Reducing debt, whatever it takes ?

Over the past fifteen years, public debt levels have practically doubled in the “advanced countries” as a whole. This is the result of successive crises, but also of historically low interest rates, which have encouraged governments to be lax. As a result, their ability to act and regulate is now constrained.

Should they therefore embark on a process of debt reduction at a time of massive investment needs linked to the energy transition, the reorganization of international trade, the rehabilitation of infrastructures and public services…? There’s nothing obvious about such a deduction, as the level of debt ratios is not a relevant indicator for answering this question, which refers to the sustainability of public debts. The latter depends on a range of variables of varying natures (the maturity of these debts and the status of their holders, the State’s capacity to raise taxes, etc.), so that it cannot be quantified so easily: there is no “magic number” fixing a limit to a State’s solvency. This explains and justifies the considerable differences between the debt ratios of certain developed countries. In reality, what’s important in assessing solvency is not the level of the debt ratio, but rather an analysis of its foreseeable trajectory, and more specifically its capacity to stabilize over the medium-to-long term (i.e., not to grow exponentially).

Thus, the imperative for countries that have let their public finances run amok is not, in any case, to reduce their debt (which would require budget surpluses), but to correct the trajectory of their debt ratio. This trajectory depends on anticipated primary budget balances (net of debt costs) and on the difference between the economy’s growth rate on the one hand, and the real interest rate borne by debts on the other. The calculations then show that if growth remains at the modest level it has averaged in most advanced countries since the early 2000s (say, between 1% and 2%), and if real interest rates do not return to their very low levels of the past (around 1%), primary budget deficits would need to be no higher than 1% to stabilize the trajectory in question. This means that, in some countries, it will be necessary to carry out a serious restructuring of public finances, and also to forego a large proportion of the investments mentioned above.

But this is not the end of the story, as fiscal restraint may well have a negative impact on growth, and thus reduce its stabilizing effect on the debt ratio, if it is not properly targeted. This will be the case, for example, if the reduction of public spending focuses on investment rather than consumption, if the increase in taxation affects corporate competitiveness, if it weighs too heavily on agents with a high propensity to consume, or more generally if these attempts at rebalancing are perceived as unfair, jeopardizing social equilibria.

This relationship between budgetary decisions and growth may, moreover, suggest answers that seem paradoxical and provocative to the question before us. Indeed, taking it into account may lead us to wonder whether an increase in indebtedness devoted to financing investments, which are supposed to increase productivity, is not ultimately the best way to stabilize the medium-to-long-term trajectory and thus make public debts sustainable. This proposal, which has already been mentioned and promoted by various observers, naturally has a paradoxical side; all the more so as, within the eurozone, it would undoubtedly lead some member countries to disregard the recently reformulated budgetary rules. The fact remains, however, that in the face of the array of constraints facing many economies, the quest for a rebound in growth is becoming inescapable. Advocating and acting in this direction would certainly not obviate the need for an in-depth review of public finance policies. But it would at least avoid reducing budgetary strategy to a simplistic objective that could prove excessively costly.