By Hema Senanayake –
The legal and political issues of the U.S. debt-ceiling crisis would be resolved sooner – And as a result the shutdown of the U.S. government will end sooner. But the economic issue behind this crisis will continue, being unresolved.
In order to understand the economic issue behind the debt-ceiling crisis, let us put it as debt-to-GDP ratio. Any increase of the debt-ceiling means that, this ratio would go up. What is the optimal debt-to-GDP ratio for any economy, developed or developing? Do the economists have any credible answer? No. Does the IMF have any official answer? No. The absence of coherent answer to this important question indicates a crisis of the existing world-view of economics.
As at now, according to some estimates, the debt-to-GDP ratio of the U.S. is around 105%. The current debt limit is $16.7 trillion. The U.S. treasury demands that this limit has to be increased on or before October 17, 2013 to prevent defaults. After debt-ceiling is increased the treasury will borrow more and the debt-to-GDP ratio will rise again. In 2008 the same ratio was 64.8%.
By seeing this trend of increasing debt, majority Republicans who dominate the U.S. Congress demand that there should be spending cuts in the government. If we ignore their obsession to repeal Obama-care Act (The Patient Protection and Affordable Care Act), what they mean is that the debt-to-GDP ratio cannot go up and up. Why? They have no economic answer but have a morale one. Republicans say that increasing debt means that those debts will have to be paid by our children and grand-children. If we can’t pay our debt now, so would be for our children until the economic system crashes in big time. Do we pay for the debt that our fathers borrowed? No. We are just piling more debt on top of what we inherited. That is what we do by increasing debt-ceiling.
However, being honest to their thinking, the Republicans in 2011 brought a resolution to amend the constitution to legally enforce to have a balance budget. If the budget is balanced then there is no need to increase the debt ceiling. That resolution was defeated. The argument won the day was an old piece of economic theory. Winners argued that a balance budget is not possible in each year even though it could be possible within an economic cycle spanning over a few years. The reason is that there will be years of surpluses which would be spent in the lean years of economy, and as a result in the long run the budget would be balanced. But in lean years the budget cannot be balanced. In fact there are no evidences to prove the argument but the argument won and the resolution was defeated with the support of considerable number of Republicans.
I am happy that the resolution was defeated but the economic argument that helped to defeat the resolution was grossly inaccurate. Economists who reject the idea of balance budget suggest that around 60% of debt-to-GDP ratio would be pragmatic. This is really an irrational thought. Let us investigate this matter a little further.
Even though the IMF has no officially set benchmark for optimum debt-to-GDP ratio, through certain studies done by IMF staffers have suggested certain benchmarks for optimum debt-to-GDP ratio. For developed countries they suggest that 60% of debt-to-GDP is best. When the European Monetary Union was established, this benchmark figure was included into their Stability and Growth Pact (SGP) signed by all member countries. By the SGP it was made mandatory that no member country should exceed the debt-to-GDP ratio over 60%. For a considerable number of member countries this figure is over 100% by now. For Japan, the same ratio is over 229% in November 2013. In the U.S. it is over 105%. The failure of benchmark setting is apparently clear.
However if there is optimal debt-to-GDP ratio at any level then having a balance budget is also possible. In a balance budget scenario the debt-to-GDP ratio is zero per cent (0%). Let us assume that the optimum ratio is 60%. If there are a few lean years then the ratio will go up to, let us assume to, 70% and in order to bring it down to 60% we have to bring down the ratio to 50% in the years of growth. If this is possible then having a balance budget in the long run might have been also possible. In the lean years deficit spending (budget deficit) will go up to 10% of GDP and in the years of growth there will be surpluses of 10% of GDP which could bring down the debt-to-GDP to zero per cent in the long run.
In fact there is no reason as to why we should allow the debt-to-GDP ratio go up to 60% and stabilize at that level. If we can maintain the debt-to-GDP ratio at 60% or at any level, then the same thing could have been possible at 0% or any lower level than 60%. Globally, empirical evidences prove that there is no such optimum debt-to-GDP ratio instead what we see is that ever growing debt-to-GDP ratio. This is the reality. If we can maintain a 60% of debt-to-GDP ratio as was mentioned in the SGP then we should be able to have a balance budget at a debt-to-GDP ratio of 0%; there is economic necessity to allow the ratio to go up to 60% anyway. Instead what we see is that the debt-to-GDP ratio has surpassed the set benchmark figure for larger economies. Why this is happening so?
My answer to this question is this: “there is a systemic problem in the contemporary macroeconomic system” which I will explain later. Senator Obama also replied to this same question in 2006. Voting against the debt-ceiling increase by that time he said, “Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘‘the buck stops here.’’ Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better. I therefore intend to oppose the effort to increase America’s debt limit.”
But today he is a different person when he presses the legislature to increase the debt-ceiling so as to pile up debt beyond 100% of GDP. Republicans, today, play the role that Obama played in a few years ago opposing to increase the debt-ceiling.
The truth is that there is no political party that can stop ever increasing debt-to-GDP ratio. Because this is not a political or legal question, instead a technical (or theoretical) question. That is why both Democrats and Republicans must unite now to find an accurate technical answer to this question. I know that it is possible to find an answer but only if the right question is asked. Let me briefly explain the theoretical nature of this important question.
In the economic system there is a peculiar thing that happens. In any given year a certain amount of goods are purchased in the economic system. Therefore equal amount of goods are supplied to the buyers. Let us call the former as the “demand” since they were purchases made and the later we may call as “supply.” Therefore the demand-and-supply must be in equilibrium as per our definition. By this definition we rationally ignore all other definitions in the subject of economics in regard to “demand” and “supply.” In the economy the said demand-and-supply equilibrium has to prevail; it is a must and it prevails because you can’t buy if somebody is not selling.
In a growing economy this equilibrium takes place in increasing output levels. In a recession, still, this equilibrium takes place at a decreasing output levels. However, the strange thing that happens in the economy is that this equilibrium is met with a component of debt that cannot be paid back. If this is true then it provides a clear answer as to why debt is ever increasing. Is this true? This is the right question that the White House, U.S. Senate and the U.S. Congress get together to ask, possibly from the Federal Reserve first. I will end this essay with the following quote.
“The scientist is not a person who gives the right answers; he’s one who asks the right questions.” ― Claude Lévi-Strauss.