‘”On both sides of the Atlantic, the largest contributors to the current crisis are excessive debt and spending. We are now at a point where additional government stimulus measures will have negligible, if not detrimental effects on the economy and long-term growth.”
“The historical evidence shows that countries with large governments and high levels of debt have on average, achieved lower economic growth. Given the already high level of debt and deficits in most developed countries, it is doubtful that increased fiscal stimulus will really help the recovery. It’s clear that debt is the problem and the solution does not lie in piling on even more of it.”
“The current misconception that our economic salvation lies with more stimulus is both treacherous and self-defeating. As long as we continue down this path, the “solution” will continue to be the problem. There is no miracle cure to our current woes and recent proposals by central planners risk worsening the economic outlook for decades to come.” (Emphasis added) – Eric Sprott & Etienne Bordeleau
The Solution…is the Problem, Part II
By Eric Sprott & Etienne Bordeleau
When we wrote Part I of this paper in June 2009, the total U.S. public debt was just north of $10 trillion. Since then, that figure has increased by more than 50% to almost $16 trillion, thanks largely to unprecedented levels of government intervention.
Once the exclusive domain of central bankers and policy makers, acronyms such as QE, LTRO, SMP, TWIST, TARP, TALF have found their way into the mainstream. With the aim of providing stimulus to the economy, central planners of all stripes have both increased spending and reduced taxes in most rich countries. But do these fiscal and monetary measures really increase economic activity or do they have other perverse effects?
In today’s overleveraged world, greater deficits and government spending, financed by an expansion of public debt and the monetary base (“the printing press”), are not the answer to our economic woes. In fact, these policies have been proven to have a negative impact on growth.
While it hasn’t received much attention in recent years, a wide body of economic theory suggests that government policies and their size relative to the total economy can have a significant detrimental impact on economic growth. A recent paper from the Stockholm Research Institute of Industrial Economics compiles evidence from numerous empirical studies and finds that, for rich countries, there is overwhelming evidence of a negative relationship between a large government (either through taxes and/or spending as a share of GDP) and economic growth.1 All else being equal, countries where government plays a large role in the economy tend to experience lower GDP growth.
Of course, correlation does not imply causation. While the literature is not definitive on causation, it still provides strong evidence that more taxes and government spending as a share of GDP (except for productive investments such as education) is associated with lower growth.
One exception to these findings is the experience of Scandinavian countries. They have both high taxes and high government spending as a share of GDP but have experienced relatively rapid growth over the past 20 years. However, a significant share of their spending goes to education, which has been found to foster growth. They also counterbalance the large role of the state with very liberal, pro-market reforms and low levels of public debt.2
Debt overhang and economic growth
Even if one believes that temporary Keynesian-type fiscal stimulus, in the form of tax breaks and increased government spending, can spur growth in the short-term, these actions inevitably lead to larger deficits and higher government debt (see July 2010 Markets at a Glance, “Fooled By Stimulus”). As Figures 1 and 2 below show, the U.S. Federal Government deficit and debt levels are already at their highest levels since the end of World War II and the scope of future stimulus appears to be rather limited. According to our projections (which assume there will be no fiscal cliff), the U.S. federal debt will increase significantly as the deficit remains sustained and elevated. For many European countries the situation is even worse.
Source: The White House: Office of Management and Budget (OMB) and Sprott Calculations
High levels of debt, or debt overhangs, cause more problems. Recent work by Carmen Reinhart and Kenneth Rogoff (Harvard University) demonstrates that banking crises are strongly associated with large increases in government indebtedness, long periods of unemployment and, ultimately, some form of default. They identify a threshold of 90% debt-to-GDP as the trigger to a debt crisis.3 As shown in Figure 2, the U.S. has already passed that threshold. Complete article HERE
© Sprott Asset Management LP 2012
|1||Bergh, A., Henrekson, M. (2011): “Government Size and Growth: A Survey and Interpretation of the Evidence”, Research Institute of Industrial Economics, IFN Working Paper No. 858, April 2011.|
|2||Bergh, A., Karlsson, M., (2010): “Government Size and Growth: Accounting for Economic Freedom and Globalization”, Public Choice 142 (1–2): 195–213.|
|3||Reinhart, C., Rogoff, K. (2010): “From Financial Crash to Debt Crisis”, National Bureau of Economic Research, NBER Working Paper #15795, March 2010. Reinhart, C., Rogoff, K. (2011): “A Decade of Debt”, National Bureau of Economic Research, NBER Working Paper #16827, February 2011. Reinhart, C., (2012): “A Series of Unfortunate Events: Common Sequencing Patterns in Financial Crises”, National Bureau of Economic Research ,NBER Working Paper #17941, March 2012.|
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