Tuesday, February 12, 2013

A thought on the national debt and economic growth

Last night economist Adam Posen was on the Charlie Rose show. Among other points, he pointed out that a fairly large debt is OK as long as it is invested in money making activities. A company can borrow a lot if it uses the money to build its business and generate not only the money to pay the debt but to give profits to its investors. So too a country need not worry about debt (at the level of the federal debt in the United States) as long as the country economy can grow enough to pay the interest and eventually bring down the debt. This sounds very reasonable to me.

But I got to thinking about growth. We know that a lot of economic growth has been the result of the reduction in birth rates. As dependency ratios decreased and a greater portion of the population were working, investments increased, productivity increased, and the economy grew. Of course, this was in countries in which the population was young. It is the young who save and invest. As our population ages, a smaller portion of the population will be saving and a larger portion will be pulling down savings to support them in their retirement. Moreover, with our low birth rate, the dependency ratio is likely to increase as more people retire from the workforce in order to live their longer lives at ease.

We also know that technological revolutions can fuel growth. This happened in the Industrial Revolution, and in the second Industrial Revolution (electrification, internal combustion engines, mass production, etc.) and the Information Revolution. The United States has been enjoying the benefits of these sequential industrial revolutions for a couple of centuries. It also enjoyed the benefits of a huge amount of free lands (that had been taken from the remnant population of the American Indians) and a huge inflow of workers (who brought with them the human capital that resulted from the investments made in them in their original countries). It even may be that a country with more young workers will have more technological innovation.

Of course, we also know that economic growth can be promoted by good institutions and good policies. But can we depend on our dysfunctional politicians to produce good policies? Can we depend on our superstitious, "what can you do for me" population to maintain good institutions?  Do we know that there will be a new technological revolution? We certainly know that we are facing declining birth rates and an aging population.

Perhaps the motors for rapid economic growth that have served our fathers and grandfathers will fail our children and our grandchildren.

I think we would be well advised to prepare for a long term period of slower growth by bringing down the federal debt. We have time, but 15 years from now I would hope to see the debt lower and on the way down. If our children and grandchildren see a new technological revolution, and other factors combine to produce another long period of economic growth, all to the good!

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