The debt economy

All nations of the world have something in common. They have debts. The entire global debt exceeds the staggering amount of $ 40 trillion (1 trillion is 1000 billion). But to whom they owe? The answer can be simplified as follows: every single country is indebted to everybody else. The accumulation of huge debts coupled with disproportionately slow economic growth in southern Europe led to the debt crisis we face today.

Why does the state borrow money?

Sovereign states primarily borrow to boost economic growth. In other words, they borrow money from international or internal capital markets to invest in public infrastructure, knowledge and expertise, thus creating conditions to increase the Gross Domestic Product (GDP) with obvious benefits for all their citizens. Some states borrow money to maintain and equip huge armed forces while they prepare for a war or simply while they are in a constant state of high tension with their neighbors (see the parade example for Greece and Turkey).

In a direct analogy to the size of the debt crisis that many states in the euro zone are facing, the following historical example exists. After the Second World War the public debt of the United States of America (USA) reached 120% of the GDP. A massive public investment program created by the US, including a significant extension of the transport network, investment in education, research and technology, resulted 30 years later (in 1970) to a public debt just 40% of the GDP.  Additionally, the US became the point of reference for science and technological innovation, a position that they still hold today.

A general rule for the public debt

One could think that constant borrowing cannot go well in the long run. Ultimately, a state is not able to spend more money than it earns. However, what is true for households and businesses does not necessarily apply at the level of entire countries.

There is a general rule that we may keep in mind when considering public debt: a state is able to take on new debts, e.g. 4% of its existing debt, when the growth rate of its economy is 4%. In this particular case the debt (always as a percentage of the GDP) remains constant. If the growth rate is less than 4%, then the overall debt will be increased. The above rule shows the importance of growth in order to tame the accumulation of debts.

Having this in mind, there are three ways to reduce public debt as a percentage of the GDP:

a) by reducing the state’s budget deficit, so that borrowing needs, as a percentage of public debt, are lower than the growth rate of the national economy,

b) by pursuing higher economy growth rates than the borrowing needs, expressed as a percentage of public debt,

c) by combining the above.

The pressure of the capital markets

Capital markets are always «impatient» because they think in terms of monthly and quarterly results. On the other hand, states should use strategic (that means long-term) planning for their future development.

Sovereign states, as opposed to households or businesses, may alter their political agenda, changing spending priorities for infrastructure, education, research, etc., thereby directly affecting their financial results. In other words they create growth. States that prefer reductions in salaries and pensions delay the building and repairing of roads and rails, block sound investments with meaningless bureaucracy and high taxes, cannot hope to achieve sustainable high rates of economic growth.

Capital markets may exert great pressure on sovereign states for immediate deficit reduction through a reduction of costs and an increase of direct and indirect taxes. The natural road of creating growth, which is a lengthy and arduous evolutionary process, is thus neglected.

The importance of growth

It is sometimes useful to borrow from capital markets. Indeed, without debts, the global financial system could simply stall! When a state needs to enhance its growth prospects it borrows money. These loans can be paid by the anticipated revenues of the growing economy. The alternative would be to increase taxes or reduce social benefits, options that would surely affect the purchasing power of citizens negatively and reduce social cohesion.

In the Greek case, the aggressive budgetary cuts that followed the pressures of our lenders proved extremely short-sighted. They strangled the internal market and led to a long and severe recession. Even if Greece finally achieves a balanced state budget, the living standards of its people will have declined dramatically and many doubt if this method will prove viable for the economy in the long run.

A strategy for economic recovery must equally give importance to reducing the deficit and achieving economic growth. Little else is left while Greece is facing deep recession for a fifth consecutive year. It is therefore absolutely essential to achieve growth by any possible means necessary: lowering taxes, privatizing public companies, easing and facilitating Direct Foreign Investments. Even at the eleventh hour, there is still time to save the Greek economy.

SOURCES

This is the English version of an article that was posted on 18 September 2011 in the “Neos Agon” newspaper in Karditsa, Greece.

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