Sunday, April 28, 2013

Narrow focus on debt and deficits distracts us from the primary problems

Published in The Tennessean, Sunday, April 28, 2013 and at FORBES with archives.

by Richard J. Grant

In scientific controversies, as in political contests, the people most ignored are those who would prefer to vote for “none of the above.” In political contests, we must often take sides between the two remaining “most electable” candidates in order to minimize the damage that will ensue. But in scientific controversies we are not so constrained.

That is why this column never endorsed the 2010 study by economists Carmen Reinhart and Kenneth Rogoff that purported to find a sudden increase in “debt intolerance” in countries whose national debt levels exceeded 90 percent of GDP. The problem was not with the concept of debt intolerance, but rather with the portrayal of the 90 percent level as some sort of natural threshold beyond which economic growth rates would be severely curtailed.

Even before reading their article, it could be guessed (correctly, as it turned out) that the 90 percent threshold was more an artifact of how the data were selected and grouped rather than anything resembling a natural law. At the best of times, statistical studies of economic phenomena are exercises in economic history, not economic science. At the worst of times, working with whatever data happen to be available, they resemble a drunk looking for his keys under the lamppost. The science resides in the theory that is necessary to interpret the data.

Last week, researchers who were given access to the original data and spreadsheet used by Reinhart and Rogoff announced they had discovered calculation errors. After correction, the 90 percent threshold had disappeared. There was still a negative correlation between the size of the national debt and GDP growth, but there was no implied causal relationship or sudden change at 90 percent.

Unfortunately, all of this had played out in a political environment in which the U.S. and some state governments were running record deficits, partly in response to the recent recession. The debate over deficits grew in shrillness and crowded out discussion of the deeper problems, such as excessive government spending, overregulation, and the abuse of the powers of the Federal Reserve System.

During the past three years, the study’s conclusions were used to overstate the case for deficit reduction. With the revelation of the spreadsheet errors, some supporters of big government were giddily proclaiming victory as if they had not already been discredited before Reinhart and Rogoff entered the scene.

Those who need the assurance of statistical studies would be better served by the Rahn Curve (named after economist Richard Rahn), which shows a long-term negative relationship between the size of government expenditures as a percentage of GDP and economic growth rates. In other words, the bigger the role of government in the economy, the lower will be long-term economic growth rates.

The original theory underlying the Rahn Curve assumed that as the size of government increased from zero, supplying law and order and some basic services, economic growth rates would increase until government reached some optimal size. Government expenditures are not the only variable, so even if we had more examples of small government, we would still not be able to specify an optimal size of government expenditures, where the Rahn Curve peaks.

But what we can be sure of is that the peak of the Rahn Curve is much closer to zero than to where we are now. Instead of obsessing over debt and deficits, we should instead focus on the primary factor of government interference in the economy. If we constrain government spending, reduce the burden of regulation, and assure the value of the dollar, the national debt will cease to be a threat.


Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears fortnightly on Sundays in the print and online versions of The Tennessean. He is also a regular FORBES contributor. E-mail messages received at: rjg@richardjgrant.com

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Copyright © Richard J Grant 2013