The 100% Debt Club
Last week Bloomberg reported that Bahrain, an island country situated off of the northeastern coast of Saudi Arabia, is set to become the newest member of the 100% debt club by 2019. If that occurs, Bahrain would join a group that includes the United States, Egypt, Portugal, Italy, and Greece. What does it mean to be a part of this group and how does it affect the economies of these countries?
The 100% debt club is a group of countries whose national debt is equal to or greater than its gross domestic product (GDP). A country’s GDP is the monetary amount of goods and services that a nation produces for a given year. Japan and Greece currently lead the club with high debt-to-GDP ratios of 240% and 180%, respectively. Egypt has the lowest ratio with its debt equating to 101% of its GDP. The United States, who has been a member of the club since 2015, has a debt-to-GDP ratio of around 108%. Bahrain has a ratio of 90.6% as of 2017.
A Cause for Worry?
Research has shown that there tends to be a “tipping point” in which too high of a debt-to-GDP ratio causes reduced economic growth. A study of 99 countries conducted by The World Bank established a threshold public debt-to-GDP ratio of 77%. The study notes that “each additional percentage point of debt costs [a country] 0.017 percentage points of annual real growth.” A percentage point is a unit of one percent, which would mean that every unit of one percent over 77% causes decreased economic growth of 0.017%. The decrease in growth is even more concerning for developing countries, who suffer a loss of 0.02% annual growth for every percentage point over a 64% threshold.
Any country in the 100% debt club will be sacrificing at least 0.39% of annual economic growth. For the United States, a 108% debt-to-GDP ratio would mean that the country is sacrificing around 0.53% annual growth per year because of its deficit. In a bad year, America will have 2.5% economic growth. Detracting 0.53% off of that can easily turn bad years into intolerable ones. Japan, who I mentioned earlier to have a 240% debt-to-GDP ratio, would be sacrificing around 2.77%, which puts them in an even worse position than the United States. Bahrain, as an emerging market, would be sacrificing around 0.53% annual growth, the same as the United States.
A decrease in the rate of growth is important because that could mean less jobs are being created. Okun’s Law, named after the economist Arthur Okun, describes a positive statistical relationship between increases in GDP and job creation. As a general rule of thumb, a one percentage increase in GDP is associated with a two percent decrease in the unemployment rate. Although this relationship does not hold up 100% of the time, it makes sense for there to be a positive relationship between the two variables. Production, which is measured by GDP, requires workers, so more production would mean more workers. A slower rate of production, then, would also mean a slower rate in the demand for new workers.
Decreased economic growth will not have an equal impact on all countries in the 100% debt club. Some countries with relatively high debt-to-GDP ratios can simply allow economic growth to decrease the ratio over time. The United States, for example, fits into this category. Even though the country’s high debt is decreasing the amount of economic growth, overall GDP is still increasing significantly. Maintaining the current amount of debt while allowing the economy to grow will gradually decrease the debt-to-GDP ratio. For the United States, an increase in taxes to pay back the public debt would mostly likely slow economic growth more than it is being slowed under the weight of being in the 100% debt club. An increase in taxes would divert investment (money) away from the rest of the economy where it is being used to fuel growth and expansion.
Some countries in the 100% debt club do not have the luxury of waiting until GDP catches up to their debt. Japan and Greece, for example, have no more room to run. Their debt-to-GDP ratios are too high, demanding that they actively pay back more of their debt. Some countries, such as Portugal with a current debt-to-GDP ratio of 125%, should begin to pay back their debt as well. There is no set percentage of debt-to-GDP in which it becomes necessary to actively pay back the debt. The decision should be made by analyzing a specific country’s economic situation individually. Stress tests, which are simulations that can be performed on an economy to see how it would react to certain crises, can be useful in determining whether or not a country’s debt has reached dangerous levels.
Being part of the 100% debt club is not a designation that countries should strive for, as significant debt has been shown to slow economic growth. Slower economic growth leads to slower job creation and expansion. That said, being a member of the club does not, by default, lead to economic disaster. Some countries’ economies can handle the amount of debt while they work to decrease their debt-to-GDP ratio. The United States should consider balancing its budget by allowing GDP to catch up and surpass its current debt. However, if the United States continues to increase its debt relative to its GDP, it will continue to sacrifice more of its economic growth and an even greater proportion of jobs.