Here are two things about how debt affects economy. First, in the abstract it doesn’t matter. For every debtor there is a creditor, and in theory an economy should be able to hum along just fine if a country’s citizens have a great deal of debt or none. A company’s ability to produce things depends on the workers and machines it employs, not the composition of its balance sheet, and the same can be said of nations.
Second, in practice this is completely wrong, and debt plays an outsize role in creating boom-bust cycles across the world and through history. High debt increases the amplitude of economic swings. To think of as a corporate metaphor, high reliance on borrowed money may not affect a company’s output in theory, but makes it more vulnerable to bankruptcy.
That’s what makes a new report from McKinsey, the global consulting firm. Researchers compiled data on the full range of debt that countries owe — not just governments, but corporations, banks and households as well. The results: Since the start of the crisis at the end of 2007, debt worldwide has risen $57 trillion, rising to 286% of global economic output from 269%. Combining these types of debt is useful because it gives a better idea of how a country’s finances work. As we learned during the financial crisis, a country with high debt can get into trouble regardless of whether its debts are mostly owed by the government (Greece, Italy), households (Spain, US), or financial institutions (Ireland, Britain). The ratio of total debt to economic output has declined in only some smaller countries, like Romania, Saudi Arabia and Israel. In all of the world’s economic powerhouses, total debt has risen. While some of the places with the steepest increases are European countries that were enmeshed in that continent’s debt crisis — Ireland, Greece and Portugal, with Spain and Italy just behind — others are a bit more surprising.
Indeed, two Asian giants that were only modestly affected by the last crisis are in this group. China has seen its ratio of debt to economic output rise by a whopping 83% points since 2007, according to the calculations by the McKinsey Global Institute, to 217% of GDP, with increases in government, corporate and household debt.
So far, the Chinese government has skilfully managed a slowdown in economic growth and signs of a housing boom reaching its end, but whether it will be able to avoid a sharper correction is one of the great questions hanging over the global economy.
Then there is Japan, the most indebted country in the world, at 400% of GDP. Debt is up 64 percentage points since 2007. Its fiscal challenges are almost entirely from government debt, and they long predate the financial crisis. Its borrowing costs remain astoundingly low, reflecting ultra-low inflation and strong domestic demand for Japanese government bonds. But it is hard to look at the balance sheet of the world’s third-largest economy and not wonder how this can end well.
Meanwhile, the McKinsey report can be read as giving a largely positive assessment of the US. While total debt for the real economy is up by 16 percentage points in the US, to 233% of GDP, household debt is actually down by 18 percentage points and corporate debt by 2 percentage points. A rise in public debt since 2007, in other words, largely offset declines in private-sector debt.
And perhaps most promising for the US, its financial institutions have become significantly less leveraged, with financial-sector debt falling by 24 percentage points of GDP by McKinsey’s calculations. “One bright spot in our research is progress in financial-sector deleveraging,” write Richard Dobbs and three co-authors. “Financial-sector debt relative to GDP has declined in the US and a few other crisis countries, and has stabilised in other advanced economies. At the same time, banks have raised capital and reduced leverage.”