Debt, Deficits, and Jobs. Where's the Link?

Economists and pols debate the impact of government spending
Republican Senator Rand Paul Photograph by Ron Sachs/AP Photo

Congressional Republicans still refuse to increase the country’s borrowing limit without concessions. The nation’s $16.7 trillion debt, in their view, is a major drag on the economy, weighing down growth and job creation. “Some economists say that we’re losing a million jobs a year just because of the burden of our debt,” Kentucky Republican Senator Rand Paul said in an Oct. 6 appearance on Meet the Press.

There’s a fierce debate among economists over the truth of such statements. One view—essentially Paul’s position—is that the more a government borrows, the more it competes with borrowers in the private sector. That contest tends to push interest rates higher; as a result, businesses lower investment since they can’t access financing. Lower investment means lower rates of hiring.

The theory that public debt has a psychological effect on investors plays a part, too. Nineteenth century British economist David Ricardo studied the impact of government borrowing: When it increased, he believed, consumers and businesses reacted by saving more and spending less to prepare for tax increases needed to pay off the public debt. Businesses failed to expand—and hire—out of concern that their profits would be taxed away.

Opponents of this theory say they see neither the Ricardo effect nor the crowding out of private-sector borrowing happening in a big way. Interest rates are at historic lows despite a level of public debt not seen since the 1950s. Last year the U.S. paid $220 billion in interest, or 6.2 percent of government spending overall. The Office of Management and Budget says that since 1973 the government has spent an annual average of 10.6 percent of the budget on interest.

The national debt also doesn’t appear to be businesses’ main preoccupation. In a September survey of 773 small enterprises by the National Federation of Independent Business, 65 percent said it was a bad time to expand. Of those, 52 percent said the main reason was weak sales. Only 2 percent said financing was their top problem. “Small businesses are not that worried about the debt,” says Bill Dunkelberg, chief economist for the NFIB. “They’re worried about demand. Until they see more customers walking through their doors, they’re not going to increase hiring.” Adds Joseph LaVorgna, chief U.S. economist at Deutsche Bank: “There is simply no evidence to suggest that the debt is holding back hiring.”

At the core of this debate is a 2010 paper by Harvard University economists Carmen Reinhart and Kenneth Rogoff. Growth in a Time of Debt amassed evidence that when countries hit public debt levels of about 90 percent of GDP, their economies shrink by an average of 0.1 percent, with negative consequences for hiring. The accuracy of the paper, which has been cited by U.S. conservatives fighting for deficit reduction, was challenged in April by economists at the University of Massachusetts, who uncovered a coding error in its calculations. According to the UMass researchers, the economies of countries with public debt greater than 90 percent of GDP actually grew by an average of 2.2 percent. Even without the technical error, some economists say Reinhart and Rogoff’s paper applies to a world that no longer exists after the 2008 financial crisis. “Those kinds of models are simply not useful right now,” says Martin Eichenbaum, an economics professor at Northwestern University. In a 2012 follow-up paper, Reinhart and Rogoff clarified their findings but reiterated that in advanced economies, high levels of public debt correlate with slower growth.

Even though the deficit has been halved since 2009, it will rise in 2016 as entitlement spending begins to eat up funds, and the debate over the debt’s impact on jobs will intensify. “I don’t vote for a debt-ceiling increase unless we get cuts in return,” says Representative John Fleming, a Republican from Louisiana. He compares the economy to families and small businesses. “When you max out your credit card, you have to figure out what you can cut before asking for another one.” Not so, Eichenbaum says: “Repeat after me: What is true about your family or your business is not true about the economy.”


    The bottom line: The U.S. last year paid $220 billion in interest on its debt, only 6.2 percent of the government’s budget.

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