National debt and economic literacy in uncertain times

Economic events affect each and every one of us, yet many people regard economic issues as an impenetrable “black box”. Martin Wagner, Professor of Economics at the University of Klagenfurt, sheds light on the much-debated topic of national debt and stresses the importance of increased economic literacy.

What is national debt and how does it come about?
The term national debt describes debts incurred by the public sector; in Austria public debt is mostly held by the federal government. Put simply, these debts arise when government expenditures exceed government revenues, i.e. when there is a budget deficit. For the most part, government debt is financed by issuing government bonds. These are, essentially, securities in which the Republic of  Austria guarantees to pay agreed interest payments over a defined period of time and to settle the outstanding amount, usually the nominal value, once the bond reaches maturity.  Thus, a country’s debt is held by investors, making the link between savings and debt more obvious than, for example, when it comes to the question of what happens to the money held in traditional savings accounts. Roughly one third of Austrian debt securities are held by domestic investors, including investment funds, banks, etc., and correspondingly two thirds are held by foreign investors. It should also be noted that Austrian government bonds are considered to be very safe and therefore bear low interest rates, making it comparably cheap for Austria to finance its debt.

What is the extent of Austria’s national debt?
National debt is usually considered in relation to the gross domestic product (GDP) and currently stands at approximately 84 % of GDP, following a marked increase last year. Expressed in numbers, we are talking of roughly 315 billion Euros. Due to the recent economic crisis, national debt rose sharply, as the budget deficit accounted for more than 10 % of GDP last year, according to preliminary figures. The year 2020 was the first year in many decades in which the global economy – seen as a whole – contracted, resulting in high budget deficits in many countries.

What should we bear in mind when it comes to budget deficits?
The past year – and depending on the course of the pandemic, likely this will be the case this year as well –  has been characterised by muted economic activity, leading to substantial budget deficits. This was due in part to the need to finance various emergency measures such as short-time work. Hence, we should view last year’s deficit above 10 % of GDP as an exceptional occurrence.

As a general rule, there are two things to consider when looking at budget deficits. First of all, we must take into account the state of the economy in a given year: It is one thing to have a budget deficit in a crisis year, but a very different thing if there were large budget deficits even in years when the economy is booming. Secondly, it is important to note what government spending is used for. A higher budget deficit owing to increased spending on infrastructure improvements ought to be judged differently than if the money is used to finance short-term consumption-enhancing “goodies”, for example.

How important is a nation’s economic capacity?
When it comes to the so-called sustainability of national debt, the comparison with the economic performance is certainly of central importance; which is why one typically considers national debt in relation to GDP.  This corresponds very roughly to relating debt and income for private individuals. In addition, of course, there is also the value of assets to be used as collateral, which are difficult to assess at the country level.

On the whole, governments are able to obtain cheap financing on the bond market as long as – and ultimately because – government debt is deemed sustainable in the long term. In recent times, Austrian bonds have been so highly coveted on the market that it has been possible to place bonds with negative interest rates. The fact that Austria is (currently) seen to be in a good position can also be deduced from the observation that even at the beginning of the pandemic, Austrian bonds were only traded with a very small risk premium compared to German government bonds. Within the euro area, German government bonds are traded at the lowest yields, as they are considered to be the safest government securities in the euro area.

What is the general context in which we should think about national debt?
Expected long-term economic developments and, to the extent quantifiable, the likelihood of future crises enter into the evaluation of government debt. Over the long term, this also includes issues related to international competitiveness, and the question of the composition of the population, more precisely the ageing of the population. The more significant the differences between countries, the less informative is a direct comparison of public debt ratios.

For instance, when some of the more recent members (previously characterised by a centrally planned economic system) joined the EU in 2004, Austria’s public debt ratio was just over 65 %, while the Baltic countries entered the Union with ratios below 20 % for historical reasons. At that time, there was little to be gained from conducting direct comparisons. However, the longer countries remain in a similar system and the more they resemble each other in terms of their economic environment and structure, the greater the informative value of direct comparisons.

Is Austria’s membership in the monetary union a relevant factor?
Up to a point, yes, although it should be noted that public debt is not subject to joint EU liability according to the Maastricht Treaty of 1992. Fiscal policy, unlike monetary policy, is largely determined at the national level. Compared to national budgets, the EU budget is tiny, and it is not financed by taxes at the European level, but by payments from the EU member states. This is beginning to change gradually in the wake of the European Recovery Plan on the one hand, and the European tax on non-recycled plastic waste from 2021 onwards on the other.

Still, membership in the monetary union does afford certain advantages, as the risk premiums relative to the anchor Germany will most likely be lower for countries in the euro area than they would be if the country in question were not a euro area member. Even so, the risk associated with government bonds varies across the euro area. For example, Spanish, Italian or Greek bonds are traded with higher risk premiums than, say, Austrian or Dutch bonds. To some degree, being a member of the monetary union has a certain insurance effect – one need only think of the crises in Italy and Greece in 2008 and 2013, for example.

Is there such a thing as an optimal sustainable ratio of expenditure to income?
In principle, public services and spending (in democracies) reflect collective decision-making processes that take place by means of elections and the subsequent composition of parliaments. Accordingly, the optimal scenario may manifest itself quite differently in different countries but also in different periods, and generally tends to defy attempts at a one-fits-all definition.

To avoid plunging into a national debt crisis, it is certainly advisable not to accumulate excessively high deficits and debt ratios, and to allocate the greatest possible share of government expenditure to investment purposes that will continue to produce a positive impact in the long term. Increasing competitiveness, better infrastructure, and a greater number of well-educated people all contribute to making it easier to repay the national debt at a later stage.

In the public arena, before elections and in times of crisis, economic issues frequently prove highly controversial. Still, the impression of a nebulous, elusive concept persists. How can “economic literacy” make a difference?
I think it would be useful to promote the notion that having more knowledge about “the economy” should be considered a normal adult virtue. Unfortunately, as with maths, people often playfully almost boast that they don’t have a clue what economics and the economy is all about. And that is unfortunate, as the combination of being unaware of economic mechanisms and the huge impact that these very mechanisms have on all of our lives – just look at the pandemic – raises the likelihood of making poor decisions for one’s own life.

It is against this backdrop that I see “economic literacy”, i.e. the ability to understand, discuss and respond appropriately to events that shape our economic environment, as a reasonable contribution of the individual and a dimension of responsible citizenship.

It also seems to me that another crucial aspect is to communicate more persuasively that many events and occurrences are fraught with uncertainty. It appears that uncertainty is something many cannot cope with well, and hence they resort to supposedly simple explanations. It is in the interest of every one of us to work on our ability to deal with uncertainty and learn to accept that there are many questions for which we do not have a definitive or binary answer. Also, we should remember that not knowing every detail about the future certainly doesn’t mean that we don’t know anything at all.

In order to reduce uncertainty, it is vital, particularly in times of crisis, to communicate as clearly and consistently as possible, while also describing aspects and areas that remain uncertain. Quantifying or describing uncertainties can help to reduce the sense of uncertainty. Ultimately, less uncertainty tends to have a positive impact on economic activity, which may in turn help to overcome crises.

About Martin Wagner

Martin Wagner joined the university in October 2019 as Full Professor of Economics with a focus on Macroeconomics. He also serves as Chief Economic Advisor to the Governor of the Central Bank of Slovenia. His research focuses on quantitative economics, econometrics and empirical environmental economics.

Martin Wagner

for ad astra: Karen Meehan