26 April 2013

One in Four African Countries May Double GDP This Decade

For a change here is some good economic news. From the World Bank's latest Africa's Pulse:
About a quarter of countries in the region grew at 7 percent or better, and several African countries are among the fastest growing in the world. Medium-term growth prospects remain strong and should be supported by a pick-up in the global economy, high commodity prices, and investment in the productive capacity of the region’s economies.
Seven percent is pretty good. It is not a threshold, or a tipping point, but as a growth rate it has the neat quality that 7% is about what you need to double in size in ten  years. 

Growth alone does not guarantee development, and the report points out that poverty reduction lags behind the economic performance. This is basically good news; for many people the world is becoming an easier place to live.

20 April 2013

Moving the Threshold

It seems that the tipping point for the decision by Fitch to downgrade the UK credit rating was their forecast that gross government debt would pass 100% of GDP. FT Alphaville reports:
Fitch now forecasts that general government gross debt (GGGD) will peak at 101% of GDP in 2015-16 (equivalent to 86% of GDP for public sector net debt, (PSND) and will only gradually decline from 2017-18. This compares with Fitch’s previous projection for GGGD peaking at 97% and declining from 2016-17 and the ‘AAA’ median of around 50%.
It looks like: 97% good, 101% bad.

It comes at the end of a week when we have been celebrating the demise of the myth of the 90% threshold for debt to GDP beyond which lay catastrophe.

A 100% the threshold doesn't make any better sense than 90%. In fact as Frances Coppola pointed out yesterday, the debt ratio is a poor way to predict the health of an economy. It is even a poor way of looking at the health of public finances. She explains it like this:
Debt/GDP is a pretty confusing metric, since it compares a stock and a flow. It would be more meaningful to compare fiscal deficit/GDP. But even that is not ideal, since GDP measures activity in the economy, not government income, and the government income figure is netted with spending to give the deficit. The reality is that governments do not have to pay all their debt off in one year - in fact most governments pay off little or no debt. What they have to do is service the debt. And their ability to service the debt is governed by two things: 1) the interest rates prevailing on outstanding debt stock and on new issues during that period: 2) revenue from taxation and other income.
What does it mean to say that national debt is 100% of a country's annual income? It means  that debt is 50% of two years income, 25% of four years income or 10% of ten years income. That is what happens when you mix a stock and a flow. I've talked before about how government's can run deficits forever, provided the economy is growing.

The reasoning behind Fitch's downgrade is flawed and we should take no notice. Unless, like Ed Balls you want to add to Mr Osborne's discomfort.

18 April 2013

Begging the Queston

Yesterday's post was a bit long winded (by my standards) but the fuss over that paper has helped me refine my critique.

Never mind the economics or the maths, the problem I see in Reinhart and Rogoff is an error of logic. The idea of a 90% threshold is an assumption. It cannot therefore be a conclusion.

I can expose the logic using an old fashioned syllogism:
High debt correlates to low growth
The threshold for high debt is 90%                        
Therefore 90% debt is the threshold for low growth

If the premises are true so is the conclusion. R&R put a lot of effort into establishing the first premise but none at all into the second. It is an assumption.

Assuming your conclusions is the logical fallacy of begging the question, or as the ancients called it petitio principii. I have long supported the idea of teaching logic in schools. I now think it should be a compulsory subject for economists.

17 April 2013

The 90 Percent Solution

Economic growth slows when public debt passes a threshold of 90% of GDP.

This factoid (or as economist prefer "stylised fact") had become part of the armoury of those defending austerity. It is now officially nonsense.

The idea came from a paper by Reinhart and Rogoff, the authors of an acclaimed book on financial crises, This Time Is Different: Eight Centuries of Financial FollyThe 90% myth however is from a different paper. That paper has recently been found to contain some errors of arithmetic which when corrected makes the 90 threshold disappear.

The paper has been criticised before, for example by Krugman , but now it is discredited. However I have always argued that the methodology, or the logic, was flawed. The two economists examined a vast dataset of countries with various levels of debt to GDP ratios. Here is how I explained the error of logic in an earlier post:
The paper simply slices the data into four sets where the debt ratio is below 30%, 30%-60%, 60%-90% and above 90% and then compares median and mean growth rates. So the 90% "threshold" is manufactured by the methodology. It does not emerge from the data.
In other words they chose 90% and so cannot conclude that 90% is a threshold. As an error of logic it is known as petitio principii or begging the question or a circular argument. What if they had cut the date into 20 % chunks instead. Would we have had an 80% threshold or a 100% threshold?

Indeed looking at the footnotes of the original paper we find that the authors were aware of this problem, (although it didn't prevent them boldly stating their conclusion):
The four “buckets” encompassing low, medium-low, medium-high, and high debt levels are based on our interpretation of much of the literature and policy discussion on what is considered low, high etc debt levels. ... Sensitivity analysis involving a different set of debt cutoffs merits exploration ...
At last, the notion of a threshold can be junked because of a mistake in a speadsheet. But don't let that put you off the book. It is in a different class altogether.