Paradoxes of Debt
IDFC-U hosted a private roundtable with James W. Dean, Professor of Economics and International Finance at Simon Fraser University, for a discussion on "Paradoxes of Debt." Dean discussed how debt has played a paradoxical role in global economies and how relatively low debt and room to lower interest rates can work to propel India's growth rates. The discussion explored aspects including the appropriate load of debt for a country, bankruptcy procedures in India, the dangers of short term capital outflows from India in the face of interest rate increases from the US, and near-future prospects for India to attract long term capital inflows.
Watch an interview with James Dean on the subject and video excerpts of the discussion below, along with a summary.
Dean began by remarking on the dual nature of the lender- as a hero when the money is being borrowed but as a villain when the money lent is being asked for. He enunciated three paradoxes of debt in his talk.
In the context of Germany and Greece where the former is ‘punishing’ the latter due to its inability to pay back, Dean argued that the debt should be written off. The declining GDP and rising unemployment are witness to the fact that at this rate, Greece may never pay back the debt. Hence, letting go of the loan is in the interest of Germany itself- which no more is the hero, but villain instead. He nuanced that forgiving and forgetting an optimal amount of debt is the first paradox that the countries-at-large need to reconcile with.
The discussion then considered the state of the global economy. The falling savings rate in China, fiscal pressure on Germany due to influx of refugees, and low growth rate of Japan- all point toward the forgiving and forgetting strategy to be applied in the near future. The Mexican crises in the 80s that then spread to Latin America and doubled its debt was dealt with through co-ordination between central and private banks- something that is missing in the Euro zone today. During that crisis, to prevent free-riding of banks on waving off loans- Paul Volker got the head of Citibank, Bill Rhodes, into confidence to take negotiations forward. Such co-operation is lacking today. Dean also gave the example of the ‘’debt-laffer curve’’ which calls for forgiving loans beyond a point, and used this caveat to buttress the first paradox he highlighted.
The second paradox is that of allowing fiscal profligacy, rather than austerity, in debt ridden countries. He argued that Greece has become much worse after the enforcement of the austerity clause than it was before. By that effect, it has also become more incapable of paying back the loan. The GDP dropped by 25%, the overall unemployment went up by 25%, and youth unemployment went up by 50%, thus calling for a need to stop austerity enforcement on Greece.
He explained that if the government is allowed to spend, the debt may increase but the debt-to- income ratio will reduce as incomes increase with spending. He also pointed out that countries cannot be insolvent forever because of their sovereign right to collect taxes. Thus, it is important to keep them alive, and this is analogous to taking care of the golden goose when it is sick because of its ability to lay a golden egg. The debt-to-GDP ratio has to be reduced. But, it should be reduced by increasing GDP and not reducing debt.
The third paradox is that high debt is not disastrous to a country, unlike what is popularly believed. A country is not doomed if it has a large amount of debt. Dean pointed to the example of Great Britain that held a debt of almost 200% of its GDP but still managed to remain one of the prosperous countries in the world. Japan, too has a debt-to-GDP ratio at around 200%, but still has managed to maintain great infrastructure and a high quality of life for its citizens.
When asked about the effect of borrowing in foreign currency for emerging market economies, Dean acknowledged that it is a problem to pay interest with exchange rate adjustments, but said that the question should hinge on whether the marginal borrowing has a greater advantage in terms of the rate of return. With the extra borrowed money, if the GDP of the country can grow at a faster rate than the interest rate, then it is beneficial for the country.
An important part of the discussion was the problem of moral hazard while forgiving debt. Dean, however, felt that bankruptcy procedures would be put in place to prevent such accidents. The discussion then considered India’s bankruptcy laws and those of the USA, which evolve very rapidly.