History of national debt teaches a clear lesson

T he popular claim that America’s exploding national debt doesn’t matter has many disturbing past parallels. Repeatedly leading societies have convinced themselves that “this time is different,” only to repeat the fate of previous profligate states.

History teaches that high spending on politically favored priorities and rising debt have consistently undermined growth through crowding out private-sector investment, crowding out public-sector investment in longer-term priorities, and sparking financial crises as investors come to doubt the government’s creditworthiness.

Highly indebted countries have generally experienced relatively high real interest rates, low capital investment and growing inability to invest in infrastructure and education. Investors have been right to worry, since government defaults have been surprisingly frequent.

Enthusiasts for “Modern Monetary Theory” correctly note that governments printing their own currency need never default. Still, such governments have caused countless crises through high inflation and other disguised variations on debt repudiation.

Today’s debt apologists argue that history’s lessons don’t apply to America because the United States issues the leading reserve currency and remains the world’s preeminent geopolitical power. Evidence from faded great powers of the past, however, tells a more worrisome story.

The Roman Empire. Imperial Spain. 18th century France. China in the 19th century during the Qing Dynasty. The United Kingdom starting in the 1920s, but particularly after World War II. Each of those leading powers spent lavishly in some way and undermined their strength by not controlling their spending and debt.

Debt apologists also argue that Japan, whose ratio of gross debt to GDP is above 240%, shows that a wealthy country can spend freely and incur large indebtedness without paying any economic price. But Japan’s net indebtedness is far lower, as the government holds an unusually large stock of financial assets.

The good news is that history offers abundant evidence that countries with sound institutions can achieve what economists call “fiscal consolidation” — that is, long-term paths back to sustainable finances. Economist Alberto Alesina has documented numerous examples of fiscal consolidation, many taking place after financial crises. The most durable debt reductions, he finds, have typically resulted from sustained spending restraint rather than tax increases.

Evidence that fiscal consolidation can succeed in modern democratic societies comes from Sweden, Denmark and Finland, which experienced severe crises in the early 1990s after two decades of galloping growth in social spending. In each country, parties across the ideological spectrum reached consensus on fiscal prudence and began long processes of thoughtfully reforming their welfare states.

The lessons of history are clear. Countries that spend and borrow extravagantly do so at their economic and geopolitical peril. But history also teaches that great nations on an unsustainable trajectory can sometimes course-correct. America can, and must, stop the growth in its debt.

J.H. Cullum Clark is director of the Bush Institute-SMU Economic Growth Initiative.