A no-growth economy and interest

When we borrow money we assume that the economy will be big enough in the future to enable us to earn the money that is necessary for us to pay back what we have borrowed: the more we borrow the more the economy will need to grow so that we can achieve this. Borrowing money is one of the main reasons that we must have economic growth, and the consequences of that growth.

 

What if we decide collectively that we want to avoid the ever-increasing debt that we create when we borrow money? We could do this by assuming, when we take out loans, that the economy in the future will be the same size as it is now; that is, we could limit our borrowing so that the total amount of debt never increases.  An economy of this sort, which is designed not to grow, is called a steady-state economy.

 

We could still borrow money against our promise to repay it, on the basis of our future ability to repay it; however, the total debt across the entire economy must never increase; because if it does, the future economy will have to grow to be big enough for it to be possible for us to repay the increased debt.

 

Achieving a steady-state economy by constraining borrowing means that before someone could borrow money someone else must repay their debt. The debt would progressively transfer from person to person as people pay off their loans and other people take out loans, but the total debt would never increase.

 

By constraining borrowing, it appears that you could have a steady-state economy and still use debt to have what you want now and pay for it later; but there is one thing missing from this scenario: interest.

 

When interest is applied to the loans that create the debt, more than the amount of the original debt will have to be paid back. When the original amount borrowed (the principal) has been paid back, some money will still be owed (the interest). If the total debt is to be kept constant to avoid economic growth in a steady-state economy, the next round of borrowers will not be able to borrow as much as the previous round of borrowers because the previous round of borrowers will still owe money: the interest. In each round of paying back and new borrowing there will be less money to borrow, as more will be tied up in intererst from the previous rounds of paying back and borrowing.  If the amount of debt doesn't increase, eventually all debt will be unpaid interest.

 

This means that current loans can only be paid back if the economy grows enough to pay back the full amount including the interest. At a currently typical interest rate of 8%, a loan with regular repayments over 35 years will require double the original amount borrowed to be repaid, so the size of the economy will have to double in that time.

 

As long as debt incurs interest, we cannot avoid economic growth. Even if we are careful to ensure that the value of new loans directly replaces the initial value of old loans as they are paid out, we will still need the economy to grow to be able to pay the Interest on those loans.

 

This page is linked from:

Why the economy must grow  

 

  

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