OECD issues growth warning over public sector debt

7 Jul 15

Many developed countries are likely to experience slower growth because they have levels of public sector debt greater than 80% of economic output, a study by the Organisation for Economic Co-operation and Development has warned.

In research looking at the impact of public debt on economic expansion, the global think-tank said governments must target “prudent” levels of debt following the financial crisis and create fiscal rules to ensure they are maintained.

The Prudent Debt Targets and Fiscal Frameworks policy paper highlighted that debt levels across the 34 OECD member states stood at an average of 111% of gross domestic product in 2014. This is the highest ratio since the aftermath of the Second World War and above the level where it could hinder national economies and limit governments’ fiscal space to increase spending during a recession, the report warned.

Countries with debt above the 80% threshold include Austria (90% of GDP in 2014 according to OECD figures), Belgium (106.8%), Canada (94.2%), France (115.1%), Germany (83.9%), Greece (188.7%), Ireland (133.1%), Japan (229.6%) and the UK (101.7%).

These levels are a consequence of both the 2008 financial crisis and the sluggish growth following the crunch, OECD chief economist Catherine Mann highlighted.

“Our research has shown that such high debt levels have a negative impact on the economy. Prudent debt targets for the medium-term provide the commitment tool that can reassure markets, diminish risk [premiums] and, most importantly, allow the use of active fiscal policy to stabilise and grow the economy in the short term.”

Although an 80% debt-to-GDP ratio was cited as a guide level, a lower level would be prudent in specific circumstances, according to the OECD report.

For example, it warned that a debt level of 50-70% could inhibit the economies of eurozone countries due to the fact that member states have no control over monetary policy, and the absence of debt pooling makes it more difficult to respond to economic shocks.

The report comes after voters in Greece rejected the terms of an extension to the country’s international bailout. The country’s government has called for some of its debt, which is estimated to fall to around 70% of output if calculated under International Public Sector Accounting Standards, to be written off.

Even for OECD states that do have their own currency, accumulated debt stock could damage growth at levels of around 70% of GDP in some cases, according to the analysis.

For emerging economies, the threshold could be as low as 30% to 50% as they are more susceptible to individuals and firms moving their money out of the country due to debt concerns.

To ensure debt stocks are maintained at levels that do not hit growth, the OECD recommended the implementation of fiscal frameworks that set debt targets around 15 percentage points lower than critical thresholds.

This would provide governments with fiscal space to increase spending that could stabilise an economy in the event of a severe economic shock.

However, this target for headroom will also vary from country to country, and administrations should develop specific rules around balanced budgets and expenditure to regulate public speeding.

“Well-designed expenditure rules appear decisive to ensure the effectiveness of budget balance rules and can simultaneously foster long-term growth,” Mann added.

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