The benefits of having a massive public debt1 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 …
War 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.
[h/t Brad DeLong]