Huge public debt makes Trump's promised growth rates impossible

Huge public debt makes Trump's promised growth rates impossible
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With the second and third quarter’s growth figures from 2017 coming in above 3 percent, certain political commentators are starting to lament that the U.S. economy is on track to achieve robust and sustained levels of growth above 3 percent for the longer-term.

The president commented on the improving growth figures only a month ago, stating, “We’re going to see economic growth of 4, 5 and maybe even 6 percent, ultimately.”

Large public debt makes sustained robust economic growth impossible

With the total gross debt set to surpass $21 trillion in the coming months, federal debt held by the public will equate to around 77 percent of GDP by the year's end. This upward trajectory presents some serious challenges to political hopes of sustained growth rates above 3 percent.

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Several empirical studies consistently demonstrate that developed economies that reach and surpass debt levels of 90 percent of GDP fail to achieve robust levels of economic growth.

Over the past decade, academic research has highlighted the adverse effects of high public debt on levels of economic growth. In a 2010 study by the European Central Bank, economists Philipp Rother and Cristina Checherita concluded that the government debt-to-GDP ratio has a deleterious impact on long-term growth above 90 percent of GDP.

The study also found that the negative growth effect of high debt starts from debt levels above 70 percent of GDP, although these effects are less significant. The result of high public debt levels are 1) reduced private savings, 2) reduced public investment and 3) lower total factor productivity — all of which lead to lower levels of economic growth.

A more recent study from the University of Lisbon measured the effect of public debt on economic growth. The study finds that for every 1 percent increment of public debt above the 75 percent threshold, there is a a 0.04-percent reduction in annual growth rates.

A more conservative figure was discovered by an IMF study on public debt and growth — the empirical results suggest a 10-percent increase in the debt-to-GDP ratio is associated with a 0.2-percent reduction in annual GDP.

In a 2010 working paper, Harvard economists Carmen Reinhart and Kenneth Rogoff found that, “For 1900–2009, median and average GDP growth hovers around 4–4.5 percent for levels of debt below 90 percent of GDP, but median growth falls markedly to 2.9 percent for high debt (above 90 percent); the decline is even greater for the average growth rate, which falls to 1 percent.”

When looking at the current debt figures for the 35 Organization of Economic Cooperation and Development (OECD) countries in 2016 and the subsequent GDP growth figures for the decade 2008-2017, a similar pattern is found.

There is a clear relationship between higher levels of debt and lower growth rates, particularly for levels of debt above 90 percent of GDP. This relationship is demonstrated in the chart below.

Average growth '08-'17

All of the aforementioned studies point to the same fundamental conclusions: First, there is a debt ratio threshold around 70 percent whereby growth begins to be negatively affected, but there is also a second threshold around 90 percent whereby the effects of debt become far more deleterious.

Second, all studies suggest that the adverse effect largely reflects a slowdown in labor productivity growth mainly due to reduced investment and slower growth of capital stock.

What does this mean for future economic growth?

The economic impacts of an ever-increasing national debt will be crippling for future generations, with federal debt held by the public to surpass 90 percent of GDP in the coming decade. As federal borrowing reduces national savings over time, the nation’s capital stock will ultimately be smaller, meaning that both productivity and income will be lower than would be the case if the debt was smaller.

Based on the findings of the aforementioned studies, a sustained growth rate of 3 percent or more in coming years and decades will be impossible given our current debt trajectory. In the CBO’s 2017 Long-Term Budget Projections, U.S. debt held by the public is projected to balloon to 134 percent of GDP by 2043 — that constitutes almost a doubling in the debt ratio in just 25 years.

According to the growth effects calculations from the University of Lisbon study, on current debt projections, GDP growth in 2043 will be 2.3 percent lower than the baseline. In other words, if baseline growth was 3 percent, the growth rate accounting for debt largesse will be just 0.7 percent.

The more conservative calculations by the IMF study suggest that growth in 2043 will be 1.1-percent lower than the baseline, or 1.9 percent if we assume that 3 percent is the baseline.

Based on the well-established and widely acknowledged relationship between public debt and GDP growth, it is highly unlikely that we will experience GDP growth figure of 3 or 4 percent in the coming years. On current debt projections, 2-percent growth may even be an ambitious target in years to come.

Policymakers must recognize this problem for what it ultimately is: a spending problem. Until this problem is properly addressed, we can expect years of economic stagnation ahead.

Jack Salmon is a Washington, D.C.-based researcher focused on federal fiscal policy. Salmon holds an M.A. in political economy with specializations in macroeconomics and comparative economic analysis from King's College London.