quinta-feira, abril 18, 2013

On Reinhart and Rogoff: debt and growth, causality or mere correlation

The economists Reinhart and Rogoff are having to defend their statistical analysis of debt and growth over decades as well as their conclusions.

Some analysts even question whether their "advice that high debt-GDP ratios – particularly above 90 per cent – are harmful to growth" is relevant to countries in the Eurozone. 

On the contrary, the negative correlation between excessive external debt and economic growth is all the more critical to the member countries of a customs and currency union such as the Eurozone, who are defenseless, having given away nearly all of their adjustment policy tools. 

And the causality is pretty clear, at least  to those of us on the front lines rather than in academia: Increasing external debt and other tsunamis of hot-money capital inflows finance persistent and growing trade deficits. Higher imports mean lower GDP. Even imports of capital goods fail to deliver (export-led) growth to the extent that local production loses economies of scale and becomes noncompetitive. And the net exporters are only too eager to recycle their trade surpluses in the form of more “vendor-financing” for more imports, of cars, submarines... 

Lacking the correct FX price signals to provide advance warning of the excessive external debt accumulation,  whatever the currency of denomination, net importers are lulled into the illusion that external deficits no longer matter, until the creditors impose a sudden stop. 

The lack of recognition of the flow of causation from speculative external credit, to external deficits to internal (Government deficits) means that the Eurozone adjustment programs are mis-designed and mis-directed, and thus ineffective. For example, the so-called “bail-outs” have not included the pre-export trade finance revolving lines of credit that were a standard feature of the Latin American debt crisis.

In a customs and currency union, for the weaker member countries, trade deficits  are not self-correcting, so they must be kept low. That means that trade surpluses of the net exporters must also converge, and not keep “Testing the Limits of Divergence in the Eurozone".  

Word to the wise net exporter / net creditor:  If you keep inflating exports sales to weak importers with easy credit, be prepared to take some losses, or to find a rich uncle (ex. the ECB) to bail you out.  

Mariana Abrantes de Sousa 
PPP Lusofonia

See Record trade surplus tests divergence  http://ppplusofoni...a-divergencia.html
Testing the limits of divergence in the Eurozone
Reinhart and Rogoff response
The article in the Economist
and  PPP Lusofonia comments in the Economist