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Public debt: What's the ideal level?

Economic growth goes beyond debt financing. [iStockphoto]

One of the highlights of President Uhuru Kenyatta’s Madaraka Day speech was his assertion that debt leads to economic growth. It was a convincing statement, quoting South Korea’s phenomenal economic growth.

The best measure of the national debt is its ratio to gross domestic product (GDP). In 2021, South Korea’s debt to GDP ratio was 47.3 per cent against Kenya’s 68.1 per cent.

Why do we always use South Korea as a benchmark for economic growth?

Was her growth prompted as a bulwark against communist North Korea?

Why not use Scandinavian countries as the benchmark? What does empirical research say about debt versus growth?

A policy brief, “Debt and Growth: A Decade of Studies” by Veronique de Rugy from George Mason University dated 2020 suggests a negative relationship between debt as a percentage of the GDP and economic growth.

The author finds that once the debt to GDP ratio goes beyond 90 per cent, more debt reduces growth.

One of the papers quoted in the policy brief is by Kenneth Rogoff, a 2001 Nobel Prize winner in Economics.

This could be good news for Kenya since our ratio is still below 90 per cent. Why would a higher debt ratio lead to negative growth? Such high ratios could prompt “higher taxes, lower future incomes, and intergenerational inequity,” says the brief. Does that sound familiar?

At age 59, this country is old enough to stop borrowing and start lending. [iStockphoto]

The brief further adds: “High public debt can negatively affect the capital stock accumulation and economic growth via heightened long-term interest rates, higher distortionary tax rates, inflation, and constraint on countercyclical fiscal policies, which may lead to increased volatility and lower growth rates.”

We have not mentioned the crowding effect, the possibility of the private sector dissaving and the cost of servicing the debt. The money borrowed by the State crowds out (denies) the private sector money. Yet, the private sector is often more efficient in utilising such funds, leading to job creation.

The popularity of debt arises from the possibility of shifting responsibility from one regime to another or even generation. It’s also more palatable politically. Taxation affects voters immediately. Did you expect the new tax proposals to go through parliament a few months to the polls?

Too much debt might make us feel it’s normal, almost like free money. You know serial debtors?

In Kenya, we have even made it easier for individuals to borrow electronically. That’s why taxi drivers don’t want to be paid through M-Pesa.

President Kenyatta was explaining to Kenyans that debt is not that bad in the right hands, and can be a catalyst for economic growth. We have tried to explain that this borrowing has a limit.

We add it must be put into sectors that have the highest socioeconomic returns.

We have seen how debt has uplifted entrepreneurs and individuals in the countryside. Add chamas.

Economic growth goes beyond debt financing; add innovation, regulation and even the attitude of citizens towards work.

Will the next regime take Uhuru’s advice and continue borrowing? My hunch is Yes.

It’s unlikely that a new president will start his term with higher or new taxes.

The proposal to raise the debt ceiling to Sh10 trillion is a clear indicator that more borrowing is likely after August 2022.

And more debt ceilings will come as the next regime tries to create its legacy and impact. Some have suggested that we need a debt ceiling fixed by law. Some could argue this could tie the hands of the Central Bank of Kenya in its policy making.

The debt ceiling should not be an absolute figure but a percentage of GDP.

Economic growth goes beyond debt financing. [iStockphoto]

The proposed 55 per cent is within the range for which debt is a catalyst of growth. Sixty per cent is quoted as the optimal ratio. Why is this a better approach?

Simple algebra says that to reduce or keep that ratio constant, we just increase the GDP. Simply put, grow the economy.

A ratio as debt ceiling means that we shall not just look at the absolute money borrowed but whether it is put into good use, and grows the economy.

Theoretically, we can take as much debt as we can as long as the economy grows.

This should make even the dullest economist smile. This approach will force our leaders to come up with pro-growth policies, laws and regulations.

Ensuring no one is left behind will also catalyse economic growth. Tying debt to economic growth will truly confirm that debt can be a catalyst for economic growth. 

Finally, we need to grow fast enough to start lending money to other countries - it’s prestigious and profitable.

As children, we have given money. After maturity, we started earning our own money and even lending or giving out to charity. That applies to countries. At age 59, this country is old enough to stop borrowing and start lending.