Public debt and economic growth

24 January, 2017 at 11:43 | Posted in Economics | 6 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 … and taxes increased rapidly but not enough to keep pace with the rise in spending …

vothjuly15fig1

Until now, scholars mostly thought of the effect of government borrowing on growth as either neutral or negative…

In a recent paper, we argue that Britain’s borrowing binge was actually good for growth (Ventura and Voth 2015). To understand why massive debt accumulation may have accelerated the Industrial Revolution, we first consider what should have happened in an economy where entrepreneurs suddenly start to exploit a new technology with high returns. Typically, we would expect capital to chase these investment opportunities – anyone with money should have tried to put their savings into new cotton factories, iron foundries and ceramics manufacturers. Where they didn’t have the expertise to invest directly, banks and stock companies should have recycled funds to direct savings to where returns where highest.

This is not what happened. Financial intermediation was woefully inadequate – it failed to send the money where it should have gone …

By issuing bonds on a massive scale, the government effectively pioneered a way – unintentionally – to put money in the pockets of entrepreneurs in the new sectors …

The shift from investing in liming, marling, draining, and enclosure into government debt liberated resources – labour that could no longer be profitably employed in the countryside had to look for employment elsewhere. Because so much of English agricultural labour was provided by wage labourers, the switch to government debt pushed workers off the land. Unsurprisingly, wages failed to keep pace with output; real wages, adjusted for urban disamenities, probably fell over the period 1750-1830. What made life miserable for the workers, as eloquently described by Engels amongst others, was a boon to the capitalists. Their profit rates continued to rise as capital received an ever-larger share of the pie – while the share of national income going to labour and land contracted. Higher profits spelled more investment in new industries, and Britain’s industrial growth accelerated.

Jaume Ventura & Joachim Voth

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6 Comments

  1. The trouble with national debt is the interest on it. Today that amount is comparatively low but as the recovery from 2008 continues there will be more competition to borrow money from the capitalists, and the rates of interest will rise. This means that the government will need to borrow lots more or begin seriously to try to expand the amount of money in the system by printing more or the electronic equivalent. These activities will result in more money chasing the slightly more goods and their prices will rise due to the effect of competition of what there is available. This is also called inflation and is harmful for anybody who previously believed in lending money rather than getting into debt.

    • Hi David,

      First, the CB can always control interest rates (even long-term) if it wants to.

      Second, a strong recovery would reduce the deficit, not raise it.

      Alex

    • As for interest on the debt (i.e. T-securities), it benefits the public, especially T-security holders. If you own any T-bills, T-notes, or T-bonds, you benefit from interest. You will benefit even more, when rates are raised.

      This is a problem?

      • Indeed it is. Who pays for this benefit if it is not the tax-payer and that’s not right! Learn to look at all of the picture for a balanced viewpoint.

  2. […] 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’. […]

  3. The causal links alleged by Ventura & Voss are tenuous or have only minor importance. The alleged links are: Bigger UK government debt > changed investment preferences of the aristocracy > population migration > cheap labour > industrialization.
    Regarding just one of these links, the dominant factor causing the migration of workers from agriculture in the UK 1750-1850 was rapid population growth.
    UK population trebled during this century. See:
    http://urbanrim.org.uk/population.htm


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