In a recent paper - "Growth in a Time of Debt" - Carmen Reinhart and Kenneth Rogoff make use of their deep empirical knowledge of financial crises and their aftermath to establish some relations between real growth and debt. Their general findings are important though not altogether surprising. Briefly stated, they find that there is no strong link between real GDP growth and public debt below the threshold of 90 per cent of GDP. Only when public debt goes beyond that threshold does growth suffer with accumulating debt. For emerging markets, and as far as external debt (both public and private) is concerned, the threshold for the appearance of a strong relationship between weak real growth and debt is at 60 per cent of GDP.
Before the current crisis, Portuguese public debt was little above 65 per cent of GDP. Since then, things went out of control. Large budget deficits coupled with zero nominal GDP growth, to say the least, here as well as in Greece, which had a far larger public debt to start with, forced - and are forcing - public debt way up. According to the Portuguese government's own projections, public debt will reach Reinhart and Rogoff's threshold by 2012. (And don't forget Portugal's huge demographic problem.) Also, it is a widely known fact that Portuguese external debt has already gone beyond the 100 per cent of GDP threshold.
According to Reinhart and Rogoff's findings, emerging economies with external debts exceeding 90 per cent of GDP have had, in average, negative real growth. Unfortunately, the authors's paper does not analyse the problem of external debt in advanced economies for lack of data (we may assume that the corresponding threshold is a little bit higher for reputational reasons).
It is difficult to decide whether Portugal is on the side of advanced or emerging economies. That question notwithstanding it is a safe bet to say that growth perspectives in Portugal look grim. Not only the economy-wide deleveraging process is going to be costly, not only do we have the historical-empirical evidence against us, but try to take a few percentage points of GDP off aggregate demand each year - due to deficit contraction - with investment down, consumption going nowhere and exports weakened by everything else - real appreciation, relatively high labour costs, weak foreign demand (keep in mind that miserable Spain is our biggest trade partner). Put on top of that insignificant nominal GDP growth in the next few years which will make it even more difficult to reduce our public debt.
Did anyone ask for a miracle? "Miracle" is nowadays a code word for "surge in productivity" among Portuguese economists and other people of good faith. Fortunately, the Pope will be visiting us next month.
The relevance of government indebtedness cannot be minimised, notably for economic growth and a country’s sovereign risk, as well as for capital markets and consumers’ expectations. Indeed, some non-linearity is at play in there, and indicative thresholds can be estimated. However, I always find it problematic to draw conclusions on purely illustrative examples (“Growth in a Time of Debt", Reinhart and Rogoff), without background modelling or econometric analysis. Therefore, when extracting policy conclusions from such studies, one has to be cautious and aware of their strengths and weaknesses in order to better inform the public and politicians. Naturally, without credible and sound fiscal behaviour, the non-linearity flag can be waved to a country much sooner.
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