Rising government debt in the world economy

When the full effects of the 2019 pandemic hit in 2020 all economies experienced a dramatic decline in economic activity and a resulting drop in GDP. This sharp fall in countries’ national income led to a massive reduction in tax revenues. Households and firms earned and spent less which reduced both direct and indirect tax revenues. Many governments across the world put into place government spending plans to support households and firms to protect them from this Covid19 economic shock.

For example, many governments in MEDCs set up schemes to pay the wages of workers who were forced to staff remain at home because of lockdown restrictions. In addition to this, many governments also put into place expansionary fiscal policies to stimulate their economies to combat the recessions caused by the pandemic. The fall in tax revenues and rise in government spending during 2020 and 2021 led to a huge rise in government borrowing.

The chart shows the US government's borrowing as a percentage of GDP over the last 10 years. The jump from 107.2% to 128.4% of GDP in 2020 shows the impact of the pandemic on government borrowing in the US, which was replicated in countries worldwide. (Source: https://tradingeconomics.com/)

Achieving a sustainable level of national (government) debt can be viewed as one of a government’s macroeconomic objectives. The national debt is the total value of government borrowing accumulated over time. One year’s government borrowing is called the budget deficit.

A sustainable level of national debt means that government borrowing can be maintained at a level in the long term and does not adversely affect an economy's economic performance. This means the government can pay the interest on its debt (interest on government bonds) and repay the parts of the debt when it is due for payment (repay government bonds when they mature).

If the national debt gets too big then the debt can become unsustainable which makes it difficult for the government to repay debt and make interest payments. Because of this, there could be an opportunity cost for the government if it has to give up spending on areas such as health and education. An unsustainable debt could also lead to a loss of confidence in a country's economy which causes a fall in the value of its currency which increases the cost of any external debt owed to foreign creditors.

The rise in world interest rates is an additional challenge to governments trying to achieve sustainable debt. As world inflation has increased following the pandemic central banks have been forced to increase interest rates and this has increased the cost for governments of the national debt. There is something of a perfect storm going on here with rising debt and rising interest rates happening at the same time. Some countries, particularly ELDCs, have reached a point where their debt is not sustainable.

The United Nations has said there are 54 MEDCs with severe (unsustainable) debt. Although these countries only account for 3% of the global economy, they represent 18% of the world’s population and 50% of people living in extreme poverty. Some countries are now spending more on debt servicing than on health, education and social protection.

Some possible questions for discussion with a class

1. What is the national/government debt?
2. What is debt servicing?
3. How has rising inflation affected national/government debt?
4. Discuss the consequences for ELDCs of unsustainable national/government debt.