Why the real global debt crisis is bigger than you think

Graeme Leach

HERE IS a very easy economic forecast. Public debt will be the number one economic issue on the planet over the coming decades. Hugely indebted governments will get even more indebted, and politicians will remain behind the curve in terms of finding a solution. Governments will find it even more difficult to attain and maintain a primary surplus (the budget balance before interest payments).

I can hear you agreeing with me, but at the same time crying “so what?” The “so what” depends on which set of public debt numbers you’re looking at.

The most recent IMF Fiscal Monitor shows gross public debt at the global level rising from 60 per cent to 80 per cent of GDP between 2008 and 2014. Over this period, it will have jumped from 73 per cent to a projected 107 per cent of GDP in the US, and from 70 per cent to 95 per cent of GDP across the euro area.

The trailblazer, of course, is Japan, which will have managed to increase its gross public debt from an astonishing 192 per cent of GDP at the start of The Great Recession, to a stupendous 242 per cent this year. In the US, the Congressional Budget Office (CBO) projects gross federal debt to exceed $25 trillion by 2025. That’s $25,000,000,000,000.

Consequently, the conventional story is bad, but for many it’s not seen as that bad. The standard response to numbers of this magnitude is to say that, in the immediate aftermath of the Second World War, countries like the UK had higher public debt ratios than Japan does today. We’re told we’ll be fine; a good dose of growth, as in the 1950s, and it’ll all look different. I beg to differ.

In a cracking new paper from the Institute of Economic Affairs, Jagadeesh Gokhale highlights the other set of fiscal numbers, which we really should be concerned about. The other numbers focus on the unfunded liabilities of the public sector and the impact of an ageing population. They are shocking because governments across the advanced economies have made promises to hundreds of millions of people that they can’t afford to honour. The result is the most expensive set of lies in history.

Just consider a few headline figures from Gokhale. Under realistic assumptions, when you add in unfunded spending commitments to future generations of older people, the total indebtedness of the US government is seven times the official headline figure.

The US fiscal imbalance equals 9 per cent of the estimated present value of future GDP – i.e. there is a need to set aside 9 per cent of GDP each year to achieve future generational balance in the public finances. In simple terms, the tax burden on workers would need to rise by almost 20 per cent to ensure that the US government can meet all its future spending, not met out of current tax. And it’s even worse in the EU, fuelled by a decline in the ratio of workers to retirees. The average fiscal imbalance in the EU is projected at 13.5 per cent (of the present value of future GDP).

In the UK, around a quarter of public spending elsewhere might have to be cut to meet unfunded liabilities without worsening the fiscal position.

Across the globe, the political leaders who own up to this crisis today, and who are prepared to risk sacrificing their careers to sort it out, will become the heroes of tomorrow. Without such leadership, tomorrow’s generation will be hammered by punitive taxation. We need to meet this challenge now, with a reduction in spending and future commitments. Tax hikes are precisely the wrong solution.

Our children will not thank us for letting this deception persist. Where are the political leaders saying we have a responsibility towards future generations and we are going to meet it?

Politicians will say they have matters under control. “We’re raising the retirement age”. “We’re raising employment participation”. “We’re going to raise GDP growth”. “It’ll be alright on the night”. But will it?

Governments have expanded public debt massively without having any ageing problem of consequence to deal with. The growth of the state has already undermined the supply-side competitiveness of the advanced economies, so the long-term outlook is for weaker not stronger growth. As demographic decline kicks in across the EU, higher levels of productivity growth will be required to maintain existing – already weak – trend growth. And if that productivity surge doesn’t emerge, the ensuing higher tax burden to fund the state will further undermine competitiveness.

The solution to the most important economic issue of our time has little to do with the technical skills of economists, and far more with the courage and character of politicians.

Graeme Leach is director of economics & prosperity studies at the Legatum Institute in London.