Government debt: you’re a part of it. Is it a problem?
Eye-watering government debt makes for good headlines, but how much is too much is far less clear, writes UNSW Business School’s Gigi Foster
In March 2020, governments around the world, panicked by COVID-19 ordered lockdowns, sharply pulling the handbrake of their economies. To tide their populations over while normal business was suspended they needed trillions of dollars, pounds and euros they didn’t have.
Those trillions were manufactured with the magic of government debt creation and then pumped into the economy to prop up household incomes, spending and confidence, to keep businesses afloat (at least the big ones) and financial markets booming. Now governments have to service a higher level of debt with a smaller GDP than they otherwise would have had, and those debt repayments will crowd out expenditures on everything else in years to come.
Egged on by economists who opined confidently that it was a great time to go into debt because interest rates were low as far as the eye could see, governments spent like drunken sailors. Largesse was distributed through stimulus cheques, income support schemes, industry bailouts and vast transfers and subsidies for the newborn industry of masks, gowns, shower caps, sanitisers and vaccines.
National debt in many countries flourished at an unprecedented rate. In the United States, it rose by 38 per cent in the space of three years, from approximately US$22.7 trillion at the end of 2019 to a dizzying US$31.4 trillion at the end of 2022.
But more important than the raw magnitude of debt is its level relative to the size of the economy, as this ratio indicates a country’s ability to service its debt. (The same basic principle holds for households: it’s how much of your income it takes to pay your mortgage, not absolute mortgage payments, that banks notionally care about.)
In the US, national debt climbed from 107 per cent of GDP in 2019 to 132 per cent in March 2021, before trailing off to 123 per cent currently. In the United Kingdom, debt was 83 per cent of GDP before COVID, rising to just over 100 per cent at the end of 2022. Australia’s debt rose from 47 per cent of GDP to 57 per cent. The European Union’s rose from 84 per cent to approximately 93 per cent.
As high as some of these numbers are, they are still modest compared to, say, Japan, which has a debt-to-GDP burden of 226 per cent. No wonder Japan is often used as an example by modern monetary theorists, who point out that since national debt levels that high can apparently be sustained, governments should have no qualms about big debts.
Nonetheless, there are downsides to having spent so much to maintain lockdowns and deliver on other COVID-era promises. We accumulated debt not to pay for investments in productivity and growth, but merely to tread water. Imagine what public investments could have been made with the trillions that went instead to staunching the wounds delivered by lockdowns and other COVID policies. This cost is hidden – it’s called an opportunity cost – but it represents the extra health, productivity, and equality that nations could have had from a better use of these funds.
Another downside of debt is essentially political. Politicians sometimes make it difficult for countries to pay their own bills, which impairs confidence and interferes with the smooth functioning of the financial system. (They also get in the way in the first place by spending irresponsibly, leaving a mess to be cleaned up by successors who often have no incentive to do so – see the first point.)
The US is an unfortunate poster child for this political issue. To meet its financial obligations, the US government must periodically raise its ‘statutory debt ceiling’. This is an artificial threshold and is subject to political game-playing. If that debt ceiling isn’t raised, then by law the government can’t meet its financial obligations and the Treasury has to resort to ‘extraordinary measures’ to keep the government running. In the latest chapter of this saga, extraordinary measures kicked in on about 19 January 2023.
These measures might work until mid-year, maybe plus a few months at most. Eventually though, a political solution needs to be reached, or the US government defaults. The consequences of that would be serious, including a fall in confidence in the US currency and higher future government borrowing costs, since interest rates on US government debt will rise to reflect the greater risk perceived by market players.
Who exactly are these ‘market players’? Most US government debt takes the form of Treasury bills, notes, bonds and other fixed-term obligations held by individuals, companies, and foreign governments. The smaller portion (currently US$6.9 trillion) is what’s called intragovernmental debt, consisting of IOUs that the Social Security Trust Fund and other governmental agencies are holding because they lent money to various other branches of government: in essence, this is money that the government owes itself. This is why, in the event of a default, the US might not be able to meet obligations such as Social Security payments and military personnel salaries. Public debt is a much larger sum — US$24.5 trillion — consisting of obligations held by foreign governments, investors, banks, pension funds, and so on.
Accumulating and managing debt responsibly is, more than anything, a political problem. In a democracy, this means the person on the street has more of a role to play than she may think. First, if ‘the people’ deem their leadership to be doing the wrong thing in their spending decisions or anything else, that leadership can be shown the door. Arguably, this happened recently in the UK with Liz Truss, the 44-day prime minister. It happened in Australia with the demise of the Scott Morrison government in 2022, and more recently in New Zealand with Jacinda Ardern.
Second, the person on the street is often a government creditor. If you have a retirement fund, chances are a government somewhere (maybe even your own!) owes you something. You have the power to stop lending to it by altering your investment mix – and together with the choices of many others, this can matter. A leading reason why countries sometimes get in big financial trouble (recall the PIIGS crisis in 2010-2012, or Argentina in the 1980s) is the emergence of a belief that their governments may be unable to pay their debts, often after politicians have over-spent or over-borrowed – a belief that a huge number of people, from the uber-rich to the guy with $20,000 in a mutual fund, have a role in forming and then displaying via their investment choices.
People often feel they are powerless in the face of high finance organised by the well-connected elite classes, a problem made worse by a political monoculture in which the major parties promote nearly indistinguishable policies. Yet while the elites back-slap each other in Davos and central banks chatter to one another night and day, regular people still hold the power to put their money, their voice and their vote behind more sensible spending programmes and more accountable leadership for their country.
Gigi Foster is a Professor in the School of Economics at UNSW Business School. She works in diverse fields including education, social influence, corruption, lab experiments, time use, behavioural economics, and Australian policy. For more information please contact Prof. Foster directly. A version of this article was originally published on 360info.