By Hema Senanayake –
I wrote about the first flaw in my previous article. This article is about the second one. This is another axiom in economics. Let us first see how it articulates by IMF. It refers to debt sustainability. IMF think that, “current and future generations of nations must not be saddled with more debt than they can ever repay.” And IMF says that this is very important for any country’s debt sustainability. This is another axiom we take for granted because people like to pay debt. But this axiom based on people’s innocent feelings, is wrong and need to be challenged. To understand my point, let me construct a question. We have an economic system. This is a system created by human imagination. We can design the system to enable nations not to be indebted than they can ever repay. Or we can design the system to enable nations to be indebted than they can ever repay. Now the question is, what system do we have at present? Unfortunately, by our own mistake we have designed an economic system that forces nations to be indebted than they can ever repay no matter however much prudence applied to economic governance. It is true that whims and fancies of governments and structural weaknesses of the financial system contribute to aggravate the debt crises, but the said inability to pay debt, arises due to a systemic error.
Total debt in the economic system should be understood as core debt which comprises public debt, household debt and non-financial corporate debt. Since household debt and corporate debt are considered as private debt, core-debt includes public debt and private debt. In general, if a country’s public debt is low then its private debt must be high creating an unsustainable private debt bubble. Therefore, when we discuss about debt sustainability, we must look at the big picture not only the public debt.
The notion of strict debt sustainability or this axiom brings real economic misery along with the previous axiom I pointed out in my previous article. Both axioms are interrelated and bring poverty amidst abundance while hinder potential global output, prevent the potential of increasing global physical capacity of production itself.
Bear with me, I am not asking, not to pay debt or for debt forgiveness. Perhaps I should explain how the economic system works so that you may come up with your own conclusion whether to accept or reject the axiom mentioned above. If you choose to change the axiom, a new system emerges. In this new system economic efficiency globally would be at its optimum, no arbitrary hindrances, just allowing people to reveal their true wants and needs freely, as consumers and in turn as producers.
In the economic system, an entrepreneur can sell his output either to a consumer or another entrepreneur. What is sold has been in demand and is purchased. Therefore, what is sold can be defined as realized-supply and what is bought can be defined as realized-demand. Since what is sold is bought, it is common sense that the realized-supply and realized demand is always in equilibrium. This equilibrium between realized-supply and realized-demand must exist in periods of increasing output as in the case of an economic growth, or periods of stagnation and in periods of recessions as well. However, strange thing happens when this equilibrium between realized-supply and realized-demand is met. This is what IMF and most of economists ignore at present. In fact, the said equilibrium always takes place by creating a component of debt that can never be paid back. If this happens, then the said component of debt should accumulates creating over-indebtedness in the economy as time passes, if not removed by design or accident. If the argument is true it must be supported by data. Let us check some data.
Three largest economies of the world as measured by nominal GDP, are the United States, Japan and China. Japan’s total debt to GDP at the end of 2019, before pandemic begins, was 382.3%. Comparable figure for the U.S. was 253.6%. China’s total debt to GDP ratio at the end 2019 was 257.6%. These three countries indebtedness far exceed than their share of global output. In other words they are the most indebted countries. All countries aspire to increase GDP with an intention to be free from indebtedness. If the world’s largest economies cannot realize this goal as shown by above data, it is clear that no matter how ever much we increase GDP we will not be able to free from over-indebtedness. This situation is resulted fundamentally from the fact that the equilibrium between realized-supply and realized-demand always takes place by creating a component of debt that can never be paid back. Hence debt sustainability in the global economy is not a thing supported by the very design of the economic system.
This problem of unsustainable nature in debt regime has recently been observed by a well-known American economist even though he has not explained the cause/s. He is Professor Lawrence Summers, a former Treasury Secretary of the United States. He said that developed economies cannot achieve significant economic growth without creating ‘unsustainable financial conditions.’ As you may presume, ‘unsustainable financial conditions’ mean nothing but heavy debt. This hypothesis is now known as Summer’s version of “Secular Stagnation Hypothesis.”
This is the new axiom in economics. It is different from the existing axiom that debt sustainability is an achievable goal, but it is not. For certain countries based on their position in economic growth trajectory, debt sustainability is an achievable goal temporarily but as economies developed and reached to a certain maturity level which is typified by slow growth, near full employment, low population growth, less inventions/innovations etc., debt sustainability is not an achievable goal. If we change this axiom, a new system emerges, and ‘debt sustainability’ will ensure by incorporating a global system to deflate debt by design time to time, without allowing for any moral hazard for any country or any economic entity or individual. That should be the new task of IMF and global leaders if they do not prove that ‘debt sustainability’ is supported by the fundamental design of the economic system.