The specter of subprime housing loans still looms large in many minds, as they sparked a financial crisis from which the world is still recovering over a decade later. But our new research shows that excessive corporate debt is just as problematic—if not more so—than excessive household debt. Asian governments ignore this at their peril.
Since the 2007-2008 global financial crisis, private debt has grown rapidly in emerging market economies around the world even, as it has leveled off in advanced economies as our charts below show. In Asia, it is particularly high in the People’s Republic of China and the Republic of Korea, among others.
Rising private debt is a growing concern given that the US Federal Reserve’s monetary policy normalization makes raising and rolling over debt much more costly than it has been for several years. Plus, a number of studies have shown that crises caused by financial market crashes tend to inflict greater damage to real economies than business cycle recessions.
Crucially though, we wanted to check whether it makes a difference to economies if the debt buildup is led by household versus corporate borrowing.
Looking at 21 advanced economies and 17 emerging market economies in 1970-2014, we identified 195 business cycle peaks in advanced economies and 140 such peaks in emerging market economies. Business cycle peaks are surges in economic growth that are succeeded by a crisis. We then broke that data down into “financial crisis peaks” and “normal peaks”.
“Financial crisis peaks” are peaks that immediately precede financial market crises, while “normal peaks” are peaks in economic growth followed by a downturn caused by other factors such as falling consumption or investment. Finally, we disaggregated the financial crisis peaks.
We found that the 17 emerging market economies suffered 26 financial crisis peaks in 1970-2014. Of those, 12 were corporate-debt driven (the corporate debt build up was faster than the household debt build-up) and 10 were household-debt driven. Data limitations prevented us from identifying the cause of the other four.
The breakdown clearly showed that a rise in corporate debt has been the cause of slightly more crises than household debt in emerging market economies, a contrast from recent studies that have found that recessions are primarily due to soaring household borrowing.
But what about the real economy impact of all this?
Our analysis found that in emerging market economies, the growth rates of output, consumption, and investment are comparable in the period running up to the financial market-induced crises as in the run-up to other types of downturns, but that contractions are much sharper following financial-market induced downturns than other types of downturns.
However, when we drill down we find that when crises are induced by high corporate debt, growth in output, consumption, and investment are all slightly lower during the pre-crisis expansion and during the post crisis period than when crises are induced by household debt buildup. There was no evidence of debt deleveraging during any type of recession.
For advanced economies, the average growth rates of these real-economy variables are lower before financial market-induced crises than during normal business cycle crises, and are much lower following financial market-led crises. When the financial market crisis has been driven by high corporate debt, the average output growth rate is slightly lower before the crisis and substantially lower afterwards compared to a household debt-induced crisis.
We found no clear evidence of any immediate reduction in private debt—either corporate or household—following recessions of any type, indicating that debt deleveraging during recessions is a difficult process in advanced economies.
In short, while the rapid growth in household debt seen in some Asian countries should be a cause for concern, policy makers should be equally—if not more—concerned if they see a sustained surge in corporate borrowing. Financial crises are painful, whatever their cause.