Debt-inequality trap risks being sprung any moment

Debt-inequality trap risks being sprung any moment

Last month, the International Monetary Fund issued its latest assessment of the global economy for 2014, lowering the growth rate from 3.7% projected in its previous assessment to 3.3%. The picture is less rosy despite better outlook for the United States - the largest engine of the world economy – that leads the Federal Reserve System to stop pumping massive amounts of money into the economy via quantitative easing, which totaled some $4.5 trillion over the past six years. Gloomier prospects for other economies have been attributed to continued feeble demand.

Debt and inequality have been the main contributing factors for weak demand and will continue to be, not only in the next few quarters but also in the long term. It was private sector debt that caused the American housing bubble, which burst in 2008 and set off the Great Recession.

Public sector debt sent Greece and a few other economies into insolvency. Despite what has happened in the past, world debt continues to grow, attesting to the fact that the world is addicted to debt and, serious consequences notwithstanding, debt continues to be used in attempts to boost economic growth.

In a recent report, McKinsey Global Institute estimates that world debt totals $186 trillion, which includes government debt, corporate bonds, and loans to individuals, families and businesses. This represents an increase of about $34 trillion from 2008.

An increase in the absolute amount of debt may not entail serious problems if the economy has grown faster, leading to a lower debt burden. But that is not the case.

The latest Geneva Report indicates that global debt increased from 174% to 212% of GDP during 2008-2013. The biggest increases were largely in the developing economies led by China, which saw its debt rise from 72% to 217% of GDP during that period. This ratio is quickly approaching those of other countries — 257% for countries using the euro, 264% for the US, and 411% for Japan.

The Great Recession was a painful lesson for households over borrowing. They, therefore, have been reluctant to spend even after their economies have come out of recession. Instead, they have chosen to pay off debt and to increase savings. Saddled with debt, the governments have not been able to boost spending as much as they would have wished. In response, the business sector has lowered investment.

Reluctance to spend by the household sector, however, has not been the only factor causing weak demand. Increased income inequality has also been playing a significant role as the rich, whose spending in proportion to income tends to be lower than those of the lower-income groups, have benefited the most from the economic recovery.

Inequality is getting so serious that it prompted prominent economists to take up the issue, such as Joseph Stiglitz, who in 2012 published The Price of Inequality: How Today's Divided Society Endangers Our Future. Soon after that, Thomas Piketty published — first in French and then in English — a best seller on the subject of inequality, entitled Capital in the Twenty-First Century. They warn that continued increases in inequality will cause social and economic instability.

Even Janet Yellen, chairman of the Board of Governors of the Federal Reserve System, has chimed in. Lecturing in Boston a couple of weeks ago, Ms Yellen called increasing inequality un-American and warned that it would do great harm. As her agency does not deal with this area of economics, she provided no specific policy prescriptions besides general suggestions in the areas of improving support for education and entrepreneurship.

The world would face a catastrophe if this weak demand caused by heavy debt and extreme inequality leads to deep deflation. The process could start with further cutbacks in spending by households, governments and businesses as they need more funds to service the increased debt.

The result would be lower growth, making it more difficult to service debt. It would be the rich who would benefit from this with a lower spending rate.

Such lower spending-lower growth coupling could create a vicious circle of deeper and broader rounds of cutbacks until a tipping point is reached, triggering widespread defaults, bankruptcies, steep price drops, and rising unemployment. Such an event —  unlikely as it may seem — could cause widespread social unrest and class warfare

For Thailand, the debt and inequality numbers may not look as problematic as in many countries. But be warned: in many cases, statistics do indeed lie. Despite having a modern financial sector, households and businesses still borrow from private sources — heavily by some estimates. Although there is no general rule on how much debt is too much debt, Thais should not borrow a lot more, as the government plans to do, just because the debt-GDP ratio is lower than that of Japan.

Also, no one can predict how long inequality can last before it triggers social unrest. Thais should not think the country is risk free because the inequality numbers look better than those of other countries.

Some strong measures need to be implemented urgently to reverse the trends and they should not be just along the lines suggested by Ms Yellen, for those take a long time to bear fruit.

The US has implemented many measures in support of education and entrepreneurship but inequality continues to grow. For Thailand, as for many countries, if not reversed, the present trends could very well spring the debt-inequality trap at any time.


Sawai Boonma has worked as a development economist for more than two decades. He can be reached at sboonma@msn.com.

Sawai Boonma

Writer

Former Senior Country Economist at the World Bank and now a freelance writer.

Email : sboonma@msn.com

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