Debt Can’t Replace Productivity as the Long-Term Driver of Economic Growth

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After 10 years of bull market and growing economy we are seeing the first signs of rising uncertainty about the economy in the next few years.

How the economy works is really fascinating. There are thousands of variables involved and of course there is not a single interpretation.

However, a common ground can be found in the concept that the economy economy works based on cause and effects.

As Ray Dalio said:

Economies and markets work like machines with basic cause-effect relationships (including human nature) interacting to cause their movements.

I strongly recommend to check out this video by Ray Dalio showing his point of view, just 30 minutes, totally worthy.

Since we talked about cause and effect relationships, what are the drivers of the economy?

Here are three factors that determine economic growth:

  • Productivity Growth
  • Short-Term Debt Cycle (5–10) years
  • Long-Term Debt Cycle (50–75 years)

Productivity: the Real Driver of Growth

Financial news talk about everything, from trade wars, politics, trends to monetary policy and interest rates, but let me ask you a question: how often do you hear news about productivity?

Productivity has the most important long-term influence on economic growth but very few people and politicians pay close attention to it.

Productivity depends on a wide range of factors of a country. Among them, the country competitiveness, the value of the people, the work attitude, saving rates, corruption, infrastructures and law.

When you start thinking this way the real issue in developed countries’ economies is clear:

Productivity growth IS SLOWING

Considering United States, year after year, the following chart clearly shows that in the last decade there hasn’t been any consistent growth in productivity compared to the previous period.

Source — FRED

If you want to have a great economy, increasing people’s productivity is mandatory.

For example, improving laws, infrastructure and education provides a fertile soil for development. Or having STEM students at the end of the day improves the overall technological progress.

This is hard and not immediate.

The easy solution? Debt.

It is easier to get debt to buy a new car, it is easier to get debt to buy a larger home, it easy to create a big deficit to keep the economy going.

The slowing down in productivity has been “compensated” by a higher debt growth.

Creating more debt is easy compared to improving productivity. This allows for results in the short-term, even if they may cost way more in the long-term.

Why today’s economy is so debt oriented? Because debt hurts only in the long-term, meanwhile the patry keeps going.

Debt to Boost the Economy

The trick here is that if there is low productivity, it is possible to use debt to boost economic output in the short-term.

That is what has been going on in the last decade and following the last financial crisis. What nobody talks about is that it is possible to do so only for a certain period of time.

This is nothing permanent and gives birth to a cycle because at some point the debt becomes a burden which slows down economic growth.

Instead of increasing productivity, developed countries tried to stimulate the economy through a higher level of debt.

This is an indisputable fact and while we could argue about the level of impact on GDP growth economy we can all agree on the fact it was a major driver of that growth

I have already talked extensively about debt and debt cycles and their effects in the economy. Just to put things in perspectives, here is the total public debt as a percentage of the GDP in the United States.

Source — FRED

The debt of all the deveoped economies exploded in the last decade. Keep in mind that this is just government debt, the overall level of debt is even higher and takes into account both consumer and corporate debt, that could really be one of the catalyst of the coming market crash.

There has been some kind of economic growth, but while this provides a feeling that everything is good, it is just a temporary thing that creates even bigger problems in the coming years.

It is not a accident that financial crisis are bigger and bigger every time they show up. 

While it is true that now interest rates are lower so the cost of debt is lower, there is no guarantee that it will be the case in the coming years. Interest rates change over time and if they were to go up, the burden of that debt becomes higher and higher.

Debt works as a self-reinforcing cycle: More debt → more spending → higher economic growth → more employment

What happens when the economy reaches a limit and can’t accept a higher level of debt?

In the short-term, there is typically a slowing down in the economy, with debt restructuring, interest rates that gets lowered and open the way to a new cycle of cycle of debt and leverage.

In the long-term? That’s the right question.

Long-Term Debt Cycle lasts from 50 to 75 years, that’s why nobody cares. But the fact that no one cares doesn’t mean that they don’t exist or that they are not important.

I think that the next couple of decades will be very interesting times for the economy and I am really curious to see what’s next, when creating even more debt won’t work any longer.

Any ideas? I’d really like to know your opinion on that.

This article is for informational purposes only, it should not be considered financial advice. You can read the full disclaimer here.

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