It has been said many times that the debt levels being racked up by some governments are simply not sustainable. This anxiety, after all, is the prime and only justification for the swingeing round of public sector spending cuts the UK Coalition Government is currently imposing, and it lies at the heart of the austerity measures being promoted in European countries such as Greece and Spain. However, austerity measures raise two opposing questions. First, is what is being done enough? Second, is what is being done a threat to any recovery that might be taking place? After all, if the medicine kills before it cures, then there really wasn’t that much point to prescribing it.
In March 2010, the Head of the Monetary and Economic Department at the Bank of International Settlements (BIS), Stephen Cecchetti, and two of his colleagues, M. S. Mohanty and Fabrizio Zampolli, took a serious look at national debt levels in a paper entitled: “The future of public debt: Prospects and implications”. What particularly concerned them was that industrial countries such as Britain, the US and Japan were facing a double whammy. Not only had they grown their deficits hugely in their efforts to boost their way out of the potential deflationary spiral created by the crash of 2008, these countries are also facing a mounting public debt associated with their rapidly ageing populations.
In other words, both debt and demographics are powerful headwinds for many industrial countries, and the BIS authors’ prognosis of the likely outcome is not a happy one. In their view, “Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and [to] reduce their adverse consequences for growth and monetary stability.”
Note the phrase, “drastic measures.” As the market analyst John Mauldin, who has a very good eye for such things, points out, senior BIS figures are not given to using hyperbole. When they use a term like this, it means they really believe that there is serious cause for concern. The paper has been out for almost a year now, but its findings are as relevant as the day it was published. The debt position in all the countries surveyed has worsened, not improved, over the course of the last year, for the obvious reasons they point out in their paper (debt interest and additional pressures on public sector budgets through social welfare safety nets being obvious cases in point).
According to the OECD, the total debt of the world’s industrialised countries is expected to exceed 100% of GDP this year, and that, as Cecchetti and his colleagues point out, has never happened before outside of World War II. But this doesn’t plumb the full depths of the debt misery ahead. As they note:
"As bad as these fiscal problems may appear, relying solely on these official figures is almost certainly very misleading. Rapidly ageing populations present a number of countries with the prospect of enormous future costs that are not wholly recognised in current budget projections. The size of these future obligations is anybody’s guess. As far as we know, there is no definite and comprehensive account of the unfunded, contingent liabilities that governments currently have accumulated."
While this is serious, provided investors continue to believe that the industrial nations are capable of growing their way out of their problems, and so will be in a position to repay their debt, then everything should carry on as normal. Indeed, as the authors of this paper note, 10 year bond interest rates are still at historically low levels, which gives cause for optimism, despite the debt levels.
This, however, should not lull us into thinking that all is well:
"... bond traders are notoriously short-sighted, assuming they can get out before the storm hits: their time horizons are days or weeks, not years or decades. We take a longer and less benign view of current developments, arguing that the aftermath of the financial crisis is poised to bring a simmering fiscal problem in industrial economies to boiling point. In the face of rapidly ageing populations, for many countries the path of pre-crisis future revenues was insufficient to finance promised expenditure."
Put like this, there doesn’t seem to be any good way out, other than dramatic austerity measures, and there is every chance that such measures will jeopardise “the incipient economic recovery”. Cecchetti and his colleagues do not try to recommend quite how governments are supposed to pull off a balancing act which requires cutting their budgets to the bone while not tipping their respective countries into a further recession. But what they do say is that all countries should take a long hard look at what they can afford by way of a society wide safety net. Raising the retirement age significantly would be a good start, they suggest…
Further reading on fiscal deficits, austerity measures and demographics:
- The Impact of Demographics on Business and the World Economy, by Gabriel Stein
- Betting against China, by Anthony Harrington (blog)
- Review of 2010: Stimulus versus Austerity, by Ian Fraser and Anthony Harrington (blog)
Tags: austerity measures , demographics , fiscal deficit , fiscal stimulus , industrialised economies , public sector