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Debt and deleveraging: Uneven progress on the path to growth

Safely reducing debt and clearing the way for economic growth in the aftermath of the global credit bubble will take many years and involve difficult choices, as MGI’s 2010 report showed.


What history tells us about deleveraging

MGI’s Charles Roxburgh and Susan Lund assess the progress in deleveraging by the major mature economies today and the difficult trade-offs involved in stabilizing financial systems, reducing debt, and restarting growth in the aftermath of the financial crisis.

Two years later, major economies have only just begun deleveraging. In only three of the largest mature economies—the United States, Australia, and South Korea—has the ratio of total debt relative to GDP fallen. The private sector leads in debt reduction, and government debt has continued to rise, due to recession. However, history shows that, under the right conditions, private-sector deleveraging leads to renewed economic growth and then public-sector debt reduction.

These are the principal findings of MGI’s latest perspective on deleveraging, which revisits the world’s ten largest mature economies to see where they stand in the process of reducing debt ratios (United States, Japan, Germany, France, United Kingdom, Italy, Canada, Spain, Australia, and South Korea). It focuses in particular on the experience and outlook for the United States, United Kingdom, and Spain—three countries covering a range of deleveraging and growth challenges. It also examines the relevant lessons from history about how governments can support economic recovery amid deleveraging, and identifies six key markers business leaders can look for to monitor progress of specific countries.

Deleveraging has only just begun in the ten largest developed economies
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Highlights of the research include:

  • The deleveraging process has only just begun in most countries. Based on data up to Q2 2011, total debt has actually grown across the world’s ten largest mature economies since the 2008–09 financial crisis, due mainly to rising government debt. Only three countries in the sample—the United States, Australia, and South Korea—have seen the ratio of total debt to GDP decline.
  • The deleveraging processes in Sweden and Finland in the 1990s offer relevant lessons today. Both endured credit bubbles and collapses, followed by recession, debt reduction, and eventually a return to robust economic growth. Their experiences and other historical examples show two distinct phases of deleveraging. In the first phase, lasting several years, households, corporations, and financial institutions reduce debt significantly. While this happens, economic growth is negative or minimal and government debt rises. In the second phase of deleveraging, GDP growth rebounds and then government debt is gradually reduced over many years.
  • The historic deleveraging episodes reveal six critical markers of progress: the financial sector is stabilized and lending is rising; structural reforms unleash private-sector growth; credible medium-term public deficit reduction plans are in place; exports are growing; private investment has resumed; and the housing market is stabilized and residential construction revives.
  • As of January 2012, the United States is most closely following the Nordic path towards deleveraging. Debt in the financial sector has fallen back to levels last seen in 2000, before the credit bubble, and the ratio of corporate debt relative to GDP has also fallen. US households have made more progress in debt reduction than other countries, and may have roughly two more years before returning to sustainable levels of debt. Deleveraging in the United Kingdom and Spain is proceeding more slowly, and these countries could face many years of gradual debt reduction ahead.
  • Understanding the course of deleveraging will be of critical importance both to business leaders, who will need to take a granular approach to strategy, and to governments. The report examines implications for business strategy and suggests that current macroeconomic models do not fully capture the impact of deleveraging on demand—so companies must develop their own views of how deleveraging is proceeding to find pockets of opportunity in the near term. Overall growth in the time of deleveraging is likely to be restrained, but the pace of debt reduction varies across nations and sectors and from place to place within nations. No single country has all the conditions in place to revive growth. 

This is the second of three Global Institute reports on this issue. The others are Debt and deleveraging: The global credit bubble and its economic consequences (July 2011) and Debt and (not much) deleveraging (February 2015).

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