Drowning in debt


The Bank of International Settlements has released an interesting new piece of research: The real effects of debt by Cecchetti, Mohanty, and Zampolli. Essentially, the paper shows that once debt rises beyond a certain level, it becomes a drag on economic growth (and increases likelihood and severity of financial crises). If you want to check out their data and economic modelling, you can download the whole paper here.

Their findings apply to household, corporate and public (i.e. government) debt. Government debt becomes a drag on growth at between 80 and 100% of GDP. Corporate debt becomes a drag on growth once it rises above 90% of GDP. Household debt becomes a drag on growth beyond 85% of GDP. The bad news is the UK already exceeds all these debt thresholds: our household debt is 106% of GDP, our corporate debt is 126% of GDP, and our government debt is 89% of GDP.

Here’s how household, corporate and government debt have risen as a percentage of GDP since 1980:

And here’s what has happened to total, combined debt in the UK since 1980 (it now stands at 322% of GDP):

Unfortunately, it gets worse:

A clear implication of these results is that the debt problems facing advanced economies are even worse than we thought. Given the benefits that governments have promised to their populations, ageing will sharply raise public debt to much higher levels in the next few decades. At the same time, ageing may reduce future growth and may also raise interest rates, further undermining debt sustainability. So, as public debt rises and populations age, growth will fall. As growth falls, debt rises even more, reinforcing the downward impact on an already low growth rate. The only possible conclusion is that advanced countries with high debt must act quickly and decisively to address their looming fiscal problems. The longer they wait, the bigger the negative impact will be on growth, and the harder it will be to adjust.

A previous paper (PDF) by the Bank of International Settlements projected the UK’s government debt forward to 2040, assuming current policies are maintained. On the graph below, the red line is the baseline scenario, the green line shows what would happen with a small gradual adjustment (a fiscal consolidation of 1% of GDP each year from 2012), and the blue line shows what would happen with a small gradual adjustment in which age-related spending was held constant (as a percentage of GDP).

Note that on the baseline scenario, government debt exceeds 500% of GDP. That would mean the government spending more than a quarter of the UK’s GDP servicing its debts. In reality, we would be forced into default long before debt reached such a level.

It all makes for pretty grim reading, doesn’t it? The simple fact is that Britain, like most Western economies, is living on borrowed time. In the medium term, only a genuinely radical re-evaluation of the scope and scale of the state can avert disaster. Look around Westminster, Washington or Brussels right now though, and all you will see is lots of heads buried in the sand.