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The Abuse of Public Debt–And How It Sets the Stage For Economic Disaster

The 2020–21 recession has been devastating for the global economy. It has been ninety years since the global economy last suffered through a recession of this magnitude (in the Great Depression). Nonetheless, it seems that the social effects of the current recession have not yet come about. The reason for this disparity between cold macroeconomic data and popular sentiment can be found in the enormous public spending by practically all of the countries in the world.1

This article argues that exorbitant increases in public debt, such as those seen in 2020, are not free. It examines the potential economic effects of accumulating vast quantities of public debt.

The First Problem: Less Economic Growth

The countries with the greatest amount of public debt saw per capita income grow the least, as seen in chart 1.

Chart 1: GDP Growth per Capita

df
Source: Kumar and Woo. Created with Datawrapper

The economic mechanism that explains this statistical relationship is relatively simple. An excessive public debt causes the so-called expulsion effect, in which credit is redirected from the private sector to the public sector. The growth of public debt deprives the private sector of loanable funds, reducing the generation of wealth. (It is the private sector that generates economic activity. The most the public sector can aspire to do is to establish a framework that favors private endeavors.)

The Second Problem: Disincentivizing Investment and Reducing Productivity

This second problem is an extension of the first. One of the best indicators of an economy’s future growth is its investment rate. When investment increases, so too does productivity, which is accompanied by economic growth.

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