Sunday, May 29, 2011

Government spending Vs public debt

Conventional wisdom attributes the massive public debts that many developed countries face today to a legacy of large government spending. In this context, Lane Kenworthy points to an insightful graphic that matches net government debt in 2010 to government expenditures (as a % of GDP) over the 1990-2010 period, and finds no co-relation whatsoever.

His conclusion is spot on,

"A high level of government spending doesn’t necessarily produce heavy government debt. Nor does low spending guarantee low debt. Debt levels are a function of government expenditures and revenues and economic growth."

As Mark Thoma has written, the conservatives have tried to sell their "shrink the government" agenda by arguing that expenditure cuts are the only way out of the huge public debt. Raising taxes, the other side of the fiscal balance equation, is opposed on ideologically spurious supply-side (being on the other-side of the Laffer curve) arguments.

This conservative ideology has exercised a firm grip on politics in even many developing economies. The high rates of economic growth have been responsible for keeping the fiscal status of these governments on the balance.


Sai Prasad said...

Debt depends on the expenditure as well as the income. Higher expenditure with proportionately high incomes would not increase debt.

It might be correct to say that disproportionately high expenditure is the culprit.

gulzar said...

agreed sir. the critical parameter is economic growth rate.

if growth rates are high, as is the case with developing economies, then their ability to sustain higher levels of debt stock (and therefore higher levels of expenditures) increases. the problem comes when economy shrinks, as is happening in Greece etc, and debt stock remain the same (the debt to GDP ratio increases).

sai prasad said...

So, should borrowing be set to a parameter other than GDP, which is not as stable as it once was thought to be ?

Anonymous said...

debt can be incurred to fill the vacuum left by imbalanced budgets. however this shows that we had deficits it does not mean that there are no other sources to finance this. debts depend on how best they are used.