The benefits of having a massive public debt

1 August, 2015 at 18:46 | Posted in Economics | 3 Comments

Towering debts, rapidly rising taxes, constant and expensive wars, a debt burden surpassing 200% of GDP. What are the chances that a country with such characteristics would grow rapidly? Almost anyone would probably say ‘none’.

And yet, these are exactly the conditions under which the Industrial Revolution took place in Britain. Britain’s government debt went from 5% of GDP in 1700 to over 200% in 1820, it fought a war in one year out of three (most of them for little or no economic gain), and taxes increased rapidly but not enough to keep pace with the rise in spending …

0005397318999_621db3b6e1War drove up spending and led to massive debt accumulation … Over the same period, Britain moved a large part of its population out of agriculture and into industry and services – out of the countryside and into cities. Population grew rapidly, and industrial output surged … As a result, Britain became the first country to break free from the shackles of the Malthusian regime …

How much of the situation in industrialising England has any relevance for the world as it is now? Is this a tale from a distant island and period of which we know little – to paraphrase Chamberlain – or does it hold lessons for the present? Financial frictions are still very prominent even in the most developed countries today; changing the profitability of revolutionary sectors should have first-order effects on the long-run rate of growth. The issuance of government debt may still crowd out investment that is, overall, inefficient.

These efficiency-enhancing effects of government debt may be all the more important in developing countries. There, the added benefits of debt that we did not discuss – such as providing a safe store of value, and a certain source of liquidity (Holmstrom and Tirole 1998) – may tilt the overall scoresheet even more in favour of government borrowing. None of this is to say that debts may not become excessive (Reinhart and Rogoff 2009) – but when we consider the dangers of debt, we should keep an eye on its potential benefits as well.

Jaume Ventura & Hans-Joachim Voth

[h/t Brad DeLong]



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  1. Debt is such a pejorative in many people’s personal lives, for excellent reasons, that I suppose that it is inevitable that that emotional association would carry over to issues involving public debt. I don’t think that is the only problem revealed here: economics, too, is guilty of having profoundly neglected the mechanics of money and banking in its teaching and pontificating over policy.
    It is not enough to wave a hand at late 17th or 18th century England and its emerging financial capacity, and then sagely allow that “None of this is to say that debts may not become excessive.” Among economists, even acknowledging that there was a 17th century may pass for an indication of scholarly depth, but what is wanted here is some summary outline of the economic function of public debt in the system of money and finance, treated in the quoted material only by a footnoted aside concerning, “a safe store of value, and a certain source of liquidity”.
    It should be deeply troubling that some of the most advanced economies in the world are playing with a currency that lacks the ballast of a marketable public debt carrying zero-risk, financed by a fiscal capacity to tax economic rent. That the European Central Bank stands aside and watches as the payments system of a member state is laid waste is bad; that many economists cannot explain the relation of marketable public debt to stable systems of payments and banking makes it seem hopeless.

  2. Watch this stuff. It is another example of what Palley calls “Gattopardo economics”.

    The links between debt and the rise of Britain as the first country to industrialise has been well known for some time, even if mainstream economists who will gadgetise this discussion and by not paying attention to the complexity of the interlinking factors, basically hollow it’s meaning out, have just discovered it. People should not be given credit for things they did not discover. A lot of meticulous historical work has gone into this issue, and historians are far ahead of mainstream gadget economists in understanding it. It also important to understand that the debt and bond finance raising issues are part of a more complex story here. You cannot isolate factors. For example, imperialism is another crucial factor that underlined both the industrial revolution and the ability to underwrite this debt.

    This is not deep or pioneering stuff. For example I went to a brilliant seminar given by Patrick O’Brien on this very subject at LSE over a decade ago.

  3. Yes it lasted a 100 years until the U.S. of A took over and soon it´s time again, after a 100 years or so, for Asia/China. It´s all about diminishing returns, resource misallocation, welfare(too many promises) and corruption. This finally results in overindebtness and borrowing outside borders(interest is not reinvested within) and as the last nail in the coffin, capitalflight. Yes, in the end even the reserve-currency risks being abandoned.

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