Here’s the core problem with Reinhart and Rogoff’s claim that public debt levels above 90% of GDP cause reduced growth: it’s all correlation and no mechanism. It epitomizes the worst aspects of empirical economics, searching tirelessly for statistical regularities, but not the mechanisms that might underlie them. Because economic contexts are highly diverse, often singular, it’s the processes at work, not generalizations about outcomes, that economics has the power to elucidate.
Sorry to be so abstract.
The R&R dataset, as the authors proudly explain, encompasses 44 countries over two centuries. We’ve got Finland, Spain, Japan and the US, Thailand, Mexico and Colombia. We’ve got the aftermath of the American Revolution against England and WWII, banking crises under the gold standard, the third world debt crisis of 1982. It’s all there in one hopper, ready to be crunched. I would convert to Rosicrucianism before I would embrace the belief that a single statistical relationship captures all these places and times.
Paul Krugman has highlighted two cases in particular, the US demobilization following WWII and the Japanese lost decades (still lost). Yes, he says, there is a correlation between public debt and slow growth, but in the US episode it’s spurious (war gave us the debt, demobilization the slow growth), and in Japan the causation runs from slow growth to high debt.
Just scanning the R&R list, I see lots of countries that have battled external deficits, a condition that weakens growth and puts governments in the position of running deficits in order to delay adjustment. And what about price shocks that cripple countries with a narrow export base or particular import dependencies? The R&R list is thick with these cases too. Given these interrelationships, it is revealing that, under “Debt and growth causality”, R&R consider only “Growth-to-debt” and “Debt-to-growth”, without the vast third category of “joint causation by other factors”.
Which gets us back to mechanisms. What are the forces, economic, political or otherwise, that cause runups of public debt? Under what circumstances does debt feed back to these other factors? What mechanisms govern the expansion and contraction of fiscal space? These are the kinds of things we need to know.
R&R have it backwards: they are looking for broad generalizations that might be identified over large samples but have uncertain application to any particular case. A better kind of economics would be one that identified processes that, while they generate diverse outcomes with no discernible central tendency over large samples, can be applied precisely to individual cases.
Like, for instance, ours.