Dec 9th 2020

The Pandemic Public-Debt Dilemma

by Michael Spence and Danny Leipziger

Michael Spence, a Nobel laureate in economics and Emeritus Professor at Stanford University, served as Chair of the Commission on Growth and Development.

Danny Leipziger, a professor at George Washington University’s School of Business, served as Vice Chair of the Commission on Growth and Development. 

MILAN – Increased government spending during the pandemic is essential for managing public health, supporting households that have lost income, and preserving businesses that otherwise may fail and thus cause longer-term damage to output and employment. Kristalina Georgieva, the managing director of the International Monetary Fund, has urgedpolicymakers to “spend but keep the receipts.” Likewise, World Bank Chief Economist Carmen M. Reinhart reminds us that, “first you worry about fighting the war, then you figure out how to pay for it.”

Although these are sound recommendations for countries with solid fiscal foundations, the long-term risks of increased spending may be dangerously high for others. In 2008, the Commission on Growth and Development (on which we both served) showed that successful developing countries owe their economic growth in part to the quality of their social and capital spending. And the most successful of these countries, we found, had run their economies with savings levels at or close to investment levels, such that their current account deficits were small.  

Today, however, there are many countries – some that entered the pandemic already highly indebted – that have not been effective stewards of public resources, owing to poor project selection and implementation, ineffective targeting of social spending, wasteful subsidies, or outright corruption. Both the World Bank and the IMF have effective tools for measuring the quality of public spending, and there are a plethora of indices showing how well a country’s governance fares across standard benchmarks. For governments with a poor track record, simply borrowing and spending more may not be the best course of action.

After all, a country’s citizens are not well-served when their government becomes more indebted in order to spend imprudently. For such countries, borrowing in hard currencies when exports are depressed and their own exchange rates are under duress simply makes future debt re-scheduling more likely, and it may place international financial institutions like the IMF in an awkward position, given that they are now urging additional unconditional spending.

Economic growth depends on high returns from public investment in human capital and infrastructure. Countries that have invested wisely in these areas have seen their economic fortunes rise, whereas those that have invested poorly have been left more indebted and less able to repay, especially if those debts are in a foreign currency. Given that most developing countries have limited scope to borrow in their own capital markets, any additional spending is likely to be externally and commercially financed. That is potentially a recipe for disaster.

In today’s low-interest-rate environment, it is often said that as long as borrowing costs are below the rate of growth, additional debt-financed spending makes sense. But, again, while this argument is defensible when applied to rich countries, it poses dangers in the context of emerging and developing economies, where factors such as the efficiency and equity of spending matter greatly. These issues must not be overlooked – even during a pandemic – because they can increase future debt burdens and reduce the chances of long-term successful development.

Moreover, there are more effective approaches to deal with the fiscal dilemmas facing emerging and developing economies. These include increasing the amount of targeted assistance for vulnerable populations; extending the duration of IMF lending, which could be conditional on assurances that resources will be put to good use; and combined IMF and World Bank programs that include fiscal-performance measures.

In the aftermath of the 1980s debt crises, the Bretton Woods institutions collaborated to produce medium-term policy frameworks that would both provide new financing and embed funds in sensible development plans. Such formal frameworks could now be revived in some fashion to provide greater assurances to creditors that key structural bottlenecks and governance concerns are being addressed.

To those worried about the implications of such conditionality, it is worth remembering that debt re-profiling, if it is to be done pre-emptively, requires borrowers to produce growth- and debt-sustainability frameworks that can be designed and implemented with third-party guidance. The alternative – debt re-scheduling under duress or outright default – is a far worse option than jointly financed World Bank-IMF programs that can crowd in private debt on revised and more affordable terms.

Of course, a framework that provides longer-term relief while also addressing fiscal gaps and unsustainable debt implies improved international financial mechanisms to put debt repayments on a sustainable path. In contrast to previous debt-reduction exercises (the Initiative for Heavily Indebted Poor Countries and the Multilateral Debt Relief Initiative), current circumstances indicate that debt distress will fall largely on middle-income borrowers. As such, there needs to be a new debt-rescheduling architecture that actively involves commercial lenders.

Any such initiative would need to be endorsed by the G20, which has already agreed to work toward a new global debt-restructuring framework. This approach must formally include all major creditor countries. It is in the interests of all creditors to join such an exercise, both to avoid free-rider problems and to ensure transparency of debt information. 

Extraordinary times call for extraordinary measures. Failing bold action, developing countries could be on track to lose years or even decades of progress in the post-pandemic world. In the pandemic economy, fiscal shock absorbers, efficient public spending, and new instruments for pre-emptively re-profiling unsustainable debt payments are each an indispensable part of the necessary response.


Michael Spence, a Nobel laureate in economics and Emeritus Professor at Stanford University, served as Chair of the Commission on Growth and Development.

Danny Leipziger, a professor at George Washington University’s School of Business, served as Vice Chair of the Commission on Growth and Development. 

Copyright: Project Syndicate, 2020.

www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Apr 22nd 2021
EXTRACT: "As far as anyone can tell, the US military is not on the verge of an internal breakdown, let alone primed to stage a coup d’état. But few predicted anything like the US Capitol riot before protesters equipped with body armor, stun guns, and zip-ties breached the building. Before the US is blindsided again, its leaders must act resolutely to root out extremism in the military."
Apr 17th 2021
EXTRACT: "The new report on 2020 by the International Renewable Energy Agency reveals that the world’s renewable energy generation capacity increased by an astonishing 10.3% in 2020 despite the global economic slowdown during the coronavirus pandemic." .... "In 2020, the global net increase in renewables was 261 gigawatts (GW). That is the nameplate capacity of some 300 nuclear power plants! There are actually only 440 nuclear power plants in the whole world, with a generation capacity of 390 gigwatts. So let’s just underline this point. The world put in 2/3s as much renewable energy in one year as is produced by all the existing nuclear plants!"
Apr 16th 2021
EXTRACT: "When we examined the development of nations worldwide since 1820, we found that among rich Western countries like the United States, the Netherlands and France, improvements in income, education, safety and health tracked or even outpaced rising gross domestic product for over a century. But in the 1950s, even as economic growth accelerated after World War II, well-being in these countries lagged.
Apr 11th 2021
EXTRACT: "Some presidents indulge in the “Mount Rushmore syndrome” making an obvious effort to achieve greatness. Normally soft-spoken and apparently modest Biden is making his own bid for immortality."
Apr 9th 2021
EXTRACT: "New ways of thinking about the role of government are as important as new priorities. Many commentators have framed Biden’s infrastructure plan as a return to big government. But the package is spread over eight years, will raise public spending by only one percentage point of GDP, and is projected to pay for itself eventually. A boost in public investment in infrastructure, the green transition, and job creation is long overdue."
Apr 7th 2021
EXTRACT: " One can, and perhaps should, take the optimistic view that moral panics in the US blow over; reason will once again prevail. It could be that the Biden era will take the sting out of Trumpism, and the tolerance for which American intellectual life has often been admired will be reinvigorated. This might even happen while the noxious effects of American influence still rage in other countries. For the sake of America and the world, one can only hope it happens soon.  "
Mar 28th 2021
EXTRACT: "By refusing (despite having some good reasons) to end electoral gerrymandering, Chief Justice John G. Roberts, Jr., has directly enabled the paralyzing hyper-partisanship that reached its nadir during Donald Trump’s presidency. By striking down all limits on corporate spending on political campaigns in the infamous 2010 Citizens United decision, he has helped to entrench dark money in US politics. And by gutting the 1965 Voting Rights Act in Shelby County v. Holder, Roberts has facilitated the racist voter-suppression tactics now being pursued in many Republican-controlled states."
Mar 24th 2021
EXTRACT: "the UK’s tough choices accumulate, and the problems lurking around the corner look menacing. Britain will have to make the best of Brexit. But it will be a long, hard struggle, all the more so with an evasive fabulist in charge."
Mar 15th 2021
EXTRACT: "Over the years, the approach of most American policymakers toward the Israeli-Palestinian conflict has been Israel-centric with near total disregard for the suffering endured by the Palestinian people. The architects of policy in successive US administrations have discussed the conflict as if the fate of only one party (Israel) really mattered. Israelis were treated as full human beings with hopes and fears, while Palestinians were reduced to a problem that needed to be solved so that Israelis could live in peace and security.  ..... It is not just that Israelis and Palestinians haven’t been viewed with an equal measure of concern. It’s worse than that. It appears that Palestinians were judged as less ​human than Israelis, and were, therefore, not entitled to make demands to have their rights recognized and protected."
Mar 8th 2021
EXTRACTS: "XThere’s a global shortage in semiconductors, and it’s becoming increasingly serious." ...... "The automotive sector has been worst affected by the drought, in an era where microchips now form the backbone of most cars. Ford is predicting a 20% slump in production and Tesla shut down its model 3 assembly line for two weeks. In the UK, Honda was forced to temporarily shut its plant as well." ..... " As much as 70% of the world’s semiconductors are manufactured by just two companies, Taiwan Semiconductor (TSMC) and Samsung."
Mar 5th 2021
EXTRACT: "Back in 1992, Lawrence H. Summers, then the chief economist at the World Bank, and I warned that pushing the US Federal Reserve’s annual inflation target down from 4% to 2% risked causing big problems. Not only was the 4% target not producing any discontent, but a 2% target would increase the risk of the Fed’s interest-rate policy hitting the zero lower bound. Our objections went unheeded. Fed Chair Alan Greenspan reduced the inflation target to 2%, and we have been paying for it ever since. I have long thought that many of our economic problems would go away if we could rejigger asset markets in such a way as to make a 5% federal funds rate consistent with full employment in the late stage of a business cycle."
Mar 2nd 2021
EXTRACT: "Under these conditions, the Fed is probably worried that markets will instantly crash if it takes away the punch bowl. And with the increase in public and private debt preventing the eventual monetary normalization, the likelihood of stagflation in the medium term – and a hard landing for asset markets and economies – continues to increase."
Mar 1st 2021
EXTRACT: "Massive fiscal and monetary stimulus programs in the United States and other advanced economies are fueling a raging debate about whether higher inflation could be just around the corner. Ten-year US Treasury yields and mortgage rates are already climbing in anticipation that the US Federal Reserve – the de facto global central bank – will be forced to hike rates, potentially bursting asset-price bubbles around the world. But while markets are probably overstating short-term inflation risks for 2021, they do not yet fully appreciate the longer-term dangers."
Feb 28th 2021
EXTRACT: "To be sure, calls to “build back better” from the pandemic imply some awareness of the need for systemic change. But the transformation we need extends beyond constructing modern infrastructure or unlocking private investment in any one country. We need to re-orient – indeed, re-invent – global politics, so that countries can cooperate far more effectively in creating a better world."
Feb 23rd 2021
EXTRACT: "So, notwithstanding the predictable release of pent-up demand for consumer durables, face-to-face services show clear evidence – in terms of both consumer demand and employment – of permanent scarring. Consequently, with the snapback of pent-up demand for durables nearing its point of exhaustion, the recovery of the post-pandemic US economy is likely to fall well short of vaccine development’s “warp speed.” "
Feb 20th 2021
EXTRACT: "Human rights abuses under Erdogan are beyond the pale of inhumanity and moral decadence. The list of Erdogan’s violations and cruelty is too long to numerate. The detention and horrifying torture of thousands of innocent people for months and at times for years, without being charged, is hard to fathom. Many prisoners are left languishing in dark cells, often in solitary confinement. The detention of tens of thousands of men and hundreds of women, many with their children, especially following the 2016 failed coup, has become common. It is calculated to inflict horrendous pain and suffering to bring the prisoners to the breaking point, so that they confess to crimes they have never committed."
Feb 20th 2021
Courtyard of the Amsterdam Stock Exchange, circa 1670, (Job Adriaenszoon Berckheyde).
Feb 12th 2021
EXTRACT: "Global regulators will no doubt be concerned about a potential volatility spillover from digital asset prices into traditional capital markets. They may not permit what could quickly amount to effective proxy approval by the back door for companies holding large proportions of a volatile asset on their balance sheets."
Feb 11th 2021
EXTRACT: "Since Russians began protesting opposition leader Alexei Navalny’s imprisonment, the security forces have apparently had carte blanche to arrest demonstrators – and they have done so by the thousands. If Russians so much as honk their car horns in solidarity with the protesters, they risk personal repercussions. The official response to the protests goes beyond the Kremlin’s past repression. It is war."
Feb 6th 2021
EXTRACT: ".......like Biden, Roosevelt was certainly no revolutionary. His task was to save American capitalism. He was a repairer, a fixer. The New Deal was achieved not because of Roosevelt’s genius or heroism, but because enough people trusted him to act in good faith. That is precisely what people are expecting from Biden, too. He must save US democracy from the ravages of a political crisis. To do so, he must reestablish trust in the system. He has promised to make his country less polarized, and to restore civility and truth to political discourse. In this endeavor, his lack of charisma may turn out to be his greatest strength. For all that he lacks in grandeur, he makes up for by exuding an air of decency."