Covid-19 in 2020 precipitated the largest one-year debt surge since the second world war, with global debt rising to $226tn. Borrowing by governments accounted for more than half of that increase, as the global public debt ratio jumped to a record 99 per cent of gross domestic product. This debt mountain now poses a monumental political economy challenge.
Having largely expunged history from its processes, the modern economics profession tends to discuss public debt in jargon-ridden terms relating to personal utility maximising individuals and social welfare maximising governments. Yet in reality it is all about politics. As the Italian economist Alberto Alesina once remarked, public debt management boils down to whether to bleed the rentier, sweat the worker or tax the entrepreneur to tears.
History offers the best lens through which to grasp the nature of today’s debt crisis. So much the better, then, that In Defense of Public Debt explores the rise of the sovereign debt market all the way from the Italian city states to the multitrillion global government debt overhang of the 21st century. In addition it offers a debt management primer rooted in historical experience.
The authors show how over time governments moved from borrowing to provide the public good of national defence to borrowing to provide the public good of financial stability, while also financing railways, urban infrastructure and social capital, thereby underpinning economic growth. The resulting accumulation of debt makes it essential to restore capacity in order to handle any future military, health or financial crises.
There are numerous ways to bring down the debt-to-GDP ratio. These include governments running primary budget surpluses — surpluses before interest — to pay off debt. If the growth rate exceeds the interest rate on the debt the ratio also declines. Inflation is another resort. And then debt can be restructured or written off. Which of these tools does more or less of the job largely reflects the balance of power between debtors and creditors.
The authors point out that after the Napoleonic wars the decline in the British debt-to-GDP ratio from 194 per cent in 1822 to 28 per cent nine decades later relied chiefly on primary budget surpluses, which outweighed an adverse interest rate-growth differential. The franchise was limited then to 2.5 per cent and there was considerable overlap between public creditors and voters. Much the same dynamic applied to debt reduction in the US after the civil war and in France after the Franco-Prussian war.
The broadening of the franchise in the 20th century changed that dynamic as demands emerged for state provision of social and income security. Two world wars also had to be financed. So after 1945, growth played a bigger part in debt reduction while governments kept interest rates low and maintained capital controls. Inflation also played a greater role, since it is a default solution in distributional struggles where politicians fail to reconcile conflicting interests through legislation.
Why, you might ask, does public debt need to be defended? One reason is that austere moralists dislike debt and fear the burden it might impose on future generations. The book cites John Boehner, who when he was speaker of the US House of Representatives, declared that debt arising from the financial crisis was immoral. Also Rand Paul, Republican senator from Kentucky, complained in 2020 that the US fiscal cupboard was bare. Similar sentiments prevailed in Germany during the eurozone crisis towards Greece and southern Europe more generally.
Another reason is that some economists argued that fiscal retrenchment would be expansionary in the eurozone crisis because it would bolster confidence, although a 2011 IMF study poured cold water on this view.
The authors have no illusions about the difficulties of addressing the current debt overhang given mounting political polarisation and anaemic growth prospects. Yet they could have been more critical of central banks’ debt-inducing monetary policies involving aggressive easing in response to successive crises unmatched by equal tightening during economic upturns. More thoughts would have been welcome, too, on the existence or otherwise of a debt trap whereby monetary tightening might now beget a perpetual cycle of financial instability, involving frequent returns to morally hazardous ultra-low interest rates.
That said, this is a rich and absorbing narrative that makes an unanswerable case for the legitimacy of incurring massive debts to protect citizens against war, pandemics and financial crises. The snag is that retreating from current public debt levels is a political nightmare and tactically fraught. Policymakers’ current penchant for muddling through inspires little confidence in a benign outcome.
In Defense of Public Debt by Barry Eichengreen, Asmaa El-Ganainy, Rui Esteves and Kris James Mitchener, Oxford University Press, £22.99, 320 pages