Government debt is one of humanity's great inventions: it allows societies to store wealth, fight crises and build for the future.
Gross public debt as a share of GDP in advanced economies stands near 110%, close to an all-time high. Rich countries as a whole spend half as much again on interest as they do on national defence. About half of outstanding debt with a fixed interest rate in the OECD club of rich countries costs less than 2% a year to service—a legacy of having issued the debt when rates were low.
The biggest single episode of debt reduction identified in 220 years of data by Barry Eichengreen of the University of California, Berkeley, and Rui Esteves of the Geneva Graduate Institute occurred in Britain between 1947 and 1956. The country's debt-to-GDP ratio fell by 131 percentage points. About half of the drop came because inflation exceeded interest rates, though America's simultaneous debt reduction, of about half the size, relied more heavily on economic growth.
One has to go back to before the first world war to find debt reductions driven by budget surpluses in big economies. From 1896 to 1913 France shrank its debt-to-GDP ratio from 96% to 51%. Britain managed to run nine decades of primary surpluses after the Napoleonic wars to slash its debt-to-GDP ratio from 194% in 1822 to 28% in 1913. America nearly wiped out its debt of 30% of GDP using surpluses between 1867 and 1913.
Of Eichengreen and Esteves's top 30 debt consolidations, the only one in the post-war era achieved primarily through budget adjustment among the G7 was in Canada between 1997 and 2006.
Before the second world war, defaults by leading economies were not unheard of. France forcibly made some short-term obligations perpetual in 1848. Britain never repaid some of its great-war debts to America. America passed a law in 1933 voiding the rights of creditors to demand repayment equal in value to a certain weight of gold, after President Franklin Roosevelt abolished the gold standard—technically a default. Many European powers defaulted during or shortly after the second world war. Since then there has been a norm that advanced economies always repay their bondholders, violated only by Greece and Cyprus in the 2010s.
In advanced economies, governments spent about half the time between 1945 and 1980 gaining more from inflating away debt than they paid in interest, according to Carmen Reinhart of Harvard University and Maria Belen Sbrancia of the IMF. The average annual saving in interest expenses ranged from 1-5% of GDP.
There is no defined level at which debt can be said to be too high. Economists prefer to assess whether a debt-to-GDP ratio is stable or increasing. A ratio that is stable one moment can be explosive the next: high debts leave countries at the mercy of small changes in the interest rate-growth differential. Like banks, highly indebted governments are vulnerable to runs—fear of a crisis can start a crisis by pushing up financing costs.
The IMF has estimated that debt interest, pensions, health, defence and climate change in Europe's advanced economies will create additional annual spending "pressure" worth nearly 6% of GDP by 2050. In Britain, Spain, Portugal and Switzerland the figure is above 8% of GDP. The Penn Wharton Budget Model estimates that America would need to raise taxes and cut spending, by 15% in both cases, to eliminate the future gap between spending and taxes.
Budget projections tend to be too optimistic. Britain's fiscal watchdog found that, when asked to forecast deficits five years in the future, it had underestimated them by 3.1% of GDP. The IMF has reached a similar conclusion across rich countries.
A significant minority of the rich world has opted out of the debt supercycle. Economies accounting for a third of rich-world output have net public debts of less than 50% of GDP. Four blocs stand out: the junior Anglosphere (Canada, Australia and New Zealand); Scandinavia; the Rhineland economies (Germany, Switzerland and the Netherlands); and the Asian tigers (South Korea, Hong Kong, Singapore and Taiwan).
Frugal governments tend not to be identifiable by their political systems but by whether they implemented budgetary reforms in the 1990s and 2000s. Sweden adopted fiscal rules after a financial crisis in the early 1990s, capping spending and eliminating open-ended appropriations, and went from being one of the most indebted European countries to one of the least. New Zealand responded to sovereign-ratings downgrades with deep austerity in 1991 and strict budget rules. Switzerland introduced a "debt brake" in 2003, backed by 85% of voters. Germany enacted a constitutional deficit cap in 2009.
Countries with pre-funded pension systems tend to fare better. Australia, Canada, Denmark, Iceland, the Netherlands, Switzerland and Sweden have accumulated pension assets over 100% of GDP. Germany, despite its fiscal rectitude, has pension-plan assets amounting to just 6% of GDP.
Since Frank Ramsey wrote the canonical model of economic growth in 1928, economists have typically argued that productivity and interest rates rise and fall together. Pro-growth policies may therefore not lower the interest rate-growth rate gap. Faster growth prompts additional investment, putting upward pressure on real interest rates.
Since 1980, transfers to the elderly and spending on health care have grown by about 5% of GDP in the OECD, twice the rise in other social spending. The average male retirement is 18 years long. At their inception, public pensions in Britain and Germany offered meagre support to those over 70 when life expectancy was 45-50.
A person who was 70 in 2022 had the cognitive ability of a 53-year-old in 2000, according to data analysed by the IMF. The trend towards "healthy ageing" is sufficient to add 0.4 percentage points to forecast annual global growth between 2025 and 2050, reducing the overall negative effect of ageing by about a third.
The average migrant who arrives in America aged 25-34 with a graduate degree brings discounted lifetime fiscal benefits of nearly $2.3m to the federal government, according to David Bier of the Cato Institute. A migrant of the same age without a high-school diploma brings in less than $15,000. Evidence from the Netherlands suggests that migrants must have at least a bachelor's degree to have a positive fiscal effect.
Gregory Mankiw of Harvard University has set out five options for ending unsustainable debt accumulation: big cuts in government spending; extraordinary economic growth; large tax increases; default; or large-scale money creation (inflation). In countries that issue debt in their own currencies and have the power to create money, creditors historically suffer via inflation rather than outright default. In the first few decades after the second world war, inflation played a major role in reducing war debts. In America, the Federal Reserve capped long-term bond yields from 1942 to 1951.
Experience is the worst teacher. It always gives the test first and the instruction afterward.