advanced economies, governments, companies, and households nevertheless increased their debt. Could that have ever been a good idea? Theoretically, yes. When used to invest in productive assets, debt can be a lever of future economic growth and prosperity. But all debt does of course need to be repaid at some point (unless it evaporates because of inflation, but that has been less than 2 percent on average in advanced economies in the past 20 years21). The only alternative is to default, but that is akin to playing Russian roulette.
So what kind of debt has been made in recent decades? The debt of governments is often a mix of high-quality and low-quality debt. High-quality debt includes that used for building modern infrastructure or investments in education, for example. High-quality debt is typically paid back over time—and can likely even provide a return on the investment. Such projects should be encouraged. By contrast, low-quality debt, such as deficit spending to boost consumption, generates no returns, even over time. This type of debt should be avoided.
Overall, it is safe to say low-quality debt is on the rise. In part, this is because low interest rates in the West incentivize lending, which discourages borrowers from being careful with their spending. For governments, deficit spending has become the norm in recent decades, rather than the exception. The COVID crisis that erupted in the early months of 2020 hasn't made that picture any rosier. Many governments have effectively used “helicopter money” to sustain the economy: they printed money, creating an even higher debt with their central banks, and handed it to citizens and businesses in the form of one-off subsidies and consumption checks so they could get through the crisis unscathed. In the short term, this approach was necessary to prevent an even worse economic collapse. But in the long run, this debt too will need to be repaid. Overall, it adds to the large amounts of debt in recent years that wasn't used to spur long-term economic growth or to make the switch toward a more sustainable economic system. This debt will thus remain a millstone, hanging around many governments’ necks.
One silver lining comes from emerging and developing markets. Before the COVID crisis, they had relatively lower public debt levels of around 50–55 percent,22 with much of it invested in infrastructure (though during the COVID crisis, the debt level increased by about 10 percent). Some of these countries can be considered to have a demographic dividend, meaning a population with an average age in the low twenties, that is, heavily skewed toward younger generations. This type of population pyramid could make repaying debt more feasible if the coming surge in their working-age population is complemented by an equally high surge in available jobs. (The latter, however, has proven problematic in some Arab and African economies. Faced with a job shortage, a demographic dividend can rather turn into a ticking time bomb.23, 24)
How some ageing Western countries are supposed to repay their debts in a slowing economy, though, is highly questionable. The economies with the highest government debt load have historically been Japan and Italy. In addition to their debt, they have some of the world's most rapidly shrinking and ageing populations. While private savings of Japanese households can alleviate many of the most acute problems this trend could cause, the country's debt will sooner or later come back to haunt it, as its population shrinks from 127 million to fewer than 100 million over the next three decades, and its ratio of workers to retirees falls even further. It could easily increase the debt burden per head by another quarter or third.25
Other European countries such as France, Spain, Belgium, and Portugal, all of which have gross public debt of over 110 percent of GDP26 (and often much higher than that), could one day find that they are facing a similar fate. In a significant development, the United States joined the 100 percent club in the early 2010s, with its debt rapidly rising further in recent years, to over 130 percent in 2020.27 The US situation raises a peculiar uncertainty because US government bonds are among the most traded in the world, and the US dollar is the de facto world reserve currency. A US government default is unlikely, given that its Federal Reserve has its hands on the printing press, but if it does happen, the global economic system as we know it might collapse.
It is in the combination of high debt and low growth that things really get problematic, from a financial point of view. In an environment where growth of 3 percent and more can be expected, government debt can quickly evaporate: the relative importance of past debt would decline in comparison to a growing GDP. Even in the recent past, countries like Germany and the Netherlands managed to considerably lower their debt burden on the back of favorable economic growth. But if low growth does remain the new normal, which seems likely, there is no easy mechanism for countries to repay their historical debt. Looking away certainly will not solve this problem.
Low-Interest Rates and Low Inflation
There was one life buoy for low growth and debt until now: low interest rates. Having a low interest on your loan, as many homeowners or student borrowers know, is a blessing. It allows you to pay back your debt without having to worry about the debt load getting larger.
Since the financial crisis, central banks have ushered in an era of low lending rates, giving governments, companies, and consumers low interest rates as a form of relief. The goal is to, ultimately, restore higher growth as people consume more, companies invest more, and governments spend more.
In the United States, the Federal Reserve kept interest rates near zero from 2009 until 2016. It then gradually raised them again to 2.5 percent, half the historical normal rate. But in 2019, the Fed once again cut interest rates28 several times, and when COVID hit, it crashed back down to 0.25 percent.29 Given the challenging macroeconomic environment, a return to the era of high interest rates is very unlikely anytime soon. In other advanced economies, rates are even lower. The European Central Bank has kept its key borrowing rate for the eurozone at under 1 percent since 2012, and at zero since 2016. Most other European countries have similar low rates; Japan and Switzerland even charge depositors for buying bonds, in fact meaning they have a negative interest rate.
As indicated, this is a blessing for governments, companies, and individuals alike who are willing and able to take up new loans or for governments who want to refinance their historical debt. Some observers may even go as far as to suggest the historical debt-to-GDP burden is not as big a problem as it seems, as it can be perpetually refinanced.
But this view fails to consider that repayment problems can quickly get out of hand as government funding gaps for other liabilities increase. Costs related to pensions, health care, and infrastructure are becoming an ever-growing burden on governments, not to speak of consumption subsidies, such as governments paying a part of oil and gas prices for consumers.30 They produce low-quality debt and are hard to roll back, given their popularity with voters.
Public health care spending, notably, already rose by 66 percent from 2000 to 2016—long before the COVID-19 crisis hit—according to the World Health Organization.31 During the same period, GDP growth in OECD countries was only 19 percent. In aggregate, public health care spending in OECD countries now represents close to 7 percent of GDP, with peaks in the United States and Switzerland at double that rate, and that percentage can be expected to rise further as populations age and more viruses or even non-communicable diseases threaten the population.
