It´s not so much the level of public debt, but the weight of government that tends to slow growth

The abstract to recent research by Ugo Panizza and Andrea F Presbitero on the effects of public debt on growth reads:

Countries with high public debt tend to grow slowly – a correlation often used to justify austerity. This column presents new evidence challenging this view. The authors point out that correlation does not imply causality – it may be that slow growth causes high debt. They argue that policymakers should be wary – the case for cutting debt to boost growth still needs to be made.

The conclusion:

Our reading of the empirical evidence on the debt-growth link in advanced economies is:

  • Many papers that show that public debt is negatively correlated with economic growth.
  • No paper that makes a convincing case for a causal link going from debt to growth.
  • Our new paper suggests that such a causal link does not exist (more precisely, our paper does not reject the null hypothesis that there is no impact of debt on growth).

We realize that our results are controversial. While we are convinced of the soundness of our findings, we know that skeptical readers will find ways to challenge our identification strategy. However, the first two points are uncontroversial. The case that public debt has causal effect on economic growth still needs to be made.

But maybe it´s not the level of public debt that stifles growth, but the size of government as measured by the ratio of government expenditures to GDP (G/Y). Australia, for example, has a relatively low G/Y ratio, but its public debt ratio is not that much different from the average debt ratio in advanced economies.

A few months ago I did a post on that topic. A summary:

In the top part of the table below are the 6 OECD countries which registered the lowest increases in the G/Y ratio between 1960 and 2007 (brake point defined to avoid the “distortions” that followed the onset of the crisis). In the lower part the countries that registered the largest increases.

The last three columns show the average real economic growth rates in the first 13 years of the sample, in the last 13 years and the change in growth between the two periods.

Notice that the weight of government (G/Y) increased in all OECD countries between 1960 and 2007. However, the differences are substantial. In those countries where G/Y rose less the average increase was 10.6 percentage points while in those countries that the government share increased most, the average rise was 25 points.

As seen in the last three columns, growth was more strongly reduced among the countries that experienced the largest increase in G/Y: -2.8% which compares to -0.5% for the countries with the lowest increase in G/Y.

Note that three of today´s “crisis countries” – Greece, Portugal and Spain – are also countries that saw the largest increase in the share of government and the largest loss of dynamism, with economic growth rates falling significantly.

8 thoughts on “It´s not so much the level of public debt, but the weight of government that tends to slow growth

  1. Marcus, just playing devil’s advocate:

    It looks like growth was stronger for all the English speaking countries. Also, abundant natural resources and cultures supportive of immigration both might have helped.

    Also, do aging societies have higher public debt? Maybe aging populations cause both high public debt and slower growth.

    • Steve – The english speaking countries also have the lowest increase in G/Y. You are right. In economics there is always an “abundance” of possible influences. In the original post I link to, I also examined the converse: If countries that had reduced G/Y grew more. There are not many cases to examine, but in all growth increased when G/Y was reduced.

      • “If countries that had reduced G/Y grew more.”

        That’s the inverse, not the converse 😉

  2. I think the prosperity of nations rests upon limiting government to 20 percent of GDP or less, balanced budgets, and printing money aggressively.

    This will not solve every problem; it will create less problems than any other system.

  3. Ok, so what happens when you control for (i) demographics and (ii) changes in working time ? Nordic countries saw a drastic drop in the latter, anglophone countries not so much (especially the US). Equating the relative reduction in output, produced by taking advantage of productivity gains to shift to more leisure, with some form of stagnation, would seem somewhat ideologically loaded, no ?

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