Misery loves company, as they say. But does financial irresponsibility also enjoy spending some quality time with friends? If so, it’s a good party. While the US government is known to be accumulating debt to stratospheric levels, governments around the world have been spending beyond their means and borrowing to make ends meet. The likely result: financial markets imperiled by overextended governments and sluggish economic growth for almost everyone.
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Public debt growing everywhere
“Government debt as a fraction of gross domestic product has increased significantly in recent decades, in both advanced, emerging and middle-income economies,” write Tobias Adrian, Vitor Gaspar and Pierre-Olivier Gourinchas for the International Monetary Fund (IMF ). “It is expected to reach 120% and 80% of production respectively by 2028.”
Public debt – money borrowed by governments – has steadily increased, they add, because years of very low interest rates “have reduced pressure for fiscal consolidation and allowed the deficit and public debt to rise.” Then, Covid-19 disrupted the global economy and governments responded by funding “large emergency support packages” on credit.
Now, with rising interest rates, the cost of debt servicing is also rising. But governments continue to borrow as if nothing has changed. Of course, riskier governments have to pay higher interest rates.
“On average, African countries pay four times more in loans than the United States and eight times more than the richest European economies,” UN Secretary-General António Guterres warned last summer in the release of a report A world of debt: a growing burden on global prosperity. “A total of 52 countries – nearly 40% of the developing world – are in serious debt trouble.”
In 2022, the report revealed, global government debt stood at $92 trillion and rising. Interest payments have replaced other expenses in a growing number of nations, especially in developing countries. High government debt takes away financial space from everything else, including the ability of private entities to borrow to start or expand businesses that create jobs and create wealth.
Public debt excludes private investment
“Households who purchase government debt reduce their savings in productive private investments,” Kent Smetters and Marcos Dinerstein wrote in 2021 for the Penn Wharton Budget Model. “Because spending is unproductive, the economy is poorer and total savings are lower due to capital crowding out.”
“Public spending redirects the economy’s real resources and can crowd out private capital formation,” they add. “An additional $1 trillion in debt this year could decrease GDP by as much as 0.28% in 2050.”
If you take this insight and apply it to a world of governments engaged in a collective borrowing spree, you will end up with a hobbled global economy in which prosperity becomes increasingly elusive.
“Medium-term growth rates are expected to continue to decline due to mediocre productivity growth, weakening demographics, weak investment and continuing scars from the pandemic,” note the IMF’s Adrian, Gaspar and Gourinchas. “Growth projections for the next five years have fallen to their lowest level in decades.”
Heavy public debt also creates risks for the financial sector, putting banks at the mercy of large debtors with uncertain creditworthiness. “The more banks hold their countries’ sovereign debt, the more their balance sheets are exposed to the country’s fiscal fragility,” IMF analysts note.
Heavily indebted governments also reduce their ability to act as a backstop in the event of a financial crisis as they become the most likely causes of future crises. As they continue to borrow, they reduce the likelihood that productive private economic activity will get them out of their financial problems.
“Higher government debt implies greater state interference in the economy and higher taxes in the future,” The Economist highlights in his interactive overview of global government debt. Furthermore, the editors add, rising debt “creates a recurring popularity test for individual governments” that often goes badly in terms of fiscal responsibility because paying outstanding bills is not popular with voters.
Higher debt leads to loss of prosperity
Well, isn’t that cheerful? He is also extraordinarily unlucky. After thousands of years of painfully slow progress, recent decades have seen the human race escape poverty. According to the World Bank, even as the population has increased, the number of people living below the poverty line, adjusted for inflation, has plummeted from 2.01 billion in 1990 to 689 million in 2019.
In 2016, economist Deirdre N. McCloskey attributed the improving prospects for so many people around the world to “liberalism, in the European free-market sense.”
But this progress has reversed in recent years, with poverty rising again (712 million people in 2022) against a backdrop of slower economic growth and after drastic government interventions during the pandemic. A future of economies stumbled and hobbled by debt-ridden governments crowding out private investment is a future in which more and more people will be poorer than they would have been if the world had remained faithful to the free market and implemented a modicum of accountability financial.
As much as the United Nations is concerned about rising public debt, the proposed “solutions” are more or less what you would expect from that organization. Much talk of a “more inclusive” system that provides “greater liquidity” and “accessible long-term financing” boils down to letting riskier governments have more say in offering themselves cheap financing. What could go wrong?
IMF analysts, on the other hand, propose “sustained fiscal consolidation” while “financial conditions remain relatively accommodative and labor markets robust”. I take this as a gentle suggestion that governments need to start repaying their debt at sustainable levels before interest rates and economic conditions deprive them of any options in the matter.
Nice suggestion or not, governments need to get their fiscal affairs in order before dragging us all down with them. Heavily indebted governments result in burdened economies leading to a poorer world for all. With its irresponsible borrowing and spending, the US government, unfortunately, is not alone. Most, if not all, world governments are in very bad company.