Drama over Debt Paper Changes Nothing…and Everything
Business + Economy

Drama over Debt Paper Changes Nothing…and Everything

REUTERS/Carmen Reinhart

Few economic papers ever stirred up Washington as much as the 2010 analysis of the relationship between sovereign debt and crippled growth by Ken Rogoff and Carmen Reinhart.

It met with incredible acclaim and fed into fears of American decline. The gospel-like trust in the research only amplified its fall from grace, after follow-up research issued Tuesday found errors in its weighting and Excel spreadsheet calculations.

As weird as it sounds, this changes everything and nothing about the debate over the U.S. national debt.

The survey was supposedly exhaustive, tracking the finances of 44 nations over the course of two centuries. The results confirmed fears—economic growth gets kneecapped when a country has a debt-to-GDP ratio of more than 90 percent.

That simple threshold quickly led to calls to slash the U.S. deficit. It had exploded above $1.4 trillion in the wake of the 2008 financial crisis and pushed the national debt toward the danger zone. The gross national debt of more than $16.5 trillion currently stands at 104 percent of GDP.

In 2011, then Treasury Secretary Timothy Geithner called the paper an “excellent study.” House Budget Committee Chairman Paul Ryan, R-Wisc., quoted the research that same year as proof of why lawmakers should cut spending to balance the budget.

In Europe, the United Kingdom embraced austerity—and entered into a double-dip recession as a result—while a profligate Greece spiraled into chaos in a way that suggested the gravity of debt was inescapable.

But on Tuesday, the tizzy-inducing study turned out to be wrong, or at least inconclusive.

A trio of economists at the University of Massachusetts-Amherst corrected the errors by Rogoff and Reinhart, who are both now at Harvard University. Their follow-up found that countries with a debt-to-GDP ratio of 90 percent reported average growth of 2.2 percent, not the -0.1 percent originally reported back in 2010.

This should cause a rethink by champions of austerity, but it does not mean that high debt loads propel growth, only that the 90 percent figure is not an absolute. In acknowledging their mistakes, Rogoff and Reinhart note that the median average still corresponds with their original conclusions, although the mean is off.

Both economists enjoyed time in the intellectual spotlight. Nor are they partisan toadies, producing a separate study indicating that the U.S. recovery from the Great Recession may have been better than other rebounds from financial crises.

In the wake of criticism over their 90 percent study, they highlight that their study did not show that high debt levels caused an economic shutdown, only that it was correlated with a decline.

But in Washington, the nuances of their research quickly became over-hyped and distorted by those with a political agenda. It reinforced biases that already existed.

Even though Ryan can no longer cite the 90 percent figure with confidence, he will continue to warn about the ravages of the $16.8 trillion national debt. Similarly, the Obama administration will continue to claim that its budget “stabilizes” publicly held debt at more than 70 percent of GDP, even though this is nearly double the historical norm.

For starters, no one knows at which point the national debt achieves a terminal velocity that pulls down an entire country, a point discussed and debated earlier this year at the National Association of Business Economics by Laura D’Andrea Tyson—an adviser for President Obama—and John Taylor—an economist that House Speaker John Boehner consults.

As Justin Fox correctly points out at the Harvard Business Review, there is still not enough data to get an accurate snapshot of the situation.

The economy depends on a seemingly infinite amount of variables and isolating each variable for analysis is extremely difficult.

Lawmakers might cloak their arguments with data, but the underpinnings of their beliefs almost never conform to the scientific method, let alone change in response to the facts.

Part of the reason for this is how Democrats and Republicans interpret the same trends. They highlight one set of variables to explain the economy at the expense of others, proclaiming a degree of clarity that does not yet exist.

Senate Minority Leader Mitch McConnell—either unaware or oblivious to the refutation of the 90 percent number—highlighted its findings in a Wednesday speech, noting that the current debt level is “handicapping the present.”

The Kentucky Republican specifically proposed increasing the eligibility age for Social Security and Medicare recipients to reduce future budget deficits—an idea suggested by the bipartisan Simpson-Bowles fiscal commission in 2010.

McConnell, 71, said the coming wave of debt is being driven by something positive—Americans are living longer and collecting entitlement benefits for a longer period of time. “It is a tribute to our magnificent health care system, if we haven’t completely fouled it up [with Obamacare],” he said at a Washington summit for the American Bankers Association.

As McConnell, sees it—demographics are a driver of debt that causes anemic economic growth. Compare that conclusion to the analysis of the fiscal 2014 budget proposal from Obama.

The exhaustive document also grapples with the demographics of an aging population, noting that a graying population means more Americans will be retired and the labor participation rate will fall.

When a smaller percentage of the country holds jobs, average economic growth will be much lower than it was in previous decades. Without the usual increases in employment and wages, it becomes more difficult for the government to bank on the same revenue increases that occurred in the past.

From this angle, demographics are a driver of low growth that will create debt pressures. 

Even if both points are valid, debate will persist and heat up next month as the country once again breaches the debt ceiling. House Republicans have insisted on more spending cuts to offset any increase in borrowing authority, while the administration has maintained that the economy should be held hostage in this manner.

Despite all the gridlock, what both sides can agree upon is this: high debt and low growth is no way to treat the economy.