Borrowing Is Not Necessarily Pro-Growth
How many ways can the folks at the National Review try to argue that Bush’s fiscal fiasco increases long-term growth rather than decreases it? William Kucewicz tries another one:
Net lending in the first quarter totaled a record $4.50 trillion (seasonally adjusted annual rate), up $457 billion, or 11.3 percent, from the previous quarter and $1.46 trillion, or 47.9 percent, above year-earlier levels, according to the Federal Reserve’s latest “Flow of Funds Accounts of the United States.” As a consequence of the Bush tax cuts on income and capital, total net lending (i.e., all credit market instruments excluding corporate equities) has risen $2.57 trillion, or a resounding 132.8 percent, in the past five years.
Kucewitz is referring to table F.1 from the Flow of Funds Accounts, which shows both net lending and net borrowing. By definition, the totals are the same. Now would it matter who is borrowing and for what purpose? Since Kucewitz does really address this issue, let’s pose the following query. Suppose that the government decided to increase its borrowing by $100 billion. What would be the effect on savings and investment? I can think of five possible answers here:
Answer 1. A Ricardian Equivalence type might argue it does not affect national savings as households increase private savings by the increase in the government deficit as they recognize that the rising Federal debt represents future tax liabilities. Of course, George W. Bush wanted to give people their money back so they can consume more as he pretends his tax cuts are permanent.
Answer 2. A closed economy classical would suggest that any rise in consumption (fall in national savings) would completely crowd-out investment.
Answer 3. An open economy classical model would suggest that part of the crowding-out would be in the form of reduced net exports partially offsetting the crowding-out of investment so the reduction in national savings from massive government borrowing might take the form of more lending to the U.S. from the rest of the world.
Answer 4: If the economy began from a state of high unemployment, a Keynesian might argue the fiscal stimulus would increase overall production back towards full employment with the prospect of the paradox of thrift suggesting that a downward shift in the national savings schedule would also induce a favorable movement along the savings schedule.
Answer 5: The National Review crowd wants us to believe that national savings rose as if people are consuming less. Not only does this premise contradict the rhetoric of the President they worship, it is also contrary to the facts. When economists raise the concept of crowding-out, the National Review crowd seemingly says what crowding-out.
The following graph shows investment as a share of GDP from 2000 to 2005 as well as imports net of exports (labeled TB for trade balance deficit) as a share of GDP, and gross savings (GS which is the sum of investment and net exports) as a share of GDP. Answer 3 seems to capture the long-run picture with some Keynesian elements thrown in as the economy fell below full employment from 2001 to 2003 only to at least partially return to full employment by now. We had a rather dramatic fall in the national savings rate, which mainly crowded out net exports but also crowded investment.
Our second graph displays net lending (= net borrowing) as a percent of GDP, which did increase from 17% in 2000 to over 27% in 2005 as Kucewicz’s discussion notes (although expressing the numbers in terms of nominal figures and not relative to GDP sort of exaggerates things). While Kucemicz fails to mention this fact, our graph shows about half of the increase represents an increase in government borrowing or put differently an increase in the amount of net lending from the rest of the world.
But you may ask – what about the rest of the increase in net lending? Kucewicz charts the increase in the debt to equity ratio as he writes:
Finance is the sine qua non of economic growth. Without it, risk-taking is stymied, knowledge can’t be commercialized, and an economy stagnates … New corporate bond issues in the first quarter topped $965.8 billion (seasonally adjusted annual rate), up 3.9 percent, or $36.2 billion, from the prior quarter and a smashing 50.6 percent, or $324.7 billion, higher than a year before. Throughout much of the first half of the decade, corporations took advantage of low U.S. interest rates by switching from equity to bond financing. In the first quarter, in fact, equity financing totaled about $99 billion, down almost 73 percent, or $267 billion, from a year earlier.
In other words, much of the increase in borrowing represents corporations paying out retained earnings to shareholders. At this point, we have to mention the Modigliani-Miller propositions:
the value of a firm is unaffected by how that firm is financed. It does not matter if the firm’s capital is raised by issuing stock or selling debt. It does not matter what the firm’s dividend policy is.
A shift from equity to debt financing might indeed increase the amount of risk borne by equity owners but the Modigliani-Miller propositions would hold that this change in method of financing is only a risk transfer.
Kucewicz fails to mention who is doing the additional borrowing and lending and what is driving the decision to increase borrowing. Certainly, we have not witnessed an outward shift of the national savings schedule – regardless of how many distortions of the data the National Review can concoct.