IT was never meant to be like this. After the initial fiscal pump priming that followed the financial crisis, the advanced economies were supposed to engage in a judicious mix of fiscal consolidation and structural reforms in the interests of debt sustainability and economic growth. Instead it has been a case of anything but.
The International Monetary Fund’s latest Fiscal Monitor shows that the advanced countries’ gross general government debt rose from 92pc of gross domestic product in 2009 to 106pc in 2015. With the notable exception of Germany, all the big economies saw significant increases in government debt.
Those most committed to austerity were among the least successful in preventing debt from rising, despite tightening budgetary policy. This was most notably true of the UK. Between 2009 and 2015 its gross general government debt rose at nearly double the rate of the eurozone and much faster than the US or Japan.
The most egregious debtor, predictably enough, is Japan where the gross figure amounted last year to 248pc, although the country is unusual in the size of the disparity between gross and net debt, which is calculated after deducting intra-governmental debt and other government-owned assets. The net figure last year was 128pc - significantly lower but nonetheless alarming.
In the absence of more pro-growth policies and a return to inflation, the public debt overhang will remain obdurate
Will this public debt ever be repaid? An optimist could legitimately claim that such numbers are not outrageous in the light of history.
Consider, for example, the British national debt since the Napoleonic wars, when the debt-to-GDP ratio reached 260pc. By 1914, after nearly a century of peace in Britain, that figure fell to 24pc. There was virtually no reduction in the debt. In fact the burden was made worse by a deflation that stemmed chiefly from a fall in agricultural prices in the second half of the 19th century. It was compound average annual real growth of 2pc over the period that did all the work.
After the second world war, Britain’s public debt peaked at close to 240pc of GDP. This time it was a blend of growth and inflation that helped bring the figure back to just under 40pc before the financial crisis. The mid-1970s, when inflation as measured by the retail price index peaked at 27pc, was a potent force for debt reduction. During the same period the US relied on the same formula, but with higher growth and lower average inflation.
Today economic growth is anaemic and the climate more deflationary. Yet IMF simulations show that in advanced economies with relatively high debt ratios in 2015, the build-up of debt since 2008 could be undone with one percentage point of additional real growth over the next 10 years on average, provided governments save the higher revenues.
The snag is that central banks’ current low or negative interest rates are removing discipline from the system. Even with sky-high debt-to-GDP ratios, governments have no problem servicing and refinancing debt. With notable exceptions such as Greece, markets have been lulled into a false sense of security on the issue of debt sustainability and the risk of insolvency.
The role of the bond vigilante is impossible when a quarter or more of the global bond market has negative yields. Nor is there much pressure for structural reform. In practice, fiscal consolidation is being achieved by tax increases and reduced public infrastructure spending, rather than pro-growth measures.
Meanwhile, in the private sector, unconventional central bank policies keep inefficient companies in business and risk another accumulation of housing debt.
Demographics are also much less helpful than in the decades that followed the second world war. Japan provides a chilling illustration. Its economy has shown healthy growth in per-capita GDP since the bursting of the Japanese bubble in the 1990s, despite the general perception of stagnation in the economy. But fast growth in per-capita terms is no help in dealing with a huge debt overhang if the absolute size of the economy is shrinking.
In the absence of more pro-growth policies and a return to inflation, the public debt overhang will remain obdurate. Yet with a return of growth and inflation the issue of solvency would resurface. There is no escape from this double bind.
Published in Dawn, Business & Finance weekly, May 23rd, 2016
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