We’re revisiting the academic furor of the Reinhart/Rogoff data controversy today because there has been some new analysis to come out of the debate that seeks to answer a good question: Does a high national debt burden lead to slower economic growth, or vice versa?
Arindrajit Dube of the University of Massachusetts, Amherst, a colleague of the authors of the paper identifying the errors in one of Reinhart and Rogoff’s datasets, took on this question using the repaired data.
With that data, he sought to answer a simple question: “Does a high debt-to-GDP ratio better predict future growth rates, or past ones?”
It’s kind of the economics version of which came first: the chicken or the egg!
Here, if a high national debt burden (national debt-to-GDP ratio) causes slower economic growth, then it would be a good “predictor” for future economic growth rates, which we would see in the form of a declining future GDP growth rates with respect to higher national debt burdens. If a high national debt burden is better at predicting past economic growth rates, then that would be a good indication that poor economic growth is a driving factor that causes a nation’s national debt burden to escalate.
The graphs below illustrate what he found. The chart on the left shows what the recorded range of inflation-adjusted economic growth rates typically were three years after a particular national debt burden was reached (answering the question of “how are future economic growth rates typically affected by high national debt burdens?”), while the chart on the right shows what they were in the three years before a particular national debt burden was reached (answering the question of “Do national debt burdens typically rise because of past poor economic growth?”):
Dube comments on his results:
As is evident, current period debt-to-GDP is a pretty poor predictor of future GDP growth at debt-to-GDP ratios of 30 or greater—the range where one might expect to find a tipping point dynamic. But it does a great job predicting past growth.
This pattern is a telltale sign of reverse causality. Why would this happen? Why would a fall in growth increase the debt-to-GDP ratio? One reason is just algebraic. The ratio has a numerator (debt) and denominator (GDP): any fall in GDP will mechanically boost the ratio. Even if GDP growth doesn’t become negative, continuous growth in debt coupled with a GDP growth slowdown will also lead to a rise in the debt-to-GDP ratio.
Besides, there is also a less mechanical story. A recession leads to increased spending through automatic stabilizers such as unemployment insurance. And governments usually finance these using greater borrowing, as undergraduate macro-economics textbooks tell us governments should do. This is what happened in the U.S. during the past recession. For all of these reasons, we should expect reverse causality to be a problem here, and these bivariate plots are consistent with such a story.
Now, here’s what Dube glosses over in his analysis. In showing the range of values associated with future real economic growth rates in the chart on the left, we observe that the average growth rate still follows a negative trend – for a higher national debt burden, we should still expect that future economic growth will still be slower than it would be than if a nation had a lower national debt burden. Even three years it first attained its high debt burden.
Dube’s analysis also doesn’t tell us what the secret is for getting good economic growth for the nations with high debt burdens that managed to achieve that feat after racking up such high debts. For all we know from the data presented, it could be a post-default recovery, much like what has occurred in Iceland. Or it could be the result of austerity done right, as in Estonia, which was heavily biased in favor of cutting government spending rather than imposing massive tax hikes.
And what caused the most negative post-three year reaction Dube indicates? Could it be the opposite of what has occurred in Iceland or in Estonia? Could government central bank-directed bailouts to stave off debt defaults or imposing massive tax hikes that dwarf any spending cuts (kind of like the tax-hike heavy “balanced” approach that President Obama favors for the United States) be what’s really behind the ongoing economic tragedies unfolding today in Europe’s most debt-ridden nations?
Finally, and perhaps most importantly, the ability of a nation to withstand or recover from a significant economic shock, as visualized by the range of historic real economic growth rates shown in the chart on the right, will depend greatly upon how large its national debt burden is when such a shock occurs. The nonpartisan e21 editorializes:
Higher debt levels increase the required level of future taxation, increase the probability of a financial crisis, and reduce governments’ flexibility to deal with future crises that may emerge. Higher expected future tax rates reduce incentives to invest today. The probability of a fiscal crisis makes investors seek liquidity and safety rather than productive investment. Both factors increase savings, reduce current spending, and slow growth rates. On the last point, it is important to recognize that TARP did not succeed because it was a genius plan with perfect execution. TARP succeeded because federal debt was just 36.5% of GDP at the start of 2008. Had the U.S. entered 2008 with today’s debt level, it is not clear the federal government would have had the capacity to backstop the banking sector. The result would have been a situation similar to the one in Europe, where the weakness of the sovereign and the banking system create a negative feedback loop that reduces credit availability and investment demand. Moreover, the higher the debt level, the more dependent the fiscal authority becomes on the central bank suppression of interest rates. At 1980s interest rates, it would cost more than 10% of GDP to service current federal debt.
That’s much like how an emergency reservoir acts as an important backstop in preventing a community from going up in flames after a massive wildfire breaks out. If a nation has already burned through much of its capacity to borrow at the time it faces an emergency, which is the case for nations with high national debt burdens, then it can reasonably expect to face a debt crisis on top of whatever other economic crisis it is facing.
If the U.S. budget sequester debate has taught us anything, it is that most people won’t even notice when government spending is reduced, a point that has only just recently dawned on the anti-government spending cut crowd.
And that’s why it’s time to go after the excessive government spending that supports the corrupt power structure in Washington D.C. Because no one else deserves to lose more than those people.
Last week it was revealed that secret negotiations were happening on Capitol Hill between House and Senate leadership regarding a key requirement of Obamacare — that members of Congress and their staff purchase healthcare coverage through insurance exchanges.
Republicans slammed the Democrats for trying to create a special exception for themselves in the President’s landmark health care legislation. The healthcare law requires lawmakers and congressional staff to buy their healthcare coverage through the newly created insurance exchanges.
Democrats denied the claim and argued they have not sought an exemption and would not support one if proposed. Senator Harry Reid’s spokesman also denied the claim.
In referencing the secret meetings, Senate Minority Leader Mitch McConnell said in an op-ed in today’s Philadelphia Inquirer that “Democrats have no one to blame but themselves for the health-care “train wreck” that’s about to be inflicted upon hardworking Americans.”
The fact remains that many Americans are unclear about the impact of Obamacare and whether they will be able to maintain current coverage and how much their premiums will increase. A survey released last week claimed that 49 percent of Americans do not understand how the law will affect their families. This is a significant number of people who could benefit from additional information about the legislation’s impact on their daily lives and their family’s overall budget. As we all know, healthcare costs can comprise a significant chunk of any family’s budget, especially if a serious illness arises.
There is merit to some Republican’s assertions that this Administration should publicly explain to Americans what lies ahead for them in Obamcare. The revelation about the secret meetings and their apparent “cover up” sums up what many Americans feel about our legislative process, that Congress makes the laws, but somehow, the rules simply do not apply to them.
Senator Richard Burr (R-NC), an outspoken opponent of Obamcare and opposed to exempting Congress from the exchanges, seemed to sum up the situation:
“I have no problems with Congress being under the same guidelines,” Burr said. “I think if this is going to be a disaster — which I think it’s going to be — we ought to enjoy it together with our constituents.”
Not so fast.
That fat sum is miniscule compared to the size of the national debt—a mere 0.2 percent of the nearly $16.8 trillion owed by Uncle Sam.
Moreover, the Treasury Department’s scheduled debt payment may result from many factors—including the sequester, the recent collection of income-tax revenues, the higher tax rates levied on those earning higher incomes, and the payroll tax hike that went into effect last January. But it most emphatically is not a result of some lasting and meaningful improvement in the government’s fiscal habits: In the same press release in which the Treasury announced its $35 billion payment this quarter, the agency also said it expects to borrow $223 billion in the following quarter.
It should come as no surprise that some luminaries in the investment community are extremely distressed by the government’s fiscal mismanagement.
“We’ve spent so much money at this point that we cannot pay it back...ever,” writes Keith Fitz-Gerald, chief investment strategist at Money Morning. “We’re either going to default or we’re going to pay our way out of it—and the former is much more likely than the latter.”
Fitz-Gerald isn’t predicting that a default is imminent. But he worries that if policymakers don’t adequately deal with the problem in the near term, the crisis will get much worse in the long term.
The fiscal overhang isn’t a problem only for the future, however. It’s a significant drag on the economy now. Perhaps the worst damage has come from investors’ uncertainties about how the debt problem will be resolved.
Bill McNabb, chairman and CEO of the Vanguard mutual fund family, says that investors’ skittishness about the uncertainty regarding the debt-ceiling debate has cost the U.S. economy $112 billion over the past two years. Add to that amount the cost of uncertainty over regulatory policy, monetary policy, and foreign policy, and the price tag, according to his company’s economists, comes to a staggering $261 billion—more than $800 per person in the country.
“Without this uncertainty tax, real U.S. GDP could have grown an average 3% per year since 2011, instead of the recorded 2% average in fiscal years 2011-12,” he writes in an op-ed for the Wall Street Journal. “In addition, the U.S. labor market would have added roughly 45,000 more jobs per month over the past two years. That adds up to more than one million jobs that we could have had by now, but don’t.”
McNabb warns that individual investors who focus heavily on the gyrations of the stock market may lose sight of economy’s underlying vulnerabilities. “Until the U.S. debt issue is resolved for the long term,” he continues, “market gains and losses will be built on an unstable foundation of promises that cannot be kept.”
Taxes are not the only way government wrings money out of the workers. Governments also impose fees, and the Sacramento Bee has recently exposed one of California’s favorite tricks: Government establishes fees, which the Bee describes as “targeted assessments to people who participate or benefit from a state program for the purpose of funding that service.” The government said the fees were temporary “but quietly extended them as expiration dates neared.”
According to state records, “nearly two of every three state fees scheduled to end between 2010 and 2012 have been kept alive for years to come.” Further, “thirteen of 21 fees received extensions, cumulatively raising more than $70 million annually for programs ranging from a missing persons database to an effort to fight auto insurance fraud.” Government not only extends the allegedly temporary fees. They also jack up the price.
In 2003, the state tacked a $20 court fee on all criminal convictions, including traffic violations. The state later raised the fee to $30, then to $40, twice the original amount, “then expiration dates were eliminated, leaving the charge permanent.” In 1991 the state slapped a fee of $3.15 on steelhead fishermen then proceeded to extend it four times and raise it to $7.05, more than double the original amount.
The Bee report also notes that in the past three years eight fees have been allowed to die. Now governor Jerry Brown wants to bring back a small fee on homeowners’ insurance policies “to help fund the state’s Seismic Safety Commission.” The state’s income and sales taxes, highest in the nation, are evidently inadequate for that task, and the Commission is apparently off-limits to the type of cuts that affect to ordinary citizens, such as closing parks while the parks department has secret slush fund of $54 million.
Extending and raising temporary fees is another application of government greed and deceit. The practice is particularly hypocritical coming from a government that purports to protect people from unethical business practices. But state governments hold no monopoly on bait and switch tactics.
The federal government began withholding money from workers’ paychecks in 1943, during World War II. It was supposed to be a temporary, wartime measure but 70 years later the federal government still gets workers’ money even before they do.
Fisker Automotive, Inc, got a federal loan of $529 million to produce its $100,000 Fisker Karma hybrid, built not in America by American workers but in Finland by Finnish workers. Fisker has not produced a car since last summer and recently dumped all its rank and file employees. The company faces bankruptcy and could represent the largest loss of federal loan money since Solyndra. But according to the Associated Press there’s more to the story.
The Obama administration, it turned out, knew as early as 2010 that Fisker was not in compliance with loan requirements. Even so, Fisker kept getting money until June 2011. Aoife McCarthy, Department of Energy mouthpiece, said one person raised only a possibility that Fisker was failing. Turns out it was, and now Congress is looking into it in hearings on “the Department of Energy’s Bad Bet on Fisker Automotive.”
“Whatever they spent on Fisker was just not going to be enough,” one Detroit restructuring expert testified. Sen. Charles Grassley asked “How did the Energy Department determine Fisker’s potential before writing a check? Was there due diligence, or instead a blind hope that Fisker would produce something useful?” The DOE’s Aoife McCarthy responded that Fisker did not represent the wider efforts of the Obama administration to promote green vehicles. “There will always be an element of risk with investments in the most innovative companies,” she said. Further, the $529 million loan to Fisker was one of 33 clean-energy loans that failed.
So taxpayers shouldn’t worry that government picked a loser in Fisker because, count ‘em, 33 federal loans went bad. Other estimates peg the number of federally-backed troubled or bankrupt energy companies at 50. What we have here is misguided and wasteful policy that subsidizes failure then justifies it on the grounds of other failures. And none of this is supposed to reflect badly on administration clean-energy policy. Even by Washington’s low standards that is truly pathetic.
The federal government spends nearly $1 million a year on fees for bank accounts with a balance of zero. The Washington Post calls this “one of the oddest spending habits in Washington” and explains how it works.
When federal agencies hand out grants they don’t just send out checks. Rather, they create “an account within a large, government-run depository,” and the federal agency is charged a monthly fee “which goes to the government depository and is used to cover the costs of operating it.” The money eventually runs out but the fees continue because the federal agencies fail to close out the accounts, which “takes work.” Audits and so forth are supposed to happen within 180 days, but they don’t. So the accounts stay open, with a balance of zero and the government paying fees.
By the Post’s count, the federal government has 13,712 such accounts drawing $890,000 in service fees, and about 7 percent of more than 200,000 grant accounts have a balance of zero. A grant administrator at Health and Human Services told the Post “These accounts are a normal part of the grants business cycle and will never be totally eliminated.”
Such “cost untainted by any reward,” is all part of the waste inherent in the system. The Obama administration tried to fix this problem but some agencies have the same number of zero-balance accounts as they did three years ago. So the federal bureaucracy is not only inherently wasteful but essentially reform-proof. A government that can’t close out a bank account will never eliminate an entire agency, however redundant or wasteful it may be. The Post also noted that “six federal government agencies have begun separate projects to do the same thing: build a computer program to track personnel background checks.”
The Federal Food and Drug Administration (FDA) is keeping busy overhauling the nation’s food-safety system, a legacy of the 2010 Food Safety Modernization Act, which tasked the FDA to prevent food-borne illnesses rather than just respond to them. That means the FDA will have to decide which fruits and vegetables will be subject to new safety standards. In its great wisdom, the FDA wants to target tree fruits such as apples, and pears.
Those who grow apples and pears could be forced into a regulatory regime that calls for stricter testing of their irrigation water, heavier sanitization measures, and more stringent rules on animal abatement. Tree fruit farmers say their product has strong safety record, grows above the ground, and has protective skins. They say the FDA measures defy common sense and would do little to enhance safety. As some argue, the FDA would do better to focus on spinach and cantaloupes, which have caused outbreaks of disease, rather than hang a new regulatory regime on tree fruit.
One Virginia farmer told the Washington Post “what’s being proposed is very onerous and expensive.” Another, from Washington State, said, “Somebody in an office in Washington, D.C., who’s never stepped foot off concrete has decided we need this rule and that rule. . . The market has already taken care of this problem, if it’s a problem. Which it isn’t.”
With good reason, some tree fruit farmers fear that foreign products will not be subject to the same regulation, and that American farmers will be driven out of business. Yet another farmer from Washington State said, “If it ain’t broke, don’t fix it.” The FDA says it is listening, but should also adhere to a different rule: If it ain’t broke, don’t break it.
The FDA is also hitting up Congress for more money, proposing a raise of $821 million to $4.7 billion for 2014. FDA boss Margaret Hamburg said that the FDA “is a true bargain among federal agencies” giving Americans “an extraordinary array of benefits for about 2 cents a day.”
After the mortgage crisis left many homeowners in foreclosure, the federal government cut a $3.6 billion settlement with banks accused of wrongful evictions and such. But now those settlement checks are being returned for “insufficient funds.”
As the New York Times noted, the government chose Rust Consulting to distribute the checks. But Rust failed to move the money into the account of the bank that issued the checks. That led to delays and now to checks being returned for insufficient funds. The consumer help line of the mighty Federal Reserve told homeowners their checks could not be cashed. Then the Fed issued a statement that Rust had corrected the problems and that the Fed would continue to monitor the payments. That will come as scant consolation to homeowners who have been waiting for assistance. But it is instructive in several ways.
The involvement of the federal government is no guarantee of efficiency or even, apparently, of solvency. The bouncing checks should also remind people that federal efforts to help people can have unintended negative consequences. According to a recent study by the National Bureau of Economic Research, the Community Reinvestment Act, federal legislation dating from the Carter Era, fueled the mortgage crisis with its “flexible” lending standards, low down payments and reduced credit standards. So the federal government is attempting to fix a problem largely of its own making. And even though the federal government takes increasing amounts of money from the people, there are limits to what it can and should attempt to do.
As a rule, most things that academics argue most about among themselves tend to have very few or little real world consequences. At least, that’s the main insight of what has become known as Sayre’s Law, which states: “Academic politics is the most vicious and bitter form of politics, because the stakes are so low.”
But today, we have an exception to that rule in of the form of an academic debate that broke out very publicly within the past week, over one of the findings a very widely cited paper by Harvard researchers Kenneth Rogoff and Carmen Reinhart into the effects of high national debt levels upon national economic growth rates. Mike Konzcal describes the influence of the Rogoff-Reinhart research:
In 2010, economists Carmen Reinhart and Kenneth Rogoff released a paper, “Growth in a Time of Debt.” Their “main result is that...median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.” Countries with debt-to-GDP ratios above 90 percent have a slightly negative average growth rate, in fact.
This has been one of the most cited stats in the public debate during the Great Recession. Paul Ryan’s Path to Prosperity budget states their study “found conclusive empirical evidence that [debt] exceeding 90 percent of the economy has a significant negative effect on economic growth.” The Washington Post editorial board takes it as an economic consensus view, stating that “debt-to-GDP could keep rising — and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth.”
Problems arose within the academic community however because other researchers weren’t able to fully replicate Reinhart and Rogoff’s results. At least until very recently, when Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts, Amherst acquired a copy of the Excel spreadsheet that Reinhart and Rogoff used to develop their results from them, which allowed the UMass-Amherst researchers to review their analysis and to identify some issues with how it was done, which they published in a recently released paper. Konzcal explains:
They find that three main issues stand out. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. All three bias in favor of their result, and without them you don’t get their controversial result.
San Diego State University’s James Hamilton has one of the better summaries of the issues with the data in dispute with respect to the full scope of the Reinhart and Rogoff paper:
The specific evidence reported in Reinhart-Rogoff (2010) came from three different data sets. First, they followed 20 individual countries for up to two centuries, calculating the average growth rate for that country in the years when debt levels exceeded 90% of GDP and average growth rates for years with other debt levels. They reported these separately for each individual country (see Table 1 of Reinhart and Rogoff (2010)), and found that growth rates were slower when debt levels were higher. Second, they combined data from a panel of 20 different emerging economies over 1970-2009 and found that growth rates were slower when debt levels were higher. The recent critique by Herndon, Ash, and Pollin (2013) did not discuss either of these first two claims. Instead, their critique concerns Reinhart and Rogoff’s analysis of a third data set, a panel of 20 advanced economies over the last half-century.
Let me first jump to the bottom line, and then review the details. Reinhart and Rogoff originally claimed that for this last of the three data sets, real growth rates were around 4% for low debt levels, 3% for moderate debt levels, and -0.1% or +1.6% for debt levels above 90%, with the latter difference depending on whether the aggregation was done using the mean or the median. Herndon, Ash, and Pollin claim that when the numbers are correctly tabulated, real growth rates are around 4% for low debt levels, 3% for moderate debt levels, and 2.2% for debt levels above 90%, with the latter inference based solely on the mean.
If, like us, your eyes have glazed over with the numbers and academic commentary at this point, let’s compare these two sets of results in conflict in graphical format:
The big point of debate is for national debt-to-income (GDP) ratios over 90%. Thanks mainly to an Excel spreadsheet coding error, Reinhart and Rogoff had erroneously found that average real economic growth rates for nations with high national debt loads were negative. After correcting for Reinhart and Rogoff’s data handling errors, Herndon, Ash and Pollin find that instead of being negative, average real economic growth rates for nations with high national debt loads are positive, but are a full percentage point lower than for nations that maintain lower national debt burdens.
And that’s what all the academic hubbub is about. What then gives this academic debate real world consequences is the degree to which a number of leftist organizations have seized upon the Excel programming errors in Reinhart and Rogoff’s third dataset to try to discredit all their findings as a way to undercut those seeking to bring government spending back down to get the size of the national debt under better control.
Which we note is a lot harder to do if real economic growth rates aren’t anywhere as near as strong as they could otherwise be because of an excessively high national debt burden.