Excessive debt slows economic growth

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RALEIGH — New research by two North Carolina State University professors has brought into stark relief the following facts: America is in a debt crisis, our economy is suffering as a result, and politicians of both major political parties bear responsibility.

Economists Thomas Grennes and Mehmet Caner worked with a third author, Qingliang Fan of China’s Xiamen University, to produce the study. The key finding is that when the level of indebtedness in a country reaches a certain level, it becomes a drag on economic growth. Low levels of debt don’t necessarily have this effect. If institutions borrow in order to finance valuable investment, that enhances productivity. The resulting gains can more than offset the cost of the debt.

But investments contain built-in uncertainties. Not all capital projects pay off. We generally borrow to fund the best bets at first, then the next-best gets, and so on. The more we borrow and spend, the less likely the spending will be worth it. What’s worse, we don’t always borrow to invest. We use credit to buy things for immediate consumption.

The temptation is particularly strong in government. Those who make the initial decision, the politicians, can get credit for what gets funded without getting personal blame years or decades later for the taxes or foregone expenditures required to pay off the resulting debts. And because governments don’t face the same competitive pressures that private institutions do, they are more likely to use borrowed funds either for questionable capital projects or for expenditures that are unquestionably consumption.

Generally speaking, states and localities are less guilty than Washington is. Their rules require that operating budgets be balanced every year. Moreover, bonds that pledge the full faith and credit of state and local governments often require voter approval by referendum. Both rules serve as a brake, however imperfect, on reckless borrowing.

The federal government lacks these precautions. Even so, Grennes and his colleagues found that for most of its history, the federal government used debt sensibly. “During wars, spending increased, the government borrowed, and the debt ratio increased,” they observed. “After wars, the debt ratio gradually reverted toward the prewar ratio, without a clear long-term trend.”

That ended in the late 1960s, as the federal government took on new spending obligations, most involving consumption rather than investment. What’s worse, during the same period federal tax and regulatory policies incentivized an increase in private borrowing, too.

The bill is now due. According to the new study, the annual rate of economic growth in the United States from 1995 to 2014 was more than a percentage point lower than it would have been in the absence of America’s debt explosion. That’s a very large effect.

What can be done? Previous attempts to use moral suasion or legislative pressure, such as the Simpson-Bowles Commission and debt-ceiling shutdowns, have fizzled. Another NCSU professor, Andy Taylor, advocates an intriguing set of federal budgeting reforms that may help. Or we could try devolving federal programs to the states, trusting that their preexisting safeguards will hold. As Johnny Mercer put it, something’s gotta give.

John Hood (@JohnHoodNC) is chairman of the John Locke Foundation and appears on “NC Spin,” broadcast statewide Fridays at 7:30 p.m. and Sundays at 12:30 p.m. on UNC-TV.

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