Here are two things we know about how debt affects the economy.
First, in the abstract it doesn’t matter. For every debtor there is a creditor, and in theory an economy should be able to hum along just fine whether a country’s citizens have a great deal of debt or none. A company’s ability to produce things depends on the workers and machines it employs, not the composition of its balance sheet, and the same can be said of nations.
Second, in practice this is completely wrong, and debt plays an outsize role in creating boom-bust cycles across the world and through history. High debt increases the amplitude of economic swings. To think of it in terms of the corporate metaphor, high reliance on borrowed money may not affect a company’s level of output in theory, but makes it a great deal more vulnerable to bankruptcy.
That’s what makes a
new report from McKinsey, the global consulting firm, sobering. Researchers compiled data on the full range of debt that countries owe — not just their governments, but corporations, banks and households as well. The results: Since the start of the global financial crisis at the end of 2007, the total debt worldwide has risen by $57 trillion, rising to 286 percent of global economic output from 269 percent.
Combining these different types of debt is useful because it creates a richer picture of how a country’s finances really work. As we learned during the financial crisis, a country with high debt levels can get into economic trouble regardless of whether its debts are most heavily owed by the government (Greece, Italy), households (Spain, the United States), or financial institutions (Ireland, Britain).
The ratio of total debt to economic output has declined in only a handful of smaller countries, like Romania, Saudi Arabia and Israel. In all of the world’s economic powerhouses, total debt has risen. While some of the places with the steepest increases are European countries that were enmeshed in that continent’s debt crisis — Ireland, Greece and Portugal, with Spain and Italy just behind — others are a bit more surprising.
Indeed, two Asian giants that were only modestly affected by the last crisis are in this group. China has seen its ratio of debt to economic output rise by a whopping 83 percentage points since 2007, according to the calculations by the McKinsey Global Institute, to 217 percent of G.D.P., with increases in government, corporate and household debt.
So far, the Chinese government has skillfully managed a slowdown in economic growth and signs of a housing boom reaching its end, but whether it will be able to avoid a sharper correction is one of the great questions hanging over the global economy.
Then there is Japan, the most indebted country in the world, at 400 percent of G.D.P. Debt is up 64 percentage points since 2007. Its fiscal challenges are almost entirely from government debt, and they long predate the financial crisis. Its borrowing costs remain astoundingly low, reflecting ultralow inflation and strong domestic demand for Japanese government bonds. But it is hard to look at the balance sheet of the world’s third-largest economy and not wonder how this can end well.
Meanwhile, the McKinsey report can be read as giving a largely positive assessment of the United States. While total debt for the real economy is up by 16 percentage points in the United States, to 233 percent of G.D.P., household debt is actually down by 18 percentage points and corporate debt by 2 percentage points. A rise in public debt since 2007, in other words, largely offset declines in private-sector debt.
And perhaps most promising for the United States, our financial institutions have become significantly less leveraged, with financial-sector debt falling by 24 percentage points of G.D.P. by McKinsey’s calculations.
“One bright spot in our research is progress in financial-sector deleveraging,”
write Richard Dobbs and three co-authors. “Financial-sector debt relative to G.D.P. has declined in the United States and a few other crisis countries, and has stabilized in other advanced economies. At the same time, banks have raised capital and reduced leverage.”
Still, if you accept our starting premise — that high debt, whether public or private, makes economies more vulnerable to economic shocks and tends to fuel booms and busts — the report offers plenty to worry about.
The McKinsey researchers propose a few policy changes that might reduce the inexorable shift toward greater debt or at least reduce its potential to throw economies into chaos. An example of the former: Reduce tax incentives for debt, such as the home mortgage interest tax deduction or the tax deductibility of corporate interest payments. An example of the latter: Create more ways for countries to restructure sovereign debt, such as clauses in newly issued bonds that compel bondholders to accept majority votes on restructurings.
But the solutions they offer are big policy changes that would happen only glacially. The reality that economic policy makers around the world must grapple with, especially those in China and Japan, is that eight years after a financial crisis brought on by high debt, we may not have learned as much as we would like to think we have.
