Debt build-up in the West a worry

Government debt in rich countries is on track to reach World War II levels, but without the war.

Government debt in rich countries has quadrupled since the 1970s. Picture: Bloomberg

Government debt in rich countries is on track to reach World War II levels, but without the war.

The focus on Donald Trump and his trade wars has obfuscated the real elephant in the room — relentless debt accumulation by advanced countries, whose debts as a share of economic output have quadrupled since the 1970s.

The government of the world’s biggest economy, as the accompanying figure shows, now has debts equivalent to more than 100 per cent of US GDP, or the same levels of the early 1940s.

It’s worse in Europe, where the governments’ off-balance sheet liabilities — in essence, promises to pay their citizens’ pensions — are five times as large as the official debt.

Traditional economics can’t explain the build-up, concludes Professor Pierre Yared, of Columbia University, in a paper that sounds the alarm on rising debts. Governments have been behaving like spoilt children gorging on sugar-coated lollies, oblivious of the health implications, or as he puts it, “an agent with presently biased and dynamically inconsistent preferences”.

Public debt can be useful. It’s the obvious choice to build infrastructure, or ward off or end a recession. Selling bonds to the wealthy damages the economy much less than arbitrarily taxes in a time of depressed economic conditions.

“Unanticipated temporary fiscal needs resulting fro m the global financial crisis (cannot) explain the long-term trend in government debt across advanced economies,” Yared finds.

As for anticipated spending shocks, such as those related to population ageing, governments should intensify their efforts to pay back debt.

“A government facing rising future fiscal pressures should pay down a larger portion of the debt in the present so as to alleviate forecasted fiscal strain,” he says.

Government debt in the US

Yet Japan, the most rapidly ageing society, has exhibited the most rapid build-up.

After the war, inflation and economic growth eroded the real debts quickly. Now, inflation is stubbornly low and growth is relatively meagre. Ever higher debts are hobbling future governments’ ability to borrow, and will force higher levels of damaging taxation.

Politics explains the debt build-up better than economics. Far from being an irrational child, it turns out governments are reflecting the rational desires of the fastest growing portion of its population.

“The larger is the fraction of old impatient households relative to young patient households, the more shortsighted is the government, the larger are government deficits and the more rapid is government debt accumulation,” Prof Yared says.

Indeed, Prime Minister Scott Morrison’s decision to scrap plans to lift the age pension age to 70 was a classic example. That’s the first problem; increasingly febrile political systems are the second.

“The presence of political turnover causes the current government to be impatient, since the party holding power recognises that it may not have the opportunity to benefit from spending in the future,” Prof Yared says.

Australia has both factors in spades. The share of the population aged over 65 is on track to increase from 15 per cent to 23 per cent by the 2050s.

And the revolving-door prime ministership and the decline of support for the major two political parties is sapping any leader’s certainty he’ll be around to see the benefits from fiscal prudence.

Some countries have recognised the problem though. Since 1990 the number that has imposed constitutional or legislative curbs on their ability to borrow has surged from seven to 92. Wealthy Switzerland, for instance, has a constitutional “balanced budget” requirement over a three-year period.

Canberra’s budget “rules” are vague and toothless, as the Morrison government’s latest cash splash of $4.5 billion on Catholic schools has shown. It hasn’t been paid for by spending cuts elsewhere, which budget rules say should “more than offset new spending measures”.

“A clear path back to surplus is underpinned by decisions that build over time” — another “rule” which is barely grammatical let alone effective.

A drover’s dog could have got the federal budget back to surplus.

As the Parliamentary Budget Office has repeatedly shown, relentless bracket creep, also known as unlegislated increases in income tax, are propelling the budget slowly back into the black. The Morrison government has even dumped a plan to chop a welfare payment that was meant to compensate for the carbon tax.

We can’t rely on morality either. There is, or was, something about debt that used to disgust us. Islam and Christianity both condemned interest on loans, for instance. The word debt meant “sin” or “guilt” in many Indo-European languages. In the 19th century governments proselytised about the evils of debt and tried to encourage their citizens to scrimp and save. This deep cultural disapproval of borrowing might have even been an efficient response to our innate myopia.

“A social norm that causes them to take on little debt could be welfare improving,” wrote four economists, separately, in a study on attitudes to debt in Sweden. “People may underestimate the future debt burden associated with a loan, due to limited financial literacy.”

It found the baby boomers and the current generation of young people were far more comfortable with personal debts.

The results would probably hold true in most advanced countries, including Australia where, in contrast to most advanced countries, household debt looms even larger than government debt.

So just how will governments ultimately escape this debt vice?

Deliberately increasing inflation is the most likely scenario I think, which, for all the protestations of central banks, is very easy to do when there’s a paper, or even digital, currency.