Why is economic growth so weak and income inequality constantly increasing? How can new technologies change the global economic landscape? On this site we look at the most important global trends from the perspective of an economist.

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