The dangerous consequences of debt-led growth

Photo credit:   Mike Paws

April 9, 2014 // By: James Meadway

So, the IMF now thinks the UK will be the “best-performing of the largest economies” over 2014. Growth, returning in force last year, is expected to accelerate over this, the economy growing by 2.9%. George Osborne is apparently “vindicated”.

But as we’ve highlighted, a fairly cursory glance away from the headline-grabbing GDP figures tells a very different story. Real earnings are still falling. Firms are barely investing. Productivity is down. And the latest figures for exports show the UK is still spectacularly failing to pay its way in the world, with sales of UK goods and services to the rest of the world falling to their lowest level since November 2010.

What keeps growth going now is the same thing that has kept it going for more than a decade: consumer spending, fuelled by debt. As I’ve argued before, this isn’t so much a recovery, as a relapse – straight back to the bad old ways of the early 2000s. We’re repeating exactly the same mistakes as before.

Where will this lead us? A new paper by Jo Michell at the University of the West of England makes the case grimly clear. Assuming future governments stick to austerity measures, and that investment remains low, it becomes painfully obvious that the course we are on is totally unsustainable.

The table below is taken from the paper. It shows that to maintain a 2% average growth rate, consumption spending would rise to a record-breaking 69% of GDP, while the financial balance of the private sector (its excess of spending over saving) heads further into the red,and - perhaps worst of all - the current account deficit more than doubles to -7.5% of GDP. This is debt-led growth, with a vengeance.

Projections for debt-led growth scenario (assuming 2% annual GDP increase)

The UK would, in short, be desperately fuelling an economy increasingly burdened by debt by taking on greater and greater piles of debt - failing to invest, and then consuming more from the rest of the world. If the economy grows at 2.5% a year, as the IMF expects over the longer term, this situation would merely worsen – even more borrowing would be needed.

These are, of course, projections, made using the sophisticated Cambridge Alphametrics model. Like any such forecasts, they can be (at best) only indicative. Harold Macmillan’s much-feared “events” can always intervene, for good or ill. But the sheer scale of the figures involved here should act as a guard against unreasonable optimism. Even if investment picks up, or exports begin to fly across the world, we are heading for what is sometimes delicately called a “correction”.

The crash of 2008 provided a spectacular confirmation of Hyman Minsky’s basic insight, in his Financial Instability Hypothesis: that the sheer volume of debt in an economy is itself a source of risk, and will, eventually, collapse under its own weight. Meanwhile, the UK’s external balance (the net amount we buy and borrow from the rest of the world) plainly cannot be sustained.

We live in a tired, battered economy. It does not pay its way. It is worryingly unproductive. It offers increasingly insecure and poorly-paid work for growing numbers of us, and even that it can only provide by inflating, yet again, a bubble of debt. Without a change of course, we are coming due for what Wynne Godley, warning of the crash last time, called a “sensational day of reckoning”.

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Macroeconomics

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