MYTH OF PUBLIC DEBT

SHAMSUL GHANI
(feedback@pgeconomist.com)
Mar 14 - 20, 20
11

Back in January 2001, Alan Greenspan, US Fed chairman wondered what the utilization of mounting US surpluses could be? The competing alternatives were across the board tax cuts to provide relief to American citizens, upgrading of social security programs, and redemption of federal debt to the public which then stood at $3.4 trillion, out of which $2.5 trillion debt was considered reducible.

The Congressional Budget Office (CBO) had made a forecast of $5.6 trillion surplus over the next ten years. Assuming no major shift in fiscal policy, CBO expected the reducible portion of debt to get wiped off by 2006. All surpluses after 2006 were supposed to be held in some form of non-federal assets. Alan Greenspan writes in his book The Age of Turbulence: "My colleagues at the FOMC seemed a bit disoriented too. In our late January meeting, we spent hours trying to imagine how the Fed will operate in a brave new world of minimal federal debt. Of course, shedding the debt burden would be a happy development for our country, but it would nevertheless pose a big dilemma for the Fed. Our primary lever of monetary policy was buying and selling treasury securities Uncle Sam's IOUs. But, as the debt was paid down, those securities would grow scarce leaving the Fed in need of a new set of assets to effect monetary policy. For nearly a year, senior Fed economists and traders had been exploring the issue of what other assets we might buy and sell."

Like many aspects of economics, budget deficits and surpluses are also tricky issues. The Fed chairman didn't have to think long over the issue of 'new federal assets' as the US economy soon veered off in an unforeseen direction - the chief propellants being the 9/11 of 2001 and the subprime mortgage crisis of 2007-08.

When George W. Bush took over in 2001, the US public debt to GDP ratio was 56.4 per cent. When he left after 8 years, the ratio had shot up to 83.4 per cent. Obama regime, within the next two years, has seen this ratio climb further up to more than 96 per cent. Despite all these adverse developments, during the last 10 years, the US still remains the number one world economy. The myth of public debt still remains unexplainable. Its relationship, if any, with the state of economy, fiscal deficits and surpluses, inflation, employment and poverty is yet to be understood. Can anyone draw any conclusion with the help of comparative data of a few economies given in the following table?

COUNTRY RANK GDP
BILLION $
PUBLIC DEBT
BILLION $
DEBT TO GDP
RATIO (%)
INFLATION
RATE %
UNEMPLOYMENT
RATE %
POPULATION
% BELOW POVERTY
US 1 14660 14000 95.9 1.6 8.9 14
China 2 5750 1006 17.5 4.9 4.2 NA
Japan 3 5391 10586 196.4 0.0 4.9 NA
UK 6 2290 1225 53.5 4.0 7.9 14
Russia 10 1477 140 9.5 8.7 13.0 6.6
India 11 1430 758 53.0 8.4 9.4 37
Australia 13 1220 273 22.4 2.7 5.1 NA
S. Korea 15 986 232 23.53 3.0 3.7 NA
Iran 18 338 55 16.3 11.8 14.6 18.7
Pakistan 27 174 108 62.1 14.2 11.2 40

It is almost impossible to shed light on the state of a particular economy simply on the basis of the ratio of its public debt to its GDP. Vice versa, it is equally difficult to predict the size of public debt of a particular economy on the basis of any indicators or a combination thereof mentioned in the table. Should an economy have as large a public debt as its GDP, like the US? Historically, US has been the number one economy since long. Its debt size witnessed a dramatic increase just after 2002. During the period from 2003 to 2007, the debt increased at an almost constant rate of $500 billion a year. In FY08, the debt went up by $1.0 trillion followed by $1.9 trillion in FY09 and $1.7 trillion in FY10. Finally, it stood at $14.2 trillion in February 2011. Japan, having risen from the ashes to an economic position that struck terror in the hearts of US and European nations for decades, has blown up its public debt to almost double of its GDP. One may feel inclined to conclude that public debt size is the ultimate force that decides the ranking of world economies. But, this view is immediately challenged by the sleeping economic giant of Asia which has recently toppled Japan from its second position, and that too by maintaining as meager a size of public debt as 17.5 per cent. Similarly, we cannot draw any inference from the simple fact that Pakistan's public debt to GDP ratio is 62 per cent.

PAKISTAN'S DEBT POSITION (BILLION RS)

DEBT PARTICULARS FY09 FY10 FY11 QRTR-1 FY11 QRTR-2
1. Government domestic debt 3861 4654 4959 5295
2. Government external debt 3452 3667 3864 3840
3. Debt from IMF 419 690 769 749
4. External liabilities 104 96 95 94
5. Private sector external debt 198 218 231 227
6. PSE external debt 87 106 106 95
7. PSE's domestic debt 290 375 359 391
8. Commodity operations debt 336 415 387 364
A. Total debts and liabilities (1 thru 8) 8747 10221 10770 11055
B. Total public debt (1 thru 4) 7836 9107 9687 9978
C. Total external debts & liabilities (2 thru 6) 4260 4777 5065 5005

Instead of focusing on the size of public debt, we should divert attention to the use of funds thus raised. So long as the economy gets growing, we need not worry about the size of the debt provided the money is not siphoned off to the safe heavens of Switzerland banks. It is good to watch the size of the debt but the tracking of its end use is more important. During the 5-year period (FY02 to FY07), our economy grew at an average annual rate of 6.75 per cent and our public debt stood at 55 per cent of GDP at the end of FY07. In sharp contrast, during the 3-year period that followed - FY08 to FY10 - the economy grew at an average annual rate of three per cent while the public debt ratio went up to 62 per cent. The economic efficiency of public debt witnessed during the earlier 5-year period could not be maintained during the subsequent period. And, that is what really matters.