Usually an ivory tower controversy in economics fails to spill over into the public domain, but the Rogoff‑Reinhart debt modelling affair is the latest notable exception to this rule.
In 2010 noted economists Kenneth Rogoff and Carmen Reinhart produced a highly influential paper which showed that countries with a public debt to GDP ratio exceeding 90 per cent exhibited slower growth than less indebted countries.
Unsurprisingly, this paper has been cited widely by those favouring public sector budget deficit and debt reductions, however three researchers, including doctoral student Thomas Herndon, recently found that something was amiss with their efforts to replicate the Rogoff‑Reinhart empirical results.
Herndon and his colleagues contradict the Rogoff‑Reinhart findings for heavily indebted countries, and state that ‘coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth.’
Rogoff and Reinhart initially presented a rather defensive response to this empirical challenge, stating that the Herndon study also found that countries with greater debt to GDP ratios have recorded slower growth rates and that research finding differences were informed, in part, to varied emphases and interpretations.
This week they followed up with an opinion piece in the New York Times. They acknowledged the coding error, but stridently defend the integrity of the remaining aspects of their work. Rogoff and Reinhart also made a telling remark about the public reaction to the recent controversy as follows:
Our research, and even our credentials and integrity, have been furiously attacked in newspapers and on television. Each of us has received hate-filled, even threatening, e-mail messages, some of them blaming us for layoffs of public employees, cutbacks in government services and tax increases. As career academic economists (our only senior public service has been in the research department at the International Monetary Fund) we find these attacks a sad commentary on the politicization of social science research.
It should be said that econometrics, as the empirical sub‑branch of the social science discipline of economics, is conducted by mostly intelligent, but nonetheless fallible, human beings, and this occasion will not be the last in which mistakes might be made in modelling.
In scientific endeavours, where theoretical constructs and empirical findings can be falsified by the presentation of superior alternatives, this occasion will not the last in which academic studies will come under challenge by others.
Academic and professional economists will no doubt eagerly await further responses about this matter in due course, but the more immediate question for everyone else is does this controversy matter in public policy terms?
The way in which certain commentators (of a particular political bent) have latched onto this issue, claiming that the challenges posed to the Rogoff‑Reinhart study altogether invalidates the rationale for fiscal consolidation measures throughout the Western world, suggests that it does matter.
However the controversy surrounding the Rogoff‑Reinhart work, especially the nomination of a numerical tipping point of debt leading to slowing growth, risks letting profligate governments off the hook by encouraging us to overlook the longstanding economic narrative of a negative association between public debt and growth.
Arguably the most well known aspect of this narrative is that greater public sector borrowings will tend to crowd out private sector investments, and this in turn will tend to dampen growth.
Individuals and corporations that have purchased government securities need have to have their loans repaid, and that means additional future tax burdens upon general taxpayers.
These extra tax burdens will tend to further depress other productive economic activities such as savings and work effort, again affecting economic growth.
Other things equal, public indebtedness sustains levels of government often greater than what is fiscally sustainable, artificially depressing the effective tax price of public goods today which encourages greater demands for larger, but more inefficient, government.
However, as suggested above, it is future generations of taxpayers who are largely stumped with the full tax burden arising from public debt, even though they were not in a position to give politically consent to today’s excess spending or tomorrow’s excess taxation.
For some economists, such as the late James Buchanan, public debt was not solely an economic issue but was also a moral one, in that public indebtedness is the manifestation of inappropriate legal plunder across the generations. If there is a more unprincipled, unethical practice conducted in the name of public sector financial management, it is difficult to find.
In empirical terms, the Rogoff‑Reinhart controversy should not be construed as the be-all-that-ends-all when it comes to the growth effects of debt.
A number of other empirical studies do suggest that higher levels of debts assumed by governments are associated with lower economic growth and other aspects of compromised economic performance.
For example, a 2010 paper for the IMF found an inverse relationship between initial debt and subsequent economic growth for advanced economies, including Australia.
Another study, by Simone Salotti and Carmine Trecroci, suggests that high public debt levels in twenty OECD countries, including Australia, have tended to reduce not only private sector investments but productivity growth.
For the sake of blog-length parsimony, I just refer to these two studies for now. There are plenty of others that can be found, courtesy of a Google search.
Whilst Australia’s overall general government gross debt to GDP ratio (comprising all levels of government) is relatively low in international terms, it has grown strongly from a pre‑GFC ten per cent in 2007 to 27 per cent last year.
As commonwealth and state budget papers in recent years have also made plain, governments during the GFC and beyond have expanded borrowings to cover for revenues which had not grown in accordance with prior expectations.
To put it more simply, Australian governments have written down their balance sheets to pump up recurrent spending even further.
While researchers relying upon the Rogoff and Reinhart debt data might have to go back to the empirical drawing board, this in no way suggests that concern about Australia’s accelerating public debts should be eased.