By LUDGER SCHUKNECHT
The Group of 20 leaders’ communiqué out of Hamburg earlier this month promises it: Public debt is to be put on a sustainable path. High debt is a mortgage on the future. Even the larger European countries, such as Italy and Spain, can be pushed to the brink, leading to the fiscal crises and widespread panics of only a few years ago. With the global economy strengthening, there’s no reason to delay focusing on this important longer-term issue. The challenge now is to shift away from complacency and inaction.
Today the debt situation appears stable. But the truth is it’s rather precarious: Gross government debt for the Group of Seven countries is now at broadly the same level as it was after World War II. And it shows no sign of coming down.
Debt exceeds 100% of gross domestic product in the U.S., Italy and Japan. And it isn’t far below in France and the U.K. Germany still shows debt well above the reasonably safe level of 60%. And even in today’s relatively good times, many national deficits are stubbornly stuck in the range between 2% and 5% of gross domestic product. As a result, little progress with debt reduction can be expected. This could lead to some really big dominoes toppling in the next major crisis.
Three arguments are commonly offered as to why governments and policy advisors may take a relaxed approach to public debt. None of them holds up to scrutiny.
The first is that a country can grow itself out of public debt. However, with working-age populations shrinking, it’s unlikely that growth will pick up again. In advanced economies, it certainly won’t exceed 1% by much over the next decades. Strong reformers and countries trying to catch up may do a little more. But with the current deficits this won’t be enough to bring down the debt.
Some claim that expansionary fiscal policies can have such a strong effect on growth that debts will come down despite temporarily higher deficits. Although growth-friendly fiscal reforms are certainly needed, self-financing fiscal expansions are an illusion. Fans of big government like to exaggerate the effect of higher public-works spending, while their opponents tend to trump up the supply-side effects of lower taxes. Neither is a solution to high debt.
The second argument reflects the hope that somebody else will pay, especially in Europe. Debt relief - as demanded, for example, by Greece - is one facet. A new European debt facility, or the hope that Europe turns its national debts into a common responsibility, is another.
The EU budget already transfers several percent of GDP each year to the poorer countries. Claims between eurozone central banks exceed €1.2 trillion ($1.377 trillion). And the European rescue fund, known as th European Stability Mechanism, provides a €500 billion fire wall. The combination of conditionality and support may have been an uncomfortable one for some countries, but in almost all cases it has also been quite successful.
Nor would the sale of Eurobonds and other debt instruments lead to less debt or lower deficits. Quite the opposite: It would be a recipe for greater collective irresponsibility, thanks to increased moral hazard. It might also destabilize the eurozone. What proponents call pro-European would actually prove to be anti-European. Nor is there any guarantee that it would work, given Europe’s spotty history of keeping fiscal-discipline promises.
The third illusion refers to the role of monetary policy. The hope is to deflate the real value of government debt through a combination of inflation and low interest rates. But to think this can keep governments from piling on more debt and fool today’s supersavvy investors is a long shot. Instead, it could well induce a vicious circle of capital flight, higher interest rates, capital controls and protectionism. Be the result high inflation or a financial crisis, things would be very bad indeed.
Where does this leave us? We can’t expect long-term stability and resilience from more spending, monetization and bond issuances. Governments must make credible commitments to reducing the public debt. This requires a revival of rules-based fiscal policy making.
In Europe, the Stability and Growth Pact must be properly implemented. At the national level, the fiscal compact must be adhered to, no matter what the expansionists claim. Without these, any grand new schemes from a eurozone budget and finance minister would only result in more broken promises and an inherently unstable debt union. In the U.S. and Japan, mechanisms for debt reduction must also be put in place.
Debt reduction requires hard and smart choices. The right time to start is now.
Mr. Schuknecht is chief economist of the German federal ministry of finance.
The article was first published online by the Wallstreet Journal on 18th July 2017.