MICKEY MOUSE NUMBERS IN ECONOMIC HISTORY: THE ORIGINS AND SPINNING OF 60 / 90 PERCENT DEBT-TO-GDP RATIOS
By Dieter Plehwe and Moritz Neujeffski
Humankind has always attributed mythical meanings to numbers. Take the famous inventor Nikolai Tesla, who regarded ‘the magnificence of the numbers three, six and nine’ to be the ‘key to the universe’. In terms of fiscal deficits and debt-to-GDP ratios, the values of 3, 60 and 90 percent came to play near-mythical roles too. Through the Maastricht criteria for economic and monetary union (EMU) in Europe, a 3 percent annual deficit and 60 percent debt-to-GDP ratio were set as authoritative thresholds. The star American economists Carmen Reinhart and Kenneth Rogoff further argued that the 90 percent debt-to-GDP ratio is a maximum threshold, above which accumulated government debt measurably stifled growth and significantly undermined economic performance in general.
Both ratios have played a key role in European and global economic governance, serving as significant parameters for rating agencies, for example, which oversee and (de-)legitimize public finance. In fact, the discursive power of the 90 percent fortified the freely invented belief in a 60 percent debt-to-GDP threshold. Since there has been no serious economic justification for the validity of a desirable debt-to-GDP ratio of 60 percent, the apparently scientific discovery of a maximum level of debt-to-GDP appeared to fill a critical gap in the architecture of legitimate austerity. Readers may vaguely remember the miscalculation of Reinhart and Rogoff. Nonetheless, the debt-to-GDP and other ratios relevant for pro-austerity arguments need to be examined more closely to move a surreal debate nearer to a real one. Furthermore, we need to assess the circumstances under which debt can hamper economic performance and human development.
First we take Brussels…
The myth of a reasonable debt-to-GDP ratio belongs to a more general class of pro-austerity arguments, according to which debt is simply a burden (see, for example, the chapters on crowding out and the Swabian housewife). These figures create a metric authority based on an allegedly accurate measurement of economic activities and public finance. Based on this figure, other parameters have been set to shape government behavior further, most notably the 3 percent Maastricht annual deficit constraint. Assuming a growth rate of 5 percent, a 3 percent deficit does not add new debt to the 60 percent stock. This is known as the combined 60 percent and 3 percent rule. But what exactly was the basis for these two figures?
The history is telling. Let’s start with the 3 percent deficit rule. The number was introduced by the French economist Guy Abeille back in 1981. After his landslide electoral victory that year, the French Socialist president, François Mitterrand, was facing high expectations from cabinet members and the public—and a soaring deficit, which stood at 2.6 percent of GDP. He called upon a group of junior economists to come up with a number suitable to put a lid on the boiling pot, to stop the overflow. Since it would have been hard to meet a 2 percent deficit target that year, due to the existing budget shortfall, the young expert at the Ministry of Finance suggested a limit of no more than 3 percent, which gave Mitterrand the fiscal cap he desired.
The selection of GDP as reference was arbitrary from a macro-economic calculation, being chosen simply as a figure everyone would immediately understand. Since the budget deficit’s impact on total national debt depends on the growth rate, a 3 percent deficit ceiling does not make sense, in times neither of strong growth (as even a higher deficit would not add to debt) nor weak (when the deficit would need to be lower according to the simplistic rationale of austerity). Following the euro crisis, European authorities have kept with the logic of the 60 percent debt-to-GDP ratio and ‘corrected’ the initial French mistake by moving the maximum structural annual deficit down to 0.5 percent, in line with the more restrictive Stability and Growth Pact for the eurozone.
Surely the 60 percent debt-to-GDP ratio was not founded on an ad hoc political rationality as with the 3 percent rule? Alas, as DCM Platt once quipped, it is a similar Mickey Mouse number in the history of statistics. The figure is based on neither thorough research nor excellent studies. It was simply invented as a reference point, much like the 3 percent rule, which would prepare the path for a monetary union focused on stability. According to the economist Luigi Pasinetti, the only reasonable explanation for choosing 60 percent was that it was the approximate average debt-to-GDP ratio of the EU member states at the time of negotiation of the EMU. Both Germany and France were close to this mark too. Once established, the arbitrary calculation however provided the legitimacy for an apparently authoritative reference point, an authority only numbers can provide.
…and then we take the world—the political influence of the 90 percent argument
During the financial crisis, public finance was out of balance due to the bailout of private banks. Many countries added plenty of percentage points to their debt-to-GDP ratios. With no scientifically-based rationality for an optimal debt-to-GDP ratio at hand and rapid movement away from the 60 percent ratio in the wrong direction, the shaky grounds on which the debt-to-GDP rationale had been built were laid bare. But rescue was coming from the ivory tower of sound economics, Harvard University and from the University of Maryland.
In 2010, Carmen Reinhart and Kenneth Rogoff published the non-peer-reviewed article ‘Growth in Time of Debt’, which provided the desperately-needed academic expertise on the issue of sustainable debt-to-GDP ratios and was soon cited widely. Analyzing the relation between public debt and GDP growth between 1946 and 2009, the authors claimed that public debt-to-GDP ratios of more than 90 percent decreased median growth rates by 1 percent. When measured in average growth, the effects were meant to be even more severe. While this must have caused the Greek government a serious headache (in 2010, its debt-to-GDP ratio shot up by 42 percentage points compared with 2006), it was music to the ears of pro-austerity authorities. The Republican 2012 budget plan used the paper as an exclusive reference; the former European commissioner for economic affairs Olli Rehn regarded the 90 percent finding as widely acknowledged and the former UK chancellor of the exchequer George Osborne praised Rogoff’s influence on his economic thinking.
This general myth of how austerity and a balanced budget lead to economic success had been debunked before and would not need to be so again, had it not exerted such a strong intellectual backing for the random Maastricht debt-to-GDP ratio. In their 2013 critique of the Reinhart and Rogoff paper, Thomas Herndon, Michael Ash and Robert Pollin replicated the study based on data Reinhart and Rogoff had used. The new results challenged the very idea of negative effects resulting from high debt-to-GDP ratios. Herndon et al showed that major mistakes by Reinhart and Rogoff had led to serious errors, misrepresenting the relationship between public debt and growth. The errors included selective exclusion of time periods of data for Australia, New Zealand and Canada, unusual weighting techniques and simple Excel coding errors which excluded entire countries, such as Belgium and Denmark, from the summary statistics. Appropriately recalculated, they derived a 2.2 percent annual growth rate for countries displaying a 90 percent debt-to-GDP ratio. This was contrary to the myth of automatic GDP reduction established by Reinhart and Rogoff, and only slightly lower than their findings for lower debt-to-GDP ratios.
Despite its inaccuracy, neither the European authorities nor the leadership of the international financial institutions took the opportunity to trash the 60 percent rule. Devoid of any substantive academic backing, European authorities still hang on to the ‘(excessive) debt diminishes growth’ argument in general, and to the dogmatic fantasy of a 60 percent debt-to-GDP ratio in particular.
Necessary meditations on debt, growth and austerity
The debunking of the authority of the 3, 60 or 90 percent figures does not imply that we should be comfortable with fast-rising debt and with high structural debt, public or private. Depending on such parameters as economic growth, the purpose of debt, reasons for deficits or interest-rate levels, debt matters immensely for economic development. Both absolute and relative levels can be detrimental to citizens’ wellbeing. But there is a huge difference between when a country incurs high debt due to military spending or bailouts and when debt is incurred through, for instance, public investments in health care or CO2-reducing transport infrastructures. The latter increase a country’s productivity, which consequently enables the service of temporarily higher debt. Contrary to arbitrary ceilings, the so-called ‘golden rule’ of public deficits links additional government debt to productive investment. The golden rule still expresses the Keynesian spirit of state capacity, which runs counter to austerity logics and supply-side economics—balanced and minimized public spending.
Economists are aware that there is a major difference between a state financed by domestic or foreign lenders and one that is subject to monetary rigidity, which disables exchange-rate adjustment, and is consequently subject to economic power and decision-making from the outside. Countries such as Japan can carry more than 200 percent debt-to-GDP ratios owing to domestic lenders in national currencies, while other countries rely on foreign capital. The discipline of financial markets was introduced in the 1980s for most of the world, when rating agencies started to assess public finance and debt according to principles previously applied to commercial banks.
There simply is no authoritative number regarding debt-to-GDP ratios or annual deficits in general. Nevertheless, the rules applied are used to consolidate austerity capitalism and to deflect alternative discussions on the causes of debt, deficits and the purpose of public finance.