Fiscal verities

Does the 2008 financial crisis still plague governments?

You know the old saw – the two certainties of life are debt and taxes. What is less certain is that the latter will pay for the former. As a share of the economy, government debt is rising far more rapidly than tax revenues (Figure 2). In 2015, public debt around the world was almost 100% of gross domestic product -- up from about 60% in 2007, just before the financial crisis, according to World Bank data. The trend has a Western flavor: Debt ratios in the European Union and the United States closely track the global one (Figure 1). Meanwhile, around the world, the tax share of GDP was roughly 15%, as it has been for 20 years.

These patterns may seem to jibe with the notion of a debt overhang from the crash of 2008, propounded by a former chief economist of the International Monetary Fund, Kenneth Rogoff. In this view, debt trends persist because of feedback effects.  When assets rise in value, they serve as collateral for more debt. Credit expands. When they fall in value, credit contracts. A business cycle is born.

The details of this story vary with the region.  In Russia, the public debt share exceeded 140% of GDP in 1998 but has since swooned below 20% (Figure 3). It isn’t much higher in Kazakhstan. It has been rising in Ukraine since 2007 -- and steeply in Kyrgyzstan since 2014, when resource prices began falling. But their debt shares are still only about 70%.      

For the peculiarly national nature of borrowing, look at the share of all external debt in gross national income. In Russia, the share soared near 100% in the ruble crisis of 1997-8 but fell rapidly, according to World Bank data (Figure 4). On the other hand, China in recent decades has never had a problem, perhaps partly because the Opium Wars in the mid-1800s left it suspicious of foreign loans.

Even if we confine ourselves to a region, national disparities are evident. In Central Asia, the income share of external debt is much higher in Kyrgyzstan than in its neighbors, although debt ratios indeed have risen throughout the region in the last few years (Figure 5). In Kazakhstan, Kyrgyzstan and Russia, tax shares of GDP have fallen in the last few years and have rarely exceeded 18% since 1993 (Figure 6).  National history and institutions may play as large a role in debt and tax patterns as does international economics.

The growing prospect of government defaults, especially in the West, is a bit of a migraine. Relative to GDP, debt is rising faster than taxes. As the gap widens, creditors like Germany may press vulnerable governments like Greece for payment. This can lead to sudden spikes in tax rates that puncture fragile recoveries. Even if the government does fend off the wolves at the door, it is obliged to pay interest on foreign debts that drains its dollar reserves, weakening its currency and exposing it to speculative attacks.

Governments today are in a nasty fix. Interest rates, in terms of purchasing power, are negative around the world: Interest payments cannot keep up with price hikes. Since real interest rates are negative, creditors loan money when goods are cheap and are paid back when goods are expensive, so they are worse off than they would have been had they never lent. This applies to governments with surpluses – that is, those that collect more in taxes than they spend this year – because they are basically creditors trying to buy back their old debts. And governments with deficits – those that spend more than they collect – will be tempted by the low interest rates to borrow even more. The ratio of debt to taxes may keep rising.   

Which brings us to the third certainty of life: Debt woes don’t vanish, even when they no longer make the headlines. – Leon Taylor, tayloralmaty@gmail.com

References

Rogoff, Kenneth S. Debt supercycle, not secular stagnation. In Olivier J. Blanchard, Raghuram G. Rajan, Kenneth S. Rogoff, and Lawrence H. Summers, eds., Progress and confusion: The state of macroeconomic policy. International Monetary Fund (The MIT Press). 2016. 

World Bank. World Development Indicators. worldbank.org . The source of all data in this post.

Figure 1: The ratio of public debt to GDP.

Figure 2: The ratios of government debt and tax revenues to GDP.

Figure 3: Regional debt shares

Figure 4: Ratios of external debt to gross national income in Russia and China

Figure 5: Ratios of external debt to gross national income in Central Asia

Figure 6: Ratios of tax revenues to GDP