The marginal productivity of debt

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The marginal productivity of debt

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2011 Oct 14, 11:08am 1,627 views 6 comments

by uomo_senza_nome ➕follow (0) 💰tip ignore

Please consider this article: http://professorfekete.com/articles/AEFTheMarginalProductivityOfDebt.pdf

I quote from the article:

The key to understanding the problem is the marginal productivity of debt , a concept curiously missing from the vocabulary of mainstream economics. Keynesians take comfort in the fact that total debt as a percentage of total GDP is safely below 100 in the United States while it is 100 and perhaps even more in some other countries.

However, the significant ratio to watch is additional debt to additional GDP, or the amount of GDP contributed by the creation of $1 in new debt. It is this ratio that determines the quality of debt. Indeed, the higher the ratio, the more successful entrepreneurs are in increasing productivity, which is the only valid justification for going into debt in the first place. Conversely, a serious fall in that ratio is a danger sign that the quality of debt is deteriorating, and contracting additional debt has no economic justification.

The volume of debt is rising faster than national income, and capital supporting production is eroding fast. If, as in the worst-case scenario, the ratio falls into negative territory, the message is that the economy is on a collision course and crash in imminent. Not only does more debt add nothing to the GDP, in fact, it causes economic contraction, including greater unemployment. The country is eating the seed corn with the result that accumulated capital may be gone before you know it. Immediate action is absolutely necessary to stop the hemorrhage, or the patient will bleed to death. Keynesians are watching the wrong ratio, that of debt-to-GDP. No wonder they constantly go astray as they miss one danger signal after another. They are sailing in the dark with the aid of the wrong navigational equipment. They are administering the wrong medicine. Their ambulance is unable to diagnose internal hemorrhage that must be stopped lest the patient be dead upon arrival.

Here's a chart:

Angry face

Comments 1 - 6 of 6 Search these comments

1 swebb 2011 Oct 16, 10:40am

As a total lay person with no economics education (formal or otherwise), I found the article and the central idea to be interesting and sane. The article itself was not particularly well written, lacked in the references department, and otherwise was not up to the standard for academic writing (which it purports to be). The apparent simplicity of the argument and lack of any meaningful analysis leave me a little bit suspect of the conclusions. The concept of the marginal productivity of debt is interesting, and the fact that it isn't discussed (stonewalled?) in economic discussions makes me curious as to why.

So, interesting article (at least superficially), but not particularly conclusive one way or another. The chart you provided is at least as interesting as the article.

-S

Dan8267 2011 Oct 17, 6:51am

austrian_man says

Keynesians take comfort in the fact that total debt as a percentage of total GDP is safely below 100 in the United States while it is 100 and perhaps even more in some other countries.

It's just like Keynesians to take comfort in the fact that things are more fucked up in other economies, as if they makes ours "better".

Also, the GDP figures are complete garbage. For example, during the housing bubble, the GDP reflected the overpricing of land and new homes. Yes, even land, which wasn't actually "produced" during that year was counted toward the GDP if sold with a house. Also, the GDP would include the cost of producing a window if one got broken by a vandal. It's a net-zero increase in wealth, but counts as over $100 of GDP.

GDP does not measure production of wealth. So using its ratio with debt is meaningless.

uomo_senza_nome 2011 Oct 17, 4:09pm

swebb says

The apparent simplicity of the argument and lack of any meaningful analysis leave me a little bit suspect of the conclusions.

Consider this, may be it'll help in understanding the concept better:

http://professorfekete.com/articles/AEFGrowthAndDebt.pdf

The liquidation value of the debt contracted in the past increases as interest rates are go down. Counter-intuitive, but this is what exacerbates deflation since people need more money to pay their past debt as their revenue streams (which may indirectly be tied to interest rate) reduces.

uomo_senza_nome 2011 Oct 17, 4:13pm

Dan8267 says

Also, the GDP would include the cost of producing a window if one got broken by a vandal. It's a net-zero increase in wealth, but counts as over $100 of GDP.

Very good Dan, turning Austrian are we? :) - This is the classic broken window fallacy.

Dan8267 says

Also, the GDP figures are complete garbage

yeah its nonsense, but we live in a perpetual debt world. So the meaningless number sort of has to be used to figure out if we can do something meaningful to help people deleverage debt.

Dan8267 2011 Oct 18, 2:40pm

austrian_man says