I was recently reading news on India’s interim budget and I read something that by 2025 they (the country) expect fiscal deficit to be x% of GDP, and it had me confused.
How is GDP, which a metric for production and exports imports within a country, an appropriate base for fiscal deficit?
In: Economics
Because different economies are different sizes. A country with an economy the size of the US or China can cope with a annual deficit of a trillion dollars, while a trillion dollar deficit would likely be absolutely devastating for a smaller country/economy like France or Canada or whatever.
Expressing the deficit as a percentage of the country’s GDP goes a decent way towards contextualizing their current spending in regards to the size of their economy.
Governments repay their debts via taxation.
GDP is a measure of how much you can theoretically tax.
Using Debt to GDP ratio is a way to apples-to-apples compare countries ability to repay their debts.
The numbers are super large, and using a percentage allows them to get into a couple of digits so people understand them better.
The other analogy is to your personal income. If you make $50K/year, then a $30K car loan might cost you 10% of your income in payments. If you company president makes $500K/year then the payments on his $300K Lamborghini is about the same percentage of income. It’s not that his Lambo is the same price as your Honda, but it’s the same fraction of what he has available to spend.
GDP is the total amount of stuff that a country can create in a year. It is a reasonable proxy for the total value that has the potential to be taxed; countries don’t really have “income” or “assets” like an individual does, so we need some metric to assess what the reasonable tax base is. GDP is a decent metric for that; it is _loosely_ what a country’s “income” is.
So debt to GDP is a similar metric to debt to income ratios for individuals – how much debt do you have vs. how much value are you producing every year. That gives you a good sense of how capable a country is of servicing its debts.
GDP is a rough measure of the size of the overall economy to provide some scale. There are a host of other metrics you could use.
If I tell you a country has a $10 billion deficit, is that good or bad? If you’re the United States with a $25 trillion GDP, that wouldn’t even register. If you’re Fiji and your country is only producing $4.9 billion worth of stuff in a year, you’re gonna have a bad time.
Its very sensible to look at fiscal deficit as % of GDP for couple of reasons. First of all, public debt is looked at as % of GDP, because GDP is what forms the basis paying it back. Secondly, growth rate of GDP determines how high fiscal deficit is sustainable and how much inflation it will cause. If your economy can outgrow your debts, then your debts are not a problem. And thirdly, fiscal deficit is just one alternative way to pay for government spending. The main one being taxation. In any case, economy of the country has to pay for spending of the government so looking at government spending as % of GDP makes a lot of sense.
The simplest way to put it is, if you (assuming you’re a relatively average person) have a debt of $5,000 and Bill Gates has a debt of $100,000, who has a greater concern with debt?
Probably you, because Bill Gates has far more money available to him than you, even if the debt is far higher. So instead of presenting debt on its own, you use debt as percent of earnings.
It provides context for debt between countries earning a different amount
Imagine you have a $10,000 debt on your credit card and no money in your bank account. If you make 5 million a year, no problem. You’ll get your next paycheck and easily pay off the balance. Now imagine you make $30,000 a year. You’re in trouble. You’ll only be able to pay off a small amount of the balance at a time and the interest rate may be such that you’ll never be able to get out from under that debt.
Now picture the same thing but with a country. A big country can take on a large amount of debt and it’s not a huge cause for concern because it has a large economy and it’s treasury collects lots of tax revenue every year. The US has something like 30 trillion in debt. That’s not good but it’s also not effecting our credit rate significantly because we have the ability to collect revenue. If a smaller country, say France had that much debt, it would be an absolute crisis and the government would probably be insolvent because France doesn’t have the economic means maintain that debt.
Imagine you’re in a million dollars of debt.
But your job pays you 2 million dollars a year.
Not a big deal.
Imagine you’re in a million dollars of debt.
but your job pays you 50k a year.
Big deal.
Same thing, but with an entire economy.
Kinda like a debt to income ratio. If your debt is 80% of your income level it’s gonna be hard to fathom you can pay back any new debt.
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