It is no surprise that each country’s economic model is not the same. We have analyzed aggregate balance sheet and income statement data and created four buckets or ways to grow GDP. However, each country rarely relies solely on one of these strategies. Instead, they usually combine strategies depending more on one or two.
The three approaches are: the government debt and spending model, net export model, and the business debt and spending model. There are two notes we should mention with each of these growth models.
First, once using a given model, that strategy must be continued. If an overnight pivot to another model would occur, a painful outcome or downturn could happen.
Secondly, the other problem is that all the models are difficult to sustain over the long run because the kind of debt that fuels them must continue accumulating.
Some governments don’t even realize that they’re following a specific strategy. It just happened organically. Others have no deliberate strategy, and their approach is simply the byproduct of their prevailing economic circumstances and social and political situation. The data is not sufficiently current to know with certainty whether any of the countries’ boosted government spending proliferated wealth inequality.
So, let’s compare the Big Seven countries. Together, they constitute 62% of the global GDP. Pay close attention to the remarkable differences of Germany and China when compared to the other five.
The American Way
Five of the Big Seven follow the U.S. paradigm, so let’s start there. As explained in previous blog posts , government spending and deficits directly boost private sector net income (household net income). Another way of saying this is that a decline in government net worth is directly offset by a household sector wealth gain. This is called the government debt and spending model.
The government debt and spending model works best for large, developed countries because they have deep markets for their debt. However, it’s risky for a small country’s government. They borrow in a foreign currency and run a trade deficit that can easily lead to a devaluation and a government borrowing crisis. Plus, in some countries, like Japan, government spending benefits nonfinancial businesses (NFBs) instead of households. As a result, government debt is the most significant loss for the U.S., Japan, France, India, and the UK.
British Try to Find Balance
Unsurprisingly, the UK economic strategy is reasonably like the U.S. The country adopts a government debt and spending model. The UK’s total debt doubled from 133% to 261% of GDP from 1970 to 2021. Explosive private debt growth occurred between 1979 and 1991, 1997 and 2008, in the early 1990s, and after the Great Financial Crisis. As in the case of the U.S. and France, government debt grew, so the government spent to bolster the economy.
In terms of household net worth, UK households lost money from 2017 to 2019. This was also evident in the U.S. in the years immediately preceding the crashes of 1987 and 2008. As in the U.S., the UK saw very high household spending on real estate purchases resulting in losses.
The high level of net income for the rest of the world (ROW) is a disadvantageous trend for the UK. This is because of its large trade and current account deficit. It also helps explain the discontent over an unfair trade disadvantage, which may have pushed the Brexit vote. This deficit has worsened with the Ukraine-Russia War and the corresponding increase in natural gas prices because of the UK’s dependence on natural gas imports.
Persistent trade deficits create vulnerability. For example, it contributed to a late 2022 collapse in the pound’s exchange rate versus the dollar, making imports more expensive for Britain when COVID-linked inflation was already decimating household budgets.
The UK government’s net worth has declined for the same reason as in the U.S. and France. Its debt is increasing. But again, that decrease is more than offset by an increase in household net worth. From 2000 to 2020, the net worth of Britain’s households increased from 404% of GDP to 535% of GDP, while the government’s net worth declined from negative 4% to negative 69% of GDP.
Compared to France, however, its total debt growth has moderated over the last decade.
France’s Debt Economy
France’s total debt has grown rapidly. From 1970 to 2021, total debt rocketed from 115% to 346% of GDP. From 2013 forward, French private debt has continued to grow excessively. The spike in debt in 2020 reflects pandemic relief spending, including higher payments from unemployment schemes and a drop in GDP. Like in the U.S., the increase in government pandemic spending fueled a dramatic rise in household net income and net worth. And in not-so-great news for France, a substantial amount of this relief ended up in the hands of the ROW sector, because France’s exports declined more than its imports.
France’s net income trends show the same outcome as in the U.S. Increased government spending boosted the net income of its household sector. However, France’s total domestic net income is slightly negative because of the small but persistent French trade deficit. As in every country, total domestic net income and the net income in the ROW are inversions of each other, since net income is a zero sum game.
However, a notable difference between France and the U.S. is that the French government’s macrosector has a positive net worth. In contrast, the U.S. government has a significant negative net worth. Much of this is because the French government, including its local governments, owns substantial stocks and other financial assets, while the U.S. government holds almost none. As a result, the U.S. government has far fewer assets relative to GDP than all the six other governments.
Germany as an Exception to the Rule
Germany’s total debt is the lowest among the developed Big Seven countries. An exceptionally favorable trade balance from 1981 to 1990 and 2003 through 2021 allowed Germany to have favorable economic growth without relying too much on total debt growth. Still, its total debt growth has risen from 102% to 199% of GDP from 1970 to 2001.
To understand Germany’s economic approach, it must be noted that, for the five countries that adhere to the government debt and spending model (U.S., UK, France, India, and Japan), increased government debt has provided a positive net income to households. However, most of the increased spending of households comes from increased household debt, not increased government debt. Household debt and spending alone does not and cannot bring increased household net income since the spending from one household to another offset each other. It has to be payments to households from outside the household macrosector, either from government debt and spending, business debt and spending, or net exports. And, among these three options, it is most typically government debt and spending that has the most significant impact on increased household net income and net worth. It generally takes the government’s spending for household income to exceed its expenses.
But there have been two major exceptions: Germany and China. Germany uses what is called the net export model. For Germany, the macrosector with the most extensive loss has been the ROW, since Germany’s partners in trade collectively post a sizable net loss in their net trade with Germany. That means Germany sells more to them than they sell to Germany, which is much to Germany’s net income benefit. As a result, the country has seen moderate growth while maintaining low debt, but vulnerability to trade conflict.
This ROW loss has been good news for Germany because it means more net income for the country’s private sector and, thus, more taxes for Germany’s government. Exports provide income that isn’t reliant on domestic debt growth but on the importing country's deficit. Because of this significant trade surplus, Germany’s combined NFB and household net income, in ratio to its GDP, has been more robust than that of the net importing nations—the U.S., UK, and France—and the country is simultaneously able to post slightly positive government net income. Every domestic macrosector’s net worth, has gone up in the twelve years since the Great Financial Crisis, including the government’s.
But Germany’s golden age of a vast net export surplus is being challenged. In 2022, as its imports have exploded mainly due to rising energy costs, that surplus has declined markedly.
Signs of Improvement in India
The economies of the U.S. and China tower over all the others, but India is now on par with the UK and France. However, there are scarce metrics available for India. The country’s total debt is considerably lower than that of other Big Seven nations. And, while India’s debt is starting from a lower base, its growth in debt has still been high. Since 1970, its total debt has gone from an estimated amount of below 50% to 176% of GDP in 2021.
India posts a trade and current account deficit, as it has not translated its low wage profile into a net trade advantage, so the net income of the ROW has been positive, to India’s disadvantage. Less developed countries like India have less debt, and as such, much of India’s debt accumulation will happen in the future as it increases its spending on development.
The Highs and Lows of Japan
Japan’s total debt is the highest among the Big Seven. Japan’s debt grew from 130% to 430% of GDP from 1970 to 2021, although roughly 90 percentage points of that debt have been to fund the Japan Treasury’s purchase of financial assets, including stocks, so the Treasury’s net debt is lower. The extraordinary rise of private debt from 1981 to 1991 led to meteoric real estate and stock market valuations, which then collapsed in the early 1990s. After a peak in the mid-1990s, private debt declined as a percent of GDP through the mid-2010s, exerting a grim 25 years of downward pressure on GDP growth.
Growth declined from a stratospheric 219% to GDP private debt ratio in 1993 to 153 percent in 2015. This extended period of little or no GDP growth has been referred to variously as the Lost Decade, the Lost Decades, and the Lost Generation. Japan’s government moved to offset this through a radical increase in government spending and debt, beginning in the 1990s.
Japan’s net income tells the same story as in the U.S., UK, and France and illustrates that a government deficit is a key source of increased household income. However, in Japan, NFBs get as much of the benefit of government deficit spending as households do.
In 2020, Japanese government debt growth rose at twice the level in the previous five years to combat the pandemic. This increased 2020 government spending and loss translated into significantly increased 2020 household and NFB net income. However, the net worth of Japan’s government went up in 2020 despite the increase in its borrowing because it holds a significant quantity of financial assets whose value went up during the COVID boom.
And Then There’s China
China uses a business debt and spending model because its own NFB macrosector posts the largest net loss. But it has attempted to employ every strategy and is still posting a smaller annual growth in GDP, a problem compounded by its heavy-handed approach to managing the pandemic. This has come partly from decelerating debt growth, but it also means that a good portion of China’s business debt is going to things that don’t increase GDP.
China relies to an extraordinary degree on business sector debt and losses. The country’s government has almost absolute authority over NFBs and lenders, which is a unique element to the big 7. This strategy would be next to impossible otherwise. In other words, China’s non-financial business sector, instead of the central government, is used by that government to pump income into the household sector. However, that may not have been the government’s original intention.
China follows a radically different strategy for boosting household net income growth, unlike any other major country. In China, as NFB net losses grow, household net income increases. Government spending is present as well and includes the spending and debt of local governments. China’s banks and other lenders accommodate this loss by lending whatever is needed to cover that loss and keep those NFBs operating fully. Of course, this is why business loans have grown so rapidly for so many years, and are now at 158% of GDP, a problematic level that is twice the relative level of business loans to GDP in the U.S.
The Big Seven Wrap Up
France is a solid model of most large, developed countries. However, it has very high total debt growth and reliance on government debt growth to increase household net income. The most concerning factor regarding France is the high growth trend in its private sector debt, which could result in an economic reversal within the next few years.
In many respects, Japan is a harbinger of the future for other countries within the Big Seven. It had its cataclysmic debt crisis in the 1990s, well over a decade before the U.S. and Western Europe and a generation before any financial crisis that China may experience. Moreover, with the GDP growth boost provided by private debt growth, Japan has become more reliant on government debt growth, not just to prop up household income but to prop up its financial markets with huge government purchases of stocks and other financial assets. And it may serve as an example of the diminishing impact of rising debt on asset values once they reach extraordinary levels.
All three economic models require significant growth in debt to boost household net income and net worth: government debt in the case of the U.S. and other business debt in the case of China, and the private sector debt of the ROW in the case of Germany. The limits on growth for each of these types of debt represent the limits of each respective model.
This blog is adapted from The Paradox of Debt: A New Path to Prosperity Without Crisis by Richard Vague.
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