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Why Dutch debt tells us economic growth may be fragile

Date:04 April 2017
Author:Dirk Bezemer
Debt shift in the Netherlands since 1990 until the 2008 crisis. Source: DNB
Debt shift in the Netherlands since 1990 until the 2008 crisis. Source: DNB

How does the financial sector help, hurt or hinder the economy? My research into this issue builds on the theory of Hyman Minsky (1919-1996), an American economist. He described how over the course of a long financial cycle, investors will shift towards riskier and more speculative investments.

This theory can be applied to data on bank credit allocation. The shift which Minsky wrote about shows up as a decline in bank credit to the ‘real sector' -- the actual production of goods and services -- compared to the funds flowing towards property and financial asset markets.

This long-term trend could be called a ‘debt shift’. With my research team, I collected international data on bank credit allocation over more than 70 economies. The patterns we observed are broadly in line with Minsky’s theory.

Our research shows that the consequences of the debt shift have been threefold:  lower economic growth, growing income inequality and more vulnerability to financial shocks.

All this is very relevant to the Netherlands. Since the 1990s, the Netherlands has experienced levels of debt shift that are extremely large when compared internationally. By 2008, most bank loans were to real estate and financial asset markets, as the graph above shows.

The 2008 crisis demonstrated that the Netherlands behaved in line with Minsky’s insights. It proved very vulnerable indeed to financial shocks. The country also experienced a stagnation in economic growth which was unusually long in international comparison. Fortunately, income inequality is low and stable, thanks to effective redistribution.

Nevertheless, this long-term trend and its consequences do not loom large in policy debates. The general mood is that in 2017, we have finally left behind us the 2008 financial crisis and the stagnation that followed. After nine years of negative or near-zero income growth in the Dutch economy, it is again above 2% per annum. Consumers have started to spend again and unemployment is falling.  

But there are a few oddities in this boom. Interest rates and inflation remain ultra-low, capacity utilization is still falling. The Netherlands remains in the top three among developed economies in the private debt league table. And debt shift was never reversed. It has picked up again since 2012

In the logic of Minsky’s theory, current economic growth may be brisk, but it is fragile. It seems to be underpinned by consumer confidence, and by more debt to asset markets, rather than to business. Confidence is a sentiment, which unlike other drivers of growth can quickly evaporate in the event of a shock - especially at high levels of debt, and especially if there is a shock to financing conditions.

We can see one such shock approaching with reasonable certainty. Interest rates are unlikely to stay very low forever. In particular, vigorous government investment in the United States may well drive up rates there. Europe must follow or it will face capital outflow. A small increase in interest rates in a situation of high debt levels constitutes a large burden on the cash flows of firms and households. If this bites into confidence and consumer spending, what will happen to growth?

Nor can we trust that global growth will continue to fuel economic performance in The Netherlands. International institutions such as the IMF, the OECD  and the Bank for International Settlements have repeatedly warned that high levels of private debt internationally are still a major threat to stability.

All this suggests that greater emphasis must be placed on rebuilding the financial basis for growth in the Netherlands. Debt shift must be reversed. More of our financial resources must be directed towards investment in the real sector, rather than to real estate and financial asset markets.

There is no dearth of investment opportunity in the Netherlands, such as in infrastructure in the north, or in the transition to sustainable energy. Low interest rates and abundant finance offer a window of opportunity. Now is the time to act before that window closes. This should be a priority for the incoming government.

Dirk Bezemer will give his inaugural address on this topic on March 14th, as he accepts a professorship in the economics of international financial development at the University of Groningen.


Further reading:

Bezemer, D., & Samarina, A. (2016). Debt Shift, Financial Development and Income Inequality in Europe. SOM Research Reports; Vol. 16020-GEM.

Bezemer, D., M. Grydaki & L Zhang, (2016) More mortgages, Lower Growth? Economic Inquiry, 54(1), 652-674.

Bezemer, D. & M. Hudson (2016), Finance is not the Economy: Reviving the Conceptual Distinction. Journal of Economic Issues. 50, 3, p. 745-768 24 p.

Zhang, L., & Bezemer, D. (2015). A global house of debt effect? Mortgages and post-crisis recessions in fifty economies. SOM Research Reports; Vol. 15009-GEM.

Bezemer, D., & Grydaki, M. (2014). Financial fragility in the Great Moderation. Journal of Banking & Finance, 49, 169-177.