Thu | Jan 18, 2018

How important is debt-to-GDP ratio?

Published:Wednesday | March 30, 2016 | 12:00 AM
Paul Ward

A country's debt-to-GDP ratio is a very limited measure of anything predictive, certainly when taken on its own. The debate ignited in 2010 with Reinhart and Rogoff arguing that anything over 60 per cent is likely to seriously dampen growth:

'Growth in a Time of Debt' is an economics paper by American economists Carmen Reinhart and Kenneth Rogoff published in a non-peer-reviewed issue of the American Economic Review in 2010. Politicians, commentators, and activists widely cited the paper in political debates over the effectiveness of austerity in fiscal policy for debt-burdened economies.

The paper argues that when "gross external debt reaches 60 per cent of GDP", a country's annual growth declined by two per cent, and "for levels of external debt in excess of 90 per cent", GDP growth was "roughly cut in half". Appearing in the aftermath of the financial crisis of 2007-2008, it provided support for pro-austerity policies.

In fact, the limits to debt must also involve GDP growth rate and the interest rate being paid on the debt.

A recent paper titled 'Is There an Optimal Debt-GDP Ratio' tends to support the idea that the debt-to-GDP ratio should be, and perhaps actually is, the dependent variable. The target of government policy should thus be on (inclusive) growth to both reduce the debt burden and also to the more direct benefit of those who need relief from austerity. (

The paper goes further:

"As long as the interest on the debt is less than the annual increase in nominal GDP, the debt need not be repaid because it will be a shrinking fraction of GDP." This was pointed out more than half a century ago by Evsey Domar: "The problem of the burden of debt is essentially a problem of achieving a growing national income."

Domar again emphasised, after 50 years, "the proper solution of the debt problem lies not in tying ourselves into a financial straitjacket, but in achieving faster growth of the GNP ... ".

What are these figures for Jamaica (2015)?




GDP was J$1,800 billion. A 1% per cent increase would be J$18 billion. Interest on the J$2,100-billion debt was, however, seven times higher at J$130 billion with an average interest rate of 6.2% (130/2100). It would take 7% growth to make the debt eventually disappear without paying off any of the capital.

With a lower interest rate of 1% (as was PetroCaribe), an achievable 1.1% annual growth in GDP would suffice. At these rates of interest, our debt-to-GDP ratio of about 120% would be quite tolerable, requiring no amortisation.

Without that unlikely event, however, the size of the debt means that something else has to be done. It could be at the expense of the people. But they have recently rejected any such thing as continuing to support a large primary surplus taken from their tax payments, rejected spending money on debt instead of services.

Some kind of default on both local and foreign debt is the only answer, at a minimum by declaring a 4% top limit (like Greece) on the primary surplus. But default would inevitably mean a poorer credit rating. Borrowing (foreign especially) would become difficult and more expensive.

This is why I am driven to the next level of avoiding the need to borrow by 'avoiding' the cost of debt servicing. Declare a moratorium on debt servicing (just as companies are allowed to do when in trouble), followed by a debt audit and then a haircut (not just an interest rate reduction a la JDX/NDX).




The strong primary surplus (J$126b in 2015-16) would make this financially possible, with funds available to prime demand (via the tax threshold break) and also productive local investment. Empirical evidence has shown that with two to three years, strong growth can result from radical default measures. As I always have to add, attention needs to be given to productivity and our too-open trade policy as well.

The same paper, 'Is there an optimal debt-to-GDP ratio?', takes this one step further. Forget about reducing the high debt-to-GDP ratio because it may well not be an inhibitor to growth. Instead, put money into schooling (and, hence, productivity).

"The claim that high public debt causes lower growth is also not grounded in robust empirical evidence ... . A July 2010 IMF study of 38 developed and developing economies for the 1970-2007 period found that the elasticity of growth with respect to debt is only -0.02. The same study found that the elasticity of growth with respect to other variables (such as initial years of schooling which contributes positively to growth) is much higher (the size of the elasticity coefficient on schooling is well in excess of 2.0)."

Surely, anything is worth trying as possibly better than the current very-slow-progress-if-any-at-all policy.

- Paul Ward is a member of Campaign for Social & Economic Justice. Email feedback to and