Debt is not the problem

When trying to refute a misplaced idea it is best to take its most coherent and lucid expression as a target. Taking apart a sloppily expressed argument is unlikely to convince many that its premises are fundamentally flawed.

In the spirit of aiming at hard targets it is worth looking closely at the work of Adair Turner. Not only is he exceptionally clever but he is also what could be called a go-to guy when government wants someone to think through difficult challenges. His many roles have included chairing three high-profile public investigations: the Pensions Commission, the Low Pay Commission and the Climate Change Committee. He was also chairman of the Financial Services Authority, then the main financial regulator, when the financial crisis broke in 2008. His early career was at McKinsey, a management consultancy with a reputation for recruiting many of the brightest graduates.

It was with this impressive CV in mind that I was keen to attend Lord Turner’s recent lecture entitled “Caught in the debt trap” at Cass Business School. I suspected, based on past experience, that I would disagree with much of it but I knew I would also find it stimulating.

The thrust of his argument was that the western economies are likely to suffer from a prolonged period of slow growth, mainly as a result of a debt overhang. Although private sector debt has declined in some cases in recent years an increase in public sector debt has more than compensated for it. This was the conclusion of what he described as a “very fine” report called Deleveraging? What Deleveraging?.

Turner also pointed to a well-known study by Richard Koo, the chief economist at the Nomura Research Institute, on the Balance Sheet Recession. The book contends that in high debt environments the priority for firms is often to pay down debt rather than to make profits. In such a climate, with little capital investment, economic growth is likely to be slow. Koo’s analysis was initially based on Japan’s experience but Turner and others have claimed it now applies to many other advanced economies.

For Turner the debt overhang has merged with other trends such as widening inequality and a shifting demographic balance. He also argues that there is a reduced need for capital investment as developments in information technology have made it much cheaper.

There are additional elements to Turner’s scenario but it seems to me that on a fundamental level he gets things upside down. The long-term rise in debt levels is a symptom, rather than cause, of sluggish growth. In a weak economy it is often more attractive for firms to invest in financial assets, including property, rather than the real economy.

Low levels of capital investment are much more problematic than Turner suggests. They are also symptomatic of a fundamentally weak dynamic towards economic growth. In contrast, his arguments on the cheapening effects of information technology are grossly exaggerated.

Although Turner is a consummate economic insider it is interesting that he presents his argument as a challenge to the orthodoxy. That helps explain his involvement with the Institute for New Economic Thinking. It is also worth noting that there are parallels between his arguments and those of David Graeber, who I wrote about in my last blog post. Both mistakenly see a heavily reliance on debt as a cause, rather than a symptom, of the plight of the western economies.

This blog post was first published today on Fundweb.