GDP and the Perpetual Debt Trap

In the previous article, we read about how the GDP system encourages incessant and reckless borrowing on the part of the governments. This system rewards both the governments and the individual politicians for indulging in financially imprudent behavior. However, the problem does not end there. The GDP system not only makes borrowing money seem like an attractive proposition. It also makes paying off debt seem like a bad thing to do. When both these factors are combined, we can see why the GDP system has implicitly encouraged and even led governments into the perpetual debt trap. We will explore this in detail in this article:

Borrow and Raise GDP!

As we already know that government spending forms a major part of the GDP in most countries. In many developed countries the government spending accounts for as much as 40% of the total GDP! This means that the government has the power to simply borrow money and create the illusion of economic prosperity at least momentarily. Needless to say, that these powers are being widely exercised by governments worldwide. The recent debate and the resultant raising of the debt ceiling by the Obama government is testimony to this fact. Also, one needs to consider that United States, which is arguably the biggest economy in the world with a $45 trillion GDP needs to borrow $2 billion on a daily basis merely to stay afloat.

If the US government simply failed to raise these $2 billion dollars on any given day, it would end up defaulting on its previous debt obligations and a cascading spiral of economic failures would erupt.

Artificial Rise vs. Legitimate Rise:

So, now we have a problem. We have two different types of growths happening in the economy. One is the good kind of growth i.e. the legitimate growth. This means that this growth has been accomplished by more efficient use of resources. For instance, when a car is developed which is more fuel efficient, growth has happened. Technology has enabled more transport to happen with the same or lower amount of gas being used! This is the real growth.

On the other hand, we have this artificially created government growth. There is no concern for efficiency. It doesn’t matter if the car is more fuel efficient or less. The idea is to produce as many cars as possible. This kind of growth is artificial growth and causes wastage of resources.

However, GDP does not differentiate between the kinds of growth. Any growth is considered an increment in the GDP.

What Happens Tomorrow?

When governments fund the artificial growth with borrowed money, big problems emerge in the future. The artificial growth was basically wastage of money. This means that it is not sustainable i.e. it cannot pay for itself. Since it cannot pay for itself, but the government borrowed the money, now the taxpayers have to pay the bill.

Thus, poor government borrowing decisions lead to high interest and principal payments in the future. Since the projects were never economically viable in the first place, taxpayers have to shell out more and more in taxes as time passes by.

Disincentives to Pay off Debt:

Let’s say that governments and taxpayers find themselves in a downward debt spiral. They realize that the expenditure has been wasteful and also realize that they need to pay the debt back, then what happens.

Well, if the government pays off more debt, it means less spending. Less government spending means a smaller GDP. A fall in the rate of GDP is defined as recession. Therefore, if the government decides to do the right thing and pay off the debt, it ends up creating a recession! The effects of the recession once again have to be borne by the common people in the form of unemployment and job losses.

Thus, any government which relies on excessive borrowing, even in the short term ends up creating a debt spiral. Firstly cutting down on spending becomes extremely hard because of the added interest costs. Even if the government took the difficult steps, it would end up creating a recession and be voted out of power! It is no wonder that governments across the world do not try to cut debt unless it is absolutely necessary.

Incentives to Borrow More:

Governments would have to take so many drastic and unpopular steps to restore the economic system. However, on the other hand, if the government simply continued to borrow more, it would keep up the illusion of prosperity. More borrowing would show up as more expenditure and would therefore boost the GDP! The governments and politicians would win laurels for improving the growth rate when in reality they have taken reckless decisions.

The GDP system is therefore bound to create a debt spiral for any country which chooses GDP maximization as their objective. Like a drug, GDP maximization keeps nations hooked on debt. Any attempt to restore the underlying economic fundamentals is extremely difficult in the short run.

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