Photo by Ruth Enyedi on Unsplash

Government Debt and How it Slows Economic Growth

Today’s governments are drowning in debt, and the global economy is slowing down. Let’s take China, for example, in 1992 China’s GDP was 20%, today it’s at a paltry 6%. Granted 6% economic growth is still celebrated by many. However, going from a 20% yearly growth rate to a 6% growth rate is a huge blunder. China isn’t alone in this either. The US GDP growth has historically fallen significantly as well.

Furthermore, the catalyst for lower economic growth is the ever-expanding government debt. If we take a look at the US GDP growth rate and the US debt chart we can see that the moment the US debt begins to accelerate in the early 1980s, the GDP growth rate begins to slow.


source: tradingeconomics.com

source: tradingeconomics.com

Even here we can see the difference of total public debt as a percent of GDP. Starting in the early 1980s, we can see that the debt to GDP ratio begins to rise.

 Federal Debt: Total Public Debt as Percent of Gross Domestic Product

 Federal Debt: Total Public Debt as Percent of Gross Domestic Product

Taxes Reduces Economic Activity

Government debt slows the economy in many ways. One of the primary ways is through taxation. Governments often raise taxes to pay the debt. The problem with this is that the money is collected to pay for inefficient government programs that are usually not very beneficial for society, i.e., pension payments.

Many local governments are under financial stress due to outstanding pension obligations. Moreover, making adjustments to pension obligations is not an easy solution as many pensions have protection laws that prevent government reforms.

Therefore, governments are left with two choices, raise taxes or cut services. If the government decides to raise taxes, consumers often slow down on their purchases causing economic growth to slow. If the government decides to cut services, workers are laid off, and public work projects are canceled.

Also when governments raise taxes, especially income taxes, less money goes into personal savings. Speaking for myself, I pay over $500 in federal income taxes, money that I could otherwise save for personal use that would ultimately benefit the economy. As I said previously, savings is what grows the economy, not spending.

Inflation to Pay for Government Debt

Another factor that we must look at is monetary policy. When government debt is high, central banks lower interest rates to keep the debt interest expense low. If the interest rates on government debt rise, so too do the cost of borrowing.

If taxes are already high and the government is unable to raise it again without public discourse, they will begin to inflate the debt away. Today, nations use inflation as the primary method of wiping out government debt. Why is this a popular method? Because governments all have a monetary printing press. There’s no stopping the amount of money they can print to pay the debt.

However, inflation causes the price of goods or services to rise. If prices are rising, then consumers will slow down on their discretionary spending or even savings. Once again causing the economy to slow down.

Furthermore, rising prices, low economic growth, the inability to save, are all factors that lower the American standard of living. They harm the economy and the nation’s citizens and are a result of a substantial amount of government debt.

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