Is debt a good or bad idea
Debt is good, debt that is too high is bad
The modern economy cannot do without credit - but the tendency towards ever more debt makes the system unstable. Isn't there anything against it?
It is piling up ever more threateningly, the mountain of global debt. Almost all of them are now in debt: the private sector, the states, the industrialized nations, the emerging countries. According to the Bank for International Settlements (BIS), debt in the world's major economies is more than double economic output. An end to life “on credit” is not in sight.
But why exactly is debt harmful? And are they in any case? Answering these questions is not entirely trivial, despite the obvious discomfort many people experience when they hear the word "debt". Debts certainly have an economic justification for existence, because the debts of one are always the demands of the other. From an economic point of view, it is undisputed that the credit system increases the welfare of an economic system. It is only thanks to him that capital that is currently not being used in one place can be passed on to another place, where it can then be used productively - with the result that the prosperity of the entire system increases. The view that debts are the devil in any case falls short of the mark. Problems only arise when they are no longer paid back.
When is debt too high?
In any case, bankruptcies are as old as the debt system itself. Therefore, even in ancient times, the penalties for not paying debts were draconian. In Babylonia, insolvent debtors were sold as slaves, in ancient Rome they were even split in two in the worst case. But why is there such pressure over the centuries that debts have to be paid, and that debtors have a morally justified duty to pay them off? The answer is as banal as it is plausible, as the discussions at this year's workshop on “Debt and Freedom” of the Progress Foundation have shown: A well-functioning debt system is a public good. The “institution of debt” increases the welfare of an economy, therefore she must be taken care of. Anyone who does not adhere to the rules of the game of credit damages the reputation of the "institution of debt" and thus the lending in an economy. But the economy does not thrive without credit.
Normally, bankruptcies of private individuals or private companies in the real economy, if they are not endemic, do not lead to major economic upheavals, crises or even economic depressions. The situation is different for over-indebted states that can no longer pay their outstanding debts. Over the centuries, states have lived beyond their means and finally had to file for bankruptcy. Most of these national bankruptcies were accompanied by severe economic slumps and very high unemployment.
For this reason, the national debt is particularly in the limelight - today as it was in the past. The state's over-indebtedness has a wide variety of negative effects on a country's economic activity, most notably through the level of interest rates: the poorer a country's creditworthiness, the higher the risk premium it has to pay for borrowing. The general uncertainty about the debt sustainability of the state generally has a negative effect on interest rates in a country. Higher interest rates have a contractive effect because they curb investment activity and thus economic growth.
Economists argue very well about when national debt is “too high” and therefore a danger for a country. At least since the work of Reinhart / Reinhart / Rogoff, the threshold of 90% has been viewed as critical, i.e. a national debt of at least 90% of the gross domestic product. Under these conditions, according to the three economists, economic growth in an economy is particularly low. This threshold is currently being exceeded in several regions of the world, and global “watchdogs” such as the BIS or the IMF are concerned about it.
Sanctions are not scary
States that can no longer pay their debts and therefore declare national bankruptcy must expect harsh reactions from their creditors and thus from the financial markets. Why is the threat of exclusion from the capital market (a state can no longer finance itself through the market) or at least significantly higher borrowing costs (a state has to pay very high interest rates to refinance) not enough to prevent states from becoming overindebted? Because the threatening backdrop isn't that terrifying at all.
Recent studies of sovereign bankruptcies show that the market exclusion for bankrupt countries only lasts for a short time these days. Up until around 40 years ago, insolvent states had to reckon with being unable to raise funds on the capital market for an average of four years; however, since 1980 the exclusion has lasted an average of just two years. The higher borrowing costs are also kept within limits: Immediately after a default, the premiums for defaulting public debtors are steep (400 basis points), but after one year they are only half as high and after three years they no longer exist. The situation is similar with the loss of creditworthiness. Here, too, the old credit rating is reached again after around three years on average. The fear of a loss of reputation on the capital market is therefore rather limited because of its consequences for states. Even more “tangible” sanctions, ie diplomatic-military interventions, are hardly to be feared today. In earlier times, when states simply declared war on defaulting neighbors, a mountain of debt and the consequences of bankruptcy probably had a deterrent effect. Though even the prospect of armed conflict in the event of a national bankruptcy has seldom stopped nations from getting into debt. On the contrary: in the past, wars were the main reason for getting into debt in the first place.
The financial punishment of the market seems to have disappeared as a threat to national bankruptcy, which could explain the lively piling up of mountains of debt around the globe in recent times. The greatest costs that a state bankruptcy entails, however, are not incurred on the global financial market, but “at home” in one's own economy. The insolvency of a state leads to a collapse in consumption, investment and output, to capital flight, to high unemployment and, associated with this, to the migration of human capital. If the national bankruptcy is also connected to a banking crisis, national bankruptcies are particularly serious. Violent upheavals domestically as a result of excessive national debt or due to national bankruptcy are not infrequently associated with changes of government. During the European sovereign debt crisis of the past few years, there have been a number of changes of government in crisis countries - although national bankruptcy has been avoided in every single case thanks to solidarity-based aid from Europe.
Why is the threat of a political vote not enough to prevent governments from taking on excessive debt? Political economy provides simple explanations for this. Borrowing can also be useful for states, as it is for private individuals. With external financing, large projects such as investments in infrastructure can theoretically be realized, which in later years will yield a dividend that exceeds the borrowing costs shouldered. Unfortunately, the credit cycles do not match the political cycles. Governments have a time horizon that is limited to their term of office or the next election.
As political economy teaches, politicians have a strong incentive to increase government spending in order to be (re) elected. But they are only too happy to leave the unattractive debt reduction to their political successors. The idea of smoothing government consumption over good and bad times also suffers from the political dimension: in bad times, government spending is increased, but in good times it is not reduced - and the mountain of debt continues to rise.
The tendency of modern western states to steadily borrow can also be explained by the fact that this means that the costs of government spending can be passed on to future generations. The latter typically cannot have a say when decisions are made about debt-financed state projects and the corresponding borrowing. Sad but true: the modern welfare state as we know it today is based to a large extent on passing costs on to future generations.
There is no world without crises
So what must be done to prevent the global mountains of debt from growing and becoming a threat to financial stability? Research regards the phenomenon of debt as a typical time inconsistency problem. From today's point of view, borrowing appears sensible (investments in infrastructure), but from the perspective of the future it is usually not (investments do not pay off, the debts are all the more heavy).
The solution to this type of problem is to limit the discretionary space of governments. Instead of being able to take on debts as they see fit, they would have to adhere to strict rules. These can be formulated as a maximum debt in relation to the gross domestic product or as a function of growth or in another way. It is only important that, thanks to strict rules, the behavior of politicians and governments explained by political economy is undermined. A debt brake, as it is known in Switzerland, is such a rule. Studies show, however, that even the best rules only work if healthy finances are a high priority in a country.
In order to reduce the risk of contagion emanating from debt crises, better mechanisms are also needed to deal with sovereign defaults. While the enforcement of private bankruptcies is regulated by law, the handling of state bankruptcies is insufficiently defined. Clear rules in this regard - such as the simple structuring and rapid implementation of debt rescheduling in states - could also help here.
These economic approaches may make a small contribution to keeping the national debt somewhat in check - the vision of a world without national bankruptcies can still not be implemented. The view that sovereign debt crises are inevitable and therefore easy to accept may sound cynical to citizens of affected countries. But there is a core truth in it.
Avoiding national debt and the corresponding crises entirely meant placing very tight - if not too tight - shackles on the economy. Studies show that isolated countries with an underdeveloped financial system that do not go into debt at home or abroad suffer fewer crises than open, highly developed economies with access to the international capital market. In return, however, the long-term average growth there is also significantly lower. Regulating the state and the economy so tightly that debt crises are no longer possible cannot therefore be the right answer to the debt problem.
Soberly, there is such a thing as an optimal number of debt crises - and it is not zero. The above-average frequency of debt crises, as has been observed in the recent past, can, even should definitely be reduced through the use of suitable institutional rules.
- When did online dating start
- Foreigners are allowed to visit North Korea
- Where was the first airport in India
- Why do CPUs have cache memories
- How do you take care of younger siblings
- Still rules the British Empire
- How did the first eyes develop?
- What are the prices for betta fish
- Why are inverter air conditioners better
- What is a jamb saw
- Does Islam promote peace?
- What is ethnocentrism
- What do most IITians become
- Is introverted a personality disorder
- What is the Italian fashion style
- Why does the family break your heart
- How can I learn Malayalam
- Is Narendra Modi the Mabus
- What do atheists think of Islamophobia
- Which royal hymn of the country is called Kongesangen
- What is the French word for water
- All Indian parents are terrible
- Who are the NRIs
- How does tourism contribute to national development