Turner: Banks can produce the wrong type of debt – Akerlof: Insolvent debtors can become irresponsible – Lazear: There is good and bad demand for debt – Zhao: Bad management of borrowing by Chinese cities – Kastrop: Markets need to discipline sovereign borrowing
Kiel – Almost a decade after the start of global financial crisis, participants of the Global Economics Symposium warned the world economy was still too reliant on debt. But economists and policy experts at the meeting, organized by the Kiel Institute for the World Economy, also praised efforts to counter reckless borrowing.
“A free banking system left to itself will produce the wrong source of debt,” said Adair Turner, chairman of the Institute for New Economic Thinking and former head of the UK’s Financial Services Authority. In his view, banks are currently more prone to finance existing assets like real estate than lend to businesses looking to build capacity. In times of economic downturn, the resulting investment bubbles can burst and lead to debt shifting from private to public accounts, rather than being paid off. “Since 2007 debt levels haven’t gone down.”
George Akerlof, Economics Nobel Prize Laureate and a professor at Georgetown University, noted that there were “ways in which debt is a good security”. But he agreed that there comes a point at which excessive debt – and insolvency - can become a problem, even leading to recklessness. “Once you get to the point where the debtor is under [water], then the incentives are the exact opposite of when you own the house,” he said.
One way to assess whether debt levels are sustainable is to look at what is driving demand, according to Edward Lazear, a professor at Stanford Graduate School of Business. The investment needs of a strong economy produced “good demand” for debt, while “bad demand” was found in situations “where borrowers don’t bear the cost of default.” He suggested this might currently be the case with tech entrepreneurs seeking venture capital.
Chinese municipalities, which borrowed heavily to build houses and roads, were seen as a current example of debt-financing gone awry. “There was bad management of expansionary lending, bad planning, waste of capital,” said Changhui Zhao, chief country risk analyst at the Expert-Import Bank of China. The only way to take stock of the gravity of the situation was for the central government to step in. “If we can manage debt in a balanced and sustainable way, it can reinforce growth. Other than that, it is a real issue we have to deal with all of the time.&rdquo
But participants could not agree on safe levels for sovereign debt. Pablo Guidotti, professor at the School of Government at Argentina’s Universidad Torcuato di Tella said, “There is no guide to as when sovereign debt is too high.” But he warned investor sentiment could turn very quickly. Christian Kastrop, Director of Policy Studies at the OECD, said studies suggested debt levels between 40 and 60 percent of GDP. He praised Eurozone budget consolidation. Peer pressure had worked. “But markets also need to play a role and signal first.”
Find the program of the GES 2015 here.