We hear about Debt/GDP all the time (national debt/Gross Domestic Product; total output of the economy) and the standard argument is that we should be looking at Debt/GNP (national debt/Gross National Product; GNP strips out non-Irish domiciled output – what remains here).
The question should perhaps not be ‘which is better Debt/GDP or Debt/GNP’ it should be is ‘Debt/G-anything’ the relevant metric? There are a few reason for why GNP and GDP are both lacking, in fact it distorts a true view of our Deficit
1. It’s a thing of the past – both examples are historical by nature, they change and that is why any conversation on GDP and GNP is a constantly movable feast. Imagine if I asked you to drive across the country and describe the scenery to me, but you could only do so by telling me what you saw in the rear-view mirror? That is what GDP & GNP are about. Debt/GDP levels in Europe soared after World War II but that was a historic event at that time, the current financial crisis is far from unwinding and that weakens the case of a historic indicator.
2. Gross Debt vs Net Debt – Debt/GDP is a gross measurement and therefore it overstates the net financial liabilities, in particular when part of that lending is to acquire assets (for instance: banks/AMC’c etc. – and that isn’t to say any of those are good purchases, just to make the point).
3. Missing information – these metrics only account for a portion of the governments contractual liabilities. In Ireland there are huge ‘unfunded’ liabilities, that means there is no pool of cash there to service a certain liability, so while it exists, we have no money on the side to pay for it with and therefore it comes out of current taxation. Public pensions and public sector pensions are both in this category, and while there is the NPRF it isn’t nearly at the size it would need to be to fully offset these. Contingent liabilities are also not covered.
4. Accountancy – what really matters at a state level is the same thing that matters at a corner shop level, namely the cash-flow and cost of sales versus revenue. If you can figure that out then you can figure out why Debt/GDP or GNP isn’t the right approach. You have to look at the debt versus actual state revenue left to service it, and better yet would be to look at where the maximum point of revenue raising exists and then set your debt against that as a stress test. That would give a more definitive answer of where the point of no return lies in reference to Ireland, I suspect that the likes of S&P have already performed this test and that is behind the downgrades.
That makes a case for considering Debt/Revenue, and in that respect Ireland doesn’t look like the worst dog in the pack, rather we are (to use one of my bad analogy gems) one of the better looking horses in the glue factory. The noise in news-flow has been about banks for too long, even when you strip them out we’d still have a deficit of more than 10%, rather it is the debt versus our revenue that we need to focus on and the graph above shows that we are not the only one running behind (equally there are many doing quite well [queue drumroll for Norway]).
Yes we are in deep trouble, but not, it doesn’t have to end in catastrophe, that is not yet inevitable, it has a probability not unlike that of muddling our way through the middle, having said that, remember who has the wheel in their hands, on that basis you might want to err on the downside.
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