Public debt in Australia is well below average – but the figure is misleading | Satyajit Das

The Australian economy is often reduced to debates around public debt. The claims and counterclaims regarding debauchery and borrowing overlook several issues.

Firstly the current amount of debt is unprecedented outside of wars. At the end of 2021, global debt stood at $295 billion, or 350% of all the world produced in a year, up from 282% in 2008. The main increase is in public debt, which has reached a record of 99% of world production. The public debt of the United States, the eurozone and Japan now stands at 103%, 98% and 257% of output respectively.

Australian federal debt set to peak to less than 40% of production by 2025, well below the average for advanced countries. But the number is misleading.

It excludes state and local government borrowing, which over the same period will reach around 20% of production, but could be bigger based on government infrastructure spending. It does not take into account contingent liabilities, such as New South Wales’ controversial Transport Asset Holding Entity, which holds public transport assets that help improve state finances. It ignores exposure to public-private partnerships used to finance infrastructure, which governments may have to support to deliver essential services.

It overlooks implicit government guarantees for the Australian banking system “too big to fail”, highly exposed to indebted households amounting to approximately 130% of production, among the highest in the world.

Australia’s debt levels are also high given a narrow-based economy, limited tax base and overreliance on a single trading partner, China.

Second, rather than funding investments that would generate future income, much of Australia’s public debt has been used to fund recurring spending, transfers and tax cuts – and, during the Covid-19 lockdowns, to replace lost income.

Third, excessive government borrowing limits economic flexibility. Higher rates would increase Commonwealth and State interest payments (already expects to reach 1.4% of production over the next three years), reducing funds for other expenses. Rising debt levels reduce the ability to cope with crises such as the pandemic and natural disasters.

Fourth, individuals and businesses must satisfy lenders regarding their income and repayment capacity. In contrast, governments increasingly rely on central bank money creation to meet their obligations. The Reserve Bank currently holds around a third of all government debt (over $300 billion), most of which has been purchased since 2020. But fiscal deterioration and currency depreciation risk losing confidence among foreign investors who hold around two-thirds of federal government bonds, limiting access to foreign capital.

Fifth, debt management options are limited.

“Fiscal repair” (raising taxes or cutting spending) risks weakening an already weak growth outlook. As economic activity requires ever-increasing amounts of new debt, controlling borrowing could trigger a negative spiral that is detrimental to activity and public budgets.

Other alternatives are equally unattractive. Inflation, disguised taxation in fact, can contribute to deleveraging by raising incomes and reducing purchasing power, but it would hurt low-income groups, exacerbate inequality and increase social tensions. Devaluations reduce the value of Australian government debt held by foreigners, but would affect the cost of imports or the ability to borrow overseas. Debt default or restructuring, or even national bankruptcy or Former Prime Minister Paul Keating’s ‘banana republic’, is unthinkable.

The historical experience of managing over-indebtedness is not encouraging.

Between 1914 and 1939, the First World War and the Great Depression undermined public finances. Countries accounting for almost half of global production have either defaulted or been forced into deals with creditors, with severe social and economic costs.

After World War II, some countries defaulted or experienced hyperinflation. Others have resorted to capital controls, loan rationing and compulsory investment in public debt at rates below inflation. Strong growth driven by pent-up demand and post-war reconstruction, conditions that do not apply today, helped control borrowing levels. While the now abandoned gold standard while political choices are restricted, substantial debt reduction still remains difficult.

The problem is fundamentally behavioral.

Voters appreciate lower taxes and government-provided goods and services financed by public borrowing rather than taxes. Over time, more and more loans with diminishing returns must be taken just to maintain the status quo. Unfortunately, true prosperity cannot be built on excessive cheap credit.

Since the global financial crisis of 2008, the world has perversely attempted to solve debt problems by borrowing more. As the philosopher Denis Diderot observed, “we greedily swallow any lie that flatters us, but we only sip a truth that we find bitter little by little.”

Australia’s public debt has grown the most of any major economy this century, more than doubling in two decades. The nation faces perhaps another 10 years of budget deficits.

While government borrowing is not yet unsustainable or unrecoverable, an informed and thoughtful discussion of the trajectory would help, preferably before that point is reached.

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