Public debt: a boon or a drag on the economy?

Public debt in the world has skyrocketed in recent years and its figures are now similar to those of global GDP. While public debt can be a very useful tool to stimulate the economy in times of stagnation or to improve a country’s competitiveness, the current levels of debt are a cause for concern because of their capacity to weigh on growth.

 

In macroeconomics, public debt is not necessarily seen as a bad thing. In fact, it can be very positive. Although this counter-intuitive statement is hard to digest, the fact is that governments have been using it for centuries to finance themselves without, in most cases, leading to the ruin of countries.

So what determines its positive or negative impact on economic performance, and why can what should be a resource become a burden? There are three key factors: how the money is used, the global competitive context and the volume of debt. 

 

Lubricant for the economic engine

The economy is a complex cog that periodically goes through ups and downs, in interlocking cycles. When this gear becomes stuck, public debt can serve as a lubricant to improve its functioning. Hence, States tend to apply expansionary public investment policies when the economy stagnates and must take advantage of economic growth cycles, in which their revenues increase thanks to higher tax collection, to balance their accounts.

Public debt has consequences for both the present and the future. The most immediate objective is to provide resources to avoid economic collapse. If in a context of crisis a normally profitable company sees its sales reduced and goes into the red, it could close down. As a result, unemployment would rise and what had previously been state revenue from sales taxes would become expenditure for the State in the form of unemployment benefits. In turn, workers’ lower incomes would reduce their purchasing power, so that more and more companies would find themselves in a precarious situation due to reduced demand.

This is why public debt is used primarily to stem the drain in exceptional situations through aid and fiscal stimuli that prevent the destruction of the productive fabric. This explains, for example, why a reduction in the self-employed quota is now being considered to prevent the closure of many micro-businesses. And even unemployment benefits and other current expenditures could be considered instruments to prevent demand from collapsing in a context of stagnation or recession.

If short-term borrowing makes it possible for the system to catch its breath and become competitive again without public stimulus, the economy could be strengthened. But if this indebtedness only serves to keep the productive fabric alive artificially, we would be faced with a zombie economy, incapable of surviving without public stimuli, so the debt could become chronic. Hence the importance of how public debt is used and of accompanying this investment with the necessary structural reforms.

 

Competitiveness, the magic word

In addition to stopping the shock of a crisis, public debt can also serve to increase an economy’s growth potential. Public investment in infrastructure, education, health or active employment policies can strengthen the foundations for future development.

Although deficits and debt may initially increase, this will result in a stronger economy. And that will mean a greater capacity to meet interest payments and debt repayments thanks to increased revenue.

A commonly accepted example of good practice is the reversal of the American Recovery and Reinvestment Act after the financial crisis of 2007-2008. The more than three quarters of a trillion dollars in spending approved by the US Congress enabled the modernisation of US infrastructure and technology networks. In addition, health care and unemployment reform improved social cohesion. All this has contributed to the fact that the US economy is today in a slightly less compromised situation than its European counterpart.

However, for several years now, developed countries have been facing a worrying loss of competitiveness, which complicates their economic growth and limits their ability to balance their debt levels.

 

The risks of excessive debt

It should be borne in mind that, while debt is not bad in itself, it implies a commitment to repay with interest in the future. And this may eventually restrict the government’s financial and budgetary room for manoeuvre if there is no offsetting increase in revenue. Moreover, issuing public debt can attract capital that would otherwise be used to finance the private sector.

Although the Maastricht Treaty limit on public debt for states is 60 % of GDP, the eurozone countries as a whole have already been above 100 % for a year, according to Eurostat data. The situation outside Europe is no better, with the International Monetary Fund estimating that, by the end of 2021, global public debt represented 100 % of world GDP. And the situation could worsen if the crisis deepens.

Spain has already been above the 60 % recommendation for more than a decade. In fact, the International Monetary Fund (IMF) issued a series of warnings to Spain in March about the risk of debt becoming chronic at levels above 115% of GDP. But, in view of current trends, it will be difficult for this ratio to be reduced in the near future. Even more so if we take into account the demographic structure, which in the coming years will push up pension expenditure.

Most economists warn against such excessive public debt. Significantly, a review of 40 studies published over the past decade indicates that 36 of them conclude that debt has a negative influence on economic growth.

 

11Onze is the community fintech of Catalonia. Open an account by downloading the super app El Canut for Android or iOS and join the revolution!

If you liked this article, we recommend you read:

Economy

Spain almost quadruples its debt

4 min read

Spain has gone from a public debt of 384.6 billion euros in

Economy

Debt interest rates, highest since 2015

4 min read

Public debt in Europe is at record highs, and the interest

Economy

The keys to the inevitable debt crisis

5 min read

All economic forecasting rates indicate that we are heading for



Equip Editorial Equip Editorial
  1. Mercè ComasMercè Comas says:
    Mercè

    Sí que és un tema complex.
    Recordo fa anys, quan l’economia no tirava i va aparèixer el mot “atur”, dèiem : Que el govern faci carreteres, a Alemanya ho fan. Sentíem campanes sense saber ben bé d’on venia els so. Gràcies per fer entenedor el paper de l´estat en l’economia, amb la seva segona gran arma, el deute públic.

  2. Francesc Estafanell PujolFrancesc Estafanell Pujol says:
    Francesc de Borja

    Un tema d’una verta vomplexitat explicat d’una manera entenedora. Bona feina!

  3. Manuel Bullich BuenoManuel Bullich Bueno says:
    Manel

    Molt bon article👍

    • Silvia GarrigaSilvia Garriga says:
      Silvia

      Moltes gràcies, Manel, ens alegrem que t’agradi.

      4 months ago

Leave a Reply

App Store Google Play