Reducing Debt and Other Measures For Improving U.S. Competitiveness

At more than $16 trillion, the United States’ gross national debt has grown to equal its gross domestic product—a level that for other nations has marked an economic tipping point.

A new Mercatus Center study discusses potential near- and longer-term impacts of high levels of government debt on U.S. economic growth and competitiveness. The study also reviews the experiences of other nations with debt-to-GDP ratios similar to that of the United States.
  
Below is a brief summary. To read “Reducing Debt and Other Measures for Improving U.S. Competitiveness” in its entirety and learn more about its authors, please click here.

Key Points:

The United States’ high levels of debt are already contributing to slower economic growth and decreased competitiveness. These impacts will worsen if the nation’s debt-to-GDP levels continue to rise, as is currently projected.

Competitiveness

• High levels of government debt undermine U.S. competitiveness in several ways, including crowding out private investment, raising costs to private businesses, and contributing to both real and perceived macroeconomic instability.
  • A nation’s ability to compete successfully depends on its ability to employ resources productively. Servicing high levels of debt directs resources away from productive activity.
  • When government borrows, demands for funds increase, private businesses must compete for capital, and eventually, the price of borrowing—interest rates—rises.
    • This increases the cost of doing business in the United States, reducing profits and growth and driving some businesses out of the market altogether.
    • For a nation, this means a decrease in the level of capital accumulation—the core of economic development. As the nation’s producers accumulate less capital, fewer goods are produced overall, and economic growth declines.
  • High levels of debt also contribute to macroeconomic instability.
    • High and growing levels of debt create uncertainty about the tax levels required to service debt costs, and about the potential for inflation; this uncertainty is detrimental to overall productivity and growth.
  • Further, the direct financial burden of large and indefinite interest payments interfere with a nation’s ability to provide essential services and to make needed investments to improve national productivity and competitiveness.

International Examples

• Two key international studies provide empirical examinations of the impact of high levels of government debt on economic growth.
  • Carmen Reinhart and Kenneth Rogoff examine historical data from 40 countries over 200 years and find that when a nation’s gross national debt exceeds 90% of GDP, real growth was cut by one percent in mild cases and by half in the most extreme cases. This result was found in both developing and advanced economies.
  • Similarly, a Bank for International Settlements study finds that when government debt in OECD countries exceeds about 85% of GDP, economic growth slows.
  • The United States’ gross debt has already exceeded both of these empirical thresholds.

Immediate Steps

• While debt must ultimately be paid down, there are other competitiveness-enhancing reforms that can be quickly implemented. These include:
  • Corporate tax reform. While fundamental tax reform is required to correct a host of structural inefficiencies, policymakers can quickly reduce the U.S. statutory rate of 35% to the OECD average rate of 26% or less.
  • Regulatory reform. Regulations have been historically biased toward existing technologies and increasing regulatory burdens on new entrants to a sector. This negatively impacts growth, and increases prices for consumers.
    • To mitigate the impact of industry and interest group bias on regulatory outcomes—and on economic growth—near-term reforms should include an auxiliary criterion that requires regulators to evaluate the impact of a potential regulation on domestic and global competition. Near-term reforms should also ensure sufficiently flexible regulations that allow firms to comply with the desired mandate of regulators, while still continuing to innovate, finding low-cost ways to comply, and implementing new technologies.
  • Tort reform. U.S. businesses are liable without bound within a complex and decentralized code that varies from state to state. This structure of U.S. product liability laws deters innovation and places domestic firms at a competitive disadvantage with international competitors who face no such litigation.
    • Overarching federal legislation could introduce bounds and simplicity into the U.S. product liability system. Such reforms could include caps on the amount for which companies are liable and time limits for liability after a good was produced.