By Michael Pomerleano

In Growth in a Time of Debt, presented at the AEA 2010 Annual Meetings in Atlanta (www.aeaweb.org/aea/conference/program/retrieve.php?pdfid=460) Carmen Reinhart and Kenneth Rogoff study the link between different levels of debt and countries’ economic growth over the last two centuries. The paper reviews 200 years of economic data from 44 nations and reaches the conclusion that countries that are as highly indebted as the UK and US will, at the end of the crisis, grow at sub-par rates. While there is a discontinuity in the data (growth is affected only over a certain debt threshold) the findings are ominous. One explanation is fairly straight forward: more resources are diverted away from the private sector. Governments do not create, but consume wealth.

A second, more subtle explanation focuses on the massive transfer of private debt onto government balance sheets. The message is fairly simple. The nationalisation of private debt injects considerable inefficiency into the economic system, inhibiting Schumpeter’s process of Creative Destruction that is essential in a market economy and needed to maintain the private sector. In short, the recent massive bailouts by national authorities of their financial systems in some countries amount to nationalising private sector debt with fiscal resources. In countries without fiscal headroom and lacking reserve currencies, such as Hungary, Romania and Ukraine, the IMF jumped to the rescue with sovereign lending that has basically nationalised the losses of the private sector – what Joe Stiglitz calls ‘Ersatz Capitalism’: the privatising of gains and the socialising of losses. Read more