The debate around the need to reform the global financial architecture to address its vulnerabilities is a vitally important part of a broader debate about how to improve our global governance in the 21st century, to enable us to confront a range of complex challenges. The discussions that surround it have evolved in the past two decades in response to various factors, from the emergence of economic powerhouses such as China and India, to the diminishing importance of international trade as an engine of global economic growth in the aftermath of the 2008-09 global financial crisis, to the rapidly narrowing fiscal space and the swift rise of public indebtedness nearly everywhere, made worse by the response to that crisis and, more recently, the impact on the public finances linked to the consequences of the COVID pandemic. In this article we will examine one dimension of this debate, namely the impact of rising public indebtedness, focusing specifically on the high-income countries. A subsequent piece will address the question of the debt burden of low and middle-income countries.

A looming fiscal crisis

A good starting point for this discussion is an IMF study done some years ago looking at the fiscal deficit for all IMF members over a 35-year period leading to the 2008-09 global financial crises. It showed, on average, a fiscal deficit of 3 percent of GDP in all years without exception. Regardless of the economic cycle, IMF members showed a clear deficit bias. Were that study to be updated today it would show a much larger aggregate deficit, given the sharp deterioration of the fiscal accounts in the aftermath of the global financial crisis and, more recently, the interventions carried out to mitigate the impact of COVID-19. Our focus here on high-income countries is justified because given their size, they have the capacity to destabilize the global economy in ways that most emerging markets—also highly indebted as a group—do not. Two interesting recent examples are France and Spain.

France has been running a fiscal deficit for 45 consecutive years, at least since 1980, the first year for which we have comparable data. In good times and in bad times, under conservative governments and left-leaning ones. Along the way, public debt has risen from about 21 percent of GDP to a projected 112 percent of GDP in 2024 according to the latest IMF estimates. Spain has not been so consistent, and, over the same period, there were a few years when the budget was in surplus. But its fiscal performance since 2007 has been dismal, with public debt levels rising from under 36 percent of GDP to 101 percent of GDP in 2024, nearly three times higher. During this 17-year period Spain has also had right-of-center and left-of-center governments. When it comes to discussing the kinds of fiscal adjustments that are needed to put the public finances on a sustainable path, Spain’s political parties are not interested in having a meaningful debate. No party is ready to campaign on the need for fiscal consolidation, as Spain´s 2022 election made clear, where the focus was elsewhere (i.e., a controversial amnesty law for separatist Catalan politicians who carried out an illegal referendum in 2017). The equivalent figures for the evolution of government debt in the United States is 31.2 percent of GDP in 1980 and 121.0 percent of GDP in 2024. For the United Kingdom: 42.5 percent of GDP in 1980 and 101.8 percent in 2024.

A dire medium-term outlook

A vital question today is whether high-income country governments will be able to prevent a debt crisis in the context of ageing populations, higher interest rates and slower growth. But we would suggest that the situation is much worse than that suggested by a narrow look at the excess of government expenditures over revenues. A look at the balance sheet of most high-income countries, capturing past fiscal operations as reflected in the outstanding public debt today as well as future liabilities reflecting binding expenditure commitments, such as pensions, health benefits, and the like would show a much more dire fiscal picture suggesting that absent major changes in policy, many of these governments are on an unsustainable fiscal path.

It is useful to look at the French case because its government has just collapsed in the absence of an agreement between the various parties to find consensus on the need to engineer a small reduction in the deficit for 2025 from a projected 6 percent of GDP this year to about 5 percent next year. The opposition, at both ends of the political spectrum, did not wish to support a narrowing of the deficit on the grounds that this would have some adverse impact on living standards. (There was a need to “protect the French” is how one noted politician put it). Some years ago, French citizens were out in the streets violently protesting a proposed increase in the retirement age from 62 to 64 years without which the long-term financial viability of the French pension system would be seriously in question. Putting aside the opportunism of politicians and their machinations in their pursuit of power, the fact is that citizens in France and multiple other countries simply do not wish to face realities. There is an implicit assumption that unsustainable public finances and the risks of a fiscal implosion that will came in the face of policy paralysis is something that future politicians and their voters will have to worry about, ¨not us, the voters today.”

Is there a solution to this mess? The case of Sweden and Finland

The answer is yes and here we illustrate by briefly examining the experience of Finland and Sweden in the 1990s. Both countries faced a sharp deterioration of their public finances in the aftermath of serious banking crises. In Finland the budget deficit in 1993 rose to over 8 percent of GDP and in Sweden it rose to 11 percent of GDP, with debt levels rising rapidly in both countries, by some 44 percentage points in Finland (a quadrupling of debt levels within a three-year period!) and by 30 percentage points in Sweden. Both countries moved rapidly to restore sustainability through a combination of expenditure restraint and institutional reforms. While moving to formulate fiscal policies in a medium-term framework, both countries also made important changes to entitlement programs, tightening qualification rules, temporarily lifting inflation adjustments to certain benefits, and generally imposing a downward adjustment of various types of transfers to households. By the latter part of the decade the budgets had moved into surplus, debt levels and interest rates were on a downward trend and the economies had entered a phase of sustained recovery.

The experience of these two countries in the 1990s merits study not only because they succeeded in simultaneously reducing budget deficits and public debt while stimulating a broad-based economic recovery, but also because the authorities managed the political economy of painful reforms in very sensible ways, creating a broad social consensus for the reforms. For instance, the reform measures were comprehensive in scope, ensuring a fairly equitable distribution of the burdens of adjustment. They involved expenditure cuts (the impact of which tends to fall disproportionally on the less well-off) and tax increases, broadly balanced to ensure distributional fairness. In Sweden, in particular, there was an effort to ensure that women did not have to bear an unfair share of the burden, a particularly important consideration given that many of the measures involved cuts in social benefits and transfers.

Governments in both countries went out of their way to explain in detail the reasons for the measures, their content and how these were expected to address the underlying fiscal problem. There was an understanding in both countries that transparency is essential to build up government credibility and trust. Consistent with this, there was no attempt to minimize or trivialize the real pain brought about by many of the measures, since it was seen that this would be counterproductive; as the impact of the measures kicked in, the public would have felt that they were cheated or lied to. Whenever possible governments presented reform measures—say involving retrenchment in benefits—not simply as cuts that were necessary because they were otherwise unaffordable (which run the risk that following economic recovery people would demand their restitution), but rather as structural improvements that would be beneficial from a longer-term perspective. In this respect, both countries were greatly helped by their accession to the EU on January 1, 1995 which contributed to boost investor confidence, but also allowed governments to present the reforms as part of the overall package of reforms necessary to ensure smooth EU entry.

The Ministry of Finance in Sweden allocated to a senior official the task of being available at all times to meet with financial sector representatives who wanted to gain a better understanding of the content and the direction of government policy. The authorities recognized the important role played by market participants in buttressing (or derailing) government efforts to deal with the crisis. In his public pronouncements about program implementation and in making forecasts about the evolution of the economy and various underlying aggregates (e.g., interest rates, unemployment) the finance minister was unfailingly cautious, always aiming not to oversell the success of the program, but rather to emphasize that much remained to be done.

Good governance requires coherent policies, candid communication with voters, and a political class prioritizing national welfare over personal ambition.”

No magic formulas

In the above paragraphs we have highlighted the experience of Finland and Sweden because it shows that a combination of well-designed policies and political will can make a critical difference in allowing countries to get back to a sustainable debt path. Perhaps the painful lessons of the 1990s and the difficult choices that the crisis forced upon their governments may partly explain the more cautious response adopted by both countries to the latest global financial crises; public debt levels—particularly in Sweden—remained broadly stable. The Nordic countries have often been taken as examples of the compatibility between extensive safety nets and high levels of productivity and competitiveness. It is often not noticed that they are also fine examples of sound fiscal management.

In other words, there are no magic formulas. Good governance is difficult; it requires coherent policies, explaining them to voters candidly and frequently, a political class that puts the good of the country above the personal ambition of politicians and it also helps enormously if taxpayers feel that the people implementing painful belt-tightening programs are honest, not corrupt kleptocrats enjoying extravagant lifestyles, a sad reality in many parts of the world.

RELATED