Tag: economic growth

Dallas Fed: High And Rising Public Debt Is Associated With Slower Growth

Yesterday I was on a panel at Heritage looking at a Swiss-style debt brake and whether it was appropriate for the US.

US federal debt is now at its highest level as a proportion of GDP since 1950. Even prior to the recent tax cuts and budget-cap busting omnibus spending deal, debt was forecast to rise to 150 percent of GDP over the next three decades, primarily due to an aging population interacting with existing entitlement promises. Next week the Congressional Budget Office will publish its economic and fiscal outlook, which will show much higher deficits over the coming years following recent policy changes, and hence an even worse baseline of debt to ride into this fiscal headwind. Analysts expect the annual deficit could rise to around 5.3 percent of GDP in the next year or so.

Why does this matter from an economic perspective?

There are good economic reasons why we should desire a lower long-term debt-to-GDP ratio. For starters, a lower debt burden is insurance against the kind of “earthquake” debt crisis that John Cochrane and his Hoover Institution colleagues wrote about in the Washington Post last week. There are also obviously significant intergenerational consequences for taxpayers stemming from continually kicking the can down the road with ever-rising accumulated debt, with rising debt interest payments taking up a much higher proportion of government spending.

But a new Dallas Fed Economic Letter builds on previous research suggesting potentially the most damaging consequence: a rising debt trajectory seems to be associated with slower economic growth.

Back in the early part of this decade there was a huge debate about this. Ken Rogoff and Carmen Reinhart published a paper suggesting that growth across countries tended to slow substantially when government debt exceeded 90 percent of GDP. This “threshold effect” was taken by some commentators and politicians as gospel, but economists were more skeptical of thinking 90 percent represented a magical threshold beyond which disaster would strike. Then mistakes were found in the Reinhart-Rogoff work, and that hook was used to discredit the idea that there was a negative transmission mechanism between high debt and low growth at all.

This was an overreaction. Reinhart and Rogoff were not the only ones to find such an association. In fact, there was a lot of evidence out there that high debts were associated with slower growth. Stephen Cecchetti, M. S. Mohanty, and Fabrizio Zampolli identified a debt-to-GDP threshold of about 85 percent as a point beyond which growth tends to slow. Even Thomas Herndon, Michael Ash, and Robert Pollin, who replicated Reinhart and Rogoff’s work correcting for the errors, found that, on average, growth was 1 percentage point per year lower when government debt exceeded 90 percent of GDP than when debt levels were between 60 and 90 percent.

That’s what makes the new Dallas Fed note so interesting. They acknowledge, in line with basic intuition, that “the debt–growth relationship is complex, varying across countries and affected by global factors.” They also highlight the problem of disentangling the two-way causality between the two, and the possibility of discontinuities. Nevertheless, looking at a panel of advanced and emerging economies they conclude:

persistent accumulation of public debt over long periods is associated with a lower level of economic activity. Moreover, the evidence suggests that debt trajectory can have more important consequences for economic growth than the level of debt to gross domestic product (GDP).

Although there is no universally applicable threshold beyond which growth slows, countries with “rising debt-to-GDP ratios exceeding 60 percent tend to have lower real output growth rates.” What’s more, persistent accumulations of debt are associated with worse long-run growth outcomes:

These estimates are all negative and in the range of -5.7 to -9.4 percent, suggesting that a persistent accumulation in the debt-to-GDP ratio at an annual pace of 3 percent is eventually associated with annual GDP growth outcomes that are 0.2 to 0.3 percentage points lower on average.

Though the authors are careful to point out that this does not prove causality, the study does present evidence that if there is a transmission mechanism from high debt to low growth, the key to overcoming it is credible commitments and action to ensure debt increases are temporary phenomena. For the US federal government, rising debt looks a permanent reality right now as far as the eye can see.

For more on how fiscal rules could help play a part in changing this, read here.

And here’s the full discussion at Heritage from yesterday.

Taxes and Economic Growth: What Academic Studies Find

As Republicans press ahead with major tax reforms, politicians and pundits are debating the effects of tax cuts on economic growth. This 2012 study by the former Tax Foundation chief economist took a detailed look at the academic literature on the issue.

Here is what Will McBride found:

So what does the academic literature say about the empirical relationship between taxes and economic growth? While there are a variety of methods and data sources, the results consistently point to significant negative effects of taxes on economic growth even after controlling for various other factors such as government spending, business cycle conditions, and monetary policy.

In this review of the literature, I find twenty-six such studies going back to 1983, and all but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth. Of those studies that distinguish between types of taxes, corporate income taxes are found to be most harmful, followed by personal income taxes, consumption taxes and property taxes.”

These results support the neo-classical view that income and wealth must first be produced and then consumed, meaning that taxes on the factors of production, i.e., capital and labor, are particularly disruptive of wealth creation. Corporate and shareholder taxes reduce the incentive to invest and to build capital. Less investment means fewer productive workers and correspondingly lower wages. Taxes on income and wages reduce the incentive to work. Progressive income taxes, where higher income is taxed at higher rates, reduce the returns to education, since high incomes are associated with high levels of education, and so reduce the incentive to build human capital. Progressive taxation also reduces investment, risk taking, and entrepreneurial activity since a disproportionately large share of these activities is done by high income earners.”

This review of empirical studies also establishes some standards by which a tax system may be judged. If we apply these standards to our national tax system, the U.S. has probably the most inefficient tax mix in the developed world. We have the highest corporate tax rate in the industrialized world. If it came down 10 points—still higher than most of our trading partners—it would add 1 to 2 points to GDP growth and likely not lose tax revenue, because the tax base would expand from in-flows of foreign capital as well increased domestic investment, hiring, and work effort.

McBride’s study, with a nice summary table, is here.

Martin Feldstein on U.S. Growth vs. Other Major Economies

Martin Feldstein has a new short paper out with some thoughts on a relatively under-researched subject: Why is Growth Better in the United States than in other Industrial Countries?

He begins:

In 2015, real GDP per capita was $56,000 in the United States. On a purchasing power basis, the real GDP per capita in the same year was only $47,000 in Germany, $41,000 in France and the United Kingdom, and just $36,000 in Italy. So the official measures of real GDP clearly point to the cumulative result of higher sustained real growth rates in the United States than in the major industrial countries of Europe and Asia.

Over the very long term, this is a truism. In order for the U.S. to be that much richer, it must have experienced faster real GDP per capita growth than comparator countries. We know from figures collated by the Maddison Project that the U.S. had around half the level of GDP per capita of the UK in the early 18th century, but by 1900 it was overtaking the UK as the richest country by income per head, and has remained in that leading position for almost all the period since.

But showing higher levels of income does not necessarily mean that the U.S. growth of GDP per capita was higher than other countries over more recent periods.

GDP Growth Was “Stronger after Tax Increases on the Wealthy”?

New York Times columnist David Leonhardt claims, “G.D.P. growth has been stronger after recent tax increases on the wealthy.”  To prove it he writes,  “The economy has performed better under Democratic Presidents during the last half century.”  

This might make sense if Eisenhower and Nixon had cut tax rates for the wealthy and JFK and LBJ raised them.  But the opposite happened.  It might also make sense if Clinton had raised the capital gains tax rate in 1997 rather than cutting it from 28% (under Reagan-Bush) to 20%. 

President Eisenhower put the highest tax rate up to 92% in 1953-54 and the lowest rate to 22%.  By contrast, President Kennedy’s 1963 plan for “getting America moving again” proposed to cut income tax rates to 14-65%.  As enacted by LBJ after Kennedy’s assassination, the top tax rate was reduced to 70% and the lowest to 15%.  These rate cuts came quickly, unlike Reagan’s – which were was unwisely postponed until 1983-84. 

Chile’s Success Story on Television

A new documentary series, “Improbable Success,” looks at countries that have thrived by implementing free-market policies. The series is currently running on Sinclair Broadcast Group stations, which are found across the country, from WJLA in Washington, D.C., to KBFX in Bakersfield, California. (Sinclair stations are variously affiliated with all major networks.) This weekend, including at noon Sunday on WJLA, host Emerald Robinson will look at Chile’s economic growth since its reforms around 1980. Experts on the show include Jose Pinera, Ian Vasquez, and Richard Rahn, along with several Chilean entrepreneurs. Last week featured Estonia; next week, Switzerland. 

Jose Pinera with Emerald Robinson

Capitalism, Global Trade, and the Reduction in Poverty and Inequality

Drawing on a new World Bank study, Washington Post columnist Charles Lane today notesa vast reduction in poverty and income inequality worldwide over the past quarter-century” – despite what you might think if you listen to Pope Francis, Bernie Sanders, and other voices prominent in the media.

Specifically, the world’s Gini coefficient — the most commonly used measure of income distribution — has fallen from 0.69 in 1988 to 0.63 in 2011. (A higher Gini coefficient connotes greater inequality, up to a maximum of 1.0.)

That may seem modest until you consider that the estimate’s author, former World Bank economist Branko Milanovic, thinks we may be witnessing the first period of declining global inequality since the Industrial Revolution.

Note that this hopeful figure applies to the world’s population as though every individual lived in one big country. When Milanovic assessed the distribution of income between nations, adjusted for population, the improvement was even more striking: a decline in the Gini coefficient from 0.60 in 1988 to 0.48 in 2014.

The global middle class expanded, as real income went up between 70 percent and 80 percent for those around the world who were already earning at or near the global median, including some 200 million Chinese, 90 million Indians and 30 million people each in Indonesia, Egypt and Brazil.

Those in the bottom third of the global income distribution registered real income gains between 40 percent and 70 percent, Milanovic reports. The share of the world’s population living on $1.25 or less per day — what the World Bank defines as “absolute poverty” — fell from 44 percent to 23 percent.

So maybe this is a result of all the agitation on behalf of a more moral or planned economy? No, says Lane, citing Milanovic:

Did this historic progress, with its overwhelmingly beneficial consequences for millions of the world’s humblest inhabitants, occur because everyone finally adopted “democratic socialism”? Was it due to a conscious, organized effort to construct a “moral economy” as per Vatican standards?

To the contrary: The big story after 1988 is the collapse of communism and the spread of market institutions, albeit imperfect ones, to India, China and Latin America. This was a process mightily abetted by freer flows of international trade and private capital, which were, in turn, promoted by a bipartisan succession of U.S. presidents and Congresses.

The extension of capitalism fueled economic growth, which Milanovic correctly calls “the most powerful tool for reducing global poverty and inequality.”

This is the good news about the world today. Indeed, it’s the most important news about our world. We hear so much about poverty, inequality, gaps, resource depletion, and the like, it’s a wonder any NPR listeners can bear to get out of bed in the morning. But as the economic historian Deirdre McCloskey says, this is the “Great Fact,” the most important fact about our world today – the enormous and unprecedented growth in living standards that began in the western world around 1700. She calls it “a factor of sixteen”: we moderns consume at least 16 times the food, clothing, housing, and education that our ancestors did in London in the 18th century. And this vast increase in wealth that began in northwestern Europe, mostly Britain and the Netherlands, has now spread to most of Europe, the United States, Japan, and increasingly to the rest of the world.

Some Blessings of Cheap Oil and Low Inflation

1. Cheaper oil lowers the cost of transporting people and products (including exports), and also the cost of producing energy-intensive goods and services.  

2. Every upward spike in oil prices has been followed by recession, while sustained periods of low oil prices have been associated with relatively brisk growth of the U.S. economy (real GDP).

   

3. Far from being a grave danger (as news reports have frequently speculated), lower inflation since 2013 has significantly increased real wages and real consumer spending.

 

4. Cheaper energy helps explain why the domestic U.S. economy (less trade & inventories) has lately been growing faster than 3% despite the unsettling Obama tax shock of 2013.

   

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