Blog Series: The World Through One Economist’s Lens (Part 1)

As the world grapples with the economic impact of the COVID-19 pandemic, traditional policy tools are being stretched in real time and in dramatic fashion. Alternative views and methods are being formed with potentially long-dated ramifications. From emerging forms of economic theory to potential consequences of fiscal & monetary policy action, we are at a pivotal point where near-term decisions have compounding implications on future outcomes.

We felt it was time to start a multi-part series addressing various topics that will likely shape the future of sustainable economic development. Our goal here is to be short, concise, and to spark dialogue. As always, please feel free to comment & share as well as subscribe to our newsletter for more content.

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PART 1: SOVEREIGN DEBT SOARS TO NEW HEIGHTS: BUT WHO’S COUNTING?

Throughout the developed world, sovereign debt levels have been increasing at an exponential rate. While this is not a new phenomenon, as governments contend with how to pay for stimulus programs aimed at the COVID-19 crisis, national budgets are of secondary concern. But a budget would imply the desire to strike some sort of a balance between revenue and expenses. This does not necessarily pertain to absolute debt levels. In this first installment of a new bi-weekly series, we take a look at how current and potential future economic policy contends with rising debt levels in the face of an unprecedented crisis.

As far as budgets go, the revenue side of the equation is relatively constrained. Typically, a developed country’s revenue, such as the United States, is primarily fueled by taxation. Tax revenue is closely tied to economic activity (GDP) but with a perverse relationship. As tax rates increase, spending by consumers and profitability by businesses may fall as their net earnings are reduced. The reverse is also true to a degree. As an analogue, President Trump lowered tax rates early in his presidency in an attempt to spur GDP growth.

A government’s spending, on the other hand, has a more direct and positive relationship to economic activity. As government spending increases, more resources are made available by way of creating job opportunities and providing assistance to those who have been displaced. This in turn promotes greater confidence among workers/consumers as their earning power grows. Additionally, if government expenditures are directed towards infrastructure projects (i.e. toll roads, airports, seaports, railways, etc) then revenues may also be generated through the direct utilization of these assets. All of this increased spending generates future revenues for the government in the form of taxation. The key here is whether the expenditures exceed the revenues; or at least by how much.

The current commonly accepted economic policy is that government spending should increase as a countercyclical measure to assist during economic downturns. But since the Global Financial Crisis (GFC), the debt levels of many countries throughout the world has grown at an increasing rate; even as the global economy has endured the longest expansion in modern history. To compound matters, sovereign debt has far outpaced GDP during that time. That is to say that expenditures have exceeded revenues and so spending is funded through additional borrowing.

As a result, the national budget in most developed countries, including the U.S., is increasingly in a deficit position. As we all may relate through lessons from personal finance, solvency issues don’t arise from the sheer amount of debt owed. It’s the inability to pay on time with mounting interest rate charges that becomes overwhelming through time.

Currently, we are faced with an economic crisis and governments around the world have resorted to what they know best: increase expenditures. In theory, as described above, this will promote economic growth. That is certainly true, relative to the alternative of complete stagnation in the wake of social distancing measures that have caused tens of millions of Americans to file for unemployment. With interest rates at historically low levels, the amount of debt we can reasonably service has undoubtedly increased. But with GDP growth falling by an unprecedented amount and a deep recession already underway, how much more debt can we sustain before the burden is too great to endure?

This is difficult to answer decisively, and a bit nebulous to be sure, but proponents of a different school of thought referred to as: Modern Monetary Theory (MMT) are emerging to try to answer that question. Stay tuned for our next installment in this series as we discuss the MMT as well as other alternative tactics being considered by world leaders to restore our global economy.

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