In retrospect, last week’s debunking of one of the key conclusions of Kenneth Rogoff and Carmen Reinhart about government debt looks inevitable. The whole story, from the initial lavish praise for the Harvard professors to the current harsh criticism, is a sad reminder of the power of ideology in the angry debate over economic policy.
In 2011, the two eminent professors claimed to show a tipping point for government borrowing. If the debt amounted to more than 90 percent of GDP, the GDP growth rate was typically much slower than in more fiscally prudent countries. When Thomas Herndon, a mere graduate student at the University of Massachusetts, redid the maths this year, he also found a correlation between higher government debt and slower growth. But there was nothing remotely like a tipping point.
The new paper was a blow to the politicians who relied on the Rogoff-Reinhart 90 percent line to support fiscal “austerity” (smaller government budget deficits). But they were always foolish to trust a study which drew a universal conclusion from a small sample of countries in vastly different situations.
Insofar as the Rogoff-Reinhart research had any value, it merely restated something that should have been obvious anyway: unsatisfactory economic performance and excessive government borrowing generally go together.
The connection is social, not financial. In societies that can get things done, respond well to challenges, compromise when necessary and do not spend more than is affordable, the government is likely to be fiscally competent and the economy is likely to be effective. Conversely, if the society is deeply divided, the economy is probably enfeebled and there is a high chance of a political deficit – to stay in power governments then need to spend more than they take in taxes.